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Unit : 5
Ethical & Corporate Issues
Ethics is a branch of philosophy that deals with questions about what is morally right and wrong,
good and bad, just and unjust.
Business ethics refers to the moral principles and guidelines that govern the conduct of
individuals and organizations in the business world.
ELEMENTS OF BUSINESS ETHICS
Some of the basic elements of business ethics while running a business are as follows:
1. Commitment of Top Management: Top management guides and decides the course of action to
be followed by others. If top management supports the ethical behaviour of the employees then it will
certainly be followed. The top management should be strongly committed towards ethical conduct
and guide lower level people to follow ethical behaviour.
2. Devising Code of Conduct: It is essential to define what is ethical and what is not. A code of
conduct should be devised and set of ethics be set for the employees to be followed. The principles
of ethics are brought out in writing for the guidance of employees.
3. Compliance Mechanism: In order to implement ethical values in the working there should be a
suitable mechanism to monitor it. There should be corporate ethics in recruitment, selection, training,
etc. The employees should be free to bring it to the notice of the organisation if there is some deviation
in implementing ethical standards.
4. Involvement of Employees: There should be an involvement of employees at all levels while
ethical programmes and policies are involved. It is the employees, who are to implement ethical
values so their involvement is essential.
5. Measuring Results: Though it may be difficult to measure ethical results, but still efforts should
be made to find out whether the work is carried out as per the ethical values or not. Top management
should meet employees from time to time to check out future programme of action.
ETHICAL ISSUES IN FINANCIAL MANAGEMENT
The term “ethics in financial management” refers to the moral code of conduct that guides and
governs the behaviour of finance managers. Ethics play an important role in financial management
including the planning, organizing and controlling the financial resources of a firm. The ethics in
financial management cover the responsibility of the finance executives towards all the stakeholders,
including shareholders, employees, government rules and policies, various regulatory bodies,
customers, suppliers, society, etc.
Some of the important ethical issues in financial management are:
1. Conflict of interest between owners, management and various stakeholders.
2. Financial frauds and corruption.
3. Insider trading in stock markets.
4. Misrepresentation of financial statements.
5. Tax evasion.
6. Manipulation of wealth.
7. Unfair practices.
8. Conduct of transactions in unfair manner, etc.
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Meaning:
Corporate governance refers to the system of rules, practices, processes, and structures by which
corporations are directed, controlled, and managed.
It encompasses the relationships among various stakeholders, including shareholders, board
members, management, employees, customers, suppliers, and the broader community, and aims to
ensure that corporations operate in an ethical, transparent, and accountable manner while maximizing
shareholder value and promoting the long-term interests of all stakeholders.
THEORIES OF CORPORATE GOVERNANCE:
1. Agency Relationship Theory:
Agency theory is a fundamental concept in corporate governance and economics, explaining
the relationship between principals (such as shareholders) and agents (such as managers or
executives) and the potential conflicts of interest that may arise between them. The theory seeks to
understand how to align the interests of principals with those of agents to ensure that agents act in the
best interests of the principals.
Key components of agency theory include:
1. Principal-Agent Relationship: The principal-agent relationship exists when one party (the
principal) delegates authority to another party (the agent) to act on their behalf. In the corporate
context, shareholders are the principals who entrust management (agents) with the responsibility of
running the company.
2. Conflicts of Interest: Conflicts of interest arise because agents may have incentives that differ
from those of the principals. For example, managers may prioritize their own interests, such as job
security, salary, or personal advancement, over the interests of shareholders, leading to agency costs.
3. Agency Costs: Agency costs refer to the expenses incurred by principals in monitoring and
controlling agents to ensure that they act in the principals' best interests. These costs include
monitoring costs, bonding costs (such as performance bonds or insurance), and residual loss (the loss
resulting from agents' actions not aligning with principals' interests).
4. Alignment Mechanisms: Agency theory examines various mechanisms designed to align the
interests of principals and agents, thereby reducing agency costs. These mechanisms include
incentives, such as executive compensation tied to performance metrics (e.g., stock options, bonuses),
monitoring mechanisms (e.g., board oversight, audits), and contractual arrangements (e.g.,
employment contracts, covenants).
5. Risk Sharing and Risk Aversion: Agency theory considers how risk-sharing arrangements
between principals and agents can influence their behaviour. Principals may seek to align incentives
by sharing risks with agents, while agents may exhibit risk-averse behaviour to protect their own
interests.
6. Information Asymmetry: Information asymmetry occurs when one party has more or better
information than another party. In the context of agency theory, information asymmetry can lead to
adverse selection or moral hazard problems, where agents may take advantage of information
asymmetry to act against the principals' interests.
Overall, agency theory provides insights into the challenges of corporate governance and
offers guidance on designing governance mechanisms and incentive structures to mitigate agency
conflicts and align the interests of principals and agents.
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2. Transaction Cost Theory
Transaction cost theory (TCT) provides insights into corporate governance by analysing the
costs associated with transactions within organizations and between organizations in the marketplace.
It is coined by economist Oliver Williamson.
Here's how transaction cost theory relates to corporate governance:
1. Firm Boundaries: Transaction cost theory helps explain why firms exist and why they choose to
internalize certain activities rather than relying solely on market transactions. Firms may internalize
activities to reduce transaction costs associated with market transactions, such as search costs,
negotiation costs, and the risk of opportunistic behaviour by external parties.
2. Vertical Integration: TCT sheds light on the extent of vertical integration within firms, i.e., the
degree to which firms own or control multiple stages of the production or distribution process. Firms
may vertically integrate to minimize transaction costs associated with coordinating activities,
ensuring quality, and managing relationships with suppliers and customers.
3. Governance Structures: TCT suggests that firms adopt governance structures and mechanisms,
such as hierarchical control, relational contracting, and hybrid organizational forms, to minimize
transaction costs and facilitate efficient transactions. For example, firms may establish internal
hierarchies and procedures to reduce the need for costly external monitoring and enforcement.
4. Incomplete Contracts: Transaction cost theory recognizes that contracts are often incomplete.
meaning they cannot specify every possible contingency or outcome. Incomplete contracts give rise
to transaction costs related to uncertainty, opportunistic behaviour, and the need for costly
enforcement mechanisms. To mitigate these costs, firms may rely on trust, reputation, and relational
contracting to fill contractual gaps and facilitate efficient transactions.
5. Outsourcing and Alliances: Transaction cost theory helps explain why firms engage in
outsourcing, strategic alliances, and other forms of inter-firm cooperation. By outsourcing non-core
activities or forming strategic alliances with other firms, companies can reduce transaction costs
associated with internal production or market transactions, such as the costs of coordination,
negotiation, and monitoring.
GOVERNANCE STRUCTURE AND POLICIES
Governance structure and policies refer to the framework and guidelines that define how an
organization is directed, controlled, and managed. These structures and policies are designed to ensure
transparency, accountability, and ethical conduct while promoting the interests of stakeholders.
Here are key elements of governance structure and policies:
1. Board of Directors: The board of directors is a central component of the governance structure. It
provides oversight, strategic guidance, and supervision of management on behalf of shareholders.
The board establishes policies, approves major decisions, and monitors performance to ensure
alignment with the organization's mission and objectives.
2. Board Committees: Board committees, such as audit, compensation, and nominating/ governance
committees, are established to oversee specific aspects of governance and management. These
committees provide focused attention on critical areas, such as financial reporting, executive
compensation, and board composition, and make recommendations to the full board.
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3. Executive Leadership: The executive leadership team, including the CEO and other senior
executives, is responsible for the day-to-day management of the organization. They implement the
board's strategic directives, manage operations, and ensure compliance with policies and regulations.
4. Corporate Policies and Codes of Conduct: Organizations develop and implement corporate
policies and codes of conduct to guide behaviour and decision-making at all levels. These policies
cover various areas, including ethics, compliance, conflicts of interest, confidentiality, and diversity
and inclusion. Codes of conduct outline expected standards of behaviour and provide guidance on
ethical dilemmas and decision-making.
5. Risk Management Policies: Risk management policies define the processes and procedures for
identifying, assessing, and managing risks across the organization. These policies establish risk
tolerance levels, escalation procedures, and mitigation strategies to protect the organization from
potential threats and uncertainties.
6. Financial Policies: Financial policies govern the management of financial resources, including
budgeting, financial reporting, capital allocation, and investment decisions. These policies ensure
transparency, accuracy, and accountability in financial operations and help safeguard assets and
shareholder value.
7. Compliance and Regulatory Policies: Compliance and regulatory policies ensure that the
organization adheres to applicable laws, regulations, and industry standards. These policies cover
areas such as data privacy, anti-corruption, environmental regulations, and product safety, and
establish processes for monitoring and reporting compliance.
8. Stakeholder Engagement Policies: Stakeholder engagement policies outline how the organization
interacts with and responds to the needs and expectations of its various stakeholders, including
shareholders, employees, customers, suppliers, communities, and regulators. These policies promote
transparency, dialogue, and relationship-building to foster trust and support.
9. Crisis Management and Business Continuity Policies: Crisis management and business
continuity policies establish protocols for responding to emergencies, disruptions, and unforeseen
events. These policies ensure that the organization can effectively manage crises, protect stakeholders,
and maintain continuity of operations in challenging circumstances.
Overall, governance structure and policies provide the framework for effective decision-
making, risk management, and stakeholder engagement within organizations. By establishing clear
roles, responsibilities, and guidelines, organizations can enhance transparency, accountability, and
ethical conduct while promoting long-term sustainability and value creation.
SOCIAL AND ENVIRONMENTAL ISSUES
Social and environmental issues are increasingly becoming integral components of corporate
governance practices as companies recognize the importance of sustainability, ethical conduct, and
stakeholder engagement.
Here’s how social and environmental issues intersect with corporate governance:
1. Stakeholder Engagement: Social and environmental issues are often top concerns for
stakeholders, and effective governance requires companies to engage with these stakeholders, listen
to their concerns. and incorporate their perspectives into decision-making processes.
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2. Board Oversight: Corporate governance frameworks increasingly require boards to consider
sustainability issues, assess their impact on the company's long-term performance, and integrate them
into strategic planning and decision-making.
3. Risk Management: Effective corporate governance involves identifying, assessing, and managing
these risks to protect shareholder value and ensure long-term sustainability. This includes
understanding the potential financial, reputational, and regulatory risks associated with social and
environmental issues and implementing appropriate risk management strategies.
4. Transparency and Disclosure: Transparency and disclosure are fundamental principles of
corporate governance. Companies are expected to provide accurate, timely, and transparent
information about their social and environmental performance, initiatives, and impacts. This includes
disclosing relevant metrics, targets, and progress towards sustainability goals in corporate reports,
such as annual reports, sustainability reports, and regulatory filings.
5. Executive Compensation: Executive compensation practices are increasingly tied to social and
environmental performance metrics to align executive incentives with long-term sustainability goals.
Corporate governance frameworks may include provisions for linking executive pay to key ESG
indicators, such as greenhouse gas emissions reductions, diversity and inclusion targets, and
community engagement initiatives.
6. Compliance and Ethics: Compliance with social and environmental regulations and ethical
standards is essential for maintaining trust and credibility with stakeholders. Corporate governance
frameworks establish codes of conduct, policies, and procedures to ensure compliance with relevant
laws, regulations, and industry standards, as well as ethical conduct in all aspects of business
operations.
7. Community Relations: Building positive relationships to engage with communities is an
important aspect of corporate governance. Companies are expected to engage with communities to
address their concerns, and contribute to their well-being through philanthropic initiatives,
community development projects, and responsible business practices.
8. Environmental Management: Corporate governance frame include provisions for managing
environmental mental risks and promoting environmental stewardship. This may involve
implementing environmental management systems, setting targets for reducing environmental
impacts, and investing in clean technologies and sustainable practices to minimize negative
environmental effects.
In summary, social and environmental issues are integral to corporate governance, as they
impact stakeholder trust, reputation, risk management, and long-term value creation. Companies that
integrate social and environmental considerations into their governance practices are better positioned
to mitigate risks, seize opportunities, and contribute to positive social and environmental outcomes
while enhancing shareholder value and sustainable growth.
ESG Framework:
ESG stands for Environmental, Social, and Governance, and it represents a framework used
by investors, businesses, and other stakeholders to evaluate and assess the sustainability and ethical
impact of an organization's operations and practices.
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CONTENTS OF INTEGRATED REPORT IN CORPORATE GOVERNANCE
An integrated report in corporate governance typically includes a wide range of content
designed to provide stakeholders with a holistic understanding of the company's performance,
strategy, and value creation efforts.
The content of an integrated report typically covers the following key areas:
1. Introduction and Overview:
• Company Profile: Overview of the company's history, mission, vision, and core values.
• Chairman's or CEO's Message: High-level commentary from senior leadership on the
company's performance, strategic priorities, and outlook.
2. Strategic Focus and Business Model:
• Strategic Objectives: Description of the company's strategic goals and priorities for value
creation.
• Business Model: Explanation of how the company creates value for stakeholders through its
products, services, and operations.
3. Governance Structure and Practices:
• Board of Directors: Overview of the composition, roles, responsibilities, and diversity of the
board of directors.
• Governance Framework: Description of the company's corporate governance policies.
practices, and compliance with relevant regulations.
• Executive Compensation: Disclosure of executive compensation practices, including the link
between pay and performance.
4. Financial Performance:
• Financial Highlights: Summary of key financial metrics and performance indicators.
• Financial Statements: Presentation of audited financial statements, including the balance sheet,
income statement, cash flow statement, and statement of changes in equity.
5. Non-Financial Performance:
• Environmental Performance: Disclosure of environmental impacts, initiatives, and
performance metrics, such as energy consumption, emissions, and waste management.
• Social Performance: Description of social initiatives, community engagement activities, and
efforts to promote diversity, equity, and inclusion.
• Stakeholder Engagement: Overview of stakeholder relationships, feedback mechanisms, and
engagement activities.
6. Risk Management and Opportunities:
• Risk Profile: Identification and assessment of key risks and opportunities facing the company,
including financial, operational, environmental, and reputational risks.
• Risk Mitigation: Description of risk management strategies, controls, and measures to mitigate
identified risks and capitalize on opportunities.
7. Sustainability and ESG Initiatives:
• Sustainability Strategy: Explanation of the company's approach to sustainability, including
goals, targets, and performance against sustainability metrics.
• ESG Performance: Disclosure of environmental, social, and governance (ESG) performance
indicators, benchmarks, and progress towards sustainability goals.
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8. Outlook and Future Prospects:
• Market Outlook: Discussion of industry trends, competitive landscape, and market
opportunities.
• Future Plans: Overview of the company's strategic initiatives, investment priorities, and growth
prospects.
9. Assurance and Compliance:
• Independent Assurance: Confirmation of external assurance or audit of the report's contents to
enhance credibility and transparency.
• Compliance Statement: Confirmation of compliance with relevant laws, regulations, and
industry standards.
10. Appendices and Additional Information:
• Glossary: Definitions of key terms and acronyms used in the report.
• Supplementary Information: Additional data, charts, and disclosures that provide further
context and detail on specific topics.
An integrated report is designed to present a cohesive narrative of the company's performance,
governance practices, and sustainability efforts, integrating financial and non-financial information
to provide stakeholders with a comprehensive view of the company's value creation journey
