Unit 2 - Governance

Chapters in Study Text – 7,8,9,11,12,14,16.

 The system by which companies are directed
and controlled, through compliance,
accountability, transparency and ethics:
 Primarily in the interest of shareholders,
and then all stakeholders
 For stakeholders, which brings into light
the concerns over social responsibility
 Internally – through the Board and the
control mechanisms
 Externally, through the compliances - the
regulatory framework that defines codes
of best practice, compliance and legal
statute
 Who controls a corporation, is
answered by corporate governance
 A control environment is needed to
ensure that all entities do their jobs
well and do not engage in illegal and
unethical practices
 Property rights theory:
 Small group of wealthy individuals pool money
for an undertaking that they cannot finance
alone
 They jointly own the common enterprise (they
include shareholders), and therefore are entitled
to full proceeds of profits
 1919 – Ford Motors
 Social institution theory / Stakeholder
Theory:
 Underlines that even a private
organisation should not be merely created
for personal enrichment, but is also a
public enterprise created to serve some
larger social good
Aims:
 Fulfilling long term strategic goals of owners
 Taking care of the interests of employees
 Taking into consideration the local community and
environment
 Maintaining excellent relations with customers and
suppliers
 Complying with the applicable legal and regulatory
requirements
 Holding the balance between economic and social
goals
 Encouraging the efficient use of resources
 Accountability for the stewardship of those
resources.
 Helping to ensure that an adequate and
appropriate system of controls exists and operates
within a company so that assets may be
safeguarded
 Preventing any single individual have too many power
 Ensuring that a company is managed in the best
interests of shareholders and other stake holders
 Encouraging transparency and accountability for
investors by monitoring those parties within a
company which control the resources owned by
investors
 The foundation to governance is the action of the
individual. These actions are guided by a person’s
moral stance.
 Codes and policies will provide a framework, it is the
individual stance that translates it into action
 Ethics and governance is required to create a positive
public perception
 Principles of trust, openness, fairness, transparency,
skepticism, probity (integrity), honesty etc.
 Efficient, effective and economical
 While dealing with internal and external stakeholders
 While taking decisions
 In maintaining professional relationships
 While questioning anything that seems fraudulent
 Devoid of personal interest
 While taking accountability for decisions

 Pages 182, 183, 184 – test your understanding examples

– CEO’s moral stances, Professional Accountant’s
moral stance
Agency Theory:
 An agent is employed by a principal to carry out a task
on their behalf.
 A principal is someone who heavily relies on an agent
to execute decisions and transactions that can result in
fluctuating outcomes.
 A separation of control occurs when a principal hires
an agent
 By accepting to undertake a task on their behalf, an
agent reputation becomes accountable to the principal
by whom they are employed.
 Agency costs are incurred by principals in monitoring
agency behaviour, because of a lack of trust in the
good faith of agents.
 The risk that the agent will make a poor decision, or
otherwise act in a way that is contrary to the principal’s
best interest is also agency costs.
 Additional agency costs can be incurred while dealing
with problems that arise from an agent's actions.
 Adam Smith
 "You can not expect those who manage
other people's money to be as careful and
caring as it would belong to them. Waste
and negligence are present, always, more
or less, in the management of every
business."
Conflicts
 Any Stakeholder with any other stakeholder can be in
conflict when it comes to decision making
 Directors and Shareholders
 There are always debates about the power of boards of
directors, and how stakeholders (not just shareholders)
can seek to ensure that directors do not abuse their
powers.
 The agency problem is a conflict of interest that occurs
when agents don't fully represent the best interests of
principals
Stakeholders and CSR
 CSR is the impact that organizations have
on various stakeholders
 The model by which companies seek ways to
create social and environmental benefits
while pursuing organizational goals of
revenue growth and maximizing
shareholder value.
 Reducing carbon footprints
 Improving labor policies
 Participating in fair trade
 Diversity, equity and inclusion
 Charitable global giving
 Community and virtual volunteering
 Corporate policies that benefit the environment
 Socially and environmentally conscious investments
 Protection of privacy of data
Stakeholder Identification:
 Internal / external
 Narrow / wide
 Primary / secondary
 Active / passive
 Voluntary / involuntary
 Legitimate / illegitimate
 Nobel Laureate and Economist, Milton Friedman:
A corporation has no responsibility outside of
making profit for shareholders
 It is the managers' duty to act solely in the
interest of shareholders
 Any other action is dilution of managerial
capability and shareholder betrayal.
 Social issues are the province of the state and
not corporations.
 Stakeholder Conflict in Business Decisions:
 Who promotes and who detracts:
 Closing down a unit and offshoring the
work
 Increasing prices to improve profit
margins
 Automation
 Adding shifts to increase production
 Low interest – low power:
 Small shareholders and the general public. They have
low interest in the organisation primarily due to lack of
power to change strategy or influence corporate
governance.
 High interest – low power:
 Staff, customers and suppliers - These stakeholders
would like to affect the strategy or influence corporate
governance of the organisation but do not have the
power to do this
 Low interest – high power:
 Government – Normally a low interest in the
organisation, but has the ability to affect strategy and/or
influence corporate governance should they choose to
do so.
 High interest – high power:
 Directors, major shareholders and trade unions - a high
interest in the organisation and have the ability to affect
strategy and/or influence corporate governance.
 Stakeholder
 Power,
 Legitimacy and
 Urgency

 Stakeholders and CG – an organization is a corporate

citizen, and so:
 Ethical, social, environmental and sustainability
accounting play a large role in maintaining balance
OECD Principles of CG – Organisation for
Economic Cooperation and Development
The Organisation for Economic Co-
operation and Development is
an intergovernmental economic
organisation with 37 member countries,
founded in 1961 to stimulate economic
progress and world trade.
 Ensuring the basis for an effective
governance framework:
 Promote efficient and transparent
dealings, be consistent with the rules of
law, articulate the division of
responsibilities between supervisory,
regulatory and enforcement authorities.
 Rights and equitable treatment of
shareholders:
 Framework should protect the rights of
shareholders and ensure equitable
treatment of shareholders. Should provide
shareholders opportunity to obtain
effective redress for violation of their
rights
 Role of stakeholders:
 Recognition of rights of stakeholders,
and promote active cooperation
between corporations and
stakeholders in creating wealth, jobs
and sustainability of financially
sound enterprises
Disclosure and transparency:
Timely and accurate disclosure of
financial situation, ownership,
performance and governance of
the company
 Board Responsibilities:
 Should ensure strategic guidance to
the company, effective monitoring of
the management by the board and
the accountability of the board to the
company and shareholders
 International Corporate Governance Network
(ICGN): (Non Profit) – around 500 organizations
from 45 countries
 ICGN was founded in 1995 at the instigation of
major institutional investors, with the intention
of representing investors, companies, financial
intermediaries, academics and other parties
interested in corporate governance and
developing effective global practices and
standards in this field.
 ICGN considers that while the OECD Principles
the necessary base of good corporate governance,
amplifications are required to give them sufficient
force.
 ICGN believes that companies around the world
deserve clear, concrete guidance on how the OECD
Principles can best be implemented.
• Influencing public policy and professional practice
with global standards of corporate governance and
investor stewardship.
• Convening impactful global events to share
knowledge, build networks and collaborate across
capital markets. The network facilitates knowledge
sharing, dialogue, and collaboration through
conferences, events, and working groups.
 Highlight corporate governance elements that ICGN-
investing members take into account when making
asset allocations and investment decisions
 The ICGN principles encourage jurisdictions to
address certain broader corporate and regulatory
policies in areas which are beyond the authority of a
corporation.
 The ICGN principles are drafted to be compatible with
other recognised codes of corporate governance,
although in some circumstances, the ICGN principles
may be more rigorous.
Objectives:
 Corporate objective – shareholder returns
 Disclosure and transparency
 Audit
 Shareholders’ ownership, responsibilities, voting rights
and remedies
 Corporate boards
 Corporate remuneration policies
 Corporate citizenship, stakeholder relations and the
ethical conduct of business
 Corporate governance implementation.
 Limitations:
 All codes are voluntary and are not legally
enforceable unless in statute by individual
countries.
 Local differences in company ownership
models may mean parts of the codes are
not applicable.
 Rules based and principle based approach to
governance:
 Standardization Vs Interpretation
 Binding obligations Vs Flexibility
 Clarity Vs Suggestive Precedents and decisions
 Regulation overload and Box Ticking Vs reasonable
freedom to customize

 Pg 220 – 226 – self study

 https://cag.gov.in/en/page-cag-s-auditing-standards-
2017

 For public sector governance

Public sector Governance:
 A single mechanism being appropriate to control and
monitor the achievement of objectives might not be
possible, so
 Accountability is achieved, at least in part, by having a
system of reporting and oversight.
 This means those in charge of the service delivery
reporting to an external body of oversight which may
be a board of governors or trustees.
 The oversight body acts in the interest of the providers
of finance, the taxpayer to ensure that the service is
delivered on time and is for the benefit of the users.
 The role of the oversight bodies includes:
 To ensure the service complies with government rules
 To ensure that performance targets are met
 To set and monitor performance against budgets
 To oversee senior appointments
 To monitor management performance
 To remove underperforming senior managers
 To report to higher authorities on the organisations
being monitored.
Will allowing a public
organisation to be converted into
a private company allow these
objectives to be achieved more
easily?
 More efficiency through profit driven performance
measures?
 Improved governance?
 Ideally profit shouldn’t be a motive?
 Competition will lower quality?
 Detrimental effects more?
 PPP?

 Ch.7 – page 195 to 197 – responsibilities, role and main

interests of internal and external stakeholders – self
reading
 Public sector organizations have the 3E
objectives:
 Economy - a measure of inputs to achieve
a certain service or level of service.
 Effectiveness – a measure of output
 Efficiency – optimum of both above
Governance for Other
Organizations:
Not for Profit
Small limited companies
Family owned businesses, big and
small
Multinational organizations
The Board of Directors:
 Who are Directors?
 What is a Board?
 What are the roles and responsibilities?
 What are the structures of the Board?
 Is professional development of the Board necessary?
 Diversity on the Board?
 How should Directors’ behaviour be aligned to
stakeholder interest?
 What are the issues associated with remuneration of
Directors
 A director is an officer of the company entrusted with
the conduct and management of its affairs
 The directors of the company collectively are referred
to as a Board of Directors
 The shareholders appoint the Chairman of the Board
and all other directors (upon recommendations from
the nominations committee)
 Directors, individually and collectively, as a Board of
Directors, have a duty of corporate governance.
Role of the Board:
 Directors are elected by shareholders to exercise their
right of control in the operation of a corporation
 Directors select and monitor the CEO, approve of the
strategic plan and ensure that control systems are in
place
 Board exercises control through an audit committee
that reviews financial reports, nomination committee
recruiting new members and compensation
committee supervising compensation of the CEO
Key Responsibilities:
 Provide entrepreneurial leadership of the company
 Represent company view and account to the public
 Set a ‘tone at the top’
 Determine the company’s mission and purpose
(strategic aims)
 Select and appoint the CEO, chairman and other board
members
 Set the company’s values and standards
 Ensure that the company’s management is performing
its job correctly
 Establish appropriate internal controls that enable risk
to be assessed and managed
 Ensure that the necessary financial and human
resources are in place for the company to meet its
objectives
 Ensure that its obligations to its shareholders and
other stakeholders are understood and met
 Meet regularly to discharge duties effectively
 Board members should have
confidence in the CEO to operate the
company, and yet should also exercise
independence by conducting executive
sessions with the CEO, and other
senior leadership, without the CEO
present
 Board Diversity:
 What is diversity and how does it bring about:
 Better governance
 Better decision making
 More effectiveness than All Male Boards
 What could be the issues with a non diverse
board?

 Article on ACCA website: “Diversifying the Board – A

step toward better governance”
 https://hbr.org/2019/03/when-and-why-diversity-
improves-your-boards-performance
 Unitary Boards – single boards
comprising of Executive and Non
Executive Directors
 Two Tier Boards – Corporate /
Supervisory (Upper tier)and
Management / Operating (Lower tier)
Board Agenda:
 Approval of interim and final financial statements.
 Approval of interim dividend and recommendation for
final dividend.
 Approval of significant changes to accounting policies.
 Appointment or removal of key staff such as company
secretary.
 Remuneration and appointment or removal of
auditors
 Approval of press releases concerning significant
matters decided by the board.
 Approval of group's commercial strategy.
 Approval of group's annual operating budget.
 Approval of group's annual capital expenditure plan.
 Changes relating to the group's capital structure.
 Terms and conditions/service agreements of directors.
 Major changes to the group's management and control
structure.
NEDs
 Build a recognition by executives of their contribution
in order to promote openness and trust
 Be well-informed about the company and the external
environment in which it operates
 Have a strong command of issues relevant to the
business
 Continually develop and refresh knowledge and skills
to ensure that contribution to the board remains
informed and relevant
 Uphold the highest ethical standards of integrity and
probity
 Question intelligently, debate constructively, challenge
rigorously and decide dispassionately
 Promote the highest standards of corporate
governance and seek compliance wherever possible
 Be detached and objective
 ‘No crooks, no cronies, no cowards’
 Induction of new members onto the Board, including
an Induction packet – Page 281 of ACCA text
 CPD – Continuous Professional Development for
Directors:
 Refreshing knowledge
 Personal development
 Other clauses on disclosure, conflict of interest,
especially in matters of asset sale, personal relations,
material interest, insider trading
 Conflict of interest:
 A conflict of interest occurs when a board member's
private interests influence their actions or decisions,
which compromises their duty to the company
 When a person chooses personal gain over the
duties to an organization in which they are a
stakeholder or exploits their position for personal
gain in some way, and could compromise his or her
judgment, decisions, or actions in the workplace.
 A board member owns a competing business
 Has a family member working for a vendor
 Receives monetary or non monetary awards from a
supplier
 Has a personal relationship with the CEO or other
executives
 Had had personal favors executed
 Uses information from a board meeting to his/her gain
 Performance of the Board and expectations:
 Contribution
 Composition
 Strategy
 Risk management
 Communication
 Timeliness
 Relationships and networking
 Effectiveness
 Leadership
 Ethics
 Succession planning
 Committees:
 Nominations
 Remuneration - NED
 Risk
 Audit - NED
 Board (Directors’)Remuneration:
 Basic
 Performance related bonus / Share Options
 Pension
 Benefits
 Issues with Directors’ Compensation:
 Legal
 Ethical
 Regulatory
 Competitive
 Issues with Boards:
 Lack of awareness
 Lack of attention
 Lack of competence
 Conflict of interest
 Failure to prevent wrongdoing
 Low percentage of independent directors - NEDs