BACHELOR OF SCIENCE IN ACCOUNTANCY

CORPORATE GOVERNANCE, BUSINESS ETHICS, RISK MANAGEMENT, AND INTERNAL CONTROL

2. Openness / Transparency
– This means not hiding anything. Transparency means clarity. This involves full disclosure of material matters which
could influence the decisions of stakeholders. Transparency should not be confused with ‘understandability’.
Information should be communicated in a way that is understandable, but transparency is concerned more with the
content of the information that is communicated.
3. Responsibility
– The board has a responsibility to oversee the work on management. The board should also retain responsibility for
certain key decisions, such as setting strategic objectives and approving critical capital investments.
4. Accountability
– If the objective of a company is to maximize the wealth of its shareholders, it might follow that directors should be
held accountable to shareholders on the basis of the returns on shareholder capital that the company has achieved.
The emphasis is the managers accountability to the shareholders, but also accountable to other possible
stakeholders.

Other Key Concepts in Corporate Governance

5. Independence
– The emphasis is making sure that there are truly nonexecutive directors on the board who are free to critique the job
performance of management. Independence is not having a conflict of interest issue.
6. Probity / Honestly
– Be honest that statements about the company are truthful, hence, not putting a spin on the facts.
7. Reputation
– A company’s reputation, if good, is built on success and management competence. However, it might take years for a
company to gain its reputation and only a day for it to get ruined. Companies that are badly governed can be at risk
of losing goodwill – from investors, employees and customers.
8. Judgment / Decision making
– All directors are expected to have sound judgment and to be objective in making their judgments. The OECD says
‘the board should be able to exercise judgment on corporate affairs independent, in particular, from management.’
9. Integrity
– This is similar to honestly, but it also means behaving in accordance with high standards of behavior and a strict
moral or ethical code of conduct. This means ‘doing the right thing.’ ‘Being a straight shooter.’

MAJOR AREAS OF ORGANIZATION AFFECTED BY ISSUES IN CORPORATE GOVERNANCE

1. Duties of directors and functions of the board (including performance measurement).
 Directors have a fiduciary duty to act in the best interest of the company. They need to use their powers for proper
purpose, avoid conflicts of interest and exercise a duty of care.
2. The composition and balance of the board (and board committees).
 Boards must be balanced in terms of skill and talents from several specialisms relevant to the organization’s situation
and also in terms of age (to ensure senior directors are brining on newer ones to help succession planning).
3. Reliability of financial reporting and external auditing.
 The reliability of the financial reports is crucial to ensuring that management is held accountable. External auditors
need to make sure that they are getting the right information in order to verify the reliability of the financial reports.
External auditors cannot be fearful of asking awkward questions because of fear of losing the audit.
4. Director’s remuneration and rewards.
 Directors’ remuneration has to be seen as being fair. Excessive salaries and bonuses have been seen as one of the
major corporate abuses for a number of years.
5. Responsibility of the board for risk management systems and internal control.
 Boards should meet regularly as to provide proper oversight for risk management and internal control systems.
Without proper oversight, the organization may have inadequate systems in place for measuring and reporting on
risks.
6. The rights and responsibilities of shareholders, including institutional investors.
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 Shareholders should have the right to receive all material information that may affect the value of their investment
and to vote on measures affecting the organization’s governance.

7. Corporate social responsibility and business ethics.

 Corporate social responsibility and business ethics is an important part of the corporate governance debate. At this
point, there is no any real consensus about these issues.

THEORETICAL FRAMEWORK OF CORPORATE GOVERNANCE

It is useful to consider the theoretical justification for a system of rules or guidelines on corporate governance. Agency
theory can be used to justify a ‘shareholder approach’ to corporate governance. Stakeholder theory can be used to justify a
‘stakeholder’ approach. These alternative approaches are explained later.

Agency Theory (Michael Jensen and William Meckling, 1976)

The theory is based on the separation of ownership and control in the business. Agency relationship is defined as a form of
contract between a company’s owners and its managers, where the owners (as principal) appoint managers (as agents) to
manage the company on their behalf; delegating decision-making authority to the management.

The nature of governance in a company reflects the conflicts of interest between the company’s owners and managers.

 Shareholders are concerned not only about short-term profits and dividends but they are even more concerned
about long-term profitability.
 The managers run the company on behalf of the shareholders. Unless they own shares, or unless their
remuneration is linked to profits or share values, their main interests are likely to be the size of their remuneration
package and their status within the company.

Agency Conflict

Agency conflicts are differences in the interests of owners and managers. They arise in several ways.
1. Moral hazard
 A manager has an interest in receiving benefits from his position in the company. Jensen and Meckling suggested that
a manager’s incentive to obtain these benefits should be higher when they have no shares, or only a few shares, in the
company. Senior managers may pursue a strategy of growth through acquisitions even though takeovers might not be
in the best interests of the company and its shareholders.

2. Level of effort
 Managers may work less hard than they would if they were the owners of the company. The effect of this lack of effort
could be smaller profits and a lower share price.
3. Earnings retention
 The remuneration of directors and senior managers is often related to the size of the company (measured by annual
sales revenue and value of assets) rather than its profits. This gives managers an incentive to increase the size of the
company, rather than to increase the returns to the company’s shareholders. Management are more likely to want to
reinvest profits in order to expand the company, rather than pay out the profits as dividends. When this happens,
companies might invest in capital investment projects where the expected profitability is quite small, or propose high-
priced takeover bids for other companies in order to build a bigger corporate empire.
4. Time horizon
 Shareholders are concerned about the long-term financial prospects of their company while managers might only be
interested in the short term. The reasons for short term interest of managers are (1) they receive annual bonuses
based on short-term performance, and (2) they might not expect to be with the company for more than a few years.

Agency Costs
Agency costs are the costs of having an agent make decisions on behalf of a principal. Hence, agency costs are the costs
that the shareholders incur by having managers run the company. Agency costs are potentially very high in large
companies, where there are many different shareholders and a large professional management.