CERTIFICATE LEVEL

Subject Fundamentals of Ethics, Corporate Governance & Business Law (BA4)

Boopathy Kahathuduwa
Lecturer Attorney At Law, CIMA Exams Complete, BBA (International Business) UOC

Module Corporate Governance Short Note

Code Corporate
BA4/BK/11 Social Responsibility 3
 Corporate Governance ( CG )
CHAPTER 3 - CORPORATE GOVERNANCE System by which companies are directed & controlled.

Organizations ?
Purpose
• Social Arrangement
• Facilitate effective, entrepreneurial and prudent management
• Controlled performance
• For long term success
• Collective goals
• Smooth run of the company
Types of Organizations • In interests of shareholders and the wider community

Responsible party - Board of directors

Organisation Board of directors

• Appointed by the shareholders
• Setting company’s strategic aims
Public Private • Leadership
• Supervising the management
For Profit
Not For • Reporting to shareholders on their stewardship
Profit
Shareholders - Appoint the directors
Public Private NGos Charities
The areas that CG code covers:
Common areas in world-wide CG codes
Cooperatives
D Role of the board of Directors
R Reliability of financial Reports
A Relationship b/w the company & Auditors
Sh Interests of the Shareholders

BA4 Nov. 2020 – Corporate Governance Short Note – Boopathy Kahathuduwa 1

 Compliance Penalty
Importance of CG
Law Must obey - Civil penalties : Recover funds
1. Mandatory for listed companies as set by regulators or statutes. from directors who breach legal
• US - Rules based approach - Sarbanes-Oxley act 2002 obligation
• UK - Principle based approach - London Stock Exchange - Criminal penalties : Fine
2. Embedded into listing rules
3. Model for best practice

Reasons to focus on CG
1. Company collapses - Enron , Maxwell , Worldcom
2. Financial crisis
CG , Company law & Bs Ethics
law
CG - UK - Principle based - suffering loss of reputation & bad
- Listed companies : Explain publicity
reasons for non-compliance
- Unlisted companies : No
obligations to comply, but
best of practice to do so
Bs - ethics begins where law ends - Loss of reputations
Ethics
- Sanctions by employers
CG - Dismissal of job

Ethics

Why CG if the law in stringent

Directors are smarter than law-makers where they will find loopholes dues
to :
1. Limited expectations of shareholders
2. Shareholders not being united

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 KEY CONCEPTS OF CG - SARA
KEY CONCEPTS OF CG - SARA
AGENCY THEORY - Relationship of the
STEWERDSHIP - Responsibility in taking ownership & control of the
( Trustees ) care of another’s business.
resources - Reason : Divorce of
- Fiduciary duty : In good ownership & control of the
faith of responsibility business
Eg : directors - Assumption : Separation
ACCOUNTABILITY of the ownership &control
- Being responsible for the
decisions made
Eg : Directors to the s/h
RESOURCE - How external resources
DEPENDENCY THEORY affect the org’s behavior
• Comp needs resources
• Resources are with other
org.
• Need to depend on other
org.
• Resources are basis of
power
• Independent org depend
on each other

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Agency theory : OECD Principles of CG
( Org of Economic Co-operation & Development )
- For countries

• Countries that want free market with one set of rules for CG
• 1999 - first published
• 2004 - revised
• This is for Public traded entities
PRINCIPAL
- Shareholder Reasons :
- To assist member & non-member countries to evaluate & improve CG
in their country
- Provide guidance & suggestions for parties involved in the process of
developing good CG
AGENT
- Directors

TASK
-Running the
company

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 OECD FRAMEWORK - 6
EFFECTIVE CG - Everyone knowing what they are
FRAMEWORK
responsible & accountable for
- Promote efficient & transparent
markets
- Consistent with the rule of law
DISCLOSURE & - Directors have to be responsible to
TRANSPARENCY make full disclosure on everything
BOARD - Strategic guidance of the entity
RESPONSIBILITY
- Monitoring the management :
- Audit committees
- NEDs (more independent since
they don't involve in day-to-day stuff

RIGHTS OF THE - Protect & facilitate S/H rights

S/H
- Directors should act in the best
interest of the S/H

FAIR TREATMENT - All S/H should be treated equal

FOR S/H
- Opportunity to effective redress for
violation of their rights

ROLE OF - Recognize the legal & mutual rights

STAKEHOLDERS
IN CG - Encourage active co-operation

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IFAC’s drivers for corporate success for companies CIMA’s proposals for CG
Report Leadership
• Published by - PAIB ( Prof. Accountants in Business )
• Aim : Better disclosure than more disclosure & disclosures adapted to
the circumstances of the company
IFAC’S DRIVERS - 8
PR - Effective & transparent PROPOSALS
communication
Tone from the top
BOD - Customer & stakeholder
focus How the board works together
MARKET - Effective leadership & Key actions of the board & committee
strategy
Board effectiveness
RISK MNGMNT - Integrated governance ,
rick & control Communication & engagement with the S/H

R&D - Innovation & adaptability

FINANCIAL MNGMNT
HR - People & talent mngmnt
OPERATIONAL
EXCELLENCE

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Choice of governance regime BOARD STRUCTURES
1. state of the economy
2. History & culture SINGLE TIER TWO TIER
( UNITARY ) ( DUAL )
3. Global political & economic climate
UK, US, Sri Lanka Germany, France
4. Capital inflows or Investments flowing into the country
5. Policies & structure of the government NEDs EDs Supervisory Mngmnt
Board Board
6. Legal system & Power ( Upper tier ) ( Lower tier )
7. Dominant ownership structure
- NEDs get a fixed salary. - Reasons :
No performance bonuses. Codetermination &
Rules Based CG – Follow the letter of the law, enforced through law, Relationship
ADV
Example: United States 1. NEDs expertise UPPER LOWER
2. NEDs active
involvement • Chairman • CEO
Principles Based CG – Follow the Spirit of the law 3. Wider view points coordinate coordinate
4. Reduction of fraud • Selected • Selected
Example : United Kingdom, South Africa 5. Improved investor by S/H by Upper
confidence tier
• Attends • Attends
Types of directors strategic day-to-day
matters. stuff
- Executive Directors – Runs operations of the business • Reports to • Reports to
S/H Upper tier
- Non Executive Directors - No executive functions & only attends •
meetings. Scrutinize Shareholders.

BA4 Nov. 2020 – Corporate Governance Short Note – Boopathy Kahathuduwa 7

 TWO TIER :
ADV DISADV
1. Separation of ownership & 1. Confusion over authority
control 2. Agency problem
2. Independent decision making 3. Increased bureaucracy
3. Wider stakeholder involvement 4. Slow decision making
4. Implicit S/H involvement 5. Isolation of supervisory board
5. Direct power over mngmnt since they won't attend meetings
6. Lack of transparency over
appointment
UK CG Code
• All public companies listed in the LSE ( London Stock exchange ) should
comply with the listing rules.
• A report on how the company applied all the principles of the CG code
must be provided. Comply or Explain
PRINCIPLES OF UK CG CODE - LASER
LEADERSHIP
ACCOUNTABILITY
SHAREHOLDER RELATIONS
EFFECTIVENESS
REMUNERATION

BA4 Nov. 2020 – Corporate Governance Short Note – Boopathy Kahathuduwa 8

Development of the UK CG Code REPORT FOCUS OUTCOME

REPORT FOCUS OUTCOME HIGGS 2003 Role of NEDs

- Guidelines on
BOD - CEO & Chairman TYSON 2003 Recruitment of NEDs
are 2 separate NEDs
people SMITH 2003 Auditors & audit - Role
Institutional - Continuous committee - Relationship
investors communication
SIR DAVID 2008 Complete review - Birth of UK
CADBURY 1992 Audit & - wider disclosure WALKER & of CG CG code 2010
accountability - Clearer THE FRC After the financial
communication crisis 2008/9
“Comply or explain” : Comply
with the rules or explain the non-
compliance

GREENBUR 1995 Director - Paid based on RAN Committees (Remunaration, Appointment,Nominations)

Y Remuneration performance
Importance / reasons for having sub-committees
HAMPEL 1998 Criticism of - Introduced the 1. Segregation of duties
previous combined code 2. Reduced work load of the board
reports 3. Builds confidence in S/H
TURNBULL 1999 Internal - How an internal 4. Mandatory user the UK CG code 2010 for public companies
control & control system
periodic should be
reporting established

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 BOARD COMMITTEES - RAN COMMITTEES
REMUNERATIONS COMMITTEE AUDIT COMMITTEE NOMINATIONS COMMITTEE
100% NEDs 100% NEDs Majority NEDs
Payments pensions and other perks Internal & external audits Structure & recruitment of directors

• First required : Cadbury

• Now required : 2010 UK CG code
• Due to the criticisms on the following
the audit committee was created :
- remuneration of auditors
- appointment of auditors
- auditors reports
- auditors being given other work
• Solutions to criticisms :
- consisting of 100% NEDs
- meeting of the committee at least 3
times a year
- having clear guidelines
- being appointed by the audit
committee
- Review & monitor remuneration - Appointment & removal of auditors - Periodic review of the balance in the
- Fairly remunerate - Deciding the remunerations of boards
- Ensure that their decisions are auditors - Recommend directors
independent - Reviewing the financial statements & - Ensure independency in the board
- Negotiate remuneration packages internal control system - Decide succession
with NEDs when they loose their jobs - Discussing findings from the external - Have diversity in the board
- Explain remuneration packages audits - Prepare JDs for directors
- Ensure proper system for
- Reduce dominancy
whistleblowing

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 RULES BASED CG PRINCIPLES BASED CG
Sarbanes-Oxley act King report III

• Extremely detailed • In south Africa

• Full force of law • 2010 ( Before 1994 &
• Relevant for US 2002 )
companies • 9 Sections in the code
• Includes the requirements • “Comply or Explain”
of the securities & Here the org has to
Exchange commission to comply with the principles, if
issue certain rules on CG they failed to do so they
must explain why it wasn't
Requirements :
possible to comply
• No bonus
• Vouch by chairman &
CEO
• Auditor rotation every 5
years
• Auditor can't perform non-
audit work
• S/H can't deal with shares
at sensitive times
• Detailed disclosure on off
balance sheet transaction
• Public Company Oversight
Board ( PCOB )
Eg: US Eg: UK & South Africa

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 Importance of CG to public companies :
Listed Private NFP
Companies companies organization Principal & agent is much wider
S/H need to know their money is safe
Primary Shareholders Shareholder Public
accountability Regulators Regulators Share values are affected
Doners
Listed companies must comply to the CG code
Principal Shareholders Shareholder Public
stakeholder Regulators
Why is CG more important to NFPs :
Doners
• The donors need to know and feel that their only isn't misused or
Monitoring Financial Financial *Financial defrauded
performance Statements Statements Statements
*Report of the ADVANTAGES OF CG DISADVANTAGES OF CG
impact on
society Reduces fraud, risks & loss Doesn't stop fraud
Board Executives & Executives Voluntary Attracts investors Limits decisions
structure NEDs trustees & paid
Better performance Harmful for competition
or unpaid
management Increases share prices Red tapes & bureaucracy

Transparency Highly required Not as much For donation

/ openness raising

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