VIET NAM NATIONAL UNIVERSITY HO CHI MINH CITY

UNIVERSITY OF ECONOMICS AND LAW

FACULTY OF ACCOUNTING AND AUDITING

CHAPTER 04
OVERVIEW OF CORPORATE GOVERNANCE

Course: Professional Ethics and Corporate Governance

Lecturer: ThS. Mai Thi Phuong Thao
 Name Student Code Assessment
1. Nguyễn Minh Hiếu K184091150 100%
2. Phan Tôn Thị Thiên Kim K184091154 100%
3. Trương Thị Mỹ Linh K184091159 100%
4. Phạm Thị Kim Loan K184091160 100%
5. Nguyễn Hữu Luật K184091161 100%
6. Trần Thị Trà My K184091164 100%
7. Lê Thị Na K184091165 100%
8. Nguyễn Thị Thanh Ngân K184091167 100%
Contents
INTRODUCTION .................................................................................................... 2
1. Theory of governence ...................................................................................... 3
1.1. Company ownership and control ............................................................... 3
1.2. Definotion, purpose, objectives and key concepts corporate governance . 5
1.2.1. Definition ............................................................................................ 5
1.2.2. Purpose and Objectives ....................................................................... 6
1.2.3. Differences between Management and Governance .......................... 6
1.2.4. Key concept of coporation governance .............................................. 7
1.3. Operational areas affected by issues in corporate governance .................. 8
1.3.1. Board of director ................................................................................. 8
1.3.2. Directors’ remuneration (Thù kim thành viên hội đồng quản trị) .... 10
1.3.3. Relations with shareholders .............................................................. 11
1.3.4. Accountability and Audit .................................................................. 11
1.4. Internal and External coporate governance stakeholder .......................... 12
1.4.1. Definition: ......................................................................................... 12
1.4.2. Classification .................................................................................... 12
1.5. Agency theory.......................................................................................... 15
1.5.1. Definition .......................................................................................... 15
1.5.2. Agency theory and Coporate Governance ........................................ 16
1.5.3. Solution Agency problem: ................................................................ 17
1.5.4. Key concepts ..................................................................................... 18
1.5.5. Agency costs: .................................................................................... 18
1.6. Transaction cost theory ............................................................................ 20
1.7. Stakeholder theory ................................................................................... 21
1.7.1. Definition .......................................................................................... 21
1.7.2. The main role of Stakeholder theory ................................................ 21
2. Development of corporate governance ........................................................ 23
2.1. Influences on corporate governance ........................................................ 23
2.2. Reasons for developing a code ................................................................ 23
2.3. Development of corporate governance codes.......................................... 24
2.3.1. The process of development in corporate governance codes the UK
24
2.3.2. The process of development in corporate governance codes the US
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 Overview of Corporate Governance

INTRODUCTION

Corporate governance is a topic that has attracted the attention of both

academics and entrepreneurs, especially after the collapse of many big companies in
the US and UK such as Worldcom, Enrol and Arthur Andersen ... In Europe Asia, it
is thought that weak corporate governance was one of the main reasons for the 1997
economic crisis.
In Vietnam, corporate governance is becoming a hot topic in the discussions
of government officials, especially when the Government is committed to
promoting reform of state-owned enterprises or also called "equitization". One of
the important elements of State-owned enterprises reform is financial transparency
and accountability of effective governance principles to improve the business
performance of these enterprises and attract foreign investment.. On the other hand,
Corporate governance is seen as a catalyst in the long term to change Vietnamese
business thinking, thereby better meeting the requirements of foreign investors and
the global economy.
The reason to need corporate governance: Many companies are managed by
directors who do not own the company. Many problems have arisen due to the
separation of ownership and control .e.g. directors having inadequate skills to
manage their area, or awarding themselves large bonuses whilst not meeting targets.
Due to the many problems which have arisen in the past, corporate governance has
been developed.
The fall of Enron:

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 Overview of Corporate Governance

When Jeffrey Skilling was hired into the company and later assumed the
position of CEO Enron, under Lay's tolerance, Skilling focused on meeting Wall
Street expectations by developing a cover executive board. hide billions of dollars
in losses and debts from failed deals and projects. They exploit accounting
loopholes, use special-purpose institutions (Enron-controlled "partners") and
dishonest financial reports.
They pressured Arthur Andersen Auditing Company (one of the five largest
audit firms in the world) to ignore the risky accounting issues in Enron
In addition to his self-management insights, Enron was effectively advertised
through Arthur Andersen and Wall Street analysts, resulting in a record high
number of people buying shares of the company.
Arthur Andersen's Houston branch receives $ 1 million a week and also
participates in finding partners for Enron. The above sums of money blurred the
eyes of auditors and they easily ignored the principle. Accordingly, the non-
transparent financial statements did not clearly describe the operation and financial
situation of Enron to shareholders and analysts, instead, we painted the performance
of the company. The case broke in October 2001.
Enron shares, from a peak of $ 90 in mid-2000, dropped steeply to less than
USD at the end of November 2001, resulting in the collapse of the enron.
The above is a typical example of corporate governance, managing a
company operating for personal purposes without regard to corporate interests,
damaging the interests of shareholders' assets and long-term influence to the
business. This shows that the issue of corporate governance needs more attention

Theory of governence
Company ownership and control
In small businesses, there is very little difference between business
ownership and business control because generally the person who owns the business
also runs (controls) the business.
However, in big business, corporations and public companies it is rare for the
owners (shareholders) of the business to also run (control) the business. This is
because shareholders are numerous and they often lack the specific management
skills required to successful manage large enterprises.

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 Overview of Corporate Governance

So the business owners (shareholders) will appoint a board of directors to run

the business on their behalf. In appointing the board of directors, the shareholders
vest the management and control of the business in the board.
• Business ownership represented by the shareholders, are the company's
owners. They have the potential to profit if the company does well,
coupled with the potential to lose money if the company performs poorly.
• Business control represented by the board of directors, are the governing
body appointed by the shareholders to look after the shareholder's
interests. They are the ultimate decision-making authority for the
company and so control the policies, direction, dividends and managerial
appointments for the business.
The business owners (shareholders) vest control of the business in a board of
directors who employ specialist management to run the business and return the
profits of the business back to the shareholders.

Company ownership Company Control

Represent Shareholders Directors

The main GOVERNANCE MANAGEMENT

Role Governance is the answer to Management is the answer
“what”-The strategic planning and to ‘how’ - the delivery of the
leadership of an organization that is strategic plans and the work
carried out by the appointed Board. of the organization. It
It reflects the overall mission and reflects the implementation
vision of the organization. of governance decisions. It’s
the daily activities that must
be taken to ensure the
mission, vision and/or
strategic plan is executed.

The • determine the mission, policy, • develop and deliver

activities and strategy policy and strategy
• appoint and oversee • set and oversee
management annual operational
• manage governance processes business plans
• providing insight, wisdom, and • appoint managers

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 Overview of Corporate Governance

judgment and staff

• monitor the performance of the • support governance
organization processes
• implement Board
• strategically identify and
decisions
manage risk
• measure
performance
• deliver services and
activities
• manage strategic and
operational risk
Objectives Strong returns in the form of To maximize profit
dividend payment and rising for the
share prices shareholders.

Definotion, purpose, objectives and key concepts corporate governance

Definition
• Corporate governance (“CG”) is the system by which companies are
directed and controlled (Cadbury Report, 1992)
• In VietNamese: “Quản trị công ty là hệ thống các quy tắc để đảm bảo cho
công ty được định hướng điều hành và được kiểm soát một cách có hiệu
quả vì quyền lợi của cổ đông và những người liên quan đến công ty (QĐ
số 12 ngày 13/03/2007 – BTC)
• Good governance requires the following to be considered:
o Direction from within:
-The nature and structure of those who set direction, the board of
directors
-The need to monitor major forces through risk analysis
-The need to control operations: internal control.
o Control from outside:
-The need to be knowledgeable about the regulatory framework that
defines codes of best practice, compliance and legal statute

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 Overview of Corporate Governance

-The wider view of corporate position in the world through social

responsibility and ethical decisions

Purpose and Objectives

Differences between Management and Governance

Most organizations are able to distinguish between governance and
management. They delegate different kinds of decisions to different individuals,
sub-groups, or forums according to their understanding of the two words.
• Why separate governance and management?

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 Overview of Corporate Governance

Separating governance and management promotes accountability at all

levels. It also provides a mechanism for good enterprise governance that focuses on
stakeholder value by balancing performance and conformance.
According to the COBIT5 framework by ISACA, governance ensures one
evaluates stakeholder needs, conditions and options. It helps determine whether
there are standard enterprise objectives. Also, setting direction through prioritization
and decision making is important. Last but not the least, monitoring performance
and compliance against agreed-on direction and objectives proves essential in this
area.
This means that governance should:
-Evaluate to determine agreed-on enterprise objectives
-Direct through prioritization and decision making
-Monitor performance, compliance and progress against agreed direction and
objectives.
→This means that a key responsibility of governance is to evaluate, direct, and
monitor (EDM).

Management Governance

Management is concerned with running Governance is about giving the lead to

business operation of a company the company and monitoring and
→ routine decisions and administrative controlling management decisions
work related to the daily operations of →oversight and decision-making
the orgnization related to strategic direction, financial
planing and bylaws - the set of core
policies that outline the organization’s
purpose, values, and structure.

Key concept of coporation governance

• Fairness: refers to the principle at all stakeholders should receive fair
treatment from the director
• Openness/ Transparency: means “not hiding anything”. Intentions should
be clear, and information should not be withheld from individuals who
ought to have a right to receive it

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 Overview of Corporate Governance

• Independence: freedom from the influence of someone else. A principle

of good CG is that a substantial number of directors of a company should
be independent, which means that they are able to make judgment and
give options that are in the best interest of the company, without bias.
• Probity/honesty: essential quality for directors and advisors
• Responsibility & Accountability: The directors are given most of
the power for running company. Many of these power are delegated
to executive managers, but the directors remain responsible for the
way in which those power are used. The board of directors should be
accountable to the shareholders.
• Reputation: good or bad, based on a combination of several
qualities including commercial success and management
competence.
• Judgment: Director make judgment in reaching their opinion.

Operational areas affected by issues in corporate governance

Board of director
• A board of directors (B of D) is an elected group of individuals that
represent shareholders. The board is a governing body that typically meets

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 Overview of Corporate Governance

at regular intervals to set policies for corporate management and oversight.

Every public company must have a board of directors. Some private and
nonprofit organizations also have a board of directors.
• Boards of directors’ are categorized into two different categories for
instance, executive and nonexecutive directors. Executive directors are
deemed as non-independent directors. They are assigned by specific
operating roles within the entities for example finance, administration and
operation. In the other hand, non-executive directors are deemed as
independent directors because they are not directly involved operating
function. They are given tasks such as chairing remuneration committee,
audit committee and nomination committee within the board’s purview to
monitor the executive directors. (Talha M., Sallehhuddin A. and Masuod S.,
2009).
o The term ‘standing committee’ refers to any committee that is a
permanent feature within the management structure of an
organisation. In the context of corporate governance, it refers to
committees made up of members of the board with specified sets of
duties.
o Audit Committee: (Ủy ban kiểm toán): This committee is composed
of internal audit members, building an internal control system of the
Company.
-Ensure integrity of financial information
-Increase the emphasis on risk and control
-Give directors more insight in the system
-Increase directors understanding in external and internal audit
-Improve communication between board and external auditor
-Improquality of financial reporting
-Create forum for the chief financial officer
-Strenthen the internal audit function
o Nominating committee (Ủy ban tiến cử): This Committee will seek
candidates in the Board of Directors to ensure the Board of Directors
is always valid.
-Assessing and recommend to the board candidate of director
-Appointment of director to board commitee

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 Overview of Corporate Governance

-Review board’s succession plains and training programs

-Facilitate board induction and training program
-Establish policy formalising its approach to board room diversity
o Remuneration commmitte (Ủy ban lương thưởng): This committee
will decide the salaries of the members of the Board of Directors to
ensure that no one director can determine his own salary. Non-
executive directors will determine the salaries of the CEO. And the
salary of a non-executive director is a fixed salary.
-Determine the compensation and benefits of director and executive
-Setting compensation plans
• Importance of board committee:
- Reduces board workload and improve focus on other isues
- Creates structures that can use inherent expertise to improve decisions
in key areas
-Communicates to shareholders
-Increase in shareholder confidence
-Comunicates to stakeholder
-Satisfy requirements of the governance requirements.
Directors’ remuneration (Thù lao thành viên hội đồng quản trị)
Directors’ remuneration is the payment made for services or employment of
directors on the board the company or corporation. Directors may be compensated
by fee, salary, and or use of the company's property as an agreement between them
and the company. However, the amount of remuneration cannot exceed the amount
specified in the articles of association (AOA) as stated in company law. The
directors can be sue by the stakeholder if they exceed the stated amount or pay
themselves too big a share of profit instead of distributing it as dividends. Without
the approval of shareholders, it is generally illegal for companies to compensate
directors for loss of office.
To run the company successfully, the levels of make-up remuneration should be
sufficient to attract and retain the directors. The component parts of remuneration
should be structured so as to link rewards to corporate and individual performance,
in the case of executive directors. In the case of non-executive directors, the level of
remuneration should reflect the experience and level of responsibilities undertaken

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 Overview of Corporate Governance

by the particular non-executive concerned. Companies should establish a formal and

transparent
The management will only do their best to improve the financial performance
of their company when the pay is often related to the size or profitability of
the company. As a consequence, shareholders tendto exercise control and
influence the behaviors of the executives by designing incentive schemes for
directors with an attempt to align the interests of shareholders and directors.
First, directors will be rewarded financially for maximizing shareholdersinterest.
Conversely, when there is no value created for shareholder there will be no reward
for them, except the basic salary and benefits. Such schemes may include
plans whereby senior executives obtain shares, perhaps at a reduced price,
thus aligning financial interest of directors with those of shareholders. Other
similar schemes tie levels of bonuses and compensation of the executives to
shareholders returns. Part of directors’ compensation is deferred to the future
to reward long-run value maximization of the company and deter short-run
executive action, which harms corporate value.

Relations with shareholders

Historically, individual shareholders, whether institutions or private persons,
have had little chance of influencing the board or management given the
fragmentation of ownership.
Shareholder (investor) activism can also force better corporate governance.
Shareholders have rights under both common and corporate law to
participate in key corporate governance decisions, including the right to
nominate, appoint and remove directors and external auditors, and the right
to approve major corporate decisions.
Accountability and Audit
• Risk and internal control: ensure the accuracy and reliability of financial
reporting include: clearly defined lines of accountability and delegation
of authority; policies and procedures that cover financial planning and
reporting: preparation of monthly management accounts, and review of
the disclosures within the Annual Report, from function heads to ensure
that the disclosures made appropriately reflect the developments in the
year and meet the requirement of being fair, balanced and
understandable.
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 Overview of Corporate Governance

• Audit: reviews and approves the internal audit plan for each year. One of
the responsibilities of the internal audit function is to confirm to the
Board the effective operation of our internal control framewor
Internal and External coporate governance stakeholder
Definition:
• The term “stakeholder” is used to describe a person or an organization
with an interest or concern in a company.
• Stakeholders of a company include stockholders, bondholders, customers,
suppliers, employees, and so forth.
Classification
Financial stakeholders and Interest stakeholders
• Financial stakeholders are those with a financialrelationship with the
organization. In other words, should financial problems occur to the
organization then the stakeholders will suffer.
• Interest stakeholders are interested in how the organization behaves and
are very often more powerful than the financial stakeholders due to the
influence they have over it.
Financial stakeholders Interest stakeholder
Shareholder and other investors- Media-publicity and reporting events
investment
Employees-job and wages Non-government organisations-impact
on their activities
Customers-own or have ordered goods Activists group-environmental impact
and services
Suppliers-owned money for goods and Competitors-strategy and development
services supplied
Government/community-taxation Regulators-Fair trading, stock exchange

Internal stakeholders and External stakeholders

❖ Internal stakeholders: Internal stakeholders are individuals or groups who are
directly and/or financially involved in the operational process.
• Each internal stakeholder has:

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 Overview of Corporate Governance

-An operational role within the company

-A role in the corporate governance of the company
-A number of interests in the company (referred to as the stakeholder 'claim).

Stakeholder Operational Role Corporate Main interest in

governance role company

Directors Responsible for Control company • Pay

the actions of the in best interest of • Performance
corporation stakeholders linked bonuses
• Share options
• Status
• Reputation
• Power
Company Ensure Advise board on • Pay
Secretary compliance with corporate • Performance
company governance linked bonuses
legislation and matters • Job stability
regulations and • Career
keep board progressio
members • Status
informed of their • Working
legal conditions
responsibilities

Sub-board Run bisiness Identify and

management operations. evaluate risks
Implement board faced by company
policies Enforce controls
Monitor success
Report concerns
Employees Carry out orders Comply with
of management internal controls
Report breaches

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 Overview of Corporate Governance

Employee Protect employee Highlight and • Power

representatives eg interests take action • Status
trade against breaches
unions in governance
requirements

❖ External stakeholders are indirectly influenced by the organization ‘s

operations.
• Each stakeholder has:
-A role to play in influencing the operation of the company
-Its own interests and claims in the company.

External Party Main role Interest and claims in

company

Auditors Independent review of • Fee

company reported • Reputation
financial position • Quality of
relationship
• Compliance with
audit requirements
Regulators Implementing and • Compliance with
monitoring regulations regulations
• Effective of
regulations
Government Implementing and • Compliance with
maintaining laws which laws
all companies must • Payment of taxes
comply • Level of
employment
• Level of
imports/exports

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 Overview of Corporate Governance

Stock Implementing and • Compliance with

Exchange maintaining rules and rules and
regulations for companies regulations
listed on the exchange • Fee
Small Limited power of use of • Maximisation of
Investors vote shareholder value

Institutional Through considered use of • Value of shares and

Investors their votes can dividend payments
beneficially influence
• Security of fund
corporate policy invested
• Timeliness of
information

Agency theory
Definition
Agency theory is a principle that is used to explain and resolve issues in the
relationship between business principals and their agents. Most commonly, that
relationship is the one between shareholders, as principals, and company executives,
as agents.

In theory, the shareholders - the true owners of a company, must be the

people who run its own activities. However in reality, the shareholders of large

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 Overview of Corporate Governance

corporations today are highly fragmented and the executive authority is actually in
the hands of managers (perhaps executives).
- Directors (acting as agent) are those who are authorized by shareholders to
run the company, bringing benefits to both sides.
- However, the authorization itself causes the separation of ownership and
management rights of a business. The separation between ownership and the right to
manage businesses raises concerns that managers will pursue goals that are
appealing to them, but may not be beneficial for shareholders, for company.
- Or maybe the owner's goal is to maximize the value of the business, that is,
maximize the market value of the company's equity. While managers are aiming for
short-term goals: increasing sales, increasing market share, maximizing profits ... in
order to increase their salaries, bonuses or reputation for the business.

Agency theory and Coporate Governance

Agency theory can help to explain the actions of the various interest groups
in the corporate governance debate.

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 Overview of Corporate Governance

Historically, companies were owned and managed by the same people. For
economies to grow it was necessary to find a larger number of investors to provide
finance to assist in corporate expansion.
This led to the concept of limited liability and the development of stock
markets to buy and sell shares.
o Limited liability: limited risk and so less interest in the firm.
o Stock market: wide and limited individual ownership and the ability
to simply sell without the need to take any interest in the firm.
Shareholder rarely pay attention to the operation of the company, therefore,
The principals (shareholders) employ the agent and delegate the running of the
company. → Separation of goals between wealth maximisation of shareholders and
the personal objectives of managers. The different interests of principals and agents
may become a source of conflict, as some agents may not perfectly act in the
principal's best interests. The resulting miscommunication and disagreement may
result in various problems and discord within companies. Incompatible desires may
drive a wedge between each stakeholder and cause inefficiencies and financial
losses. This leads to the agency problem.
Solution Agency problem:
• Salary and bonus regimes associated with the scale of profits that managers
create for businesses to encourage managers to do their best
• Turn the manager into a co-owner (shareholder) with the stock bonuses
• Preferential treatment of stock options for managers (Executive share option
plans -ESOPs)
Under this measure, the manager will be granted a number of stock options.
Each right gives the holder the right after a certain date to register to buy
company stock at a fixed price. The value of an option will increase if the
company is operating effectively and its stock price goes up. Therefore,
managers are motivated to make the right decisions to increase the value of
the company - acting in the interests of shareholders.
• Strengthen management oversight measures by establishing an internal audit
system, transparent and strict sanctions system (even possible dismissal or
lawsuits) for those The manager didn't fulfill the responsibility ...
Example: IBM may be a good example of the combination of the above
measures in its remuneration. Managers at IBM enjoy a preferential rate
based on the Group's performance, including 3 criteria:
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 Overview of Corporate Governance

- Contribution in the current year (Current Year Performance): including

salaries and bonuses reflecting the results of operating activities within 12
months.
- Long-term Performance: Long-term rewards reflect operating results for at
least 3 years, in order to maintain the current business results of the Group. .
- Full career performance: deferred payment bonuses, pensions
accumulations aimed at keeping current executives in IBM until the end of
their careers.
IBM's remuneration is intended for long-term performance of managers,
inextricably linked with the owners' goal of maximizing business value. This
is reflected in the remuneration rate of the leaders. For executives, for
example, salary accounted for 8%, annual bonus accounted for 29%, stock
bonus accounted for 63% of total remuneration.
Key concepts
• Agent: An agent is employed by a principal to carry task on their behalf.
• Agency: refers to the relationship between a principal and their agent.
• Agency cost: are incurred by principles in monitoring agency behavior
because of a lack of trust in a good faith of agents
• Accountable: by accepting to undertake a task on their behalf, an agent
becomes accountable to the principal by whom they are employed. The agent
is accountable to that principle.
• Fiduciary responsibility: Directors (agents) have a fiduciary responsibility to
the shareholders (principal) of their organization.
• Stakeholders: are any person or group that can have affect or be affected by
the policies or activities of an organization.
• Agent objectives (such as a desire for high salary, large bonus and status for
director) will differ from the principal’s objectives (wealth maximization for
shareholders)
Agency costs:
Definition
An agency cost is a type of internal company expense which comes from the
actions of an agent acting on behalf of a principal. Agency costs typically arise
in the wake of core inefficiencies, dissatisfactions and disruptions, such

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 Overview of Corporate Governance

as conflicts of interest between shareholders and management. Payment of the

agency cost is to the acting agent.
The Principal-Agent Relationship of Agency Cost
The problem of asymmetric information exists between the owner and the
CEO is a typical form of this type of cost. The agent (corporate governance) is the
person who works on behalf of the owner( shareholders) of the business. The
shareholders of the enterprise do not have or have very few conditions to regularly
supervise every action of the administrator. This is an easy point to give rise to
disproportionate information and continues to cause ethical risks and conflicting
choices.
According to Jensen - Meckling, the problem of managers evading their
responsibilities will be seen as a kind of expense, managers who do not show their
leadership ability are also considered as a kind of expense.
The nature of agency costs
Representation costs include all fees associated with managing the needs of
the parties involved in the dispute assessment and settlement process. This cost is
also known as representative risk. Representation fee is a necessary expense in any
organization in which the principal does not give up his / her entire operating rights.
Because they fail to operate in a way that is beneficial to the representatives
who work under them, they can negatively impact the company's profits.
Agency costs arise largely from principals monitoring activities of Agents
• Incentive schemes and remuneration packages for directors
• Cost of management providing annual report data
• Cost of meetings
• Cost of accepting high risk
• Residual loss: relates to directors furnishing themselves with expensive
cars and planes etc
Some of the most famous examples of agency costs - representative risks that
appeared in famous financial scandals such as the failure of Enron in 2001. The
board of directors and senior executives of the company sold all of their stocks at
prices higher than their real values, relying on fraudulent accounting information to
artificially increase their stock values. As a result, the shareholders lost a
considerable amount of money. This is further caused by Enron's stock price
plummeting.

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 Overview of Corporate Governance

Transaction cost theory

Transaction cost theory is an alternative variant of the agency understanding of
governance assumptions. It describes governance frameworks as being based on
the net effects of internal and external transactions, rather than as contractual
relationships outside the firm
Transaction cost theory is part of corporate governance and agency theory. It is
based on the principle that costs will arise when you get someone else to do
something for you
❖ External transactions

Transaction costs will occur when dealing with another external party:
-Search and information costs: to find the supplier.
-Bargaining and decision costs: to purchase the component.
-Policing and enforcement costs: to monitor quality.
The way in which a company is organised can determine its control over
transactions, and hence costs. It is in the interests of management to internalise
transactions as much as possible, to remove these costs and the resulting risks and
uncertainties about prices and quality.
For example a beer company owning breweries, public houses and suppliers
removes the problems of negotiating prices between supplier and retailer.
❖ Internal transactions:
Transaction costs still occur within a company, transacting between departments
or business units. The same concepts of bounded rationality and opportunism on
the part of directors or managers can be used to view the motivation
behind any decision.

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 Overview of Corporate Governance

Stakeholder theory
Definition
The stakeholder theory is a theory of organizational management and
business ethics that addresses morals and values in managing an organization, such
as those related to corporate social responsibility, market economy, and social
contract theory.
Agency theory is a narrow form of stakeholder theory.
The main role of Stakeholder theory
Stakeholder’s theory emphasizes the interconnections between business and
all those who have a stake in it, namely customers, employees, suppliers, investors
and the community.
The company should fulfill accountability to many more sectors of society
than solely their shareholders. Although External stakeholders are not the members
of a company, they can affect or be affected by its operations. Therefore, the
business has to serve the needs of the stakeholders, and not just the shareholders.
Other bodies that are considered stakeholders include the media, the
government, political groups, trade associations and trade unions. All of these are
linked to business organizations and can affect and are affected by them in turn. The
firm has a responsibility to consider their interests as well, and not just the monetary
interests of the owners of the firm.
Classification

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 Overview of Corporate Governance

❖ Internal stakeholders have an operational role in the company and therefore,

a role in corporate governance of the company also .
• Directors are responsible for running the company in the best interest
of shareholders.
• Company secretary is responsible for company legislation compliance
and for advising the board on corporate governance matters.
• Sub board management are responsible for implementing board
policy and running the company. They identify risks faced by the
company report concerns enforce controls and monitor success.
• Employees carry out management orders by complying with internal
controls and reporting breaches.
• Trade unions are employee representatives who protect employee
interests. They protect whistleblowers and highlight and take action
against breaches in corporate governance of employees.
→ Internal stakeholders main interests in a company are pay performance
related bonuses share options, career, progression status, reputation
power and working conditions.
❖ External stakeholders are not members of a company but kemon affect or be
affected by its operations.
• Auditors are responsible for the independent review of a company's
financial position. They are interested in the payment of their fees
their reputation. The quality of their relationship with their client and
the compliance of audit requirements.
• Regulators are responsible for the implementing and monitoring of
regulations. They are interested in the effectiveness and compliance of
regulations.
• Government are responsible for implementing monitoring and
maintaining laws which companies must comply with they aren't
interested in the compliance with law, payment of taxes, employment
levels and import-export levels.
• Stock Exchange are responsible for implementing and regulating rules
and regulations for companies listed on the stock exchange. They are
interested in fee payment and compliance with stock exchange rules
and regulations.

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 Overview of Corporate Governance

• Small investors invest in the company but have limited power and are
interested in the maximization of value of their investment.
• Institutional investors can have considerable influence on corporate
policies. They are interested in the value of shares and dividend paid
the security of funds invested timeliness of information received from
the company and the rights of shareholders being observed.

Development of corporate governance

Influences on corporate governance
Governance theory concludes that there are two major factors affecting
organisational operation:
Agency theory leads to shareholder pressure and shareholder activism.
Stakeholder theory leads to stakeholder lobbying and concerns over social
responsibility.
In addition:
- Company law provides a framework within which operations occur
- Audit and auditors impact on governance and are covered in depth in internal
control and risk sections of the syllabus
- Codes of governance are developed by government, operate as a prerequisite
to membership of stock exchanges, maybe grounded in legislation, and guide
individual professional bodies.
Reasons for developing a code
It should reduce instances of fraud and corruption improving shareholder
perception and market confidence.
There is statistical evidence that poor governance equates to poor
performance.
Management consultancy, McKinsey, found that global investors were willing
to pay a significant premium for companies that are well-governed.
The existence of good governance is a decisive factor for institutional
investors.
Even if it does not add value, it reduces risk and huge potential losses to
shareholders.

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 Overview of Corporate Governance

Development of corporate governance codes

The process of development in corporate governance codes the UK
The UK Corporate Governance Code (formerly known as the Combined
Code) sets out standards of good practice for listed companies on board
composition and development, remuneration, shareholder relations, accountability
and audit. The code is published by the Financial Reporting Council (FRC).

1992: The Committee on the Financial Aspects of Corporate Governance

was set up in May 1991 by the Financial Reporting Council, the Stock Exchange
and the accountancy profession in response to continuing concern about standards
of financial reporting and accountability, particularly in light of the BCCI and
Maxwell cases. Its subsequent report (published in 1992), which became known as
the Cadbury Report after Sir Adrian Cadbury who Chaired the Committee,
developed a set of principles of good corporate governance that were incorporated
into the LSE’s Listing Rules. It also introduced the principle of ‘comply or explain’.
It made the following three basic recommendations:
-The CEO and Chair of companies should be separated;
-Boards should have at least three non-executive directors, two of whom
should have no financial or personal ties to executives;
-Each board should have an audit committee composed of non-executive
directors.

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 Overview of Corporate Governance

1995: The Greenbury Committee was established in 1994 by the

Confederation of British Industry in response to growing concern at the level of
salaries and bonuses being paid to senior executives. Its key findings were that
Remuneration Committees made up of non-executive directors should be
responsible for determining the level of executive directors' compensation packages,
that there should be full disclosure of each executive's pay package and that
shareholders be required to approve them. Remuneration should be linked more
explicitly to performance, and set at a level necessary to 'attract, retain and
motivate the top talent without being excessive. It also proposed that more restraint
be shown in awarding compensation to outgoing Chief Executives, especially that
their performance.
1998: The Hampel Committee was established to review the extent to which
the objectives of the Cadbury and Greenbury Reports were being achieved. The
resulting Hampel Report led to the publication, in June 1998, of The Combined
Code on Corporate Governance (the Combined Code) (PDF), which applied to all
listed companies. It added that:
-The Chair of the board should be seen as the "leader" of the non-executive
directors;
-Institutional investors should consider voting the shares they held at
meetings, though rejected compulsory voting; and
-All kinds of remuneration including pensions should be disclosed.
1999: The Turnbull Committee was established to provide direction on the
internal control requirements of the Combined Code, including how to carry out risk
management. The resulting Guidance helps boards meet the Code’s requirements
that they should maintain a sound system of internal control, conduct a review of
the effectiveness of that system at least annually, and report to shareholders that
they have done so.
2003: Sir Derek Higgs was commissioned by the UK Government to review
the roles of independent directors and of audit committees. The resulting Report
proposed that:
-At least half of a board (excluding the Chair) be comprised of non-executive
directors;
-That the non-executives should meet at least once a year in isolation to
discuss company performance;

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 Overview of Corporate Governance

-That a senior independent director be nominated and made available for

shareholders to express any concerns to;
-That potential non-executive director should satisfy themselves that they
possess the knowledge, experience, skills and time to carry out their duties with due
diligence;
-The revised Combined Code published in June 2003 brought in these
changes and applied to financial years beginning on or after 1 November 2003.
2008: A revised version (PDF) of the Combined Code was published in June
2008 and applied to financial years beginning on or after 29 June 2008. Changes
reflected new EU requirements relating to Audit Committees and corporate
governance statements.
The process of development in corporate governance codes the US
The Sarbanes-Oxley Act of 2002 is a law the U.S. Congress passed on July
30 of that year to help protect investors from fraudulent financial reporting by
corporations. Also known as the SOX Act of 2002 and the Corporate Responsibility
Act of 2002, it mandated strict reforms to existing securities regulations and
imposed tough new penalties on lawbreakers.
The Sarbanes-Oxley Act of 2002 came in response to financial scandals in
the early 2000s involving publicly traded companies such as Enron Corporation,
Tyco International plc, and WorldCom. The high-profile frauds shook investor
confidence in the trustworthiness of corporate financial statements and led many to
demand an overhaul of decades-old regulatory standards.
At the very beginning of 21st-century corporate governance gets above all
the attention, and reason for this lies in the growing number of scandals, crises, and
Close relationships between auditors and clients that occurred in those years. The
collapse of companies such as Enron, WorldCom, Tyco and others led to numerous
re-examination of the role of the committee, auditors, independent directors and so
on; and that led to questioning the professional ethics of the companies. The
scandals and crises are in fact merely the manifestation of a number of structural
problems for which corporate governance gained and keeps increasingly gaining in
importance in the field of country’s economic development. The cause of the
problem is in several segments, such as privatization – which drew a number of
issues of corporate governance in the areas that were previously in hands of the

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 Overview of Corporate Governance

state; technological development, liberalization and the opening of financial

markets, free trade and other structural reforms make the importance of corporate
governance grows, and with time it becomes more complicated; the growing role of
institutional investors through the mobilization of capital and increases the need for
well-managed arrangements; growth of international financial integration, trade,
and investment create difficulties in corporate governance across their borders.

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