CHAPTER 1 INTRODUCTION TO CORPORATE GOVERNANCE WHAT IS GOVERNANCE? Generally, governance refers to a process whereby elements in society wield power, authority and influence and enact policies and decisions concerning public life and social upliftment. It comprises all the processes of governing ~ whether undertaken by the government of a country, by a market or by a network — over a social system and whether through the laws, norms, power or language of an organized society. Governance therefore means the process of decision-making and the process by which decisions are implemented (or not implemented) through the exercise of power or authority by leaders of the country and / or organizations. Governance can be used’ in several contexts such as corporate governance, international governance, national governance and local governance. The focus of this book is on Corporate Governance. CHARACTERISTICS OF GOOD GOVERNANCE Whatever contest good governance is used, the following major characteristics should be present: Participation Rule of Law Accountability Nl soo0 Eectveness & Transparency = Governance |“ Effdeney ZN Responsiveness Equity & inclasveness| Consensus _ Oriented Scanned with CamScannerer 4 Chapter 1 These characteristics are briefly described as follows: Rule of Law . Transparency Responsiveness Consensus Oriented Participation by both men and women is a key rte of good governance. Participation could be eit! er direct or through legitimate institutions or representatives. It ig important to point out that representative democracy does not necessarily mean that the concern of the Most vulnerable in society would not be taken into consideration in decision making. Participation needs to be informed and organized. This means freedom of association and expression on one hand and an organized civil society on the other hand. Good governance requires fair legal frameworks that are enforced impartially. It also requires full protection of human rights, particularly those of minorities, Impartial enforcement of laws requires an independent judiciary and an impartial and incorruptible police force. Transparency means that decisions taken and their enforcement are done in a manner that follows tules and regulations. It means that information is freely available and directly accessible to those who will be affected by such decisions and their enforcement. It also means that enough information is provided and that it is provided in easily understandable forms and media. Good governance requires that institutions and processes try to serve the needs all stakeholders within a reasonable timeframe. Good governance requires mediation of the different interests in society to reach a broad consensus on what is in the best interest of the whole community and how this can be achieved, It also requires a broad and long-term Perspective on what is needed for sustainable human development and how to achieve the goals of such development. This can only result from an understanding... of the historical, cultural and social contents of a aivepul society or community. i Scanned with CamScannerEquity & Inclusiveness Effectiveness &Efficiency Accountability Introduction to Corporate Governance _ 5 Ensures that all its members feel that they have a stake in it and do not feel excluded from the mainstream of society. This requires all groups, but particularly the most vulnerable, have opportunities to improve or maintain their well being, Good governance means that processes and institutions produce results that meet the needs of society’ while making the best use of resources at their disposal. The concept of efficiency in the context of good governance also covers the sustainable use of natural resources and the protection of the environment. Accountability is a key requirement of good governance. Not only governmental institutions but also the private sector and civil society organizations must be accountable to the public and to their institutional stakeholders. Who is accountable to whom varies depending on whether decisions or actions taken are internal or external to an organization or institution. In general, an organization or an institution is accountable to those who will be affected by its decisions or actions. Accountability cannot be enforced without transparency and the rule of law. CORPORATE GOVERNANCE: AN OVERVIEW Corporate governance is defined as the system of rules, practices and processes by which business corporations are directed and controlled. It basically involves balancing the interests of a company's many stakeholders, such as shareholders, management, customers, suppliers, financiers, government and the community. Corporate governance is a topic that has received growing attention in the public in recent years as policy makers and others become more aware of the contribution good corporate governance makes to financial market stability-and economic growth. Good corporate governance is all about controlling one’s business and so is relevant, and indeed vital, for all organizations, whatever size or structure. Scanned with CamScanner6 Chapter I a — The corporate governance structure specifies the responsibilities among different managers, shareholde Procedures for making decisions on corporate provides the structure through which the attaining those objectives and monitoring performance. PURPOSE OF CORPORATE GOVERNANCE The purpose of corporate governance is to facilitate effective, entrepreneurial and prudent management that can deliver long-term success of the company. In simple terms, the fundamental aim of corporate governance is to enhance shareholders’ value and protect the interests of other stakeholders by improving the corporate performance and accountability. It is also about what the board of directors of a company does, how it sets the values of the business firm. OBJECTIVES OF CORPORATE GOVERNANCE, The following are the basic objectives of corporate governance: i distribution of rights and icipants in the corporation, such as the board, stakeholders, and spells out the rules and ‘affairs. By doing this, it also objectives are set and the means of . and other Fair and Equitable Treatment of Shareholders A corporate governance structure ensures equitable and fair treatment of all shareholders of the company. In some organizations, a group of high- net-worth individual and institutions who have a substantial proportion of their portfolios invested in the company, remain active through occupation of top-level positions that enable them to guard their interest. However, all shareholders deserve equitable treatment and this equity is safeguarded by a good governance structure in any organization. Self-Assessment Corporate governance enables firms to assess their behavior and actions before they are scrutinized by regulatory agencies. Business establishments with a strong corporate governance system are better able to limit exposure to regulatory risks and fines. An active and independent board can successfully point out deficiencies or loopholes in. the company operations and help solve issues internally on a timely basi Scanned with CamScannerIntroduction to Corporate Governance _1. 3. Increase Shareholders’ Wealth Another corporate governance’s main objective is to protect the long- term interests of the shareholders. Firms with strong corporate governance structure are seen to have higher valuation attached to their shares by businessmen. This only reflects the positive perception that B00d corporate governance induces potential investors to decide to invest ina company. 4. Transparency and Full Disclosure Good corporate governance aims at ensuring a higher degree of transparency in an organization by encouraging full disclosure of transactions in the company accounts. BASIC PRINCIPLES OF EFFECTIVE CORPORATE GOVERNANCE Effective corporate governance is transparent, protects the rights of shareholders and includes both strategic and operational risk management. It is concerned in both the long-term earning potential as well as actual short-term earnings and holds directors accountable for their stewardship of the business. The basic principles of effective corporate governance are threefold as presented belo ‘Transparency and Full Disclosure Is the board teling us what is going on? ‘Accountability 1s the board taking responsibilty? Good and Effective Governance Corporate Control Is the boara doing the ihtthina? Scanned with CamScannerChapter t 3 f ions indicate Positive answers to the following questions indi sate governarice: compliance with the basic principles of good corp A. Transparency and Full Diselosure B. Accountability C. Corporate Control a firm's conformance ang. Does the board meet the information needs of investment communities? : Does it safeguard integrity in financial reporting? Does the board have sound disclosure policies and practices? > Does it make timely and balanced disclosure? > Can an outsider meaningfully analyze the organization's actions | and performance? ‘ Does the board clarify its role and that of management? > Does it promote objective, ethical and responsible decision making? v Does it lay solid foundations for management oversight? vy Does the composition mix of board membership ensure a appropriate range and mix of expertise, diversity, knowledge and added value? oe Is the organization's sei official committed to widely accepted standards of correct and proper behavior? Has the board built long-term sustainable growth in shareholders’ value for the corporation? Does it create an environment to take risk? v Does it encourage enhanced performance? Does it recognize and manage risk? ¥ v Does it remunerate fairly and responsibly? v Does it recognize the legitimate interests of stakeholders? Are conflicts of interest avoided su interests prevail at all times? v ich that the organization's best Scanned with CamScannerIntroduction to Corporate Governance _9 ILLUSTRATIVE APPLICATION OF THE BASIC PRINCIPLES OF CORPORATE GOVERNANCE AND BEST PRACTICE RECOMMENDATIONS Principles of Good Corporate Governance Best Practice Recommendations 4. Accompany should lay solid foundation for management and oversight. It should recognize and publish the respective roles and responsibilities of board and management. 1-2, Formalize and disclose the functions reserved to the board and those delegated to management. 2. Structure the board to add value. Have a board of an effective composition, size and commitment to adequately discharge its responsibilities and duties. 2a. A board should have independent directors. 2b. The roles of chairperson and chief executive officer should not be exercised by the same individual. 2b. The board should establish a nomination committee * ‘3 Promote ethical and responsible decision- making, Actively promote ethical and responsible decision-making $a, Establish a code of conduct to quide the directors, the chief executive officer (or equivalent), the chief financial officer (or equivalent) and any other key executives asto: ‘© + The practices necessary to maintain confidence in the ‘company's integrity; and © The responsibilty and accountability of individuals for reporting and investigating reports of unethical practices 3b. Disclose the policy concerning trading in company securities by directors, officers and employees. Scanned with CamScanner10 Chapter 1 4. "Safeguard integrity in financial reporting, Have a structure to independently verify and safeguard the integrity of the company's financial reporting Ta. Require the chiel executive of (or equivalent) and the chief financial office (or equivalent) lo state in \witing to the board that the ‘company’s financial reports present a trve and fair view, in all material respects, of the ‘company’s financial condition and operational results and are in accordance with relevant accounting standards. 4-b. The board should establish an audit ‘committee. 4-c. Structure the audit committee 60 that it consists of ‘« Only non-executive or independent directors; © Anindependent chairperson, who is not chairperson of the board; and Atleast three (3) members. 5. Make timely and balanced disclosure. Promote timely and balanced disclosure of all material matters concerning the company. a, Establish wilten policies and procedures designed to ensure compliance with IFRS, 5. Listing Rule disclosure requirements ‘and to ensure accountability at a senior management level for compliance. Respect the rights of shareholders and facilitate the effective exercise of those rights. 6a, Dasign and discose a communications strategy to promote effective ‘communication with shareholders and encourage effective participation at general meetings. 6-b, Request the external auditor to attend the annual general meeting and be available to answer shareholder questions about the aucit. Scanned with CamScannerIntroduction to Corporate Governance _\\ 7 Recognize and manage risk Establish a sound system of risk oversight and management and internal control. 7-a. The board or appropriate board Committee should establish policies on risk oversight and management. . The chief executive officer (or equivalent) and the chief financial officer (or equivalent) should state to the board in writing that: The statement given in accordance with best practice recommendation 4-a (the integrity of financial statements) is founded on a sound system of risk management and internal ‘compliance and control which implements the policies adopted by the board; and The company's risk management and internal compliance and Control system is operating efficiently in all material respects. 2. Encourage enhanced performance, Fairly review and actively encourage enhanced board and management effectiveness. e Disclose the process for performance evaluation of the board, its committees and individual directors, and key executives. Remunerate faily and responsibly. Ensure thatthe level and composition of remuneration is sufficient and reasonable and that its relationship to corporate and individual performance is defined. a, Provide disclosure in relafion tothe company's remuneration policies to enable investors to understand: ‘© The costs and benefits of those policies; and © The link between remuneration paid to directors and key executives and corporate performance 9-b. The board should establish a remuneration committee. 9c, Clearly distinguish the structure of non- executive director's remuneration from thal of executives. 9.4, Ensure that payment of equily-based executive remuneration is made in accordance with thresholds set in plans approved by shareholders. Scanned with CamScanner12 Chapter 1 1d disclose a code of ish an 10. Recognize the legitimate interests of 10-8. a ve uidecomplence with ga stakeholders. Recognize legal and other Jigations to legitimate and other obliga obligations to all legitimate stakeholders, stakeholders REVIEW QUESTIONS Questions , 3. Explain how governance can be us appropriate examples: a. national governance b. local governance ©. corporate governance d. international governance 4, Explain briefly the eight (8) basic characteristics of good governance. 5. Transparency and accounta statement is correct or not. 6. Explain whether the following statement is true or false. “Responsivent 7. Define corporate governance. 8. What does corporate governance structure involve? 9. State the purpose of corporate governance. 10. Explain the basic objectives of corporate governance. 11. Explain the three basic principles of effective corporate gov What does governance mean? Explain whether the following statement is true or false. “Governance is exercised only by the government ofa country”. ed in the following contexts and give ty are synonymous. Explain whether the usually results to effectiveness and efficiency”. Scanned with CamScannerIntroduction to Corporate Governance | 13 Multiple Choice Questions 1. The basic principle of “transparency and full disclosure” for effective corporate governance responds positively to the following questions except. a. Does the board of directors safeguard integrity in financial reporting? b. Does the board meet the information needs of investment ‘communities? ; c. Can an outsider meaningfully analyze the firm’s actions and performance? d, Has the board built long-term sustainable growth in shareholders” value for the corporation? 2. The basic principle of “accountability” for effective governance answers the following questions positively, except a. Does the board recognize and manage risk? b. Does the board lay solid foundations for management oversight? c. Does the composition mix of board membership ensure an appropriate range and risk of expertise diversity, knowledge added value? d. Does the board promote objective, ethical and responsible decision making? 3. “Transparency and full disclosure” principle advocates the following except a. Sound disclosure policies and practices b. Solid foundations for management oversight c. Meeting the information needs of investment communities d. Safeguards integrity in financial reporting 4. The rights of shareholders can be effectively upheld through the following measures except a. By establishing an audit committee b. By designing and disclosing a communications strategy to promote affective communication with shareholders. c. By encouraging active participation at general meetings. 4. By requiring the extemal auditor to attend the annual general meeting and to answer quest ions about the audit. sia Scanned with CamScanner4 Chapter 5. To safeguard integrity in financial reporting, the business firm should dg the following except a. Establish an audit committee b. Request the external auditor to att ¢. Disclose the functions reserved to t! management d. Disclose the policy concerning trading in com directors, officers and employees. end the annual general meeting he board and those delegated to pany securities by 7 To encourage enhanced performance by the board and management, it is recommended that the following should be adopted except a. Disclosure of the process for performance evaluation of the board, its committees. individual directors and by executives. b. A remuneration committee | ©. Distinguish between non-executive director's remuneration from that of executives. d, Establish policies on risks oversight and management ‘The characteristic of good governance where fair legal framework are enforced impartially is a. Participation b. Rule of Law c. Equity d. Accountability Scanned with CamScanner