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    Gover

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    INTRODUCTION TO CORPORATE GOVERNANCE Expected Learning Outcomes After studying the chapter, you should be able to . 1. 2. Describe what governance involves Enumerate the different contexts in which governance can be applied Name and explain the characteristics of good governance Explain the meaning, purpose and objectives of corporate ~ governance Know, and describe the principles of effective corporate governance Understand how the principles of goad corporate governance can be applied QUges CHAPTER 1 INTRODUCTION TO CORPORATE GOVERNANCE ‘WHAT IS GOVERNANCE? Generally, governance refers to a process whereby elements in society wiek 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 th government of a country, by a market or by a network — over a social system an whether through the laws, norms, power or language of an organized society. Governance therefore means the process of decision-making and the process b which decisions ate implemented (or not implemented) through the exercise ¢ power or authority by leaders of the country and / or organizations. Governance can be used in several contexts such as’ corporate governanct international governance, national governance and local governance. The focus of this book is on Corporate Governance. CHARACTERISTICS OF GOOD GOVERNANCE Whatever context good governance is used, the following: major characteristic should be present: . Participation | “Ful otaw { ecu wee eee Transparency —govtsnance En. als uit &ichasiveness feaien| (Consensus ‘Oriented _| 4 Chapter 1 ‘These characteristics are briefly described as follows: Participation Rule of Law Transparency Responsiveness Consensus Oriented Participation by both men and women is a key cornerstone of good governance. Participation could be.either direct or through legitimate institutions or representatives. It is important to point out that representative democracy does not necessarily mean that the concer 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 takeri ‘and their enforcement are done in a manner that follows rules 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 goveriance 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 contexts of a given society or community. : ____tntruetion to Corporate Governance _! Equity & Ensures that all its members feel that they have a stake in Inclusiveness and do not feel excluded from the mainstream of society This requires all groups, but particularly the mos vulnerable, have opportunities to improve or maintain thei well being. Effectiveness Good governance means that processes and institutions &E ficiency produce results that meet the needs of society whi making the best use of resources.at their disposal. Th concept of efficiency in the context of good governance also covers the sustainable use of natural resources and th protection of the environment. Accountability is a key requirement of good governanct Not only governmental institutions but also the prival sector and civil society organizations must be accountab! to the public and to their institutional stakeholders. Who accountable to whom varies’ ‘depending on wheth decisions or actions taken are internal or extemal to ¢ organization or institution. In general, an organization « an institution is accountable to those who will be affecte by its decisions or actions. Accountability cannot t enforced without transparency and the rule of law. CORPORATE GOVERNANCE: AN OVERVIEW Corporate governance is defined as the system of rules, practices and process by which business corporations are directed and controlled. It basically involv balancing the interests of a company's many stakeholders, such as shareholde management, customers, suppliers, financiers, government and the community. Corporate governance is a topic that has received growing attention in the pub in recent years as’ policy makers and others become more aware of t contribution good corporate governance makes to financial market stability @ economic growth. Good corporate governance is all about controlling ont business and so is relevant, and indeed vital, for all organizations, whatever si or structure, 6 Chapter | ‘The. corporate governance structure specifies thé distribution of rights and responsibilities among different participants in the corporation, such as the board, managers, shareholders, and other stakeholders, and spells out the rules and Procedures for making decisions on corporate affairs. By doing this, it also provides the structure through which the objectives are set and the means of 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: 1, Fair and Equitable Treatment of Shareholders A corporate governance structure ensures equitable and fair treatment of all shareholders of the eompany. In some organizations, a group of high- hnet-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. 2. 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 basis. Introduction to Corporate Governance 3. Increase Shareholders’ Wealth Another corporate governance’s main objective is to protect the long term interests of the shareholders. Firms with strong corporat governance structure are seen to have higher valuation attached to thei shares by businessmen. This only reflects the positive perception tha ‘g00d corporate governance induces potential investors to decide to inves ina company. 4, Transparency and Full Disclosure Good corporate governance aims at ensuring a higher degree o transparency in an organization by encouraging full disclosure o transactions in the company accounts. BASIC PRINCIPLES OF EFFECTIVE CORPORATE GOVERNANCE Effective corporate governance is transparent, protects the rights of shareholder and includes both strategic and operational risk management. It is concerned it both the long-term earning potential as well as actual short-term-earnings ani holds directors accountable for their stewardship of the business. The basic principles of effective corporate governance are threefold as presenter below: ‘Transparency and Full Disclosure 's the board ting us what i going on? ‘Accountability |s the board eng responsi? Good and Effective Governance Corporate Control Is the boar dong the ht hing? 8__Chapter 1 Positive answers to the following questions indicate’a firm's conformance and compliance with the basic principles of good corporate governance: A. Transparency and Full Disclosure 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 balaniced disclosure? > Can an oiltsider meaningfully analyze the organization's actions and performance? B, Accountability Does the board clarify its role and that of management? > Does it promote objective, ethical and responsible decision making? > Does it lay sold foundations for management oversight? > Does the composition mix of board membership ensure an appropriate range and mix of expertise, diversity, knowledge and added value? > Is the organization's senior official committed to widely accepted standards of correct and proper behavior? C. Corporate Control Has the board built long-term sustainable growth in shareholders’ value for the corporation? Does it create an environment to take risk? > Does it encourage enhanced performance? Does it recognize and manage risk? Does it recognize the legitimate interests of stakeholders? ‘Are conflicts of interest avoided such that the organization's best interests prevail at all times? > > Does it remuinerate fairly and responsibly? > > Introduction to Corporate Governance ILLUSTRATIVE APPLICATION OF THE BASIC PRINCIPLES OF CORPORATE GOVERNANCE AND BEST PRACTICE RECOMMENDATIONS Principles of Good Corporate Best Practice Recommendations Governance 1, company should ly solid foundation for_| +a. Formalize end dscose the functions management and oversight. It should reserved tothe board and those recognize and publish the respective roles delegated io management. and responsibles of board and management. 2 Shucure the board to add value, Have ‘board ofan effective composition, size and ‘commitment io adequately discharge its responsibities and dutes. 2a. Aboard should have independent directors. 2b, Theos of chaiperson and chief executive cer should not be exerciser by the same individual. 2b. The board should establish a nominator committee 3, Promote efical and responsibie decision- making. Actively promote ethical and responsible decision-making $a, Establish a code of conduct to guide the directors, the chief executive officer (or equivatent, the chief financial officer (ot equivalent) and any other key executive asto: ‘©The practices necessary to maintain confidence in te company's integty, and ‘© Theresponsiity and accountability of individuals for reporting and investigating reports of unethical practices 34. Disclose the policy concerning trad in company securities by direct coficers and emplo 10 Chapter 1 4 Safeguard intogiy in fandial reporing, Have a structure toindependenty verify ‘and safeguard the integtty of the ‘company’s financial reporting, “ar Require tie ciel execulve of (or equivalent) and the chief nancial ‘officer (or equivalent to stata in ‘iting tothe board thatthe ‘company’s financial eports present a ‘rue and fair ew, in al material | respects, ofthe company fnancal condition and operational results and are in accordance wih relevant accounting standards, “4b, The board should estabish an audit commits. 4-0, Structure the auit commitee so that it consists of, * Only non-executive or independent directors; ‘+ Anindependent chairperson, ‘who is not chairperson ofthe board and Atleast three (3) members. ‘Make timely and balanced disclosure Promate timely and balanced disclosure of all material matters concern the ‘company. ‘a. Estebish writen poicies and procedures designed to ensure ‘compliance wit IFRS. 5: Listing Rule discosure requirements ‘ang/to ensure accountability ata senior management level for compliance. Respect the rights of shareholders and facial the effective exercise of those rights a, Design and disclose a communications strategy to promote efectve communication wth shareholders and encourage effective partcpaton at general mectinge 6, Request the external auitoroatond the annual general meeting and be avalable o answer shareholder questions about the audit. Introduction to Corporate Governance _ 7. Recognize and manage risk. Establish a sound system of risk oversight and management and internal contr Ta, The board or appropriate board commitiee should establish poicies 0 tisk oversight and management. 2.a, The chief executive ofice (or equivalent) and the chet financial offoer (or equivalent) should state to the board in writing that: ‘© The statement given in accordance with best practice recommendation 4-2 (the integrity of financial statements {is founded on a sound system risk management and internal ‘compliance and contol which implements the poicies adopte by the board; and © The company’s sk managem ‘and internal compliance and control system is operating efficiently in al material respec noourage enfiancec performance. Fairly review and actively encourage enhanced board and management effectiveness. ‘a, Disclose the process for performand evaluation ofthe board, ts committe ‘and individual directors, end key executives. Remunerae fay and responsibly. Ensure that the level and conpositon of = remuneration is sufcient and reasonable and tat its relationstip to corporate and individual performance is defined. > 3, Provide decosure i relafon tothe company's remuneration potcies to enable investors to understand: ‘© The costs and benefis of thot polices; and ‘© The lnk between remuneratio paid to directors and key executives and corporate performance. Sb. The board should estabish.a remuneration committee 9-0, Cleary distinguish the structure ofp executive directors remuneration f that of executives. 9-4 Ensure that payment of equi-base executive remuneration is made in accordance with thresholds set in plans approved by shareholders. Chapter 1 10. Recognize the legimate interests of “{Oa. Estabish end disclose a code of conduct to guide compliance wit egal and other obigatons to legimate stakeholders, stakeholders. Recognize legal and oer ‘obligations to al legitimate stakeholders. REVIEW QUESTIONS Questions 1. What does governance mean? 2. Explain whether the following statement is true or false. “Governance is exercised only by the government of a country”. 3. Explain how governance can be used in the following contexts and give appropriate examples: a. national governance local governance . corporate governance 4. intemational governance 4, Explain briefly the eight (8) basic characteristics of good governance. 5. Transparency and accountability are synonymous. Explain whether the statement is correct or not. 6. Explain whether the following statement is true or false. “Responsiveness usually results to effectiveness and efficiency” 7. Define corporate governance. 8. What does corporate governance structure involve? 9. State the purpose of corporate governance, 10. Explain the basie objectives of corporate governance. 11. Explain the three basic principles of effective corporate governance. Introduction to Corporate Gover 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 basie 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? ©. 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 be Solid foundations for management oversight cc. Meeting the information needs of investment communities 4. Safeguards integrity in financial reporting 4, The rights of shareholders can be effectively upheld through the folowing measures excep . By establishing an audit committee b. By designing and disclosing a communications strategy to promote affective communication with shareholders. ¢. By encouraging active participation at general meetings. 4. By requiring the extemal auditor to attend the annual general ~~ meeting and to answer questions about the audit. 4 5 Chapter 1 To safeguard integrity in financial reporting, the business firm should do the following except a. Establish an audit committee b, Request the external auditor to attend the annual general meeting ©. Disclose the functions reserved to the board and those delegated to ‘management 4. Disclose the policy conceming trading in company securities by directors, officers and employees. ‘To encourage enhanced performance by the board and management, itis, 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 c. Distinguish between non-executive director's remuneration from that of executives, 4. 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 cc. Equity d. Accountability Chapter CORPORATE GOVERNANCE RESPONSIBILITIES AND ACCOUNTABILITIES Expected Learning Outcomes After studying the chapter, you should be able to... 1. “Explain the relevance of good governance to both large Publicly-listed companies and SMEs 2. Know the relationship between shareholders or owners and other stakeholders: 3. Identify the parties involved in Corporate Governance 4. Describe the respective broad rate and specific responsibilities of the different parties in a corporate setting QUIS CHAPTER 2 CORPORATE GOVERNANCE RESPONSIBILITIES AND ACCOUNTABILITIES INTRODUCTION Many of the characteristics of good governance described in Chapter 1 are relevant to both SME's and large listed public companies. As an organization grows in size and influence, these issues become increasingly important. However, it is also important to recognize that good corporate governance is based on principles underpinned by consensus and continually developing notions of good practice. There are no absolute rules-which iiist be adopted by all organizations. "There is no simple universal formula for good governance”. Instead emphasis is many localities, has been to encourage organizations to give appropriate attention to the principles and adopt approaches which are tailored to the specific needs of an organization at a given point in time. When corporate governance is discussed, it is often spoken of in terms of a company's corporate governance framework. The key elements within an effective governance framework, and the issues relating to each element, are set out on the following pages and are relevant to organizations large and small, in both the private and the public sectors. The table provides a useful structure for any company to consider its own approach to corporate governance and the ‘matters which may assist it to achieve its strategic objectives. Many of the matters listed may not be directly relevant in all situations and some ‘may not, in particular circumstances, be within the board's control, but it provides 4 useful context in which any organization can consider its governance needs so that they might be most appropriately addressed. The essence of any system of good corporate governance is to allow the board ‘and management the freedom to drive their organization forward and to exercise that freedom within a framework of effective accountability Corporate Governance Responsibilities and Accountabilities 17 RELATIONSHIP BETWEEN SHAREHOLDERS / OWNER(S) AND OTHER STAKEHOLDERS. The relationship between the shareholders / owners, management and other stakeholders in a corporation is shown below. Pubile Corporation Stakeholders [batt] | SraroersT-) Loree ‘Onners Treciie Brera Delegate | |_Marapement Atos roam L_—Owners |) Responses —Oparataral—] [Remus anapeent | Tena] [Seco ad) Audios [Lone rs Governance starts with the shareholders/owners delegating responsibilities through an elected board of directors to management and, in tur, 0 operating units with oversight and assistance from internal auditors, The board of directors and its audit committee oversee management and, in that role, are expected to protect the shareholders’ rights, However, it is important to recognize that management is part of the governance framework; management can influence who sits on the board and the audit committee as well as other governance conteols that might be put into place. {n return for the responsibilities (and power) given to.management and the board, ‘governance demands accountability back through the system to the shareholders. However, the accountabilities do not extend only to the shareholders. Companies also have responsibilities to other stakeholders. Stakeholders caii be anyone who is influenced, whether directly or indirectly, by the actions of a company, Management and the board have responsibilities to act within the laws of society and to meet various requirements of creditors, employees and the stakeholders, 18 Chapter 2 A broad group of stakeholders has an interest in the quality of corporate governance because it has a reletionship to economic performance and the quality of financial reporting, For example, it is likely that many employees have significant funds invested in pension plans. Those pension plans are designed to protect the financial interests of those employees in their retirement. We use the ‘word society in the diagram to indicate those broad interests. Ina similar fashion, employees and creditors have a vested interest in the organization and how it is governed. Regulators are a response to society's wishes to ensure that organizations, in their pursuit of returns for their owners, act responsibly and ‘operate in compliance with relevant laws. While shareholders / owners delegate responsibilities to various patties within the corporation, they also require accountability as to how well the resources“that have been entrusted to management and the board have been used. For example, the owners want accountability on such things as: © Financial performance ‘+ Financial transparency — financial statements that are clear with full disclosure and that reflect the underlying economics of the company. * Stewardship, including how well the company protects and manages the resources entrusted to it * Quality of internal control * Composition of the board of directors andthe nature of its activities, including information on how well management incentive systems are aligned with the shareholders’ best interests. The owners want disclosures from management that are accurate and objectively Verifiable. For instance, management has responsibility to provide financial reports, and in some cases, reports on intemal control effectiveness, Management has always had the primary responsbility for the accuracy and completeness of ‘an organization's financial statemeits. From a financial reporting perspective, it is management's responsibility to: * Choose which accounting principles best portray the economic substance of company transactions. * Implement a system of internal control that assures completeness and accuracy in financial reporting, ‘* Ensure that the financial statements contain accurate and complete disclosure, Corporate Governance Responsibilities and Accountabilties 19 PARTIES INVOLVED IN CORPORATE GOVERNANCE: ‘THEIR RESPECTIVE BROAD ROLE AND SPECIFIC RESPONSIBILITIES Corporate governance and financial reporting reliability are receiving considerable attention from a number of parties including regulators, standard setting bodies, the accounting profession, lawmakers and financial ‘statement users. Party: Overview of Responsibilities Shareholders ‘Broad Role Provide effective oversight through election of board members, | ‘pproval of major intiaives such as buying or seling stock, annual ‘eparts on maniagemert compensation, from the board. 2” Board of Directors | Broad Role ‘The major representative of slackholders to ensure thatthe ‘xganization fs run acceding tothe organizations charter and that ‘there is proper accountability Svecific activin incluce among ators: 4. Overall Operations '* Establsting the organizations vision, mission, values ard ethical standards, ‘© Delegatirg an appropriate level of authority to ‘manegement. © Demonstating leadership. ‘+ Assuming responsibilty forthe business ‘elationstip with CEO Including his or her ‘appointment, suocession, performance ‘remuneration and dismissal * Overseeing aspects of the employment the ‘management eam including management | ‘emuneraion, performance and succession planning. . * Recommending auditors and new directors to shareholder, ‘+ Ensuring efectve communication with shareholders other stakeholders, Crisis maragerent, Appointment ofthe CFO and corporate sooretay. 20. Chapter 2 2, Performance © Ensuring the organization's long term viability and enhancing the nancial poston, : ‘+ Formulating and overseeing implementation of corporate strategy. ‘Approving the plan, budget and corporate pois. © Agreeing key performance indicators (KPIs) + Monitoring / assessing assessment, performance of the organization, the board ise, management and "major projects. Overseeing the risk management framework and monitoring business risks. ‘+ Monitoring developments inthe industry and the ‘operating environment, Oversight ofthe and organization, including its contol and accountabilty systems, ‘© Approving and monitoring the progress of major capital expenditure, capital manegement and ‘oquistons and divestitures, 3. Compliance / Legal Conformance ‘= Understanding and protecting the organization's financial position, * Requiing and monitoring legal and regulatory comeliance including compliance with accounting standards, unfir trading legsiations, occupational health and safety and environmental standards, ‘© Approving annual financial reports, annual reports ‘and other public documents / sensitive reports, ‘© Ensuring an efiectve system of internal controls vists and is operating as expected. 3. Non-Executive or iad ROI: Independent Directors ‘The same as the broad role ofthe entire board of directors: ‘Specific actives in oth ‘© tounderstand the organization, its business, ts operating environment and its financial positon, ‘+ to apply expertise and sils inthe organization's bestinerests, * to.assist management to keep performance ‘objectives atthe top ofits agenda, [4 Wanagenient ——— stakeholder and recuiatory requirements _____]__stekeholdsr and requistory requirements. | + _10 ask apcropriate questions relative to operations * founderstand tha hismner role is not to act as ‘auditor, nor to act as a member of the management team, + torospect the collective, cabinet nature of the boards decisions, ‘o prepare for and attend board meetings, ‘+ {0300k information on a timely basis to ensure that helshe isin a positon to contribute tothe

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