Appendix 1

UNIVERSITI TUNKU ABDUL RAHMAN

FACULTY OF BUSINESS AND FINANCE

Assignment Cover Sheet

Course Details
Subject Code/Title : MPU33023/MPU33423 BUSINESS AND SOCIETY
Tutor’s Name : Cik.Hayati Binti Yusof
Tutorial Group : Tutorial 2

AssignmentDetails
Topic of Assignment: Corporate governance and the role of the board of directors

Students’ Details

No. Name Student I.D. No.

1. Chong Jetson 1904186

2. Mock Wen Jun 2103907

3. Tan Han Yu 2106352

4. Tan Zhi Yang 1904254

5. Vincent Woo Weng Kei 2200746

6. Wong Chia Jin 1901656

Assignment Overall Marks: _________ Marks

Important Note: Submission of assignment is the responsibility of the students.
 Appendix 2

UNIVERSITI TUNKU ABDUL RAHMAN

FACULTY OF BUSINESS AND FINANCE

MPU33023/MPU33423 BUSINESS AND SOCIETY

MARKING SCHEME FOR PROJECT I

Item Assessment Criteria Mark Marks

Allocation Awarded

(a) Abstract
5
(b) Introduction
10
(c) Discussion
20
(d) Recommendation
10

(e) Conclusion
5
(f) Overall report format and structure
5

(g) APA referencing

5

Total Marks 60

Covert to (30%)

Comment(s):

Name and Signature of Marker:

Date:
Introduction
The procedure of monitoring or administering a firm is referred to as corporate
governance. From Investopedia, the "system of rules, practices, and procedures that govern
and regulate a corporation" is corporate governance, and the board of directors of a
corporation often supervises it. Corporate governance standards are significant they provide
an unambiguous path for an organization's goals and operations and outline its ethical
standards (SCU, 2023). The board of directors is among the key components of corporate
governance. Having been legally tasked with setting business objectives, formulating
fundamental policies, and selecting top staff to carry them out, the board is a selected group
of individuals. To ensure that the company is operated efficiently and that the interests of
every participant, including shareholders, are protected, the board also evaluates
management's effectiveness. Directors often serve for 8 to 10 years (Lawrence et al., 2017).
Moral hazard, which refers to the risk that business decisions or behaviors may cause
damage or negatively affect the public interest or ethics (SCU, 2023), is a pervasive problem
in corporate and the board of directors. Because the role of the board of directors is the key
component of the governance of the company, when a moral hazard arises within the board of
directors, such as unauthorized use of authority, collusion between the top and the bottom of
the hierarchy, misrepresentation of performance and financial information, and abuse of
power for personal gain, then the chances of moral hazard arising from corporate governance
will be greatly increased. Moral hazards in corporate governance can be mainly divided into
the following categories: environmental pollution risk, which means to pursue profits,
enterprises may adopt some irresponsible behaviors, which lead to environmental pollution;
social responsibility risks, such as employee relations, consumer rights, and interests, social
welfare (SCU, 2023); personal safety risk, related to the risk of personal safety caused by
unsafe production processes and product quality problems in the enterprise.
Moral hazard is an incredibly significant issue related to business and society, which
may seriously impact a company's reputation, brand image, and market position, impact
society and the environment, and even jeopardize the company's survival. And the board and
corporate governance are interrelated, both need to find ways to reduce the likelihood that
moral hazard will arise. From the perspective of corporate governance and the role of the
board of directors, an important basis for an enterprise's existence and sustainable
development is its institutional norms, and a good company should have to be convincing to
society. Whereas the consequences of moral hazard are the exact opposite of this and create
serious business and social problems, they must be taken seriously.
Discussion
Moral hazard represents the risks when partners enter into contracts in bad faith or
providing the misleading information about its properties, debits or creditworthiness.
Moreover, moral hazard also means the partners has a motivation to take the risks in
negatively attempt to realize the benefits before the settlement of the contract. Moral hazards
exist whenever two partners agree with each other, Each partner, in contracts, has the
occasion to benefit from behaving against the rules and standards that are set out by the
contracts. Every time a partner in the contracts does not suffer from the possible risk
consequences, the moral hazard will increase (Kenton, 2020). Moral hazard in the corporate
governance refers to a situation where the executives or employees of a company are
encouraging to take the excessive risks or engaging in unethical behavior because they do not
bear the full consequences of their actions. It arises when the individuals or entities are
shielded from the potential negative outcomes of their own decisions. Moral hazard typically
arises when there is a separation between ownership and control in the company.
Shareholders, who are the owners of the company, represent the management and decision-
making to executives and managers. However, these managers may have the different
objectives and risk preferences than the shareholders, which can lead to moral hazard.
Therefore, the board of directors plays a significant role in corporate governance in providing
the oversight, guidance, and accountability in the management, so the board of directors
might help in minimize the moral hazard and promote more responsible decision-making
within the organization.
Moral hazard had been linked in the economic crisis, because in among other things,
some of the individuals were creating the risks that will be led to the crisis that may not have
the interests sufficiently aligned with those put at the risks by their own actions. An example
was from a Securities and Exchange report in 2008 on ratings agencies, which focusing on
the rating agencies’ activities in rating subprime residential mortgage-backed securities
(“RMBS”) and collateralized debt obligations (“CDOs”) which are linked to the subprime
residential mortgage-backed securities. The purpose of the examinations was to develop an
understanding of the practices of the rating agencies with surrounding of the rating of RMBS
and CDOs. the challenging issue of when board of directors should look after the risks that
can be stated in the following formula which are the board of directors should actively look
after a C & E area if the sum of the following two is relatively high for that area which are
the general risks to the company and moral hazard in connection with leaving C & E for that
area to the sole discretion of senior management and board of directors. That was a moral
hazard analysis identifies from an incentive’s perspective, senior managers’ interests
regarding a particular risk area might deviate sufficiently from those of the company so that
the board of directors should look after what is otherwise regarded as an area of the moderate
risk (Jeffrey M. Kaplan, 2009).
The Theory of Agency and Moral Hazard
Corporate governance is an important component of the current business environment
since it influences organisational behaviour and decision-making. It relates to a collection of
procedures and policies that guarantee the management is effectively under control and
accountable to shareholders and other stakeholders. However, the problem of moral hazard,
which can have negative effects for all parties involved, is an ongoing issues in corporate
governance. In this discussion, a theory relating to the moral hazard problem in corporate
governance will be examined, along with its causes, effects, and possible solutions.
The moral hazard problem in corporate governance can be clarified using the concept
of agency. This theory holds that shareholders (the principals) provide managers (the agents)
decision-making power and control over firm resources so they may act in their best interests
(Abdullah, 2009). However, this delegation establishes a principal-agent relationship, which
raises the risk of moral hazard.
When agents have a motivation to act in a way that serves their own interests over
those of the principals, this is known as moral hazard. Moral hazard can take many different
forms in the context of corporate governance, including excessive risk-taking,
misappropriation of company's assets, and manipulating financial information (Arcot &
Bruno, 2011). These behaviours may result in monetary losses, damage to reputation, and a
decrease in the organization's long-term value.
The occurrence of moral hazard in corporate governance is caused by a number of
factors. One important factor is the separation of ownership and control, which occurs when
shareholders, who are the actual owners of the business, lack direct authority over managerial
decisions (Achim & Borlea, 2013). Due to managers' better comprehension of the day-to-day
operations and financial performance of the company, this separation results in an
information asymmetry. Managers might take advantage of opportunities for their own
benefit while hiding risks or unfavourable outcomes from shareholders due to this
information asymmetry.
The imbalance of incentives between shareholders and managers is another factor
(Achim & Borlea, 2013). Stock options, bonuses, and other performance-based remuneration
are frequently given to managers as part of their compensation packages. Although these
incentives are intended to bring managers' interests and shareholders' interests together, they
may unintentionally provide perverse incentives. For instance, managers could be encouraged
to prioritise short-term gains above any other consideration or take excessive risks in order to
maximise their own remuneration, even if performing so is harmful for the company's
sustainability in the long run.
Moral hazard has wide-ranging effects on corporate governance that might have
negative effects on all stakeholders. From a financial standpoint, moral hazard can result in
resource misallocation, ineffective investment decisions, and in severe circumstances, even
bankruptcy. The majority of these effects are encountered by shareholders in the form of
decreases in stock prices and lower investment value.
Moral hazard is also damaging businesses' reputations by eroding the public's trust in
companies (Achim & Borlea, 2013). Relationships with clients, suppliers, and other
important stakeholders may suffer as a result of this lack of trust. Additionally, it can result in
more stringent regulatory oversight, legal proceedings, and possible penalties. If moral hazard
is not controlled, the overall effectiveness and stability of the financial system may be
affected.
Recommendations
The moral hazard problem can be effectively addressed by strengthening risk
management. When one party takes risks knowing that the other party will be responsible
for the negative outcomes if those risks occur to progress, the scenario is referred to as moral
hazard. Organisations can establish the right policies and incentives to assist reconcile
individual interests with the organization's primary objectives (Maverick, 2021). Board of
directors can encourage employees to engage in ways that reduce moral hazard by attaching
incentives and rewards to moral conduct and prudent risk-taking. In order to identify and
reduce potential moral hazard situations, regular oversight and monitoring are important
(Maverick, 2021). Boards should establish strong control mechanisms, doing audits, and
putting in place reporting systems that motivate employees to disclose illegal activities or
potential dangers are all necessary to achieve this. To lessen the damaging effects of moral
hazard, the business may also deploy risk mitigation methods (San-Jose et al., 2022).
Diversifying risks, putting in place risk-sharing tools like insurance, and creating backup
plans for unforeseen circumstances can all contribute to this. Organisations can prevent
excessive risk-taking by distributing the risks and ensuring that those responsible for the
consequences bear them (San-Jose et al., 2022).
By establishing a culture of integrity, accountability, and ethical decision-making
within organisations, promoting ethical leadership can help to lessen the moral hazard
problem (Bazerman, 2020). Leaders that maintain moral principles act as great role models
for their teams. They create explicit ethical standards and requirements, ensuring that
employees are aware of what constitutes appropriate conduct and reducing the possibility that
people may act in a way that is immoral. Leaders encourage people to emphasise the common
good through promoting ethical decision-making, which encourages people to think about
how their decisions will affect all stakeholders more broadly. Leaders help people in
navigating moral conundrums and lessen the danger of moral hazard by encouraging ethical
decision-making (Bazerman, 2020). Additionally, they promote an open climate where
employees feel free to voice moral concerns or warn of potential moral hazards. They also
encourage direct communication, attentive listening, and non-retaliatory reactions
(Bazerman, 2020). Leaders may recognise and resolve moral hazard problems before they get
out of hand by creating a safe environment for ethical discussion. When making decisions,
ethical leaders consider the broader influence on all stakeholders, as opposed to only their
own interests or short-term benefits. Furthermore, they put the general good first and work
for a better society. Moreover, morally responsible leaders include ethical considerations into
risk management procedures, proactively addressing moral hazards and reducing their
negative effects (Bazerman, 2020). Overall, organisations can foster an environment where
people are more conscious of moral quandaries, empowered to make moral decisions, and
accountable for their deeds through encouraging ethical leadership.
Another effective approach to manage moral hazard problems is by implementing
incentive alignment measures that discourage opportunistic behaviour while promoting
desired outcomes of corporate executives and managers with those of shareholders and
stakeholders (Dou et al, 2020). This can be achieved by designing compensation packages
that incorporate performance-based incentives, such as stock options and bonuses tied to
long-term company performance (Narayanan.2014). By tying executive rewards to the
organization's success, the likelihood of moral hazard behaviour decreases. On the other
hand, the board of directors also require actively monitors the actions of top executives and
ensures they act in the best interests of the company and its stakeholders (Gillian & Starks.,
2016). Through regular review and oversight, the board can identify and address potential
moral hazard problems. This includes monitoring the implementation of strategic plans,
financial performance, risk management, and compliance with legal and ethical standards.
Last but not least, having independent directors on the board is essential to reduce
moral hazard. Independent directors are individuals who have no affiliation or financial
interest in the company, ensuring impartiality in decision-making (Dezoort et al., 2020). They
bring an objective perspective to the boardroom and can act as a check on managerial
behaviour. Besides, it is important for the board of directors to establish clear of policies and
guidelines to guide decision-making processes, ensure transparency, and align executive
behaviour with the best interests of the company and its stakeholders. Effective
communication channels between the board and executives, such as regular meetings and
reporting mechanisms, foster accountability and reduce the potential for moral hazard
(Dezoort et al., 2020).
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