Corporate Governance, Business Ethics, 2019-2020 Edition MA. ELENITA BALATBAT CABRERA BBA MBA CPA CMA PRESENTLY: ‘Academic and Business Consultant President and CEO, CLA Consultancy and Training Center, Inc. FORMERLY: \Vice Chairman and Examiner, Professional Regulatory Board of Accountancy World Bank Consultant Dean, College of Business Administration, Lyceum University of the Philippines CPA Review Director & Reviewer, Professional Review and Training Center, Inc. Professor of Accounting & Finance, University of the East, Far Eastem University, ‘Do La Salle University, Centro Escolar University, St. Scholastica’s College Audit Staff, SGV and Co., CPAs GILBERT ANTHONY B. CABRERA BBA MBA CPA PRESENTLY: : Vice President - Risk and Finance, Global Insurance Brokerage, USA. FORMERLY: : ‘Chief Financial Officer, Food Retail Conglomerate, USA. Senior Auditor, SGV and Co., CPAs Accounting Instructor Liniversity of Maryland, Robert Smith Schoo! of Business University of the East, ManilaPhilippine Copyright, 2019 by MA. ELENITAALATBAT CABRERA CiLBDpPNA OPN. CABRERA Any copy of this book not bearing the signature of the author(s) shall be considered as proceeding from an illegal source. The Internet addresses listed in the text were accurate at the time of publication, The inclusion of a website does not indicate endorsement by the authors or GIC Enterprises & Co, Ine. and they do not guarantee the accuracy of information | presented ai these sites. ALL RIGHTS RESERVED ISBN; 978-621-416-073-0 Published & Printed by: GIC ENTERPRISES & CO., INC. ‘National Book Development Board Registered 2017 C. M. Recto Avenue, Manila PhilippinesAbout the Authors Ma. Elenita B. Cabrera BBA MBA CPA CMA Dean Cabrera graduated Magna Cum Laude from the University of the East with a degree of Bachelor of Business Administration, major in Accounting and was one of the topnotchers when she passed the CPA Licensure Board Examination. She earned her Master in Business Administration major in Financial Management from the University of the Philippines and is a candidate for Doctor of Education at the University of the East. She.is a holder of a Certificate in Management Accounting from the Institute of Certified Management Accountants of Victoria, Australia. Dean Cabrera worked with SGV & Co. as Staff Auditor. She taught Financial Accounting, Financial Management, Management Advisory Services, Auditing Theory and Practice in various colleges and universities and authored books in these subjects. She previously held the position of Dean of the College of Business Administration at the Lyceum of the Philippines University. A former Vice Chairman of the Professional Regulatory Board of Accountancy, she was the BOA representative to the Financial Reporting Standards Council (FRSC), Philippine Interpretations Committee (PIC) and Auditing and Assurance Standards Council (AASC). She served as the Chairman of the PRC CPE Couneil for Accountancy and Chairman of the CHED Technical Committee for Accountancy Education. She was a World Bank Project Consultant on the creation of an Accounting Oversight Board in the Philippines. She was a recipient of the Philippine Institute of Certified Public Accountants (PICPA) awards as Outstanding CPA in Education, Honorary Life Membership, Distinguished Accountancy Author and 2018 Accountancy Hall of Fame. Gilbert Anthony B. Cabrera BBA MBA CPA Gilbert received his bachelor's degree in Accountancy from the University of the East, Cum Laude. He obtained a Master in Business Administration degree with concentrations on Intemational Finance and Accounting from the University of Maryland, College Park, Robert H. Smith School of Business. A certified public accountant, he has public accounting experience with SGV & Co. (Emst and Young Member Firm) and teaching experience with the University of the East, Manila and University of Maryland, Robert H. Smith School of Business. Presently; he is ~ Vice-President, Risk and Finance, of Global Insurance Brokerage in California, USA. An active member of the Association of Filipino Finance Managers in California, he is also a former Board Member of Bay Area Red Cross.Preface The business environment continues to change in dramatic ways and university graduates Joining the corporate world or entering the accountancy profession, whether it be in the public practice sector, management accounting practice, intemal audit or accounting information system management, must be prepared for a high standard of responsibilty. This textbook on Corporate Governance, Business Ethics, Risk Management and Internal Control, aims to equip its readers the basic knowledge, skills and perspective that are necessary in facing this Challenge. Having a solid understanding of fundamental business, its governance, risk management, ethical practices and intemal contral will become even more important in a world of advancing technology. While businesses in different industty have strikingly different characteristics, most have some fundamental characteristics in common. A fundamental widely accepted mode! of business consists of govemance, objectives, strategies, business processes, risks, controls and reporting. This book is organized to provide authoritative, practical and contemporary content as follows: Unit I- Corporate Governance This unit describes corporate govemance and the partes involved in it It discusses the structure that specifies the distribution of rights and responsibilities among different participants in a corporation. It also spells out the rules and procedures for making decisions on corporate affairs. Unit Il - Business Ethics This unit discusses the various forms of unethical business practices. It also articulates how to institutionize integrity in all aspects of business process and how business with integrity enjoys competitive advantage in both government and private transactions. Unit Ill - Risk Management This unit emphasizes the nature, forms and basic management of risks related to business. Unit IV - Internal Control: A Vital Tool in Managing Risk This unit articulates the nature, scope, elements and importance of internal control. It also covers extensive discussion of what how fraud can be prevented, detected and reduced if not fully eliminated in an enterprise. The end of chapter materials have been thoroughly chosen and streamlined to be much more user friendly. Special thanks to our families for their continued support and encouragement, £282. g.8.@.Preface UNIT Chapter Chapter Chapter Chapter UNIT Chapter Chapter Chapter Chapter Chapter Chapter 0 Contents in Brief CORPORATE GOVERNANCE INTRODUCTION TO CORPORATE GOVERNANCE CORPORATE GOVERNANCE RESPONSIBILITIES AND ACCOUNTABILITIES SECURITIES AND EXCHANGE (SEC) COMMISSION CODE OF CORPORATE GOVERNANCE SEC CODE OF CORPORATE GOVERNANCE, CONTINUED BUSINESS ETHICS INTRODUCTION TO ETHICS BUSINESS ETHICS COMMON UNETHICAL PRACTICES OF BUSINESS ESTABLISHMENTS ETHICAL DILEMMA ADVOCACY AGAINST CORRUPTION INITIATIVES TO IMPR OVE AND REDUCE coRRUPTION ESS ene 26 76 93 103 109 121 128 146UNIT i Chaprer Chapter 12 UNIT Iv Chapter 13 Chapter 14 Chapter 15 Chapter 16 Chapter 17 Appendices Appendix A Appendix B Appendix C Appendix =D Appendix © Appendix F Appendix G References INTRODUCTION TO RISK MANAGEMENT RISK MANAGEMENT PRACTICAL INSIGHTS IN REDUCING AND MANAGING BUSINESS RISKS INTERNAL CONTROL: A VITAL TOOL IN MANAGING RISK OVERVIEW OF INTERNAL CONTROL, FRAUD-AND ERROR ERRORS AND IRREGULARITIES IN THE TRANSACTION CYCLES OF THE BUSINESS ENTITY INTERNAL CONTROL AFFECTING ASSETS INTERNAL CONTROL AFFECTING LIABILITIES: AND EQUITY Code of Ethics for Professional Teachers International Standards for the Professional Practice of Internal Auditing International Standards of Ethical Conduct for Practitioners of Management Accounting Code of Business Conduct and Ethics ofa Telecommunications Company Code of Business Conduct and Ethics of a Manufacturing Company Code of Business Conduct and Ethics of a Commercial Bank ‘ Partial List of Organizations who are actively Participating in the “Integrity Initiative” Campaign against Corruption Wi 162 163 180 195 196 217 232 244 264 273 281 283 287 293 303 307 311ww Contents Preface I CORPORATE GOVERNANCE Chapter 1 INTRODUCTION TO CORPORATE GOVERNANCE UNIT Expected Learning Outcomes What is Governance? Characteristics of Good Governance Corporate Governance: A Overview Purpose of Corporate Governance Objectives of Corporate Governance Basic Principles of Effective Corporate Governance illustrative Application of the Basic Principles of Corporate Governance and Best Practice Recommendations Review Questions 2 CORPORATE GOVERNANCE RESPONSIBILITIES AND ACCOUNTABILITIES Expected Learning Outcomes Chapter Introduction Relationship between Shareholders / Owners and Other Stakeholders Parties involved in Corporate Governance Their Respective Broad Role and Specific Responsibilities ° Shareholders * Board of Directors © Non-Executive or Independent Directors © Management © © Audit Committees + Regulators Board of Accountancy ° External Audit © Internal Audit Review Questions NaaueW w ©SECURITIES AND EXCHANGE COMMISSION (SEC) CODE OF CORPORATE GOVERNANCE Expected Learning Outcomes The Board's Governance Responsibilities Principles 1 to7 Disclosure and Transparency Principles 8 0 11 Internal Control System and Risk Management Framework Principle 12 Cultivating a Synergies Relationship with Shareholders Principle 13 Duties to Stakeholders Principles 14 t0 16 Introduction The Code of Corporate Governance Objective Approach Organization Recommendation Explanations Coverage Definition of Terms The Board's Governance Responsibilities Establishing a Competent Board Establishing Clear Roles and Responsibilities of the Board Establishing Board Committees Fostering Commitment Reinforcing Board Independence “Assessing Board Performance Strengthening Board Ethics Enhancing Company Disclosure Policies and Procedure Strengthening the External Auditor's Independence and Improving Review Questions and Exercises 26 28 28 29 29 29 29 29 29 30 30 30 30 30 30 30 31 31 31 34 34 34 39 49 37 59 65 67 68 7 "4 26vi Chapter UNIT Chapter SEC CODE OF CORPORAT! £ GOVERNANCE, CONTINUED Expected Learning Outcomes Increasing Focus on Non-Financial and Sustainability Reporting / Promoting a Comprehensive and Cost-efficient ‘Access to Relevant Information Strengthening the Internal Control System and Enterprise Risk Management Framework Cultivating a Synergic Relationship with ‘Shareholders Respecting Rights of Stockholders and Effective Redress for Violation of Stakeholder's Rights Encouraging Employees Participation Encouraging Sustainability and Social Responsibility Review Questions Il BUSINESS ETHICS INTRODUCTION TO ETHICS Expected Learning Outcomes Introduction Characteristics and Values Associated with Ethical Behavior Why is Ethical Behavior Necess ary? Why do People Act Unethically? ” Categories of Ethical Principle The Need for Professional Ethics Review Questions 76 7 B 94 95 96 98 8 100 102 76 93 4Chapter 6 BUSINESS ETHICS Expected Learning Outcomes Basic Concept of Business Ethics Purposes of Business Ethics Main Purpose Special Purpose , Scope and Impact of Business Ethics Economic Impact Social Impact Environmental Impact Impact on Business Managers Ethical Challenges in Today's World Review Questions Chapter. 7 COMMON UNETHICAL PRACTICES OF BUSINESS ESTABLISHMENTS Common Unethical Practices of Business Establishments, Misrepresentation and Over Persuasion Direct Misrepresentation Deceptive packaging Misbranding or mislabeling False or misleading advertisement Adulteration Weight understatement Measurensent understatement Quantity undersiatement Indirect Misrepresentation Caveat emptor Deliberate withholding of information Passive deception Over Persuasion Corporate Ethies Unethical Practices of Corporate Management Board of Directors Executive Officers and Lower Level Managers Some Unethical Practices of Employees Review Questions 103 104 104 104 104 105 106 106 106 106 107 108 109 110 110 110 10 10 110 ww i Vu 12 (12, 112, 112 M2 113 113 13 113 114 7 19 vil 103, 109vill 8 ETHICAL DILEMMA Chapter Expected Learning Outcomes 1, Introduction ee Resolving Ethical Dilemmas 122 ‘Mlustrative Case: Resolving an Ethical Dilemma 122 Ethical Issue 18 Who is Affected and How is each Affected 123 Bert's Available Alternatives 124 Consequences of Each Alternative 124 Appropriate Action Bs Review Questions and Exercises 126 Chapter. 9 ADVOCACY AGAINST CORRUPTION Expected Learning Outeomes 128 What is Corruption? —- 129 What does Corruption Look Like? 130 Why and how does a Person Become Corrupt? 131 1 Effects of Corruption 131 Characteristics of Corruption 133 The Philippine Corruption Report 137 sudicial System 137 Police 8 Public Services B Land Administration 4 Tax Adminisiration be Customs Administration fe Public Procurement Pid Natural Resources Be Prevention of Corruption ie Clear Business Process = ole on Gifts and Entertainment ie aration of Conflict of ine 2 : rest Convenient Corruption Reporti re Efforts to Curb Corruption Throws pete Y Vigilance of Civil Sociery 48" Legislation Ia 143 Review Questions 145Chapter 10 INITIATIVES TO IMPROVE BUSINESS ETHICS AND REDUCE CORRUPTION ide Expected Learning Outcomes 146 Introduction 147 The Iniegrity Initiative Campaign 147 Corporate Values id Need for a Code of Conduct 149 The Unified Code of Conduci for Business 150 ~ Top Management 150 Human Resources 130 Sales and Marketing 150 Finance and Accounting i Procurement ' Logistics (52 Implementation and Monitoring 152 Bishops-Businessmen's Conference Philippines — Code of Ethics for the Philippine Business 153 Survey of Laws Advocating Business Ethics 159 Review Questions 160 UNIT III INTRODUCTION TO RISK MANAGEMENT . 162 Chapter 11 RISK MANAGEMENT 163 Expected Learning Outcomes 163 Introduction 164 Risk Management Defined 164, Basie Principles of Risk Management 165 Process of Risk Management 165 Elements of Risk Management 166 Relevant Risk Terminologies 167 1. Risk Associated with Investments 167 Il. Risks Associated with Manufacturing, Trading and Service Concerns 170 Ul. Risk Associated with Financial institutions 171 Potential Risk Treatments 172 Areas of Risk Management 1B Risk Management Framework 174 Steps in the Risk Management Process 175 Review Questions 178x CAL INSIGHTS IN REDUCING AND PRACTI Chapter 12 ?P ING BUSINESS RISKS MANAG g Outcomes sh Expected Learnin, Understand the oes ; rdentify and Prioritize Risks Gatee the Acceptable Level of Risk Understand Why Risks Become Reality Apply a Simple Risk Management Process Risk Assessment and Analysis Risk Management and Corurot ‘Avoiding and Mitigating Risks Create a Positive Climate for Managing Risk Overcoming the Fear of Risk Controlling and Monitoring Enterprise-wide Risk Practical Considerations in Managing and Reducing Financial Risk Improving Profitability Assessinent of Market and Exit Barries Break-even Analysis Controlling Costs Practical Techniques to Improve Profitability Avoiding Pitfalls Review Questions and Exercises UNIT IV INTERNAL CONTROL: ‘ A VITAL TOOL IN MANAGING RISK Chapter 13 OVERVIEW OF INTERNAL CONTROL, Expected Learning Outcumes Nature and Purpose of Internal Control Internal Control System Defined Elements of Internat Control A. Coniral Environment B. Entity's Risk Assessment Process C._ Information System, including the Business Processes, Relevant to Financial Reporting and Communication D. Control Activities E. Monitoring of Contrals Review Questions and Exercises 180 180 181 181 183 183 184 184 185 186 186 187 187 188 188 189 189 190 191 192 194 195 196 196 197 197 198 198 198 203 205 210 2ulChapter Chapter 4 15 FRAUD AND ERROR Expected Learning Outeomes ‘Inoroduction Types of Misstatements Misstatemenis arising from Misappropriation of Assets Misslatements arising from Fraudulent Financial Reporting The Fraud Triangle Incentives or Pressure to Commit Fraud Opportunities to Commit Fraud Rationalizing the Fraud Risk Factors arising from Misappropriation uf Assets Risk Factors arising from Fraudulent Financial Reporting Responsibility for the Prevention and Detection of Fraud ¢ Review Questions and Exercises ERRORS AND IRREGULARITIES IN THE TRANSACTION CYCLES OF THE BUSINESS ENTITY Expected Learning Outcomes Sales and Collections Cycle ‘Errors in Recording Sales Collections Transactions Frauds in sales and Collections Acquisition and Payments Cycle ‘Errors in the Acquisitions and Payments Cycle Frauds in the Acquisitions and Payments Cycle Payroll and Personnel Cycle Errors Frauds involving Payroll Review Questions and Exercises 217 218 218 218 219 219 220 220 221 223 224 226 227 232 233 233 233 235 235 236 237 237 237 239 xi 217 232xii Chapter 16 INTERNAL CONTROL AFFECTING ASSETS Expected Learning Outcomes 244 ‘omtrol over Cash Transactions 245 ee Misstatements — Cash Receipts 246 Potential Misstatements — Cash Disbursements 248 Internal Control over Financial Investments 249 Potential Misstatements — Financial Investments 250 Internal Control over Receivables 251 ‘Sources and Nature of Notes Receivable 251 Internal Control of Accounts Receivable and Revenue 251 Control Environment 252 Potential Misstatements — Revenue / Receivables 252 Internal Control over Notes Receivable 254 Internal Control over Inventories and Cost of Goods Sold 255 Sources and Nature of Inventories and Cost of Goods Sold 255 Potential Misstatements — Inventory / Cost of Goods Sold 256 Internal Conirol over Property, Plant and Equipment 257 Potential Misstatemenus ~ Investments in Property, Plant and Equipment 259 Review Questions and Exercises 260 Chapter’ 17 INTERNAL CONTROL AFFECTING LIABILITIES AND EQUITY 264 Expected Learning Outcomes 264 Internal Control over Avcounis Payable 265 Potential Misstatements — Accounts Payable 266 Amernal Control over Other Debts 267 Internal Control over Debt Authorization by the Board of Directors 267 Use of an Independent Trustee 268 uw, waren Payments of Boards and Notes Payable 268 trol over Owners’ Equity 268 Internal Control on Equity 269 & est a Store Capital Transactions by the’ Independent Regis a = Ta 2 “gistrar and Stock Transfer Agent 269 ernal Control over Dividends 270 Review Questions and Exercises ail 244Appendices Appendix Appendix Appendix Appendix Appendix Appendix Appendix References G ‘Code of Ethics for Professional Teachers International Standards for the Professional Practice of Internal Auditing International Standards of Ethical Conduct for Practitioners of Management Accounting, Code of Business Conduct and Ethics ot'a Telecommunications Company Code of Business Conduct and Ethics ofa Manufacturing Company Code of Business Conduct and Ethics of a Commercial Bank Partial List of Organizations who are actively Participating in the “Integrity Initiative” Campaign against Corruption 273 281 283 287 293 303 aditUNIT I CORPORATE GOVERNANCE Chapter 1 Introduction to Corporate Governance Corporate Governance Responsibilities and Accountabilities Securities and Exchange Commission (SEC) Code of Corporate Governance SEC Code of Corporate Governance, ContinuedChapter 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 aoe p good corporate governance QU sy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, noims, 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 context good governance is used, the following major characteristics should be present: ion Rule of Lay | "T Accountability a sooo _f Transparency == Governance ar Responsiveness Faulty &Incusiveness Consensus Oriented4 Chapter 1 These characteristics are brief Participation Rule of Law Transparency Responsiveness Consensus Oriented ly described as follows: Participation by both men and women isa 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 concern of the most vulnerable in society would not be taken into consideration ipation needs to be informed and in decision making. Partici inforr 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 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 reasonab! 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 contexts of a given society or community,Introduction to Corporate Governance 5 Equity & Ensures that all its members feel that they have a stake in it Inclusiveness 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, Effectiveness Good governance means that processes and institutions Efficiency 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 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 event 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.6 Chapter ! The corporate governance structure. specifies i Teast re i ‘biliti » different participants in the c 3 , esponsibilities among different pé pa holders, and spells out the rules and managers, shareholders, and other stakel m * ai procedures for making decisions on corporate affairs By dole tle Ss J provides the structure through which the objectives are sot and the means o attaining those objectives and monitoring performance: PURPOSE OF CORPORATE GOVERNANCE te governance is to facilitate effective, entrepreneurial and Edie sllaes ibia esy in deliver long-term success of the company. In prudent management that ca > in simple terms, the fundamental aim of corporate governance IS to enhance shareholders’ value and protect the interests of other stakeholders by improving nd accountability. It is also about what the board of the corporate performance ar u ‘ ri how it sets the values of the business firm. directors of a company does, OBJECTIVES OF CORPORATE GOVERNANCE ‘The following are the basic objectives of corporate governance: l. 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. 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 C ce 7 Increase Shareholders? Wealth Another corporate governanee’s main objective is to protect the long- term interests of the shareholders. Firms with strong corporate Dace are seen to have higher valuation attached to their snares Dy businessmen. This only reflects the positive perception that good 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 below: Transparency and Full Disclosure Is the board telling us what is going on? Accountability Is the board taking responsisilty? Good and Effective Governance Corporate Control {s the boat doina the right thing?‘ons indicate a firm’s conformance and Positive answers to the following que: compliance with the basic principles of good corporate governance: ‘Transparency and Full Disclosure Does the board meet the information needs of investment communitie: Does it safeguard integrity in finaneial 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? B. Accountability Does the board clarify its role and that of management? > Does it promote objective, ethical and responsible decision making? > Does it lay solid 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 remunerate fairly and responsibly? > Dogs it.recognize the legitimate interests of stakeholders? > Are conflicts of interest avoided such that the organization's best interests prevail at all times?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 1. Acompany should lay solid foundation for menagement and oversight. It should recognize and publish the respective roles and responsibilities of board and management. {-a, 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 responsibiities and duties. , 2a. Aboard should have independent directors. 2b. The roles of chairperson and chief executive officer should not be exercised by the same individuel. 2b. The board should establish a nomination committee 3. Promote ethical and responsible decision- making, Actively promote ethical and responsible decision-making, 3a, Establish a code of conduct to guide the directors, the chief exeoutive officer (or equivalent), the chief financial officer (or equivalent) and any other key executives as to: «The practices necessary to maintain confidence in the company's integrity; and © Theresponsibilty 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.10 Chapter t 4. Safeguard integrity in financial reporting. Have a structure to independently verify ‘and safeguard the integrity of the ‘company's financial reporting, 4a. Require the chief executive of (or equivalent) and the chief financial officer (or equivalent) to state in writing to the board that the company's financial reports presenta true 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 commitiee. 4-6, Structure the audit committee so that it consists of: © Only non-executive or independent directors; An independent chairperson, who is not chairperson of the board; and * Atleast three (3) members. 5. Make timely and balanced disclosure. 5-a, Establish written policies and Promote timely and balanced disclosure of procedures designed to ensure all material matters concerning the compliance with IFRS. company. 5-b. Listing Rule disclosure requirements and to ensure accountability at a senior management level for compliance. 6. Respect the rights of shareholders and facilitate. the effective exercise of those fights. 6-a. Design and disclose a communications strategy to promote effective communication with shareholders and encourage effective participation at general meetings. Request the external auditor to attend the annual general meeting and be available to answer shareholder questions about the audit. Bb.Introduction to Corporate Governance _|1 7. Recognize and manage risk. Esiabi lablish a sound system of risk oversight and Management and internal control. T-a. The board or appropriate board commiltee should establish policies on tisk oversight and management. The chief executive officer (or equivalent) and the chief financial officer (or equivalent) should stale 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 intemal compliance and cconircl system is operating efficiently in all material respects. 2a. Encourage enhanced performance. Fairly review and actively encourage enhanced board and management effectiveness. Be . Disclose the process for performance evaluation ofthe board, its committees and individual directors, end key executives. Remunerate faily and responsibly. Ensure that the level and composition of remuneration is suficient and reasonable and that its relationship to corporate end individual performance is defined. 9-a, Provide disclosure in relation to the company's remuneration policies to enable investors to undérstand: * The casts and benefits of those policies; and «The link between remuneration paid to directors and key executives and corporate performance. 9b. The board should establish a remuneration committee. 9-c, Clearly distinguish the structure of non- executive director's remuneration from that of executives. 9-d, Ensure that payment of equity-based executive remuneration is made in accordance with thresholds set in plans approved by shareholders.12_ Chapter I 70. Recognize the legitimate interests of stakeholders. Recognize legal and other . Establish and disclose a code of we ‘conduct to guide compliance with legal and other obligations to legitimate obligations to all legitimate stakeholders. akan, REVIEW QUESTIONS Questions Ts 2. What does governance mean? Explain whether the following statement is true or false. “Governance is exercised only by the government of a country”. Explain how governance can be used in the following contexts and give appropriate examples: a. national governance b. local governance ¢. corporate governance d. international governance Explain briefly the cight (8) basic characteristics of good governance. Transparency and accountability are synonymous. Explain whether the statement is correct or not. Explain whether the following statement is true or false. usually results to effectiveness and. efficiency”. “Responsiveness Define corporate governance. What does corporate governance structure involve? State the purpose of corporate governance. . Explain the basie objectives of corporate governance. - Explain the three basic principles of effective corporate governance.Introduction to Corporate Governance 13 Multiple Choice Questions lL. The basic principle of “transparency and full disclosure” for effective Corporate governance responds positively to the following questions except. as b. Does the board of directors safeguard integrity in financial reporting? Does the board meet the information needs of investment communities? € 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? 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? “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 ‘The ‘rights of shareholders can be effectively upheld through the following measures except : a. By establishing an audit committee ao b. By designing and disclosing a communications strategy to promote affective communication with shareholders. c. By encouraging active participation at general meetings. d, By requiring the external auditor to attend the annual general meeting and to answer questions about the audit.14 Chapter 1 3. al reporting, the business firm should do To safeguard integrity in finanei 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 : d. Disclose the policy concerning 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, 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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 LUGSCHAPTER 2 CORPORATE GOVERNANCE RESPONSIBILITIES AND ACCOUNTABILITIES INTRODUCTION Many of the characteristics of good governance described in Chapter | 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 must 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 a 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 Accounabl RELATIONSHIP BETWEEN . ; 5 OTHER STAKEHOLDERS SHAREHOLDERS / OWNER(S) AND The relationship. betw The eslavoraip between the shareholders / owners, management and other akeholders in a corporation is shown below. Public Corporation Stakeholders Board of Shareholders 7 Directors Owners Executive External Cele Management Have Auditors Sharcholders / Owners > ey Responsibilities | [— Operational ||| Accountabilties| [Regulators Management internal Society and Auditors Others Governance starts with the shareholders/owners delegating responsibilities through an elected board of directors to management and, in turn, to 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 controls that might be put into place. In return for the responsibilities (and power) given to management and the board, governance demands acco! ntability back through the system to the shareholders. However, the accountabilities de not extend only to the shareholders. Companies also have responsibilities to other stakeholders, Stakeholders can 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.1S Caspeer 2 A broad group of stakeholders has an interest in the quality of comorate governance because it has a relationship to economic performance and the quslity of financial reporting. For example, itis likely that many employees have significant finds invested in pension plans. Those pension plans are designe ie 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 sociefy’s wishes to. ensure that organizations. in their pursuit of retums for their owners, act responsibly and operate in compliance with relevant laws. While shareholders / owners delegate responsibilities to various parties 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 ransparency — 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 and the 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 a respensibility to provide financial Feports, and in some cases, reports on internal control effectiveness. Management bas always had the primary responsibility for the accuracy and completeness of an organization's financial statements. From a financial Teporting perspective, it is management's responsibility to: * Choose which accounting principles best portray the economic substance of company transactions. © Implement a system of internal contro! that assures completeness and accuracy in financial reporting. ¢ Ensure that the financial statements contain accurate and complete disclosure.Corporate Governance Responsibilities and Accountabilities 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 1. Shareholders’ Broad Role: Provide effective oversight through election of board members, ‘approval of rtajor initiatives such as buying or selling stock, annual feports on management compensation, from the board. 2. Board of Directors Broad Role: ‘The mejor representative of stockholders fo ensure that the organization is run acoorcing to the organization's charter and that there is proper accountability. ‘Specific activities include among others: Overall Operations «Establishing the organization's vision, mission, values and ethical standards, © Delegating an appropriate level of authority to management © — Demonstrating leadership. ¢ Assuming responsibilty for the business elationship with CEO including his or her ‘appointment, succession, performance remuneration and dismissal. © Overseeing aspects of the employment of the management team including management temuneration, performance and succession planning. = Recommending auditors and new directors to shareholders. «Ensuring effective communication with shareholders other stakeholders. © Cisis management. * Appointment of the CFO and corporate secretary.20 Chapter 2 2; 3 Performance ss Ensuring the organization's long term viebility and enhancing the financial position , Formulating and overseeing Implementation of rate strategy. i daoana the at budget and corporate policies. Agreeing key performance indicators (KPIs) Monitoring / assessing assessment, performance of the organization, the board itself, management and major projects, Overseeing the risk management framework and monitoring business risks. Monitoring developments in the industry and the operating environment. a © Oversight of the and organization, including its control and accountabilily systems. © Approving and monitoring the progress of major capital expenditure, capital management and acquisitions and divestitures. Compliance / Legal Conformance _ © Understanding and protecting the organization's financial position. * Requiring and monitoring legal and regulatory + compliance including compliance with accounting standards, unfair trading legislations, occupational health and safety and environmental standards. © Approving annual financial reports, annual reports and other public docurnents / sensitive reports. ‘Ensuring an effective system of internal controls exists and is operating as expected, 3. Non-Executive or Independent Directors Broad Role; ‘The same as the broad role of the entire board of directors Specific a include among others: * — lounderstand the organization, its business, its Operating environment and its financial Position, * to apply expertise and skills in the ‘organization's best interests, * — loassist management to keep performance objectives at the top of its agenda,Corporate Governance Responsibilities and Accountabilities 21 © to understand that his/her role is not to act as auditor, nor to act as a member of the management team, i ‘¢ lorespect the collective, cabinet nature of the board's decisions, © to prepare for and altend board meetings, * to'seek information on a timely basis to ensure that helshe is in a position to contribute to the discussion when a matter comes before the board, cr alert the chairman in advance to the need for further information in relation to a particular matter, and e _ to.ask appropriate questions relative to operations. 4, Management Broad RO: Operations and accountability. Manage the organization cffectively; provide accurate and timely reports to shareholders and other stakeholders. Specific activities include emong other recommend the strategic direction and translate the strategic plan into the operations of the business manage the company’s human, physical and financial resources to achieve the organization's objectives — run the business assume day to day responsibly for the organization's conformance with relevant laws and regulations anid tts compliance framework davelop, implement and manage the organization's risk management and internal contol fremeworks ' develop, implement and update polices and procedures be elert o relevant trends in the industry and the organization's operating environment provide information to the board got as conduit between the board and the organization developing financial and other reports that meet public, stakeholder and regulatory requirements.22_ Chapter 2 5. Audit Committees of the | Broad Role: Board of Directors ; Provide oversight of the internal and external audit function and the process of préparing the annual financial statements as well as public reports on internal control Specific activities include among others: © — Selecting the external audit firm | ‘© Approving any non-audit work performed by the audit firm * — Selecting and / or approving the appointment of the Chief Audit Executive (Internal Auditor) * — Reviewing and approving the scope and budget of the internal audit function ‘+ Discussing audit findings with internal auditor and external auditor and advising the board (and management) on specific actions that should be taken 6. Regulators Broad Role; a. Board of Accountaricy Set accounting and auditing standards dictating underlying financial reporting and auditing concepts; set the ‘expectations of audit quality and accounting quality, Specific act Iclude among others: * Conducting CPA Licensure Board Examinations * Approving accounting principles * Approving auditing standards © Interpreting Previously issued standards implementing quality control processes to ensure audit quality . Educating Members on audit and accounting requirements .b. Seourtion and Exchange Commission Corporate Governance Responsihilittes and Accounabltities 23 Broad Rol; | Enaure the accuracy, timeliness and fies of pubis reptting of | financial and other ifonnvation for public companies. Specific activities include among others; + Reviewing flings with the SEC + Interacting with the Financial Reporting Standards Council in sting accounting standards + Speclying independence standards required of auditors thal report on public financial statements * Identify corporate frauds, investigate causes, and suggest remedial actions 7. External Auditors 14d Role: Perform audits of company financial statements to ensure that the statements are free of material misstatements including misstatements that may be due to fraud, ‘Specific activities include among others: © Aucit of public company financial statements + Audits of nonpublic company financial statements * Other services such as tx or consulting 8 Internal Auditors Broad Role: Perform audits of companies for compliance with company policies and laus, audits 1 evaluate the efficiency of operations, and periodic evaluation and tests of controls, ‘Specific activities include among others: # Reporting results and analyses to management (including operational management) and audit committees # _ Evalvaling internal controls24. Chapter 2 REVIEW QUESTIONS Questions 1. v we 8. 9. “Small business enterprises do not need good governance Do you agree? Explain. Does good governance require absolute rules that must be adopted by all organizations? What is the essence of any system of corporate governance? Where does the board of directors derive its authority? To whom is the board of directors accountable? ‘On what aspects do shareholders demand accountability from the board of directors? What is management's responsibility as far.as financial reporting is concerned? Describe the broad role of the shareholders in a corporation. Describe the broad role of the Board of Directors. 10. What are the specific activities of the board of directors? Multiple Choice Questions 1, Approving annual financial reports and other public documents “are specific responsibilities of a. Management b. Board of directors c. Shareholders d. Employeeswe Corporate Governance Responsibilities and Accountabilities 25 Providing oversight of the internal and external audit function, the Process of preparing the annual financial statements and public reports on internal control are the responsibility of a. Board of directors b. Chief executive officer c. Chief financial officer 4d. Audit committee of the board of directors Who is responsible for ensuring the accuracy, timeliness of public reporting of financial and other information for public companies? a. External auditors- b. Seéurities and exchange commission c. Shareholders d. Board of Accountancy Who performs audit of companies for compliance with company policies and laws, audits efficiency of operations and periodic evaluation and tests of controls? a, External auditors b. Internal auditors ¢, Commission on audit d. Chief accountant An independent director is expected to a. Apply expertise and skills in the corporations best interest b. Asset management to keep performance objectives at the top of its agenda c. Respect the collective, cabinet nature of the board’s decision d. Act as conduit between the board and the organization~~ SECURITIES AND EXCHANGE COMMISSION (SEC) CODE OF CORPORATE GOVERNANCE Expected Learning Outcomes After studying the chapter, you should be able to... 1. Understand the need for the Gode of Governance for publicly-listed companies. - 2. Know the sixteen (18) governance responsibilities of the Board of Directors of publicly-listed companies. 3. Explain the meaning of "comply and explain" approach. 4. Describe the three aspects of the Code, namely * Principles * Recommendations * Explanations 5. Know what constitutes a competent board and how can it be established. 6. Understand the composition, functions and responsibilities of the board committees that can be established such as the * Audit Committee * Corporate Governance Committee ¢ Board Risk Oversight Committee « Related Party Transaction Committee 7. Know how the directors can show full commitment to the company 8. Understand how independence and Objectivity of the board can be teinforced and enhanced. 8. Describe how the performance and effectiveness of the board can be assessed, RamsCHAPTER 3 SEC CODE OF CORPORATE GOVERNANCE FOR PUBLICLY-LISTED COMPANIES (“CG Code for PLCs”) Securities and Exchange Commission SEC MC No, 19, Series of 2016 * On November 10, 2016, the Securities and Exchange Commission approved the Code of Corporate Governance for publicly-listed companies. Its goal is to help companies develop and sustain an ethical corporate culture and keep abreast with recent developments in corporate governance. One of its salient provisions is for publicly-listed companies to establish a code of business conduct and submit a new manual on Corporate Governance that would “provide standards for professional and ethical behavior as well as articulate acceptable and unacceptable conduct and practices”. The Board of Directors is required to implement the code and make sure that management and employees comply with the internal policies set. While many companies have already developed their Code of Business Conduct and Ethics, the real challenge is in its implementation and monitoring compliance. The SEC Code of Corporate Governance is published in this book, not only to acquaint readers particularly future professionals and businessmen of these rules and regulations but also to serve as reference and guidelines to currently existing publicly-listed corporations. (Source: www.sec.gov-ph)28_Chapter 3 ~— iple 1 Principle 2: Principle 3: Principle 4: Principle 5: Principle 6: Principle 7: working, board and to sustain consistent with ts Of its ‘The company should be headed by a competent, to foster the long-term success of the corporation, its competitiveness and profitability in a manner ¢ i its corporate objectives and the long-term best interes shareholders and other stakeholders, The fiduciary roles, responsibilities and accountabilities of the Board as provided under the law, the company’s articles and by- laws, and other legal pronouncements and guidelines should be clearly made known to all directors as well as to stockholders and other stakeholders, Board committ hould be set up to the extent possible to support the effective performance of the Board’s functions, particularly with respect to audit, risk management, related party transactions, and other key corporate governance concerns, such as nomination and remuneration. The composition, functions and responsibilities of all committees established should be contained in a publicly available Committee Charter, To show full commitment to the company, the directors should devote the time and attention necessary to properly and effectively perform their duties and responsibilities, including sufficient time to be familiar with the corporation’s busine: The Board shauld endeavor to exercise objective and independent judgment on all corporate affairs, ‘The best measure of the Board’s effectiveness is through an assessment process. The Board should regularly carry out evaluations 10 appraise its performance as a body, and assess whether it possesses the right mix of backgrounds and competencies, Members of the Board are duty-bound to apply high ethical standards, taking into account the interests of all stakeholders.SEC Code of Corporate Governance _29 ISCLOSURE AND TRA| iSPARENCY Principle Th = ; i ra ean should establish corporate disclosure policies and Pp cedures that are practical and in accordance with best Practices and regulatory expectations. Principle 9: The Company should establish standards for the appropriate selection of an external auditor, and exercise effective oversight of the same to strengthen the external auditor’s independence and enhance audit quality. Principlel0: The company should ensure that material and reportable non- financial and sustainability issues are disclosed Principle 11: The company should maintain a comprehensive and cost- efficient communication channel for disseminating relevant information. This channel is crucial for informed decision- making by investors, stakeholders and other Interested users. INTERNAL CONTROL SYSTEM AND RISK MANAGEMENT FRAMEWORK Prineiple 12: To ensure the integrity, transparency and proper governance in the conduct of its affairs, the company should have a strong and effective internal control system and enterprise risk management framework. CULTIVATING A SYNERGIC RELATIONSHIP WITH SHAREHOLDERS The company should treat all shareholders fairly and equitably, Principle 13: 7 ‘ i 9 Iso recognize, protect and facilitate the exercise of their and al; rights.30_ Chapter 3 DUTIES TO STAKEHOLDERS blished by law, by contractual Principle 14: The rights of stakeholders estal a . relation and through voluntary commitments a eo respected. Where stakeholders’ rights and/or intere: a a stake, stakeholders should have the opportunity to obtain prompt effective redress for the violation of their rights. Principle 15: A mechanism for employee participation should be developed » create a symbiotic environment, realize the company’s goals and participate in its corporate governance processes. The company should be socially responsible in all its dealings Principle 16: ; with the communities where it operates. It should ensure that its interactions serve its environment and stakeholders in a positive and progressive manner that is fully supportive of its comprehensive and balanced development. INTRODUCTION 1. The Code of Corporate Governance is intended to raise the corporate governance standards of Philippine corporations to a level at par with its regional and global counterparts. The latest G20/OECD1 Principles of Corporate Governance and the Association of Southeast Asian Nations Corporate Governance Scorecard were used as key reference materials in the drafting of this Code. 2. The Code will adopt the “comply or explain” approach. This approach combines voluntary compliance with mandatory disclosure. Companies do not have to comply with the Code, but they must state in their annual corporate governance reports whether they comply with the Code provisions, identify any areas of non- compliance, and explain the reasons for non-compliance. 3. The Code is arranged as follows: Principles, Recommendations and Explanations. The Principles can be considered as high-level statements of corporate governance good practice, and are applicable to all companies.SEC Code of Corporate Governance _31 4. The Recommendations are objective criteria that a intended fo identify the specific features of corporate governance good practice that are recommended ‘for companies operating according to the ‘ode. Alternatives to a Recommendation may be justified in Particular circumstances if good governance can be achieved by other means. When a Recommendation is not complied with, the company must disclose and describe this non-compliance, and explain how the overall Principle is being achieved. The alternative should be consistent with the overall Principle. Desoriptions and explanations should be written in’ plain language and in a clear, complete, objective and precise manner, so that shareholders and other stakeholders can assess the company's governance framework. 5. The Explanations strive to provide companies with additional information on the recommended best practice. This Code does not, in any way, prescribe a “one size fits all” framework. It is designed to allow boards some flexibility in . establishing their corporate governance arrangements. Larger . companies and financial institutions would generally be expected to follow most of the Code’s provisions. Smaller companies may decide that the costs of some of the provisions outweigh the benefits, or are less relevant in their case. Hence, the Principle of Proportionality is considered in the application of its provisions. 6. The Code of Corporate Governance for publicly listed companies is the first of a series of Codes that is intended to cover all types of corporations in the Philippines under supervision of the Securities and Exchange Commission (SEC). 7. Definition of Terms: Corporate Governance ~ the system of stewardship and control to tide organizations in fulfilling their long-term economic, moral Tegal and social obligitions towards their stakeholders. Corporate governance is a system of direction, feedback and control sain regulations, performance standards and ethical guidelines to Pei he Board and senior management accountable. for ensuring veteal behavior ~ reconciling long-term customer satisfaction with cihietpolder value —to the benefit ofall stakeholders and society.32_ Chapter 3 Its purpose is to maximize the organization’s long-term noes creating sustainable value for its shareholders, stakeholders and the nation. Board of Directors - the governing body elected by the stockholders that exercises the corporate powers of a corporation, conducts all its business and controls its properties. Management — a group of executives given the authority by the Board of Directors to implement the policies it has laid down in the conduct of the business of the corporation. Independent director - a person who is independent of management and the controlling shareholder, and is free from any business or other relationship which could, or could reasonably be perceived to, materially interfere with his exercise of independent judgment in carrying out his responsibilities as a director. Executive director —a director who has executive responsibility of day-to-day operations of a part or the whole of the organization. Non-executive director — a director who has no executive responsibility and does not perform any work related to the operations of the corporation. Conglomerate — a group of corporations that has diversified business activities in varied industries, whereby the operations of such businesses are controlled and managed by a parent corporate entity. Internal control — a process designed and effected by the board of directors, senior management, and all levels of personnel to provide reasonable assurance on the achievement of objectives through efficient and effective operations; reliable, complete and timely financial and management information; and compliance with applicable laws, regulations, and the organization’s policies and procedures. he ‘ Organization for Economic Co-operation and DevelopmentSEC Code of Corporate Governance _ 33 Enterprise Risk Management — a process, effected by an entity’s Board of Directors, management and other personnel, applied in Strategy setting and across the enterprise that is designed to identify Potential events that may affect the entity, manage risks to be within its risk appetite, and provide reasonable assurance regarding the achievement of entity objectives. Related Party — shall cover the company’s subsidiaries, as well as affiliates and any party (including their subsidiaries, affiliates and special purpose entities), that the company exerts direct or indirect control over or that exerts direct or iridirect control over the company; the company’s directors; officers; shareholders and related interests (DOSRD, and their close family members, as well as corresponding persons in affiliated companies. This shall also include such other person or juridical entity whose interest may pose a potential conflict with the interest of the company. Related Party Transaetions — a transfer of resources, services or obligations between a reporting entity and a related party, regardless of whether a price is charged. It should be interpreted broadly to include not only transactions that are entered into with related parties, but also outstanding transactions that are entered into with an unrelated party that subsequently becomes a related party. Stakeholders - any individual, organization or society at large who can either affect and/or be affected by the company’s strategies, policies, business decisions and operations, in general. This sncludes, among others, customers, creditors, employees, suppliers, investors, as well as the government and community in which it operates. __ | 7 Committee of Sponsoring Organizations of the Tread way Commission (coso Framework)3 _Chapter 3 THE BOARD'S GOVERNANCE RESPONSIBILITIES 1. ESTABLISHING A COMPETENT BOARD Principle The company should be headed by a competent, working board to foster the long-term success of the corporation, and to sustain its competitiveness and profitability in a manner consistent with its corporate objectives and the long-term best interests of its shareholders and other stakeholders. . Recommendation 1.1 The Board should be composed of directors with a collective working knowledge, experience or expertise that is relevant to the company’s industry/sector. The Board should always ensure that it has an appropriate mix of competence and expertise and that its members temain qualified for their positions individually and collectively, to enable it to fulfill its roles and responsibilities and respond to the needs of the organization based on the evolving business environment and strategic direction. Explanation Competence can be determined from the collective knowledge, experience and expertise of each director that is relevant to the industry/sector that the company is in. A Board with the necessary knowledge, experience and expertise can properly perform its task of overseeing management and governance of the corporation, formulating the corporation’s vision, mission, strategic -objectives, policies and Procedures that would guide its activities, effectively monitoring management's performance and supervising the proper implementation of the same. In this regard, the Board sets qualification standards for its members to facilitate the selection of potential nominees for board seats, and to serve as a benchmark for the evaluation of its performance.SEC Code of Corporate Governance _38 Recommendation 1,2 The Board should be composed of a majority of non-executive directors who possess the necessary qualifications to effectively participate and help secure objective, independent judgment on corporate affairs and to substantiate proper checks and balances. Explanation The right combination of non-executive directors (NEDs), which include independent directors (IDs) and executive directors (EDs), ensures that no director or small group of directors can dominate the decision-making process. Further, a board composed of a majority of NEDs assures protection of the company’s interest over the interest of the individual shareholders. The company determines the qualifications of the NEDs that enable them to effectively participate in the deliberations of the Board and carry out their roles and responsibilities. Recommendation 1.3 ‘The Company should provide in its Board Charter and Manual on Corporate Governance a policy on the training of directors, including an orientation program for first-time “directors and relevant annual continuing training for all directors. Explanation The orientation program for first-time directors and relevant annual continuing training for all directors aim to promote effective board performance and continuing qualification of the directors in earrying-out their duties and responsibilities. It is suggested that the orientation program for first-time directors, in any company, be for at least eight while the annual continuing training be for at least four hours. hours, All directors should be properly oriented upon joining the board. This ensures that new members are appropriately apprised of their duties and before beginning their directorships. The orientation program covers SEC-mandated topics on corporate governance and an introduction to the company’s business, Articles of Incorporation, and Code of Conduct. It should be able to meet the specific needs of the responsibilities,36 Chapter 3 any new director in the individual directors and ai company and Nr effectively performing his or her functions. the other hand, makes ‘ed of the developments Juding emerging risks porate governance dit, internal controls, tisk ili is raged that management, sustainability and _strategy- It ¥ a i companies assess their own training | and develop “ae determining the coverage of their continuing training program. raining program, on ly inform inel on 00! The annual continuing t certain that the directors are continuous! in the business and regulatory environments, relevant to the company. It involves courses matters relevant to the company, including au Recommendation 1.4 The Board should have a policy on board diversity. Explanation Having a board diversity policy is a move to avoid groupthink and ensure that optimal decision-making is achieved. A board diversity policy is not limited to gender diversity. It also includes diversity in age, ethnicity, culture, skills, competence and knowledge. On gender diversity policy, a good example is to increase the number of female directors, including female independent directors. Recommendation 1.5 The Board should ensure that it is assisted in its duties by a Corporate Secretary, who should be a separate individual from the Compliance Officer. The Corporate Secretary should not be a member of the Board of Directors and should annually attend a training on corporate governance. Explanation The Corporate Secretary is primarily responsible to the corporation and its shareholders, and not to the Chairman or President of the Compan; and has, among others, the following duties and responsibilities: i a. Assists the Board and the board committees in the conduct of their meetings, including preparing an annual schedule of Board andSEC Code of Corporate Governance 37 committee meetings and the annual board calendar, and assisting the chairs of the Board and its committees to set agendas for those meetings; Safekeeps and preserves the integrity of the minutes of the meetings of the Board and its committees, as well as other official records of the corporation; Keeps abreast on relevant laws, regulations, all governance issuances, relevant industry developments and operations of the corporation, and advises the Board and the Chairman on all relevant issues as they ari Works fairly and objectively with the Board, Management and stockholders and contributes to the flow of information between the Board and management, the Board and its committees, and the Board and its stakeholders, including shareholders; Advises on the establishment of board committees and their terms of reference; Informs members of the Board, in accordance with the by-laws, of the agenda of their meetings at least five working days in advance, and ensures that the members have before them accurate information that will enable them to arrive at intelligent decisions on matters that require their approval; ‘Attends all Board meetings, except when justifiable causes, such as illness, death in the immediate family and serious accidents, prevent him/her from doing so; Performs required administrative functions; Oversees the drafting of the by-laws and ensures that they conform with regulatory requirements, and Performs such other duties and responsibilities as may be provided by the SEC.38 ChapterS Reeommendation 1.6 ‘The Board should ensure that it is assisted in its duties by a Compliance Officer, who should have a rank of Senior ue Eee = i iti ith adequate stature and al equivalent position with tl Te ee compar OE the corporation. The Compliance Officer shou! a Board of Directors and should annually attend a training on corporate governance. Explanati . The Compliance Officer is a member of the company’s management team in charge of the’ compliance function. Similar to the Corporate Secretary, he/she is primarily liable to the corporation and its shareholders, and not to the Chairman or President of the company. He/she has, among others, the following duties and responsibilities: jn a. Ensures proper onboarding of new directors (i.e., orientation on the company’s business, charter, articles of incorporation and by-laws, among others); b. Monitors, reviews, evaluates and ensures the compliance by the corporation, its officers and directors with the relevant laws, this Code, rules and regulations and all governance issuances of regulatory agencies; c. Reports the matter to the Board if violations are found and recommends the imposition of appropriate disciplinary action; d. Ensures the integrity and accuracy of all documentary submissions to regulators; ©. Appears before the SEC when summoned in relation to T with this Code; compliance f. Collaborates with other departments to Properly address compliance issues, which may be subject to investigation; & Identifies possible areas of compliance issues and works towards the resolution of the same;SEC Code of Corporate Governance _39 Ensures the attendance of board members and key officers to relevant trainings; and Performs such other duties and responsibilities as may be provided by the SEC. 2. ESTABLISHING CLEAR ROLES AND RESPONSIBILITIES O) THE BOARD Principle The fiduciary roles, responsibilities and accountabilities of the Board as provided under the law, the company’s articles and by-laws, and other legal pronouncements and guidelines should be clearly made known to all directors as well as to shareholders and other stakeholders Recommendation 2.1 The Board members should act on a fully informed basis, in good faith, with due diligence and care, and in the best interest of the company and all shareholders Explanation . - There are two key elements of the fiduciary duty of board members: the duty of care and the duty of loyalty. The duty of care requires board members to act on a fully informed basis, in good faith, with due diligence and care. The duty of loyalty is also of central importance; the board member should act in the interest of the company and all its shareholders, and not those of the controlling company of the group or any other stakeholder. Recommendation 2.2 The Board should oversee the development of and approve the ness objectives and strategy, and monitor their company’s busi - q aa in order to sustain the company’s long-term viability implementation, and strength.40 Chapter 3 Explanation According to the OECD, the Board should review and pride carers strategy, major plans of action, risk management pol i 5 mance procedures, annual budgets and business plans; pean ne objectives; monitor implementation and atone ee sine am oversee major capital expenditures, acquisitions ond ies a ee i ici jectives translate to the o strategic policies and objectives i r identification and prioritization of its goals and guidance on how best to achieve them. This creates optimal value to the corporation. Recommendation 2.3 The Board should be headed by a competent and qualified Chairperson Explanation The roles and responsibilities of the Chairman include, among others, the following: a. Makes certain that the meeting agenda focuses on strategic matters, including the overall risk appetite of the corporation, considering the developments in the business and regulatory environments, key governance concerns, and contentious issues that will significantly affect operations; b. Guarantees that the Board receives accurate, timely, relevant, insightful, concise, and clear information to enable it to make sound decisions; ©. Facilitates discussions on key issues by fostering an environment conducive for constructive debate and leveraging on the skills and expertise of individual directors; d. Ensures that the Board sufficiently challenges and inquires on reports submitted and representations made by Management; e. Assures the availability of proper orientation for first-time directors and continuing training Opportunities for all directors: and f. Makes sure that performance of the B i t ‘card is evaluated at least once a year and discussed/followed up on. 7SEC Code of Corporate Governance 41 Recommendation 2.4 ube beats should be responsible for ensuring and adopting an effective feel n Planning program for directors, key officers and management Thee growth and a continued inerease in the shareholders’ value. 's should include adopting a policy on the retirement age for directors and key officers as part of management succession and to promote dynamism in the corporation, Explanation The transfer of company leadership to highly competent and qualified individuals is the goal of succession planning. It is the Board's responsibility to implement a process to appoint competent; professional, honest and highly motivated management officers who can add value to the.company. A good succession plan is linked to the documented roles and responsibilities for each position, and should start in objeotively identifying the key knowledge, skills, and abilities required for the position. For any potential candidate identified, a professional development plan is defined to help the individuals prepare for the job (e.g,, training to be taken and cross experience to be achieved). The process is conducted in an impartial manner and aligned with the strategic direction of the organization. Recommendation 2.5 ‘The Board should align the remuneration of key officers and board members with the long-term interests of the company. In doing so, it Should formulate and adopt a policy specifying the relationship between remuneration and performance. Further, no director should participate in discussions or deliberations involving his own remuneration. Explanation Companies are able to attract and retain the services of qualified and competent individuals if the level of remuneration is sufficient, inline with the business and risk strategy, objectives, values and incorporate measures to prevent conflicts of interest. Remuner in polic’ ies promote esound risk culture in which risketaking behavior is appropriate. Theyay so encourage employees to act in the long-term interest of the company as a whole, rather than for themselves or their business lines only, Moreover, it is good practice for the Board to formulate and adopt a policy specifying the relationship between remuneral ion and performance, which includes specific financial and non-financial metrics to measure performance and set specific provisions for employees with significant influence on the overall risk profile of the corporation. Key considerations in determining proper compensation include the following: (1) the level of remuneration is commensurate to the responsibilities of the role; (2) no director should participate in deciding on his remuneration; and (3) remuneration pay-out schedules should be sensitive to risk outcomes over a multi-year horizon. For employees in contro! functions (e.g., risk, compliance and internal audit), their remuneration is determined independent of any business line being overseen, and performance measures are based principally on the achievement of their objectives so as not to compromise their independence. Recommendation 2.6 The Board should have and disclose in its Manual on Corporate Governance a formal and transparent board nomination and election policy that should include how it accepts nominations from minority shareholders and reviews nominated candidates. The policy should also include an assessment of the effectiveness of the Board’s processes and procedures in the nomination, election, or replacement of a director. In addition, its process of identifying the quality of directors should be aligned with the strategic direction of the company. Explanation It is the Board’s responsibility to develop a policy on board nomination, which is contained in the company’s Manual on Corporate Governance. The policy should encourage shareholders’ participation by including procedures on how the Board accepts nominations from minority shareholders. The policy should also promote transparency of the Board’s nomination and election process.~ SEC Code of Corporate Governance 43 The Homination and election process also includes the review and evaluation of the qualifications of all persons nominated to the Board, including whether candidates: (1) possess the knowledge, skills, experience, and particularly in the case of non-executive directors, independence of mind given their responsibilities to the Board and in light of the entity’s business and risk profile; (2) have a record of integrity and good repute; (3) have sufficient time to carry out their Tesponsibilities; and (4) have the ability to promote a smooth interaction between board members. A good practice is the use of professional ac firms or external sources when searching for candidates to the joard. In addition, the process also includes monitoring the qualifications of the directors. The qualifications and grounds for disqualification are contained in the company’s Manual on Corporate Governance. The following may be considered 2s grounds for the permanent disqualification of a director: a. Any person convicted by final judgment or order by a competent judicial or administrative body of any crime that: (a) involves the purchase or sale of securities, as defined in the Secu ities Regulation Code; (b) arises out of the person’s conduct as an underwriter, broker, dealer, investment adviser, principal, distributor, mutual fund dealer, futures commission merchant, commodity trading advisor, or floor broker; or (c) arises out of his fiduciary relationship with a bank, quasi-bank, trust company, investment house or as an affiliated person of any of them; b. Any person who, by reason of misconduct, after hearing, is permanently enjoined by a final judgment or order of the SEC, Bangko Sentral ng Pilipinas (BSP) or any court or administrative body of competent jurisdiction from: (2) acting as underwriter, broker, dealer, investment adviser, principal distributor, mutual fund dealer, futures commission merchant, commodity trading advisor, or floor broker; (b) acting as director or officer of a bank, quasi-bank, trust company, investment house, or investment company: © engaging in or continuing any conduct or practice in any of the capacities mentioned in sub-paragraphs (a) and (b) above, or willfully violating the laws that govern securities and, banking activities.“4 Chapter 3 f (a) such person is the y court or administrative jon, license or The disqualification should also apply i subject of an order of the SEC, BSP or an, unt OF body denying, revoking or suspending any registrati permit issued to him under the Corporation Code, Securities Regulation Code or any other law administered by the SEC or BSP, or under any tule or regulation issued by the Commission or BSP; (b) such person has otherwise been restrained to engage in any activity involving securities and banking; or (c) such person is the subject of an effective order of a self-regulatory orpanization suspending or expelling him from membership, participation or association with a member or participant of the organization; Any person convicted by final judgment or order by a court, or competent administrative body of an offense involving moral turpitude, fraud, embezzlement, theft, estafa, counterfeiting, misappropriation, forgery, bribery, false affirmation, perjury or other fraudulent acts; ‘Any person who has been adjudged by final judgment or order of the SEC, BSP, court, or competent administrative body to have willfully violated, or willfully aided, abetted, counseled, induced or procured the violation of any provision of the Corporation Code, Securities Regulation Code or any other law, rule, regulation or order administered by the SEC or BSP; Any person judicially declared us insolvent, Any person found guilty by final judgment or order of a foreign court or equivalent financial regulatory authority of acts, violations or misconduct similar to any of the acts, violations or misconduct enumerated previously; Conviction by final judgment of an offense punishable by imprisonment for more than six years, or a violation of the Corporation Code committed within five years prior to the date of his election or appointment; and Other grounds as the SEC may provide.SEC Code of Conparate Governance 4g In addition, the following may be grounds for temporary disqualification of a director: a. Absence in more than fifty percent (50%) of all regular and special meetings of the Board during his incumbency, or any 12-month period during the said incumbency, unless the absence is due to illness, death in the immediate family of serious accident. The disqualification should apply for purposes of the succeeding election; b. Dismissal or termination for cause 4s director of any publicly-listed company, public company, registered issuer of securities and holder of a secondary license from the Commission. The disqualification should be in effect until he has cleared himself from any involvement in the cause that gave rise to his dismissal or termination; c. If the beneficial equity ownership of an independent director in the corporation or its subsidiaries and affiliates exceeds two percent (2%) of its subscribed capital stock. The disqualification from being elected as an independent director is lifted if the limit is later complied with; and d. Ifany of the judgments or orders cited in the-grounds for permanent disqualification has not yet become final. Recommendation 2.7 ‘The Board should have the overall responsibility in ensuring that there is a group-wide policy and system governing related party transactions (RPTs) and other unusual or infrequently occurring transactions, particularly those which pass certain thresholds of materiality. The policy should include the appropriate review and approval of material or significant RPTs, which guarantee fairness and transparency of the transactions. The policy should encompass all entities within the group, taking into account their size, structure, risk profile and complexity of operations. Explanation Ensuring the integrity of related party transactions is an important fiduciary duty of the director. It is the Board’s role to initiate policies and measures geared towards prevention of abuse and promotion of