University of Western Sydney, Paramatta Campus. Course: Accounting Theory

University Of Western Sydney,
Paramatta Campus.
Course: Accounting Theory
Instructor: Kevin Clark, CA, CPA.
Presentation on:
Corporate Governance
Prepared By: Dewan Mahboob Hossain

Definition
 The meaning of Corporate Governance is
influenced by different views of different
authors.
 For example, one group described it as a
‘system’ by which companies are directed
and controlled (Cadbury Report, CFACG
1992), to another group, it is concerned with
the ‘structures and processes’ for decision
making, accountability, control and behavior
at the governing body (Public Accounts and
Estimates Committee, 2002), to someone
corporate governance is about ‘finding ways’
to ensure effective decision making (Pound,
1995). Prepared By: Dewan Mahboob Hossain
Definition (contd.)
 Butit should be noted that the term
corporate governance is a separate
term than ‘management’. The term
management is highly related to the
day-to-day management of a
company’s operations. ‘Corporate
Governance’ oversights this task of
management under a harmonized
structure.

Definition (contd.)
 Vittal (2000) states that corporate governance
calls for three factors:
1. Transparency in decision-making
2. Accountability which follows from transparency
because responsibilities could be fixed easily for
actions taken or not taken, and
3. The accountability is for the safeguarding of the
interests of the stakeholders and the investors in
the organization.

Definition (contd.)
 Corporate governance is probably the widest
control mechanism used for efficient
utilization of corporate resources. It can be
defined as an organizational control device,
which is a hybrid of internal and external
control mechanisms with a view to efficient
utilization of corporate resources.
 It is the network among various corporate
players such as, shareholders, managers,
employees, lenders, government, suppliers,
and consumers for increasing the value of the
firm. Prepared By: Dewan Mahboob Hossain
OECD Principles
 To have a clear idea about corporate governance
system the principles laid out by Organization of
Economic Cooperation and Development (OECD)
can be considered in this regard:
1. Protecting the rights of shareholders: This
includes the right to secure ownership, full
disclosures, voting rights, participation in all kind
of activities in general shareholder meeting, to be
informed on fundamental corporate changes, to
have access to efficiency and transparency in
markets for corporate control. Bosch Committee
(1995) suggested that shareholders should see
themselves as owners, not just investors.
OECD Principles (Contd.)
2. Equitable treatment of shareholders: Here
OECD is concerned to protect the rights of the
minority shareholders. Corporate governance
framework should ensure the fair treatment of
all shareholders including minority and foreign
shareholders. Insider trading and abusive self-
dealing is explicitly prohibited. Members of the
board should disclose any material interests in
transactions or matters influencing the
organization.
3. Role of stakeholders: OECD recognizes that
in addition to shareholders there are other
stakeholders such as banks, bond holders,
regulatory authorities, suppliers and
employees who are very important in the way
in which companies perform and make
decisions. Corporate governance framework
should recognize the rights of stakeholders as
established by law and encourage active
cooperation between organizations and
stakeholders.
4. Ensuring disclosure and
transparency: The OECD suggests for
provision for disclosing and
communicating all material facts
(financial and non-financial). The
corporate governance framework should
ensure timely and accurate disclosures
on all matters regarding the organization.
Annual audits by independent auditors
are also required in this context.
5. Clarifying responsibilities of the
board: The OECD is much concerned
about a board’s responsibilities for
protecting the company, its shareholders
and stakeholders. The corporate
governance framework should ensure
the effective monitoring of management
by the board and the board’s
accountability to the organization and
shareholders.
The Role of Shareholders
 Shareholders consist of:

1. Individual shareholders and
2. Institutional shareholders.
They monitor the activities of
management through direct negotiations
with the management, proxy contests
and various guidelines.
The Role of Shareholders (contd.)
According to Cadbury report (1992):
“The shareholders as owners of the company elect the
directors to run the business on their behalf and hold
them accountable for its progress. …(they) have
delegated many of their responsibilities as owners to
the directors who act as their stewards. It is for the
shareholders to challenge the directors if they appear
to be failing in their stewardship as they should use
this power. While they cannot be involved in the
direction of management of their company, they can
insist on high standard of governance.”

 In Australia, a working group chaired by Henry Bosch
(the Bosch Committee) put forward some guidelines in
which the followings are identified as some of the
rights and obligations of shareholders:
1. Shareholders should make themselves as informed as
possible of the activities of the company;
2. Shareholders should see themselves as owners, not
just investors. Their responsibility as shareholders
increases with the size of their shareholdings.
3. Shareholders should have made a sufficient analysis to
vote in an informed manner on all issues raised in
general meeting.

4. Shareholders in companies listed on stock
exchanges (other than employee shareholders)
should not involve themselves in the company’s
day to day operations.
5. Shareholders should take a positive interest in
the composition of board of directors specially in
case of appointment of the non-executive
directors.
the structure of boards and, in particular, the
appointment of appropriate committees of the
Board – specially the audit committee.
7. Shareholders in listed companies should take a
positive interest in the performance of the board
and should exercise their votes in the election of
directors in an informed manner.
the auditor’s report and the competence of the
auditors and where appropriate, be prepared to
ask questions of the auditor.
9. Shareholders should not seek to receive price
sensitive information which is not available to the
market generally.
The Directors
 All companies must have directors. The
board of directors or governing body gives
direction and exercises judgment in setting
the entity’s objectives and monitoring their
implementation.
 The board of a large public corporation
cannot manage the corporation’s day to
day business. That function must be left to
the corporate executives.
The functions of the board
according to Bosch Report
1. Taking steps designed to protect the company’s
financial position and its ability to meet its debts
and other obligations when they fall due.
2. Adopting a strategic plan for the company,
including general and specific goals and compare
actual results with the plan;
3. Adopting an annual budget for the financial
performance of the company and monitoring
results on a regular basis;
4. Adopting clearly defined delegations of authority
from the board to the CEO;
5. Agreeing performance indicators with the
management.
according to Bosch Report (contd.)
6. Ensuring that systems are in place which facilitate the
effective monitoring and management of the principal risks
to which the company is exposed.
7. Determining that the company has instituted adequate
reporting systems and internal control.
8. Establishing and monitoring policies directed to ensure
that the company complies with the law and conforms with
the highest standards of financial and ethical behavior.
9. Determining that the company accounts are in conformity
with accounting standards and are true and fair.
10. Determining that satisfactory arrangements are in place
for auditing the company’s financial affairs and the scope
of external audit is adequate.

according to Bosch Report (contd.)
11. Selecting and recommending auditors to shareholders at
general meetings;
12. Selecting and if necessary, replacing the chief executive,
setting an appropriate remuneration package, giving
guidance on the appointment and remuneration of other
senior management.
13. Ensuring that the company has in place a policy that
enables it to communicate effectively with its shareholders,
other stakeholders and the public generally;
14. Adopting formal processes for the selection of new
directors and recommending them in consideration in
general meetings with adequate information to allow
shareholders to make informed decisions;
15. Reviewing its own processes and effectiveness and the
balance of competence on the board.
Categories of Directors
Two categories of directors are generally recognized:
1. Executive directors who are employees, usually
senior managers such as managing directors and
finance directors. In addition to their responsibilities
as managers, executive directors have all the same
responsibilities as other members of the board.
Therefore, it is important that they are of sufficient
stature and security of employment to express
disagreement, if necessary, with other board
members.
2. Non-executive directors who are not employees but
bring special qualifications, experience, expertise
and independent perspective to the board.

Categories of Directors (contd.)
The main functions of non-executive
directors are:
a. To bring independent view to the
board’s deliberations;
b. To help the board (and the chairman)
provide the company with effective
leadership;
c. To foster the continuing effectiveness
of executive directors and
management.
Categories of Directors (contd.)
The Cadbury Report recommended that the board
of directors should include non-executive
directors of sufficient caliber and number. On the
composition of sub-committees of the board, it
indicated that all boards would require a
minimum of three non-executive directors.
Further it recommended that the majority of non-
executive directors should be independent of
management and free from any business or
other relationship which could materially
interfere with the exercise of their independent
judgment.

How the Directors should act?
According to the Articles of Association of the Australian
Institute of Company Directors, the following are the
code of conducts of the directors:
1. A director must act honestly, in good faith and in the
best interest of the company;
2. A director has a duty to use due care and diligence in
fulfilling the functions of the office and exercising
powers attached to that office.
3. A director must use the power of the office for a
proper purpose, in the best interest of the company as
a whole.
4. A director must recognize that the primary
responsibility is to the company’s shareholders as a
whole but should, where appropriate, have regard for
the interests of all stakeholders of the company.
How the Directors should act?
(contd.)
5. A director must not make improper use of information acquired as a
director;
6. A director must not take improper advantage of the position of director;
7. A director must not allow personal interests, or the interests of any
associated person, to conflict with the interest of the company.
8. A director has an obligation to be independent in judgment and actions
and to take all reasonable steps to be satisfied as to the soundness of
all decisions taken by the board.
9. Confidential information received by a director in the course of the
exercise of directorial duties remains the property of the company
from which it was obtained and it is improper to disclose it, or allow it
to be disclosed, unless that disclosure it authorized by that company,
or the person from whom the information is provided, or is required by
law.
10. A director should not engage in conduct likely to bring discredit upon
the company.

Independent/ non-executive
Directors
 The Australian Investment Managers’ Association
defines an independent director as a director who:
1. is not a member of management;
2. is not a substantial shareholder of the company or
an officer of or otherwise associated directly or
indirectly with a substantial shareholder of the
company;
3. has not within the least three years been employed
in an executive capacity by the company or any
other group member or been a director after
ceasing to hold any such employment;
4. is not a principal or a professional adviser to a
company or another group member;

Independent/ non-executive
Directors (contd.)
5. is not a significant supplier or customer of the
company;
6. has no significant contractual relationship with
the company;
7. Is free from any interest or any business or
other relationship which could, or could
reasonably be perceived to, materially interfere
with the director’s ability to act with a view to the
best interests of the company.

The Chairman
 The role of the chair in leading the board of directors,
including determining the board agenda and obtaining
contributions from other board members in the board’s
deliberations, is crucial to ensure that the board works
effectively.
 The Cadbury committee recommended that due to the
importance and nature of chairman’s role, it should, in
principle, be separate from Chief Executive Officer
(CEO).
 A strong independent chairperson provides a check and
counterbalance to the power of CEO.
 The Bosch Committee indicated that the combination of
the roles of chairperson and CEO constitute a
concentration of power that could give rise to conflicts.
Therefore, the roles should be separated.
Sub-committees of the board
 The effectiveness of the board, and particularly of
non-executive directors, is likely to be enhanced by
the establishment of effective sub-committees.
 Generally, three sub-committees are recommended
in corporate governance practices and they are :
audit committee, remuneration committee and
nomination committee.
 Membership of these board sub-committees is
generally confined to directors and ideally they
should be governed by a charter which documents
their responsibilities.

Sub-committees of the board
(contd.)
 Further, they should report back results of
their separate meetings to the full board
on a regular basis.
 The use of sub-committees gives non-
executive directors a well defined area in
which they are expected to contribute. It is
expected that, the sub-committees should
be comprised of majority of the non-
executive directors.
Audit Committee
 An audit committee is an important component of
corporate governance.
 An audit committee is a sub-committee of the board
of directors, comprising a majority of
independent/non-executive members of the
governing body of an entity and represents owners
rather than management.
 Among other functions, it is usually assigned the
duty of oversight of the financial reporting and
auditing process.
 The auditor’s major dealing with the governing body
will be through audit committee, although the
auditor will usually meet with the full governing body
at least once per year.
Composition of Audit Committee
 Two predominant schools of thoughts:
The first school maintains that the audit committee

should be entirely composed of non-executive
directors who have no management responsibilities
or affiliations. It is claimed that this is the only way
to ensure the complete independence of the
committee in its evaluation of management and audit
representation. The NYSE requires the highest
possible standard which is that all listed companies
have an audit committee composed totally of
independent directors.

Composition of Audit Committee
(contd.)
The second school claims that at the very
least there should be one management
representative on the committee. It would
provide a more balanced perspective to
the problems under committee
investigation. The problem with this kind of
structure is the potentially adverse effect
that the management representative may
have on the committee’s independence.

Objectives and responsibilities of
audit committee
1. To enhance the ability of governing body to fulfill
its legal responsibilities;
2. To add to the credibility and objectivity of financial
reports;
3. To oversee the application of appropriate
accounting policies and procedures including
appropriate disclosures;
4. To establish and monitor corporate policies to
prohibit unethical, questionable or illegal activities;
5. To establish and monitor effective internal and
management control;
6. To provide a communication link between
management, auditors and the governing body.

Benefits of audit committees
An audit committee may:
1. Form part of an effective corporate governance
structure;
2. Strengthen the internal control structure and
ensure the maintenance of appropriate accounting
records;
3. Support the independence of internal and external
auditors;
4. Provide direct communication channel between
management, auditor and the board;
5. Improve the quality of financial disclosures and the
effectiveness of the audit function by providing
independent review of these functions.

Benefits of audit committees
(contd.)
6. Act as a forum for the resolution of disagreements
between management and the auditors.
7. Improve the effectiveness of internal and external
auditors by providing a coordinating approach for
audit planning.
8. Keep the governing body fully informed about
accounting and auditing issues;
9. Increase the effectiveness of non-executive
directors;
10. Provide evidence that members of the governing
body have exercised due care in fulfilling their
statutory responsibilities;
Limitations of audit committee
1. The audit committee, being only a sub-committee of
the governing body, may not have the power to
enforce its recommendations;
2. Financial report users may have unrealistic
expectations of audit committees;
3. The establishment of an audit committee may cause
conflict within the governing body, particularly
between executive and non-executive directors;
4. The audit committee may be ineffective due to lack
of competent non-executive members;
5. Committee members may be selected because of
their association with the CEO or chairman of the
governing body, thus reducing perceived
independence.
Limitations of audit committee
(contd.)
6. The presence of management in the audit
committee may inhibit open discussion and
affect the independence of the committee.
7. The maintenance of an audit committee is time
consuming and costly;
8. The responsibilities of audit committee may
interrupt on those of management, creating an
atmosphere of conflict and distrust.

Characteristics of effective audit
committees
1. They are perceived to be independent and actually
exercise independence in their dealings with
management and auditors;
2. They are composed of experienced and competent non-
executive directors;
3. They are established by a resolution of the full board of
the governing body;
4. They have a limited number of members;
5. They are given explicit objectives and terms of
references which are subject to regular review;
6. They should arrange necessary meetings at the request
of the auditors or management;
7. They should circulate agendas and minutes to relevant
parties.

Remuneration committees
 Remuneration committees are set up to review terms
and conditions relating to the employment of senior
management.
 Clearly this is an area where the interests of the
shareholders conflict with those of management.
 Remuneration committees will also review the design of
employee incentive schemes such as bonus schemes
and stock option plans.
 This has been a controversial area specially in the eyes
of small shareholders.
 Under agency theory, it is argued that in order to
increase shareholders’ value, it is necessary to align the
interests of management with the interests of
shareholders. One way of achieving this is through the
design of appropriate remuneration committee.

Remuneration committees (contd.)
 Remuneration committees provide a mechanism for the
views of management and shareholders to be considered
by non-executive directors and therefore assist in the
development of appropriate remuneration structure.
 Perceived excess executive remuneration has been a
continuing source of conflict between shareholders and
managers.
 According to The Australian Investment Managers’
Association (1997), remuneration committees should be
composed primarily of non-executive members. But they
did not say that all the members here should be non-
executive.
 In contrast, UK-based Institutional Shareholders
Committee has recommended that remuneration
committees comprise only independent non-executive
directors.

Nomination Committees
 Nomination Committees generally have two
main roles:
1. To establish the skills required of a
replacement or additional director and to
approach potential candidates.
2. To review, on a regular basis, the performance
of the board as a whole and the contribution of
individual members to the board.

Corporate Governance and
Internal Control
 Corporate governance is related to the
management process.
 Internal control is also related to many aspects
of the management process.
 Effective controls, coupled with good
management practices, can ensure that an
organization promptly identifies business risks,
and mitigates and limits any negative
consequences that may result from such risks.
 An effective internal control structure is central
to efficient risk management. Ineffective controls
result in an ineffective management process.
Importance of Internal control
 The Cadbury Report (1992) argued that an effective
internal structure is the key aspect of the efficient
management of a company.
 The Toronto Guidelines identify managing risk as one
of the principal responsibilities of the board.
 Thus the board needs to understand the principal
risks of all aspects of the business in which the entity
is engaged and must recognize that business
decisions require the incurrence and management of
risks.
 The board must then achieve a proper balance
between the risks incurred and the potential returns to
the shareholders.
The nature of Internal Control: The COSO
framework
 The fact that internal controls are diverse
and pervasive was recognized in the USA
by National Commission on Fraudulent
Financial Reporting (the Treadway
Commission, 1987).
 This commission had a committee called
the Committee of Sponsoring
Organizations (COSO). It released a four-
volume report entitled Internal Control-
Integrated Framework.
The nature of Internal Control: The COSO
framework (contd.)
 The COSO report defines internal control as:
“…..a process, effected by an entity’s board of

directors, management and other personnel,
designed to provide reasonable assurance regarding
the achievement of objectives in the following
categories:
 Effectiveness and efficiency of operations;
 Reliability of financial reporting; and
 Compliance with applicable laws and regulations.
“

The nature of Internal Control: The
COSO framework (contd.)
 Internal control, as defined by COSO, is
directed toward the achievement of entity
objectives relating to:
1. Effectiveness and efficiency of operations:
Related to performance, profitability and
productivity. And also related to safeguarding
resources.
2. Reliability of financial reporting: Related to the
preparation and dissemination of reliable
financial information, safeguarding entity
assets and records.
3. Compliance: With applicable laws and
regulations to which the entity is subject.
Components of Internal Control
 To achieve these three objectives, there
should be the following internal control
components:
1. Control environment: Setting the tone of the
organization. Influencing the control
consciousness of its people. Control
environment factors include: integrity, ethical
values and competence of the entity’s people;
management’s philosophy and operating style;
the way management assigns authority and
responsibility and organizes and develops its
people; and the intentions and directions
provided by the BOD.
(contd.)
2. Risk Assessment: Every company faces a
variety of risks from its internal and external
environment. Risk assessment is the
identification and analysis of relevant risks to
achievement of the objectives, forming a basis
for how the risks should be managed. Because
economic, industry, regulatory and operating
environment will continue to change,
mechanisms are needed to identify and deal
with specific kinds of risks associated with the
change.
(contd.)
3. Control activities: These are policies and
procedures that help ensure management
directives are carried out. They help ensure that
necessary actions are taken to address risks to
achievement of entity’s objectives. Control
activities occur throughout the organization, at
all levels and in all functions. They include a
range of diversified activities such as approvals,
authorizations, verifications, reconciliations,
reviews of operating performance, security of
assets and segregations of duties.
(contd.)
4. Information and communication: Pertinent information
must identified, captured and communicated in a form and
timeframe that enables people to carry out their
responsibilities.
Information systems produce reports containing
operational, financial, and compliance-related information,
that make it possible to run and control the business.
They deal not only with internally generated data, but
also information about external events, activities and
conditions necessary to informed decision making.
All personnel must receive a clear message from top
management that control responsibilities must be taken
seriously.
They must understand their own role in the internal
control system, as well as how their individual activities
relate to the works of others.
(contd.)
5. Monitoring: Internal control systems need
to be monitored- a process that assesses
the quality of system’s performance over
time. This is accomplished through
ongoing monitoring activities, separate
evaluations or a combination of the two.
Internal control deficiencies should be
reported upstream, with serious matters
reported to top management and the
board.
Role of the Auditors
 Auditors are perceived as upholders of the integrity of
financial reporting in public interest.
 Therefore, auditors are vitally interested in corporate
governance related issues.
 The Cadbury Report emphasizes the importance of
financial reports. To ensure this, direct contact between
the auditors, the non-executive directors and the board
as a whole is important.
 The external auditor, as an independent party with a
detailed knowledge about the entity’s financial affairs, is
able to provided substantial inputs to the audit
committee.
 The external auditor should also assist the audit
committee by informing it of any developments such as
legislative changes or new accounting standards.
Role of the Auditors (contd.)
 The external auditor’s roles and responsibilities in
relation to effective interaction with an effective
audit committee include the following:
1. Ensuring that information regarding the planning
of audit (e.g., scope, materiality etc.) is
communicated to the audit committees on time;
2. Communicating to the committee the
responsibilities of auditors according to auditing
standards and legal mandates.
3. Communicating to the committee matters which,
in auditor’s judgment, represent significant
deficiencies in the design or operation of the
internal control structure.
Role of the Auditors (contd.)
4. Informing audit committee of any major issues which
were discussed with the management in connection with
the appointment of the auditors;
5. Informing the audit committee of any serious difficulties
encountered in the performance of the audit;
6. Informing the audit committee about any significant
errors, problems of weaknesses revealed by the audit or
areas of significant disagreement with the management,
the corrective actions taken and their current status.
7. Asking the audit committee if there are any other
matters of which the auditor should be aware.
8. Documenting in the working papers significant matters
communicated to the audit committee.
9. Responding in an appropriate manner to reasonable
audit committee questions.
Internal Auditor’s Responsibilities
 The role of internal auditors may vary between
different situations and companies: it could
include financial, compliance or performance
audit.
 An effective internal audit function should
evaluate and monitor the adequacy and
effectiveness of the internal control structure.
 An internal audit program may assist in risk
assessment and management.
 It is important for the internal auditors to have
direct access to the audit committee.
(contd.)
 The audit committee should:

1. Monitor the scope of the work of internal
audit; and
2. Review the reports issued.
This can be achieved by having the head of

the internal audit function attend
meetings with the audit committee.
(contd.)
 The audit committee can play an important role
in ensuring that the internal audit function is
effective by addressing such issues as:
1. The level of resources allocated to the internal
audit;
2. The scope of the authority of internal audit;
3. The appropriateness of the internal audit
program and reporting line;
4. The quality and timeliness of its reports;
5. The extent to which management reacts to the
matters raised by internal audit.
(contd.)
 The audit committee can also

provide an effective means of
formalizing and coordinating the
working relationship between
internal and external auditors.

(contd.)
 Internal auditors should provide the audit committee
with the following:
1. A copy of formal audit plan, including internal audit’s
objectives, work schedules, staffing requirements,
budget and description of any limitations placed on
internal audit’s scope of work.
2. Details of the internal audit staff structure, including
staff skills, experience and qualifications.
3. Activity reports highlighting significant findings and
recommendations, particularly in relation to the
entity’s risk management, and identifying any lack of
action by management.
(contd.)
4. Major variances from the internal audit
department’s work schedules and
budgets;
5. Advice on the coordination of internal
audit plan with the external audit plan;
6. Activity reports on any major frauds or
conflict of interest.
7. Any other information requested by the
audit committee.

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University Of Western Sydney,

Prepared By: Dewan Mahboob Hossain

Prepared By: Dewan Mahboob Hossain

Prepared By: Dewan Mahboob Hossain

 Shareholders consist of:

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The first school maintains that the audit committee

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“…..a process, effected by an entity’s board of

Prepared By: Dewan Mahboob Hossain

 The audit committee should:

This can be achieved by having the head of

 The audit committee can also

Prepared By: Dewan Mahboob Hossain

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