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ChapterExpected Learning OutcomesAfter studying the chapter, you should be able to.1. Explain the relevance of good governance to both largepubliclylisted companies and SMEs2. Know the relationship between shareholders or owners and otherstakeholders3. Identify the parties involved in Corporate Gove...

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Chapter

Expected Learning Outcomes After studying the chapter, you should be able to. 1. Explain the relevance of good governance to both large publiclylisted 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

CHAPTER 2 CORPORATE GOVERNANCE

RESPONSIBILITIES AND ACCOUNTABILITIES INTRODUCTION Many of the characteristics of good governance described in Chapter 1 are relevant to both SME's and large listed public companies. As an organization grows in size and influence, these issues become increasingly important. However, it is also important to recognize that good corporate governance is based on principles underpinned by consensus and continually developing notions of good practice. There are no absolute ruleswhich 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.

RELATIONSHIP BETWEEN SHAREHOLDERS / OWNER(S) AND OTHER STAKEHOLDERS The relationship between the shareholders / owners, management and other stakeholders in a corporation is shown below. Corporate Governance Responsibilities and Accountabilities 17

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 accountability back through the system to the shareholders. However, the accountabilities do not extend only to the shareholders. Companies also have responsibilities to other stakeholders. Stakeholders 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.

18 Chapter 2 A broad group of stakeholders has an, interest in the quality of corporate governance because it has a relationship to economic performance and the quality of financial reporting. For example, it is likely that many employees have significant funds invested in pension plans. Those pension plans are designed to protect the financial interests of those employees in their retirement. We use the word society in the diagram to indicate those broad interests. In a similar fashion, employees and creditors have a vested interest in the organization and how it is governed. Regulators are a response to society's wishes to ensure that organizations, in their pursuit of returns for their owners, act responsibly and operate in compliance with relevant laws. While shareholders / owners delegate responsibilities to various parties within the corporation, they also require accountability as to how well the resources fhat have been entrusted to management and the board have been used. For example, the owners want accountability on such things as:

Financial performance Financial transparency — financial statements that are clear with full disclosure and that reflect the underlying economics of the company. Stewardship, including how well the company protects and manages the resources entrusted to it.

Quality of internal control Composition of the board of directors 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 respønsibility to provide financial reports, and in some cases, reports on internal control effectiveness. Management has always had the primary responsibility for the accuracy and completeness of an organization's financial statements. From a financial reporting perspective, it is management's responsibility to: Choose which accounting principles best portray the economic substance of company transactions. Implement a system of internal control that assures completeness and accuracy in financial reporting.

Corporate Governance Responsibilities and Accountabilities 19 Ensute that the financial statements contain accurate and complete disclosure. A

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.

20 Chapter 2 Overview of Res onsibilities

pa 1.

Shareholders

Broad Role: Provide effective oversight through election of board members, approval of major initiatives such as buying or selling stock, annual re orts on mana ementcom ensation, from the board.

2.

Board of Directors

Broad Role. The major representative of stockholders to ensure that the organization is run according to the organization's charter and that there is proper accountabiflty Specific activities include amona others: 1. Overall Operations • Establishing the organization's vision, mission, values and ethical standards.

• •

•

•

Delegating an appropriate level of authority to management.

Demonstrating leadership, Assuming responsibility for the business relationship with CEO including his or her appointment, succession, performance remuneration and dismissal.

Overseeing aspects of the employment of the management team including management remuneration, performance and succession planning.

Recommending auditors and new directors to shareholders. Ensuring effective communication shareholders other stakeholders.

•

Crisis management.

with

Corporate Governance Responsibilities and Accountabilities 21

•

2.

Appointment of the CFO and corporate secretary.

Performance Ensuring the organization's long term viability and enhancing the financial position, Formulating and overseeing implementation of corporate strategy. Approving the plan, budget and corporate policies.

•

Agreeing key performance indicators (KPls)

•

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.

•

Oversight of the and organization, including its control and accountability systems.

• 3.

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.

22 Chapter 2

Approving annual financial reports, annual reports and other public documents / sensitive reports.

•

3.

Non-Executive or Independent Directors

Ensuring an effective system of internal controls exists and is o eratin as ex ected.

Broad Role. The same as the broad role of the entire board of directors Specific activities include among others: to understand the organization, its business, its operating environment and its financial position, • to apply expertise and skills in the organization's best interests, to assist management to keep

Corporate Governance Responsibilities and Accountabilities 23 performance objectives at the top of its agenda,

• •

to understand that his/her role is not to act as auditor, nor to act as a member of the management team, to respect the collective, cabinet nature of the board's decisions, to prepare for and attend board meetings, to seek information on a timely basis to ensure that he/she is in a position to contribute to the discussion when a matter comes before the board, or alert the chairman in advance to the need for further information in relation to a particular matter, and to ask a ro riate uestions relative to o erations.

• 4.

Management

Broad Role. Operations and accountability. Manage the organization effectively; provide accurate and timely reports to shareholders and other stakeholders. Specific activities include amonq others: 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 responsibility for the organization's conformance with relevant laws and regulations and its compliance framework develop, implement and manage the organization's risk management and internal control frameworks

•

develop, implement and update policies and procedures

•

be alert to relevant trends in the industry and the organization's operating environment

24 Chapter 2

•

provide information to the board

•

act as conduit between the board and the organization

• 5.

Audit Committees of the Board of Directors

developing financial and other reports that meet public, stakeholder and re ulato re uirements.

Broad Role. Provide oversight of the internal and external audit function and the process of preparing the annual financial statements as well as public reports on internal control. Specific activities include amonq others: Selecting the external audit firm Approving any non-audit work performed by the audit firm

• •

6.

Regulators

a. Board of Accountancy

Selecting and I 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 mana ement on s ecific actions that should be taken

Broad Role. Set accounting and auditing standards dictating underlying financial reporting and auditing concepts; set the expectations of audit quality and accounting quality. Specific activities include among others:

•

Conducting CPA Licensure Board Examinations Approving accounting principles Approving auditing standards

Corporate Governance Responsibilities and Accountabilities 25 Interpreting previously issued standards implementing quality control processes to ensure audit quality

• b.

Securities and

Exchange Commission

Educating members on audit and accounting requirements

Broad Role: Ensure the accuracy, timeliness and fairness of public reporting of financial and other information for public companies. Specific activities include amonq others.

•

Reviewing filings with the SEC

•

Interacting with the Financial Reporting Standards Council in setting accounting standards

•

Specifying independence standards required of auditors that report on public financial statements

•

7.

External Auditors

Identify corporate frauds, investigate causes, and su est remedial actions

Broad 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:

•

Audit of public company financial statements

• •

Audits of nonpublic company financial statements Other services such as tax or consultin

26 Chapter 2 8.

Internal Auditors

Broad Role. Perform audits of companies for compliance with company policies and laws, audits to 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 Evaluatin internal controls

REVIEW QUESTIONS Questions I. "Small business enterprises do not need good governance ' Do you agree? Explain.

2. Does good governance require absolute rules that must be adopted by all organizations?

3. What is the essence of any system of corporate governance? 4. Where does the board of directors derive its authority? 5. To whom is the board of directors accountable? 6. On what aspects do shareholders demand accountability from the board of directors? 7, What is management's responsibility as far as financial reporting is concerned?

8. Describe the broad role of the shareholders in a corporation. 9. Describe the broad role of the Board of Directors. 10. What are the specific activities of the board of directors?

Corporate Governance Responsibilities and Accountabilities 27

Multiple Choice Questions 1. Approving annual financial reports and other public documents are specific responsibilities of

a. b. c. d.

Management Board of directors Shareholders Employees

2. 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. b. c. d.

Board of directors Chief executive officer Chief financial officer Audit committee of the board of directors

3. Who is responsible for ensuring the accuracy, timeliness of public reporting of financial and other information for public companies? a. External auditors b. Securities and exchange commission c. Shareholders d. Board of Accountancy

4. Who performs audit of companies for compliance with company policies and laws, audits efficiency of operations and periodic evaluation and tests of controls?

a. b. c. d.

External auditors Internal auditors

Commission on audit Chief accountant

5. An independent director is expected to a. Apply expertise and skills in the corporations best interest

28 Chapter 2

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...