Chapter 7Corporate Governance

PowerPoint Presentation by Matthew Tilling

©2012 John Wiley & Sons Australia Ltd

THE GROWING INTEREST IN CORPORATE GOVERNANCE

• Interest in corporate governance appears to be driven by– Highly publicised corporate misconduct– Agency problems– Realisation of other benefits

Problems with the Management of Corporations

• Management self interest– Fraud– Perquisites

• Anti-social corporate behaviour• Hiding or falsifying information• Perceived gap between performance and

remuneration

Problems with the Management of Corporations

• These problems, real or perceived, can have wider ramifications.

• Poor governance is linked to– Poorer firm performance– Increased regulation for all companies– Decreased consumer confidence– Reduced economic growth– It has even been implicated in a number of

national and global financial crises

Advantages of Good Corporate Governance

• In a globalised and competitive environment good governance can be a significant advantage.

• Good governance can– Reduce the cost of capital– Increase shareholder base– Manage increased scrutiny– Increase consumer confidence– Facilitate economic growth

WHAT IS CORPORATE GOVERNANCE?

• The procedures and processes according to which an organisation is directed and controlled.

• The corporate governance structure specifies the distribution of rights and responsibilities among the different participants in the organisation — such as the board, managers, shareholders and other stakeholders — and lays down the rules and procedures for decision-making.

WHAT IS CORPORATE GOVERNANCE?

• By doing this, it also provides the structure through which the company objectives are set, and the means of attaining those objectives and monitoring performance

Corporate Governance Stakeholders

• Whose interests are to be protected and what are ‘appropriate’ objectives of the corporation?

• Traditional or ‘Anglo-Saxon’ Model– The key role for corporate governance is enabling

the efficient use of resources by helping financial markets to work properly and gives priority to shareholder value

Corporate Governance Stakeholders

• Summarised by Milton Friedman:Corporate governance is to conduct the business in accordance with the owner or shareholders’ desires, which generally will be to make as much money as possible while conforming to the basic rules of the society embodied in law and local customs’.

Corporate Governance Stakeholders

• Alternatives to the traditional view suggest that corporate governance must go beyond the narrow interests of shareholders and should be extended to a wider group of stakeholders.

• European Models– Multiple stakeholders

THE NEED FOR CORPORATE GOVERNANCE SYSTEMS

• The corporate structure requires governance– Separation between capital contributors and

management• Under the best circumstances managers should

act as though they had contributed the capital• It would appear this does not happen and

managers may ‘bias’ or distort the financial statements

Positive Accounting Theory and its Relationship with Corporate Governance

• Positive accounting theory explains that for efficiency reasons companies are formed and can be viewed as a network of contracts or agreements that determine the relationships with and among the various parties involved.

• One important agency relationship that arises from this nexus is that between the managers and the capital contributors who authorise the managers to make the key business decisions.

Overview of the Shareholder–Manager Relationship in Agency Theory

CORPORATE GOVERNANCE GUIDELINES AND PRACTICES

• It is generally acknowledged that there is no ‘one’ system of corporate governance.

• The practices and procedures required or desired will be affected by:– The nature of the particular corporation and its

activities.– The environment in which the corporation

operates.

Elements of Corporate Governance

• Review Table 7.1 in the text.• Key elements– Controlling and directing the directors (and senior

management)• ensure that the key managers make appropriate decisions

– Role of shareholders (and other stakeholders)• ensure that shareholders have the ability to protect their interests in

the corporation– Transparency and accountability

• ensure that the stakeholders (including shareholders) are sufficiently informed about the activities of the company and its management

Elements of Corporate Governance

• Summary of ASX 8 Principles of Corporate Governance1. Lay solid foundations for management and oversight2. Structure the board to add value3. Promote ethical and responsible decision making4. Safeguard integrity in financial reporting5. Make timely and balanced disclosure6. Respect the rights of shareholders7. Recognise and manage risk8. Remunerate fairly and responsibly

APPROACHES TO CORPORATE GOVERNANCE

• The Rules-Based Approach to Corporate Governance– Prescribe precise practices that are required or

recommended to ensure good corporate governance.

– Associated with enforcement by legislation or listing rules, with imposition of penalties if the rules are not followed.

The Rules-Based Approach to Corporate Governance

• Advantages– Provides a set of minimum corporate governance

practices that must be followed by all corporations.

– Aids enforcement and clarifies potential liability.• Disadvantages– Lowest common denominator approach– Encourages form over substance– Focus on legal liability not stakeholder interests

The Principles-Based Approach to Corporate Governance

• Identifies general principles or objectives for the corporate governance system to aim to achieve.

• Responsibility is placed on the managers to consider which practices are appropriate, given their circumstances.

The Principles-Based Approach to Corporate Governance

• Advantages– Places a higher level of duty on directors to determine

which corporate governance practices are required.– Its flexibility means that practices can be adapted for

the particular circumstances and environment of the entity.

• Disadvantages– Directors must interpret these principles and decide

which corporate governance practices are needed.– It relies on their honesty, integrity and commitment to

good governance.

Practical Considerations

• In most countries, corporate governance involves various combinations of both the rules and principles-based approaches.– Specific legislation that requires certain corporate

governance practices to be followed by law.– Codes of corporate governance practice issued by

government or industry groups and also by stock exchanges.

DEVELOPMENTS AND ISSUES INCORPORATE GOVERNANCE

• The global financial crisis has provided an impetus for regulators, corporations themselves and other organisations to reconsider aspects of corporate governance.

• An OECD review concluded that while the espoused principles of corporate governance were sound, there was a ‘gap’ between the principles and their implementation.

Increased Focus onRisk Management

• The failure of many corporations to manage and control risk has been identified as a cause of the financial crisis.

• Risk management deficiencies noted include:– Risk was not managed or monitored at the entity level,

but rather at individual activity level.– Information about risks were not reaching the board.– Organisational culture encouraged risk taking– Disconnect between the corporation’s overall risk

strategy and related procedures

Increased Focus onRisk Management

• Risk management in many codes of corporate governance is not given prominence.

• Many corporations are now endeavouring to introduce more formal and comprehensive risk management policies and procedures and integrate these into their existing corporate governance frameworks.

• The task of ‘business’ risk management is now often delegated to the audit committee.

Elements of the Effective Governance Model

Executive Remuneration

• This is a contentious issue regularly scrutinised by public and the media.

• Concerns have been raised about– The size of executive remuneration.– The apparent disconnect between performance

and pay.– The use of public (bail-out) money to pay bonuses.– The connection between remuneration packages

and rewarding short-term focus

Executive Remuneration

• In response to the financial crises and concern about remuneration there have been a variety of legislative responses.– In the US, the Dodd-Frank legislation includes:

• ‘Claw back’ provisions if it is found that compensation paid was based on inaccurate financial statements

– In Australia, recent legislation includes• Increased disclosure• A ‘two-strikes’ rule where if more than 25% of shareholders

vote against the remuneration report for two consecutive years, the board itself can be put up for re-election.

ROLE OF ACCOUNTING AND FINANCIAL REPORTING IN CORPORATE GOVERNANCE

• Accounting clearly has a central role in directing and controlling a corporation.– Management accounting provides a signi cant part

of the information on which company operations will be decided.

– Financial accounting provides the means for outsiders to monitor the corporation and to assess how well those responsible for managing the corporation have performed.

Deterring, Preventing and Encouraging Certain Actions and Decisions

• There are two key ways in which accounting is used to direct and control the managers of a corporation.– Encourage appropriate decisions• Linking managers performance to rewards

– Transparency and disclosure• Requiring specific disclosure about areas relevant to

corporate governance. E.g.– AASB 124 Related Party Disclosures– AASB 2 Share-based Payment

Informing Shareholders and Stakeholders

• The key role for financial reporting in corporate governance is to provide the information needed to assess the performance of the corporation and its managers.

• To be useful the financial statements provided must be transparent, unbiased and complete.

• Financial statements are a crucial link enabling shareholders to monitor directors’ actions and to assist in identifying any deficiencies in the effectiveness of corporate governance

Financial reporting ‘problems’

• Historically and recently there are many examples of financial reporting failures.

• The choices of accounting policy may not be neutral or unbiased.

• Two key drivers are– Maximising remuneration bonuses– Meeting market expectations

• Also instances of outright fraud

THE ROLE OF ETHICS

“At the core of good governance is ‘doing the right thing’ by acting with honesty, impartiality, integrity, trustworthiness, respect for the law and due process. A commitment to ethical values is fundamental”

Peter Achterstraat, Auditor-General in New South Wales

THE ROLE OF ETHICS• Good corporate governance cannot exist without ethics.

– The Sarbanes–Oxley Act in the United States requires disclosure of whether or not there is a code of ethics for senior financial officers.

– CPA Australia argues that implementation of a corporate governance structure is not sufficient and will only work if the culture of the corporation supports good governance.

– The Hong Kong Institute of Certified Public Accountants guidelines for public bodies places emphasis on the personal qualities of individuals as the foundation for good corporate governance.

INTERNATIONAL PERSPECTIVES AND DEVELOPMENTS

• The Anglo-Saxon model placing emphasis on shareholders interest dominates in the United States, Australia, Canada and the United Kingdom.

• Asia is increasingly adopting the Anglo-Saxon shareholder model.

• In Europe, there is more direct recognition of alternative stakeholders (such as employees in France and creditors in Germany).

INTERNATIONAL PERSPECTIVES AND DEVELOPMENTS

• It is likely that corporate governance will increasingly consider broader stakeholders.

• The principles-based approach prevails at the moment, backed by legislation for particular practices.

• Future crises, collapses and financial reporting failures will influence future directions and approaches.

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