Qualitative characteristics of information on Risk and Internal Controls needed by the Board

The information on risks and internal controls should be high quality information. This means that it enables the full information content to be conveyed to the board in a manner that is clear and has nothing in it that would make any part of it difficult to understand. Communications should be reliable, relevant and understandable. They should also be complete.


By reliable means the trustworthiness of the information: the assumption that it is ‘hard’ information, that it is correct, that it is impartial, unbiased and accurate. Even In the event of conveying bad news.

By relevant means not only that due reports should be complete and delivered promptly, but also that anything that that should be brought to the board’s attention, should be brought to the board’s attention while there is still time for them to do something about it.

Not all directors possess the technical and nautical knowledge of senior operating personnel of the company. It is therefore particularly important that information conveyed is understandable. This means that it should contain a minimum of technical terms that have obvious meaning to operating managers but may not be understandable to a non-specialist. All communication should therefore be as plain as possible within the constraints of reliability and completeness.

By complete means that all information that the directors need to know and which the operating managers have access to, should be included, regardless of
any inconvenience that it may cause to one or more colleagues.



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The importance for the board of directors to have all the information

The importance for the board of directors to have all the information relating to key operational internal controls and risks

1. In the first instance, the information provided enables the board to monitor the performance of the company on the crucial issues. This includes compliance, performance against targets and the effectiveness of existing controls. By being made aware of the key risks and internal control issues at the operational level, the board can work to address them in the most appropriate way.


2. The board also needs to be aware of the business impact of operational controls and risks to enable the board to make informed business decisions at the strategic level. If the board is receiving incomplete, defective or partial information then they will not be in full possession of the necessary facts to allocate resources in the most effective and efficient way possible.


3. The board has the responsibility to provide information about risks and internal controls to external audiences. Best practice reporting means that directors have to provide information to shareholders and others, about the company’s systems, controls, targets, levels of compliance and improvement measures and hence quality information are needed to achieve this.




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Advantages and Disadvantages of Risk Committee made up of NEDs

The UK Combined Code, for example, allows for risk committees to be made up of either executive or non-executive members.

Advantages of non-executive membership

1. Separation and detachment from the content being discussed is more likely to bring independent scrutiny. Sensitive issues relating to one or more areas of executive oversight can be aired without vested interests being present.

2. Non-executive directors often bring specific expertise that will be more relevant to a risk problem than more operationally-minded executive directors will have. The NEDs, being from different backgrounds, are likely to bring a range of perspectives and suggested strategies which may enrich the options open to the committee when considering specific risks.


Disadvantages of non-executive membership (advantages of executive membership)

1. Direct input and relevant information would be available from executives working directly with the products, systems and procedures being discussed if they were on the committee. Non-executives are less likely to have specialist knowledge of products, systems and procedures being discussed and will therefore be less likely to be able to comment intelligently during meetings.

2. Non-executive directors will need to report their findings to the executive board. This reporting stage slows down the process, thus requiring more time before actions can be implemented, and introducing the possibility of some misunderstanding.



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Importance of independence of Auditor

The auditor must be materially independent of the client for the following reasons:


1. To increase credibility and to underpin confidence in the process. In an external audit, this will primarily be for the benefit of the shareholders and in an internal audit, it will often be for the audit committee that is, in turn, the recipient of the internal audit report.


2. To ensure the reliability of the audit report. Any evidence of lack of independence (or ‘capture’) has the potential to undermine all or part of the audit report thus rendering the exercise flawed.


3. To ensure the effectiveness of the investigation of the process being audited. An audit, by definition, is only effective as a means of interrogation if the parties are independent of each other.



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Framework for assessing risk

Risk is assessed by considering each identified risk in terms of two variables:

– its hazard (or consequences or impact) and,
– its probability of happening (or being realised or ‘crystallising’).

The most material risks are those identified as having high impact/hazard and the highest probability of happening. Risks with low hazard and low probability will have low priority whilst between these two extremes are situations where judgement is required on how to manage the risk.


In practice, it is difficult to measure both variables with any degree of certainty and so it is often sufficient to consider each in terms of relative crude metrics such as ‘high/medium/low’ or even ‘high/low’. The framework can be represented as a ‘map’ of two intersecting continuums with each variable being plotted along a continuum.




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Contribution of Risk Committee

Evaluate the contribution that a risk committee made up of non-executive directors could make to shareholders’ confidence in the management of an organistion


Risk committees are considered best practice by most corporate governance regimes around the world for a number of reasons. A risk committee made up of non-executive directors could provide an independent viewpoint on the company’s overall response to risk, and to challenge the CEO’s attitude. A risk committee can help increase the confidence in a number of ways:


Determining overall exposure to risk
The committee can pressure the board to determine what constitute acceptable level of risk, bearing in mind the likelihood and the risks materialising and the company’s ability to reduce the incidence and impact on the business.

Monitoring the overall exposure to risk
Once the board defined acceptable risk levels, the committee should monitor whether the company is remaining within these levels and whether earnings are sufficient given the levels of risks that are being borne.

Reviewing reports on key risks
There should be a regular system of reports to the risk management committee covering areas known to be of high risk, also one-off reports covering conditions and events likely to arise in the near future. This should facilitate monitoring of risk.

Monitoring the effectiveness of the risk management systems
The committee should monitor the effectiveness of the risk management systems, focusing particularly on effective management attitudes towards risks and the overall control environment and culture. A risk committee can judge whether there is an emphasis on effective management or whether insufficient attention is being given to risk management due to the pursuit of higher returns.



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Appointment of Internal Auditors from Inside or Outside

In practice, a decision such as this one will depend on a number of factors including the supply of required skills in the internal and external job markets. In constructing the case for an external appointment, however, the following points can be made.

Primarily, an external appointment would bring detachment and independence that would be less likely with an internal one.

Firstly, then, an external appointment would help with independence and objectivity (avoiding the possibility of auditor capture). He or she would owe no personal loyalties nor ‘favours’ from previous positions. Similarly, he or she would have no personal grievances nor conflicts with other people from past disputes or arguments.


Some benefit would be expected from the ‘new broom’ effect in that the appointment would see the company through fresh eyes. He or she would be unaware of vested interests. He or she would be likely to come in with new ideas and expertise gained from other situations.


Finally, as with any external appointment, the possibility exists for the transfer of best practice in from outside – a net gain in knowledge for the company.




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Objectivity and Internal/External Auditors

Objectivity is a state or quality that implies detachment, lack of bias, not influenced by personal feelings, prejudices or emotions. It is a very important quality in corporate governance generally and especially important in all audit situations where, regardless of personal feeling, the auditor must carry out his or her task objectively and with the purpose of the audit uppermost in mind. The IFAC Code of Ethics explains objectivity in the following terms (Introduction, clause 16): “… fair and should not allow prejudice or bias, conflict of interest or influence of others to override objectivity.”


It thus follows that characteristics that might demonstrate an internal auditor’s professional objectivity will include fairness and even-handedness, freedom from bias or prejudice and the avoidance of conflicts of interest (e.g. by accepting gifts, threats to independence, etc.).


The internal auditor should remember at all times that the purpose is to deliver a report on the systems being audited to his or her principal. In an external audit situation, the principal is ultimately the shareholder and in internal audit situations, it is the internal audit committee (and then ultimately, shareholders).



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Classification of Stakeholders

(a) Internal stakeholders
Employees, management

(b) External stakeholders
The government, local government, the public, pressure groups, opinion leaders

(c) Connected stakeholders
Shareholders, customers, suppliers, lenders, trade unions, competitors
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(a) Direct stakeholders
Those who know they can affect or are affected by the organisation’s activities – employees, major customers and suppliers


(b) Indirect stakeholders
Those who are unaware of the claims they have on the organization or who cannot express their claim directly- wildlife, individual customers or suppliers of a large organization, future generations
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(a) Narrow stakeholders
Those most affected by organisation’s strategy- shareholders, managers, employees, suppliers, dependent customers


(b) Wide stakeholders
Those less affected by the organisation’s strategy – government, less dependent customers, the wider community
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(a) Primary stakeholders
Those without whose participation the organization will have difficulty continuing as a going concern, such as customers, suppliers and government (tax and legislation)


(b) Secondary stakeholders
Those whose loss of participation won’t affect the company’s continued existence such as broad communities
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(a) Active stakeholders
Those who seek to participate in the organisation’s activities. Stakeholders includes managers, employees and institutional investors, but may also include other groups not part of an organization’s structure such as regulators or pressure group


(b) Passive stakeholders
Those who do not seek to participate in policy-making such as most shareholders, local communities and government
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(a) Voluntary stakeholders
Those who engage with the organization voluntarily – employees, most customers, suppliers and shareholders


(b) Involuntary stakeholders
Those who become stakeholders involuntarily – local communities, neighbours, the natural world, future generations
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(a) Legitimate stakeholders
Those who have valid claims upon the organisation


(b) Illegitimate stakeholders
Those whose claims upon the organization are not valid
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(a) Recognized stakeholders
Those whose interests and views managers consider when deciding upon strategy


(b) Unrecognized stakeholders
Those whose claims aren’t taken into account in the organisation’s decision making – likely to be very much the same as illegitimate stakeholders
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(a) Known stakeholders
Those whose existence is known o the organisation


(b) Unknown stakeholders
Those whose existence is unknown to the organisation (undiscovered species, communities in proximity to overseas suppliers)
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Risk awareness

Explanation

Risk awareness is a capability of an organisation to be able to recognise risks when they arise, from whatever source they may come. A culture of risk awareness suggests that this capability (or competence) is present throughout the organisation and is woven into the normal routines, rituals, ways of thinking and is taken-for-granted in all parts of the company and in all employees.

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Why is it necessary for organisation to cultivate a culture of risk awareness and that this should permeate all levels of the company?


Risks can arise in any part of the organisation and at any level. Not all risks are at the strategic level and can be captured by a risk assessment. A culture of risk awareness will help ensure that all employees are capable of identifying risks as and when they arise.

Risks are dynamic and rise and fall with changes in the business environment and with changes in the company’s activities. With changes to the company’s risk profile occurring all the time, it cannot be assumed that the risks present at the most recent risk assessment will remain the same. Being prepared to adapt to changes is a key advantage of a culture of risk awareness.


A lack of risk awareness is often evidence of a lack of risk management strategy in the organisation. This, in turn, can be dangerous as the company could be more exposed to risk than it need be because of the lack of attentiveness by staff. A lack of effectiveness of risk management strategy leaves the company vulnerable to unrecognised or wrongly assessed risks.



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Why risk assessment is dynamic

Risk assessment is a dynamic management activity because of changes in the organisational environment and because of changes in the activities and operations of the organisation which interact with that environment.


A risk may arise from a change in the activity of the company: a new product launch. The new product may introduce a new risk that was not present prior to the new product. It may be a potential liability from the use of the product or a potential loss from the materials used in its production, for example.



Changes in the environment might include changes in any of the PEST (political, economic, social, technological) or any industry level change such as a change in the competitive behaviour of suppliers, buyers or competitors. In either case, new risks can be introduced, existing ones can become more likely or have a higher impact, or the opposite (they may disappear or become less important). Risk may arise from a change in legislation which is a change in the external environment.




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Why is Auditor Independence Important?

(1) Reliability of financial information
• Reliability of financial information is a key aspect of Corporate Governance.
• S/H and other stakeholders need a trustworthy record of directors’ stewardship to be able to take decision about company.
• Assurance provided by Auditors is a key quality control on the reliability of information.


(2) Credibility of financial information
• An unqualified report by independent external auditors on the account should give credibility and enhance the appeal of the company to investors.
• This unqualified report should represent the views of independent experts who are not motivated by personal interests to give a favourable opinion.


(3) Value for money of audit work
• A lack of independence seems to mean that important audit work may not be done, and thus shareholders are not receiving value for the audit fees.


(4) Threats to professional standards
• A lack of independence may lead to a failure to fulfill professional requirements to obtain enough evidence to form the basis of an audit opinion, in this case, to obtain details of a questionable material item.
• Failure by auditors to do this undermines the credibility of the accountancy profession and standards it enforces.



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Organisational Culture

A pattern of shared basic assumptions that was learned by a group as it solved its problems of external adaptation and internal integration, that has worked well enough to be considered valid and, there fore, to be taught to new members as the correct way to perceive, think and feel in relation to those problems.


1. It is an acceptable way of thinking and acting that is embedded into processes and people.

2. It tends to be driven top down but can also shift and change without strong leadership.

3. It shapes attitudes of staff towards objectives of growth, return and risk, and their attitude towards economic, social and environmental objectives and to ethics and morality.

4. The right culture can promote business success so that agreed objectives are more likely to be met.

5. It can be managed. Good management creates culture that supports company objective.

6. The stance or perceived stance of a company, in terms of attitudes to stakeholders and their interests is a crucial part of a company culture.

7. The implication of the concept of company culture is there may be separate culture for management and staff. These cultures need to be aligned to achieve company objectives.

8. It is composed of many interrelated and sometimes conflicting objectives and values. Some companies focus on profit, others on the 3 Ps = People, Planet and Profits.


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Stakeholders

Definition

There are a number of definitions of a stakeholder. Freeman (1984), for example, defined a stakeholder in terms of any organisation or person that can affect or be affected by the policies or activities of an entity. Hence stakeholding can result from one of two directions: being able to affect and possibly influence an organisation or, conversely, being influenced by it.

Any engagement with an organisation in whom a stake is held may be voluntary or involuntary in nature.
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Importance of identifying all stakeholders

Knowledge of the stakeholders is important for a number of reasons.

1. This will involve surveying stakeholders that can either affect or be affected by company’s project. Stakeholders in the company’s project include the local government authority, the local residents, the environmental group, the local school and the customers.

2. Stakeholder identification is necessary to gain an understanding of the sources of risks and disruption. Some external stakeholders, such as the local government authority, offer a risk to the project and knowledge of the nature of the claim made upon the company by the stakeholder will be important in risk assessment.

3. Stakeholder identification is important in terms of assessing the sources of influence over the objectives and outcomes for the project (such as identified in the Mendelow model). In strategic analysis, stakeholder influence is assessed in terms of each stakeholder’s power and interest, with higher power and higher interest combining to generate the highest influence.

4. It is necessary in order to identify areas of conflict and tension between stakeholders, especially relevant when it is likely that stakeholders of influence will be in disagreement over the outcomes for the project.

5. There is a moral case for knowledge of how decisions affect people both inside the organisation or externally.




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Kohlberg’s Cognitive Moral Development Theories

Kohlberg’s cognitive moral development theories relate to the thought processes people go through when making ethical decisions.

Three Kohlberg levels

(1) Pre-conventional Level
At the preconventional level of moral reasoning, morality is conceived of in terms of rewards, punishments and instrumental motivations. Those demonstrating intolerance of regulations in preference for self-serving motives are typical preconventionalists.

Stage 1
Individual will see ethical decisions in terms of the rewards and punishments that will result:
• How will I be rewarded if I do this?
• What punishment will I suffer if I do this?

Stage 2
Individual will see ethical decisions in the more complex terms of acting in their own best interests. They will see decision in terms of the deals they can make and whether these deals are fair for them. For example it can mean helping others when others appear over-worked, but in return expecting others to help them when the situation is reversed.



(2) Conventional Level
At the conventional level, morality is understood in terms of ompliance with either or both of peer pressure/social expectations or regulations, laws and guidelines. A high degree of compliance is assumed to be a highly moral position.

Stage 3
Individual learning to live up to what is expected of them by their immediate circle (friends, workmates or even close competitors). An individual might feel pressured into staying out for a long lunch because everybody else in his team does. On the other hand the individual may feel he has to be at work by a certain time because everybody else is, even if it is earlier than their prescribed hours.

Stage 4
The individual operates in line with social cultural accord rather than just the opinion of those around them. This certainly means complying with the law as it codifies social accord. Stage 4 reasoning underlies most behaviour by accountants, as they comply with financial reporting and corporate governance requirements.



(3) Post-conventioanl Level
At the postconventional level, morality is understood in terms of conformance with ‘higher’ or ‘universal’ ethical principles. Postconventional assumptions often challenge existing regulatory regimes and social norms and so postconventional behaviour is often costly in personal terms.

Stage 5
What Individuals believe to be right is in terms of the basic values of their society, including ideas of mutual self-interest and the welfare of others. For example, is it right to charge interest?

Stage 6
Individuals base their decisions on wider universal ethical principles such as justice, equity or rights. It also means respecting the demands of individuals consciences. Business decisions made on these grounds could be disclosure on grounds of right-to-know that isn’t compelled by law, or stopping purchasing from suppliers who test products on animals, on the grounds that animal rights to be free from suffering should be respected. Using stage 6 reasoning may involve a personal cost, since it may mean failing to comply with existing social norms and regulations as they are seen as unethical.



Level 1: Preconventional level
Stage/Plane 1: Punishment-obedience orientation
Stage/Plane 2: Instrumental relativist orientation

Level 2: Conventional level
Stage/Plane 3: Good boy-nice girl orientation
Stage/Plane 4: Law and order orientation

Level 3: Postconventional level
Stage/Plane 5: Social contract orientation
Stage/Plane 6: Universal ethical principle orientation



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Professionalism and Public Interest

Public Interest is the collective well-being of the community of people and institutions the professional accountant serves, including clients, lenders, governments, employers, employees, investors, the business and financial community and others who rely on the work of professional accountants. (IFAC)


Professionalism means avoiding actions that bring discredit on the accountancy profession.

Professional behavior imposes an obligation on professional accountants to comply with relevant laws and regulations.

Professionalism means to:
• Maintain confidentiality and upholding ethical standards.
• Should avoid making exaggerated claims for their own services, qualifications and experience
• Dealing with professional colleagues - work well with other team members, deal appropriately with concerns they raise about the work they are doing. They set an example to junior staff.




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Public Interest in accounting profession

Public interest is the collective wellbeing of the community of people and institutions that the professional accountant serves, including the business and financial community and others who rely on the work of professional accountants.

Trust is a key issue in terms of the public interest as it relates to accountants. The working of capital markets depends upon reliable financial information, as does business decision-making affecting jobs and supply. The public has to be able to believe that accountants’ opinions are give on a basis of sufficient work and that they are unaffected by external pressures.

Accountants who provide audit or assurance services must be able to demonstrate clearly their detachment from the client. They cannot do this if they are providing other services to the client.



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Professional Codes

Limitation of Professional Codes

1. Treatment as Rules
Because they contain descriptions of situations that accountants might encounter, they can convey the (false) impression that professional ethics can be reduced to a set of rules contained in a code. This would be a mistaken impression, of course, as the need for personal integrity is also emphasised.

2. Cannot cover all circumstances
Ethical codes do not and cannot capture all ethical circumstances and dilemmas that a professional accountant will encounter in his or her career and this reinforces the need for accountants to understand the underlying ethical principles of probity, integrity, openness, transparency and fairness.

3. Regional differences
Although codes such as IFAC’s are intended to apply to an international ‘audience’, some may argue that regional variations in cultural, social and ethical norms mean that such codes cannot capture important differences in emphasis in some parts of the world. The oral ‘right’ can be prescribed in every situation.

4. Legal enforcement
Finally, professional codes of ethics are not technically enforceable in any legal manner although sanctions exist for gross breach of the code in some jurisdictions. Individual observance of ethical codes is effectively voluntary in most circumstances.




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Usefulness of Professional Codes

1 Fundamental Principles
Firstly, professional codes of ethics signal the importance, to accountants, of ethics and acting in the public interest in the professional accounting environment. They are reminded, unambiguously and in ‘black and white’ for example, that as with other professions, accounting exists to serve the public good and public support for the profession is likely to exist only as long as the public interest is supported over and above competing interests.

2. Internally expected standards
The major international codes (such as IFAC) underpin national and regional cultures with internationally expected standards that, the codes insist, supersede any national ethical nuances. The IFAC (2003) code states (in clause 4), “the accountancy profession throughout the world operates in an environment with different cultures and regulatory requirements. The basic intent of the Code, however, should always be respected.”

3. Minimum Standard
The codes prescribe minimum standards of behaviour expected in given situations and give specific examples of potentially problematic areas in accounting practice. In such situations, the codes make the preferred course of action unambiguous.

4. Building confidence in the profession
A number of codes of ethics exist for professional accountants. Prominent among these is the IFAC code. This places the public interest at the heart of the ethical conduct of accountants. The ACCA code discusses ethics from within a principles-based perspective. Other countries’ own professional accounting bodies have issued their own codes of ethics in the belief that they may better describe the ethical situations in those countries.




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Integrity

The IFAC code of ethics (2005) s.110.1 explains integrity as follows:

The principle of integrity imposes an obligation on all professional accountants to be straightforward and honest in professional and business relationships. Integrity also implies fair dealing and truthfulness.


Integrity is therefore a steadfast adherence to strict ethical standards despite any other pressures to act otherwise. Integrity describes the personal ethical position of the highest standards of professionalism and probity. It is an underlying and underpinning principle of corporate governance and it is required that all those representing shareholder interests in agency relationships both possess and exercise absolute integrity at all times.



In terms of professional relationships, integrity is important for the following reasons:

Reliability
It provides assurance to colleagues of good intentions and truthfulness. It goes beyond any codes of professional behaviour and describes a set of character traits that mean a person of integrity can be trusted. For auditors such as Potto Sinter, integrity means not only observing the highest standards of professional behaviour but also maintaining the appearance of integrity to his own staff and also to the client.


Efficiency and Effectiveness
It reduces time and energy spent in monitoring when integrity and openness can be assumed (the opposite of an audit situation where the professional scepticism should be exercised). Costs will be incurred by Miller Dundas if colleagues feel that Potto Sinter is untrustworthy.


Promotion of control environment
It cultivates good working relationships in professional situations. It encourages a culture of mutual support that can have a beneficial effect on organisational effectiveness. John Wang’s professional relationship with Potto is very important to Miller Dundas. It is important, therefore, that Potto has personal integrity.



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Five types of Ethical Threats

(a) Self-interest
Self-interest means the accountant’s own interest being affected by the success of the client, or the continuation of the accountant-client relationship. An example would be a financial interest in a client.

If a firm providing audit and other services disagrees with the client over the accounts that it is auditing, it faces the risk of not just losing the income from the audit, but perhaps also the much greater income from providing other services.



(b) Self-review
Self-review means the accountants auditing or reviewing work that they themselves have prepared. This could include auditing work that has been prepared as part of a non-audit service, something that prompts the suggestion that firm should not provide more than one service to a client.

If the accountants provide other services that materially affect the content of the accounts, then they will have to audit figures that they themselves have prepared, for example valuations.



(c) Advocacy
Advocacy means strongly promoting the interests of the accountants’ clients and undermining the accountants’ objectivity. Accountants can be seen as acting in the clients’, rather than the public interest.

If an accountant provides legal advice to his audit client. There are two problems. Firstly providing that advice could be seen as promoting the client’s interests rather than the public interest. Secondly the accounts may need to contain provision for, or disclosure about, legal actions. This will depend on the likelihood of the success of legal action, which could in turn depend on the advice the accountant had given. Therefore there is a clear possibility of the accountant not wishing to undermine the advice he has given by taking a prudent view of the issues’ treatment in the accounts.



(d) Familiarity
Familiarity means dealing with a client’s affairs for a long time and developing a close relationship. This can lead to reliance on previous knowledge rather than a questioning approach to information supplied.

Friendships with clients may make it more likely that clients would listen to the accountant’s advice; critics, however, suggest the friendships meant that he placed excessive trust in what he was told, and would be unwilling to raise awkward issues that could jeopardize the friendships. The provision of other services may mean that accountants are less rigorous in auditing information with which their firm has been involved.


(e) Intimidation
Intimidation means conduct of the assignment or conduct towards the client being influenced by pressure exerted by the client.

This could mean that if the client wished to intimidate the accountant into giving advice that they wanted to hear, they would have a good idea of how to do so, by for example threatening to replace the firm as auditors.




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Deontology and Consequentialism

Deontological ethics
The deontological perspective can be broadly understood in terms of ‘means’ being more important than ‘ends’. It is broadly based on Kantian (categorical imperative) ethics. The rightness of an action is judged by its intrinsic virtue and thus morality is seen as absolute and not situational. An action is right if it would, by its general adoption, be of net benefit to society. Lying, for example, is deemed to be ethically wrong because lying, if adopted in all situations, would lead to the deterioration of society.



Consequentialist ethics
The consequentialist or teleological perspective is based on utilitarian or egoist ethics meaning that the rightness of an action is judged by the quality of the outcome.

From the egoist perspective, the quality of the outcome refers to the individual (“what is best for me?”). Utilitarianism measures the quality of outcome in terms of the greatest happiness of the greatest number (“what is best for the majority?”). Consequentialist ethics are therefore situational and contingent, and not absolute.



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Company Codes of Ethics

Purposes of codes of ethics

1. To convey the ethical values of the company to interested audiences including employees, customers, communities and shareholders.

2. To control unethical practice within the organisation by placing limits on behaviour and prescribing behaviour in given situation.

3. To be a stimulant to improved ethical behaviour in the organisation by insisting on full compliance with the code.
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Contents of a corporate code of ethics

The typical contents are as follows:

(A) Values of the company
This might include notes on the strategic purpose of the organisation and any underlying beliefs, values, assumptions or principles. Values may be expressed in terms of social environmental perspectives and expressions of intent regarding compliance with best practice, etc.

(B) Shareholders and suppliers of finance
In particular, how the company views the importance of sources of finances, how it intends to communicate with them and any indications of how they will be treated in terms of transparency, truthfulness and honesty.

(C) Employees
Policies towards employees, which might include equal opportunities policies, training and development, recruitment, retention and removal of staff.

(D) Community and wider society
The manner in which the company aims to relate to a range of stakeholders with whom it does not have a direct economic relationship (eg neighbours, opinion formers, pressure groups etc).
It might include undertakings on consultation, ‘listening’. Seeking consent, partnership arrangements (eg in community relationships with local schools) and similar.

(E) Supply chain/suppliers
This is becoming important as stakeholders scrutinise where and how companies source their products (eg farming practice, GM foods, fair trade issues etc).
Ethical policy on supply chain might include undertakings to buy from certain approved suppliers only, to buy only above a certain level of quality, to engage constructively with suppliers (eg for product development purposes) or not to buy from suppliers who do not meet with their own ethical standards.

(F) Customers
How the company intends to treat its customers, typically in terms of policy of customer satisfaction, product mix, product quality, product information and complaints procedure.



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Public Interest, Professionalism

Public Interest is the collective well-being of the community of people and institutions the professional accountant serves, including clients, lenders, governments, employers, employees, investors, the business and financial community and others who rely on the work of professional accountants. (IFAC)


Professionalism means avoiding actions that bring discredit on the accountancy profession.
Professional behavior imposes an obligation on professional accountants to comply with relevant laws and regulations.

Professionalism means to:
**Maintain confidentiality and upholding ethical standards.
**Should avoid making exaggerated claims for their own services, qualifications and experience.
**Dealing with professional colleagues - work well with other team members, deal appropriately with concerns they raise about the work they are doing. They set an example to junior staff.



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Accountancy Profession - Green Ecologist?

Accounting Profession in the light of Gray, Owen & Adam’s deep green (or deep ecologist) position on social responsibility

{Green Ecologist is a concept of social responsibility – Human beings have no greater rights to resources or life than any other species and do not have the rights to subjugate social and environmental systems. Economic systems that trade off threats to the existence of species against economic objectives are immoral. Arguably business cannot be trusted to maintain something as important as the environment. Existing economic systems are beyond repair as they are based on the wrong values, privileging humans over nonhumans. A full recognition of all stakeholders would mean that business had to be conducted in a completely different way. This viewpoint is connected with the ideas of sustainability.}


(1) Economic Priority
If accountants serve the economic interests of clients, then their priorities are fundamentally flawed. The deep ecologist perspective argues that giving the economic objectives of capitalists any priority over social and environmental degradation is immoral.


(2) Environmental degradation
Environmental degradation links to the deep ecologist view that business must not threaten the habitats of other species or worsen the living conditions of humans affected by their activities.


(3) Animal rights
The emphasis on the need for accountants to address animal rights is an important distinction between the deep ecologist and other positions, as it places animal rights on an equal plane with humans.



(4) Poverty
The stress on making the relief of poverty and other social injustices a priority links in with the deep ecologist view that all humans, living and yet-to-be-born, are stakeholders in business. Businesses need to recognize the needs of all stakeholders rather than subjugating their requirements to the current economic interest of shareholders.




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Relativist vs Absolutist

Absolutist - DefinitionAbsolutist dogmatic assumptions are based on the idea that there are rules which should be followed in all circumstances, whatever the consequences.
This means that if an individual is facing an ethical dilemma, there should be a “right solution” to that dilemma.



Relativist - DefinitionRelativist position is there are a variety of ethical beliefs and practices. The Ethics that are most appropriate in a given situation will depend on the conditions at the time.
A pragmatic consequentialist position would be consider the consequences of the various options available, and choose the option that on balance produced the greatest benefits or the least degree of harm.





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5 Principles of IFAC Code

(a) Integrity - A professional accountant should be straight forward and honest in all professional and business relationships.


(b) Objectivity - A professional accountant should not allow bias, conflict of interest or undue influence of others to override professional or business judgements.


(c) Professional Competence and Due care- A professional accountant has a continuing duty to maintain professional knowledge and skill at the level required to ensure that a client or employer receives competent professional service based on current developments in practice, legislation and techniques. A professional accountant should act diligently and in accordance with applicable technical and professional standards when providing professional services.


(d) Confidentiality – A professional accountant should respect the confidentiality of information acquired as a result of professional and business relationships and should not disclose any such information to third parties without proper and specific authority unless there is a legal or professional right or duty to disclose. Confidential information acquired as a result of professional and business relationships should not be used for the personal advantage of the professional accountant or third parties.


(e) Professional Behaviour – A professional accountant should comply wth relevant laws and regulations and should avoid any action that discredit the profession.


(abbre: IOCCB)





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Institutional Investors

Who are Institutional Investors?

• Institutional Investors manage funds invested by individuals.
• They are the biggest investors in many stock markets.
• They can wield great power over the companies in which they invest.
• Examples are: Pension funds, insurance companies, investment and unit trusts.



Ways of exercising institutional investors’ influence:

1. One-to-one meeting – discussion with chairman, directors or auditors.

2. Voting – Propose resolutions in AGM or EGM, not to re-elect directors.

3. Focus list – putting companies names on a list of underperforming companies

4. Contributing to corporate governance voting systems that measures the corporate governance performance indicators

5. Complain to regulators


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Four Roles of Remuneration Committee

(1) Complying with laws and best practice
 To ensure that executive directors do not set their own remuneration.
 Remuneration committee should be staffed by non-executive directors.
 To ensure compliance with any relevant legislation.


(2) Establishing General Remuneration Policy
 Consider pay scales foe directors, taking into consideration the remuneration offered by comparable companies.
 Consider what relation remuneration should have to measurable performance or enhanced shareholder value.
 Consider when directors should receive performance-related benefits.


(3) Determining remuneration packages for each director
 To establish packages that will retain, attract and motivate directors whilst taking into account the interests of shareholders.
 To consider how different aspects of the package are balanced.
 To consider what measure are used to assess the performance of individual directors.


(4) Determining disclosure
 To consider what disclosures should be made in the remuneration committee report in the accounts, in the corporate governance section.
 The report includes details of overall policies and the remuneration o individual directors.



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How can Director's Remuneration Package be more aligned to Shareholders' Interest

Explain how the different components of the director’s remuneration package might be more aligned to shareholders’ interests

Balanced package is needed for the following reasons:

The overall purpose of a well-designed rewards package is to achieve a reduction (minimisation) of agency costs. These are the costs the principals incur in monitoring the actions of agents acting on their behalf. The main way of doing this is to ensure that executive reward packages are aligned with the interests of principals (shareholders) so that directors are rewarded for meeting targets that further the interests of shareholders. A reward package that only rewards accomplishments in line with shareholder value substantially decreases agency costs and when a shareholder might own shares in many companies, such a ‘self-policing’ agency mechanism is clearly of benefit. Typically, such reward packages involve a bonus element based on specific financial targets in line with enhanced company (and hence shareholder) value.


(1) Basic salary

 It is the salary laid down in the contract of employment.
 Generally is not related to performance (although increase in it may be).
 Length of contract may not be of excessive length, to protect shareholders’ interests, however, it may not provide enough incentive for directors to perform well.


(2) Performance related bonus

 Cash bonus paid for good performance.
 Performance measures need be determined carefully so that they are not subject to manipulation of profits, do not focus excessively on short-term results and reward individual contribution.
 Example the bonus payable to a sales director - reward based on revenue or profits would play an important part in rewarding performance, on an annual or more frequent basis.


(3) Share and share options

 Rights to purchase shares of a specified exercise price over a specified time period in the future.
 If share price goes up (due to good company performance) and it exceeds the exercise price, director would be able to purchase shares at lower than their market value.
 Share option can be used to align director’s interests with shareholder wishes to maximise company value.
 Share options can be used to reward long-term performance whereas bonuses can be used to reward short-term performance, by specifying that the options may not be exercised for some years.


(4) Benefits in kind

 Car, health care provisions and life insurance.
 It may be difficult to relate these elements to directors’ performance.
 one symptom of the breakdown of the agency relationship is the directors are being rewarded with excessive perks.
 Remuneration committee should ensure that the benefits are not excessive.


(5) Pension

 Pension contribution tends to be linked to basic salary.
 Usually not connected to performance.
 UK combined code stresses that the remuneration committee should consider the pension consequences and associated costs to the company of basic salary increases and changes in pensionable remuneration.



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Systematic approach to Control and Risk Management

How Using a systematic approach to Control and Risk Management can enable companies to fulfill the core aims of Corporate Governance


Core Aims of Corporate Governance are:
1. Ensuring integrity
2. Promotion of strategic objectives
3. Control over companies
4. Enhancing risk management
5. Involvement of shareholders
6. Protection of shareholders and stakeholders
7. Establishment of accountability
8. Maintenance of effective scrutiny
9. Provision of accurate and timely information


Ensuring Integrity

The problem that an organization may face as a result of the lack of integrity of its staff should be part of the risk assessment processes. Risk such as probity risks are significant risks which should be assessed and managed. An important aspect has been stressing the role of directors in influencing the culture, tone and core value of the company.


Promotion of strategic objectives

Guidance in risk management models stresses the need for risk management to be aligned with the strategic objectives. Most risk management models have objective setting as s key stage.


Control over companies

Risk management models emphasize the importance of companies building into their systems the need to follow governance guidance. Two of the four types of objectives in the COSO framework are reliability of reporting and compliance with applicable laws and regulations.


Enhancing risk management

Key feature of risk management model is that they demonstrate how risk management is a continual process. Models show the need to assess organization-wide risks and also specific process or unit risks. They are also used to assess the interaction between risks. Models show that risk management is a logical process, taking the organization through initial risk identification, then identification of events that may cause risks to crystallize, assessment of how great losses might be and in the light of these how best to respond to risks. This will help to identify who should be responsible for which aspects of risk management.


Involvement of shareholders

All risk management models have information provision as a key stage, and this includes information provision to shareholders. Australia and New Zealand Standard on risk management has communication and consultation as an underlying stage of its risk management model, reflecting the requirement in governance reports for communication with major stakeholders.


Protection of shareholders and stakeholders

Risk management models aim to reinforce the protection given to shareholders and other stakeholders. Adopting a systematic approach to risk management should make sure that the risks for investors are at appropriate levels, given the strategic objectives of the company. Effective risk management should mean that the directors are not reckless in their decisions, and consider the risk of solvency problems very seriously.


Establishment of accountability

Risk management models reinforce the idea that clear organizational structures strengthen governance. Responsibility for decision-making is a key part of the internal environment of organizations. Some risk management models emphasize the responsibilities of specific individuals, for example CIMA’s model stresses the need to establish a risk management group. Other models build in decision-making as a key stage


Maintenance of effective scrutiny

Models emphasize the importance of monitoring risk management procedures and controls once they are in place. The feedback from this monitoring will impact upon future risk assessments and also lead to continuous improvements in processes. Some models, for example the CIMA model, emphasize this by showing risk management as a circular process.


Provision of accurate and timely information

As indicated, information provision is a key stage of risk management models. The CIMA model puts information for decision-making at the centre of the model, with all the risk management stages feeding into it.




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Ways in which company directors leave a board

1. Death

2. Resignation
Directors can leave the board if they resign by notice in writing.

3. Failure to seek re-election
When they are required by the retirement by rotation provision in company constitutions to seek re-election, but they decide not to offer themselves for re-election.

4. Voted out
• Directors being nominated for re-election at an AGM, but members voted against their re-election.
• Directors can also be removed from office by ordinary resolution at an AGM of which special notice has been given to the company.

5. Disqualification
• Disqualified by legislation or court
• Become bankrupt
• Enter arrangement with creditors
• Become unsound mind.
• Commission of serious offence in connection with management of company






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Time-limited Appointments

1. Some roles have fixed periods e.g. Chairman, Chief Executive Officer or Directors.


2. It is provided under company’s constitution/articles of association, service contract, legislation, CG codes, etc..


3. Examples are:

• Retirement age at 55 or 60,
• NED to serve for preferably 6 years max under UK Code of CG,
• Higgs Report which recommends annual reelection after 9 yrs.,
• Retirement by rotation after 3 years.
• Fixed period contract of service for ED of Public Listed Companies except in 1st year of contract.
• Company’s Acts require directors over 70 to seek reelection annually.
• 1st year must stand for reelection at AGM as per Company’s Acts and UK Code.



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Roles of Remuneration Committee

Firstly, the committee is charged with determining remunerations policy on behalf of the board and the shareholders. In this regard, they are acting on behalf of shareholders but for the benefit of both shareholders and the other members of the board. Policies will typically concern the pay scales applied to directors’ packages, the proportions of different types of reward within the overall package and the periods in which performance related elements become payable.


Secondly the committee ensures that each director is fairly but responsibly rewarded for their individual contribution in terms of levels or pay and the components of each director’s package. It is likely that discussions of this type will take place for each individual director and will take into account issues including market conditions, retention needs, long-term strategy and market rates for a given job.


Third, the remunerations committee reports to the shareholders on the outcomes of their decisions, usually in the corporate governance section of the annual report (usually called Report of the Remunerations Committee). This report, which is auditor reviewed, contains a breakdown of each director’s remuneration and a commentary on policies applied to executive and nonexecutive remuneration.


Finally, where appropriate and required by statute or voluntary code, the committee is required to be seen to be compliant with relevant laws or codes of best practice. This will mean that the remunerations committee will usually be made up of nonexecutive members of the board and will meet at regular intervals.



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Roles of Employee Representatives

Trade unions are the most usual example of employee representation in corporate governance. Trade unions represent employees in a work facility such as an office or a plant. Membership is voluntary and the influence of the union is usually proportional to its proportion of membership.


Although a trade union is by default assumed to have an adversarial role with management, its ability to ‘deliver’ the compliance of a workforce can help significantly in corporate governance. When an external threat is faced, such as with the reputation losses following the 1970s leak, then the coalition of workforce (via Forward Together) and management meant that it was more difficult for external critics to gain support.


A trade union is an actor in the checks and balances of power within a corporate governance structure. Where management abuses occur, it is often the trade union that is the first and most effective reaction against it and this can often work to the advantage of shareholders or other owners, especially when the abuse has the ability to affect productivity.


Trade unions help to maintain and control one of the most valuable assets in an organisation (employees). Where a helpful and mutually constructive relationship is cultivated between union and employer then an optimally efficient industrial relations climate exists, thus reinforcing the productivity of human resources in the organisation. In defending members’ interests and negotiating terms and conditions, the union helps to ensure that the workforce is content and able to work with maximum efficiency and effectiveness.




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Mandatory and Voluntary Disclosures

Mandatory disclosures

These are components of the annual report mandated by law, regulation or accounting standard. Examples include (in most jurisdictions) statement of comprehensive income (income or profit and loss statement), statement of financial position (balance sheet), cash flow statement, statement of changes in equity, operating segmental information, auditors’ report, corporate governance disclosure such as remuneration report and some items in the directors’ report (e.g. summary of operating position). In the UK, the business review is compulsory.


Voluntary disclosures

These are components of the annual report not mandated in law or regulation but disclosed nevertheless. They are typically mainly narrative rather than numerical in nature. Examples include (in most jurisdictions) risk information, operating review, social and environmental information, and the chief executive’s review.



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Integrity in Corporate Governance

Meaning of ‘integrity’

Integrity is generally understood to describe a person of high moral virtue. A person of integrity is one who observes a steadfast adherence to a strict moral or ethical code notwithstanding any other pressures on him or her to act otherwise.

In professional life, integrity describes the personal ethical position of the highest standards of professionalism and probity.

It is an underlying and underpinning principle of corporate governance and it is required that all those representing shareholder interests in agency relationships both possess and exercise absolute integrity at all times. To fail to do so is a breach of the agency trust relationship.


Importance of integrity in corporate governance

Integrity is important in corporate governance for several reasons:

1. As corporate governance cannot cover every situation, maintenance of good corporate governance will sometimes depend on judgement not backed by codes. In these instances integrity is particularly important.

2. As integrity is partly about proper dealing in relationships, it also underpins the principles of fair and equitable dealing with shareholders in corporate governance, particularly in relation to directors exercising an agency relationship in respect of shareholders.

3. Good corporate governance is also about maintaining market confidence that the company is being run honestly, firm belief that directors have integrity will promote confidence in the company.



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Insider dealing/trading

Insider dealing (also called insider trading) is the buying or selling of company shares based on knowledge not publicly available. Directors are often in possession of market-sensitive information ahead of its publication and they would therefore know if the current share price is under or over-valued given what they know about forthcoming events. If, for example, they are made aware of a higher than expected performance, it would be classed as insider dealing to buy company shares before that information was published. Similarly, selling shares in advance of results publication indicating previous over-valuation, would also be considered as insider dealing.



Why is insider trading unethical and often illegal?

By accepting a directorship, each director agrees to act primarily in the interests of shareholders. This means that decisions taken must always be for the best long-term value for shareholders. If insider dealing is allowed, then it is likely that some decisions would have a short-term effect which would not be of the best long-term value for shareholders. For example, businesses which are about to be taken-over often see a significant rise in their share price. In this situation directors might purchase shares in their own companies, seek potential buyers for the company and recommend the sale to shareholders, in order to make a profit on their own share investments. For this reason, a blanket ban on insider dealing ensures that such short-term measures are not taken.

There is also the potential damage that insider trading does to the reputation and integrity of the capital markets in general which could put off investors who would have no such access to privileged information and who would perceive that such market distortions might increase the risk and variability of returns beyond what they should be.




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Grounds for Institutional investor intervention

Seven reasons are typically cited as potential grounds for investor intervention.

Whilst it would be rare to act on the basis of one factor (unless it was particularly unfavourable), an accumulation of factors may have such an effect. Furthermore, institutional investors have a moral duty to use their power to monitor the companies they invest in for the good of all investors, as recognised in most codes of corporate governance. Institutional investors have the expertise at their disposal to understand the complexities of managing large corporations. As such, they can take a slightly detached view of the business and offer advice where appropriate. The typical reasons for intervention are cited below.

1. Concerns about strategy, especially when, in terms of long-term investor value, the strategy is likely to be excessively risky or, conversely, unambitious in terms of return on investment. The strategy determines the long-term value of an investment and so is very important to shareholders.


2. Poor or deteriorating performance, usually over a period of time, although a severe deterioration over a shorter period might also trigger intervention, especially if the reasons for the poor performance have not been adequately explained in the company’s reporting.


3. Poor non-executive performance. It is particularly concerning when non-executives do not, for whatever reason, balance the executive board and provide the input necessary to reassure markets. Their contributions should always be seen to be effective. This is especially important when investors feel that the executive board needs to be carefully monitored or constrained, perhaps because one or another of the factors mentioned in this answer has become an issue.


4. Major internal control failures. These are a clear sign of the loss of control by senior management over the operation of the business. These might refer, for example, to health and safety, quality, budgetary control or IT projects. In the case of ZPT, there were clear issues over the control of IC systems for generating fi nancial reporting data.


5. Compliance failures, especially with statutory regulations or corporate governance codes. Legal non-compliance is always a serious matter and under comply-or-explain, all matters of code non-compliance must also be explained. Such explanations may or may not be acceptable to shareholders.


6. Excessive directors’ remuneration or defective remuneration policy. Often an indicator of executive greed, excessive board salaries are also likely to be an indicator of an ineffective remunerations committee which is usually a non-executive issue. Whilst the absolute monetary value of executive rewards are important, it is usually more important to ensure that they are highly aligned with shareholder interests (to minimise agency costs).


7. Poor CSR or ethical performance, or lack of social responsibility. Showing a lack of CSR can be important in terms of the company’s long-term reputation and also its vulnerability to certain social and environmental risks.




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Fiduciary responsibility of company

Definition of ‘fiduciary responsibility’

A fiduciary responsibility is a duty of trust and care towards one or more constituencies. It describes direction of accountability in that one party has a fiduciary duty to another.

Traditionally, the fiduciary duty of directors in public companies is to act in the economic interests of shareholders who invest in the company but are unable to manage the company directly.


The case for company extending fiduciary responsibility

1. It clearly demonstrates that the company values the community of which it considers itself a part.

2. It would help to maintain and manage its local reputation, which is important in business.

3. To broaden the fiduciary responsibility would be an important part of the risk management strategy, especially with regard to risks that could arise from the actions of local stakeholders.

4. It could be argued that there is a moral case for all organisations to include other stakeholders’ claims in their strategies as it enfranchises and captures the views of those affected by an organisation’s policies and actions.



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Distinguish between AGM and EGM

• Annual general meetings (AGMs) are a part of the normal financial calendar for all limited companies and take place on the occasion of the year-end results presentation and the publication of the annual report.

• Extraordinary general meetings are called to discuss strategic and other issues with shareholders outside the normal financial calendar.


Purposes

Both types of meetings are formal meetings between company directors and the shareholders of the company. They typically involve presentations by the board (typically the chairman and/or CEO) and a chance for shareholders to question the board.

AGMs
The AGM is a formal part of a company financial year. Its purpose is to allow the board to present the year’s results, discuss the outlook for the coming year, present the formal, audited accounts and to have the final dividend and directors’ emoluments approved by shareholders. Shareholder approval is signalled by the passing of resolutions in which shareholders vote in proportion to their holdings. It is usual for the board to make a recommendation and then seek approval of that recommendation by shareholders. The dividend per share, for example, is recommended by the board but only paid after approval by the shareholders at the AGM. Institutional shareholders may employ proxy voting if they are unable to attend in person.


EGMs
Extraordinary meetings are called when issues need to be discussed and approved that cannot wait until the next AGM. A full year can be a very long time. In some business environments when events necessitate substantial change or a major threat, an EGM is sometimes called. Management may want a shareholder mandate for a particular strategic move, such as for a merger or acquisition. Other major issues that might threaten shareholder value may also lead to an EGM such as a ‘whistleblower’ disclosing information that might undermine shareholders’ confidence in the board of directors.




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Differences between Charities and Listed Companies

Firstly, the two types of organisation are different in terms of regulation.

• Listed companies are subject to all the provisions of company law plus any listing rules that apply. Listing rules, such as the need to adopt the Combined Code in the UK, impose a number of obligations upon listed companies such as non-executive directors, committee structures, a range of reporting requirements, etc.

• Charities, in contrast, must receive recognition by a country’s charity authority to operate and they then receive the concessions that charitable status confers. This often involves favourable tax treatment and different reporting requirements. Because charities are not public companies they are not subject to listing rules although, depending upon the country’s rules, they may be subject to audit and have some reporting requirements.


The second difference is in the strategic purpose of the organisation.

• Listed companies exist primarily to make a financial return for their investors (shareholders). This means that they employ and incentivize people, including directors, to maximize long-term cash flows. Value is added by the creation of shareholder wealth and this is measured in terms of profits, cash flows, share price movements and price/earnings.

• For a charity, the strategic purpose is to support the charitable cause for which the organisation was set up. It is likely to be a social or benevolent cause and funds are donated specifically to support that cause and this expectation places a different emphasis on the purpose of governance.


Thirdly, the two are different in terms of stakeholders and societal expectations.

• Society typically expects a business to be efficient in order to be profitable so that, in turn, it can create jobs, wealth and value for shareholders. Society expresses its support for a business by participating in its resource or product markets, i.e. by supplying its inputs (including working for it) or buying its products.

• A charity’s social legitimacy is tied up with the charity’s achievement of benevolent aims. Stakeholders in a business often have an economic incentive to engage with the organisation whereas most stakeholders in a charity have claims more concerned with its benevolent aims.


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Governance Arrangements
There can be a number of substantive differences between the governance structures of public companies and charities.

• In a public company, a board consisting of executive and non-executive directors is accountable to the shareholders of the company. The principals are able to hold the board accountable through AGMs (annual general meetings) and EGMs (extraordinary general meetings) at which they can vote on resolutions and other issues to convey their collective will to the board.

• In a charity, the operating board is usually accountable to a board of trustees. It is the trustees who act as the interpreters and guarantors of the fiduciary duty of the charity (because the beneficiaries of the charity may be unable to speak for themselves). The trustees ensure that the board is acting according to the charity’s stated purposes and that all management policy, including salaries and benefits, are consistent with those purposes.



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Explain the core aims that underpin corporate governance regulations

Ensuring Integrity

A basic aim of all governance guidance has been to promote ethical fair dealing by companies.


Promotion of Strategic Objectives

Reports have been sought to ensure adherence to and satisfaction of the strategic objectives of the organization, aiding effective management. The UK’s Hampel Report stressed the importance of good governance in contributing to a business’s development.


Control over Companies

CG can be seen as a creating a framework for the control of multinational companies whose interests may not coincide with national interests. CG provides a framework for enforcing companies with laws on this sort of company.


Enhancing Risk Management

CG guidelines have promoted risk management principles, especially financial, legal and reputation risks. They have required compliance with accepted good practice in the jurisdiction in question and appropriate systems of control to be in place.


Involvement of Shareholders

As well as protecting shareholders, governance recommendations are designed to enhance shareholder involvement, particularly institutional shareholder involvement, in companies. This is achieved by giving them more detail about company activities, and improving proceedings at annual general meetings by recommending votes on remuneration policy and the report and accounts.



Protection of Shareholders and Stakeholders

Governance reports aim to protect shareholders in the same way that investors are protected who buy any other financial investment product, such as insurance or a pension. Governance reports are also concerned with fulfilling responsibilities to all stakeholders. This includes minimizing potential conflicts of interest between the owners, managers and wider stakeholder community, and treating each category fairly.


Establishment of accountability

Governance reports are designed to address the problem of the over-mighty managing director by emphasizing the role of the whole board in major decisions, and the need for a clear division of responsibilities at the head of companies so that one person does not enjoy unfettered power.


Maintenance of Effective Scrutiny

Governance provisions have stressed the importance of the board exercising oversight over the company’s activities by regular meetings and regular review of key areas, for example the adequacy of control systems. Governance provisions have also aimed to ensure the independence of those with primary responsibility for scrutinizing company activities. This include prescribing what constitutes, or what might jeopardize the independence of non-executive directors, it also means enhancing their position by prescribing that a certain number of directors be non-executive, and giving the internal and external auditors the right to communicate with an audit committee staffed by non-executive directors.


Provision of Accurate and Timely Information

Governance reports are designed to complement developments in financial reporting guidance by emphasizing the need for accounts to present a true and balanced picture of what is happening in the organization. They also emphasize the importance of timely information as an aid enabling directors to supervise company activities better.




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GATEKEEPER AND INFLUENCER IN CORPORATE GOVERNANCE

The Gatekeeper

Although good corporate governance pivots on the effectiveness of company directors, the boards often rely on the input of professionals within and outside the companies. Otherwise, how can we expect the directors to approve financial statements, interpret laws, assess the company's internal controls and state of compliance, advise on reliability and quality of disclosures, and provide corporate finance expertise?

These professionals the so-called gatekeepers include company secretaries, internal and external auditors, corporate advisers, lawyers, rating agencies and valuers.

The independence, integrity and professionalism of these advisers are critical in ensuring that decisions made by the board are in the best interest of the company. While the failure of these professionals in carrying out their responsibilities can have adverse consequences on the company, undue or misplaced reliance on them can result in boards being complacent and dependent.


The Influencer

The influencers are the analysts, financial journalists, watchdog groups and other corporate governance advocates. The Blueprint points out that this group does not have explicit nexus with companies or their boards, but they have an important role in promoting corporate governance through their ability to influence public opinion and to highlight poor governance practices.


5 Recommendations to step up the role of gatekeepers and influencers

1. The first is to explore extending whistleblowing obligations, which currently apply to auditors, to corporate advisers and company secretaries.

2. The second recommendation seeks to enhance the role of company secretaries by clarifying their role and looking into qualification requirements needed to raise the skills and professional standards for company secretaries of listed companies..

3. Establish a responsibility-sharing arrangement for corporate advisers in advising on corporate transactions;

4. Develop corporate governance programmes for financial journalists, and encourage provision of awards and scholarships for outstanding financial journalism in promoting corporate governance; and

5. Gatekeepers and influencers to enhance internal codes of conduct and internal controls to prevent the abuse of market-sensitive information, and to promote integrity and ethical conduct.




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Director's Remuneration Package

Explain how the different components of the director’s remuneration package might be more aligned to shareholders’ interests

Balanced package is needed for the following reasons:

The overall purpose of a well-designed rewards package is to achieve a reduction (minimisation) of agency costs. These are the costs the principals incur in monitoring the actions of agents acting on their behalf. The main way of doing this is to ensure that executive reward packages are aligned with the interests of principals (shareholders) so that directors are rewarded for meeting targets that further the interests of shareholders. A reward package that only rewards accomplishments in line with shareholder value substantially decreases agency costs and when a shareholder might own shares in many companies, such a ‘self-policing’ agency mechanism is clearly of benefit. Typically, such reward packages involve a bonus element based on specific financial targets in line with enhanced company (and hence shareholder) value.


(1) Basic salary

 It is the salary laid down in the contract of employment.
 Generally is not related to performance (although increase in it may be).
 Length of contract may not be of excessive length, to protect shareholders’ interests, however, it may not provide enough incentive for directors to perform well.


(2) Performance related bonus

 Cash bonus paid for good performance.
 Performance measures need be determined carefully so that they are not subject to manipulation of profits, do not focus excessively on short-term results and reward individual contribution.
 Example the bonus payable to a sales director - reward based on revenue or profits would play an important part in rewarding performance, on an annual or more frequent basis.



(3) Share and share options

 Rights to purchase shares of a specified exercise price over a specified time period in the future.
 If share price goes up (due to good company performance) and it exceeds the exercise price, director would be able to purchase shares at lower than their market value.
 Share option can be used to align director’s interests with shareholder wishes to maximise company value.
 Share options can be used to reward long-term performance whereas bonuses can be used to reward short-term performance, by specifying that the options may not be exercised for some years.


(4) Benefits in kind

 Car, health care provisions and life insurance.
 It may be difficult to relate these elements to directors’ performance.
 one symptom of the breakdown of the agency relationship is the directors are being rewarded with excessive perks.
 Remuneration committee should ensure that the benefits are not excessive.


(5) Pension

 Pension contribution tends to be linked to basic salary.
 Usually not connected to performance.
 UK combined code stresses that the remuneration committee should consider the pension consequences and associated costs to the company of basic salary increases and changes in pensionable remuneration.



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Assess the main areas for potential conflict of interest between the shareholders of a listed company and its EDs

Assess the main areas for potential conflict of interest between the shareholders of a listed company and its EDs, and explain how the use of NEDs should help to deal with this problem.


Conflict of interest can occur when the executive directors of a company take decision that would not be in the interests of the company’s shareholders.

The areas where conflict of interests can occur are: Remuneration of the directors and senior managers, financial reporting and nominations of new board members.


(a) Remuneration

If the EDs decide their own remuneration, they could pay themselves as much as possible, without having to hold themselves to account or justify their high pay. If EDs are allowed to devise incentive schemes for themselves, these may be linked to achieving performance targets that are not necessarily in the shareholders’ interests. For example rewarding directors with a bonus for achieving profit growth is of no value to the shareholders if the result is higher business risk and a lower share price

Solution
CG calls for remuneration committee of the board top be established to decide on directors’ pay, including incentive schemes. The members should all be independent NEDs. The remuneration committee should set remuneration packages for all EDs and the chairman, including pension rights and any compensation payments. The committee should also recommend and monitor the level and structure of remuneration for senior management. Incentive schemes should be linked to performance targets align with shareholders’ interests.




(b) Financial reporting

The EDs might be tempted to distort the results of the company in order to present the financial results in a way that reflects better on themselves and their achievements.

Solution
The board should establish Audit Committee, consisting of NEDs, whose task should be to consider issues relating to financial reporting and financial control systems. This committee should be responsible for liasing regularly with the external and internal auditors. The board should satisfy itself that at least one member of the audit committee has recent and relevant financial experience.




(c) Nomination to the board

The third potential area for conflict is nominations of new board members. A powerful chairman or chief executive could be tempted to appoint their supporters or ‘yes’ men to the board, and so strengthen their position on the board.


Solution
The board should establish a nomination committee of the board, manned by NEDs. The committee should oversee recruitment, keep the balance of the board under review and consider longer-term succession planning.




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Audit Committee Members

Distinguish between executive and non-executive directors

 Executive directors are full time members of staff, have management positions in organisation, are part of the executive structure and typically have industry or activity-relevant knowledge or expertise, which is the basis o their value to the organisation.

 Non-executive directors are engaged part-time by the organisation, bring relevant independence, external input and scrutiny to the board, and typically occupy positions in the committee structure.


Advantages of members of Audit Committee being non-executive rather than executive

 Separation and detachment from the content being discussed is more likely to bring independent scrutiny.

 Sensitive issues relating to one or more areas of executive oversight can be aired without vested interests being present.

 Non-executive directors often bring specific expertise that will be more relevant to a risk problem than more operationally-minded executive directors will have.


Disadvantages of members of Audit Committee being non-executive rather than executive

 Direct input and relevant information would be available from executives working directly with the products, systems and procedures being discussed if they were on the committee.

 Non-executives are less likely to have specialist knowledge of products, systems and procedures being discussed and will therefore be less likely to be able to comment intelligently during meetings.

 NED will need to report their findings to the executive board. This reporting stage slows down the process, thus requiring more time before actions can be implemented, and introducing the possibility of some misunderstanding



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Why the flow of information upwards to the board on matters of internal control and risk is so important

In the first instance, the information provided enables the board to monitor the performance of the company on the crucial issues in question. This includes compliance, performance against targets and the effectiveness of existing controls. By being made aware of the key risks and internal control issues at the operational level, the board can work to address them in the most appropriate way.


The board also needs to be aware of the business impact of operational controls and risks to enable us at board level to make informed business decisions at the strategic level. If the board receiving incomplete, defective or partial information then they will not be in full possession of the necessary facts to allocate resources in the most effective and efficient way possible.


The board has the responsibility to provide information about risks and internal controls to external audiences. Best practice reporting means that they have to provide information to shareholders and others, about the systems, controls, targets, levels of compliance and improvement measures and they need quality information to enable us to do this.



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