5. Corporate Governance and Ethical Considerations

Question 1

What is corporate governance?

Answer 1

Refers to how companies are directed and controlled.

Question 2

What is an issue within corporate governance?

Answer 2

The separation of ownership and control.

Question 3

What is the relationship between shareholders and directors?

Answer 3

Shareholders own the company and will appoint directors to manage the day-to-day running of the company.

Directors are agents of the shareholders and should act in their best interests.

Question 4

Why is the separation of ownership and control an issue?

Answer 4

Because it’s hard to know whether directors are running a company in the shareholder’s best interests.

Shareholders may only get a set of financial statements and attend a general meeting once a year.

Question 5

How may a director abuse the trust of the shareholders?

Answer 5

• Award themselves excessive salary
• Award themselves excessive share options
• Give themselves generous perks
• Make loans from the company to themselves
• They can take undue risks because success will likely increase their salary, while failure will result in shareholders losing the most, and their own position remains relatively secure.

Question 6

What do the recent corporate governance rules aim to do?

Answer 6

Allow shareholders to better monitor what directors are doing and how their company is actually performing.

Question 7

What does OECD stand for?

Answer 7

Organisation of Economic Cooperation Development

Question 8

What are the six principals of a corporate governance framework promoted by the OECD?

Answer 8

• Should promote transparent and fair markets and support effective supervision and enforcement
• Should protect shareholder’s rights and ensure all are treated fairly
• Should provide for stock markets to contribute to good corporate governance (e.g. prohibit insider trading)
• Should recognize rights of all stakeholders (not just shareholders)
• Should ensure timely and accurate disclosure of all material matters (e.g. financial position, performance, ownership and governance)
• Should ensure the strategic guidance of the entity, effective monitoring of management by the board and the board’s accountability to the entity and their shareholders.

Question 9

Is the Organisation of Economic Cooperate Development (OECD) a global or local organisation?

Answer 9

Global

Question 10

What are the five main principles of the UK Corporate Governance code (based on the OECD principles)?

Answer 10

• Board leadership and company purpose
• Division of responsibilities
• Composition, succession and evaluation
• Audit, risk and internal control
• Remuneration

Question 11

Describe board leadership and company purpose regarding the UK Corporate Governance code.

Answer 11

• Every company should be headed by an effective board
• The board is collectively responsible for the long-term success of the company
• All directors must act with integrity
• Directors should lead by example and promote the desired culture.

Question 12

Describe division of responsibilities regarding the UK Corporate Governance code.

Answer 12

• Should be clear division between the running of the board and the executive responsibility for running the company’s business
• No one individual should dominate decision making (roles of CEO and chairman should not be performed by the same person)
• Non-executive directors (NEDs) must be appointed to the board and constructively challenge and help develop proposals on strategy
• NEDs sit in at board meetings and have full voting rights, but do not have day to day executive or managerial responsibilities
• NEDs monitor, advise and warn the executive directors
• Should be roughly 50/50 balance between executive and non-executive directors

Question 13

Describe composition, succession and evaluation regarding the UK Corporate Governance code.

Answer 13

• Appointments to the board should be subject to a formal, rigorous and transparent procedure led by a nomination committee
• Majority of the nomination committee should be independent NEDs
• The board and it’s committees should have a combination of skills, experience and knowledge
• Length of service of the board as a whole should be considered and membership regularly refreshed
• The post of chairman should not be held beyond nine years
• Board should undertake formal and rigorous annual evaluation of its own performance and that of it’s committees and individual directors
• All directors should be submitted for re-election annually

Question 14

Describe audit, risk and internal control regarding the UK Corporate Governance code.

Answer 14

• Board should establish formal and transparent policies and procedures to ensure the independence and effectiveness of internal and external audit and the integrity of financial statements
• Audit committee (NEDs) should be established to liaise with both internal and external auditors
• The directors are responsible for establishing an internal control system and must review the need for internal audit
• The board should present a fair, balanced and understandable assessment of the company’s position and prospects and establish procedures to manage risk, oversee internal controls and determine the nature and extent of the principle risks the company is willing to take to achieve it’s long-term strategic objectives.

Question 15

What was the situation before audit committees and why was it unsatisfactory?

Answer 15

The finance director liaised with auditors.

Not ideal because the finance director was often the person responsible for accounting problems.

Therefore, auditors were often reporting problems to the person responsible.

Question 16

Describe remuneration regarding the UK Corporate Governance code.

Answer 16

• Remuneration should be sufficient to attract, retain and motivate directors of sufficient quality… But avoid paying more than is necessary
• Significant portion of executive directors’ remuneration may be structured to link rewards to corporate and individual performance
  (Profit related pay is encouraged so that the directors don’t receive high pay irrespective of company performance)
• Should be a formal and transparent procedure for developing policy on executive remuneration and for fixing remuneration packages of individual directors.
  (A remuneration committee (NEDs) should be formed to fix directors’ remuneration)

Question 17

What is principles based corporate governance?

Answer 17

Broad principles are laid down and it’s the boards responsibility to apply those principles as they see fit.

Allows flexibility to deal with a wide variety of circumstances.

Question 18

What is compliance based corporate governance?

Answer 18

Very specific requirements and rules have to be signed off by the board and often also by the auditors.

This approach, embodied in the Sarbanes Oxley Act allows much less flexibility but increases the strictness with which the rules are applied.

Question 19

Who uses principle based, and who uses compliance based corporate governance?

Answer 19

UK and most of Europe use principles based.

USA uses compliance based.

Question 20

What does comply or explain refer to in relation to corporate governance?

Answer 20

The code has no force in law so is enforced on listed companies through the stock exchange.

Listed companies are expected to state that they have complied with the code, or explain to the shareholders why they haven’t.

This allows some flexibility.

Question 21

What is corporate social responsibility?

Answer 21

The idea that companies shouldn’t be run solely for the benefit of the shareholders, but should take into account the interests of other stakeholders.

Question 22

What are some considerations in corporate social responsibility?

Answer 22

• Should companies adhere to the minimum required by law, or go above and beyond (wages, pollution, working hours)
• Do directors have legal authority to make non-essential payments? They are using shareholders assets so it’s argued they have no right to spend them needlessly.
• Who decides beneficiaries? Simply decided by directors or should others have a say.

Question 23

What are the benefits of having an ethical company?

Answer 23

• Unethical acts will usually be punished through law, compensation or the loss of goodwill and reputation.
• Ethical organisations spend less to ensure regulations are followed.
• Lower risk also means banks and other providers of capital will be willing to supply money at lower rates
• Increases reputation, which means higher chance of finding partners to form joint ventures or satisfying customers.
• Attracts better employees
• Increases sales

Question 24

Order regulations, ethics and law from least demanding to most demanding.

Answer 24

Law, regulations, ethics

Question 25

What is the ethical principle that promotes the greatest good for the greatest number?

Answer 25

Utilitarianism/consequentialism

Question 26

What is the ethical principle that says behaviour should be based on absolute moral values?

Answer 26

Duty/deontological approach

Question 27

What’s the difference between relativism and absolutism?

Answer 27

Relativism says there are many acceptable ethical standpoints.
- Provides more flexibility but has more vague guidance

Absolutism says behaviour should be based on absolute moral values.
- Source of moral values are an issue. What if two people follow separate ethical codes?

Question 28

What are four unethical payments?

Answer 28

• Extortion
• Bribery
• Grease money
• Gifts

Question 29

What values promote ethical behaviour in organisations?

Answer 29

• Openness
• Trust
• Honesty
• Respect
• Empowerment
• Accountability

Question 30

What does IFAC stand for?

Answer 30

The International Federation of Accountants

Question 31

How does the IFAC define public interest?

Answer 31

The net benefits derived for, and procedural rigour employed on behalf of all society in relation to any action, decision or policy.

Question 32

What are some public interests that accountants are obligated to act for.

Answer 32

• Increased economic certainty
• Sound decision-making
• Sound and transparent financial information
• Comparability across different organizations and jurisdictions
• Sound corporate governance
• Effective performance management
• Increased efficiency and better resource utilisation
• Provide sound financial and non-financial reporting to shareholders, investors, taxpayers and all parties impacted by reporting
• Provide truthful, effective communication with parties related to the corporate government processes

Question 33

Who is a corporate code of ethics implemented by?

Answer 33

Top management

Question 34

What are the advantages of a corporate code of ethics?

Answer 34

• Empgasises the organisation’s values
• Guidance to employees and directors
• Risk reduction (avoids legal problems)
• Good public relations and reputation

Following are improved:
- Equal opportunity
- Bullying
- Use of the internet
- Reporting wrong-doing
- Bribery
- Money-laundering
- Response to conflicts of interest

Question 35

When do ethical conflicts arise?

Answer 35

When one or both of the following are encountered:
- Internal or external pressures act as obstacles to following appropriate action
- Conflicts in applying relevant professional and legal standards

Question 36

What body offers a framework through which ethical dilemmas may be addressed?

Answer 36

IFAC

Question 37

What is the IFAC Code framework for addressing ethical dilemmas?

Answer 37

(1) Consider the facts of the situation
(2) Consider the ethical principles involved
(3) Consider relevant internal procedures
(4) Consider the alternative courses of action:
- Escalate internally
- Document every action taken to resolve the conflict
- Escalate externally to auditor, legal advisor, professional body.

Consider the consequences of each course of action. If resolution seems unlikely, disassociate yourself from the issue.