Chapter 11 Governance and ethics Flashcards
1.1 Governance
Corporate governance is a set of relationships between a company’s management, its board, its shareholders, and other stakeholders that provides the structure through which the objectives of the company are set, attained, and monitored. The impact of poor governance includes:
- Falling share price: criticism or reputation damage can result in shareholders selling their shares
- Corporate failure
- Criticism of accountants or auditors: can be subject to criticism for not reporting or preventing problems
1.2 The agency problem
In the agency relationship, the principal (company’s shareholders) hire the agent (management) to pursue the principal’s interests. The agency problem occurs when managers pursue their own objectives rather than the shareholders. Corporate governance should limit this by seeking to algin the objectives.
The objectives of corporate governance depend on perspective. From wider view to narrow view, the perspectives are public policy, stakeholder, corporate and stewardship perspective.
3.1 Influences on corporate governance: types of financial systems
A financial system has two functions, facilitation of lending and borrowing money and the transmission of money. A financial system consists of 3 elements: intermediaries (banks, pension funds, unit trusts), securities (shares and bonds) and markets (primary and secondary).
There are two types of financial system: bank-based system (Germany, France) and market-based financial system (UK and USA).
A bank-based system means bank lending is most important source of business finance after retained earnings. Lenders are highly integrated (often holding equity and having representation on the board), banks highly concentrated and integrated providing banking and insurance services, stock markets are volatile as companies have high levels of gearing, more government regulation of markets, households bear little risk (money held mainly on deposit) and any investment in securities is done via intermediaries (institutional shareholders are influential).
Market-based system means markets are more important than banks for long term finance, banks have less close relationships with the business, banks are more fragmented with less integration of non-banking services, stock markets are more efficient and larger, there is comparatively unregulated markets, householders bear more risk so are more likely to hold equity investments and a high level of indirect investment via intermediaries such as pension fund meaning institutional shareholders have a great deal of influence.
3.2 National culture and governance
Hofstede model highlights the key dimensions upon which national culture varies and the impact codes of governance:
- Power distance: considers acceptance of power differential, rank, and status in a country. High power countries accept the concentration of power, the separation of chair and CEO roles and need for NEDs is less prevalent
- Uncertainty avoidance: views how comfortable citizens are with uncertainty and ambiguity. High uncertainty avoidance rules have corporate governance code focused on risk management and control procedures
- Individualism and collectivism considers whether a country prioritises the performance of individuals or teams. Individualism promotes diversity in the board, more accepting of different views
- Masculinity/femininity: masculine orientation is fact based and aggressive with a hard decision making style. Feminine approach is consultative and intuitive
- Long term orientation: looks are countries time horizon for planning and performance measurement. Short term focuses on bonus culture, long-term on share options exercisable after a number of years
- Indulgence versus restraint considers attitude toward personal gratification. Some countries are open and relaxed, others are restrained, valuing social and behavioural norms
4.1 Governance structures
Is the set of legal or regulatory methods in place to ensure effective corporate governance. A principles-based approach to governance structures are influenced by a desire to adhere to good corporate governance set out by the OECD with covers:
- Promoting transparent and efficient financial markets
- Equitable treatment of all shareholders
- Relationships with institutional investors, stock markets and intermediaries
- Rights of stakeholders in corporate governance
- Accurate and timely disclosure and transparency of financial performance
- Responsibilities of the board and accountability to shareholders
UK take more of a shareholder-led approach to governance structures by placing more emphasis on the role of shareholders.
4.3 Possible structures of the board of directors
Unitary board which is responsible for management of company and reporting to shareholders. Or a dual board which is split between a management board to run the company and a supervisory board to oversee the management board, is separate and independent board selected by employees, has a right to approve the FS and dividends declared, can appoint, and remove directors from management board and can convene shareholder meetings.
4.4 Governance and private companies
Private companies are not required to comply with the UK corporate governance code. The companies (Miscellaneous reporting) regulations 2018 do require some private companies to include a statement in their annual reports disclosing their corporate governance arrangements if they meet at least one of the following:
- More than 2,000 employees worldwide
- Turnover over £200m globally
- Total assets above £2 billion
The wates principles are a voluntary code to help companies meet the regulations and cover six principles:
- Purpose and leadership: board develops the purpose and ensures values and strategy align
- Board should include an effective chair and be balance
- Directors’ responsibilities to include robust internal control systems and decision making
- Sustainable success based on identifying opportunities and managing risks
- Remuneration aligned to long term sustainable success
- Meaning stakeholder engagement
5.1 business ethics and values
Are the ways in which a company behaves in a society which has certain expectations of how a company behaves. The consequences of poor ethics are negative publicity, loss of customers, failure to retain employees and falling share prices. An ethical culture is where the basis values and beliefs in a company encourage people within the company to behave in line with acceptable business ethics.
Leaders in the organisation have a strong influence on ethical culture. Equality for all, no discrimination on any grounds and freedom of information are statutory requirements for all companies.
5.2 Promoting ethical leadership
The FRC made the following observations about ethical corporate culture in its 2016 report ‘Corporate culture and the role of boards’:
- Board must demonstrate leadership by embodying the desired culture
- Important to recognise value of culture
- Directors must be open and accountable
- Leaders should embed and integrate the values of the company
- Indicators and measures used to assess, measure, and engage the desired outcomes of the business
- Board exercise stewardship and include engagement about culture and better reporting
6.1 Social responsibility
Social responsibility is how far a company exceeds the minimum obligation it owes to stakeholders and society. It places emphasis on those stakeholders that are unprotected by contractual or business relationships.
