Chapter 9 - Governance and Ethics Flashcards
What is governance?
Governance involves creating a framework to safeguard the interests of stakeholders, ensuring activities align with ethics, risk, and stakeholder protection.
Why is governance an important issue? 2
Governance ensures managers focus on:
- Whom they are seeking to benefit.
- Avoiding harm to others.
What is the agency problem in governance?
The agency problem occurs when managers lose sight of stakeholders’ interests, leading to conflicts in priorities.
What does agency theory explain?
Agency theory explains the conflict between shareholders (principals) and managers (agents) due to the separation of ownership and control in large companies.
What are the roles of managers in governance?
Managers act as agents for shareholders, ensuring their interests are protected.
What is the relationship between ownership and control in large companies?
Ownership and control are separated, causing potential conflicts between managers and shareholders.
What is corporate governance?
Corporate governance is the system by which companies are directed and controlled.
What are the four perspectives of corporate governance objectives?
- Public policy perspective
- Stakeholder perspective
- Corporate perspective
- Stewardship perspective
What does the public policy perspective on corporate governance emphasize? 3
Ensuring the company meets:
- Objectives of its shareholders
- Interests of stakeholders with a direct stake
- Interests of the public at large, focusing on leadership, sustainability, and good corporate citizenship.
What is the stakeholder perspective on corporate governance? 3
It involves balancing economic and social goals with individual and communal goals. The framework encourages:
- Efficient use of resources through investment.
- Accountability from senior management to shareholders.
- Alignment of shareholder interests with other stakeholders.
What does the corporate perspective on corporate governance emphasize?
Maximizing shareholder wealth while conforming to society’s laws and customs, and balancing the interests of shareholders and other stakeholders to achieve long-term sustained value.
What is the stewardship perspective on corporate governance?
It focuses on directors acting in the best interests of the company as stewards of the company’s resources.
Why is it challenging to meet the needs of all stakeholders all the time?
It is unlikely for any organization to meet all stakeholder needs simultaneously, as stakeholders’ interests naturally come into conflict. However, priority is often given to shareholders.
What are the symptoms of serious conflicts of interest among stakeholders? 4
Symptoms include:
- Directors disguising the true financial performance of the company by manipulating accounts.
- Disputes over director remuneration, such as high salaries and bonuses, not aligned with company performance.
- Relegating shareholder interests in takeover bids and offers.
- Financial collapse without warning in extreme cases.
What are examples of symptoms which indicate poor corporate governance? 8
The following symptoms can indicate that there is poor corporate governance:
Domination of the board by a single individual or group, with other board members merely acting as a rubber stamp
No involvement by the board: meeting irregularly, failing to consider systematically the organisation’s activities and risks, or basing decisions on inadequate information
Inadequate control function, for instance no internal audit, or a lack of adequate technical knowledge in key roles, or a rapid turnover of staff involved in accounting or control
Lack of supervision of employees
Lack of independent scrutiny by external or internal auditors
Lack of contact with shareholders
Emphasis on short-term profitability, leading to concealment of problems or errors, or manipulation of financial statements to achieve desired results
Misleading financial statements and information
What are the symptoms of poor corporate governance related to board dominance?
Domination of the board by a single individual or group, with other board members merely acting as a rubber stamp.
How can board involvement indicate poor corporate governance?
Symptoms include irregular board meetings, failure to systematically consider organizational activities and risks, or making decisions based on inadequate information.
What is an example of inadequate control function in poor corporate governance?
Examples include no internal audit, lack of adequate technical knowledge in key roles, or high turnover of accounting or control staff.
What role does supervision play in poor corporate governance?
Lack of supervision of employees is a symptom of poor corporate governance.
How does lack of independent scrutiny reflect poor corporate governance?
Poor corporate governance includes lack of independent scrutiny by external or internal auditors.
Why is lack of contact with shareholders a symptom of poor corporate governance?
It indicates a failure to engage stakeholders, which is crucial for effective governance.
How does short-term profitability affect corporate governance?
An overemphasis on short-term profitability may lead to the concealment of problems, manipulation of financial statements, and misrepresentation of results.
How do misleading financial statements indicate poor corporate governance?
Misleading financial statements and information undermine transparency and trust.
What are examples of good corporate governance? 7
Good practice in corporate governance is concerned with:
Risk management and reduction
Ethical and sustainable pursuit of the business’s strategy in a way which safeguards against misuse of resources, encouraging efficient business
Openness and transparency: disclosure of information
Integrity and probity: applying the spirit of the law as well as its letter, and being honest in all
dealings
Accountability: monitoring and judging directors’ performance based on the returns that the company has achieved under their stewardship
Reducing the potential for conflict
Reconciling the interests of shareholders and directors as far as possible
What is good corporate governance concerned with in terms of risk?
Good corporate governance is concerned with risk management and reduction.
How does good corporate governance promote ethical business strategies?
It involves the ethical and sustainable pursuit of the business’s strategy to safeguard against misuse of resources and encourage efficient business practices.
What role does openness play in good corporate governance?
Openness and transparency involve the disclosure of information. PLCs also have to report to the market.
What is meant by integrity and probity in corporate governance?
Integrity and probity refer to applying the spirit and letter of the law, and being honest in all dealings.
How does good corporate governance ensure accountability?
By monitoring and judging directors’ performance based on the returns the company achieves under their stewardship.
What does good corporate governance aim to reduce?
It aims to reduce the potential for conflict.
How does good corporate governance reconcile interests?
By reconciling the interests of shareholders and directors as far as possible. Reconstruct and review.
What is Corporate Social Responsibility (CSR)?
CSR is the integration of social and environmental concerns into a company’s business operations and interactions with stakeholders.
How is CSR related to governance and sustainability?
CSR is no longer considered separately from governance and sustainability. The Sustainability Accounting Standards Board (SASB) embeds these topics into its governance standards.
How does corporate governance incorporate CSR?
Corporate governance includes acting responsibly regarding an entity’s social and environmental impacts to meet the demands of customers and investors and avoid failure in achieving financial objectives.
What are the two broad types of financial systems?
Bank-based and market-based financial systems.
What characterizes a bank-based financial system? 8
e.g Germany and Japan - Households have a low risk appetite and prefer to save cash rather than invest directly.
- Comparatively more government regulation. e.g. rent control
- Highly concentrated and integrated banking and non-banking services.
- Bank lending is the main source of finance after retained earnings, creating tightly integrated relationships between banks and businesses:
- Banks may hold equity.
- Businesses may hold equity in banks.
- Banks have access to management information.
- Banks may have a seat on the board.
What characterizes a market-based financial system? 4
e.g. UK and USA - Households bear more risk and directly invest in equity, property, and physical assets.
- Markets are more important than banks for long-term finance.
- Comparatively less government regulation.
- Banks are more fragmented, with relationships with businesses being more at arm’s length.
How are bank-based and market-based financial systems evolving?
Bank-based systems are moving closer to market-based models, but institutional shareholders remain influential in business investments under both systems.
What does Hofstede’s Cultural Dimensions framework explain? 1 What are the examples? 6
It explains how national culture affects corporate governance through various dimensions. Examples include:
Masculinity vs. femininity
Individualism vs. collectivism
Power distance
Long-term Orientation
Uncertainty Avoidance
Indulgence vs Restraint
How does masculinity vs. femininity impact corporate governance?
Feminine cultures focus on quality of life, balance, and gender diversity in boards. e.g. Nordic countires - Sweden
Masculine cultures focus on money, achievements, and aggressive decision-making, often with less emphasis on diversity. e.g. USA
What is the impact of individualism vs. collectivism on governance?
Individualistic cultures encourage debate and diverse ideas, supporting a mix of directors. e.g. USA
Collectivist cultures prioritize harmony and avoid strong, diverse opinions to prevent conflict. e.g. Japan?
How does power distance influence corporate governance?
High power distance cultures emphasize bureaucracy, authority, and concentrated power, with less focus on independent NEDs and separation of roles (e.g., CEO and chairman). e.g. asian/african cultures
Low power distance cultures encourage flat structures, autonomy, and the separation of roles. e.g. Denmark
How does long-term orientation affect governance practices?
Long-term orientation leads to long-term thinking, restrictions on short-term bonuses, and rewards based on long-term performance like share options. e.g Japan
Short-term orientation prioritizes immediate rewards, with a focus on short-term performance appraisals and profit-related bonuses. e.g. UK/USA
What is the impact of uncertainty avoidance on governance?
High uncertainty avoidance cultures prefer lower risk, strict rules, data analysis, and clear responsibilities. e.g. Japan
Low uncertainty avoidance cultures tolerate risk and encourage change and innovation. e.g. US - Venture Capitalist market e.g silicon valley
How do indulgence vs. restraint cultures influence governance?
Indulgent cultures prioritize enjoyment and have fewer spending restrictions. e.g. UK/US
Restrained cultures regulate conduct, establish social norms, and emphasize control over spending. e.g. Germany
What is a governance structure?
A governance structure is the set of legal or regulatory methods put in place to ensure effective corporate governance. Different around the world.
What are the two basic governance structures?
Statutes (Laws)
Codes of practice
How do governance structures vary across countries?
Countries use different combinations of statutes and codes of practice, depending on whether they adopt a principles-based or shareholder-led approach.
What is the principles-based approach to governance structures?
It is an approach based on adhering to principles of good corporate governance, as outlined in the OECD’s Principles of Corporate Governance.
What are some principles of good corporate governance according to the OECD? 6
- Promote transparent and fair financial markets and consistency with the rule of law.
- Ensure equitable treatment of shareholders and key ownership functions.
- Maintain relationships with investment sources, such as institutional investors and stock markets.
- Uphold the rights of stakeholders, including creating wealth and jobs.
- Ensure accurate and timely disclosure of performance, ownership, and governance information.
- Assign responsibilities to the board for self-monitoring and accountability.
What mechanism supports principles-based governance?
External audits are a key mechanism to ensure adherence to governance principles.
What is the shareholder-led approach to governance structures?
In market-based financial systems like the UK and the US, greater emphasis is placed on the role of shareholders, especially institutional shareholders, who have high levels of investment in leading companies.
What are institutional shareholders?
Institutional shareholders are organizations that invest money on behalf of others, such as insurance companies, pension funds, and investment trusts.
What is the role of institutional shareholders in governance?
Institutional shareholders should regularly engage in dialogue with the board to represent the interests of their beneficiaries and ensure proper governance.
What are the two types of board structures?
- Unitary Board: Responsible for both business management and reporting to shareholders through financial statements and meetings. It is common under UK statute.
- Two-Tier Board: Includes a Management Board and a Supervisory Board.
What is a unitary board structure? What is a country it is used in?
- Unitary Board: Responsible for both business management and reporting to shareholders through financial statements and meetings. It is common under UK statute.
What is a two tier board structure? What is a country it is used in?
A dual or supervisory board structure comprising of:
- The management board, with responsibility to manage the company using similar powers to the unitary board; and
- The supervisory board: an independent separate board elected by the shareholders and the employees, often has the power to:
* Appoint and remove members of the management board
* Request information from members of the management board
* Inspect books and records
* Perform independent reviews
* Convene shareholder meetings
Common board set up in Germany.
What is the role of the management board in a two-tier structure?
The management board manages the company with powers similar to a unitary board.
What is the role of the supervisory board in a two-tier structure?
The supervisory board is an independent board elected by shareholders and employees, with powers to:
- Appoint and remove members of the management board
- Request information from the management board
- Inspect books and records
- Perform independent reviews
- Convene shareholder meetings.
Where is the two-tier board structure commonly used?
It is a common board setup in Germany.
What are the Wates Principles?
The Wates Principles are a voluntary code to help large private companies meet the Companies (Miscellaneous Reporting) Regulations. It is applied on an ‘apply or explain’ basis.
What are the six principles outlined in the Wates Principles?
- Purpose and leadership: The board determines and aligns values, strategy, and culture.
- Board composition: The board includes a chair and maintains a balance of skills, experience, and knowledge.
- Directors’ responsibilities: Directors have a clear understanding of their accountability and responsibilities, supporting decision-making and challenge.
- Opportunity and risk: The board promotes the long-term sustainable success of the business.
- Remuneration: Reward structures are aligned with the long-term sustainable success of the business.
- Stakeholder relationships and engagement: The board engages meaningfully with stakeholders, including the workforce.
What does the principle of Purpose and leadership mean in relation to Wates principle
Purpose and leadership: The board determines and aligns values, strategy, and culture.
What does the principle of Board composition mean in relation to Wates principle
Board composition: The board includes a chair and maintains a balance of skills, experience, and knowledge.
What does the principle of Directors’ responsibilities mean in relation to Wates principle
Directors’ responsibilities: Directors have a clear understanding of their accountability and responsibilities, supporting decision-making and challenge.
What does the principle of Opportunity and risk mean in relation to Wates principle
Opportunity and risk: The board promotes the long-term sustainable success of the business.
What does the principle of Remuneration mean in relation to Wates principle
Remuneration: Reward structures are aligned with the long-term sustainable success of the business.
What does the principle of Stakeholder relationships and engagement mean in relation to Wates principle
Stakeholder relationships and engagement: The board engages meaningfully with stakeholders, including the workforce.
What is an ethical culture?
An ethical culture is a business culture where the values and beliefs in a company encourage individuals to behave in line with acceptable business ethics.
What are the key aspects promoted by corporate ethics? 3
- Openness and transparency
- Good relationships wherever possible
- High standards in personal behavior
What are the Nolan Principles for ethical values in a company? 5
- Integrity
- Objectivity
- Accountability
- Openness
- Honesty
What additional values are included by the Institute of Business Ethics? 5
- Respect
- Transparency
- Openness
- Fairness
- Trust
What are the statutory requirements for ethical behavior? 3
- Equality for all
- No discrimination on any grounds
- Freedom of information
What are business ethics?
Business ethics refer to the ways a company behaves and functions in society, often going beyond legal requirements. This includes actions like paying staff above the minimum wage, providing good working conditions, and paying suppliers on fair credit terms.
How can an ethical culture be promoted? 3
An ethical culture can be promoted through:
- Ethical leadership from the board of directors.
- Codes of ethics or business conduct.
- Policies and procedures to support ethical behavior.
What attributes and behaviors define ethical leaders, according to the Institute of Business Ethics? 5
Ethical leaders exhibit:
- Openness: Being open-minded, willing to learn, and encouraging others to learn.
- Courage: Being determined and direct, actively stamping out poor behavior.
- Ability to listen: Being aware of what is happening and knowing the right thing to do.
- Honesty: Being considerate and cautious in managing expectations.
- Fair-mindedness: Being independent and willing to challenge the status quo.
What ethical question arises in marketing?
Is it ethical to target children or vulnerable people with marketing efforts?
What ethical concern is associated with production processes in operations?
Should an organization use the cheapest production method, or opt for a more expensive but environmentally friendly alternative?
What ethical issues are present in procurement?
- Is it ethical to source meat and animal products from suppliers with low standards of animal welfare?
- Should an organization use overseas suppliers that exploit workers or pollute local environments?
What is an ethical concern in HR regarding employee contracts?
Are zero-hours contracts and low pay rates ethical?
What ethical considerations exist for IT regarding data?
Organizations have an ethical obligation to collect, store, and manage data in a way that protects the interests of individuals whose data is being handled.
What ethical issues arise in finance regarding supplier payments?
Should large organizations force down prices or demand long credit periods from small suppliers to improve their cash operating cycle?
What ethical question is associated with tax strategy in finance?
Should multinational companies structure their business to have profits taxed in countries with low tax rates?
