Corporate Governance

Question 1

Wilhelm Framework

Answer 1

1. Problem Recognition
2. Identification of alternative courses of action
3. Evaluation of alternative courses of action (which alternative can be universally applied? which alternative respects the rights and dignity of stakeholders? which alt will product the most good and least harm? do any of the alternatives break moral code? does the alt demonstrate character of a good person?
4. Estimation of outcome probabilities
5. Calculation of expected values
6. Justification of course of action taken

Question 2

Principle-Agent Problem

Answer 2

Separation of ownership and management of a company which ultimately leads to issues and misalignment of interests. Due to lack of control and oversight by owners, other control mechanisms are required.

Constant balance between monitoring and control & value creation

Question 3

Stewardship theory

Answer 3

Unlike other theories, this view is less motivated by personal gain (that individuals are self-interested and do not act in the interest of the shareholders), but for the sake of doing good (that individuals genuinely want what is best for the company)

Stewardship theory is a theory that managers, left on their own, will act as responsible stewards of the assets they control. Stewardship theorists assume that given a choice between self-serving behavior and pro-organizational behavior, a steward will place higher value on cooperation than defection.

Question 4

Stakeholder theory

Answer 4

Must consider all stakeholders involved (society at large), not just that of the shareholder and maximizing SH value.

Question 5

Trouble with the theory of creating ‘shareholder value’?

Answer 5

Difficult to assess who it the ultimate shareholder? What are their intentions? How do you decide if their action is in the shareholders interest?Who do those holders actually hold the shares for?

Question 6

What is COSO?

Answer 6

Committee of sponsoring organizations:
COSO report presents a common definition of internal control and provides a framework guiding which internal control systems may be assessed.

Question 7

What is internal control?

Answer 7

A process to provide reasonable assurance of accomplishing objectives related to 1) reliability of financial reporting 2) compliance with laws and regulations, 3) effectiveness & efficiency of operations.

Question 8

SOX Titles

Answer 8

Title 1: created a new body PCAOB, independent of but reporting to the SEC to monitor the accountancy professions, ending self regulation.
Title 2: Auditor independence
Title 3: Corporate Social Responsibility- 302: senior execs take individual responsibility for the accuracy and completeness of financial reporting (quarterly & yearly reports)
Title 4: Enhanced financial disclosures
- 404: Mgmt must state their responsibilities for establishing and maintaining adequate IC over FR. Conclude on the effectiveness of the company’s IC over FR. State that the registered public accounting firm has attested to and reported on mgmts evaluation of the company’s IC. (yearly)

Question 9

What is internal control over FR?

Answer 9

A process to provide reasonable assurance regarding the reliability of FR and preparation of FS for external purposes i.a.w. GAAP

Question 10

Elements of COSO Framework

Answer 10

1. Control environment- foundation of IC. Mgmgt establish tone at the top regarding importance of IC and expected standards of conduct.
2. Risk assessment- dynamic process for identifying risks i.r.t. to the achivement of objectives and how the risks should be managed.
3. Control activities- actions established through policies and procedures to help ensure that mgmt’s directives to mitigate risks are carried out to achieve objectives.
4. Info & Communication- info is necessary to carry out IC responsibilities and communication is vital to obtain and share information.
5. Monitoring- ongoing and separate evaluations to ascertain whether IC is present and functioning.

Question 11

What is Corporate Governance?

Answer 11

Multiple definitions:

• it is the orgs strategic response to risk
• it is a process used to manage the business affairs of the company towards enhancing business prosperity & corporate accountability with the objective of realizing LT shareholder value while taking into account the interests of stakeholder.

Question 12

Enterprise risk management

Answer 12

A process effected by an entity’s board of directors, management, and other personnel applied in strategy setting and across the enterprise designed to identify potential events that may affect the entity and manage risks to be within its risk appetite, to provide reasonable assurance regarding the achievement of entity objectives.

The aim of ERM framework is to help orgs in making strategic objectives which can effectively identify, assess, respond, and control risks. Which is why IC framework is complementary to the Erm framework (ICF is integral part of ERMF)

Question 13

Dutch CG Code on Risk Management

Answer 13

• Management board is responsible for setting the strategy of business, identifying and analyzing risks associated with strategy, designing, implementing and maintaining risk and control structures, monitoring the operational effectiveness of risk and control structures.
• management board shall report on the design and operational effectiveness and discuss the internal risk management and control systems with the supervisory board and its audit committee.
• the audit committee shall propose an external accountant to the shareholders meeting and monitor the functioning of the auditor.
• the audit report shall discuss the audit plan with the audit committee. the external auditor will report its findings in the management letter.
• the external auditor is present at the general shareholders meeting.

Question 14

5 components of ERM

Answer 14

1. governance and culture: sets entity’s tone, reinforce importance of ERM, establish oversight responsibilities.
2. strategy and objective setting: ERM is integrated in the orgs strategy and objective setting process to gain insight into internal and external risk factors. Here too their risk appetite is determined.
3. performance: identifies and assesses risks to the achievement of the strategy. According to their severity and orgs risk appetite. The org sets risk responses and monitors the performance by developing a portfolio view.
4. Review and Revision: review the risks and performance relative to its targets. Derives inputs for continuous improvement.
5. Info, communication, and reporting: use of internal and external info to support ERM. Leverage IT systems to capture, process, and manage info. Reports on risk, culture and performance.

Question 15

External risk factors

Answer 15

1. political
2. economic (i.e. FX rates)
3. Social (customer needs)
4. Technological (R&D activity, tech disruptions)
5. Legal
6. Environmental

Question 16

Internal risk factors

Answer 16

1. Capital
2. People
3. Process
4. Technology

Question 17

Steps for assessing risks

Answer 17

1. Identifying risks
2. Assessing risks
3. Prioritizing risks
4. Responding to risks
5. Developing a portfolio view- residual (and all) risk assessment overview
6. Monitoring performance

Question 18

What are ethics?

Answer 18

Involves awareness of good and wrong, the awareness of choice and responsibility, and morality and moral values.
Ethics are essentially the principles of conduct governing an organization.

Question 19

Non-executives (Sup. Board) Role

Answer 19

1) They should ensure executives are acting in the interest of shareholders.
2) And they should be certain that the appointed execs are capable (hiring, firing decisions are endorsed by SH).

Question 20

Different Type of Stakeholders

Answer 20

1. Shareholders- investors in the firm, they elect directors to protect their interests, voting rights. Separation of control and ownership.
2. Society (govt, tax authorities, stock market):
3. Employees- devote time to the firm
4. Creditors/ Suppliers: essential to the functioning of their business. Are their invoices being paid? Can they deliver to and invest in the firm in the future as well?
5. Customers- purchasing power (decisions to buy or not). Large informal influence over company. Companies survive by satisfying customers needs.
6. Directors ([non] executives):they must balance the wishes of all groups. Must maintain the activities of the org within the feasibility region determined but the intersecting acceptable sets of stakeholders.
7. Gatekeepers/watchdogs: a) auditors b) credit agencies c) media. monitor activities of company and report on findings.

Must determine ‘feasibility space’ of where these all stakeholders interests are considered.

Question 21

Backbone of a good CG?

Answer 21

1. Transparency: Requires sophisticated system of accounting and should encourage efficient operations, allow investors to assess magnitude and timing of financial cash flows, provide warning of inabilities to meet objectives, and quick corrective actions in place.
2. Integrity: doing things right.

Question 22

4 Moral Standards enforced by law

Answer 22

1. The Sup Board is to (independently) supervise the executives on behalf of the shareholders
2. The external auditor should audit the corporation and provide an independent judgment
3. The members of the executive board should manage the company well and demonstrate they are in control
4. Whistleblowers should be protected.

Question 23

Rule based vs. Principle based

Answer 23

SOX is based on punishment and fear imposed by politics, while the UK and Dutch codes have managed to restrain from strong regulation. The Dutch and UK codes have principles that you can either apply or not but in the latter case you must explain (AKA “Apply or explain Principle” -principle based and risk-based). The US is rule-based.

Question 24

Risk appetite vs. Risk Response

Answer 24

Appetite: Amount of risk, and nature of risk, that an entity is willing to take in order to meet strategic objectives (should be reelected in their strategic plan and consistent with orgs mission).
Response: the orgs reaction to the identified risk posed, while considering the risk appetite.

Overall, RA is the focal point for ERM which trickles down to the decisions made for the company’s risk response.

Question 25

Objectives of Exec remuneration

Answer 25

1. increasing SH value
2. retaining talent
3. limiting SH costs

Question 26

Fama & Jensen

Answer 26

Separation is effective do to specialization of management and risk bearing functions.

Question 27

BoD Roles under Dutch Code

Answer 27

• BoD should formulate a long term value creation strategy and monitor the achievement of the strategy (Strategic direction)
• Responsible for disclosing information in annual report and informing shareholders of their realizations of company goals and monitoring of risks. (reporting and evaluation)

1. controlling and reporting ( audit, investor relations, social responsibility)
2. evaluating and enhancing (risk mgmt, remuneration)
3. setting direction (strategic marketing, strategy, M&A, capital formation)
4. marshaling resources (board nominations, budgets, senior mgmt appointing, remuneration (salaries))

Question 28

Dutch Code of Corporate Gov.

Answer 28

1. BoD:-BoD should formulate a long term value creation strategy and monitor the achievement of the strategy (Strategic direction. Responsible for disclosing information in annual report and informing shareholders of their realizations of company goals and monitoring of risks. (reporting and evaluation). Appointment of members must be critically assessed and sufficient expertise. Members should attend meetings, and if they are frequently absent, they must be held accountable (report should also state the absenteeism rate).
2. Exec board:
3. Auditors: can perform other non-audit services, in agreement with Sup Board, and explained to the shareholders meeting. - the audit committee shall propose an external accountant to the shareholders meeting and monitor the functioning of the auditor.
   the audit report shall discuss the audit plan with the audit committee. the external auditor will report its findings in the management letter. the external auditor is present at the general shareholders meeting.
4. whistle blower: a company of more than 50 people is obliged to have a procedure for reports of misconduct.

Question 29

Corporate practices for fraud prevention

Answer 29

1) principles- better tone at the top (codes of conduct, zero tolerance policy, accounting and control standards to comply with laws)
2) processes - control and mgmt structures (establish org structures aligned to ensure ethics and compliance, balance HR processes with ethics and compliance)
3) practices- a mindset of ethics and compliance (training, periodic measurements of culture)

Question 30

Three lines of defense

Answer 30

1st line, CEO/CFO/CRO has responsibility for the initiated measures of internal control
2nd line supports, advises, coordinates, and monitors whether the design is actually being carried out
3rd line assesses the performance of the 1st and 2nd line (auditor should report (not to CEO), but to an independent body.