Corporate governance Flashcards
Relevance of corporate governance 1.1 What is corporate governance?
Corporate governance is the means by which a company is operated
and controlled.
It came to prominence in the UK during the mid-80s following a number
of high profile corporate scandals including Polly Peck International and
BCCI and directors being paid excessive remuneration.
Relevance of corporate governance 1.2 Features of poor corporate governance
The scandals over the last 35 years have highlighted the need to tackle various risks
and problems that can arise in an organisation.
Domination by a single individual
Lack of board involvement
Poor internal control
Lack of independent scrutiny
Lack of contact with shareholders
Short-term focus
Lack of transparency.
Corporate governance is particularly important for publicly traded companies as there
is separation between ownership (shareholders) and control (directors).
The first guidance on corporate governance was issued in 1992 and has been
continually reviewed since, culminating with The UK Corporate Governance Code
The UK Corporate Governance Code
The UK Corporate Governance Code applies to all companies with a
premium listing (i.e. FTSE 350 and above), but should be considered
best practice for all companies.
All companies incorporated in the UK or elsewhere and listed on the
Main Market of the London Stock Exchange must disclose in their
annual reports how they have applied the principles of the Code or,
where this is not the case, provide an explanation. This enables the
stakeholders to assess risk.
The UK Corporate Governance Code Leadership and company purpose
The role of the
board
Effective and entrepreneurial. Responsible for long-term
sustainable success.
Culture
Directors act with integrity.
Resources
Sufficient resources, such as internal controls, to assess the
achievement of company objectives.
Engagement
Engage fully with stakeholders.
Workforce
Manage workforce in line with culture and allow views to be
heard.
The UK Corporate Governance Code Division of responsibilities
Chair
The chair should lead the board and ensure it is effective.
Should be independent and separate from the CEO. The CEO
should not go on to chair the company.
Balance
An appropriate mix of executives and non-executives (NEDs).
Non-executives
Sufficient time and resources to challenge and support
management. They should make up the majority of the board.
Support
Board needs suitable levels of information, time and other
resources to function effectively and efficiently.
The UK Corporate Governance Code Composition, succession and evaluation
Appointment
Recruitment is formal and transparent. Logical succession plan
and promotion of diversity.
Qualities
Board possesses appropriate skills, experience and knowledge,
achieved by regularly refreshing the board’s membership.
Assessment
Individuals and board as a whole appraised on a regular basis.
The UK Corporate Governance Code Audit, risk and internal control
Audit and
reporting
Ensure internal and external audit are effective and
independent.
Viability
A realistic and clear picture of prospects presented to
stakeholders.
Risk and control
Directors understand the risks affecting the company’s ability to
achieve its objectives, supported by suitable internal controls.
The UK Corporate Governance Code Remuneration
Policy
Direct link between executive remuneration and achievement of
long-term strategic objectives. Share option schemes should
have minimum vesting period of 5 years.
Procedure
Directors’ remuneration set transparently and objectively
Judgement
All remuneration decisions reflect company performance and
other appropriate factors to ensure they display suitable levels of
discretion.
Note: As part of the directors’ responsibilities regarding risk and control, they will
need to consider sustainability-related risks in the form of the entity’s dependencies
and impacts.
The UK Corporate Governance Code The UK Corporate Governance Code recommends three committees:
Nomination committee – It should comprise of a majority of NEDs and
oversee the process for board appointments via a formal, rigorous and
transparent procedure.
Remuneration committee – Develop a transparent remuneration policy and
set individual directors’ packages. This committee should consist entirely of
NEDs, ideally with a minimum of three.
Audit committee – Review the effectiveness of the internal audit function,
recommend removal and appointment of the external auditors and review the
effectiveness of the internal control system. The committee should consist
entirely of NEDs, ideally with a minimum of three and at least one member
having suitable financial experience.
Corporate governance Sarbanes-Oxley Act 2002
The Sarbanes-Oxley Act was developed in the US following the
collapse of Enron and the subsequent collapse of Arthur Anderson,
Enron’s auditors. This was America’s biggest financial and accounting
scandal and was a result of a lack of transparency in the accounts,
ineffective directors and self-interest of the auditors.
The UK Corporate Governance Code is a principles-based approach to corporate
governance. This means it is not enshrined in law, however repeated noncompliance will mean the market will punish the entity.
Sarbanes Oxley is a rules-based approach which means that it has the full force of
the law behind it. All companies listed on the Securities and Exchange Commission
(SEC) are required to comply.
Main requirements
Audit committee responsible for financial reporting and accuracy.
Increased financial statement disclosures.
Companies required to have an internal code of ethics.
Restrictions imposed on share trading by company officers.
Internal controls must be properly documented and tested. The report is
attested by the external auditors.
The audit committee has to closely monitor the level of non-audit revenue the
external audit firm receives.
Corporate governance Sarbanes-Oxley Act 2002 Key provisions from an audit perspective
New regulator to set standards, with disciplinary power (Public Company
Accounting Oversight Board).
Auditing standards tightened.
Provision of other services severely restricted (ban on internal audit,
bookkeeping, valuation, with all others subject to audit committee review).
Auditor to discuss accounting policies, management letter and unadjusted
differences with audit committee.
Increased whistle-blower protection in case of fraud.
