Section E: Unit 1 Governance Principles

What are the benefits of having a strong internal control system in a company?

1. Lower external audit costs.

2. Better control over the assets of the company.

3. Reliable information for use in decision making.

What is corporate governance?

All the means (ways or methods) by which businesses are directed and controlled, including: rules, regulations, processes, customs, policies, procedures, institutions and laws that affect the way the business is administered (managed).

Who is responsible for corporate governance in an organisation?

It is the joint (shared) responsibility of the board of directors and management. Taking into consideration that the board of directors is the primary (main) direct stakeholder influencing corpotate governance.

How are members of the board of directors elected (appointed or selected)?

By shareholders in order to represent the interests of the shareholders.

What are the common shareholders’ interests?

1. Profitability.

2. Good corporate citizenship with ethical behaviour (company's impact on the economy, environment, and society of communities).

What is ISO 26000: Guidance on Social Responsibility?

It is an international standard that aids organisations in structuring, evaluating, and improving their social responsibility.

Who are the stakeholders of a corporation?

Individuals or groups affected by the corporation's actions, including employees, shareholders, management, employees, customers, suppliers, creditors, the community, and the government.

What factors contribute to creating an organisation’s governance system?

An organisation’s governance is a byproduct of:

1. The values or principles to which the organization adheres (follows).

2. The strategies it employs (uses) to achieve its objectives.

3. The policies it sets to establish the boundaries of acceptable behaviour.

4. The procedures it applies in conducting (performing or doing) its operations.

What is the agency problem?

Issues that arise from the fact that the owners of the corporation (the shareholders) and the managers of the corporation (the agents of the shareholders) are different people, because the priorities and concerns of the managers are different from the priorities and concerns of the owners. [The managers are concerned with what will benefit them personally and lead to increased salary, bonuses, power, and prestige, while the shareholders’ priorities lie with seeing the value of their investments in the corporation increase].

How to mitigate (solve or reduce) the agency problem?

By corporate governance, which specifies the distribution of rights and responsibilities among the various parties with conflicting (different or opposing) priorities or interests. Incentives for the mangers could be used as well to encourage them to work for the best interests of the shareholders.

Match letters from (A-D) with numbers from (1-4):

A) The board of directors and executive management are responsible for:

B) In setting business strategies:

C) For a company to have an effective risk management process:

D) To consider risk:

1) The company must have an effective internal control system, because an effective internal control system is necessary in order to communicate and manage risk.

2) Developing and implementing business strategies.

3) The company must have an effective process for identifying, assessing, and managing risk.

4) The board and executive management must consider risk.

A with 2 [The board of directors and executive management are responsible for developing and implementing business strategies].

B with 4 [In setting business strategies, the board and executive management must consider risk].

C with 1 [For a company to have an effective risk management process, the company must have an effective internal control system, because an effective internal control system is necessary in order to communicate and manage risk].

D with 3 [To consider risk, the company must have an effective process for identifying, assessing, and managing risk].

What is the internal audit primary role?

It is assessing internal controls over the reliability of financial reporting, the effectiveness and efficiency of operations, and the organisation’s compliance with applicable laws and regulations. In addition to making appropriate recommendations for improving the governance process.

What governance objectives should internal auditors assess and make recommendations on?

1. Promoting appropriate ethics and values within the organisation.

2. Ensuring effective organisational performance, management, and accountability.

3. Communicating risk and control information to appropriate areas of the organisation.

4. Coordinating the activities of and communicating information between and among the board, external and internal auditors, and management.

What are the principles of good governance?

1. Board Purpose: its purpose is to promote and protect the interests of the corporation’s stockholders while considering the interests of other external and internal stakeholders such as creditors, employees, and so forth.

2. Board Responsibilities: its responsibility is to monitor the CEO and other senior executives, oversee the corporation’s strategy and processes for managing the enterprise, including succession planning, and monitoring the corporation’s risks and internal controls, including the ethical tone.

   Directors should employ healthy scepticism* (means not accepting information as it is, but to thoughtfully question information, be open to evidence, and recognise that what you're told might be wrong or only part of the truth) in meeting their responsibilities.

   *This is not Hock’s definition. For Hock’s definition, please refer to footer no 33 on page 136.

3. Interaction: good governance requires effective interaction among the board, management, the external auditor, the internal auditor, and legal counsel.

4. Independence: an “independent” director has no current or prior professional or personal ties to the corporation or its management other than service as a director. Independent directors must be able and willing to be objective in their judgments.

5. Expertise and Integrity: the directors should possess relevant business, industry, company, and governance expertise. The directors should reflect a mix of backgrounds and perspectives and have unblemished records of integrity. All directors should receive detailed orientation and continuing education.

6. Leadership: the roles of Board Chair and CEO should be separate. (If the roles are not separate, then the independent directors should appoint an independent lead director). The lead director and committee chairs should provide leadership for agenda setting, meetings, and executive sessions.

7. Committees: the audit and governance committees of the board should have charters (grants), authorised by the board, that outline how each committee will be organised, the committees’ duties and responsibilities, and how they report to the board. Each of these committees should be composed of independent directors only, and each committee should have access to independent outside advisors who report directly to the committee.

8. Meetings and Information: the board and its committees should meet frequently for extended periods of time and should have unrestricted access to the information and personnel they need to perform their duties. The independent directors and each of the committees should meet in executive session on a regular basis.

9. Internal Audit: all public companies should maintain an effective, full-time internal audit function that reports directly to the audit committee of the board of directors through the Chief Audit Executive. Companies also should consider providing an internal audit report to external stakeholders to describe the internal audit function, including its composition, responsibilities, and activities.

10. Compensation: the compensation committee and full board should carefully consider the compensation amount and mix (e.g., short-term vs. long-term, cash vs. equity) for executives and directors. The compensation committee should evaluate the incentives and risks associated with a heavy emphasis on short-term performance-based incentive compensation for executives and directors.

11. Disclosure: proxy statements* and other communications (required filings and press releases) should reflect board and corporate activities and transactions in a transparent and timely manner (e.g., financial performance, mergers and acquisitions, executive compensation, director compensation, insider trades, related-party transactions). Companies with anti-takeover provisions should disclose why such provisions are in the best interests of their shareholders.

    *[A proxy statement: is a document containing the information the SEC requires publicly held corporations reporting to it to provide to shareholders so they can make informed decisions about matters that will be brought up at an annual stockholders’ meeting.]

12. Proxy Access: the board should have a process for shareholders to nominate director candidates, including access to the proxy statement for long-term shareholders with significant ownership stakes.

13. Evaluation: the board should have procedures in place to evaluate on an annual basis the CEO, the board committees, the full board, and individual directors. The evaluation process should be a catalyst (motive or reason) for change in the best interests of the shareholders.