LESSON PLAN LECTURER:Mohammad Amir Ali PROGRAMME NAME: PG DIP IN BUSINESS MANAGEMENT SUBJECT NAME:CORPORATE MANAGEMENT IN ACTION LEVEL:7 CLASS:- Indicative Content • Critically appraise the effect of changes in corporate governance on an organization • Identify the principles of sound corporate governance in an organization • Appraise the impact of corporate governance on internal controls in an organization • Describe recommendations and regulations on corporate governance within organizations Critically analyze the impact of recommendations and regulations of corporate governance on organizations within a global context CORPORATE GOVERNANCE Corporate governance is the set of processes, customs, policies, laws, and institutions affecting the way a corporation (or company) is directed, administered or controlled. Corporate governance also includes the relationships among the many stakeholders involved and the goals for which the corporation is governed. The principal stakeholders are the shareholders, management, and the board of directors.
Other stakeholders include employees, customers, creditors, suppliers, regulators, and the community at large. An important theme of corporate governance is to ensure the accountability of certain individuals in an organization through mechanisms that try to reduce or eliminate the principal-agent problem. A related but separate thread of discussions focuses on the impact of a corporate governance system in economic efficiency, with a strong emphasis on shareholders’ welfare.
There are yet other aspects to the corporate governance subject, such as the stakeholder view and the corporate governance models around the world. Gabrielle O’Donovan defines corporate governance as ‘an internal system encompassing policies, processes and people, which serves the needs of shareholders and other stakeholders, by directing and controlling management activities with good business savvy, objectivity, accountability and integrity. Sound corporate governance is reliant on external marketplace commitment and legislation, plus a healthy board culture which safeguards policies and processes’.
It is a system of structuring, operating and controlling a company with a view to achieve long term strategic goals to satisfy shareholders, creditors, employees, customers and suppliers, and complying with the legal and regulatory requirements, apart from meeting environmental and local community needs. Principles Key elements of good corporate governance principles include honesty, trust and integrity, openness, performance orientation, responsibility and accountability, mutual respect, and commitment to the organization.
Of importance is how directors and management develop a model of governance that aligns the values of the corporate participants and then evaluate this model periodically for its effectiveness. In particular, senior executives should conduct themselves honestly and ethically, especially concerning actual or apparent conflicts of interest, and disclosure in financial reports. Commonly accepted principles of corporate governance include: • Rights and equitable treatment of shareholders: Organizations should respect the rights of shareholders and help shareholders to exercise those rights.
They can help shareholders exercise their rights by effectively communicating information that is understandable and accessible and encouraging shareholders to participate in general meetings. • Interests of other stakeholders: Organizations should recognize that they have legal and other obligations to all legitimate stakeholders. • Role and responsibilities of the board: The board needs a range of skills and understanding to be able to deal with various business issues and have the ability to review and challenge management performance.
It needs to be of sufficient size and have an appropriate level of commitment to fulfill its responsibilities and duties. There are issues about the appropriate mix of executive and non-executive directors. • Integrity and ethical behavior: Ethical and responsible decision making is not only important for public relations, but it is also a necessary element in risk management and avoiding lawsuits. Organizations should develop a code of conduct for their directors and executives that promotes ethical and responsible decision making.
It is important to understand, though, that reliance by a company on the integrity and ethics of individuals is bound to eventual failure. Because of this, many organizations establish Compliance and Ethics Programs to minimize the risk that the firm steps outside of ethical and legal boundaries. • Disclosure and transparency: Organizations should clarify and make publicly known the roles and responsibilities of board and management to provide shareholders with a level of accountability.
They should also implement procedures to independently verify and safeguard the integrity of the company’s financial reporting. Disclosure of material matters concerning the organization should be timely and balanced to ensure that all investors have access to clear, factual information. Issues involving corporate governance principles include: • Internal controls and internal auditors • The independence of the entity’s external auditors and the quality of their audits • Oversight and management of risk Oversight of the preparation of the entity’s financial statements • Review of the compensation arrangements for the chief executive officer and other senior executives • The resources made available to directors in carrying out their duties • The way in which individuals are nominated for positions on the board Nevertheless “corporate governance,” despite some feeble attempts from various quarters, remains an ambiguous and often misunderstood phrase. For quite some time it was confined only to corporate management. That is not so.
It is something much broader, for it must include a fair, efficient and transparent administration and strive to meet certain well defined, written objectives. Corporate governance must go well beyond law. The quantity, quality and frequency of financial and managerial disclosure, the degree and extent to which the board of Director (BOD) exercise their trustee responsibilities (largely an ethical commitment), and the commitment to run a transparent organization- these should be constantly evolving due to interplay of many factors and the roles played by the more progressive/responsible elements within the corporate sector.
John G. Smale, a former member of the General Motors board of directors, wrote: “The Board is responsible for the successful perpetuation of the corporation. That responsibility cannot be relegated to management. ” Mechanisms and controls Corporate governance mechanisms and controls are designed to reduce the in efficiencies that arise from moral hazard and adverse selection. For example, to monitor managers’ behavior, an independent third party (the external auditor) attests the accuracy of information provided by management to investors.
An ideal control system should regulate both motivation and ability. Internal corporate governance controls Internal corporate governance controls monitor activities and then take corrective action to accomplish organizational goals. Examples include: • Monitoring by the board of directors: The board of directors, with its legal authority to hire, fire and compensate top management, safeguards invested capital. Regular board meetings allow potential problems to be identified, discussed and avoided.
Whilst non-executive directors are thought to be more independent, they may not always result in more effective corporate governance and may not increase performance.  Different board structures are optimal for different firms. Moreover, the ability of the board to monitor the firm’s executives is a function of its access to information. Executive directors possess superior knowledge of the decision-making process and therefore evaluate top management on the basis of the quality of its decisions that lead to financial performance outcomes, ex ante.
It could be argued, therefore, that executive directors look beyond the financial criteria. • Internal control procedures and internal auditors: Internal control procedures are policies implemented by an entity’s board of directors, audit committee, management, and other personnel to provide reasonable assurance of the entity achieving its objectives related to reliable financial reporting, operating efficiency, and compliance with laws and regulations. Internal auditors are personnel within an organization who test the design and implementation of the entity’s internal control procedures and the reliability of its financial reporting. Balance of power: The simplest balance of power is very common; require that the President be a different person from the Treasurer. This application of separation of power is further developed in companies where separate divisions check and balance each other’s actions. One group may propose company-wide administrative changes, another group review and can veto the changes, and a third group check that the interests of people (customers, shareholders, employees) outside the three groups are being met. • Remuneration: Performance-based remuneration is designed to relate some proportion of salary to individual performance.
It may be in the form of cash or non-cash payments such as shares and share options, superannuation or other benefits. Such incentive schemes, however, are reactive in the sense that they provide no mechanism for preventing mistakes or opportunistic behavior, and can elicit myopic behavior. INTERNAL CONTROLS In accounting and auditing, internal control is defined as a process affected by an organization’s structure, work and authority flows, people and management information systems, designed to help the organization accomplish specific goals or objectives.
It is a means by which an organization’s resources are directed, monitored, and measured. It plays an important role in preventing and detecting fraud and protecting the organization’s resources, both physical (e. g. , machinery and property) and intangible (e. g. , reputation or intellectual property such as trademarks). At the organizational level, internal control objectives relate to the reliability of financial reporting, timely feedback on the achievement of operational or strategic goals, and compliance with laws and regulations.
At the specific transaction level, internal control refers to the actions taken to achieve a specific objective (e. g. , how to ensure the organization’s payments to third parties are for valid services rendered. ) Internal control procedures reduce process variation, leading to more predictable outcomes. There are many definitions of internal control, as it affects the various constituencies (stakeholders) of an organization in various ways and at different levels of aggregation.
Under the COSO Internal Control-Integrated Framework, a widely-used framework in the United States, internal control is broadly defined as a process, effected by an entity’s board of directors, management, and other personnel, designed to provide reasonable assurance regarding the achievement of objectives in the following categories: a) Effectiveness and efficiency of operations; b) Reliability of financial reporting; and c) Compliance with laws and regulations. COSO defines internal control as having five components: Control Environment-sets the tone for the organization, influencing the control consciousness of its people. It is the foundation for all other components of internal control. • Risk Assessment-the identification and analysis of relevant risks to the achievement of objectives, forming a basis for how the risks should be managed • Information and Communication-systems or processes that support the identification, capture, and exchange of information in a form and time frame that enable people to carry out their responsibilities Control Activities-the policies and procedures that help ensure management directives are carried out. • Monitoring-processes used to assess the quality of internal control performance over time. • The COSO definition relates to the aggregate control system of the organization, which is composed of many individual control procedures. Roles and responsibilities in internal control According to the COSO Framework, everyone in an organization has responsibility for internal control to some extent.
Virtually all employees produce information used in the internal control system or take other actions needed to effect control. Also, all personnel should be responsible for communicating upward problems in operations, noncompliance with the code of conduct, or other policy violations or illegal actions. Each major entity in corporate governance has a particular role to play: • Management: The Chief Executive Officer (the top manager) of the organization has overall responsibility for designing and implementing effective internal control.
More than any other individual, the chief executive sets the “tone at the top” that affects integrity and ethics and other factors of a positive control environment. In a large company, the chief executive fulfills this duty by providing leadership and direction to senior managers and reviewing the way they’re controlling the business. Senior managers, in turn, assign responsibility for establishment of more specific internal control policies and procedures to personnel responsible for the unit’s functions.
In a smaller entity, the influence of the chief executive, often an owner-manager is usually more direct. In any event, in a cascading responsibility, a manager is effectively a chief executive of his or her sphere of responsibility. Of particular significance are financial officers and their staffs, whose control activities cut across, as well as up and down, the operating and other units of an enterprise. • Board of Directors: Management is accountable to the board of directors that provides governance, guidance and oversight. Effective board members are objective, capable and inquisitive.
They also have knowledge of the entity’s activities and environment, and commit the time necessary to fulfill their board responsibilities. Management may be in a position to override controls and ignore or stifle communications from subordinates, enabling a dishonest management which intentionally misrepresents results to cover its tracks. A strong, active board, particularly when coupled with effective upward communications channels and capable financial, legal and internal audit functions, is often best able to identify and correct such a problem. Auditors: The internal auditors and external auditors of the organization also measure the effectiveness of internal control through their efforts. They assess whether the controls are properly designed, implemented and working effectively, and make recommendations on how to improve internal control. They may also review Information technology controls, which relate to the IT systems of the organization. Rules versus principles Rules are typically thought to be simpler to follow than principles, demarcating a clear line between acceptable and unacceptable behavior.
Rules also reduce discretion on the part of individual managers or auditors. In practice rules can be more complex than principles. They may be ill-equipped to deal with new types of transactions not covered by the code. Moreover, even if clear rules are followed, one can still find a way to circumvent their underlying purpose – this is harder to achieve if one is bound by a broader principle. Principles on the other hand are a form of self regulation. It allows the sector to determine what standards are acceptable or unacceptable.
It also pre-empts over zealous legislations that might not be practical. Enforcement Enforcement can affect the overall credibility of a regulatory system. They both deter bad actors and level the competitive playing field. Nevertheless, greater enforcement is not always better, for taken too far it can dampen valuable risk-taking. In practice, however, this is largely a theoretical, as opposed to a real, risk. Action beyond Obligation Enlightened boards regard their mission as helping management lead the company. They are more likely to be supportive of the senior management team.
Because enlightened directors strongly believe that it is their duty to involve themselves in an intellectual analysis of how the company should move forward into the future, most of the time, the enlightened board is aligned on the critically important issues facing the company. Unlike traditional boards, enlightened boards do not feel hampered by the rules and regulations of the Sarbanes-Oxley Act. Unlike standard boards that aim to comply with regulations, enlightened boards regard compliance with regulations as merely a baseline for board performance. Enlightened directors go far beyond merely meeting the requirements on a checklist.
They do not need Sarbanes-Oxley to mandate that they protect values and ethics or monitor CEO performance. At the same time, enlightened directors recognize that it is not their role to be involved in the day-to-day operations of the corporation. They lead by example. Overall, what most distinguishes enlightened directors from traditional and standard directors is the passionate obligation they feel to engage in the day-to-day challenges and strategizing of the company. Enlightened boards can be found in very large, complex companies, as well as smaller companies.
Corporate governance models around the world Although the US model of corporate governance is the most notorious, there is a considerable variation in corporate governance models around the world. The intricate shareholding structures of keiretsus in Japan, the heavy presence of banks in the equity of German firms, the chaebols in South Korea and many others are examples of arrangements which try to respond to the same corporate governance challenges as in the US. In the United States, the main problem is the conflict of interest between widely-dispersed shareholders and powerful managers.
In Europe, the main problem is that the voting ownership is tightly-held by families through pyramidal ownership and dual shares (voting and nonvoting). This can lead to “self-dealing”, where the controlling families favor subsidiaries for which they have higher cash flow rights. Corporate governance principles and codes have been developed in different countries and issued from stock exchanges, corporations, institutional investors, or associations (institutes) of directors and managers with the support of governments and international organizations.
As a rule, compliance with these governance recommendations is not mandated by law, although the codes linked to stock exchange listing requirements may have a coercive effect. For example, companies quoted on the London and Toronto Stock Exchanges formally need not follow the recommendations of their respective national codes. However, they must disclose whether they follow the recommendations in those documents and, where not, they should provide explanations concerning divergent practices.
Such disclosure requirements exert a significant pressure on listed companies for compliance. In the United States, companies are primarily regulated by the state in which they incorporate though they are also regulated by the federal government and, if they are public, by their stock exchange. The most number of companies are incorporated in Delaware, including more than half of the Fortune 500. This is due to Delaware’s generally business-friendly corporate legal environment and the existence of a state court dedicated solely to business issues.