Corporate Governance, Business Ethics, Risk ent ~ and istersal Cenerol . 2019-2020 Edition MA. ELENITA BALATBAT CABRERA BBA MBA CPA CMA PRESENTLY: Academic and Business Consultant President and CEO, CLA Consultancy and Training Center, Inc. FORMERLY: \Vice Chairman and Examiner, Professional Regulatory Board of Accountancy World Bank Consultant Dean, College of Business Administration, Lyceum University of the Philippines CPA Review Director & Reviewer, Professional Review and Training Center, inc. Professor of Accounting & Finance, University of the East, Far Eastem University, ‘Do La Salle University, Centro Escolar University, St. Scholastica’s College Audit Staff, SGV and Co., CPAs GILBERT ANTHONY B. CABRERA BBA MBA CPA PRESENTLY: Vice President - Risk and Finance, Global Insurance Brokerage, USA. FORMERLY: ‘Chief Financial Officer, Food Retail Conglomerate, USA. Senior Auditor, SGV and Co., CPAS Accounting Instructor | University of Maryland, Robert Smith School of Business University of the East, ManilaPhilippine Copyright, 2019 by MA. ELENITA BALATBAT CABRERA GILBERT AMA UOBYB.CABRERA Any copy of this book not bearing the signature of the author(s) shall be considered as proceeding from an illegal source. The Internet addresses listed in the text were accurate at the time of publication. The inclusion of a website does not indicate endorsement by the authors or GIC Enterprises & Co., Inc, and they do not guarantee the accuracy of information. presented at these sites. ALL RIGHTS RESERVED ISBN: 978-621-416-073-0 Published & Printed by: GIC ENTERPRISES & CO., INC. *National Book Development Board Registered 2017 C. M. Recto Avenue, Manila PhilippinesAbout the Authors Ma. Elenita B. Cabrera BBA MBA CPA CMA Dean Cabrera graduated Magna Cum Laude from the University of the East with a degree of Bachelor of Business Administration, major in Accounting and was one of the topnotchers when she passed the CPA Licensure Board Examination. She eared her Master in Business Administration major in Financial Management from the University of the Philippines and is a candidate for Doctor of Education at the University of the East. She.is a holder of a Certificate in Management Accounting from the Institute of Certified Management Accountants of Victoria, Australia, Dean Cabrera worked with SGV & Co. as Staff Auditor. She taught Financial Accounting, Financial Management, Management Advisory Services, Auditing Theory and Practice in various colleges and universities and authored books in these subjects. She previously held the position of Dean of the College of Business Administration at the Lyceum of the Philippines University. A former Vice Chairman of the Professional Regulatory Board of Accountancy, she was the BOA representative to the Financial Reporting Standards Council (FRSC), Philippine Interpretations Committee (PIC) and Auditing and Assurance Standards Council (AASC). She served as the Chairman of the PRC CPE Council for Accountancy and Chairman of the CHED Technical Committee for Accountancy Education. She was a World Bank Project Consultant on the creation of an Accounting Oversight Board in the Philippines. ‘She was a recipient of the Philippine Institute of Certified Public Accountants (PICPA) awards as Outstanding CPA in Education, Honorary Life Membership, Distinguished Accountancy Author and 2018 Accountancy Hall of Fame. Gilbert Anthony B. Cabrera BBA MBA CPA Gilbert received hig bachelor’s degree in Accountancy from the University of the East, Cum Laude. He obtained a Master in Business Administration degree with concentrations on International Finance and Accounting from the University of Maryland, College Park, Robert H. Smith School of Business. A certified public accountant, he has public accounting experience with SGV & Co. (Emst and Young Member Firm) and teaching experience with the University of the East, Manila and University of Maryland, Robert H. Smith School of Business. Presently; he is ~ Vice-President, Risk and Finance, of Global Insurance Brokerage in California, USA. An ‘active member of the Association of Filipino Finance Managers in California, he is also a former Board Member of Bay Area Red Cross.Preface The business environment continues to change in dramatic ways and university graduates joining the corporate worid or entering the accountancy profession, whether il be in the public practice sector, management accounting practice, internal audit or accounting information system management, must be prepared for a high standard of responsibility. This textbook on Corporate Governance, Business Ethics, Risk Management and Internal Control, aims fo equip its readers the basic knowledge, skills and perspective that are necessary in facing this challenge. Having a solid understanding of fundamental business, its governance, risk management, ethical practices and intemal control will become even more important in a world of advancing technology. While businesses in different industry have strikingly different characteristics, most have some fundamental characteristics in common. A fundamental widely accepted model of business consists of govemance, objectives, strategies, business processes, risks, controls and reporting, This book is organized to provide authoritative, practical and contemporary content as follows: Unit I- Corporate Governance This unit describes Corporate governance and the parties involved in it. It discusses the structure that specifies the distribution of rights and responsibilities among different participants in a corporation. It also spells out the rules and procedures for making decisions on corporate affairs. Unit Il- Business Ethics This unit discusses the various forms of unethical business practices. It also articulates how to institutionize integrity in all aspects of business process and how business with integrity enjoys competitive advantage in both government and private transactions. Unit Ill - Risk Management This unit emphasizes the nature, forms and basic management of risks related to business. Unit IV Internal Control: A Vital Tool in Managing Risk This unit articulates the nature, scope, elements and importance of internal control. It also covers extensive discussion of what how fraud can be prevented, detected and reduced if not fully eliminated in an enterprise. The end of chapter materials have been thoroughly chosen and streamlined to be much more user friendly. Special thanks to our families for their continued support and encouragement. &. @. é. G28.if Preface UNIT Chapter Chapter Chapter Chapter UNIT Chapter Chapter Chapter Chapter Chapter Chapter 10 Contents in Brief CORPORATE GOVERNANCE INTRODUCTION TO. CORPORATE GOVERNANCE CORPORATE GOVERNANCE RESPONSIBILITIES AND ACCOUNTABILITIES SECURITIES AND EXCHANGE (SEC) COMMISSION CODE OF CORPORATE GOVERNANCE SEC CODE OF CORPORATE GOVERNANCE, CONTINUED BUSINESS ETHICS INTRODUCTION TO ETHICS BUSINESS ETHICS COMMON UNETHICAL PRACTICES OF BUSINESS ESTABLISHMENTS ETHICAL DILEMMA ADVOCACY AGAINST CORRUPTION INITIATIVES TO IMPROVE B AND REDUCE CORRUPTION ane 26 16 93 94 103 109 128 146UNIT In Chapter W Chapter 12 UNIT IW Chapter 13 Chapter 14 Chapter 15 Chapter 16 Chapter 17 Appendices Appendix A Appendix B Appendix C Appendix D Appendix E Appendix F Appendix G References INTRODUCTION TO RISK MANAGEMENT RISK MANAGEMENT PRACTICAL INSIGHTS IN REDUCING AND MANAGING BUSINESS RISKS INTERNAL CONTROL: A VITAL TOOL IN MANAGING RISK OVERVIEW OF INTERNAL CONTROL, FRAUD-AND ERROR ERRORS AND IRREGULARITIES IN THE TRANSACTION CYCLES OF THE BUSINESS ENTITY INTERNAL CONTROL AFFECTING ASSETS INTERNAL CONTROL AFFECTING LIABILITIES AND EQUITY Code of Ethics for Professional Teachers. International Standards for the Professional Practice of Internal Auditing International Standards of Ethical Conduct for Practitioners of Management Accounting Code of Business Conduct and Ethies of a Telecommunications Company Code of Business Conduct and Ethics of a Manufacturing Company Code of Business Conduct and Ethics of a Commercial Bank : Partial List of Organizations who are actively Participating in the “Integrity Initiative” Campaign against Corruption it 162 163 180 195 196 217 232 244 264 273 281 283 287 293 303 307 311Contents Preface I CORPORATE GOVERNANCE CORPORATE Chapt 1 INTRODUCTION TO a GOVERNANCE UNIT Expected Learning Outeomes What is Governance? Characteristics of Good Governance Corporate Governance: A Overview Purpose of Corporate Governance Objectives of Corporate Governance Basic Principles of Effective Corporate Governance Nlustrative Application of the Basic Principles of Corporate Governance and Best Practice Recommendations Review Questions 2 CORPORATE GOVERNANCE RESPONSIBILITIES AND ACCOUNTABILITIES Expected Learning Outcomes Chapter Introduction Relationship between Shareholders / Owners and Other Stakeholders Parties involved in Corporate Governance Their Respective Broad Role and Specific Responsibilities ° Shareholders Board of Directors Non-Executive or Independent Directors Management Audit Committees Regulators Board of Accountancy External Audit Internal Audit Se eee ee Review Questions MARA Ww © 15 16 17 19 19 19 20 21 22 23 23 24SECURITIES AND EXCHANGE COMMISSION (SEC) CODE OF CORPORATE GOVERNANCE Expected Learning Outcomes The Board's Governance Responsibilities Principles 1107 Disclosure and Transparency Principles 8 to 11 Internal Control System and Risk Management Framework Principle 12 Cultivating a Synergies Relationship with Shareholders Principle 13 Duties to Stakeholders Principles 14 t0 16 Introduction The Code of Corporate Governance Objective Approach Organization Recommendation Explanations Coverage Definition of Terms The Board’s Governance Responsibilities Establishing a Competent Board Establishing Clear Roles and Responsibilities of the Board Establishing Board Committees Fostering Commitment Reinforcing Board Independence “Assessing Board Performance ‘Strengthening Board Ethics ‘Enhancing Company Disclosure Policies and Procedure Strengthening the External Auditor's Independence and Improving Review Questions and Exercises 26 28 28 29 29 29 29 29 29 30 30 30 30 30 30 30 31 31 31 34 34 34 39 49 57 59 65 67 68 1 4 26vi Chapter UNIT Chapter 4 SEC CODE CONTINUED OF CORPORATE GOVERNANCE, Expected Learning Outcomes Increasing Focus on Non-Financial and Sustainability Reporting , Promoting a Comprehensive and Cost-efficient ‘Access to Relevant Information Strengthening the Internal Control System and Enterprise Risk Management Framework Cultivating a Synergic Relationship with Shareholders Respecting Rights of ‘Stockholders and Effective Redress for Violation of Stakeholder’s Rights Encouraging Employees Participation Encouraging Sustainability and Social Responsibility Review Questions IL BUSINESS ETHICS INTRODUCTION TO ETHICS Expected Learning Outcomes Introduction Characteristics and Values Associated with Ethical Behavior Why is Ethical Behavior Necessary? Wy: Why do People Act Unethically? Categories of Ethical Principle The Need for Professional Ethics Review Questions 76 a 7B 7B 83 87 88 90 91 94 95 98 98 99 100 102 16 93 94vii Chapter 6 BUSINESS ETHICS 6 Expected Learning Outcomes 103 Basic Concept of Business Ethics 104 Purposes of Business Ethics 104 Main Purpose 104 Special Purpose ! 108 __ Scope and Impact of Business Ethics 105 Economic Impact 106 Social Impact 106 Environmental Impact ji 106 Impact on Business Managers 106 Ethical Challenges in Today's World 107 Review Questions 108 Chapter 7 COMMON UNETHICAL PRACTICES OF BUSINESS ESTABLISHMENTS 109 Expected Learning Outeomes 109 Common Unethical Practices of Business Establishments 110 Misrepresentation and Over Persuasion , uo Direct Misrepresentation 110 Deceptive packaging 0 Misbranding or mislabeling 110 False or misleading advertisement 110 Adulteration M1 Weight understatement Ml Measurement understatement il Quantity understatement 12 Indirect Misrepresentation 112 Caveat emptor 12 Deliberate withholding of information 112 Passive deception 112 Over Persuasion 113 Corporate Ethics 113 Unethical Practices of Corporate Management 113 Board of Directors 113 Executive Officers and Lower Level Managers 114. Some Unethical Practices of Employees 17 Review Questions ugviii Chapter 8 ETHICAL DILEMMA Expected Learning Outcomes er Introduction i Resolving Ethical Dilemmas 122 Ilustrative Case: Resolving an Ethical Dilemma 122 Ethical Issue 12 Who is Affected and How is each Affected 123 Bert’s Available Alternatives 124 Consequences of Each Alternative 124 Appropriate Action 125 Review Questions and Exercises 126 Chapter. 9 ADVOCACY AGAINST CORRUPTION Expected Learning Outcomes 128 What is Corruption? — 129 What does Corruption Look Like? 130 Why aind how does a Person Become Corrupt? 131 Ul Effects of Corruption 131 Characteristics of Corruption 133 The Philippine Corruption Report 137 Judicial System Police Be Public Services ed Land Administration io Tax Administration 4 Customs Administration i Public Procurement a Natural Resources uo Prevention of Corruption 4) Clear Business Process a ‘olicy on Gifs and Enterta bn Decorating Coen ig ‘onvenient Corr ‘ ae Efforts to Curb Conmupnion Tp stem 142 Vigilance of Civil Sociery rough Legislation 142 143 Review Questions 145Chapter 10 INITIATIVES TO IMPROVE BUSINESS ETHICS AND REDUCE CORRUPTION 146 Expected Learning Outcomes 146 Introduction 147 The Integrity Initiative Campaign 147 Corporate Values 148 Need for a Code of Conduct l49 The Unified Code of Conduct for Business 150 Top Management 150 Human Resources 150 Sales and Marketing 150 Finance and Accounting 13) Procurement 1 Logistics 152 Implementation and Monitoring 152 Bishops-Businessmen’s Conference Philippines — Code of Ethics for the Philippine Business 153 Survey of Laws Advocating Business Ethics 159 Review Questions 160 UNIT III INTRODUCTION TO RISK MANAGEMENT tex Chapter 11 RISK MANAGEMENT 163 Expected Learning Outcomes 163 Introduction 164 Risk Management Defined 164 Basic Principles of Risk Management 165 Process of Risk Management 165 Elements of Risk Management 166 Relevant Risk Terminologies 167 1. Risk Associated with Investments 167 I. Risks Associated with Manufacturing, Trading and Service Concerns 170 IIL Risk Associated with Financial Institutions 71 Potential Risk Treatments 1m ‘Areas of Risk Management 1B Risk Management Framework 174 Steps in the Risk Management Process 175 Review Questions 178x L INSIGHTS IN REDUCING AND ICA! Chapter 12. PRACTIC. NESS RISKS MANAGING BUSI Expected Learning Outcomes Understand the Nature of Risk fentify» and Prioritize Risks Coulter the Acceptable Level of Risk Understand Why Risks Become Reality Apply a Simple Risk Management Process Risk Assessment and Analysis Risk Management and Control Avoiding and Mitigating Risks Create a Positive Climate for Managing Risk Overcoming the Fear of Risk Controlling and Monitoring Enterprise-wide Risk Practical Considerations in Managing and Reducing Financial Risk Improving Profitability Assessment of Market and Exit Barries Break-even Analysis Controlling Costs Practical Techniques to Improve Profitability Avoiding Pitfalls Review Questions and Exercises UNIT IV INTERNAL CONTROL: ‘ A VITAL TOOL IN MANAGING RISK Chapter 13. OVERVIEW OF INTERNAL CONTROL Expected Learning Outcomes Nature and Purpose of Internal Control Internal Control System Defined Elements of lmernal Control A. Control Environment B. Entity’ Risk Assessment Process C. Information System, including the Business Processes, Relevant to Financial Reporting and Communication D. Control Activities E. Monitoring of Controls Review Questions and Exercises 180 181 181 183 183 184 184 185 186 186 187 187 188 188 189 189 190 191 192 194 196 197 197 198 198 198 203 205 210 2il 195 196Chapter 14 FRAUD AND ERROR 217 Expeeted Learning Outcomes a7 Introduction 218 Types of Misstatemenis 218 Misstatements arising from Misappropriation of Assets 218 Misstatements arising from Fraudulent Financial Reporling 219 The Fraud Triangle 219 Incentives or Pressure to Commit Fraud 220 Opportunities to Commit Fraud 220 Rationalizing the Fraud 221 Risk Factors arising from Misappropriation of Assets 223 Risk Factors arising from Fraudulent Financial Reporting 224 Responsibility for the Prevention and Detection of Fraud 7 226 Review Questions and Exercises 227 Chapter 15 ERRORS AND IRREGULARITIES IN THE TRANSACTION CYCLES OF THE BUSINESS ENTITY 232 Expected Learning Outcomes 232 Sales and Collections Cycle 233 Errors in Recording Sales Collections Transactions 233, Frauds in sales and Collections 233 Acquisition and Payments Cycle 235 Errors in the Acquisitions and Payments Cycle 235 Frauds in the Acquisitions and Payments Cycle 236 Payroll and Personnel Cycle 231 Errors 237 Frauds involving Payrol! 2a Review Questions and Exercises 239ait INTERNAL CONTROL AFFECTING ASSETS 244 Chapter 16 244 Expected Learning Outcomes snirol over Cash Transactions 245 al Misstatements — Cash Receipts 246 Potential Misstatements — Cash Disbursements 248 Internal Control over Financial Investments 249 Potential Misstatements — Financial Investments 250 Internal Control over Receivables 251 ‘Sources and Nature of Notes Receivable 251 Internal Control of Accounts Receivable and Revenue 251 Control Environment 252 Potential Misstatements — Revenue / Receivables 252 Internal Control over Notes Receivable 254 Internal Control over Inventories and Cost »f Goods Sold 255 Sources and Nature of Inventories and Cost of Goods Sold 255 Potential Misstatements - Inventory / Cost of Goods Sold 256 Internal Control over Property, Plant and Equipment 257 Potential Misstatements ~ Investments in Property, Plant and Equipment 259 Review Questions and Exercises 260 Chapter 17 INTERNAL CONTROL AFFECTING LIABILITIES AND EQUITY 264 Expected Learning Outcomes 264 Internal Control over Accounts Payable 265 Potential Misstatements ~ Accounts Payable 266 internal Control over Other Debts 267 Internal Control over Debi Authorization by the Board of Directors 267 Use Of an Independent Trustee 268 imerest Payments of Boards and Notes Payable 268 ¢nternal Control over Owners’ Equity ou 268 Internal Control on Equity a Control of Share Capital Transactions by the Board of Directors 269 Independent Registrar and Stock Transfer Agent 269 Internal Control over Dividends 270 Review Questions and Exercises aAppendices Appendix Appendix Appendix Appendix Appendix Appendix Appendix References Code of Ethics for Professional Teachers International Standards for the Professional Practice of Internal Auditing International Standards of Ethical Conduct for Practitioners of Management Accounting Code of Business Conduct and Ethics of a Telecommunications Company Code of Business Conduct and Ethics of a Manufacturing Company Code of Business Conduct and Ethics of a ‘Commercial Bank Partial List of Organizations who are actively Participating in the “Integrity ‘a Campaign against Corruption 273 281 283 287 293 303 307 311 altiUNITI CORPORATE GOVERNANCE Chapter 1 Introduction to Corporate Governance 2 Corporate Governance Responsibilities and Accountabilities 3 Securities and Exchange Commission (SEC) Code of Corporate Governance 4 SEC Code of Corporate Governance, ContinuedChapter INTRODUCTION TO CORPORATE GOVERNANCE Expected Learning Outcomes After studying the chapter, you should be able to ... ia 2. Describe what governance involves Enumerate the different contexts in which governance can be applied . Name and explain the characteristics of good governance Explain the meaning, purpose and objectives of corporate governance Know and describe the principles of effective corporate governance Understand how the principles of ane aes princip| a good corporate governance QU yCHAPTER 1 INTRODUCTION TO CORPORATE GOVERNANCE WHAT IS GOVERNANCE? Generally, governance refers to a process whereby elements in society wield Power, authority and influence and enact policies and decisions conceming public life and social upliftment, It comprises all the processes of governing — whether undertaken by the government of a country, by a market or by a network — over a social system and whether through the laws, noims, power or language of an organized society. Governance therefore means the process of decision-making and the process by which decisions are implemented (or not implemented) through the exercise of power or authority by leaders of the country and / or organizations. Governance can be used in several contexts such as corporate governance, international governance, national governance and local: governance. The focus of this book is on Corporate Governance. CHARACTERISTICS OF GOOD GOVERNANCE Whatever context good governance is used, the following major characteristics should be present: Participation Rule of Law | "Accountabilty 6000 Effectiveness & Transparency Governance “Efficiency responincres’ | auraincser Cansendis Oriented _4 Chapter l eh thy These characteristics are briefly described as follows: n by both men and women is a key cornerstone ernance. Participation could be either direct or te institutions or representatives. It is it that representative democracy does n that the concern of the most vulnerable in society would not be taken into consideration in decision making. Participation needs to be informed and zed. This means freedom of association and sion on one hand and an organized civil society on Participatior of good gov through legit important to point ou not necessarily “meal Participation organi: expres the othér hand. Rule of Law Good governance requires fair legal frameworks that are enforced impartially. It also requires full protection of human rights, particularly those of minorities. Impartial enforcement of laws requires an independent judiciary and an impartial and incorruptible police force. Transparency ‘Transparency means that decisions taken and their enforcement are done in a manner that follows rules and regulations. It means’ that information is freely available and directly accessible to those who will be affected by such decisions and their enforcement. It also means that enough information is provided and that it.is provided in easily understandable forms and media. Good governance requires that institutions and processes try to serve the needs all stakeholders within a reasonabl timeframe. Responsiveness Consensus Oriented Good governance requires mediation of the different interests in society to reach a broad consensus on what is in the best interest of the whole community and how this can be achieved. It also requires a broad and long-term Perspective on what is needed for sustainable human development and -how to achieve the goals of such development. This can only result from an understanding of the historical, cultural and social contexts of a given society or community,Introduction to Corporate Governance _ 5 Equity & Ensures that all its members feel that they have a stake in it Inclusiveness and do not feel excluded from the mainstream of society. This requires all groups, but particularly the most vulnerable, have opportunities to improve or maintain their well being, Effectiveness Good governance means that processes and institutions &Efficiency produce results that meet the needs of society while making the best use of resources at their disposal. The concept of efficiency in the context of good governance also covers the sustainable use of natural resources and the protection of the environment. Accountability Accountability is a key requirement of good governance. Not only governmental institutions but also the private sector and civil society organizations must be accountable to the public and to their institutional stakeholders. Who is accountable to whom varies depending on whether decisions or actions taken are internal or external to an organization or institution. In general, an organization or an institution is accountable to those who will be affected by its decisions or actions. Accountability cannot be: enforced without transparency and the rule of law. CORPORATE GOVERNANCE: AN OVERVIEW Corporate governance is defined as the system of rules, practices and processes by which business corporations are directed and controlled. It basically involves balancing the interests of a company’s many stakeholders, such as shareholders, management, customers, suppliers, financiers, government and the community. Corporate governance is a topic that has received growing attention in the public in recent years as policy makers and others become more aware of the contribution good corporate governance makes to financial market stability and economic growth. Good corporate governance Is all about controlling one’s business and so is relevant, and indeed vital; for all organizations, whatever size or structure.The corporate governance structure specifies the distribution o Tat and responsibilities among different participants in the sorporanen, sucl He is ‘ joard. managers, shareholders, and other stakeholders, and spel pee iis ru . an procedures for making decisions on corporate affairs. By one re it al ot provides the structure through which the objectives are set and the means o! attaining those objectives and monitoring performance. PURPOSE OF CORPORATE GOVERNANCE The purpose of corporate governance is to facilitate effective, entrepreneurial and prudent management that can deliver long-term success of the company. ln simple terms, the fundamental aim of corporate governance is to enhance shareholders’ value and protect the interests of other stakeholders by improving. the corporate performance and accountability. It is also about what the board of directors of a company does, how it sets the values of the business firm. 6 Chapter I OBJECTIVES OF CORPORATE GOVERNANCE The following are the basic objectives of corporate governance: 1. Fair and Equitable Treatment of Shareholders A corporate governance structure ensures equitable and fair treatment of all shareholders of the company. In some organizations, a group of high- net-worth individual and institutions who have a substantial proportion of their’ portfolios invested in the company, remain active through occupation of top-level positions that enable them to guard their interest. However, all shareholders deserve equitable treatment and this equity is safeguarded by a good governance structure in any organization. 2. Self-Assessment Corporate governance enables firms to assess their behavior and actions before they are scrutinized by regulatory agencies. Business establishments with a strong corporate governance system are better able to limit exposure to regulatory risks and fines. An active and independent board can successfully point out deficiencies or loopholes in the company operations and help solve issues internally on a timely basis.—_ Introduction to Corporate Governance 7 Increase Shareholders Wealth Fee ey carmerate governanee's main objective is to protect the long- ee tersts of the shareholders. Fim with song eorporate pheresiay aa ucture are seen to have higher valuation attached to their sinessmen. This only reflects the positive perception that g00d corporate governance induces potential investors to decide to invest in a company, 4. Transparency and Full Disclosure Good corporate governance aims at ensuring a higher degree of transparency in an organization by encouraging full disclosure of transactions in the company accounts. BASIC PRINCIPLES OF EFFECTIVE CORPORATE GOVERNANCE Effective corporate governance is transparent, protects the rights of shareholders and includes both strategic and operational risk management. It is concerned in both the long-term earning potential as well as actual short-term earnings and holds directors accountable for their stewardship of the business. ‘The basic principles of effective corporate governance are threefold as presented below: Transparency and Full Disclosure Is the board telling us what is going on? Accountability Is the board taking responsibilty? Good and Effective Governance Corporate Control Is the board doing the right thing?sitive answers to the following questions indicate a firm i compliance with the basic principles of good corporate governance: ‘Transparency and Full Disclosure the information ¢. Does the board meet needs of investment communities Does it safeguard integrity in financial reporting? Does the board have sound disclosure policies and practices? > Does it make timely and balanced disclosure? > Can an outsider meaningfully analyze the organization's actions and performance? B. Accountability © Does the board clarify its role and that of management? Does it promote objective, ethical and responsible decision making’ > Does it lay solid foundations for management oversight? > Does the composition mix of board membership ensure an appropriate range and mix of expertise, diversity, knowledge and added value? > Is the organization’s senior official committed to widely accepted standards of correct and proper behavior? C. Corporate Control ¢ Has the board built long-term sustainable growth in shareholders’ value for the corporation? © Does it create an environment to take risk? > Does it encourage enhanced performance? Does it recognize and manage risk? > > Does it remunerate fairly and responsibly? > Does it.recognize the legitimate interests of stakeholders? > Are conflicts of interest avoided such that the organization's best interests prevail at all times?Introduction to Corporate Governance 9 ILLUSTRATIVE APPLICATION OF THE BASIC PRINCIPLES OF CORPORATE GOVERNANCE AND BEST PRACTICE RECOMMENDATIONS Principles of Good Corporate Governance Best Practice Recommendations 1. Acompany should lay solid foundation for management and oversight. It should recognize and publish the respective roles and responsibilities of board and management. Ta, Formalize and disclose the functions reserved to the board and those delegated to management 2. Structure the board to add value. Have a . board of an effective composition, size and commitment to adequately discharge its responsibilities and duties. , 7a, Aboard should have independent directors 2b. The roles of chairperson and chief executive officer should not be exercised by the seme individual. 2b, The board should establish a nomination committee Promote ethical and responsible decision- making. Actively promote ethical and responsible decision-meking. 3a, Establish a code of conduct to guide the ciectos, the chief executive officer (or equivalent), the chief financial officer (or equivalent) and any other key executives as to: © The practices necessary to maintain confidence in the company's integrity; and © The responsibilty and accountability of individuals for reporting and investigating reports of unethical practices 3-b. Disclose the policy conceming trading in, company securities by directors, officers and employees.10 Chapter t Safeguard integrity in financial reporting. Have a structure to independently verify and safeguard the integrity of the company's financial reporting. Fa, Require the chief executive of (or equivalent) and the chief financial officer (or equivalent) to state in writing fo the board that the company's financial reports present a true and fair view, in all material respects, of the company's financial condition and operational results and are in accordance with relevant accounting standards. 4-b, The board should establish an audit committee. 4-c, Structure the audit committee so that it consists of: « Only non-executive or independent directors; « — Anindependent chairperson, who is not chairperson of the board; and © Atleast three (3) members. ‘Make timely and balanced disclosure. Promote timely and balanced disclosure of all material matters concerning the company. 5-a. Establish written policies and procedures designed to ensure compliance with IFRS. Listing Rule disclosure requirements and to ensure accountability at a senior management level for compliance. Sb, s Respect the rights of shareholders and facilitate. the effective exercise of those rights. Design and disclose a communications strategy to promote effective communication with shareholders and encourage effective participation at general meetings. Request the external auditor to attend the annual general meeting and be available to answer shareholder Questions about the audit. 6a. ® &b. sIntroduction to Corporate Governance _\1 7. Recognize and manage risk Establish @ sound system of risk oversi ight and ‘management and internal control, 7-2, The board or appropriate board comritiee should establish policies on risk oversight and management. 2a, The chief executive officer (or equivalent) and the chief financial officer (or equivalent) should state to the board in wring that + Thestalement given in accordance with best practice recommendation 4-a (the inlegity of financial statements) is founded on a sound system of risk management and internal compliance and control which implements the policies adopted by the board; and © The companys risk management and internal compliance and contol system is operating efficiently in all material respects, Encourage enhanced performance. Fairy review and actively encourage enhanced board and management effectiveness. Bea. Disclose the process for performance evaluation ofthe board, its committees and individual directors, and key executives. Remunerale fairly and responsibly. Ensure that the level and composition of remuneration is sificient and reasonable ‘and that its relationship to corporate and individual performance is defined. 9-a, Provide disclosure in relation to the ‘company's remuneration policies to enable investors to undérstand: © — The costs and benefits of those policies; and ¢ The link between remuneration paid to directors and key execiitives and corporate performance. 9-b. The board should establish a remuneration committee. Clearly distinguish the structure of non- executive director's remuneration from that of executives. Ensure that payment of equity-based executive remuneration is made in accordance with thresholds set in plans approved by shareholders. 9. 8 912_Chapter 1 10-a, Establish and disclose a code of i timate interests of d m Setting recon legal and other SN wa legal ligati jit ders. an obligations to all legitimate stakehol peer . REVIEW QUESTIONS Questions 2. What does governance mean? Explain whether the following statement is trae or false. “Governance is exercised only by the goverriment of a country”. Explain how governance can be used in the following contexts and give appropriate examples: a. national governance b. local governance ©. corporate governance d. international governance Explain briefly the eight (8) basic characteristics of good governance. Transparency and accountability are synonymous. Explain whether the statement is correct or not. Explain whether the following statement is true or false. “Responsiveness usually results to effectiveness and efficiency”. Define corporate governance. What does corporate govemance structure involve? State the purpose of corporate governance. . Explain the basic objectives of corporate governance. Explain the three basic principles of effective corporate governance.Introduction to Corporate Governance 13 Multiple Choice Questions L The basic principle of “transparency and full disclosure” for effective corporate governance responds positively to the following questions except. a. Does the board of directors safeguard integrity in financial reporting? b. Does the board meet the information needs of investment communities? ©. Can an outsider meaningfully analyze the firm’s actions and performance? d. Has the board -built long-term sustainable growth in shareholders’ value for the corporation? The basic principle of “accountability” for effective governance answers the following questions positively, except a. Does the board recognize and manage risk? b. Does the board lay solid foundations for management oversight? ¢. Does the’ composition mix of board membership ensure an appropriate range and risk of expertise diversity, knowledge added value? d. Does the board promote objective, ethical and responsible decision making? “Transparency and full disclosure” principle advocates the following except a. Sound disclosure policies and practices b. Solid foundations for management oversight ¢. Meeting the information needs of investment communities d. Safeguards integrity in financial reporting The ‘tights of shareholders can be effectively upheld through the following measures except : a. By establishing an audit committee b. By designing and disclosing a communications strategy to: promote affective communication with shareholders. ; c. By encouraging active participation at general meetings, d. By requiring the external auditor to attend the annual general meeting and to answer questions about the audit.14 Chapt 5. To safeguard integrity in financial reporting, the business firm should do the following except a. Establish an audit committee . b. Request the external auditor to attend the annual general meeting ¢. Disclose the functions reserved to the board and those delegated to management d. Disclose the policy concerning, tra: directors, officers and employees. ding in company securities by 6. To encourage enhanced performance by the board and management, itis recommended that the following should be adopted except Disclosure of the process for performance evaluation of ‘the board, its committees, individual directors and by executives. b. A remuneration committee c. Distinguish between non-executive director’s remuneration from that _ of executives, d: Establish policies on risks oversight and management a. 7. The characteristic of good governance where fair legal framework are enforced impartially is a. Participation b. Rule of Law c. Equity d. AccountabilityChapter CORPORATE GOVERNANCE RESPONSIBILITIES AND ACCOUNTABILITIES Expected Learning Outcomes After studying the chapter, you should be able to... 1. Explain the relevance of good governance to both large publicly-listed companies and SMEs 2. Know the relationship between shareholders or owners and other stakeholders . 3. Identify the parties involved in Corporate Governance 4. Describe the respective broad rate and specific responsibilities of the different parties in a corporate setting WoBesCHAPTER 2 CORPORATE GOVERNANCE RESPONSIBILITIES AND ACCOUNTABILITIES INTRODUCTION Many of the characteristics of good governance described in Chapter | are relevant to both SME's and large listed public companies. AS an organization grows in size and influence, these issues become increasingly important. However, it is also important to recognize that good corporate governance is based on principles underpinned by consensus and continually developing notions of good practice, There are no absolute rules which must be adopted by all organizations. "There is no simple universal formula for good governance". Instead emphasis is many localities, has been to encourage organizations to give appropriate attention to the principles and adopt approaches which are tailored to the specific needs of an organization at a given point in time. When corporate governance is discussed, it is often spoken of in terms of a company's corporate governance framework. The key elements within an effective governance framework, and the issues relating to each element, are set out on the following pages and are relevant to organizations large and small, in both the private and the public sectors. The table provides a useful structure for any company to consider its own approach to corporate governance and the matters which may assist it to achieve its strategic objectives. Many of the matters listed may not be directly relevant in all situations and some may not, in particular circumstances, be within the board's control, but it provides a useful context in which any organization can consider its governance needs so that they might be most appropriately addressed. The essence of any system of good corporate governance is to allow the board and management the freedom to drive their organization forward and to exercise that freedom within a framework of effective accountability.——_____“etporate Ge nance Responsibilities and Aecommabilities RELATIONSHIP BETWEEN SHARE 5 OTHER STAREHOLD oe SHAREHOLDERS / OWNER(S) AND he relations The relationship between the shareholders / owners, management and other stakeholders in a corporation is shown below: Public Corporation Stakeholders Board of Shareholders | Directors Owners i Executive External legate Management Auditors ‘Shareholders / Owners "| Responsibiities | [— Operational Ragulalors Management intemal Society and Auditors Others Governance starts with the shareholders/owners delegating responsibilities through an elected board of directors to management and, in turn, to operating, units with oversight and assistance from internal auditors. The board of directors and its audit committee oversee management and, in that role, are expected to protect the shareholders’ rights. However, it is important to recognize that management is part of the governance: framework, management can influence who sits on the board and the audit committee as well as other governance controls that might be put into place. In return for the responsibilities (and power) given to management and the board, governance demands ‘accountability back through the system to the shareholders. However, the ‘accountabilities do not extend only to the shareholders. Companies also have responsibilities to other ‘stakeholders, Stakeholders can be anyone who is influenced, whether directly or indirectly, by the actions of a company. Management and the board have responsibilities to act within the laws of society and to meet various requirements of creditors, employees and the stakeholders.18 Crapeer 2 A broad group of stakeholders has an interest in the quality of corporate govemance because it has 2 relationship to economic performance and the quality of financial reporting. For example, it is likely that many employees have significant funds invested in pension plans. Those pension plans are designed to protect the financial interests of those employees in their retirement. We use the word society in the diagram to indicate those broad interests. In a similar fashion, employees and creditors have a vested interest in the organization and how it is governed. Regulators are a response to society's wishes to. ensure that organizations. in their pursuit of returns for their owners, act responsibly and operate in compliance with relevant laws. While shareholders / owners delegate responsibilities to various parties within the corporation. they also require accountability as to how well the resources “that have been entrusted to management and the board have been used. For example, the owners want accountability on such things as: © Financial performance * Financial ransparency — financial statements that are clear with full disclosure and that reflect the underlying economics of the company. * Stewardship, including how well the company protects and manages the resources entrusted to it. * Quality of internal control * Composition of the board of directors and the nature of its activities, including information on how well management incentive systems are aligned with the shareholders’ best interests. ‘The owners want disclosures from management that are accurate and objectively verifiable. For instance, management has a respensibility to provide financial Feports, and in some cases, reports on internal control effectiveness. Management has always had the primary responsibility for the accuracy and completeness of wani: inancia! statements. From a financial reporting perspective, it is management's responsibility to: * Choose which accounting Principles best portray the economic substance of company transactions. © Implement a system of intemal control that assures completeness and accuracy in financial reporting. ¢ Ensure that the financial statements contain accurate and complete disclosure.Corporate Governance Responsibilities ahd Accountabilities 19 PARTIES INVOLVED IN CORPORATE GOVERNANCE: THEIR RESPECTIVE BROAD ROLE AND SPECIFIC RESPONSIBILITIES Corporate governance and financial reporting reliability are receiving considerable attention from a number of parties including regulators, standard setting bodies, the accounting profession, lawmakers and financial statement ‘users. Party ‘Overview of Responsibilities 1. Shareholders Broad Role: Provide effective oversight through election of board members, approval of rigjr initiatives such as buying or selling stock, annual reports on management compensation, from the board. 2, Board of Directors Broad Role: The major representative of stockholders to ensure that the organization is run according tothe organization's charter and that there is proper accountability. Specific activities include among oth 4. Overall Operations _ Establishing the organization's vision, mission, values and ethical standards. © Delegating an appropriate level of authority to management. © Demonstrating leadership, ‘© Assuming responsibilty for the business relationship with CEO including hs or her appointment, succession, performance remuneration and dismissal ‘© Overseeing aspects of the employment of the management team including management remuneration, performance and succession planning, «Recommending auditors and new directors to shareholders. ‘© Ensuring effective communication with shareholders other stakeholders. + Crisis management. Appointment of the CFO and corporate secretary20 Chapter 2 2. Performance : © Ensuring the organization's long term viability and enhancing the financial position. A Formulating and overseeing Implementation of corporate strategy. ; Approving the plan, budget and corporate policies, Agreeing key performance indicators (KPIs) Monitoring / assessing assessment, performance of the organization, the board itself, management and major projects. Overseeing the risk management framework and monitoring business risks. ‘ Monitoring developments in the industry and the operating environment. ‘© Oversight of the and organization, including its control and accountability systems. Approving and monitoring the progress of major capital expenditure, capital management and acquisitions and divestitures. 3. Compliance / Legal Conformance * — Understanding and protecting the organization's financial position. ¢ Requiring and monitoring legal and regulatory compliance including compliance with accounting standards, unfair trading legislations, occupational health and safety and environmental standards, ‘* Approving annual financial reports, annual reports and other public documents / sensitive reports, ‘e Ensuring an effective system of internal controls exists and is operating as expected, 3. Non-Executive or Independent Directors Broad Role: The same as the broad role of the entire board of directors Specific a iclude among others: * to Understand the organization, its business, its operating environment and its financial Position, © {0 apply expertise and skils in the organization's best interests, _ * — toassist management to keep performance objectives at the top of its agenda,Corporate Governance Responsibilities and Accountabilities 24 © to understand that hisfher role is not act as auditor, nor lo act as a member of the management team, . * torespect the colleatve, cabinet nature of the board's decisions, © toprepare for end attend board meetings, ‘© toseek information on a timely basis to ensure that helshe isin a positon to contribute to the discussion when a matter comes before the board, or alert the chairman in advance to the need for further information in relation to @ particular matter, and « _to.ask appropriate questions relative to operations. Management Broad Role: Operations and accountability. Manage the organization effectively, provide accurate and timely reports to shareholders and other stakeholders. Specific activities include among others: recommend the strategic direction and translate the strategic plan into the operations of the business manage the company’s human, physical and financial + resources to achieve the organization's objectives — run the business assume day to day responsibilty for the organization's conformance with relevant laws and regulations and its compliance framework develop, implement and manage the organization's risk rmnagement and internal control frameworks develop, implement and update policies and procedures be alert lo relevant trends in the industry and the organization's operating environment provide information to the board ‘act as conduit between the board end the organization developing financial and other reports that meet public, stakeholder and regulatory requirements.22_Chaprer 2 5. Audit Committees of the Board of Directors Broad Role: Provide oversight of the internal and external audit function and the process of préparing the annual financial statements as well as Public reports on internal control. Specific activities include among others: * Selecting the external audit firm ‘© Approving any non-audit work performed by the audit firm © Selecting and / or approving the appointment of the Chief Audit Executive (Intemal Auditor) * Reviewing and approving the scope and budget of the internal audit function * Discussing audit findings with internal auditor and extemal auditor and advising the board (and management) on specific actions that should be taken 6. Regulators a. Board of Accountancy Broad Role: Set accounting and auditing standards dictating underlying financial reporting and auditing concepts; set the expectations of audit quality and accounting quality. Specific activities include among others: Conducting CPA Licensure Board Examinations Approving accounting Principles Approving auditing standards Interpreting previously issued standards implementing quality control processes to ensure audit quality Educating members on audit and ‘accounting requirements .b. Seourtios ond Exchange: Commission Corporate Governance Responutbiliies and Accountabllities 23 Broad Rolo: Ensure the accuracy, timeliness and fairngas of public reporting of financial and other information for public companies. ‘Shecific activities include among others: © Reviewing flings vith the SEC © Interacting vith the Financial Reporting Standards Gounci in seling accounting standards © Specilying independance standards required of auditors that report on public financial statements: [dently corporate frauds, investigate causes, and suggest remedial ations | 7. External Auditors Broad Role: Perform audits of company financial statements fo ensure tat the ‘statements are free of material misstatements including misstatements that may be due to fraud, Specific activities include among others: ‘+ Audit of pubic company fnencial statements + Audits of nonpublic company financial statements + Other services such 3s tax or consulting 8. Internal Auditors Broad Role: Perform audits of companies for compliance with company policies and laws, audits to evaluate the efciency of operations, and periodic evaluation and tests of contrals. Specific activities include among others: + Reporting results and analyses to management (including operational management) and audit committees + Evaluating internal controls | | | ‘24 Chapter 2 REVIEW QUESTIONS Questions lL b o> * a 8. “Small business enterprises do not need good governance Do you agree? Explain. Does good governance require absolute rules that must be adopted by all organizations? What is the essence of any system of corporate governance? Where does the board of directors derive its authority? To whom is the board of directors accountable? On what aspects do shareholders demand accountability from the board of directors? What is management’s responsibility as far as financial reporting is concerned? Describe the broad role of the shareholders in a corporation. Describe the broad role of the Board of Directors. What are the specific activities of the board of directors? le Choice Questions Approving annual financial reports and other public documents “are specific responsibilities of a, Management b. Board of directors c. Shareholders d. EmployeesCorporate Governance Responsibilities and Accountabilities 25 2. Providing oversight of the internal and external audit function, the Process of preparing the annual financial statements and public reports n internal control are the responsibility of a. Board of directors b. Chief executive officer c. Chief financial officer d. “Audit committee of the board of directors 3. Who is responsible for ensuring the accuracy, timeliness of public reporting of financial and other information for public companies? a. External auditors- b. Securities and exchange commission c. Shareholders d. Board of Accountancy 4. Who performs audit of companies for compliance with company policies and laws, audits efficiency of operations and periodic evaluation and tests of controls? a, External auditors b. Internal auditors ¢. Commission on audit d. Chief accountant 5. An independent director is expected to a. Apply expertise and skills in the corporations best interest b. Asset management to keep performance objectives at the top of its agenda Respect the collective, cabinet nature of the board’s decision Act as conduit between the board and the organization aSECURITIES AND EXCHANGE COMMISSION (SEC) CODE OF CORPORATE GOVERNANCE Expected Learning Outcomes * After studying the chapter, you should be able to. 1. Understand the need for the Code of Governance for publicly-listed companies. go 2. Know the sixteen (16) governance responsibilities of the Board of Directors of publicly-listed companies. . Explain the meaning of “comply and explain” approach. 4. Describe the three aspects of the Code, namely * Principles * Recommendations «Explanations 5. Know what constitutes a competent board and how can it be established. 6. Understand the composition, functions and responsibilities of the board committees that can be established such as the * Audit Committee * Corporate Governance Committee * Board Risk Oversight Committee * Related Party Transaction Committee 7. Know how the directors can show full commitment to the company 8. Understand how independence and objectivity of the board can be reinforced and enhanced. 9. Describe how the performance and effectiveness of the board can be assessed, QO geCHAPTER 3 SEC CODE OF CORPORATE GOVERNANCE FOR PUBLICLY-LISTED COMPANIES (“CG Code for PLCs”) Securities and Exchange Commission SEC MC No. 19, Series of 2016 + On November 10, 2016, the Securities and Exchange Commission approved the Code of Corporate Governance for publicly-listed companies. Its goal is to help companies develop and sustain an ethical corporate culture and keep abreast with recent develépments in corporate governance. One of its salient provisions is for publicly-listed companies to establish a code of business conduct and submit a new manual on Corporate Governance that would “provide standards for professional and ethical behavior as well as articulate acceptable and unacceptable conduct and practices”. The Board of Directors is required to implement the code and make sure that management and employees comply with the internal policies set. While many companies have already developed their Code of Business Conduct and Ethics, the real challenge is in its implementation and monitoring compliance. The SEC Code of Corporate Governance is published in this book, not only to acquaint readers particularly future professionals and businessmen of these rules and regulations but also to serve as reference and guidelines to currently existing publicly-listed corporations. (Source: www.see.gov.ph)28 Chapter 3 1E FOR CODE OF CORPORATE. GOVERNAN PUB Y-LISTED COMPANL THE BOARD'S GOVERNANC Principle 1: Principle 2: Principle 3: Principle 4: Principle 5: Principle 6; Principle 7: RESPONSIBILITIES competent, working, board corporation, and to sustain 1a manner consistent with term best interests of its iE ‘The company should be headed by a to foster the long-term success of the its competitiveness and profitability ir its corporate objectives and the long shareholders and other stakeholders, The fiduciary roles, responsibilities and accountabilities of the Board as provided under the law, the company’s articles and by- laws, and other Iegal pronouncements and guidelines should be clearly made known to all directors as well as to stockholders and other stakeholders. Board committees should be set up to the extent possible to support the effective performance of the Board's functions, particularly with respect to audit, risk management, related party transactions, and other key corporate governance concerns, such as nomination and remuncration. The composition, functions and responsibilities of all committecs established should be contained in a publicly available Committce Charter. To show full commitment to the company, the directors should devote the time and attention necessary to properly and effectively perform their duties and responsibilities, including, sufficient time to be familiar with the corporation’s busine: The Board shauld endeavor to exercise objective and independent judgment on all corporate affairs, The best measure of the Board’s effectiveness is through an assessment process, The Board should regularly carry out evaluations to appraise its performance as a body, and assess whether it possess the right mix of backgrounds and competencies. Members of the Board are duty-bound to aj if i the | apply high ethical standards, taking into account the interests of all stakeholders.SEC Code of Corporate Governance _29 DISCLOSURE AND TRANSPARENCY Principle The company should establish corporate disclosure policies and Procedures that are Practical and in accordance with best Practices and regulatory expectations. Principle 9: The company should establish standards for the appropriate Selection of an extemal-auditor, and exercise effective oversight of the same to strengthen the external auditor's independence and enhance audit quality. Principlel0: The company should ensure that material and reportable non- financial and Sustainability issues are disclosed. Principle 11: The company should maintain a comprehensive and cost- efficient communication channel for disseminating relevant information. This channel is crucial for informed decision- making by investors, stakeholders and other Interested users. INTERNAL CONTROL SYSTEM AND RISK MANAGEMENT FRAMEWORK Principle 12: To ensure the integrity, transparency and proper governance in the conduct of its affairs, the company should have a strong and effective intemal control system and enterprise risk management framework. CULTIVATING A SYNERGIC RELATIONSHIP WITH SHAREHOLDERS incij : any should treat all shareholders fairly and equitably, eee EL ae recognize, protect ad. fubliaa:the’ exercise of thelr rights.30 Chapter 3 DUTIES TO STAKEHOLDERS i by contractual f stakeholders established by law, relations and through voluntary commitments must be respected. Where stakeholders’ rights and/or interests an at stake, stakeholders should have the opportunity to obtain prompt effective redress for the violation of their rights. Principle 14: The rights o} A mechanism for employee participation should be developed es create a symbiotic environment, realize the company’s goals and participate in its corporate governance processes. Principle 15: Principle 16: The company should be socially responsible in all its dealings with the communities where it operates. It should ensure that its interactions serve its environment and stakeholders in a positive and progressive manner that is fully supportive of its comprehensive and balanced development. INTRODUCTION 1. The Code of Corporate Governance is intended to raise the corporate governance standards of Philippine corporations to a level at par with its regional and global counterparts. The latest G20/OECD1 Principles of Corporate Governance and the Association of Southeast Asian Nations Corporate Governance Scorecard were used as key reference materials in the drafting of this Code. 2. The Code will adopt the “comply or explain” approach. This approach combines voluntary compliance with mandatory disclosure. Companies do not have to comply with the Code, but they must state in their annual corporate governance reports whether they comply with the Code provisions, identify any areas of non- compliance, and explain the reasons for non-compliance. 3. The Code is arranged as follows: Principles, Recommendations and Explanations. The Principles can be considered as high-level statements of corporate governance good practice, and are applicable to all companies. :SEC Code of Corporate Governance 31 + The Recommendations are objective criteria that are intended to identity the specific features of corporate governance good practice that are recommended for companies operating according to the ‘ode. Alternatives to a Recommendation may be justified in Particular circumstances if good governance can be achieved by other means. When a Recommendation is not complied with, the Company must disclose and describe this non-compliance, and explain how the overall Principle is being achieved. The alternative should be consistent with the overall Principle. Descriptions and explanations should be written in plain language and in a clear, complete, objective and precise manner, so that shareholders and other stakeholders can assess the company's governance framework. . ‘The Explanations strive to provide companies with additional information on the recommended best practice. This Code does not, in any way, prescribe a “one size fits all” framework. It is designed to allow boards some flexibility in establishing their corporate governance arrangements. Larger companies and financial institutions would generally be expected to follow most of the Code’s provisions. Smaller companies may decide that the costs of some of the provisions outweigh the benefits, or are less relevant in their case. Hence, the Principle of Proportionality is considered in the application of its provisions. ‘The Code of Corporate Governance for publicly listed companies is the first of a series of Codes that is intended to cover all types of corporations in the Philippines under supervision of the Securities and Exchange Commission (SEC). 1. Definition of Terms: Corporate Governance — the system of stewardship and control to guide organizations in fulfilling their longeterm economic, moral, Tegal and social obligations towards ther stakeholders Corporate governance is a system of direction, feedback and control using regulations, performance standards and ethical guidelines to held the Board and senior management accountable for ensuring egal behavior — reconciling long-term customer satisfaction with chnreholder value —to the benefit of all stakeholders and society.32 Chapter 3 nization’s long-term success, Its purpose is to maximize the orga holders, stakeholders and the creating sustainable value for its sharel nation. Board of Directors — the governing body elected by the stockholders that exercises the corporate powers of a corporation, conducts all its business and controls its properties. Management — a group of executives given the authority by the Board of Directors to implement the policies it has laid down in the conduct of the business of the corporation. Independent director - a person who is independent of management and the controlling shareholder, and is free from any business or other relationship which could, or could reasonably be perceived to, materially interfere with his exercise of independent judgment in carrying out his responsibilities as a director. Executive director — a director who has executive responsibility of day-to-day operations of a part or the whole of the organization. Non-executive director — a director who has no executive responsibility and does not perform any work related to the operations of the corporation. Conglomerate — a group of corporations that has diversified business activities in yaried industries, whereby the operations of such businesses are controlled and managed by a parent corporate entity. Internal control — a process designed and effected by the board of directors, senior management, and all levels of personnel to provide reasonable assurance on the achievement of objectives through efficient and effective operations; reliable, complete and timely financial and management information; and compliance with applicable laws, regulations, and the organization’s policies and procedures. for Economic Co-operation and DevelopmentSEC Code of Corporate Governance 33. Enterprise Risk Management — a process, effected by an entity’s Board of Directors, management and other personnel, applied in strategy setting and across the enterprise that is designed to identify Potential events that may affect the entity, manage risks to be within its risk appetite, and provide reasonable assurance regarding the achievement of entity objectives.” Related Party — shall cover the company’s subsidiaries, as well as affiliates and any party (including their subsidiaries, affiliates and special purpose entities), that the company exerts direct or indirect control over or that exerts direct or indirect control over the company; the company’s directors; officers; shareholders and related interests (DOSRI), and their close family members, as well as corresponding persons in affiliated companies. This shall also include such other person or juridical entity whose interest may pose a potential conflict with the interest of the company. Related Party Transactions — a transfer of resources, services or obligations between a reporting entity and a related party, regardless of whether a price is charged. It should be interpreted broadly to include not only transactions that are entered into with related parties, but also outstanding transactions that are entered into with, an unrelated party that subsequently becomes a related party. Stakeholders — any individual, organization or society at large who can either affect and/or be affected by the company’s strategies, policies, business decisions‘and operations, in general. This includes, among others, customers, creditors, employees, suppliers, investors, as well as the government and community in which it operates. +S ro ore Oe wc 7 Committee of Sponsoring Organizations of the Tread way Commission (coso Framework)MoranteSEC Code of Corporate Governance 37 committee meetings and the annual board calendar, and assisting the chairs of the Board and its committees to set agendas for those meetings; Safekeeps and preserves the integrity of the minutes of the meetings of the Board and its committees, as well as other official records of ‘the corporation; Keeps abreast on relevant laws, regulations, all governance issuances, relevant industry developments and operations of the corporation, and advises the Board and the Chairman on all relevant issues as they arise; Works fairly and objectively with the Board, Management and stockholders and contributes to the flow of information between the Board and management, the Board and its committees, and the Board and its stakeholders, including shareholders; Advises on the establishment of board committees and their terms of reference; Informs members of the Board, in accordance with the by-laws, of the agenda of their meetings at least five working days in advance, and ensures that the members have before them accurate information that will enable them to arrive at intelligent decisions on matters that require their approval, ‘Attends all Board meetings, except when justifiable causes, such as illness, death in the immediate family and serious accidents, prevent him/her from doing so; Performs required administrative functions; Oversees the drafting of the by-laws and ensures that they conform with regulatory requirements, and Performs such other duties and responsibilities as may be provided by the SEC.38_ Chapter 3 Recommendation 1.6 ‘The Board should ensure that it is assisted in its duties by a Compliance Officer, who should have a rank of Senior Vice Prosdent oF equivalent position with adequate stature and author ie be corporation. ‘The Compliance Officer should not be a member Board of Directors and should annually attend a training on corporate governance. Explanation . The Compliance Officer is a member Of the company’s management team in charge of the’ compliance function. Similar to the Corporate Secretary, he/she is primarily liable to the corporation and its shareholders, and not to the Chairman or President of the company. He/she has, among others, the following duties and responsibilities: a. Ensures proper onboarding of new directors (i.., orientation on the company’s business, charter, articles of incorporation and by-laws, among others); b. Monitors, reviews, evaluates and ensures the compliance by the corporation, its officers and directors with the relevant laws, this Code, rules and regulations and all governance issuances of regulatory agencies; c. Reports the matter to the Board if violations are found and recommends the imposition of appropriate disciplinary action; d. Ensures the integrity and accuracy of all documentary submissions to regulators; ©. Appears before the SEC when summoned in relation to i with this Code; aan f. Collaborates with other departments to Properly address compliance issues, which may be subject to investigation; 8. Identifies possible areas of compliance issues and wi i orks resolution of the same; eo2 Bpemccaesn srs sn aesunrmecsce"Yes on enone lin sp 4 tes a fen ts i Suny te ine nan Sore et enon Se aap ‘inte aarebeaeaeei c © cere n a acces ‘onc eh neta Si te oy dats is © Spent sgn snes palin nein man gee rine trae mePSeSveri ore vere uirisnssae nomination and election process also includes the review and eval uation of the qualifications of all persons nominated to the Board, including whether candidates: (1) possess the knowledge, skills, experience, and particularly in the case of non-executive directors, independence of mind given their responsibilities to the Board and in light of the entity's business and risk profile; (2) have a record of integrity and good repute: (3) have sufficient time to carry out their responsibilities; and (4) have the abi to promote a smooth interaction between board members. A good practice is the use of professional search firms or entemal sources when searching for candidetes to the joard. SEC Code of Corporate Governance 43 In addition, the process also includes monitoring the qualifications of the directors. The qualifications and grounds for disqualification are contained in the company’s Manual on Corporate Governance. The following may be considered as grounds for the permanent disqualification of a director a. Any person convicted by final judgment or order by a competent judicial or administrative body of any crime that: (a) involves the purchase or sale of securities, as defined in the Securities Regulation Code; (b) arises out of the person’s conduct as an underwriter, broker, dealer, investment adviser, principal, distributor, mutual fund dealer, futures commission merchant, commodity trading advisor, or floor broker; or (c) arises out of his fiduciary relationship with 2 bank, quasi-bank, trust company, investment house or as an affiliated person of any of them; b. Any person who, by reason of misconduct, after hearing, is permanently enjoined by a final judgment or order of the SEC, Bangko Sentral ng Pilipinas (BSP) or any court or administrative body of competent jurisdiction from: (a) acting as underwriter, broker, dealer, investment adviser, principal distributor, mutual fund dealer, futures commission merchant, commodity trading advisor, or floor broker; (b) acting as director or officer of a bank, quasi-bank, trust company, investment house, or investment company: (c) engaging in or continuing any conduct or practice in any of the capacities mentioned in sub-paragraphs (a) and (b) above, or willfully violating the laws that govern securities and, banking activities.44 Chapter 3 ff (a) such person is the y court oF administrative gistration, license or The disqualification should also apply i subject of an order of the SEC, BSP or an body denying, revoking or suspending any Te permit issued to him under the Corporation Code, Securities Regulation Code or any other law administered by the SEC or BSP, or under any rule oF regulation issued by the has otherwise been restrained Commission or BSP; (b) such person J ecurities and banking; or (c) to engage in any activity involving se such person is the subject of an effective order of a self-regulatory organization suspending or expelling him from | membership, participation or association with a member or participant of the organization; Any person convicted by final judgment or order by a court, or competent administrative body of an offense involving moral turpitude, fraud, embezzlement, theft, estafa, counterfeiting, misappropriation, forgery, bribery, false affirmation, perjury or other fraudulent acts; ‘Any person who has been adjudged by final judgment or order of the SEC, BSP, court, or competent administrative body to have willfully violated, or willfully aided, abetted, counseled, induced or procured the violation of any provision of the Corporation Code, Securities Regulation Code or any other law, rule, regulation or order administered by the SEC or BSP; Any person judicially declared as insolvent; ‘Any person found guilty by final judgment or order of a foreign court or equivalent financial regulatory authority of acts, violations or misconduct similar to any of the acts, violations or misconduct enumerated previously; Conviction by final judgment of an offense punishable by imprisonment for more than six years, or a violation of the Corporation Code committed within five years prior to the date of his election or appointment; and Other grounds as the SEC may provide.SEC Code of Corporate Gave _ SEC Code of Corporate Governance _ 4s In addition, the following may be grounds for temporary disqualificatio of a director: u a. Absence in more than fifty percent (50%) of all regular and special meetings of the Board during his incumbency, or any 12-month period during the said incumbency, unless the absence is due to illness, death in the immediate family oF serious accident. The disqualification should apply for purposes of the succeeding election; b. Dismissal or termination for cause as director of any publicly-listed company, public company, registered issuer of securities and holder of a secondary license from the Commission. The disqualification should be in effect until he has cleared himself from any involvement in the cause that gave rise to his dismissal or termination; c. If the beneficial equity ownership of an independent director in the corporation or its subsidiaries and affiliates exceeds two percent (2%) of its subscribed capital stock. The disqualification from being elected as an independent director is lifted if the limit is later complied with; and d. Ifany of the judgments or orders cited in the-grounds for permanent disqualification has not yet become final. \ Recommendation 2.7 The Board should have the overall responsibility in ensuring that there is a group-wide policy and system governing related party transactions (RPTs) and other unusual or infrequently occurring transactions, particularly those which pass certain thresholds of materiality. The policy should include the appropriate review and approval of material or significant RPTs, which guarantee fairness and transparency of the transactions. The policy should encompass all entities within the group, taking into account their size, structure, risk profile and complexity of operations. Explanation Ensuring the integrity of related party transactions is an important fiduciary duty of the director. It is the Board’s role to initiate policies and measures geared towards prevention of abuse and promotion of. jation: transparency, and in compliance with applicable laws ado ealea protect the interest of all shareholders. One such nee Preiappeoved 6 ratification by shareholders of material or significant approve! by the Board, in accordance with existing laws. Other moeaaues elite ensuring that transactions occur at market prices, at ie de : e and under conditions that protect the rights of all shareholders. The following are suggestions for the content of the RPT Policy: Definition of related parties; Coverage of RPT policy; Guidelines in ensuring arm’s-length terms; Identification and prevention or management of potential or actual conflicts of interest which arise; + Adoption of materiality thresholds; + Internal limits for individual and aggregate exposures; + Whistle-blowing mechanisms, and + Restitution of losses and other remedies for abusive RPTs. In addition, the company is given the discretion to set their materiality threshold at a level where omission or misstatement of the transaction could pose a significant risk to the company and influence its economic decision. The SEC may direct a company to reduce its materiality threshold or amend excluded transactions if the SEC deems that the threshold or exclusion is inappropriate considering the company’s size, tisk profile, and risk management systems. Depending on the materiality threshold, approval of management, the RPT Committee, the Board or the shareholders may be required. In cases where the shareholders’ approval is required, it is good practice for interested shareholders to abstain and let the disinterested parties or majority of the minority shareholders decide. Recommendation 2.8 The Board should be primarily responsible for approvi i i in, and assessing the performance of the Mateagmea tel ihe cher rae citer (CEO), and control functions led by their respective eads (Chie: k i i cee is icer, Chief Compliance Officer, and Chief AuditSEC Code of Corporate Governance _47 Explanation t is the responsibility of the Board to appoint a competent management ‘eam at all times, monitor and assess the performance of the management team based on established performance standards that are Consistent with the company’s strategic objectives, and conduct a regular review of the company’s policies with the management team. In the selection process, fit and proper standards are to be applied on key Personnel and due consideration is given to integrity, technical expertise and experience in the institution’s business, either current or planned. Recommendation 2.9 The Board should establish an effective performance management framework that will ensure that the Management, including the Chief Executive Officer, and personnel’s performance is at par with the standards set by the Board and Senior Management. Explanation Results of performance evaluation should be linked to other human resource activities such as training.and development, remuneration, and succession planning. These should likewise form part of the assessment of the continuing fitness and propriety of management, including the Chief Executive Officer, and personnel in carrying out their respective duties and responsibilities. Recommendation 2.10 The Board should oversee that an appropriate internal contro! system is in place, including setting up a mechanism for monitoring and managing otential conflicts of interest of Management, board members, and shareholders. The Board should also approve the Internal Audit Charter. Explanation In the performance of the Board’s oversight responsibility, the minimum internal control mechanisms may include overseeing the implementation of the key control functions, such as risk management, compliance and internal audit, and reviewing the corporation’s human resource policies,48 Chapter 3 loyees and conflict of interest situations, compensation program for employ’ management succession plan. Recommendation 2.11 The Board should oversee that a sound enterprise risk pemeal (ERM) framework is in place to effectively identify, monitor, as a manage key business risks. The risk management anes i should guide the Board in identifying units/business lines and enterp rel risk exposures, as well as the effectiveness of risk manager strategies. Explanation Risk management policy is part and parcel of a corporation’s corporate strategy. The Board is responsible for defining the company’s level of risk tolerance and providing oversight over its risk management policies and procedures. : Recommendation 2.12 The Board should have a Board Charter that formalizes and clearly states its roles, responsibilities and accountabilities in carrying out its fiduciary duties. The Board Charter should serve as a guide to the directors in the performance of their functions and should be publicly available and posted on the company’s website, Explanation The Board Charter guides the directors on how to discharge their functions. It provides the standards for evaluating the performance of the Board. The Board Charter also contains the roles and responsibilities of the Chairman.> Biauem sommes ica eenssrneanrae Eo‘two eae oct* ateteoaiactaaar + enraant =,1 Recommends to the Board the appointment, retorihe removal and fees of the Extemal Auditor, duly aceredtied by the Commission, who undertakes an indepenient ie maaniee by corporation, and provides an objective assuranc® Of TN mere which the financial statements should be prepared and pre the stockholders; and a Board Risk Oversight tions Committee, performs provided under m. In case the company does not have Committee and/or Related Party Transact the functions of said committees as Recommendations 3.4 and 3.5. The Audit Committee meets with the Board at least every quarter without the presence of the CEO or other management team members, and periodically meets with the head of the internal audit. Recommendation 3.3 The Board should establish a Corporate Governance Committee that should be tasked to assist the Board in the performance of its corporate governance responsibilities, including the functions that were formerly assigned to a Nomination and Remuneration Committee. It should be composed of at least three members, all of whom should be independent directors, including the Chairman. Explanation The Corporate Governance Committee (CG Committee) is tasked with ensuring compliance with and proper observance of corporate governance principles and practices. It has the tollowi i functions, among others: ner begiand a. Oversees the implementation of the corporate governance framework and Periodically reviews the said framework to ensure that it remains appropriate in light of material changes to the corporation’s size, complexity and busi : * usiness strategy, a: i business and regulatory environments; BY, as well as itsSEC Code of Corporate Governance _53 c Ensures that the results of the Board evaluation are shared, discussed, and that concrete action plans are developed and implemented to address the identified areas for improvement; d. Recommends continuing education/training programs for directors, assignment of tasks/projects to board committees, succession plan for the board members and senior officers, and remuneration packages for corporate and individual performance; ¢. Adopts corporate governance policies and ensures that these are reviewed and updated regularly, and consistently implemented in form and substance; f. Proposes and plans relevant trainings for the members of the Board; g. Determines the nomination and election process for the company’s directors and has the special duty of defining the general profile of board members that the company may need and ensuring appropriate knowledge, competencies and expertise that complement the existing skills of the Board; and h. Establishes a formal and transparent procedure to develop a policy for determining the remuneration of directors and officers that is consistent with the corporation’s culture and strategy as well as the business environment in which it operates. ‘The establishment of a Corporate Governance Committee does not preclude companies from establishing separate Remuneration or Nomination Committees, if they deem necessary. Recommendation 3.4 Subjest to a corporation's size, risk profile’ and complexity of operations, the Board should establish a separate Board Risk Oversight Committee (BROC) that should be responsible for the oversight of a company’s Enterprise Risk Management system to ensure its fanctionality and effectiveness. The BROC should be composed of at least three members, the majority of whom should be independent Gaectors, including the Chairman. The Chairman should not be the Cheirman of the Board or of any other committee. At least one member of the committee must have relevant thorough knowledge and experience on risk and risk management.54 Explanation Chapter 3 k Oversight Committee (BROC) is The establishment of a Board Ris! profile. generally for conglomerates and companies with a high risk integral to an effective corporate governance process and the achievement ofa company's ve creation objectives. Thus, the BROC has the responsibility to assist the Boa ensuring that there is an effective and integrated risk Ses process in place, With an integrated approach, the Boar on top management will be in a confident position to make well-in ona decisions, having taken into consideration risks related to significant business activities, plans and opportunities. Enterprise risk management is The BROC has the following duties and responsibilities, among others: a, Develops a formal enterprise risk management plan which contains the following elements: (a) common language or register of risks, (b) well-defined risk management goals, objectives and oversight, (c) uniform processes of assessing risks and developing strategies to manage prioritized risks, (d) designing and implementing risk management strategies, and (¢) continuing assessments to improve risk strategies, processes and ‘measures; b. Oversees the implementation of the enterprise risk management plan through a Management Risk Oversight Committee. The BROC conducts regular discussions on the company’s prioritized and residual risk exposures based on regular risk management reports and assesses how the concerned units or offices are addressing and managing these risks; c. Evaluates the risk management plan to ensure its continued relevance, comprehensiveness and effectiveness, The BROC revisits defined risk management strategies, looks for emerging or changin material exposures, and stays abreast of significant develo iene that seriously impact the likelihood of harm or loss; . d es the Board on its risk appetite levels and risk tolerance jimits;SEC Code of Corporate Governance _ 55. es a least annually the company's risk appetite levels and risk thy ce limits based on changes and developments 1n the business, regulatory framework, the external economic and busintts environment, and when major events occur that are considered to have major impacts on the company; f. Assesses the probability of each identified risk becoming. © reality and estimates its possible significant financial impact and likelihood of occurrence. Priority areas of concern are those risks that are the most likely to occur and to impact the performance and stability of the corporation and its stakeholders; g. Provides oversight over Management’s activities in managing credit, market, liquidity, operational, legal and other risk exposure’ of the corporation. This function includes regularly receiving information on risk exposures and risk management activities from Management; and bh. Reports to the Board on a regular basis, or as deemed nevessa0Y, the company’s material risk exposures, the actions taken t0 reduce the risks, and recommends further action or plans, as necessary. Recommendation 3.5 Subject to a corporation’s size, risk profile and complexity of operations, the Board should establish a Related Party Transaction (RPT) Committee, which should be tasked with reviewing all material related party transactions of the company ‘and should be composed of at least three non-executive directors, two ‘of whom should be independent, including the Chairman Explanation Examples of companies that may have a separate RPT Committee are conglomerates and “rniversa/eommercial banks in recognition of the potential magnitude of RPTs in these kinds of corporations.‘The following are tho functions of the RPT Committce, among others: a, Evaluates on an ongoing basis existing relations between and among businesses and counterparties to ensure that all related part continuously identified, RPTs are monitored, and subsequent changes in relationships with counterparties (from ‘non-related lo related and vice versa) are captured. Related parties, RPT and changes in relationships should be.reflected in the relevant reports to the Board and regulators/supervisors; b. Evaluates-all material RPTs to ensure that these are not undertaken on more favorable economic terms (c.g., price, commissions, interest rates, fees, tenor, collateral requirement) to such related xirties than similar transactions with non-related parties under similar circumstances and that no corporate or business resources of the company are misappropriated or misapplied, and to determine any potential reputational risk issues that may arise as a result of or in connection with the transactions. In evaluating RPTs, the Committee takes into account, among others, the following: + The related party's relationship to the company and interest in the transaction; 2. The material facts of the proposed RP aggregate value of such transaction; 3. The benefits to the corporation of the proposed RP" 4. The availability of other sources of comparable products or services; and . 5. An assessment of whether the proposed RPT is on terms and conditions that are comparable to the terms generally available to an unrelated party under similar circumstances. The company including the proposed should have an effective price discovery system in place and exercise due diligence in determining a fi Price for RPTs; ©. Ensures that appropriate disclosure is made, and/or information is provided to regulating and supervising authorities relati ig to the company’s RPT exposures, and policies on conflicts of interest or poten conflicts of interest. The disclosure should include information on the approach to Managing material conflicts of interest that are inconsistent with such policies, and conflicts that could arise as a result of the company’s affiliation or transactions with other related parties:+ gore amare * Soemmermenmarce te Seoenes ee eee phere art a SSS —_——— mom cenaRecommendation 4.1 The directors should attend and actively participate in See et tale, the Board, Committees, and Shareholders in person of throwie We Videoconferencing conducted in aceordance Be : hes = a regulations of the Commission, except when justifial le aera ee ilness. death in the immediate family and serious accidents, prevent them from doing so. In Board and Committee meetings peal should review meeting materials and if called for, ask the ry questions or seek clarifications and explanations Explanation A director’s commitment to the company is evident in th amount of time he dedicates to performing his duties and responsibilities, ‘whi includes his presence in all meetings of the Board, Committees an Shareholders. In this way, the director is able to effectively perform his/her duty to the company and its shareholders. The absence of a director in more than fifty percent (50%) of all regular and special meetings of the Board during his/her incumbency is a ground for disqualification in the succeeding election, unless the absence is due to illness, death in the immediate family, serious accident or other unforeseen or fortuitous events. Recommendation 4.2 The non-executive directors of the Board should concurrently serve as directors to a maximum of five publicly listed companies to ensure that they have sufficient time. to fully prepare for meetings, challenge Management’s proposals/views, and oversee the long-term strategy of the company. 2 Explanation Being a director necessitates a commitment to the corporation. Hence, there is @ need to seta limit on board directorships. This engures than tre members of the board are able to effectively commit themselves to perform their roles and responsibilities, regularly ‘update their knowledge and enhance their skills. Since sitting on the board of too many companies may interfere with the optimal performance of board members, in that they may not be able to contribute enough time to keepeer core Se ee ees60 Chapier3 eit cgaquamatllieds varying opinions on the optimal number of independent dineetors in the board, However, the ideal number ranges from one-third to a substantial majority. Recommendation 5.2 dependent directors possess the The Board should ensure that its in ctOrs f the disqualifications for an necessary qualifications and none of independent director to hold the position. Explanation ss a good general understanding of is worthy to note that independence .d. It is therefore important that possess the Independent directors need to posse: the industry they are in, Further, it i and competence should go hand-in-han the non-executive directors, including independent directors, qualifications and stature that would enable them to effectively and objectively participate in the deliberations of the Board. ‘An Independent Director refers to.a person who, ideally: Is not, or has not been a senior officer or employee of the covered company unless there has been a change in the controlling ownership of the company; a, b. Is not, and has not been in the three years immediately preceding tl election, a director of the covered company; a director, officer. employee of the covered company’s subsidiaries, associates, affiliates or related companies; or a director, officer, ‘employee of the covered company’s substantial shareholders and its related companies; c. Has not been appointed in the covered company, its subsidiaries. associates, affiliates or related companies as Chairman “Emeritus” “Ex-Officio” Directors/Officers or Members of an Advi a Board, or otherwise appointed in a capacity to assist the Board nts performance of its duties and responsibilities within th immediately preceding his election; ‘caciainSEC Code of Corporate Governance 61 ei not an owner of more than two percent (2%) of the outstanding ‘ares of the covered company, its subsidiaries, associates, affiliates or related companie: Is not relative of a ditetor, officer, or substantial shareholder of the covered company or any of its related companies or of any of its substantial shareholders. For this purpose, relatives include spouse, pater. child, brother, sister and the spouse of such child, brother or sister, Is not acting as a nominee or representative of any director of the covered company or any of its related companies; Is not a securities broker-dealer of listed companies and registered issuers of securities, “Securities broker-dealer” refers to any person holding any office of trust and responsibility in a broker-dealer firm, which includes, among others, a director, officer, principal stockholder, nominee of the firm to the Exchange, an associated person or salesman, and an authorized clerk of the broker or dealer; Is not retained, either in his personal capacity or through a firm, as a professional adviser, auditor, consultant, agent or counsel of the covered company, any of its related companies or substantial shareholder, or is otherwise independent of Management and free from any business or other relationship within the three years immediately preceding the date of his election; Does not engage or has not engaged, whether by himself or with ther persons or through a firm of which he is a partner, director or Substantial shareholder, in any transaction with the covered company or any of its related companies or substantial shareholders, other than such transactions that are conducted at arm’s length and gould not materially interfere with or influence the exercise of his independent judgment; Is not affiliated with any non-profit organization that receives significant funding from the covered company or any ofits related Gompanies or substantial shareholders; and ig not employed as an executive officer of another company where any of the covered company’s executives serve as directors62_ Chapter 3 Related companies, as used in this section, refer to (a) the covered + entity’s holding/parent company; (b) its subsidiaries; and (c) subsidiaries of its holding/parent company. Recommendation 5.3 The Board’s independent directors should serve for a maximum cumulative term of nine years. After which, the independent director should be perpetually barred from re-election as such in the same compaity, but may continue to qualify for nomination and election as a non-independent director. In the instance that a company wants to retain an independent director who has served for nine years, the Board should provide meritorious justification/s and seek shareholders’ approval during the annual shareholders’ meeting. Explanation Service in a board for a long duration may impair a director’s ability to act independently and objectively. Hence, the tenure of an independent director is set to a cumulative term of nine years. Independent directors (IDs) who have served for nine years may continue as a non- independent director of the company. Reckoning of the cumulative nine- year term is from 2012, in connection with SEC’Memorandum Circular No. 9, Stries of 2011 Any term beyond nine years for an ID is subjected to particularly rigorous review, taking into account the need for progressive change in the Board to ensure an appropriate balance of skills and experience. However, the shareholders may, in exceptional cases, choose to re-elect an independent director who has served for nine years. In such instances, the Board must provide a meritorious justification for the re- election. Recommendation 5.4 The positions of Chairman of the Board and Chief Executive Officer should be held by separate individuals and each should have clearly defined responsibilities.SEC Code of Corporate Governance 63 Explanation To avoid conflict or a split board and to foster‘an appropriate balance of power, iMecreased accountability and better capacity for independent decision-making, it is recommended that the positions of Chairman and Chief Executive Officer (CEO) be held by different individuals. This type of organizational structure facilitates effective decision making and good governance. In addition, the division of responsibilities and accountabilities between the Chairman and-CEO is'clearly defined and delineated and disclosed in the Board Charter. ‘The CEO has the following roles and responsibilities, among others: a. Determines the corporation’s strategic direction and formulates and implements its strategic plan on the direction of the business; b. Communicates and implements the corporation’s vision, mission, values and’ overall strategy and promotes any organization or stakeholder change in relation to the sames c. Oversees the operations of the corporation and manages human and financial resources in accordance with the strategic plan; d. Has a good working knowledge of the corporation’s industry and market and keeps up-to-date with its core business purpose; e. Directs, evaluates and guides the work of the key officers of the corporation; f. Manages the corporation’s resources prudently and ensures a proper balance of the same; Provides the Board with timely information and interfaces between the Board and the employees; Builds the corporate culture and motivates the employees of the corporation; and the link between internal operations and external i, Serves as stakeholders. ‘the roles and responsibilities of the Chairman are provided under Recommendation 2.3.64 Chapt Recommendation 5.5 ignate a lead director among, the independent man of the Board is not independent, including, if ixeculive Officer The Board should d directors if the Cha per the positions of the Chairman of the Board and Chief are held by one person, Explanation In eases where the Chairman is not independent and where the roles of Chair and CEO are combined, putting in plice proper mechanisms ensures independent views and perspectives. More importantly, it avoids the abuse of power and authority, and potential conflict of interest. A suggested mechanism is the appointment of a strong “lead director” among the independent directors. ‘This lead director has sufficient authority to lead the Board in cases where management has clear is of interest, contli The functions of the lead director include, among others, the following: a. Serves as an intermediary between the Chairman and the other directors when necessary; b. Convenes and chairs meetings of the non-executive directors; and c. Contributes to the performance evaluation of the Chairman, as required, Recommendation 5.6 A director with a material interest in any transaction affecting the corporation should abstain from taking part in the deliberations for the same. Explanation The abstention of a director from participating in a meeting when related party transactions, self-dealings or any transactions or matters on which he/she has a material interest are taken up ensures that he h: ‘i influence over the outcome of the deliberations. The funda a fal pring to be observed is that a director does not use his position to prof or aa ean benefit or advantage for his himself and/or his/heroe, Sighgesuresruas aor pierSee ae eeSEC Code of Corporate Governance _ 69 Explanation raise Ghen have access to material inside information on the a dvaritane cee to reduce the risk that the directors might take poligy errs his information, it is crucial for companies to have a Sith a iting directors to timely disclose to the company any dealings disclosure nein shares. It is emphasized that the policy is on internal os to the company of any dealings by the director in company res. This supplements the requirement of Rules 18 and 23 of the Securities Regulation Code. Recommendation 8.3 The Board should fully disclose all relevant and material information on individual board members and key executives to evaluate their experience and qualifications, and assess any potential conflicts of interest that might affect their judgment. Explanation A disclosure on the board members and key executives’ information is prescribed under Rule 12 Annex C of the SRC. According to best practices and standards, proper disclosure includes directors and key officers’ qualifications, share ownership in the company, membership of other boards, other executive positions, continuous trainings attended and identification of independent directors. Recommendation 8.4 ‘The company should provide a clear disclosure of its policies and procedure for setting Board and executive remuneration, as well as the vevel and mix of the same in the Annual Corporate Governance Report. _ Also, companies should disclose the remuneration on an individual basis, including termination and retirement provisions. Explanation Disclosure of remuneration policies and procedure enables investors t0 understand the link between the remuneration paid to directors and key management personnel and the company's performance,70 Chapter 3 The Revised Code of Corporate Governance requires only a disclosure of all fixed and variable compensation that may be paid, directly or indirectly, to its directors and top four management officers during the preceding fiscal year, However, disclosure on board and executive remuneration on an individual basis (including termination and retirement provisions) is increasingly regarded as good practice and is now mandated in many countries. Recommendation 8.5 The company should disclose its policies governing Related Party Transactions (RPTs) and other unusual or infrequently occurring transactions in their Manual on Corporate Governance. The material or significant RPTs reviewed and approved during the year should be disclosed in its Annual Corporate Governance Report. Explanation ‘A full, acourate and timely disclosure of the company’s policy governing RPTs and other unusual or infrequently occurring transactions, as well as the review and approval of material and significant RPTs, is regarded as good corporate governance practice geared towards the prevention of abusive dealings and transactions and the promotion of transparency. These policies include ensuring that transactions occur at market prices and under conditions that protect the rights of all shareholders. The said disclosure includes directors and key executives reporting to the Board when they have RPTs that could influence their judgment. Recommendation 8.6 ‘The company should make a full, fair, accurate and timely disclosure to the public of every material fact or event that occurs, particularly on the acquisition or disposal of significant assets, which could adversely affect the viability or the interest of its shareholders and other stakeholders. Moreover, the Board of the offered company should appoint an independent party to evaluate the fairness of the transaction price on the acquisition or disposal of assets.Soe iemcsemci72 Chapter 3 i 1, aoe SN eR cece the external auditor should be recommended by the Audit a approved by the Board and ratified by the shareholders, For removal k the external auditor, the reasons for removal or change should be disclosed to the ri and the public through the company website and required disclosur Explanation The appointment, reappointment and removal of the external auditor by the Board’s approval, through the Audit Committee’s recommendation, and shareholders’ ratification at shareholders’ meetings are actions regarded as good practices. Shareholders’ ratification clarifies or emphasizes that the external auditor is accountable to the shareholders or to the company as a whole, rather than to the management whom he may interact with in the conduct of his audit. Recommendation 9.2 The Audit Committee Charter should include the Audit Committee’s responsibility on assessing the integrity and independence of external auditors and exercising effective oversight to review and monitor the external auditor's independence and objectivity and the effectiveness of the audit process, taking into consideration relevant Philippine professional and regulatory requirements, The Charter should also contain the Audit Committee’s responsibility on reviewing and monitoring the external auditor’s Suitability “and effectiveness on an annual basis. \ Explanation The Audit Committee Charter ‘includes a disclosure of its responsibility on assessing the integrity and independence of the external auditor. It establishes detailed guidelines, policies and procedures that are contained in a separate memorandum ot document. Nationally and internationally recognized best practices and standards of external auditing guide the committee in formulating these policies and procedures. Moreover, establishing effective communication with the external auditor and requiring them to report all relevant matters help the Audit Committee to efficiently carry out its oversight responsibilities,SEC Code of Corporate Governance _73 Recommendation 9.3 i company should disclose the nature of non-audit services performed y its external auditor in the Annual Report to deal with the potential conflict of interest. The Audit Committee should be alert for any potential conflict of interest situations, given the guidelines or policies on non-audit services, which could be viewed as impairing the external auditor's objectivity. Explanation The Audit Committee, in the performance of its duty, oversees the overall relationship with the external auditor. It evaluates and determines the nature of non-audit services, if any, of the external auditor. Further, the Committee periodically reviews the proportion of non-audit fees paid to the external auditor in relation to the corporation’s overall consultancy expenses. Allowing the same auditor to perform non-audit services for the company may create a potential conflict of interest. In order to mitigate the risk of possible conflict between the auditor and the company, the Audit’Committee puts in place robust policies and procedures designed to promote auditor independence in the long run. In formulating these policies and procedures, the Committee is guided by nationally and internationally recognized best practices and regulatory requirements or issuances.REVIEW QUESTIONS AND EXERCISES Multiple Choice Questions 1. Audit committee activities and responsibilities include which of the following? a. Selecting the external audit firm. b. Approving corporate strate; c. Reviewing — management compensation. d. None of the above. determining performance and 2. Which of the following audit committee responsibilities has the SEC mandated? Obtaining each year a report by the internal auditor that addresses the company’s internal control procedures, any quality control or regulatory problems, and any relationships that might threaten the independence of the internal auditor. b. Discussing in its meetings the company’s earnings press releases, as well as financial information and earnings guidance provided to a. analysts. c. Reviewing with the internal auditor any audit problems or difficulties that they have had with management. d. All of the above. Exercises Exercise 1 Below is a summary of the SEC corporate i is @ summary of | governance requirements of companies publicly-listed in the stock exchange. For each eae state 1ow it is intended to help to address the risk of fraud in publichs ee raud in publicly traded a. Boards need to consist of at least 3 independ i eed to c lent board which is higher. : tees oe 1 of is b. Boards need to hold regular executive sessions of i a . Ive session: "i without management present, Sof independent directorsSEC Code of Corporate Governance 75 c. Boards must have a/ corporate governance committee composed at least 3 of independent directors, d. the Corporate governance committee must have a written charter that : resses the commitice’s purpose and responsibilities, and there must € annual performance evaluation of the committee. e. Boards must have an audit committee with a minimum of three independent members. f. The audit committee must have a written charter that addresses the committee’s purpose and responsibilities, and the committee must produce an audit committee report; there must also be an annual performance evaluation of the committee. Exercise 2 Below is a summary of the SEC listing requirements for audit committee responsi ities of companies listed on this stock exchange. For each requirement, state how it is intended to help to address the risk of fraud in publicly traded organizations. a. h. Obtaining each year a report by the external auditor that addresses the company’s internal control procedures, any quality control or regulatory problems, and any relationships that might threaten the independence of the external auditor 7 Discussing the company’s financial statements with management and the external auditor Discussing in its meetings the company’s earnings press releases, as well as financial information and earnings guidance provided to analysts Discussing in its meetings policies with respect to risk assessment and risk management Meeting separately with management, internal arfditors, and the external auditor on a periodic basis 4 Reviewing with the external auditor any audit problems or difficulties that they had with management Setting clear hiting policies for employees or former employees of the external auditors Reporting regularly to the board of directorsChafiter SEC CODE OF CORPORATE GOVERNANCE, CONTINUED Expected Learning Outcomes ° After studying the chapter, you should be able to... 1. Understand how the ethical behavior of the board can be strengthened Describe how the company disclosure policies and procedures can be enhanced. Appreciate how the external auditor's independence can be strengthened and how audit quality can be enhanced. Understand how a company could increase focus on non- financial and sustainability reporting. Explain how a company can promote a comprehensive and cost- efficient access to relevant information. Understand how integrity, transparency and proper governance of a company could be ensured through effective internal control system and enterprise risk management framework. Describe briefly how a synergic relationship with shareholders could be cultivated and promoted. Explain how the rights of stakeholders could by respected and how to institute effective redness for the violation of their rights. QU BSSEC Code of Corporate Governance, Continued 79 Recommendation 12.1 The Company should have an adequate and effective internal control system and an enterprise risk management framework in the conduct of its business, taking into account its size, risk profile and complexity of operations. Explanation An adequate and effective internal control system and an enterprise risk management framework help sustain safe and sound operations as well as implement management policies to attain corporate goals. An effective internal control system embodies management oversight and control culture; risk recognition and assessment; control activities; information and communication; monitoring activities and correcting deficiencies. Moreover, an effective enterprise risk management frémework typically includes such activities as the identification, sourcing, measurement, evaluation, mitigation and monitoring of risk. Recommendation 12.2 The Company should have in place an independent internal audit function that provides an independent and objective assurance, and consulting services designed to add value and improve the company’s operations. Explanation A separate internal audit function is essential to monitor and guide the implementation of company policies. It helps the company accomplish its objectives by. bringing systematic, disciplined approach to evaluating and improving the effectiveness of the company’s governance, risk management and control funetions. The following are the functions of the internal audit, among others: Provides an independent risk-based assurance service to the Board, Audit Committee and Management, focusing on reviewing the effectiveness of the governance and control processes in (1) promoting the right values and ethics, (2) ensuring effective performance management and accounting in the organization, (3) communicating risk and control a.80 Chapter 4 h. activities and information information, and (4) coordinating the " internal auditors, and among the Board, external and Management: | audit as contained in the annual Performs regular and spec r he company’s risk assessment; audit plan and/or based on t Performs consulting and advisory services related to governance and control as appropriate for the organization; of relevant laws, rules and nd other commitments, the organization; Performs compliance audit regulations, contractual obligations al which could have a significant impact on Reviews, audits and assesses the efficiency and effectiveness of the internal control system of all areas of the company; rograms to ascertain whether results lished objectives and goals, and ut as Evaluates operations or pt are consistent with estab! whether the operations or programs are being carried o1 planned; Evaluates specific operations at the request of the Board or Management, as appropriate; and Monitors and evaluates governance processes. A company’s internal audit activity may ve a fully resourced activity housed within the organization or may be outsourced to qualified independent third party service providers. Recommendation 12.3 Subject to a company’s size, risk profile and complexity of operations, it should have a qualified Chief Audit Executive (CAE) appointed by the Board. The CAE shall oversee and be responsible for the internal audit acti of the organization, including that portic.. that is outsourced to a third party service provider. In case of a fully outsourced internal audit activity, a qualified independent executive or senior management personnel should be assigned the responsibility for managing the fully outsourced internal audit activity.SEC Code of Corporate Governance, Continued 81 Explanation ; The CAE, in order to achieve the necessary independence to fulfil his/her responsibilities, directly, reports functionally to the Audit Committee and administratively to the CEO. The following are the responsibilities of the CAE, among others: a. Periodically reviews the internal audit charter and presents it to senior’ management and the Board Audit Committee for approval; b. Establishes a risk-based internal audit plan, including policies and procedures, to determine the priorities of the internal audit activity, consistent with the organization’s goals; c. Communicates the internal audit activity’s plans, resource requirements and impact of resource limitations, as well as significant interim changes, to senior management and the Audit Committee for review and approval; d. Spearheads the performance of the internal audit activity to ensure it adds value to the organization; e. Reports periodically to the Audit Committee on the internal audit activity’s performance relative to its plan; and f. Presents findings and recommendations to the Audit Committee and gives advice to senior management and the Board on how to improve internal processes. Recommendation 12.4 ubject to its size, risk profile and complexity of operations, the company should have a separate risk management function to identify, assess and monitor key risk exposures. Explanation The risk management function involves the following activities, among others: a. Defining a risk management strategy;82 Chapter 4 b. Identifying and analyzing key risks exposure ee economic, environmental, social and governance i ee factors and the achievement of the organization’s strateg) objectives; Evaluating and categorizing each identified risk: using the company’s predefined risk categories and parameters; Establishing a risk register with clearly defined, prioritized and residual risks; Developing a risk mitigation plan for the most important risks to the company, as defined by the risk management strategy; Communicating and reporting significant risk exposures including business risks (i.e, strategic, compliance, operational, financial and reputational risks), contro! issues and risk mitigation plan to the Board Risk Oversight Committee; and Monitoring and evaluating the effectiveness of the organization's risk management processes. Recommendation 12.5 In managing the company’s Risk Management System, the company should have a Chief Risk Officer (CRO), who is the ultimate champion of Enterprise Risk Management (ERM) and has adequate authority, stature, resources and support to fulfill his/her responsibilities, subject to a company’s size, risk profile and complexity of operations. Explanation The CRO has the following functions, among others: a Supervises the entire ERM Process and spearheads the development, implementation, maintenance and continuous improvement of ERM processes and documentation; . Communicates the top risks and the status of implementation of risk management strategies and action plans to the Board Risk Oversight Committee;tems rer src OHS saan magpie Sommers on aj adits wT onogm taenstemt Le Ss ‘Sia erases a tay na iat i l mypuretatiicenaaea LSE ese84 Chapter 4 i c i in d to include Right to propose the holding of meetings an¢ agenda items ahead of the scheduled Annual and Special Shareholders’ Meeting; ; : Right to nominate candidates to the Board of Directors; Nomination process; and Voting procedures that would govern the Annual and Special Shareholders’ Meeting. The right to propose the holding of meetings and items for inclusion in the agenda is given to all shareholders, including minority and foreign shareholders. However, to prevent the abuse of this right, companies may require that the proposal be made by shareholders holding a specified percentage of shares or voting rights. On the other hand, to ensure that minority shareholders are not effectively prevented from exercising this right, the degree of ownership concentration is considered in determining the threshold. Further, all shareholders must be given the opportunity to nominate candidates to the Board of Directors in accordance with the existing laws. The procedures of the nomination process are expected to be discussed clearly by the Board. The company is encouraged to fully and promptly disclose all information regarding the experience and background of the candidates to enable the shareholders to study and conduet their own background check as to the candidates’ qualification and credibility. Shareholders are also encouraged to participate when given sufficient information prior to voting on fundamental corporate changes stch‘as: (1) amendments to the Articles of Incorporation and By-Laws of the company; (2) the authorization on the increase ‘in authorized capital stock; and (3) extraordinary transactions, including the transfer of all or substantially all assets that in effect result in the sale of the company. In addition, the disclosure and clear explanation of the voting procedures, as well as removal of excessive or unnecessary costs and other administrative impediments, allow for’ the effective exercise of the shareholders’ voting rights. Poll Voting is highly encouraged as opposed to the show of hands. Proxy voting is also a good practice, including the electronic distribution of proxy materials, The related shareholders’ tights and relevant company policies should - be contained in the Manual on Corporate Governance.86 Recommendation 13.4 a shareholder, an ite disputes in an included in the The Board should make available, at the option of alternative dispute mechanism to resolve intra-corporal amicable and effective manner. This should be companys Manual on Corporate Governance. Explanation It is important for the shareholders to be well-informed of the company’s processes and procedures when seeking to redress the violation of their rights. Putting in place proper safeguards ensures suitable remedies for the infringement of shareholders’ rights and prevents excessive litigation. The company may also consider adopting in its Manual on Corporate Governance established Alternative Dispute Resolution (ADR) procedures. Recommendation 13.5 The Board should establish an Investor Relations Office (IRO) to ensure constant engagement with its shareholders. The IRO should be present at every shareholders’ meeting, ! Explanation Setting up an avenue to receive feedback, complaints and queries from shareholders assure their active participation with regard to activities and policies of the company. The IRO has a designated’ investor relations officer, email address and telephone number. Further, creating an Investor Relations Program ensures that all information regarding the a ies of the company are properly and timely communicated to shareholders. ,= sega Sa gue manera eT nate cee, Soaoe nares aie eek eget bar sae coma eve ae st SSeS ees ae ees ae‘eacctonee eitckcomeyemeentpetees Said nl elm re aa {nme elie ne seen ampsSPiorec heresSEC Code of Corporate Governance, Continued —91 REVIEW QUESTIONS Questions 1. 10. Assume that management had determined that its organization's audit committee is not effective. How do the weaknesses in audit committee affect management's evaluation of internal control over financial reporting? Would an ineffective audit committee constitute a material weakness in internal control over financial reporting? State the rationale for your response. Why is there a need for a corporation to maintain a comprehensive and cost-efficient communication channels to shareholders and other investors? What is the objective of the company in having a, strong and effective: internal control system? What is the purpose of having an independent internal audit function in a publicly-listed corporation? Give at least four (4) responsibilities of the Chief Audit Executive. Enumerate the activities of the Risk Management department in a publicly-listed corporation. To what may the shareholders’ rights relate? How may participation of employee in corporate governance be encouraged? True or False. Sustainability reporting includes voluntary corporate Tieclosures about sustainability initiatives, plans, and associated outcomes. True or False. The terms non-financial reporting, corporate social reporting, and tiple botiom-line reporting are each related terms. respons! sustainability92° Chapter 4 MM. Define the terms nonfinancial reporting, corporate social responsibility reporting, and triple bottom-line reporting. How do these terms relate to sustainability reporting? . What factors have driven the demand for sustainability reporting? . Why is there a demand for independent assurance on sustainability reporting? . In unethical for a company to provide a sustainability report, but provide no assurance on the reliability of the information contained therein?UNIT I BUSINESS ETHICS Chapter 5 Introduction to Ethics 6 Business Ethics 7 Common Unethical Practices of Business Establishments 8 Ethical Dilemma 9 Advocacy Against Corruption 10 Initiatives to Improve Business Ethics and Reduce CorruptionChapter INTRODUCTION TO ETHICS Expected Learning Outcomes After studying the chapter, you should be able to... 1. 2. Define Ethics, Enumerate.and describe the basic characteristics and values associated with ethical behavior. Appreciate why ethical behavior in personal, professional and business dealings is necessary, Understand the.reasons why people act unethically. Give and explain the categories of ethical principles . Give and describe the ethical principles related to a) Personal ethics b) Professional ethics c) Business ethics . Explain why professional ethics is important and why a code of conduct should be adopted Qa sosCHAPTER 5 INTRODUCTION TO ETHICS INTRODUCTION Ethics can be defined broadly as a set of moral principles or values that govern the actions and decisions of an individual or group. While personal ethics vary from individual to individual at any point in time, most people within a society are able to agree about what is considered ethical and unethical behavior. In fact, a society passes laws that define what its citizens consider to be the more extreme forms of unethical behavior. Each of us has such a set of values, although we may or may not have considered them explicitly. Philosophers, religious organizations, and other groups have defined in various ways ideal sets of moral principles or values. Examples of prescribed sets of moral principles or values at the implementation level include laws and regulations, church doctrine, code of business ethics for professional groups such as CPAs, and codes of conduct within individual organizations. Ethics is a topic that is receiving a great deal of attention throughout our society today. This attention is an indication of both the importance of ethical behavior to maintaining a civil society, and a significant number of notable instances of unethical behavior. Much of what is considered unethical in a particular society is not specifically prohibited. So how do we know whether we are acting ethically? Who decides what standards of conduct are appropriate? Is any type of behavior “ethical” as long as it does not violate a law or a rule of one’s profession? Itis common for people to differ in their moral principles or values. Even if two people agree on the’ ethical principles that determine ethical behavior, it is unlikely that they will agree on the relative importance of each principle. These differences result from all of our life experiences. Parents, teachers, friends and tors are known t0 influence our values, but so do television, team sports, emplo: Pe ures, and thousands of other experiences. life successes and fail96 Chapter CHARACTERISTICS AND VALUES ASSOCIATED WITH ETHICAL BEHAVIOR ‘ . : istics and values The following list of ethical principles incorporates the characteristics that most people associate with ethical behavior. Integrity 7 . Be principled, honorable, upright, courageous and act on CO Eee do nok be twofaced or unscrupulous, or adopt an end-justifies-the means philosophy that ignores principle. Honesty Be truthful, sincere, forthright, straightforward, frank, candid; do not cheat, steal, lie, deceive or act deviously. Trustworthiness and Promise Keeping Be worthy of trust, keep promises, full commitments, abide by the spirit as well as the letter of an agreement; do not interpret agreements in an unreasonably technical or legalistic manner in order to rationalize noncompliance or create excuses and justification for breaking commitments. Loyalty (Fidelity) and Confidentiality Be faithful and loyal to family, friends, employers, client and country; do not use or disclose information leaned in confidence; in a professional context, safeguard the influences and conflicts of interest. Fairness and Openness Be fair and open-minded, be willing to admit error and i 1 a, 4 |, Where appropriate, change positions and beliefs, deriionstrate a commitment to jiition thee ual treatment of individuals, and tolerance for acceptance of diversit B ele overreach or take advantage of another's mistakes or diversities, ” Caring jor Others Be caring, kind, and compassionate; share, be giving help those in need and avoid harming others be of service to others;Introduction to Ethies 97. Demonstrate respect for human dignity, privacy, and the right to self- determination of all people: be courteous. prompt, and decent: provide others with the information they need to make informed decisions about their own lives; do not patronize, embarrass, or demean. Responsible Citizenship Obey just laws; if all law unjust, openly protest it; exercise all democratic rights and privileged responsibly by participation (voting and expressing informed views), social consciousness, and public service; when in a position of leadership or authority, openly respect and honor democratic processes of decision making, avoid unnecessary secrecy or concealment of information, and assure that others have all the information they need to make intelligent choices and exercise their rights. Pursuit of Excellence Pursue excellence in all matters; in meeting your personal and professional responsibilities, be diligent, reliable, industrious and committed; perform all tasks to the best of your ability, develop and maintain a high degree of competence, be well informed and well prepared; do not be content with mediocrity; do not "win at any cost". Accountability Be accountable, accept responsibility for decisions, for the foreseeable consequences of actions and inactions, and for setting an example of others. Parents, teachers, employers, many professionals and public officials have a special obligation to lead by example, to safeguard and advance the integrity and reputation of their families, companies, professions and the government itself; an ethically sensitive individual avoids even the appearance of impropriety, and takes whatever actions*are necessary to correct or prevent inappropriate conduct of others.98 Chapter § — WHY IS ETHICAL BEHAVIOR NECESSARY? Ethical behavior is necessary for a society to function in an orderly manner. if can be argued that ethics is the g/we that holds a society together. What von happen if for example we could not depend on the people we deal ea is e honest. If parents, teachers, employees, siblings, co-workers and riends al consistently lied, it would be almost impossible for effective communication to occur, The need for ethies in society is sufficiently important that many commonly held ethical values are incorporated into laws. For example, laws dealing with driving While intoxicated and selling drugs concern responsible citizenship and respect for other, Similarly, if a company sells a defective product, it can be held accountable if harmed parties choose to sue throughout the legal system. A considerable portion of the ethical values of a society cannot be incorporated into laws because of the judgmental naturé of certain values. Looking at the honesty principle, it is practical to have laws that deal with cheating, stealing, lying, or deceiving others. It is far more difficult to establish meaningful laws that deal with many aspects of principles such as integrity, loyalty and pursuit of excellence. That does not imply that these principles dre less important for an orderly society. Business decisions influence employees, customers, suppliers and competitors, while company operations affect commuiities, governments and the environment, WHY DO PEOPLE ACT UNETHICALLY? Most people define unethical behavior as conduct that differs from the way they believe would have been appropriate given the circumstances. Each of us decides for ourselves what we consider unethical behavior, both for ourselves and other. It is important to understand what causes people to act in a manner that we decide is unethical. There are two primary reasons why people act unethically: I. the person's ethical standards are diffe from those of societ a ferent from th ty ety as 2. the person chooses to act selfishly,Introduction to Ethics __ 99 In many instances, both reasons exist. 1, Person's Ethical Standards differ from General Sociely Extreme examples of people whose behavior violates almost everyone's ethical standards are drug dealers, bank robbers, and larcenists. Most people who commit such acts feel no remorse when they are apprehended, because their ethical standards differ from those of society as a whole. There are also many far less extreme examples when violate our ethical values. When people cheat on their tax returns, treat other people with hostility, lie on employment applications, or perform below their competence level as employees, most of us regard that as unethical behavior. If the other person has decided that this behavior is ethical and acceptable, there is a conflict of ethical values that is unlikely to be resolved. 2. The Person Chooses to Act Selfishly ‘A considerable portion of unethical behavior results from selfish behavior. The Pork Barrel Scam and the other political scandals resulted from the desire for political power and wealth; cheating on tax returns and expense reports is motivated by financial greed; performing below one’s competence and cheating on tests are typically due to laziness. In cach case, the person knows that the behavior is inappropriate, but Chooses 10 do it anyway because of the personal sacrifice needed to act ethically. CATEGORIES OF E THICAL PRINCIPLES Principles of Personal Ethies include among others © Basicj Respect for the right of others © Concem for the right of others © Concern for the well-being on welfare of others © Benevolence, trustworthiness, honesty © Compliance with the law100 Chapter 5 Professional Ethics include among others * Integrity, impartiality, objectivity ¢ Professional competence © Confidentiality Professional behavior . © Avoidance of potential or apparent conflict of interest Business Ethics include among others e Fair competition © Global as well as domestic justice © Social responsibility © Concern for environment The focus of this book is on Business Ethies, The Need for Professional Ethics To understand the importance of a Code of Ethics to professionals, one must understand the nature of a profession as opposed to other vacation, There is no universally accepted definition of what constitutes a profession; yet, for generations, certain types of activities have been recognized as professions while others have not. Medicine, law, enginecring, architecture and theology are examples of disciplines long accorded professional status. Public accounting is relatively new as far as the ranking of the professions is concerned but it has achieved widespread recognition in recent decades. All the recognized professions have several common characteristics. The most important of these characteristics are: (1) a responsibility to serve the public (2) a complex body of knowledge (3) standards of admission to the profession (4) a need for public confidenceIntroduction to Ethics 101 Careless w EP negative eee integrity of a professional may lead the public to a confidence of the publi entire profession. All professionals must have public different professi Public to be successful. Consequently, the members of the ions act in unison by deriving their respective code of conduct. Code of 1e of Good Governance for the Profession in the Philippines (E.0. No. 220, June 23, 2003) This Code is adopted Rouen 4 by tho Profesional Regulation Comission (PRC) and the 42 Professional perform their tasks. While gel environment of good governance in which all Fiipino professionals shall Of ethics its general profession may adopt and enforoeits oan code cf good governance and code wich covers the cotene ai te tore goer corm rong the various codes. This Code si a u 8 ic Iachesstaah inh tace lca atic gaaien er ander of various professions could be used by all General Principle of Professional Conduct Professionals are required not only fo have an ethical comm a el, a personal resolve to act ethically, but also have both piel veers end eicel Srey Ethical awareness refers to the ability to discern between wrong, while ethical competency pertains to the ability to engage in sound moral reason and consider carefully the implications of altematve actons, oe " . Specific Principle of Professional Conduct 41. Service to Others Professionals are commited to a life of service to others. They protect Ife, property, and public welfare, To serve olhers, they shall be prepared for heroic sacrifice and genuine sellessness in carving out their professional duties even atthe expense of personal gai. 2. Integrity and Objectivity To maintain and broaden public confidence, professionals shall perform their responsibilities with the highest dongo of integrly and imbued wih naonaism and spa vas, the perarmance of any professtnal servo, they shal at al nes, main object, bere f conics of terest, and refrain fom engaging in any activity that would prejudice their abies to cary out that ‘duties etically. They shall avoid making any representation that would likely cause @ reasonable person to misunderstand or fo be deceived. 3, Professional Competence In proving professional serces, acatain ol ofcompoorces nessa. knowledge, technical skits, In Be re rarnce, Profesional shal, hreoe, undrake oy those pofssiona eotoss at they ie a daver wih pcessionl competence. Coal his she exw ogee keep up oa aarapelodge and tactriques in hi fot, cominuly improve te skis and upgrade their level of ‘competence and take part in alfelong| ‘continuing educalion program. 4 Solidarity and Teamwork vasthcu as sitio wld rire and support ane xgrizaon fra is membes. Theugh a deep spi Each profession shall uri ne broader iter of he prtession above ones personal ambition and teamwork within a cohesive professional organizaon, ‘each member shall effectively Try abies pais ro eu coninung poesiona evelopment as wel as deepen one's soi an civic responsibly soapy ee their professional duties ith due consideration of the broader interest of i stways carry out thai profession vith due consideration ofthe broader int a nye Cay re iarcleislenooyr: anda pbs wih professional conan and in a enner coneéstent with their responsbliis 'o inaty, As responsible Filpno ciizen, they shal actively Gontibute to the attainment ofthe county's rational objectives.102 Chapter 5 Ey puninal fed world, He of she shall Every professional shall remain gpen to challenges of a more dynamic interconnect J. He fise up 10 global standards an mania levels of professional practices fully aligned with global best practices. 7. Equality of All Professions si a i All professionals shall real their colleagues with respect and shal strive to be fair in their another. No one group of professionals is superior or above others. All professionals perform an equally important, yel distinc, service to society. In the eyes of the PRC, all professions are equal and, therefore, every one shall real one olher professionals with respect and faimess. Examples of Code of Conduct and Ethics for Professionals are shown in: Appendix A — For Professional Teachers Appendix B — For Intemal Auditors Appendix C — For Management Accountants Examples of Code of Business Conduct and Ethics for Private Enterprises are presented in: Appendix D ~Telecommunications Company Appendix E ~ Manufacturing Company Appendix F — Commercial Bank REVIEW QUESTIONS : Questions Define “Ethics”. 2. What is the basic purpose of a code of ethics for a profession? 3. Name and explain the characteristics and values associated with ethical behavior. 4. Explain why ethical behavior is necessary. 5. What are some of the reasons why people act unethically? 6. Describe some the principles and or values that are related to a. Personal ethics b. Professional ethics c. Business ethics 7. Explain why ethical behavior is necessary’ in thi ic pores, ry @ practice of one’sBUSINESS ETHICS Expected Learning Outcomes After studying the chapter, you should be able to... 41. Explain what business ethics is 2. Discuss the purposes of business ethics 3. Describe the scope and impact of business ethics on a) the economy b) society c) ‘environment d) business managers 4. Explain the ethical challenges in today's world RUBSCHAPTER 6 BUSINESS ETHICS BASIC CONCEPT OF BUSINESS ETHICS Business ethics refers to standards of moral conduct, behavior and judgment in business. It involves making the moral and right decisions while engaging in such business activities as manufacturing and selling a product and providing a service to customers. Business ethics is an area of corporate responsibility where businesses are legally bound and socially: obligated to conduct business in an ethical manner. Business ethics is based on the personal values and standards of each person engaged in business. PURPOSES OF BUSINESS ETHICS Main Purpose The main purpose of business ethics is to help business and would-be business to determine what business practices are right and what are wrong. Hopefully, they are going to use this knowledge to guide them in making the right business decisions. Special Purpose There are other purposes which are corollary to the main purpose. These purposes include the following: 1. To make businessmen realize that they cannot employ double standards to the actions of other people and to their own actions. 2. To show businessmen that common practices which they have thought to be right because they see other businessmen doing it, are really wrong. we To serve as a standard or ideal upon which business conduct should be based. :Ean for some country's organizations, professionals which have formulated and implemented their Code of Ethics, the business world today does not have one universal standard code of ethics. Each man has to evaluate a situation according to his own belief. Often, because there is no code of ethics to guide them, businessmen take actions that may be wrong. Therefore, one of the specific purposes of business ethics is to assist the business world in formulating codes of conduct — personal, company and professional — which can be used as a guide in formulating business plans and strategies and in making business decisions. SCOPE AND IMPACT OF BUSINESS ETHICS Business ethics covers all conduct, behavior and judgment in business. This includes the slightest deviation from what is right to illegal and dishonest acts that are punishable by law. It involves making the right choices while engaging in such business activities as manufacturing and selling a product or selling and rendering a service. Generally, actions that are not forbidden by law are ethical, In some cases, however, what is legal (not forbidden by law) may be unethical. Business ethics therefore covers even acts that may be legal but which are wrong because they violate ethical principles. Business ethics is based on the personal values and standards of each person engaged in business. Since individual values differ, what is ethical or unethical in making profit also varies from person to person. And here lies the problem. rene fsrstill no uniform standards of right and wrong from which all business may base their actions. ‘The businessman who provides fair business competition isthe most likely to observe the business ethical rules of conduct, behavior and judgment. Fair business competition means achieving Success solely by offering better products, services and terms than the competitor. It is a form of business competition where success is gained by the merits of one's goods or services.106 Chapter 6 Economic Impact on society through the wages it pays to its A business has an economic impact sit pe and the prices it charges employees, the materials that it buys from their suppliers i its customers. It would have a positive social impact on its employees if they are paid fair living wages and benefits. It will have a positive effect on its suppliers that they paid fairly and on time for their supplies. The effect on its customers fe positive if the business gives them good value for the price they pay for the products and services. Social Impact The social impact of corporate governance contributes to the ethical climate of society. If businesses offer bribes to secure work or other benefits, engage in accounting fraud or breach regulatory and legal limitations on their operations, the ethics of society suffer. In addition to a deteriorating ethical environment, such as corruption may unfairly raise the price of goods for consumers or the quality of the product or service compromised. Environmental Impact Environmental protection is a key area of business influence on society. Businesses that implement good environmental policies to use energy more efficiently, reduce waste and in general lighten their environmental footprint can reduce their internal costs and promote a positive image of their company. The environmental initiatives of a business leader often force competitors to take similar action for an increased beneficial effect on the environment. Impact on Business Managers The concepts and principles for the ethical conduct in business are relegated to the managers of the business enterprise. Thus, although the manager is expected to act in the best interest of the business, he cannot be expected to act ina manner that is contrary to the law or to his conscience. In particular, a manager should: * acknowledge that his role is to serve the business enterprise and the community; ¢ avoid all abuse of executive power for personal gain, advantage or prestige; .Business Ethics 107 el the fact to his superior whenever his personal business of financial interests conflict with those df the company; be actively concerned with the difficulties and problems of subordinates, Sel then fairly and by example, lead them effectively, assuring to all . the right of reasonable access and appeal to superiors; * recognize that his subordinates have a right to information on matter affecting them, and make provision for its prompt communication unless such communication is likely to undermine the security and efficiency of the business; © fully evaluate the likely effects on employees and the community of the business plans for the future before taking a final decision and © cooperate with his colleagues and not attempt to secure personal advantage at their expense. ETHICAL CHALLENGES IN TODAY’S WORED In an article, “Ethical Challenges in Today’s World” written by Ms. Mercedes B. Suleik published in the Business Mirror on February 13, 2018 the author expressed her insights on “Business Ethics” where an inherent conflict between ethics and the pursuit of profit is more pronounced, Cited in this article is the message of Pope Francis in his Ecumenical,’ Evangeli Gaudium “Humanity is experiencing a turning point in its history as can be seen from the advances ‘occurring in the sciences and technology. We are in ‘age of knowledge and information and thai this has fed to mew and often seenymous kinds of power. We have today an economy of exclusion and inequality”. “In a system that idolizes increased profit, everything that stands in its way is pushed aside. Behind this attitude lurks @ rejection of ethics. Ethics has come to be viewed with derision as being counterproductive. Ethics is felt to be a threat because it condemns the manipulation and she person and that ethics leads to a call. for a committed debasement of t response, which is outside of the categories of the marketplace.”108 Chapter 6 She also quoted Pope Benedict XVI's Encyclical Caritas in Veritate “Humanity has a mission and the means to transform the world in, Justice and love in human relations, even in the social and economic Sield. Market economics must be underpinned by commitments fo particular moral goods and a certain version of the human person if it is to serve than undermine humanity's common good. The economy needs rather ci 7 ics in order to function correctly — not an ethics which is people- et oriented,” REVIEW QUESTIONS , Questions 2. What does business ethics mean? What is the main objective of observing ethical behavior in business? Name the other purpose of business ethics. What is the scope of business ethics? Explain the economic impact of observing business ethics, What is the impact of business ethics to society in general? Explain how business managers could act ethically. Describe the inherent conflict between ethics and pursuit of profit.Chapter COMMON UNETHICAL PRACTICES OF BUSINESS ESTABLISHMENTS Expected Learning Outcomes After studying the chapter, you should be able to... 1. To familiarize yourself of the common unethical practices of business establishments such as * Misrepresentation and © Over-Persuasion 2, Describe how direct misrepresentation is committed by business firms such as a) deceptive packaging b) misbranding or mislabeling ¢) false and misleading advertising d) adulteration : e) weight understatement f) measurement understatement g) quantity understatement 3, Describe how indirect misrepresentation is done by business firms such as a) caveat emptor b) deliberate withholding of information c) passive deception 4, Describe how over-persuasion becomes unethical. Describe some unethical corporate practices of the a) board of directors b) executive officers and lower level manager c) employees RUSSCHAPTER 7 COMMON UNETHICAL PRACTICES OF BUSINESS ESTABLISHMENTS COMMON UNETHICAL PRACTICES OF BUSINESS ESTABLISHMENTS Unethical problems in business ethics occur in many forms and types. The most common of these unethical practices of business establishments are misrepresentation and over-persuasion. Misrepresentation may be classified into two types: direct misrepresentation and indirect misrepresentation. Direct Misrepresentation is characterized by actively misrepresenting about the product or customers. This includes: Deceptive Packaging. Deceptive packaging takes many forms and is of many types. One type is the practice of placing the product in containers of exaggerated sizes and misleading shapes to give a false impression of its actual contents. An example of this type of deceptive packaging is slack-fill packaging where containers like cartons, tin cans and certain plastics are filled only up to eighty-five to ninety-five percent of their capacity. Misbranding or Mislabeling. Misbranding is the practice of making false statements on the label of a product or making its container similar to a well-known product for the purpose of deceiving the customer as to the quality and/or quantity of a product being sold. False or Misleading Advertising. Advertising serves a useful purpose if it conveys the’ right information. It is the principal means by which people are informed about the availability, nature and uses of old and new products. However, advertising does not always tell the "whole truthCommon Unethical Practices of Business Establishments 141 aod nothing but the truth" if it greatly exaggerates the virtues of a Erika st tells only half of the truth or else sings praises to its non- — ues. If advertising does not provide a useful service anymore ei customers, it can become the agent of misrepresentation. Examples are: a. Advertisements with pictures or statements that convey exaggerated impression of the product’s reliability or quality. b. Advertisement that claims that the product is the "fastest selling brand" or the "product of the year". c. Advertisements using fictitious or obsolete testimonials. Adulteration. Adulteration is the unethical practice of debasing a pure or genuine commodity by imitating or counterfeiting it, by adding something to increase its bulk or volume, or by substituting an inferior product for a superior one for the purpose of profit or gain. Itis unethical because an inferior product is passed off as a superior one. This does not meet the standard for fair service, that is achieving success by offering otter service (jn the form of a superior product and terms of payment) than the competitor. Weight understatement or Short weighing. In short weighing, the mechanism of the weighing scale is tampered with or something is unobtrusively attached to it so that the scale registers more than the actual weight. An ‘example is a foot pedal with a concealed string tied to soe cighing scale. The modus operandi of sellers isto use two sets of Scales one which gives the correct weight and has been sealed by the authorities and another which looks identical but registers more weight than the product. Short weighing ig practiced in selling products where prices depend on the weight ‘uch as sugar, meat, fish, vegetables, fruits, nails, etc. Measurement understatement or Short measurement In short measurement, the measuring stick or standard is shorter than the real Tength or smaller in volume than the standard. This unethical practice is Found in selling situations where the price of the product depends on its length such as selling cloth or textiles, electric cords or wires or on Its vesrume such as selling rice by the sack112 Chapter 7 Quantity understatement or Short numbering. In this unethical practice, the seller gives the customer less than the number asked for or aati Short numbering is often practiced in selling situations where the pro Ps being sold is in such a shape or is packed in a manner that would make counting the product difficult or inconvenient. For example, a customer who is not vigilant may receive less quantity than, what he is entitled to when buying toilet paper, bond paper, carbon paper, paper clips, thumb tacks, matches and toothpicks which are sold by the box or package. Indirect Misrepresentation is characterized by omitting adverse or unfavorable information about the product or service. Among the most common practices involving indirect misrepresentations are caveat emptor, deliberate withholding of information and business ignorance. Caveat emptor is a practice very common among salesmen. Translated, caveat emptor means "let the buyer beware". Under this concept, the seller is not obligated to reveal any defect in the product or service he'is selling. It is responsibility of the customer to determine for himself the defects of the product. Caveat emptor is indirect misrepresentation and unethical because a seller is a witness for the goods he is selling. He testifies to its nature, features, uses and qualities. As a witness, it is his obligation to "tell the truth and nothing but the truth" about his product. What makes caveat emptor unethical is the willingness of the seller to generate profit by taking advantage of the buyer's lack of information. This is passive deception which is also lying. Deliberate Withholding of Information. Following the argument that caveat emptor is unethical, the deliberate withholding of significant information in a business transaction, is also unethical, No business transaction is fair where one of the parties does not exactly know what he is giving away or receiving in return.” -Passive deception, Direct misrepresentation gives business a bad name while indirect misrepresentation or passive deception is not as obvious, it nonetheless contributes to the impression that businessmen are liars and are out to make a fast buck. Business ignorance is passive deception because the businessman is unable to provide the customer with the complete information that the latter needs to make a fair decision.Common Unethical Practices of Business Establishments 113 Over-Persuasion Eeraine isis Graces of appealing to the emotions of @ prospective customer aad Seer lithe ya ier of merchandise he needs. Persuasion is legitimate persuading him to a ing of goods ifit is done in the interest of a buyer such as toed for the vole gel a hospitalization insurance policy. However, persuasion he bavert enefit of selling a product without considering the interest of er is not ethical. The common instances of over-persuasion include the following examples: 1. Urging a customer to satisfy a low priority need for merchandise. 2. pays upon intense emotional agitation to convince a person to uy. 3. Convincing a person to buy what he does not need just because he has the capacity or money to do so. CORPORATE ETHICS Unethical Practices of Corporate Management ‘ Practices of corporate management that involve ethical considerations may be classified into two: practices ‘of the Board of Directors and practices of executive officers. In many cases, the practices may apply to both categories of corporate management and the only dividing line is in the financial magnitude and implications of a particular corporate management practice. ‘Some Unethical Practices of the Board of Directors 1. Plain Graft Board of Directors help themselves to the earnings that Stherwise would go other stockholders. This is done by voting for caorelves and the executive officers huge pet diems, large salaries, big iio not commensurate to the value of their services. They bonuses that : ten also reduce the earings going to the other shareholders by authorizing purchases of goods and services for the company’s use at a price higher than normal, in consideration of a certain percentage of the purchase value or commission accruing to them. Some of the114 Chapter 7 Interlocking Directorship Interlocking directorship is often practiced by a person who holds directorial positions in two or more corporation that do business with each other. This practice may involve conflict of interest and can result to disloyal setling. Disloyal selling happens when this person is compelled to decide which of the two corporation’s interest should be protected or upheld. Thus, whatever decisions the person makes, he- betrays the trust reposed on him by the shareholders of either of the two companies. 3. Insider Trading Insider trading occurs when a broker or another person with access to confidential information uses that information to trade in shares and securities of a corporation, thus giving him an unfair advantage over the other purchasers of these securities. 4. Negligence of Duty A more common failure of the members of the Board of Directors than breach of trust is neglect of duties when they fail to attend board meetings regularly, It is only in regular attendance that they can protect the rights and interests of the shareholders and their non-attendance of board meetings could result to betrayal of trust of the parties who elected them to their positions. Some Unethical Practices of Executive Officers and Lower Level Managers To a lesser extent, executive officers may y also guilty of unethical practices. All the unethical practices of the members - une of the Board of Directors discussed are activities they are also capable of engaging in though perhaps to a lesser degree because of certain limits to their authority. Unethical practices that are more common to executive officers and lower level managers are: |. Claiming a vacation trip to be a business trip. The President or a Vice President reports his personal vacation in Europe or in the United States as a business trip so he can get reimbursement for his expenses including those of his family’s.Common Unethical Practices of Business Establishments 15 2. Having employees do work unrelated to the business. Executive officers and lower managers ask company employees to do personal things for them on company time such as having the company janitors water and mow their lawns, having the maintenance men do house or appliance a repairs for them, and having subordinate employees secure a license or type letters pertaining to their other businesses. 3. Loose or ineffective controls. Managers do not provide adequate controls to remove temptation and to prevent or discourage employees from engaging in unethical practices. A manager has the moral obligation to provide the proper control atmosphere so that his subordinates will not be tempted to commit dishonest acts. A manager indirectly betrays the trust placed on him by higher executive officers if the administrative and accounting controls in his office are so weak or effective that employees are given the opportunity to misappropriate funds or engage in petty thievery. 4. Unfair labor practices. The labor code lists the following as unfair labor practices committed by an employer on employees or a group of employees who have organized themselves into a union. a. To interfere with, restrain or coerce employees in the exercise of their right to self-organization; b. To require as a condition of employment that a person or an employee shall not join a labor organization or shall withdraw from one to Which he belongs; To contract out services or functions being performed by union members when such will interfere with, restrain or coerce employees in the exercise of their rights to self organization: d. To initiate, dominate, a ist or otherwise in with the formation or administration of any labor organization, including the giving of financial or other support to it: To discriminate with regard to wages, hours of work. and other terms or conditions of employment in order to encourage or discourage membership in any labor organization. To dismiss, discharge, or otherwise prejudice or discriminate, against an employee for having given or being about to give testimony under the Labor Code:116 Chapter 7 g. To violate the duty to bargain collectively a prescribed by the Labor Code; h. To pay negotiation or attorneys fees to the union or its officers: or agents as part of the settlement of any issue in collective bargaining or any other dispute: i. To violate or refuse to comply with voluntary arbitration awards or decisions relating to the implementation or interpretation of a collective bar gaining agreement; J. To violate a collective bargaining agreement. Making false claims about losses to free themselves from paying the compensation and benefits provided by law. There are employers who claim non-existent losses so they can be exempted from paying the minimum wage and emergency-cost-of-living allowances required by law. Making employees sign documents showing that they are receiving fully what they are entitled to under the law when in fact they are only receiving a fraction of what they are supposed to get. Sexual Harassment. Work, education or training-related sexual harassment is committed by an employer, employee, manager, supervisor, agent of the employer, teacher, instructor, professor, coach, trainer or any other person who, having authority, influence or moral ascendency over another in a work or training or education environment, demands, requests or otherwise requires sexual favor ftom the other, regardless of whether the demand, request or requirement for submission is accepted or not by:the object.Common Unethical Practices of Business Establishments _1N7 Some Unethical Practices of Employees aa eet employees who are not mindful of their moral obligations to their = oni tt hey take advantage of their position and the trust of their employees y committing unethical practices harmful to their employers’, interest these unethical practices may be classified into conflict of interest and dishonesty. lL Conflicts of Interest A conflict of interest arises when an employee who is duty bound to protect and promote the interests of his employer violates this obligation by getting himself into a situation where his decision or. actuation is influenced by what he can gain personally from it rather than what his employer can gain from it. Some common examples of conflicts of interest are: a. Anemployee who holds a significant interest or shares of stock of a competitor, supplier, customer or dealer favors this party to the prejudice of his employer. b. The employee accepts.cash, a gift or a lavish entertainment or a loan from a supplier, customer, competitor or contractor. In this situation, the decision or action of the employee is influenced by his being indebted for a favor or loan from a party with whom the company is doing business. He, therefore, cannot act impartially. c. The employee uses or discloses confidential company information for his or someone else's personal gain. An example is revealing his employer's formula or menu for a well-liked food to a competitor. 4. The employee engages in the same type of business as his employer. He may attend to his business only after office hours because he has somebody to mind it for him but itis still unethical. An example is an auditor employed fulltime in a public accounting firm but maintains his own auditing office where he works after office hours. e. The employee uses for his own benefit a business opportunity in “hich his employer has or might be expected to have an interest.118 Chapter 7 2. Dishonesty ansactions with outside ionship, especially with it his assigned duties in Business ethics is not just limited to business tr: parties. It also covers employee-employer relati respect to an employee’s honesty as he carries oul the office. Examples of dishonest acts of employees are a. Taking office supplies home for personal use b. Padding an expense account through the use of fake receipts when claiming reimbursements. ©. Taking credit for another employee’s ideaCommon Unethical Practices of Business Establishments 119 REVIEW QUESTIONS Questions 1. What are the two most common types of unethical practices of business establishments as far as the products or customers are concerned? v Give and explain briefly at least three ways of directly misrepresenting, products. 3. How is indirect misrepresentation of a product undertaken? 4. What does"caveat emptor” mean? 5. When does over-persuasion become unethical? 6. What is “interlocking directorship” and why could it lead to unethical actions of a member of the board of directors? <7. Insider trading is considered an unethical practice. Why? 8. What are some of the unethical practices that executive officers may be guilty of? 9, Cite some unethical practices of employees to their employers. 16. Distinguish between direct misrepresentation indirect misrepresentation. Multiple Choice Questions 1, Examples of direct misrepresentation about the product include the following except _ a, False advertising b. Deceptive packaging tc. Mislabeling d. Caveat emptor