Governance, Business Ethics, Risk Management and Internal Control

Chapter 1: INTroduction to corporate governance

WHAT IS GOVERNANCE?

Governance
- refers to a process whereby elements in society wield power, authority
and influence and enact policies and decisions concerning public life
and social upliftment.
- 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, norms, power or language of
an organized society.
- 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.

CHARACTERISTICS OF GOOD GOVERNANCE

1. Participation
2. Rule of Law
3. Transparency
4. Responsiveness
5. Consensus Oriented
6. Equity & Inclusiveness
7. Effectiveness & Efficiency
8. Accountability

These characteristics are briefly described as follows:

Participation
- Participation by both men and women is a key cornerstone of good
governance.
- Participation could be either direct or through legitimate institutions or
representatives. It is important to point out that representative
democracy does not necessarily mean that the concern of the most
vulnerable in society would not be taken into consideration in decision
making.
- Participation needs to be informed and organized. This means
freedom of association and expression on one hand and an organized
civil society on the other hand.
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Chapter 1: INTroduction to corporate governance

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.

Responsiveness
- Good governance requires that institutions and processes try to serve
the needs all stakeholders within a reasonable timeframe.

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.

Equity & Inclusiveness

- Ensures that all its members feel that they have a stake in it 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 & Efficiency

- Good governance means that processes and institutions produce
results that meet the needs of society while making the best use of
resources at their disposal.
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Chapter 1: INTroduction to corporate governance

- 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.
- 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 of rights
and responsibilities among different participants in the corporation,
such as the board, managers, shareholders, and other stakeholders,
and spells out the rules and procedures for making decisions on
corporate affairs.
- By doing this, it also provides the structure through which the
objectives are set and the means of attaining those objectives and
monitoring performance.
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Chapter 1: INTroduction to corporate governance

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.
In 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.

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 individuals 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.

3. Increase Shareholders' Wealth

- Another corporate governance's main objective is to protect the long-
term interests of the shareholders.
- Firms with strong corporate governance structure are seen to have
higher valuation attached to their shares by businessmen.
- This only reflects the positive perception that good corporate
governance induces potential investors to decide to invest in a
company.
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Chapter 1: INTroduction to corporate governance

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.

A. Transparency and Full Disclosure

● Does the board meet the information 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?
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Chapter 1: INTroduction to corporate governance

○ 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?

ILLUSTRATIVE APPLICATION OF THE BASIC PRINCIPLES OF

CORPORATE GOVERNANCE AND BEST PRACTICE
RECOMMENDATIONS

Principles of Good Best Practice Recommendations

Corporate Governance

1. A company should lay 1-a. Formalize and disclose the functions

solid foundation for reserved to the board and those delegated
management and oversight. to management.
It should recognize and
publish the respective roles
and responsibilities of board
and management.

2. Structure the board to add 2-a. A board should have independent

value. Have a board of an directors.
effective composition, size
and commitment to 2-b. The roles of chairperson and chief
adequately discharge its executive officer should not be exercised by
responsibilities and duties. the same individual.

2-b. The board should establish a

nomination committee.
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Chapter 1: INTroduction to corporate governance

3. Promote ethical and 3-a. Establish a code of conduct to guide the

responsible decision- directors, the chief executive officer (or
making. Actively promote equivalent), the chief financial officer (or
ethical and responsible equivalent) and any other key executives as
decision-making. to:
● The practices necessary to maintain
confidence in the company's
integrity; and
● The responsibility and accountability
of individuals for reporting and
investigating reports of unethical
practices

3-b. Disclose the policy concerning trading

in company securities by directors, officers
and employees.

4. Safeguard integrity in 4-a. Require the chief executive of (or

financial reporting. Have a equivalent) and the chief financial officer (or
structure to independently equivalent) to state in writing to the board
verify and safeguard the that the company's financial reports present
integrity of the company's a true and fair view, in all material respects,
financial reporting. 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;
● An independent chairperson, who is
not chairperson of the board; and
● At least three (3) members.

5. Make timely and balanced 5-a. Establish written policies and

disclosure. Promote timely procedures designed to ensure compliance
and balanced disclosure of with IFRS.
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Chapter 1: INTroduction to corporate governance

all material matters

concerning the company. 5-b. Listing Rule disclosure requirements
and to ensure accountability at a senior
management level for compliance.

6. Respect the rights of 6-a. Design and disclose a communications

shareholders and facilitate strategy to promote effective communication
the effective exercise of with shareholders and encourage effective
those rights. participation at general meetings.

6-b. Request the external auditor to attend

the annual general meeting and be available
to answer shareholder questions about the
audit.

7. Recognize and manage 7-a. The board or appropriate board

risk. Establish a sound committee should establish policies on risk
system of risk oversight and oversight and management.
management and internal
control. 2-a. The chief executive officer (or
equivalent) and the chief financial officer (or
equivalent) should state to the board in
writing that:
● The statement given in accordance
with best practice recommendation
4-a (the integrity 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 company's risk management
and internal compliance and control
system is operating efficiently in all
material respects.

8. Encourage enhanced 8-a. Disclose the process for performance

performance. Fairly review evaluation of the board, its committees and
and actively encourage individual directors, and key executives.
enhanced board and
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Chapter 1: INTroduction to corporate governance

management effectiveness.

9. Remunerate fairly and 9-a. Provide disclosure in relation to the

responsibly. Ensure that the company's remuneration policies to enable
level and composition of investors to understand:
remuneration is sufficient ● The costs and benefits of those
and reasonable and that its policies; and
relationship to corporate and ● The link between remuneration paid
individual performance is to directors and key executives and
defined. corporate performance.

9-b. The board should establish a

remuneration committee.

9-c. Clearly distinguish the structure of non-

executive director's remuneration from that
of executives.

9-d. Ensure that payment of equity-based

executive remuneration is made in
accordance with thresholds set in plans
approved by shareholders.

10. Recognize the legitimate 10-a. Establish and disclose a code of

interests of stakeholders. conduct to guide compliance with legal and
Recognize legal and other other obligations to legitimate stakeholders.
obligations to all legitimate
stakeholders.

REVIEW QUESTIONS
Questions

1. What does governance mean?

Governance is defined as the process in which elements in society exercise
power, authority and influence and lay down policies relating to the public and
its welfare. It is the sound exercise of political, economic, and administrative
authority to manage a country’s resources for development. In simpler terms,
governance refers to the process of decision-making by which the
implementation is through the exercise of authority by a leader of a country or
an organization.
 Governance, Business Ethics, Risk Management and Internal Control
Chapter 1: INTroduction to corporate governance

2. Explain whether the following statement is true or false. "Governance

is exercised only by the government of a country".
Governance is not only restricted to the government of a country. It is, as well,
applicable even in a small organization where there stands an authorized
person to maintain the welfare of the whole group. It can be present in a
corporation, different organizations, local or national estate and even in small
groups where decisions are accomplished through the power of the leader.

3. Explain how governance can be used in the following contexts and

give appropriate examples:

a. national governance - Governance in the national scale is the exercise of

political and economic authority to cater public’s affairs in all aspects to
accommodate the citizen’s welfare.
b. local governance - Local governance, on the other hand, covers a small
area by which the leader makes decisions through his power and authority.
He is authorized to implement policies and laws in just a smaller scale
compared to the national setting. An example of which is the town council.
c. corporate governance - Its primary feature involves the protection of
shareholders and proper communication of policies within a corporation.
d. international governance - International governance affects more than
one country or region as it covers the political cooperation and transactions
that are beyond borders. It is a movement towards negotiating responses to
problems that involve connecting states.

4. Explain briefly the eight (8) basic characteristics of good governance.

1.Participation – It includes all both men and women, either directly or through
legitimate representatives by which their involvement plays a significant role in
decision making. It should be organized and every individual is given the
freedom of expression for the best interests of the organization.
2.Rule of Law – Good governance requires fair legal frameworks that are
enforced by an impartial regulatory body, for the full protection of
stakeholders.
3.Transparency – Transparency means information should be easily
accessible to those who will be affected by the policies and laws as well as its
results. It should be easily understood by the subordinates and its
enforcement should be in compliance with accepted rules and regulations.
4.Responsiveness - Good governance requires that organizations and their
processes are designed to serve the best interests of stakeholders within a
reasonable timeframe.
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Chapter 1: INTroduction to corporate governance

5.Consensus Oriented – A good governance requires a conference in order to

gather the different concerns of stakeholders to reach a wide consensus of
what is in the best interest of the whole group and it can be accomplished in a
wise manner.
6.Equity and Inclusiveness – It gives privilege to its stakeholders to maintain
and improve their wellbeing emphasizing their involvement in the group and to
find reason for its existence and value to the society.
7.Effectiveness and Efficiency – The organization is required to implement
policies and rules that aim to produce favorable results in order to meet the
needs of its stakeholders while utilizing the resources in the wisest manner at
its disposal. Resources may refer to human, technical, environmental, natural
and financial resources.
8Accountability – the organization should emphasize its responsibilities to
those who will be affected by its decisions, actions and implemented rules and
regulations. It should be held responsible for anything that happens to their
subordinates as long as its reason is directly attached to the organization.

5. Transparency and accountability are synonymous. Explain whether

the statement is correct or not.
This is incorrect. We might think that these two characteristics are similar but
it isn't. Transparency is concerned with the information that the company is
providing to both external and internal users. It should be able to deliver the
correct information to be used primarily in decision making. On the other
hand, accountability covers the one who will be accountable for the outcomes
of the decisions to those who are affected by it. Accountability cannot be
enforced without transparency, thus it is interrelated to one another.

6. Explain whether the following statement is true or false.

"Responsiveness usually results to effectiveness and efficiency".
This statement is false because there are instances that you might be able to
respond to what is asked but it does not mean that you always reach what is
needed in terms of either its quantity or quality. It still varies on the
performance and efforts not just on being responsive.

7. Define corporate governance.

Corporate governance refers to the system of practices and rules by which
authority and power is vested to the leader which aims to direct and control
the whole group for the welfare of both the external and internal agents
affected by its decisions. It involves balancing the interests of a company’s
shareholders, management, customers, suppliers, government, financers and
the community.
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Chapter 1: INTroduction to corporate governance

8. What does corporate governance structure involve?

The corporate governance structure specifies the distribution of rights and
responsibilities among different stakeholders such as the board, managers or
shareholders, and spells out the rules and procedures for decision-making in
corporate affairs.

9. State the purpose of corporate governance.

The purpose of corporate governance is to assist the management of a
company towards effective and prudent output, and reach a long-term
success of the company. Its primary purpose is to increase the shareholder’s
value and protect the interests of other stakeholders by improving corporate
performance and accountability.

10. Explain the basic objectives of corporate governance.

● Fair and Equitable Treatment of Shareholders - A corporate
governance ensures fair treatment of all shareholders of the
company.
● Self-Assessment - Corporate governance lets the firm assess their
behavior to lessen risks and further problems. It enables the company
to point out its deficiencies in operations and help solve issues
internally on a regular basis.
● Increase Shareholders’ Wealth - One of its objectives is also to
protect the long-term interests of the shareholders of the company.
One basis of having good corporate governance is its high valuation
attached to their shares by investors. A higher number of potential
investors reflect good corporate governance.
● Transparency and Full Disclosure - Another corporate governance’s
objective is to ensure a higher degree of transparency by which the
company is able to fully disclose its transactions to the company
accounts.

11. Explain the three basic principles of effective corporate governance.

● Transparency and Full Disclosure - An effective corporate governance
safeguards integrity in their financial reports. It is able to make timely
and balanced disclosure which aims to provide clear information
about the company to both internal and external users.
● Accountability - A company with an effective corporate governance
promotes objective and responsible decisions which caters the best
interests of its shareholders. It clearly identifies the role of its
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Chapter 1: INTroduction to corporate governance

subordinate and management and ensures an appropriate range of

expertise and knowledge among its employees.
● Corporate Control - The company should be able to build a long-term
sustainable growth in shareholders’ value for the corporation. It
should be company that recognizes risks and fairly manages it for
better outcomes needed by the company

Multiple Choice Questions

1. 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?
c. 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?

2. 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?
c. 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?

3. "Transparency and full disclosure" principle advocates the following except

a. Sound dísclosure policies and practices

b. Solid foundations for management oversight
c. Meeting the information needs of investment communities
d. Safeguards integrity in financial reporting

4. The rights 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.
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Chapter 1: INTroduction to corporate governance

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.

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
c. Disclose the functions reserved to the board and those delegated to
management
d. Disclose the policy concerning trading in company securities by directors,
officers and employees.

6. To encourage enhanced performance by the board and management, it is

recommended that the following should be adopted except

a. 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

7. The characteristic of good governance where fair legal framework are

enforced impartially is

a. Participation
b. Rule of Law
c. Equity
d. Accountability