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Transcript of 03 - Corporate Governance - 2015-16
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UNIVERSITY
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June 2015
Audit and assurance
Lecture 3
Corporate governance
The lecture uses the UK CG Code as an example
(Overseas campuses: UK, Hong Kong SAR, Malaysian, Vietnamese, Sri
Lankan and Singaporean respective Codes may be studied)
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This lecture will consider
1. The nature of corporate governance (CG)2. Codes of CG
3. CG and the Directors
4. CG and the auditor
Appendices. These slides are background material
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CG is part of corporate responsibility Corporate responsibility has a much broader focus
The main focus of CG is on the fiduciary duties of directors
to shareholders, and secondarily to other stakeholders
..to protect and advance the interests of shareholders
through setting the strategic direction of a company
and appointing and monitoring capable managementto achieve this Walker Review, 2009
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The systemby which companies are directed
and controlled for the benefit of the
shareholders. In some jurisdictions, the scope
of benefit includes multiple stakeholders Blowfield and Murray, 2008
There are substantial differences in definitionaccording to which country is considered Solomon, 2010
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1. The Importance of Corporate
Governance
Corporate Governance is important because:
The owners of a company and the people who manage the company are
not always the same (refer to appendix 2 if unsure about agency theory).
The day-to-day running of a company is the responsibility of the
directors and other management staff to whom they delegate. In some companies, the shareholders are fully informed about the
management of the business because they are directors themselves.
In other companies, shareholders only have an opportunity to find out
about the management of the company at the AGM (annual general
meeting).
AGMs are often very poorly attended.
For these reasons, there is the potentialfor conf l icts of interest between
management and shareholders.
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2. International CG Codes
a. The OECD Principles
1999: Principles of Corporate Governance
In response to the growing awareness of the importance of good
corporate governance for investor confidence and national economic
performance
2004: Revised version issued
Because of corporate scandals after 1999
2014: Review launched (due September 2015)
An international benchmark Developed by officials from OECD and non-OECD countries,
businesses, professional bodies, trade unions, civil society
organisations and international standard-setting bodies
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2a. The OECD Principles (cont.)
Good corporate governance is key to the integrity of
corporations, financial institutions and markets, and central to
the health of our economies and their stability OECD, January,2009
The World Federation of Exchanges*issued a resolution
acknowledging the important contribution of the OECD to the
development of standards of corporate governance
and strongly supporting the workof the OECD in this area -
WEF, October, 2008
*Regulated stock exchanges
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2a. The OECD Principles (cont.)
Structure (six chapters)
1. Governments place in effective institutional and legal
framework to support good corporate governance practices
2. Protects and facilitates the exercise of shareholders rights
3. Equal treatment of all shareholders, including minority andforeign shareholders
4. The importance of the role of stakeholdersin corporate
governance
5. The importance of timely, accurate and transparentdisclosuremechanisms
6. Boardstructures, responsibilities and procedures
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2a. The OECD Principles (cont.)
The Principlesare non-binding because theirimplementation must be adapted to different legal,economic and cultural circumstances. This is a keystrength of the PrinciplesGovernments andregulators also need to find a balance between rulesand regulations on one hand and flexibility on theother hand
The legislation needed to enforce these standards isthe responsibility of individual governments
OECD, January, 2009
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2a. Summary of OECD Principles
of Corporate Governance
OECD Principles of Corporate Governance
I The corporate governance framework should:
promote transparent and efficient markets
be consistent with the rule of law
clearly articulate the division of responsibilities among different supervisory,
regulatory and enforcement authorities.
II The corporate governance framework should protect and facilitate the exercise of
shareholders rights.
III The corporate governance framework should:
ensure the equitable treatment of all shareholders, including minority andforeign shareholders.
ensure that all shareholders should have the opportunity to obtain effective
redress for violation of their rights.
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2a. Summary of OECD Principles
of Corporate Governance (cont.)
OECD Principles of Corporate Governance (cont.)
IV The corporate governance framework should:
recognise the rights of stakeholders established by law or through mutual
agreements
encourage active co-operation between corporations and stakeholders in
creating wealth, jobs and the sustainability of financially sound enterprises.
V The corporate governance framework should ensure that timely and accurate
disclosure is made on all material matters regarding the corporation, including the
financial situation, performance, ownership, and governance of the company.
VI The corporate governance framework should ensure: the strategic guidance of the company.
the effective monitoring of management by the board.
the boards accountabilityto the company and the shareholders
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When applying the OECD principles, in order to obtain the
best advantages countries may adopt a hybrid approach(i.e.
make some elements of corporate governance mandatory and
some voluntary.
For instance, in the UK,
companies are required to comply with legislation(such as
Companies Acts)
There is also a voluntary corporate governance code, the
UK Corporate Governance Code, which contains some
mandatoryelements for listed companies.
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June 2015 AA - CG
2b. CG in the UK
Some history, legislation
Bubble Act 1720
Recognised the moral hazard of the relationship in theprinciple-agent
relationship
A key theme that was established and continues to today is that
directors are accountabletoshareholders
Companies Act (CA) 1844
Required auditedbalance sheet(a value statement at year-end) to be
presented to shareholders
Problem: Anyone could be the auditor (usually a shareholder)
CA 1856
The CA 1844 audit provision was removed
Led to many cases accusing directors of fraudulent behaviour
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June 2015 AA - CG
2b. CG in the UK
Some history, legislation (cont.)
CA 1900
Reintroduction of balance sheet audit
Auditor to be appointed by shareholders
CA 1929 P&L a/crequired
Shows how the company has fared over the year.
CA 1948; CA 1967
Required auditor to be qualified Auditor to express an opinion
A lot of disclosuresto shareholders required
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2b. CG in the UK
Some history, legislation(cont.)
CA 1981
Aspects of GAAPintroduced into law
Directors reportto be audited
Directors report to contain comment on the companiesfuture development
Small and medium sized companies exemptions
CA 1985; CA 1989; CA 2006 (Mainly consolidation)
Directors duty of competence (Common Law) codified
Negligence where a failure of a reasonable standard of competence
IFRS for listed companies
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June 2015 AA - CG
2b. CG in the UK
Some history, legislation(cont.)
One of the governments roles in a capitalist economy
To protect thepublic interest
Most of the statutes were in response of a public
scandal Usually involving fraudulent activity
Thus legislation has attempted to make directors
increasingly more accountable to shareholders over time
Note: The above history of the development of UK statutes related to
directors responsibilities will not be examined
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June 2015 AA - CG
2b. The history of CG in the UK
The Cadbury Report, 1992
Public concern over several corporate failures
Particularly the Polly Peck and Maxwell CommunicationsCorporation cases in 1991
The rapid growth in executive remuneration and conflicts
of interest between directors and shareholders
The Stock Exchange and CCAB therefore initiatedthe Cadbury enquiry
Corporate governance (CG) - not a new thing
Cadbury was based on existing good CG behaviour
It may thus be considered a codification exercise of goodCG practice in the UK in 1992
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2b. CG in the UK
The Code of Best Practice (1992)
A voluntary code, based on the Cadbury Report But for listed companies a compliance statement was
required
Comply or explainPrinciples rather than rules
Many reports followed
Greenbury 1995; Hampel 1998; Turnbull 1999; Higgs
2003; Tyson 2003; Smith 2003
The Code now called the UK CG Codeand isreviewed bi-annually
The most recent being in September 2014by the FinancialReporting Council and can be found on the FRC website.
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2b. CG in the UKThe UK Corporate Governance Code (2014)
Corporate governance is about what the board of a
company does and how it sets the values of the company
It is to be distinguished from the day to day operational
management of the company by full-time executives.
The Code is a guide to a number of key components of
effective board practice. It is based on the underlying
principles of all good governance: accountability, transparency, probity and focus on the
sustainable success of an entity over the longer term
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2b. CG in the UKThe UK Corporate Governance Code
The main principles of the code concern directors...
Leadership
Effectiveness
Accountability
Remuneration
Relations with shareholders
Refer to the slides in appendix 1 for more details
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2b. CG in the UKThe UK Corporate Governance Code (cont.)
The Directors main principle is to ensure
Every company should be headed by an effective board,
which is collectively responsiblefor the long-term success
of the company
The Turnbull Guidance and Smith Guidance
Detailedguidance that accompanies the Code (revised
September, 2005)
The Turnbull and Higgs reports are particularly important At this point we need to re-consider what risk
management,systems and internal controlare
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2b Systems and internal control (IC)
The basic idea
A system such
asAccounting (a sale);
Production (manufacturing);
Maintenanceand systems to
ensure corporate governance
To ensure systems
work internal
controls are built
in (checks,
authorisations,
reconciliations)
If systems are
good and all
controls are
followed the
objectivewill
be achieved
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I. Control environment
I. Attributes (such as knowledge, skills, integrity,
ethical values...) and competence and structure
of the workforce...
II. Risk assessment
The tools to identify, analyse and manage risks
of the entity Includes sales, production, marketingand
financial activities
2b Components of internal controlThe COSO Framework, 1992 (COSO 1*)* Subsequent versions of COSO are of more value in rule-based codes
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III. Control activities
The carrying out of policies and proceduresestablished by management to achieve corporate
objectivesIV. Information and communications
For management and control of entity
V. Monitoring
In order to react to changing conditions
2b Components of internal controlThe COSO Framework, 1992 (COSO 1) (cont.)
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Communication
and information
Risk assessment
Control
environment
Control
activities
Monitoring
2b Components of internal controlThe COSO Framework, 1992 (COSO 1) (cont.)
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2b CG in the UK
The Turnbull Report, 1999
back to Turnbull
Internal Control: Guidance for Directors on the
Combined Code, 1999
Focused on aspects of internal control(IC) related to CG
That is, ICs that ensure directors act in line with the Code
Although COSO (Treadwell) established the COSO model,
Turnbull set up the first Code of IC directly addressed to
CG Consistent with the Code in 1999, Turnbull maintained
the voluntary, principles-based stance
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2b CG in the UK
The Turnbull Report, 1999
Note at this point that subsequent COSO models have
been developed, but felt not to be relevant as they
lean towards more rule-based regimes (such as the
USA). COSO 1 (the pyramid) still forms the
underpinning of international ISAs and matches UK
CG (Turnbulls) approach.
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2b CG in the UK
The Higgs Report, 2003
Government concern over effectiveness of non-
executive directors (NEDs)
Government sponsored this report after overseas failures,
such as Parmalat (Italy) and Enron (USA) The role of the audit committeeand NEDs were
reviewed and changes made to the Code
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2b Key elements of The UK
Corporate Governance Code
Every listed company should have a board of directors to lead
and control the company.
There should be a clear division of responsibilities between the
chairman and the chief executive officer of the company to
ensure that a single person does not have unbridled power.
There should be a balance between executive and non-executive
(who are often part-time and independent) members of the
board, to ensure that small groups of individuals cannot
dominate proceedings.
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2b Key elements of The UK
Corporate Governance Code
The board should receive timely information that is of sufficient
quality to enable it to carry out its duties.
Appointments to the board should be the subject of rigorous,
formal and transparent procedures.
All directors should submit themselves for re-election at regular
intervals, subject to satisfactory performance.
Remuneration levels should be sufficient to attract, retain and
motivate directors of the quality required to run the company.
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2b Key elements of The UK
Corporate Governance Code
There should be formal and transparent procedures fordeveloping policy on directors remuneration.
The board should ensure that a satisfactory dialogue with
shareholders occurs.
Boards should use the annual general meeting to communicate
with private investors and encourage their participation.
Institutional shareholders should ensure that they use their votes
and enter into a dialogue with the company based on a mutual
understanding of objectives.
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2b Key elements of The UK
Corporate Governance Code
The board should publish a balanced and understandableassessment of the companys position and future prospects.
Internal controls should be in place to protect the shareholders
wealth.
Formal and transparent arrangements for applying financial
reporting and internal control principles and for maintaining an
appropriate relationship with auditors should be in place.
The board should undertake a formal and rigorous examination
of its own performance each year.
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The directors of a company
should set companypolicy, including riskpolicy
are responsible for the companys systems andcontrols
should make sure they set enough timeaside and
that they have the necessary experienceand skill,
to do this effectively.
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Policy
Directors are responsible ultimately for managing the company
Includes setting strategy
Setting and approving budgets
Managing the companys people
Maintaining company assets and
Ensuring corporate governance rules are kept
Important element of setting strategies is determining andmanaging risks.
Internal audit has a role in this area
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Policy (cont.)
The UK Corporate Governance Code requires that there is
a clear division of responsibility at the head of a company
between the chairmanand the chief executive. requires that no one individual has unfettered powers of
decision.
the chairman also has to meet the same independence criteria
as non-executive directors
Chairman should not be former chief executive of the same
company except in exceptional circumstances.
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Systems, controls and monitoring
Directors are responsible
for the systems put in place to achieve the company policies
for controls put in place to mitigate risks
for monitoringthe effectiveness of systems and controls
Internal auditors have an important role in this area but important to note
that the directors are responsible for determining whether to have an
internal audit department to assist them in monitoring in the first place.
Under the UK Corporate Governance Code, UK boards (through the audit
committee) are required to consider annually whether an internal auditdepartment is required.
If there is no internal audit function, the reasons for not having one need to
be explained in the annual report.
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Non-executive directors are directors who do nothave day-to-day operational responsibility for
the company.
are not employees of the company or affiliated with it in any other way.
may have a particular role in some sensitive areas such as: company reporting
nomination of directors and
remuneration of executive directors.
UK Corporate Governance Code recommends that the board contains
some non-executive directors to ensure that it exercises objective
judgement.
Also requires an appropriate combination of executive and non-executive directors
on the board and recommends that at least half the board should comprise non-
executive directors.
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3. Directors and
Internal Control Effectiveness
Directorsof a company are responsiblefor ensuring that a
companys risk management and internal control systems
are effective.
Internal controls are essential to management, as they
contribute to:
Safeguarding the companys assets
Helping to prevent and detect fraud
Safeguarding the shareholders investment
Helps the business to run efficiently
Reduces identified risks
ensure reliability of reporting and compliance with laws
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3. Directors responsibilities for
internal control
Ultimate responsibility for a companys system of
internal controls lies with the board of directors.
Board of directors should set procedures of internal control
and regularly monitor the system operates as it should.
Setting up an internal control system will involve assessing
the risksfacing the business so that systemcan be
designedto ensure those risks are avoided.
Internal controls systems will always have inherent limitations
(possibility of human error or chance that staff will collude in
fraud)
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3. Directors responsibilities for
internal control (cont.)
Once the directors have set up system of internal control, they
are responsible for reviewingit regularly to ensure that it still
meets its objectives.
In order to ensure that they carry out their review function
properly, the board may decide to employ an internal audit
function to undertake this task.
When deciding whether an internal audit function is required, directors
will need to consider the extent of systems and controls, and
the relative expense of obtaining checks from other parties, such as the external
auditors
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3. Directors responsibilities for internalcontrol and the UK CG Code
In the UK, if the board does not see the need for an internal
audit function, the UK Corporate Governance Code requires
companies to consider the need for one annually
Therefore, need for internal audit is regularly reviewed.
Same code also recommends that the board of directors
reports on its review of the companys risk management and
internal controls systems as part of the annual report.
Statement should be based on an annual assessment of internal
control which should confirm that the board has considered all
significant aspects of internal control.
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June 2015 AA - CG
Audit committees
An independent sub-committee of the Board of Directors
Helps a company maintain objectivity with regard to
financial reporting and the audit of financial statements. Membership
Non-executive directors (NED)
Minimum three (two for smaller companies)
At least one with recent, relevant financial experience
Written terms of reference
4. CG and the auditor
Audit Committees
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Terms of reference include:
Monitoring the integrity of the financial statements
Review internal control (IC)
Monitor and review internal audit (IA)
Recommend the appointment of auditors
Monitor and review the external auditor
Decide on non-audit services (NAS) provision by the
external auditors
4. CG and the auditor
Audit Committees (cont.)
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Board of Directors
NEDs
Audit
Committee
Executive
Directors
Auditors Other duties
Shareholders
(Owners)
4. Audit CommitteesA part of IC
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4. The Audit Committee
Audit
Committee
Auditors Other duties
Internal audit
External audit
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a) The executive directors may not understand the purpose of
an audit committee and may perceive that it detracts from
their authority.
b) There may be difficulty selecting sufficient non-executive
directors with the necessary competence in auditing mattersfor the committee to be really effective.
c) The establishment of such a formalised reporting procedure
may dissuadethe auditors from raising matters of judgement
and limit them to reporting only on matters of act.d) Costsmay be increased.
June 2015 AA - CG
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4. Auditors responsibilities for internal
control and the UK CG Code
In summary, the auditors should review the
statements made concerning internal control
in the annual report to ensure that they appear
trueand are not in conflict with the audited
financial statements.
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4. Communication with those
charged with governance
Auditors shall communicate specific matters to
those charged with governance and ISA 260
provides guidance to auditors in this area.
Those charged with governance is defined by ISA 260 as
the person(s) or organisation(s) with the responsibility for
overseeing the strategic direction of the entity and
obligations related to the accountabilityof the entity.
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4. Importance of Communication with
those charged with governance
It assists the auditor and those charged with governance to
understand audit-related matters in context and allows them
to develop a constructive working relationship.
It allows the auditor to obtain information relevant to the
audit.
It assists those charged with governance to fulfil their
responsibilityto oversee the financial reporting process,
thus reducing the risks of material misstatement in the
financial statements.
June 2015 AA - CG
49
4 Matters to be communicated by
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4. Matters to be communicated by
auditors to those charged with
governance
The following matters shall be communicated to those charged
with governance:
Auditors responsibilities in relation to the financial statement audit
Planned scope and timing of the audit
Significant findings from the audit
Auditor Independence
The auditor shall communicate with those charged with
governance on a timely basis. A written communication of key issues will usually be stated in a
report to management setting out significant deficiencies encountered
in internal control discovered during the audit, the implications of the
deficiencies and related recommendations.June 2015 AA - CG
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June 2015AA - CG
At this stage of the course, some concepts may be unclear
As you progress through the course keep these key points in mind
1. All systems have ICs that should ensure that objectives are achieved
2. There is a globally accepted model of IC (COSO)
3. Statutory auditors are mainly interested in the systems that relate tothe FSs (i) the accounting system and (ii) the CG system. Most of
your studies will focus on the accounting system.
4. A great deal of an internal auditors time nowadays is spent on CG
and risk work (lecture 5)
5. Audit committees (part of CG) enhance independence - a keyconcept in auditing
6. Directors and auditors respective duties (lectures 1 and 2)
4. CG and the auditor
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Institutional investors own over 70% of shares on the UK
stock market
Traditionally they have not got involved in the governance of
companies In recent years however, they have become more active
Using their votes, meeting with directors and intervening in
company decisions
A particular are where they have been active is directorsremuneration
June 2015 AA - CG
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The board of directors is at the apex of control of
companies
The way in which board tasks are carried out will
have a large impact on company performance Board structure is of crucial importance
Board structure will impact on the quality of these
board tasks
The key aspects of board structure and board tasks
are shown on following slide
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6. Summary
Corporate governance is the system by which companies aredirected and controlled. Good corporate governance is
important because the owners of a company and the people
who manage the company are not always the same.
The OECD Principles of Corporate Governance set out therights of shareholders, the importance of disclosure and
transparency and the responsibilities of the board of directors.
The UK Corporate Governance Code contains detailed
guidance for UK companies on good corporate governance. An audit committee can help a company maintain objectivity
with regard to financial reporting and the audit of financial
statements.
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6. Summary (cont.)
The directors of a company are responsible for ensuring that acompanys risk management and internal control systems are
effective.
Auditors shall communicate specific matters to those charged
with governance and ISA 260 provides guidance to auditors inthis area.
Institutional shareholders, who dominate the London Stock
Exchange, have taken a more active role in the affairs of listed
companies in recent years. Activism takes the form of using their votes, meetings with directors
and intervention in a companys affairs.
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Homework
Read the set text (Chapter 3), browse the following
slides (appendix) and some of the sites given in the
references section below
Do the quick quiz and Q4 For the tutorial
Read about internal control (use any texts and websites)
Make sure you understand the objectives of an internal
control system
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Further reading and reference
FRC (2014) UK Corporate Governance Code https://www.frc.org.uk/Our-Work/Codes-Standards/Corporate-governance/UK-Corporate-
Governance-Code.aspx
FRC (2005) Internal control - revised guidance for directors on the combined code
https://www.frc.org.uk/getattachment/5e4d12e4-a94f-4186-9d6f-19e17aeb5351/Turnbull-guidance-
October-2005.aspx
ICAEW (2014) UK Corporate Governance Code http://www.icaew.com/en/library/subject-gateways/corporate-governance/codes-and-reports/uk-
corporate-governance-code
ICPAI (2011) Ten To-Dos for Audit Committees in 2011
http://www.accountingnet.ie/business_finance/Ten_To-Do_s_for_Audit_Committees_in_2011.php
FRC (ICPAI) (2011)FRC Acts to Increase Transparency in Corporate Reporting
http://www.accountingnet.ie/financial_reporting/FRC_acts_to_increase_transparency_in_corporate_re
porting_printer.php
ICGN (2009) Global Corporate Governance Principles
http://www.icgn.org/files/icgn_main/pdfs/best_practice/icgn_cro_guidelines_%28short%29.pdf
http://www.ecgi.org/codes/documents/calpers.pdf
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ce-October-2005.aspxhttps://www.frc.org.uk/getattachment/5e4d12e4-a94f-4186-9d6f-19e17aeb5351/Turnbull-guidance-October-2005.aspxhttps://www.frc.org.uk/getattachment/5e4d12e4-a94f-4186-9d6f-19e17aeb5351/Turnbull-guidance-October-2005.aspxhttps://www.frc.org.uk/getattachment/5e4d12e4-a94f-4186-9d6f-19e17aeb5351/Turnbull-guidance-October-2005.aspxhttps://www.frc.org.uk/getattachment/5e4d12e4-a94f-4186-9d6f-19e17aeb5351/Turnbull-guidance-October-2005.aspxhttps://www.frc.org.uk/getattachment/5e4d12e4-a94f-4186-9d6f-19e17aeb5351/Turnbull-guidance-October-2005.aspxhttps://www.frc.org.uk/Our-Work/Codes-Standards/Corporate-governance/UK-Corporate-Governance-Code.aspxhttps://www.frc.org.uk/Our-Work/Codes-Standards/Corporate-governance/UK-Corporate-Governance-Code.aspxhttps://www.frc.org.uk/Our-Work/Codes-Standards/Corporate-governance/UK-Corporate-Governance-Code.aspxhttps://www.frc.org.uk/Our-Work/Codes-Standards/Corporate-governance/UK-Corporate-Governance-Code.aspxhttps://www.frc.org.uk/Our-Work/Codes-Standards/Corporate-governance/UK-Corporate-Governance-Code.aspxhttps://www.frc.org.uk/Our-Work/Codes-Standards/Corporate-governance/UK-Corporate-Governance-Code.aspxhttps://www.frc.org.uk/Our-Work/Codes-Standards/Corporate-governance/UK-Corporate-Governance-Code.aspxhttps://www.frc.org.uk/Our-Work/Codes-Standards/Corporate-governance/UK-Corporate-Governance-Code.aspxhttps://www.frc.org.uk/Our-Work/Codes-Standards/Corporate-governance/UK-Corporate-Governance-Code.aspxhttps://www.frc.org.uk/Our-Work/Codes-Standards/Corporate-governance/UK-Corporate-Governance-Code.aspxhttps://www.frc.org.uk/Our-Work/Codes-Standards/Corporate-governance/UK-Corporate-Governance-Code.aspxhttps://www.frc.org.uk/Our-Work/Codes-Standards/Corporate-governance/UK-Corporate-Governance-Code.aspxhttps://www.frc.org.uk/Our-Work/Codes-Standards/Corporate-governance/UK-Corporate-Governance-Code.aspxhttps://www.frc.org.uk/Our-Work/Codes-Standards/Corporate-governance/UK-Corporate-Governance-Code.aspx 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Further reading (cont.)
ICAEW (2008) The Impact of Audit Committees on Auditing http://www.icaew.com/index.cfm/route/161273/icaew_ga/Technical_and_Business_Topics/Thought_
Leadership/Audit_Quality_Forum_Evolution/The_impact_of_audit_committees_on_auditing__Audit
_Quality_Forum__Evolution__ICAEW/pdf
CalPERS (2008) Global Corporate Governance Principles
http://www.ecgi.org/codes/documents/calpers.pdf
Monks and Minnow (2008) Corporate Governance Wiley
IoD (2009) Selecting, appointing and training non-executive directors
http://www.iod.com/Mainwebsite/Resources/Document/selectingnxd.pdf
Blowfield and Murray (2008) Corporate Responsibility Oxford
Solomon (2010) Corporate Governance and Accountability3rd.edn.Wiley
FRC (2006) Good practice suggestions from the Higgs report http://www.frc.org.uk/documents/pagemanager/frc/Suggestions%20for%20good%20practice%20from
%20the%20Higgs%20Report%20June%202006.pdf
OECD (2004)Principles of Corporate Governance
http://www.oecd.org/corporate/oecdprinciplesofcorporategovernance.htm
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Further reading (cont.)
Commonwealth Secretariat (1999)Principles for corporate governance in theCommonwealth
http://www.ecgi.org/codes/documents/cacg_final.pdf
Also look for [PPT] Asia Region Corporate Governance Roadmap Workshop -IFC Home at:
http://www.ifc.org/searchresults.html?cx=009183910618791464029%3Aik2jtgcdpms&cof=FORID%
3A11&ie=&q=commonwealth&=go#1084
European Corporate Governance Institute http://www.ecgi.org/codes/all_codes
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Appendix 1
The UK Corporate Governance Code, 2014
The Code
Section A
Leadership
Section B
Effectiveness
Section C
Accountability
Section D
Remuneration
Section E
Relationswith
shareholders
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The UK Corporate Governance Code2014
Introductory sections
The Preface
The Code is limited; it is a guide ingeneralterms
to principles, structure and processes.
It cannotguaranteeeffective board behaviour
The spirit of the Code
Directors are responsible for governance of a specific
entity
This requires continuing and high quality effort
The Codes function is to helpthe directors
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The UK Corporate Governance Code2014
Introductory sections (cont.)
The Preface (cont.)
The Code recommendsthat, in the interests of
greater accountability, alldirectors (of FTSE 350*
companies) should be subject to annual re-election
* The FTSE 350 is a market index incorporating the largest 350 companies bycapitalisation listed on London Stock Exchange
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The UK Corporate Governance Code2014
Introductory sections (cont.)
The Concept of comply or explain
The Code consists of variousprinciples
Principles need not be followed if there are good
reasons Compare a rule-based approach
However, if principles are breached one rule does apply:
explain your actions
The LSE Listing Rulesrequirecompanies to applythe Main Principles and report to shareholders
on how they have done so
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The UK Corporate Governance Code2014
Introductory sections (cont.)
The Concept of comply or explain (cont.)
Companies and shareholdersboth have
responsibility for ensuring that comply or
explain remains an effective alternative to arules-based system
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The UK Corporate Governance Code, 2014
The Code
Section A
Leadership
Section B
Effectiveness
Section C
Accountability
Section D
RemunerationSection E
Relationswith
shareholders
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The Combined Code on Corporate Governance
SectionA - Leadership
A1 - The role of the board
Main principles
Every company should be headedby an effective
board, which is collectivelyresponsible for the long-
term success of the company Key supporting principles
The board give entrepreneurial leadership
Set strategic aims and provide resources to achieve
company objectives
Establish companys values andstandards
Code provisionsvisit website for details
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The Combined Code on Corporate Governance
Section ALeadership (cont.)
A2Division of responsibilities
Main principle Responsibilities for running the board and running the business
should separated
Code provision Running the board (chairman) and running the business (chief
executive) should be undertaken by different directors
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The Combined Code on Corporate Governance
Section ALeadership (cont.)
A3The chairman
Main principle Responsibility for leadership of the board
Supporting principle Visit website for details
Code provision Independence criteria must be considered (see B.1.1)
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The Combined Code on Corporate Governance
Section ALeadership (cont.)
A4Non-executive directors (NEDs)
These are directors that do not undertake executive decision-making
Main principle
NEDs challenge and advise on strategy proposals
Supporting principles
NEDs scrutinise performance, controls and risk
management
Determine executive directors remuneration
Code provision Visit website for details
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The UK Corporate Governance Code, 2014
The Code
Section A
Leadership
Section B
Effectiveness
Section C
Accountability
Section D
RemunerationSection E
Relationswith
shareholders
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The Combined Code on Corporate Governance
Section BEffectiveness
B1Composition of the board
Main principle
Directors should have an appropriate balance of skills,
experience, independence and knowledge
Supporting principles
Appropriate size of board
Appropriate mix of EDs and NEDs
No individual or small group can dominate
Code provisions
Relate to independence and the proportion of NEDs Visit website for details
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The Combined Code on Corporate Governance
Section BEffectiveness (cont.)
B2Appointment of directors
Main principle
There should be a formal, rigorous and transparent
procedure for the appointment of new directors to theboard
Supporting principles
Candidate search by merit
Orderly succession
Code provisions Visit website for details
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The Combined Code on Corporate Governance
Section BEffectiveness (cont.)
B3Commitment
Main principle All directors should receive induction on joining the board and
should regularl y update and refresh their skills and knowledge
Code provisions
Visit website for details
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The Combined Code on Corporate Governance
Section BEffectiveness (cont.)
B4Development
Main principle All directors should be able to allocate sufficient time to the
company to discharge their responsibilities effectively
Supporting principles Directors skills and knowledge must be updated
Code provisions
Visit website for details
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The Combined Code on Corporate Governance
Section BEffectiveness (cont.)
B5Information and support
Main principle The board should be supplied in a timely manner with information
in a form and of a quality appropriate to enable it to discharge its
duties
Supporting principles Visit website for details
Code provisions Visit website for details
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The Combined Code on Corporate Governance
Section BEffectiveness (cont.)
B6Evaluation
Main principle The board should undertake a formal and rigorous annual
evaluation of i ts ownperformance and that of its committees and
individual directors
Supporting principles Chairman evaluates performance and proposes new members and,
or resignations of current directors
Code provisions Visit website for details
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The Combined Code on Corporate Governance
Section BEffectiveness (cont.)
B7Re-election
Main principle FTSE 350 companies: All directors should be submitted for annual
re-election
Other companies, not more than three yearly
Code provisions Visit website for details
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The UK Corporate Governance Code,2014
The Code
Section A
Leadership
Section B
Effectiveness
Section C
Accountability
Section D
Remuneration
Section E
Relationswith
shareholders
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The UK Corporate Governance Code
Section CAccountability
C1Financial and business reporting Main principle
The board should present a balanced and understandable
assessment of the companys position and prospects
Supporting principle
Responsibility extends to statutory and other reports
Code provisions
Directors and auditors should explain their respective duties in annual
report
Report on the business model and going concern status
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The UK Corporate Governance Code
Section CAccountability (cont.)
C2Risk management and internal control This section refers the reader to the Turnbull guidance
Main principle
The board should determine acceptable risks And maintain sound risk management and internal controls
Code provision
Annual review and report of financial, operational and compliance
controls and risk management systems
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Section CAccountability (cont.)
C3Audit committee and auditors(Smith Guidance)
Main principle
Establish corporate reporting, risk management and internal control
systems
Maintain relations with external auditors
Code provisions
Audit committee (minimum three NEDstwo for smaller entities)
Audit committee must have duties in writing
Monitor internal audit
Auditor related recommendations (appointment, removal)
Annual report on non-audit services provided by auditor
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The UK Corporate Governance Code, 2014
The Code
Section A
Leadership
Section B
Effectiveness
Section C
Accountability
Section D
Remuneration
Section E
Relations withshareholders
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Section DRemuneration
D1The level and components of remuneration
Main principle
Not more than necessary for the purpose
Substantially linked to performance
Supporting principles Performance related elements should promote the long term success of
the entity
Remuneration committee to be sensitive to pay conditions
Code provision
Schedule A of the Code gives advice on remuneration NED remuneration should relate to the time and commitmentgiven
Commitments of early contract termination must be considered
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Section DRemuneration (cont.)
D2Procedure
Main principle
Formal and transparent procedure
No director vote on own remuneration
Supporting principles
Remuneration committee appoints consultants
Code provision
A Remuneration committee is requiredNEDs (minimum three [two])
Responsible for remuneration Share-holder approval on long-term schemes
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The UK Corporate Governance Code, 2014
The Code
Section A
Leadership
Section B
Effectiveness
Section C
Accountability
Section D
Remuneration
Section E
Relations withshareholders
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Section ERelations with shareholders
E1Dialogue with shareholders Main principle
Dialogue on understanding of objectives
Supporting principles
Awareness of shareholder opinion
Code provisions
Communication of views between all executive and NEDs
Visit website for details
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Section ERelations with shareholders (cont.)
E2Constructive use of the AGM Main principle
Should be used to communicate with investors and encourage
participation
Code provisions
Resolutions should be presented individually
Audit,, remuneration and nomination committee chairmen should
attend
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The UK Corporate Governance Code
Schedules
Schedule A
The design of performance-related remuneration
for executive directors
Schedule B
Disclosure of corporate governance arrangements
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Appendix 2 Notes on Agency
Theory and CG
The Cadbury Report on financial aspects of corporategovernance, commissioned by the UK government,
identified the following various stakeholders in
companies.
Directors: responsible for corporate governance.
Shareholders: linked to the directors by the
financial statements.
Other relevant parties: such as employees,
customers and suppliers (stakeholders).
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GREENWICHTheoretical frameworks
Theories view subjects from different
perspectives
Two major theoretical approaches used to explain
CG are...
Agency theory
Stakeholder theory
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Agency theoryPrincipal (P)
Agent (A)
Stewardship accounting Owners, shareholders(P)
Directors, stewards, managers(A)
The agency problemSeparation of ownership (P) and control (A)
Objectives of P and A may be different
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GREENWICHAgency theory (cont.)
Control
The (Annual) General Meeting (AGM)
Should be the time for agents to account for themselves
Practical problems
Large ownership base (shareholders)
Owners interested in return not control
Short-termism (rather than maximising long-termreturns)
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Short-termism
Agents (directors)
Bonuses, salaries, benefits-in-kind
Residual losses Using company assets for private use, taking time off...
Principals (investors)
Churning
Focus on profit from share dealing, rather than the success ofthe company itself
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The exchange relationship (March and Simon, 1958)
Anybody, organisation, or even thing (animals,
environment) that is in some way involved with
the give and take of the presence of anorganisation in society
Contributions and inducements
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Specifically considering financial reportingaspects:
The Corporate Report (ASSC*, 1975)
The fundamental objective of corporate reports isto communicate economic measurements of, and
information about, the resources and performance
of the reporting entity useful to those having
reasonable rights to such information
* The original UK accounting standards body, now theFRC
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y ( )The Corporate Report ASSC, 1975
The Corporate Report questioned: Who should report what to whom?
Public accountability
Users of corporate reports...
1. Equityholders
2. Loan creditors
3. Employees
4. Analysts and advisors
5. Business contacts
6. Government
7 The public