FINS3626 Notes1. Introduction to corporate governance What is corporate governance?There is no single definition of corporate governance. The general definition is how a complex organisation is directed and controlled. It involves outlining the roles between shareholders and relevant stakeholders who may have influence on the corporation. The areas examined are internal control and regulations, board structures and roles of directors, accounting and auditing committees. The focus however, has recently shifted from shareholders (narrow view; agency theory) to stakeholders (broad view; stakeholder theory). Agency Theory: Shareholders are the owners and hires the management to run the company in their place. Conflict arises when the managers (agents) make decisions not in the best interest of owners (principals) forcing shareholders to control management through policies and incentives (agency costs). Transaction Cost Theory: suggests that companies are growing so large they essentially become markets and substitute allocation of resources. It removes market transactions and management directs and controls production. It is ideal to internalise costs as it removes uncertainty and risk of volatile prices. This paradigm assumes managers are opportunists and will act in their own interest. The difference between the two is the way that managers are categorised. Agency theory assumes moral hazard and agency costs while transaction costs describes as opportunistic. Another difference is the unit of analysis for agency is an individual while the other is a transaction. Stakeholder theory: a concept that involves philosophy, ethics, politics, law and economic theories in the decision making of a company. It suggests that companies have become so large that they account not just for shareholders but the greater community. Stakeholders relationship suggests that it is an exchange whereby stakeholders or suppliers contribute to the company and expect return. Social responsibility is in the forefront of current political and social climate and companies are to act in a socially ethical manner. Corporate governance involves four main components: People, principles, cultures & values and tools & mechanisms. Principles include: Ensuring basis for effective corporate governance framework Rights & equitable treatment of shareholders and ownership functions Role of stakeholders Disclosure and transparency Responsibilities of the board Tools and mechanisms: Codes Charter Committees Policies and procedures2. Regulation and Internal Arrangements Two types of regulation Self Regulation Advantages: Proximity: closer to industry; detailed and current market and industry information Flexibility: Corporations can construct their own policies to best fit firm objectives; lack of political constraints Compliance: greater involvement in industry may result in rules that seem more applicable and reasonable to individual firms. Collective Interests of Industry: competitors can police each other Disadvantages: Conflict of Interest: Inadequate Sanctions: may mete out modest sanctions for serious violations Underenforcement: May be insufficiently moderated Government Regulation: Corporation policies are constructed by government bodies such as ASIC, AASB, APRA Advantages: Responsibility to the Public Resources Legislative Support Disadvantages: Political Constraints Lack of Involvement with the industry Lack of Risk taking How should regulations be imposed? Rules: outlines that must follow and compels you to comply through punishment or threat Advantages: Simplicity: ease of compliance; outline clear guidelines Certainty: outcomes are predictable; less discretion & variations Disadvantages: Complex: when lawmakers try to address every issue it become tedious (tax) Oversimplification of complex concept: can be manipulated Requires updates Principles: recommendations that outlines options are most appropriate, recommend, should Advantages: Flexibility: regulate how individual companies see fit More incline to take risk Disadvantages: Requires skill in judgement making Difficult to compare with different companies Higher chance of mistake Current Regulations ASX CG: continuous process of amendments and recommendations; " the Principles and recommendations are not mandatory and do not seek to prescribe the corporate governance practices that listed entity must adopt"; Listing rules state that corporate governance practices should conform with the council's recommendations and if not, then to disclose reasons why 1. Lay solid foundation for management and oversight 2. Structure the Board to add value 3. Act ethically and responsibly 4. Safeguard integrity in corporate reporting 5. Make timely and balanced disclosure 6. Respect the rights of security holders 7. Recognise and manage risk 8. Remunerate fairly and responsibly CLERP (Corporate Law Economic Reform Program): 2004 Act in response to corporate collapses; Focused on remuneration disclosures and auditing; truth and fairness 1. Remuneration disclosure, directors' report and financial reporting and shareholder participation and information 2. Continuous disclosure reforms 3. Audit reform 4. Conflict of interest management, prospectus and product disclosure statement requirements and exemptions, enforcement and amendments Sarbanes-Oxley Act: key dimension 1. Governance: the board oversees financial reports and management; focus on independence 2. Management Certification 3. Audit Committee: provide audit of financial reporting process and financial statements; comprise of experts and independent directors 4. Public company accounting oversight board: standard of independence and ethics for auditors; requires three opinions: whether financial statements are fairly stated management assessment of internal control over financial reports whether internal controls over financial reporting process are effective 5. Internal controls: requires management to complete assessment of internal controls; auditors prohibited from providing non-auditing services but may document internal control