What is a Corporation?

To better understand the term corporation (revisit) its definition as stated in the Corporation Code of the Philippines. “A corporation is an artificial being created by operation of law, having the right of succession and the powers, attributes and properties expressly authorized by law or incident to its existence.” (The Corporation Code of the Philippines, Sec. 2) From the definition, we can get the following attributes of a corporation.

Artificial BeingWhich means that, by fiction of law a corporation is a juridical person whose personality is separate

and distinct from its owners. Corporation has some of the rights that a natural person possesses. It can sue and be sued in court, it can own and dispose properties and it is supposed to be given independence by its owners in terms of existence. Corporation can also be convicted on criminal offenses, fraud is an example.

Created by Operation of LawWhich means it will come into existence through a charter or a grant from the state. It cannot exist by

a mere agreement or a unilateral and self declaration of existence. Functions of corporations are governed strictly and it has to do within the bounds of what is being provided in the corporate charter.

Right of SuccessionA corporation can continue to exist even in death, incapacity or insolvency of any stockholder or

member. The corporation will not be dissolved even when there are transfers of ownership.

Powers, Attributes and PropertiesWhich means it is authorized to do activities within the purpose(s) of its creation, it has its own traits,

and it operates based on what has been expressly provided in the charter including those that are considered incident to its existence as a corporation for example, a fishing company need not ask if they could put up a storage facility for this purpose. These are examples of implied authority being given occasioned by the giving of the express authority.

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ManagementThis refers to the party given the authority to implement the policies as determined by the board in

directing the course/business activities of the corporation (SEC, Code of Governance). This is the group of people running the day-to-day activities of the corporation. This team is composed of decision makers from the top to the bottom of the corporate hierarchy. They are the ones entrusted by the stockholders to do some maneuverings for the corporation to reach its destination. They are the decision makers who will shape the future of the organization. The decisions that will be made by these people may spell-out failure or success of the corporation. Examples of people who belong to this party are the board of directors, officers, and other managers that in one way or another influence on the way the corporation is being run.

CreditorsThis refers to the party who lend to the corporation goods, services or money. Creditors may gain

from corporation by way of interest for money loaned or profits for goods sold or services rendered, thus it is important that in running the corporate affairs, the concerns of the creditors should be taken into consideration. It is comforting in the fact that whenever there is liquidation the first priority of payment belongs to the outside creditors.

ShareholdersThis refers to people who invest their capital in the corporation. The people who, in some cases

considered as the first believer of what the entity can do. These are people who bet their money and assume the high risk of having their money going down the drain. Unlike creditors, shareholders being part-owner of the entity cannot demand payment from the corporation. Creditors, on the other hand, can demand payment for principal and the interest and can go to court in case the borrowing corporation cannot pay its obligation.

EmployeesThese are the people who contribute their skills, abilities, and ingenuity to the corporation. They are

the ones who invested their future in the company with full trust and confidence that the entity would make them secure. Running the corporation with high emphasis on employees is popular in corporate world nowadays that when business owners decide to expand or diversify they always cite the number of jobs being created. And, when these businessmen are confronted with business challenges they always have this question, “what will happen to the employees?”

Employees and corporations have symbiotic relationships. In an ideal scenarios, employees do what is best for the corporation so that the corporation can provide them gainful and satisfying work. Good employees can contribute would lead to profit, profit could mean additional benefit to workers.

ClientsThe party considered to be the very reason for the existence of the corporation. They are the buyers of

the corporation’s product or services for final consumption, enjoyment, or maybe for the use in the production/creation of another goods. Clients or customers should be one of the paramount considerations in the operation of a corporation. It is important to note in this context that big businesses are directly or indirectly touching so many people’s lives. Some of these consumers are so dependent on what these big corporations are producing leaving them vulnerable to commercial exploitation. To balance best the interest of the customers, first there has to be unilateral and voluntary act of compassion by these businesses to consumers. Predatory instinct of corporations has to be reduced if not eradicated by having a sincere and visible operating philosophy which always place clients on the equation not just plain and simple profit driven motives.

GovernmentThe government has several interests in private corporations the most apparent of which are the taxes

that the corporations are paying. Taxes make government stay afloat and survive as highlighted in the “lifeblood theory” of taxation. Apart from taxes, corporate activities help economy, in general, and the individuals, in particular. Existence of businesses means jobs. Jobs provide income to individuals in forms of salaries. Salaries translate to purchasing power. It is worth emphasizing that it is the duty and responsibility of the government to provide the people the basic ways and means to survive and the government gets the biggest help from the corporations.

Aside from those mentioned, there are services offered by private corporations that somehow lessen the burden of the government, for example: health services, education, vital industries like power, water and transportion. In developing countries like Philippines, it can be expected that the government cannot provide these services to level of competence to the greater majority. The private corporations fill the gaps in helping the government in the delivery of these basic services to the people. Government is also a buyer of product of some corporation. Government also set standards and regulate important aspects of corporation activities. All these things make the government an important stakeholder of corporations.

Public The public has a stake in corporations that the latter provides the citizens with the essentials such as

goods, services, employment and tax money for public programs. The result of responsible or irresponsible conduct of these corporations can also affect public in so many ways. For example, if a corporation is environmentally inconsiderate by giving too much emphasis to their profit objectives, it is the public that would bear the brunt of the consequences like pollution, calamities, diseases and many other undesirable consequences.

Another aspect being considered are the concerns on natural resources. There is great public interest in businesses that belong to the extractive industries like mining, logging and petroleum exploration and extraction of exhaustible natural resources. There is nothing wrong with all these activities so long as what is due to the general public should be considered. In some cases, however, there is a problem of access to vital information and given that the locations of the operations of these businesses are in the far flung areas then the issue of access is aggravated. That is why it can be said that sometimes there exists a "bureau industrial conspiracy" which means that there is a connivance between the persons who decide on the part of the government and the representatives of the big businesses seeking government approval. This scenario leaves the people helpless in asserting their rights as stakeholders. These natural resources that they are trying to exhaust for profit belongs to the people and it is but normal and fitting that whatever they do the interest of the public should be considered.

PURPOSES OF A CORPORATION

Early Stage Survival

There are several theories on the aims and objectives of a corporation. However, for an entity which has just started, the main objective would be survival especially during the early years of its existence. Corporation should aim first for the most basic. That is, how to gain the momentum especially when its entry is during crisis, for it to withstand the hostile environment of commercialism.

To Increase Profit

According to Milton Friedman, the social responsibility of business is "to increase profit". This is anchored on the argument that stockholders are the owners of the corporation and therefore, corporate profits ultimately accrue to them. Corporate executives and hired managers are the stockholders' agents and should operate in the interests of their principal, the stockholders.

Stockholders are entitled to their profits as a result of a contract among the corporate stakeholders. A stakeholder in this perspective refers to employees, managers, customers, the local community (public) and the stockholders. Each cluster of stakeholder has a contractual relationship with the firm, since they receive the remuneration they mutually and freely agreed to, in a pre-established agreement or contract.

Based on the above, giving the corporation the authority to operate carries with it the idea that corporation should earn for the following purposes: first, to serve its purpose of existence which is to make the stockholders happy. Second, to perform its contractual obligation to stakeholders embedded in the grant of authority to operate. These includes but not limited to the payment of taxes to the government, taking care of employees within the bounds of what is legal, giving back to the community and many others which is part of the implied agreement for its existence.

To Offer Vital Services to the General Public

There are services that are hard for the government to offer to the vast majority of people without the help of private enterprises. The government cannot even solve by itself the problem as basic as traffic. It is in this contrast that partnerships between the government and the private corporations be considered to deal with some problems. Typical example of this in Metro Manila area where traffic is almost intolerable. Fortunately, the government got a big help from private investors in NLEX, SLEX, Northrail, Southrail, and other semi-private infrastructures and other mass transport system investors. Other services in which the government needs help are in the areas of power, water, education and health services.

To Offer Goods and Services to the Mass Market

Some corporations are run not only for the sole purpose of generating profit but also to provide service to masses. This endeavor will meet the needs of the lower income class group by offering them something at a price they can afford. For example, cheap and accessible transport service. Some might ask, what is the difference of this purpose from the previous one? First they differ in the area of pricing. Pricing in vital industries are not market-dictated. The investors are given guaranteed returns to cover for their investment risks. And, most are government sanctioned and enjoys an almost monopolized if not fully monopolized environment. Second, they differ in the area of competition. In a perfectly competitive market, the services and goods are easily obtainable because there are lots of suppliers. In the less-competitive vital industries obtained by government contracts, regulations and/or franchises, the services and goods are only provided buy a few or worse, by one producer.

SHAREHOLDERS, BONDHOLDERS AND DIRECTORS

After getting a significant understanding about the corporation and its stakeholders, one needs to know the other players of the corporation. Shareholders, bondholders and directors complete the cast when the corporation starts to operate. these are the parties which will be having various claims over the entity. shareholders will be having its claims in the form dividends. bondholders' claims will be in the form of interest earned via long term agreement. And, the directors will have their eyes on their salaries, incentives, stock options and bonuses.

To gain a better understanding, we need to discuss who they are and how they are related to the corporation.

Shareholders

Shareholders or Stockholders are artificial or natural persons that are legally regarded as owners of the corporation. Stockholders are bestowed with special privileges depending on the class of their stockholdings. These rights may include:

1. The right to vote on matters such as elections of the board of directors.2. The right to propose shareholders resolutions.3. The right to receive dividends.4. Pre-emption right which is the right to purchase new shares issued by the company to maintain its

percentage of ownership in the company. This can also be called right to first refusal.5. The right to liquidating dividends. That is the right to receive the company’s assets during

liquidation or cessation of business.

However, stockholders right to the company’s assets come only second to the rights of the outside creditors of the company. This means that stockholders typically may receive nothing if

after the company is liquidated, there is not enough money to pay its creditors. Shareholders play an important role in raising capital for organization, the capital that is otherwise hard to be raised in a proprietorship or partnership form of business organization.

Shareholders are considered principals, and the directors and officers are considered agents under the agency theory in governance. As principals, they are expecting that things that the agents would do would be for the paramount benefit of the stockholders .Although directors and officers of a company are bound by the fiduciary duties to act in the best interest of the shareholders, still the shareholders themselves deserves an independent third party that would attest on what the management team is doing. This is here where the external auditors would come into the picture to lend credibility on the report prepared by management.

Bondholder

A bondholder is generally defines as a person or entity that is the holder of a currently outstanding bond. A bond being a certificate of indebtedness by the issuing corporation provides some advantages on the holder of the said instrument. The holder has the complete authority to manage the bond in any way that he sees fit and advantageous to him. He can sell them for it is an investment on his part.

There are several advantages to being a bondholder rather than a shareholder of a company. One of the major advantages is that when the company goes through a process that involves the liquidation of assets, bondholders and other outside creditors are given priority over stockholders, which means that the bondholders will receive payments for the outstanding bonds before any of the stockholders receive theirs in relation to their outstanding shares of stock. Another advantage is that bonds are not exposed to the fluctuation of interest rates because whatever is the agreed interest rate when the bonds were issued it will be the one to be used throughout the life of the bonds. Interest rate is “nailed” so the bondholder need not worry. There is an element of predictability of income.

The bondholder will receive regular interest payments during the life of the bond computed at face value multiplied by the interest rate. This interest payment usually takes place every six months and will continue to go on until the maturity of the bond. Typically, the life of a bond would take as short as 5 years as long as 25 years. The bondholder has a guaranteed return of the principal at some point in the future. This makes investment in bonds rewarding on the part of the investor who can afford to have their money in the hands of the investor for longer periods of time.

Board of Directors

BOD refers to the collegial body that exercises the corporate powers of all corporations formed under the Corporation Code (SEC Code of Corporate Governance). It conducts all business and controls or holds all the assets of such corporations. This body is formed by the stockholders and they will act as the governing body of the corporation. The BOD will be headed by the chairman of the board who is considered as the most influential person in the corporation. The board’s activities are determined by the powers, duties and responsibilities delegated to it or conferred on it by an authority. These issues are typically detailed in the corporation’s by-laws. The by-laws normally specify the number of members of the board. It may also contain matters such as how the board members are to be chosen including the specifics on when and where they are going to meet to discuss things concerning the operation of a corporation.

Duties of the Boards of Directors

● governing the organization by establishing broad policies and objectives;Examples of these broad policies are as follows: investment policies that will answer the question as to

where to put excess money for additional revenue purposes; diversification policies that will answer the question as to what type businesses that the corporation will be getting into as additional lines of business in the near future.

Selecting, appointing, supporting and reviewing the performance of the chief executive.

As stewards of the corporation, the board of directors is expected to be with the chief executive in latter’s direct or indirect dealings with the corporation.

Ensuring the availability of adequate financial resources.

It is expected from the board that the survival and financial healthy functioning of the entity will be on the top of their agenda. With the coordination of people from the finance department, BOD has to make certain that funds are available to finance the day-to-day activities of the entities.

Approving annual budgets

Another responsibility of board of directors is to approve the annual budget,which can be described as the reflection of organizational program and plan into financial terms. The annual budget will more or less define the operations of the corporation at any given year.

Accounting to the stakeholders the organization’s performance

One of the most critical duty of the board of directors is to account for the entity’s performance to its stakeholders, more importantly, to the shareholders who are the owner of the corporation. They need to inform every stakeholder what went on at any particular given period. This can be accomplished by providing the report on financial highlight, short and long-term plans, material investments during the period, including the financial statements duly audited by an independent auditing firm.

MULTINATIONAL AND TRANSNATIONAL CORPORATION

International corporations have several categories depending on the business structures, investment, and product/service offerings. Multinational Companies (MNC) and Transnational Corporation (TNC) are two of these categories. Both MNC and TNCAre enterprises that manage production or delivers services in more than one country. They are characterized as business entities that have their management headquarters in one country, known as the home country, and operate in several other countries, known as host countries. Industries such as manufacturing, oil, mining, agriculture, consulting, accounting, construction, legal, advertising, entertainment, hotels, banking and telecommunications are often run through TNCs and MNCs.

Multinational corporations (MNC) have investment in other countries, but do not have coordinated product offerings in each country. They are more focused on adapting their products and service to each

individual local market. Well-known MNCs are mostly consumer goods manufacturers and quick service restaurants like Unilever, Proctor & Gamble, McDonald's and 7-11.

Transnational corporation (TNC) has been technically defined by the United Nations Commission on Transnational Corporations and Investment as "enterprises which own or control production or service facilities outside the country in which they are based."

A transnational corporation is any corporation that is registered and operates in more than one country at a time. A transnational has its headquarters in one country and operates wholly or partially owned subsidiaries in one or more other countries. The subsidiaries report to the central headquarters.

Compared with MNCs, transnational corporations are much more complex firms. They have invested in foreign operations, have a central corporate facility but give decision-making. R&D and marketing powers to each individual foreign market. Most of them come from petroleum, I.T, consulting, pharmaceutical industries among others. Examples are Shell, Accenture, Deloitte and Roche.

Many of them are owned by a mixture of domestic and foreign stockholders. Most TNCs and MNCs are massive with budgets than outweigh smaller nations' gross domestic product (GDP). For example, the combined 2011 GDP and sales revenues of top corporations (World Bank and Fortune Global 500) showed that the sales revenues of Royal Dutch Shell, Exxon Mobil, Wal-Mart Stores, BP and Sinopec Group was ranked 25th, 26th, 27th, 29th and 30th respectively.

Thus, TNC and MNC alike are highly influential to globalization, economic and environmental lobbying in most countries. Because of their influence, countries and regional political districts at times tender incentives to MNC and TNC in form of tax breaks, pledges of governmental assistance or improved infrastructure, political favors and lenient environmental and labor standards enforcement in order to be at an advantage from their competitors. Also due to their size, they can have a significant impact on government policy, primarily through the threat of market withdrawal. They are powerful enough to initiate lobbying that is directed at a variety of business concerns such as tariff structures, aiming to restrict competition of foreign industries.

Corporations have various motives for establishing a corporate presence in other countries. One possible motive is a desire for growth. A corporation may have reached a plateau meeting domestic demands and anticipate little additional growth. A new foreign market might provide opportunities for new growth.

Other corporations desire to escape the protectionist policies of an importing country. Through direct foreign investment, a corporation can bypass high tariffs that prevent its goods from being competitively priced. For example, when the European Common Market (the predecessor of the European Union) placed tariffs on goods produced by outsiders, US corporations responded by setting up European subsidiaries.

Two other motives are more controversial. One is preventing competition. The most certain method of preventing actual or potential competition from foreign businesses is to acquire those businesses. Another motive for establishing subsidiaries in other nations is to reduce costs, mainly through the use of cheap foreign labor in developing countries. A transnational corporation can hold down costs by shifting some or all of its production facilities abroad.

Transnational corporations with headquarters in the United States have played an increasingly dominant role in the world economy. This dominance is the most pronounced in the developing countries that rely primarily on a narrow range of exports, usually primary goods. A transnational corporation has the ability

to disrupt traditional economies, impose monopolistic practices, and asserts a political and economic agenda on a country.

Another concern with transnational corporations is their ability to use foreign subsidiaries to minimize their tax liability. The Internal Revenue Service (IRS) must analyze the movement of goods and services between a transnational company’s domestic and foreign operations and then assess whether the transfer price that was assigned on paper to each transaction was fair. IRS studies indicate that US transnational corporations have an incentive to set their transfer price so far as to shift income away from the United States and its higher corporate tax rates and to shift deductible expenses into the United States. Foreign-owned corporations doing business in the United States have a similar incentive. Critics argue that these tax incentives also motivate US transnational corporations to move plants and jobs overseas.

Company Overview: Walt Disney Company

The Walt Disney Company, together with its subsidiaries and affiliates, is a leading diversified international family entertainment and media enterprise with five business segments: media networks, parks and resorts, studio entertainment, consumer products and interactive media.

Media Networks

Media networks comprise a vast array of broadcast, cable, radio, publishing and digital businesses across two divisions – the Disney/ABC Television Group and ESPN Inc. In addition to content development and distribution functions, the segment includes supporting headquarters, communications, digital media, distribution, and marketing groups.The Disney/ABC Television group is composed of the Walt Disney Company’s global entertainment and news television properties, owned television station group, and radio business. This includes the ABC Television Network, ABC owned television station group, ABC entertainment group, Disney Channels worldwide, ABC family as well as Disney/ABC Domestic Television and Disney Media Distribution. The Company’s equity interest in A&E Television network, Music and Fusion round out the group’s portfolio of media businesses.

Parks and Resorts

When Walt Disney opened Disneyland on July 17, 19.., he created a unique destination built around storytelling and immersive experiences, ushering in a new era of family entertainment. More than 55 years later, Walt Disney Parks and Resorts (WDP&R) has grown into one of the world’s leading providers of family travel and leisure experiences, providing millions of guests each year, with the chance to spend time with their families and friends, making memories that will last forever. At the heart (WDP&R) are five world-class vacation destinations with 11-theme parks and 44 resorts in North America, Europe, and Asia, with a sixth destination currently under construction in Shanghai, WDP&R also includes the /Disney Cruise Line with its four ships--- the Disney Magic, Disney Wonder, Disney Dream, and Disney Fantasy. Disney Vacation Club with 12 properties and approaching a total of 200,000 member families, and Adventures by Disney which provides guided family vacation experiences to destinations around the globe.

The Walt Disney Studios

For over 90 years, The Walt Disney Studios has been the foundation on which the Walt Disney Company was built. Today, the studio brings quality movies, music, and stage plays to consumers throughout the world. Feature films are released under the following banners: Disney, including the Walt Disney

Animation Studios and Pixar Animation Studios, Disney Nature, Marvel Studios, Lucasfilm, and Touchstone Pictures, the banner under which live-action films from DreamWorks studios are distributed. The Disney Music Group encompasses the Walt Disney Records and Hollywood Records Labels as well as Disney Music Publishing. The Disney Theatrical Group produces and licenses live events, including Disney on Broadway, Disney on Ice and Disney Live!

Disney Consumer Products

Disney Consumer Products (DCP) is the business segment of The Walt Disney Company (NYSE:DIS) and its affiliates that delivers innovative and engaging product experiences across thousands of categories from toys and apparel to books and fine art. As the world’s largest licensor, DCP inspires the imaginations of people around the world by bringing the magic of Disney into consumers' homes with products they can enjoy year-round. DCP is comprised of three business units: Licensing, Publishing and Disney Store. The licensing business is aligned around five strategic brand priorities: Disney Media, Classics & Entertainment, Disney & Pixar Animation Studios, Disney Princess & Disney Fairies, Lucasfilm and Marvel. Disney Publishing Worldwide (DPW) is the world's largest publisher of children's books, magazines, and digital products, and also includes an English language learning business, consisting of over 40 Disney English learning centers across China and a supplemental learning book programs. DPW’s growing library of digital products includes best-selling eBook titles and original apps that leverage Disney content in innovative ways. The Disney Store retail chain operates across North America, Europe and Japan with more than 350 stores worldwide and is known for providing consumers with high-quality, unique products.

Disney Consumer Products (DCP) is the business segment of The Walt Disney Company (NYSE:DIS) and its affiliates that delivers innovative and engaging product experiences across thousands of categories from toys and apparel to books and fine art. As the world’s largest licensor, DCP inspires the imaginations of people around the world by bringing the magic of Disney into consumers' homes with products they can enjoy year-round. DCP is comprised of three business units: Licensing, Publishing and Disney Store. The licensing business is aligned around five strategic brand priorities: Disney Media, Classics & Entertainment, Disney & Pixar Animation Studios, Disney Princess & Disney Fairies, Lucasfilm and Marvel. Disney Publishing Worldwide (DPW) is the world's largest publisher of children's books, magazines, and digital products, and also includes an English language learning business, consisting of over 40 Disney English learning centers across China and a supplemental learning book programs. DPW’s growing library of digital products includes best-selling eBook titles and original apps that leverage Disney content in innovative ways. The Disney Store retail chain operates across North America, Europe and Japan with more than 350 stores worldwide and is known for providing consumers with high-quality, unique products.

CORPORATE GOVERNANCE

DEFINITIONS

The Malaysian High Level Finance Committee Report on Corporate Governance defined corporate governance as follows:

“Corporate governance is the process and structure used to direct and manage the business and affairs of the company towards enhancing business prosperity and corporate accountability with the ultimate objective of realizing long-term shareholder value while taking into account the interests of other stakeholders.”

and in turn become a source of their competitive advantage. Good reputation is just one example to these intangibles which could largely predict the future of the business. Better relations with employees engender employees’ commitment. Good relations with customers and suppliers complete the full circle of strong alliances.

Conscious Consideration of Interests of Other Stakeholders

When a company meets the objective of increasing the shareholder value, it will have greater internally-generated resources in improving its commitment in meeting its environmental, community and social obligations, it can pay taxes well, reward, train, and retain key staff, and enhance employee satisfaction. A key

focus area is company’s human capital, which is a lead indicator of success (Principle 1, Corporate Governance Principle, ADB and Hermes Pension Management).

WHAT GOOD GOVERNANCE PROMOTES

Transparency

Transparency is vital with respect to good governance due to critical nature of reporting financial and non-financial information. The aim includes maintaining investor, consumer and other stakeholders’ confidence. The lack of dedication to corporate governance policies particularly those related to transparency will drive home the point that the company is unbalanced and the leadership is not incorporating it to the highest level of truthfulness. Failure on transparency issues could lead to many things, scaring off investors is just one of them, being singled out by the authority is another which could mean the watchful eyes of the agencies will be focused on the company and many other uncomfortable scenarios which no company wants to be in.

Information is the currency of democracy according to Thomas Jefferson. Transparency is a thing of huge concern in government setting since it entails giving out of information. It is crucial because nearly all the decisions of government officials are in the interest of the public. Transparency lessens the likelihood of nepotism, corruption, favoritism and the likes. Shortage of information about the how the government agencies functions can make it easy to corrupt officials to cover their tracks. It can be said that the most corrupt countries are the least transparent. Sunshine has its cleansing properties; so let the light in.

Accountability

Accountability is the recognition and assumption of responsibility for the decisions, actions, policies, administration, governance and implementation of programs and plans of the corporate people involved, including the obligation to report, explain and be answerable for its resulting consequences. It is acknowledging and taking charge for and being transparent about the impacts of the company’s policies, decisions, actions, products and its associated performance.

It is based on the premise that an accountable organization will take action to: Set a policy based on a comprehensive and balanced understanding and response to material

stakeholders’ issues and concerns; the emphasis on this premise is the overall broad philosophy and operating style of the entity itself.

Set goals and standards against which strategy and associated performance can be measured and evaluated. This highlights the deliverables by the people to the organization.

Disclose credible information about strategy, goals, standards and performance to those who base their actions and decisions on this information. In this way, there will be goal congruence in the organization.

Recall that the above premises are actually the fundamental objectives of corporate governance: (1) improvement of stakeholders value and (2) conscious consideration of the interests of other stakeholders.

PrudencePrudence is defined within the Code of Corporate Governance as “care, caution and good judgment as

well as wisdom in looking ahead.” It is the management committee which is in corporate setting, the board of director, who will be the body responsible in safeguarding the interests of the organization through good planning and management of finances and other resources of the organization.

BENEFITS OF GOOD GOVERNANCE

To put it into perspective, Arthur Levitt (former chairman of the US Securities & Exchange Commission) once said, “If a country does not have a reputation for strong corporate governance practices, capital will flow elsewhere. If investors are not confident with the level of disclosure, capital will flow elsewhere. If a country opts for lax accounting and reporting standards, capital will flow elsewhere. All enterprises in that country suffer the consequences.” From investors’ perspective a simple question can be raised, “will you invest in a region or a country the track record of which in governance is questionable? If yes, how long?”

It is a well-established reality that investors would behave differently in settings in which good governance, both in political and corporate setting, is not seriously practiced. Investors’ concern will be more on short-term prosperity instead of long-term stability. There are many countries in the world where investors are so speculative. One of evidences of these speculative behaviours are the fact that they are now more flexible in terms of location. For instance, HSBC, in Hong Kong, has a collapsible building; that is, it can be dismantled, shipped out, and assembled at a place of choice. A better example is in utility services, there was a time in Nigeria when utility companies providing power are having their main supply of power in barges for them to easily get out of the country if something goes wrong.

It can be deduced that good governance immeasurably benefits not only a specific company or industry but also the country. The following are the specific benefits of good governance.

Reduced VulnerabilityAdopting good corporate governance practices leads to an improved system of internal control. This

leads to greater accountability, protection of corporate resources and eventually, better profit margins. Good corporate governance practices will also pave the way for probable future development, diversification, including the capability to attract investors, both sourced nationally and abroad. Good corporate governance will also reduce the cost of loans and credits for corporations since companies with good governance can be considered low-risk companies in the eyes of debt investors.

MarketabilityEmbracing principles of good corporate governance can also play a role in enhancing the corporate

value of companies. This leads to easy access to capital in financial markets which helps the company survive in an even more competitive environment. Good corporate governance will also make the company more attractive in open market. This attribute will be beneficial and will place the company at the finer end of the bargaining in times when strategic alliances are needed. Examples of these strategic alliances are mergers, acquisitions, corporate absorptions and buy outs, partnerships, joint ventures and other risk mitigating initiatives.

CredibilityThere are a good number of benefits when an entity embraces good corporate governance, one of

which is the company need not spend more resources in compliance with the regulatory and other financial institutions necessary since all these things are already integrated in company’s operating approach.

Companies that are known for good governance practices do not need to sell themselves that hard for the investors to fuse in their investments either as equity or as debt investors. In the context of investment, everything could raise and fall in credibility and reputation. When a company is credible, investors trust comes next, where investors’ trust is in, money follows, when there is money, there is flexibility. It is in having that flexibility in a competitive world that could spell out the difference between failure and success.

ValuationObserved evidence and studies conducted in recent years back the idea that it pays to have good corporate governance. It was found out that more than 84% of the global investors are willing to

pay a higher price or a premium for the shares of a well-governed company over one considered poorly governed given all financial figures comparably equal. The issue is reliability of company provided-information. This is one convincing fact that embracing corporate governance principles and practices affects corporate financial and non-financial value of the enterprise.

AGENCY PROBLEM IN CORPORATIONSIn traditional (neo-classical) approach, corporation is treated as a single entity. It is often called holistic approach. It is one of the features of a sole proprietorship. Owner-managers have no conflicts of interest. In big companies, we almost always have the separation of owners and managers. Financial manager should work in the best interests of the owners by taking actions that increase the value of the company. However, we’ve also seen that in large corporations ownership can be spread over a huge number of stockholders.

If we assume that stockholders buy stocks because they gain financially, then the answer is obvious, good decisions increase the value of the stock and bad decisions decrease the value of the stock. It follows that the financial manager acts in the stockholders best interest by making decisions that increase the value of stocks. The goal of financial management is to maximize the correct value per share of the existing stock.

The separation of stockholders and management has some advantages. It allows share ownership to change without interfering so much with the operations of the business. It allows the company to hire professional managers. This dispersion of ownership means that managers, not owners can control the firm. But, it brings problems if the managers’ and owners’ objectives are not the same and whether management really acts in the best interest of the owners.

` The goal of maximizing the value of the stock avoids the problems associated with the sometimes conflicting parochial goals. There is no ambiguity in the criterion and there is no short run and long run issue. We explicitly mean that our goal is to maximize the current stock value. By this we mean that they are only entitled to what is left to the employees, suppliers and creditors (and anyone else with a legitimate claim) are paid their due. If any of these groups go unpaid, the stockholders get nothing. Because the goal of financial management is to maximize the value of stocks, we need to learn how to identify those investments and financing arrangements that favorably impact the value of the stock.

Agency Relationship and Costs The connection between owners and managers is called an principal-agent problem and the conflict is

called an agency relationship. Such relationship exists whenever someone (the principal) hires another (the agent) to represent his interests. The shareholders are the principals; the managers are their agents. Shareholders want management to increase the value of the firm, but managers may have their own axes to grind or nests to feather. Agency costs are incurred when (1) managers do not attempt to maximize firm value and (2) shareholders incur costs to monitor the managers and influence their actions. More generally, the term agency costs refers to the costs of the conflict of interest between stockholders and management. Of course, there are no costs when the shareholders are also the managers.

Agency costs can be indirect or direct. An indirect agency cost is a lost opportunity such as the one we have just described. Direct agency costs come in two terms. The first type is a corporate expenditure that benefits management but costs the stockholders. Perhaps, the purchase of a luxurious and unneeded corporate jet would fell under this heading. The second type of direct agency cost is an expense that arises

from the need to monitor management actions. Paying outside auditors to assess the accuracy of financial statement information could be one example.

Goals of Financial Management Assuming that we restrict ourselves to for profit businesses, the goal of financial management is to make

money or add value for the owners. This goal is a little vague, of course, so we examine some different ways of formulating it in order to come up with a more precise definition. Such a definition is important because it heads to an objective basis for making and evaluating financial decisions.

If we were to consider possible financial goals, we might come up with some ideas like the following:

1. To survive 2. To avoid financial distress and bankruptcy 3. To beat the competition 4. To maximize sales or market shares 5. To maximize costs 6. To maximize profits 7. To maintain a steady earnings growth.

What would be the management goal if they have no control at all? One of main answer comes from outside the mainstream economy. It is the idea that mangers prefer the company to be bigger than more profitable. So mangers left to themselves would tend to maximize the amount of resources over which they have control or, more generally, corporate power or wealth. This goal could lead to an overemphasis on corporate size or growth.

Our discussion shows that management may tend to overemphasize organizational survival to protect job security. Also, management may dislike outside interference, so independence and corporate self-sufficiency may be important goals.

Do Managers Act in the Stockholders’ Interest?Principal-agent problems would be easier to resolve if everyone had the same information. That is

rarely the case in finance. Managers, shareholders, and lenders may all have the same information about the value of a real or financial asset, and it may be many years before all the information, the perfect information is revealed. Financial managers need to recognize these information asymmetries and find ways to reassure investors that there are no nasty surprises on the way.

Whether managers will, in fact, act in the best interests of stockholders depends on two factors, first, how closely the management goals aligned with stockholder goals? This question relates to the way managers are compensated. Second, can management be replaced if they do not pursue stockholders goals? This issue relates to the control of the firm. As we will discuss, there are a number of reasons to think that even in the largest firms, management has a significant incentive to act in the interest of the stockholders. Managerial Compensation

Management will frequently have a significant economic incentive to increase share value for two reasons. First, managerial compensation, particularly at the top, is usually tied to financial performance in general and enhancements to share value in particular. For example, managers are frequently given the option to buy stocks at a bargain price. The more the stock is worth, the more valuable is this option. In fact, options are increasingly being used to motivate employees of all types, not just top management.

The second incentive managers have relates to job prospects. Better performers within the firm will tend to get promoted. More generally, those managers who are successful in pursuing stockholder goals will be in greater demand in the labor market and thus command higher salaries. In fact, managers who are successful in pursuing stockholder goals can reap enormous rewards.

Control of the FirmControl of the firm ultimately rests with stockholders. They elect the board of directors who in turn,

hire and fire the management. An important mechanism by which unhappy stockholders can to replace existing management is called a proxy fight. A proxy is the authority to vote someone else’s stock. A proxy fight develops when a group solicits proxies in order to replace the existing board and thereby replace existing management.

Another way that management can be replaced is by takeover. Those firms that are poorly managed are more attractive as acquisitions than well-managed firms because a greater profit potential exists. Thus, avoiding a takeover by another firm gives management another incentive to act in the stockholders’ interests.

StakeholdersManagement and stockholders are not the only parties with an interest in the firm’s decisions.

Employees, customers, suppliers and even the government all have a financial interest in the firm. Taken together, these various groups are called stakeholders in the firm. In general, a stakeholder is someone other than a stockholder or creditor who potentially has a claim on the cash flows of the firm. Such groups will also attempt to exert control over the firm, perhaps to the detriment of the owners.

AGENCY THEORY IN GOVERNANCEAgency theory suggests that the firm can be viewed as a loosely defined contract between resource

providers and the resource controllers. It is a relationship that came into being occasioned by the existence of one or more individuals, called principals, employing one or more other individuals, called agents, to carry out some service and then entrust decision-making rights to the agents. Agency theory argues that in the modern corporation, in which share ownership is publicly or widely-held, managerial actions sometimes depart from those required to maximize shareholder returns. In agency theory language, the owners are principals and the managers are agents, and there is an agency loss necessary, the extent of which, is the benefits that should have accrued to the owners had the owners been the ones who exercised direct control of the corporation.

The agency loss can be reduced through the installation of some mechanism like providing financial incentives for executives and managers for their efforts of putting priority on maximizing the shareholders’ wealth. This system includes shares options for senior executives at discounted prices. This way the senior executives’ interest will be aligned to that of the shareholders. Other similar systems tie executive compensation and levels of benefits to the shareholders’ returns and have part of executive compensation deferred to the future. This is to provide executive rewards on for the long-run value maximization of the corporation. This system would deter short-run executive mentality of “harvest and enjoy while available” and other actions which harms corporate value.

In similar terms, the related theory of organizational economics, is concerned in anticipating managerial “opportunistic behavior” which includes policy skirting and indulging in excessive privileges at the expense of shareholder interests. The key structural mechanism to restrain such managerial “opportunism” is the board of directors. This body should provide a monitoring of managerial actions on behalf of shareholders. Such impartial review will only take place when the chairman of the board is independent of executive management. Where the chief executive officer is also chairman of the board of directors, the objectivity of the board will possibly be compromised. Agency and organizational economics theories predict that when the CEO also holds the dual role of chair, then the interests o f the owners will be sacrificed to a certain degree in

favour of management, that is, there will be managerial opportunities and agency loss. This loss is way above the owners normal benefits had they been the ones performing the agents’ functions of running the day-to-day corporate activities.

EFFECTS OF AGENCY IN GOVERNANCEAs said earlier, corporation is a form of business organization where a principal-agent relationship

exists, the shareholder being the principal and the board of directors, executive and managers as the agents. This unique relationship also presents a very unique effect in the context of corporate governance. The following are the effects of agency in corporate governance.

Conflict of InterestPrincipal and agent have diverse interests, and the separation of ownership and control provides

potential for different interests to surface. Shareholders lack direct control of corporations, especially those which are publicly-traded corporations. Board of directors, on the other hand, has the direct control on the activities of these enterprises being the ones entrusted by the shareholders to decide on corporate affairs. In the above situation, it can never be avoided that sometimes problems arise when the agent makes decisions that result in the quest of goals that conflict with those of the shareholders.

Managerial OpportunismManagerial opportunism refers to the act by the agent of taking advantage on things that are within his

control by virtue of the rights given to him by the principal. Sometimes, the uncalibrated and unchecked enjoyment of corporate resources and capabilities contradicts the idea of increasing the shareholders’ and firm’s value. Excessive monetary benefits like bonuses and privileges, routine efforts of trying to secure comfortable position like undue diversification to increase compensation and to reduce employment risk, are just some of examples of managerial opportunism.

Incurrence of Agency CostAs mentioned earlier, agency presents conflicts of interest because agents might do things which are

detrimental to the maximization of shareholders’ wealth. To counter this, the principal needs to sacrifice resources for him to closely monitor and control agent’s behaviour. These costs are called agency cost, which refers to the sum of incentive costs, supervision and monitoring costs, enforcement costs and other agency losses incurred by principals in trying to ensure that agent’s operating style is consistent with the aim of maximizing the shareholders’ and the firm’s value.

Shareholder ActivismShareholders can call together to discuss the corporations'. They can vote as a block to elect their

candidates to the board. Institutional activism will also offer on companies with good corporate governance since this type of activism carries with it the capability to give incentives when agents perform well. Another issue that is connected to shareholder activism is share ownership. Having some board members, executives and managers that are at the same time shareholders may cause alignment of interest with other plain shareholder. This is especially applicable with institutional investors. The increasing pressure and power of institutional owners to discipline ineffective top-level managers will now definitely influence the firm's choice of strategies to be employed in internal governance.

Managerial DefensivenessThis is in relationship to issues of takeovers whereby management will employ some tactics to

discourage takeovers and buyouts. These tactics may involve asset restructuring via termination of investments, changes in financial restructuring of the firm such as acquisition of own shares in open market, presenting bad takeover scenarios to the shareholders for them not to approve takeover. Normally, in a

takeover, the non-performing executives and managers are dismissed from their jobs. This anti-takeover tactics are discussed in a different chapter of this book.

Concept of Goal CongruenceGoal congruence is the harmony and alignment of goals of both principal and the agent which is

consistent with the overall objectives of the organization. While it is true that in agency relations, the presence of self-interested behaviors is a given. Nevertheless, managers can be encouraged to act as shareholder's best interests by giving incentives which will compensate them for good performance on one hand at the same time give them disincentives on their poor performance on another.

Corporate Governance of Oracle Corporation The board of oracle corporation has throughout its history developed corporate governance practices

to fulfill its responsibility to oracle corporation shareholders. The corporation and activities of the company's board of directors, the approach to public disclosures and the availability of ethics and business conduct resources for employees exemplifies the company's commencement to good corporate governance practices, including compliance with new standards.

The board has adopted the following corporate and committee guidelines to help ensure it has the necessary authority and procedures in place to oversee the work of management and to exercise independence in evaluating oracle corporation's business operations. These guidelines allow the board to align the interests of directors and management with those of oracle corporation's shareholders. All guidelines are subject to future refinement or

changes as the Board may find necessary or advisable for Oracle Corporation in order to achieve the above objectives.

Oracle continuously applies good corporate governance principles to multiple areas of the Company in addition to those guidelines. Oracle has had a Code of Ethic and Business Conduct since 1996.

PERFORMANCE INCENTIVES AND DISINCENTIVES

Pay Dependents on Profit levelWhen management is rewarded based on the level of profits made, naturally members of

management will make every effort to achieve high profits levels for them to earn more. This system is the most effective way to increase not only the value of shareholders wealth but also the value of the firm, both in tangible and intangible context. The flip side this scheme, however, is that it encourage the use of creative accounting and reporting practices to attain certain profit objectives. For example, the infamous corporate scandals, the mark to market accounting used by Enron Corporation is one of the most glaring of these creative practices.

Share IncentivesThis can be done when a company is a publicly-listed company and managers are given a chance to

subscribe shares of the company at a discounted price. Managers will have something to protect and it can be naturally expected that they will venture into projects which will improve the firm’s value. In this system, there is commonality of stake between the plain shareholders, and those executives and managers that are at the same time shareholders. Duality of capacities of executives and managers are not without disadvantages, intricacies on shareholders at the same time agents will be discussed further in agency problem in a succeeding chapter of this book.

Shareholders’ Intervention

There is now a visible shift of character of shareholders by a large scale. Shareholders of today are now more active than before. They now dip their hands more unlike before when some of them will just wait on what the board will present on the table. Some shareholders are now active institutional investors who will definitely exercise a more direct influence over the performance of the enterprise. They are now taking an active role by scrutinizing performance of the company, and are very swift in their efforts of lobbying with other small shareholders when they believe poor service or any mismanagement by the directors is happening.

It is the above characters that will make board, executives, and managers more connections on the way they manage and decide things. It will make their decisions more leaning in favour of shareholders knowing that somebody is watching over their shoulders. Somebody keenly monitoring on the operating philosophies they employ.

Threat of being fired

The shareholders who have ultimate control over of the corporation can take a straight and hostile approach by threatening the board, executives and managers with removal from office if they place their personal interests over that of shareholders’ and that of maximizing the value of the firm. The increase in numbers of institutional investors has enhanced the shareholder’s power to discharge directors since they are able not only to dominate but also lobby other shareholders in decision making.

Takeover Threat

It is but normal for board, executives, and managers to move heaven and earth to avoid or discourage corporate takeovers as they are aware that their job would at least be at risk if not to be lost totally if takeover takes place. To push for goal congruence, that is to have things in accordance with welfare of shareholders and enhancement of firm’s value, the shareholders can easily make a threat to accept takeover proposal if their set objectives are not met by the agents (board, executives, and managers) in general.

ROLES OF NON-EXECUTIVE DIRECTORS

A Non-Executive Director is a member of the board of directors of the company who does not take part on the executive function of the management team. This director is not an employee of the company or connected with it in any other way. He is separate from the inside directors who are members of the board who also serve or previously served as executive manager of the company.

Fundamentally the non-executive director’s role is to give a meaningful contribution to the board by providing objective criticism. At present, it is widely accepted that non-executive directors have an important contribution to make for the proper administration of companies and, therefore, on the company at a larger context. Non-executive director “should bring an independent judgement to bear on issues of strategy, performance, and resources including key appointments and standards of conduct.” (Taken from the Cadbury report).

Strategy

As an outsider, the non-executive director may have an impartial, clearer, and wider view of external factors affecting the company and its business environment than the executive directors. The normal role of an executive director in strategy development is therefore to offer a creative contribution and to act as a

constructive reviewer in looking at the goals and plans developed by the chief executive and his executive team.

Non-executive director should continually face and contribute in the development of the company’s long-term goals and visions. Together with the other directors and officers of the company, he is expected to participate in setting long-term broad operational principles and policies that benefits the stakeholders in areas that concerns on company stability, increasing the firm’s value, and ultimately, In increasing share holders’ value.

Establishing NetworksOne of the important functions of the non-executive director is to represent the company in some

external corporate undertakings. It is the job of the non-executive director (NxD) to connect the company to the outside world and in the process, gain benefit from networks of businesses. This network of businesses are no doubt beneficial to the organization since this could spark certain avenues for alliances which the most effective way to survive in a very competitive environment

Monitoring PerformanceNon-executive directors should take responsibility for monitoring the performance of executive

management, more particularly on matters relating to the progress made towards realizing the established company strategies. Non-executive directors should not be concern only on strategy alone. Included in his responsibility is to monitor and examine the performance of management in meeting agreed goals and objectives of the company. Succession planning is also part of his responsibilities but taking into consideration the sensitivity of the matter he should do it more carefully with the concurrence of the other directors and officers.

AuditIt is the duty of the whole board to ensure that the company report properly to its shareholders, this

can be done by presenting a true, fair and real reflection on how the company was administered at any given time, included in this report is financial performance and highlights that are deemed necessary, including the assurance that the internal control systems are in place and monitored routinely and thoroughly. A non-executive director has an important role to play in fulfilling this responsibility whether or not a formal audit committee of the board has been established.

ROLES OF THE CHIEF FINANCIAL OFFICCER (CFO)The chief financial officer (CFO) is a corporate officer principally accountable for managing the financial

risks of the corporation. This officer is also responsible for financial planning and record-keeping, as well as financial reporting to higher management. He will be the one who will direct the corporation’s finances. In corporations large and small, a CFO is needed to handle both the cash inflow and outflow and to create reports about the corporation’s spending. Keeping track on the working capital requirements of the company to meet short-term and daily requirements on operation are also responsibilities of the CFO.

In large corporations, the primary duties of CFO may be to supervise and manage a large accounting department, while coming up with ways to maximize profit to the company. A CFO, might for example, evaluate the way in which employees work to determine the way to most efficiently get work done for the least amount of money. These responsibilities however can be shared with other corporate heads or with general managers or lower level supervisors.

CFOs have different specific roles depending on so many things: industry, peculiarity, corporate structure, profile of investors (e.g. majority family-owned), government intervention, and whether the company listed or not both in local stock exchange or international exchanges. However the following roles cut across corporate CFOs around the world.

Implements Internal ControlsA CFO will be the one responsible for conveying the important financial controls to a company. These

controls features should the effective administration of cash flow and overhead expenses, establishing credit policies for customers and working with major vendors to attain more favorable payment terms, and implementing measures for assessing and evaluating optimal inventory levels. At a higher level, a CFO should also develop effective controls that provide supervision against fraudulent activities.

Supervises Major Impact ProjectsOutside of implementing and monitoring company controls relating finance, an effective CFO also

handles and supervises those projects that require significant quantitative and qualitative interpretations and analysis in order to reach an understanding of the options that are available. For example, a CFO will take responsibility for developing a company’s annual budget, work together with the business owners and divisions or department managers to ensure that the final financial product accurately and objectively projects the real requisites of the business. A CFO might also carry out a meticulous analysis of a company’s future capital investment requirements as a prerequisite in securing additional financing.

Develops Relations with Financing Resources One of the most important responsibilities of an effective CFO is to institute good working relationships

with banks and other financial institutions that may impact on the company’s ability to finance operations. Specific activities in this area may include regular meetings with officers of the company’s banks(s) to review ongoing operations, discussing possible future loan transactions, revisiting loan covenants if there is any, negotiating more favorable terms for bank lines of credit, and discussions with private investors on how additional capital might be invested into the enterprise.

Advisor to ManagementAn effective CFO is also an important member of the management teams of some emerging

companies. Because of his financial sharpness and General Business knowledge, a good CFO van facilitate and help business owners, executives and other top managers make the substantial connection between a company’s operations and its financial performance that are reflected in the actual figures and also with that of projections.

Drives Major Strategic IssuesA good CFO can also be expected to take part in important role on getting involved on some major

strategic decisions that will have an impact on the company’s long term future. These issues include the hatching of the company acquisition strategy which in the end would help fuel and boost the company’s additional growth. Keeping an eye on diversification of a particular product lines, business activities, and Portfolio is the part of CFO’s concern. A CFO would also play a significant role in any endeavour the purpose of which is to seek investment from the public or financial markets especially in times when company is having an initial public offering.

Risk ManagerThe CFO is in the best position to foresee risks considering that they have this rare perspective on how

the company operates. CFO are close to the internal control system and financial reports which pass through many organizational areas. CFO’s are high risking officer doing real and actual things in the industry. The views are not just only tree top, their views are real and they are in proximity of hard figures that could back their decisions

The CFO’s viewpoint on risk can be a helpful source to the board of directors and the CEO as well as other senior officers as they manage the corporate affairs. The CFO may be in the best position to anticipate

high risks transactions and the adverse consequences of the changing external environment. This unique capability of CFOs however is only valuable if the CFO is communicating well with the CEO, the board and the other officers of the organization.

Relationship RoleMore often the CFO is the nucleus in an organisation with many connections. The CFO will work

together with the CEO, the board of directors the audit committee, the internal auditor and the external auditor. Strong verbal and written communication skills are indispensable if the nucleus is to support the connections effectively. CFO serves the bridge between these a variety of parties within the organization.

Objective referee CFOs needs to demonstrate impartiality such as when advising the CEO or the board of directors on

accounting matters. The skill to present important financial issues is an invaluable resource but it should always be in the context that it is not being done to favor somebody. CFOs are not valued by board of directors or audit committees on attributes or tendencies of boosting financial figures with sacrificed transparency.

In consonance with the principle of good corporate governance, board of directors, audit committees and CEOs need to understand all sides of a financial accounting or disclosure issues so they can make an informed and rational decision. The CFO can and should be a trusted adviser in matters of financial reporting.

ROLES OF THE AUDIT COMMITTEE The audit committee is an essential component in the overall good governance system. The objectives

of this committee should be geared toward carrying out practical progressive changes in the functions and expectations placed on corporate boards. One of the fundamental principle of an effective audit committee is that committee should be independent from the operational aspects of the company. This means that a company's senior management should not be audit committee members. The senior management however has to be given the opportunity for important communication with the audit committee.

Understanding the Audit Committee's Responsibilities An audit committee should be engaged mainly in an oversight function and is ultimately responsible for

the company's financial reporting processes and the quality of its financial reporting. For the committee to carry out the said responsibilities, the committee must have a working knowledge on the company's goals and its long term plans and visions including the issues the company is facing in trying to achieve this objectives. Examples of issues that audit committee should consider:

-Risk identification and response -Pressure to manage earnings - Internal control and company growth.

Risk Identification and Response To be effective, an audit committee must have an understanding of the risks the company faces and

more importantly, the company's internal control system for identifying and mitigating those risks. Risks that could affect the company and that the audit committee should be conscious about include:

•External Risk (Independent)

Rapid Technological Changes Audit committee should always be on the lookout for the company not to be left behind due to

advancement of technology. The new rule in this modern time is embrace things brought about by technology and be a survivor.

Downturns in the Industry The product that the company is selling may have passed already its maturity stage and it is already its

way down. The audit committee should have a clear picture of the "what if scenario" of the entity. A very good example, Nokia, began as a textile company then went into electronics and then from electronics migrated to wireless devices (mobile phone) but they missed the next boat.

Unrealistic earnings expectations by analysts An audit committee is expected to be not just composed and collected but also less aggressive when it

comes to expectations of business outcomes. Audit commitees should be associated with conservative and realistic information, and thus they should deal figures from the realist point of view. They should reasonably know how much meat within a cup of soup because this would be the real basis in putting up plans for the company's future.

•Operating/Internal Risk

Recurring organizational changes, turnover of key personnel are some of the danger signs that the audit committee cannot afford to neglect. Things like these hamper the operational momentum of the company rendering it slow in its progress in achieving its vision.

Another internal risk worthy of consideration is the complexities of transactions, complex organizational structure, swift growth, performance- based compensation that are excessively inappropriate, exposure to currency differences on foreign currency denominated loans, and financial results that are abnormally different from that of the industry.

•Information and Control Risk

The audit committee, in carrying out its responsibility has to address the following concerns which are considered as perennial in most organizations: unsuitable control environment that are sometimes "toned at the top." Another is the lack of sincere management supervision and inappropriate management override of existing controls which is by description, the best habitat for abuse. Timeliness is another concern since information needs to be communicated early enough to the stakeholder for these information to be useful.

Who is responsible for financial reporting? The responsibility for financial reporting is vested in three groups;

1. The BOD – the company’s board of directors including the audit committee2. Finance and Accounting – financial management including the financial auditors3. Auditor – the independent auditorsWhile it is true that this triumvirate forms a “three-legged stool” there is a need to emphasize that the

audit committee must take the lead in the financial reporting process, since the audit committee is the extension of the full board and hence the ultimate monitor of the process. An audit committee that functions well could definitely send a strong message and partial assurance to the other stakeholders that the system is in place and it is protecting the organization both in short and in long-term basis

ROLES OF THE EXTERNAL AUDITORSAuditing is a systematic process by which a competent, independent person, objectively obtains and

evaluate evidence regarding assertions about economic actions and events to ascertain the degree of correspondence between those assertions and established criteria and communicate the results to interested users (American Accounting Association).

Need for external auditorThere is a need for independent auditor because of the apparent separation of ownership and

management. Audit services are used extensively by business organization to cast away doubts on the information given by the management which are also generated under its direct control. There exist information risk. Business structures are becoming more complex which increases the possibility that unreliable information might be led not only to decision makers but more importantly to the stakeholders.

Factors that contribute to information risk1. Remoteness of Information Providers to Information Users

This makes first-hand knowledge difficult to obtain by some stakeholders because they are divorced form management. Complex corporate structures, less involvement by the shareholders in day-to-day operations or decisions as well as geographical dispersion are just some of the factors that widen the distance between the information user and provider.

2. Bias of Information ProviderThere is an assumed conflict of interest between the shareholder and management regarding

financial information. Financial statements and other financial information serve as the “report card” of management of its stewardships, the only report card prepared by the one being graded. Having said this, information may be presented in favor of the provider when his goals are different with some stakeholders.

3. The Volume of DataWhen business grow, possibly thousands if not millions of transactions are processed

daily through the use of sophisticated computer programs or via manual system. There is this possibility therefore that improperly recorded information may be buried in the records leaving the overall results inaccurate if not misleading, trained professionals therefore are needed in the area.

4. Complexities in TransactionsChanging and new relationship in business leads to some innovations ion accounting

and reporting process. Transactions nowadays are getting complicated and becoming more difficult to record and alone be understood by the stakeholders. Examples of these are derivatives, futures, multi-level mortgages in securities, reinsurances, different valuations and other complex transaction in the financial markets which the board of directors and other decision makers in the company might venture into.

Auditing is an endeavor of assuring the readers of the financial statements with confidence in the figures of financial statements. This is highlighted by the accountancy profession’s meaning of an audit. Audit of financial statements which is an exercise, the objective of which is to permit auditors to express an opinion as to whether the financial statements give a true and fair view of the affairs of an entity at a given period in accordance with the relevant frameworks and standards (reworded from International Standard on Auditing (ISA) 2000, Objective and General Principles Governing on Audit of Financial Statements).

The logic behind this definition is that the auditor’s opinion will lend and add some credibility to the financial statements. It is expected that the auditor, as an independent expert on financial preparation and reporting, should conduct the examination exhaustively for him to have good backings on the opinion he will be expressing in the independent audit report.

Auditor’s Duties

In most countries, the auditor has a legal duty to make a report to the enterprise on the fact and fairness of the entity’s annual accounts. This report should state the auditor’s opinion on whether the statements have been prepared in accordance with the relevant standards more importantly on relevant legislation and whether they present a true and fair view of the profit or loss at any given period. The responsibility to report on the truth and fairness of the financial statements rests with the management, the auditor therefore has a responsibility to form an opinion on certain other matters and to report any reservations that he has on the reports. In the audit report, these reservations can be seen in the qualifications of opinion by the auditor.

In the conduct of an audit, the auditor must consider whether the following are present:1. Proper accounting records kept by the company.2. Financial statement figures that agree with accounting records.3. Adequacy of notes to financial statement and other disclosures necessary.4. Compliance with relevant laws and standards of financial accounting and reporting.

In three (3) of the above, the auditor is impliedly given the right to access to any information or material that is relevant to examination of the financial statements. In addition, the auditor has a duty to review the other information issued alongside the audited financial statements. There is, however, no guarantee that the statements are free from misstatements and errors, this is partly because the auditor is only required to form an opinion for him to discharge his duties. This must be understood that the audit is not designed to discover errors, irregularities and fraud. Activities in external auditing are only designed to form an opinion, not a conclusion; it can only give reasonable assurance, not absolute assurance.

Based on the preceding terms, it can be summarized that the external auditor is there to attest to the data and other information prepared by the management in accordance with some legal and other established criteria. The criteria in the Philippine setting are provided by Philippine Financial Reporting Standards and other standards. The overall role of the external auditor is to express an opinion on the financial statements provided by the management. This means that an external auditor lends credibility to financial statements which are to be used by shareholders and other shareholders.

Supplemental ReadingsCorporate Governance Awards

Received by Premier Philippine Corporations

Manila WaterSource: www.manilawater.com

Corporate Governance Asia Annual Recognition Awards 2009

Manila Water was cited as one of the best in Corporate Governance in the Philippine in the Corporate Governance Asia Annual Recognition Awards for 2009. This is the third straight year that Manila Water was cited by Corporate Governance Asia. The awarding was held last June 26, 2009 at JW Marriott Hotel in Hong Kong.

Gold Award for ICD’s CorpGov Scorecard Project

For the third straight yea, Manila Water has been recognized as one of the best in Corporate Governance in the last Corporate Governance Scoreboard Institute of Corporate Directors (ICD). Given in the

last ICD’s Annual Dinner last may 27, 2009, the Gold Award was received by Manila Water’s president Jose Rene Almendras.

The Asset Magazine’s Annual Governance Index

Manila Water has been named the best company in the Philippines, in terms of Corporate Governance in The Asset Magazine’s annual Corporate Governance Index 2008. The results were published in the November 2008 issue of the asset.

The publication’s basis for corporate governance standards is The Combined Code Principles of Good Governance and Code of Best Practice derived by the committee on its final report and from the Cadbury and Greenbury Reports. It also based it on the White Paper on Corporate Governance in Asia produced by the Organization of Economic Cooperation and Development (OECD). As in previous years, The Asset invited companies to present their annual results in complying with best practices.

Corporate Governance Asia Annual Recognition Awards 2008

Manila Water was one of the recipients of the Corporate Governance Asia Annual Recognition Awards for 2008. This marks the second straight year that Manila Water was cited by Corporate Governance Asia. This year, Corporate Governance Asia included the following items to its criteria for the award:

Rights of shareholders Disclosure and transparency Board and management discipline

Audit and remuneration committee Independent, non – executive directors Public impression Investor relations Corporate governance as a business proposition Corporate social responsibility and environmental practices

2007 Corporate Governance Scorecard Project

Manila Water received two awards at the Institute of Corporate Directors’ (ICD) Annual Dinner on May 28, 2008. Manila Water was among the twenty companies given an award for gathering the highest ratings in the 2007 Corporate Governance Scorecard Project, jointly conducted by the ICD, Philippine Stock Exchange and Securities and Exchange Commission among 134 publicly-listed companies. From its average rating of 71% in 2006 Corporate Governance Scorecard Project where Manila Water ranked 7 th out of 64 listed companies, Manila Water’s rating jumped to 85% in 2007.

Manila Water was also one of 11 companies to receive a citation for its active participation in the ICD Companies’ Circle, composed of publicly-listed companies who have committed to strengthen corporate governance practices in the country. The Companies’ Circle meets monthly and undertakes projects such as the review of the SEC Code of Corporate Governance and the SEC Manual of Corporate Governance.

Corporate Governance Asia Annual Recognition Awards 2007

Manila Water was one of the recipients of the Corporate Governance Asia Annual Recognition Awards in 2007. The award was given to Manila Water in recognition of its continuing commitment of the development of corporate governance in the region.

Corporate Governance Asia is the only journal currently specializing in corporate governance in the region. It evaluated the performance of key companies and listed those that have contributed significantly to the overall development of corporate governance during the past year. In the Philippines, seven companies were chosen. Along with Manila Water, Ayala Corporation, Globe, MetroBank, PLDT, San Miguel Corporation and SM Investments were also cited.

According to Corporate Governance Asia, the annual recognition awards recognize Asian companies that demonstrate excellence in corporate governance with Asian values and spirit.

The criteria for the award are as follows: The awardee must have a previous publicly-acclaimed track record for corporate governance (This can

come in the form of other CG-related awards).

The awardee must have been involved in a specific publicly-known activity/activities (legislation, surveys, studies, etc.) directly related to improving or enhancing the standards of corporate governance during the past 12 months; and

The awardee must have implemented significant and specific CG-related reforms during the past 12 months.

2007 Asiamoney AwardIn January 2007, Manila Water was voted 2nd Best Over-all for Corporate Governance in the Philippines

for 2006 in a survey conducted by Asiamoney. The criteria for the survey were disclosure and transparency, responsibilities of management and the board of the directors, shareholders’ rights and equitable treatment, and investor relations. Manila Water considered the high rating as a significant achievement for the company especially since it was evaluated only months after its listing in March 2006. Further, Manila Water is the only medium-sized company among the seven Philippine awardees. The rest of the awardees were large-cap stocks.

Asiamoney, a leading financial publication, conducted the survey among CEOs, CFOs, and senior executives from fund management and specific fund companies in the Asia-Pacific region, UK, and USA, as well as heads of research and senior analysts in brokerages across the region. Asiamoney received a total of 88 valid responses from 76 different institutions. Seventeen Philippine companies were cited in the survey, with Manila Water coming after PLDT. Manila Water’s parent company Ayala Corporation was voted third best.

2006 Corporate Governance Scorecard Project Manila Water racked seventh in the 2006 Corporate Governance Scorecard Project for Publicly-Listed

Companies conducted by the institute of Corporate Directors. This marked the first time that Manila Waters was rated by the Scorecard Project as it was listed only on March 2006, making ranking so high even more of an achievement.The Scorecard Project involves an annual rating of the corporate governance practices of local publicly-listed companies. 68 companies listed companies were rated for 2006. The project was conducted under the suspires of the Capital Markets Development Council and the President’s Governance Advisory Council. The criteria for the project are rights of shareholders, equity of shareholders, role of stakeholders, disclosure and transparency, and board responsibility.

SM InvestmentsSource: www.sminvestments.com

Corporate Governance Asia Annual Recognition Awards

In recognition of its continuing commitment to the development of corporate governance in the region, SMIC has been chosen as one of the recipients of the Corporate Governance Asia Annual Recognition Awards for two successive years, 2007 and 2008. Corporate Governance Asia is the only journal currently specializing in corporate governance in the region. The annual recognition awards recognize Asian companies that demonstrate excellence in corporate governance with Asian values and spirit. To this end, Corporate Governance Asia evaluated the performance of listed companies to determine which companies have contributed significantly to the over-all development of corporate governance for a given year. In the Philippines, seven companies were chosen in 2007 and eight in 2008.

In 2007, the criteria for the award were as follows: The awardee must have a previous publicly-acclaimed track record for corporate governance (This

can be in the form of either CG-related awards); The awardee must have been involved in specific publicly-known activity/activities (legislation,

surveys, studies, etc.) directly related to improving or enhancing the standards of corporate governance during the past 12 months; and

The awardee must have implemented significant and specific CG-related reforms during the past 12 months.

In 2008, Corporate Governance Asia included the following criteria for the award: Rights of shareholders Disclosure and transparency Board and management discipline Audit and remuneration committee Independent, non-executive directors Public impression Investor relations Corporate governance as business proposition Corporate social responsibility

The Asset

The SMIC has been cited as 2nd Best in Corporate Governance in the Philippines in 2008 and 3rd Best in 2007 by The Asset, one of Asia’s leading finance monthly publications circulated worldwide, mostly to major institutional investors invested in Asia. The Asset conducted a survey among listed companies in the Philippines and evaluated each company’s financial highlights, board of directors, Audit Committee, Risk Management Committee, corporate social responsibility, investor relations and digital communications. The Asset also consulted institutional investors, sell-side analysts and its board of editors through The Asset Benchmark Surveys or in the course of the Triple A selection.

According to The Asset, The Best in Corporate Governance Award is given to the companies that have gone beyond regulatory compliance to promote a corporate culture that is transparent, investor-friendly and that takes cognizance of the rights of minority shareholders. The award is also given to companies who have taken the lead in engaging with the community they operate within in a socially responsible way.

Finance Asia

SMIC was awarded 4th Most Commitment to Corporate Governance in the Philippines in 2007 and 8 th in 2008. Finance Asia is one of the region’s leading financial publishing companies based in Hong Kong and covering Asia’s financial and capital markets. It conducts an annual Best Managed Company poll among investment professionals and financial analysts. Respondents are asked to rank companies in 10 Asian countries on the basis of over-all management, corporate governance, investor relations and their commitment to strong dividend payments.

IDENTIFICATION:On the space provided, supply the word/phrase being described and/defined:

1. ____________As attribute of the corporation which means that, a corporation continue to exist even in death, incapacity, or insolvency of any stockholder or member.2. ____________Refers to the party given the authority to implement the policies determined by the board in directing the course of business activities.3. ____________Stakeholders who invested their capital in the corporation.4. ____________According to Ambrose Bierce, it is an ingenious way of obtaining profit without individual responsibility.5. ____________Who said that the social responsibility of the corporation is to increase profit?6. ____________They are natural or artificial persons considered as the owners of the corporation.7. ____________The collegial body that exercises the corporate powers of all corporation under the corporation code.8. ____________This refers to the system whereby shareholders, creditors and other stakeholders of a corporation ensure that management enhances the value of the corporation as it competes in an increasingly global marketplace.9. ____________The openness of information that is due to be made known by the stakeholders.10. ___________Recognition or assumption of responsibility for decisions, actions, policies, the administration, governance and implementation of programs and plans.

Multiple Choice

1. The basic premise on accountability is that accountable organization willa. all choices belowb. set a policy based on balance understanding and response to material stakeholders issues and

concerns.c. disclosed credible informationd. set goals and standards against which strategy and associated performance can be measured and

evaluated.

2. Which one is not a benefit of good governance?a. improves marketabilityb. reduce the vulnerability of companiesc. reduction of corporate valued. improves company’s credibility

3. The primary inside stakeholder of a corporationa. bondholderb. board of directors

c. shareholdersd. public

4. Which one is not the role of non-executive director?a. monitoring of performanceb. auditc. implements internal controld. setting of strategy

5. Which one is not a role of CFO?a. supervises major impact projectsb. relationship rolec. risk managerd. none of the above

6. The following are the external risk (independent) that the audit committee should consider excepta. downturns in the industryb. rapid technological changesc. unrealistic earnings expectationd. turnover of key personnel

7. Which of the following would contribute to information risk?a. unsuitable control environmentb. lack of sincere management supervisionc. inappropriate management overrided. all of the above

8. Which one is/are not part of corporate governance?a. BODb. CFOc. CEOd. All of the abovee. None of the above

9. Which one is not among the incentives and disincentives of agency under principal-agent relationship?a. Managerial defensivenessb. Share incentivesc. Threat of being firedd. takeover threat

10. Which is not among the effects of agency in governance?a. conflict of interestb. managerial opportunismc. incurrence of agency costd. all of the abovee. none of the above

On the space provided write A for stakeholders; B for agency issues and problem; C for attributes of corporation; D for responsibility of CFO/CEO.

1. _____Public2. _____implement internal control3. _____employees4. _____conflict of interest5. _____managerial opportunism6. _____develop relations with financing sources7. _____advisor to management8. _____managerial defensiveness9. _____management10. ____audit

Internet Exercise

Locate the website of the World Council for Corporate Governance and work on the following:

1. What are the mission, vision and objectives of the WCFCG?2. What was the 2005 London Declaration?3. Explain the acronym PREEMPTIVE.

Multiple Choice

1. One of the tasks for financial managers when identifying projects that increase firm value is to identify those projects where

a. benefits are at least equal to the project’s costs.b. taking the project will increase the book value of the firm’s ordinary shares.c. taking the project will decrease the book value of the firm’s debt outstanding.d. none of the above

2. Which form of invested capital is subject to most of the firm’s business and financial risk?a. debt capitalb. equity capitalc. borrowed capitald. intellectual capital

3. The rules dictating voting procedures and other aspects of corporate governance for a corporation area. the minutes of the board of directors meetingb. the articles of incorporationc. the Corporate Governance Institute of the Philippinesd. the Securities and Exchange Commission’s Rules for Corporate Governance.

4. The ultimate owner(s) of a corporation area. the national governmentb. the debt holdersc. the equity holdersd. the executive staff of the corporation

5. Agency costs refers toa. the costs associated with managing the demands of governance agencies.

b. the costs involved when converting an entity from a proprietorship to a corporationc. the costs that arise due to conflicts of interest between shareholders and managersd. none of the above

6. Managers of firms should only take actions that:a. increase the value of the firm’s future cash flowsb. they expect will increase the firm’s share pricec. have benefits which are at least as great as the cost of those actionsd. all of the above

7. Which of the following parties have the proper incentives to make risky, value increase investments for the firm?

a. suppliersb. creditorsc. shareholdersd. manager who are only compensated with a salary

8. Shareholders can attempt to overcome agency problems by all but the following:a. incurring costs to monitor managersb. paying managers a good salaryc. relying on market forces to exert managerial disciplined. paying the manager a proportion of the profits that the firm generates

9. Which of the following is one of the most expensive methods for the firm to overcome agency costs?a. let the Securities and Exchange Commission inform the firm of a problemb. proper design of an executive’s compensation contractc. monitor the executive’s work d. require executives to own a large proportion of their firm’s outstanding shares

10. Which of the following is the best bounding expenditure to help limit agency costs? a. auditing the managers work on a monthly basis b. a contract where by the manager will forfeit a portion of his deferred compensation in the event of

poor performance c. granting the manager a large number of options that will become valuable if the firm’s performs

well d. paying the manager a bonus if the firm performs well

11. A root cause of firm agency costs isa. managerial carelessnessb. a managerial owning too much of his firm’s stockc. a managers concern for his personal well-beingd. the various BIR and SEC filing requirements

12. Which of the following is a strength of the corporate form of business?a. Limited life of the businessb. Unlimited access to capitalc. Unlimited liabilityd. Double taxation of income

13. Which of the following is not a strength of the corporate form of business?a. Unlimited life of the businessb. Unlimited access to capitalc. Unlimited liabilityd. individual contracting

14. Shareholders are said to have a residual claim on the firm’s assets. What does this mean?a. Shareholders have limited liability in their investmentb. Shareholders do not receive any payoff from the firm until all creditors are paidc. Shareholders are allowed to recover their investment first if the firm experiences financial distressd. Shareholders have priority in electing the board of directors for the firm

15. What is a fiduciary?a. Someone who performs ratio analysis for a corporationb. Someone who Invest and managers money on someone else’s behalf c. Someone who manages the release of a initial public offeringd. Someone who evaluates the performance of individual bonds

16. What is the proper goal for management of a firm?a. Maximize shareholder wealthb. Maximize net income or earningsc. Maximize sales revenued. Minimize expenses

17. What is a basic guide for financial decision making?a. Make decision where the benefits exceed the costsb. Make decision where the total benefits exceed the total costsc. Make decision where the average benefits the fixed costsd. Make decision where the average benefits the average costs

18. Which of the following describes the “collective action problem”?a. When the CEO fails to represent the interest of shareholders in daily decision of the firmb. When the shareholders of a firm fail to act in their own best interestc. When the managers of a firm lack incentive to maximize shareholders wealthd. When a individual stockholder spends time and resources monitoring managers, bearing the cost, while the benefits go to all the shareholders in the firm

19. You were just hired as the CEO of a company. Your primary objectives should bea. to maximize the company’s earningsb. to maximize profitsc. to maximize the company’s price of ordinary sharesd. to eliminate the company’s competitors

20. What should be the objective of a focus on stakeholders?a. Maximize the stakeholders’ interestb. In situation of conflict pick stakeholders’ interests over shareholders interestsc. Preserve stakeholders’ interestsd. Disregard shareholders’ interests all together

21. Which of the following encourage managers to act in the shareholders’ interest?a. Performance-based compensationb. Auditsc. Threat of hostile takeoversd. all of the above

22. Why do shareholders bear most of the risk of running a firm?a. They only have a residual claim on the firm’s cash flowsb. They receive a salary from the companyc. They are guaranteed a fix payout each quarterd. Shares can be taken away at any time without notice

23. What do we call the possible conflict of interest between shareholders and management?a. Agency problemb. Stakeholder problemc. Double taxationd. Shareholders’

24. Investors expect management to do all of the following excepta. consult them on ethical decisionb. increase salesc. boost the company’s profitd. increase the return to the investorse. make sensible financial decision

25. What are the responsibilities of the board of directors in a corporation? a. Hire and fire managers b. Manage day-to-day operations c. Amend the firm’s articles of incorporation when necessary d. Hire and fire entry level employees