Session 9

Governance and Social

Responsibility

FOCUS
This session covers the following content from the ACCA Study Guide.

B. Business Organisation Structure, Functions

and Governance

5. Governance and social responsibility in business

a) Explain the agency concept in relation to corporate governance.
b) Define corporate governance and social responsibility and explain their
importance in contemporary organisations.
c) Explain the responsibility of organisations to maintain appropriate
standards of corporate governance and corporate social responsibility.
d) Briefly explain the main recommendations of best practice in effective
corporate governance.
i) Executive and non-executive directors
ii) Remuneration committees
iii) Audit committees
iv) Public oversight
e) Explain how organisations take account of their social responsibility
objectives through analysis of the needs of internal, connected and
external stakeholders.
f) Identify the social and environmental responsibilities of business
organisations to internal, connected and external stakeholders.

Session 9 Guidance
Note that there are a number of codes world-wide on corporate governance. In this study system, the
UK's Corporate Governance Code and the OECD code are used to illustrate good governance procedures.
Understand the underlying principles of corporate governance (CG) rather than the detailed
provisions laid down in each separate code, especially the OECD definition (s.1.2).

(continued on next page)

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VISUAL OVERVIEW
Objective: To explain the impact corporate governance and social responsibility have had
on business organisations.

CORPORATE GOVERNANCE
• Development
• Meaning
• Underpinning Concepts
• Key Issues
• Rules- or Principles-Based

RECOMMENDATIONS SOCIAL RESPONSIBILITY

• Development • Concept
• Board of Directors • Factors
• Non-executive Directors • Stakeholder Considerations
• Remuneration Committees
• Audit Committees
• Public Oversight

Session 9 Guidance
Know the key underpinning concepts (s.1.3) and the key issues in CG (s.1.4 and s.1.5).
Recognise "good corporate governance" (s.2). Read through a couple of times to understand the
role of the board, non-executive directors, the various committees and the idea of "public oversight".
Understand corporate social responsibility (CSR) and sustainability (s.3).

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1 Corporate Governance

1.1 Development
 Organisations have existed for thousands of years, be they
in the form of individuals (sole traders) or groups (merchant
trader guilds).
 The way they operated (the way they were governed) was
determined by the trading individuals, the regulations of any
trade organisation (guild) they belonged to and the laws of the
district/country they operated in.
 Financing of these organisations would have been provided by
those who were directly involved in the organisation (i.e. the
owner traders, craftsmen and merchants themselves). Where
additional finance was required, this would have been obtained
from individual (very rich) benefactors and appropriate contracts
drawn up between the provider and user of the finance.
 In the early 1600s, governments started to issue charters
to organisations which allowed them to form companies and
raise public funding for ventures that required very significant
funding (e.g. the East India Company formed to develop trade
into the East Indies). Each investor was said to hold a "share"
of the company and markets (stock markets) developed so
they could trade their "shares".
 1720 saw the first serious collapse of a company and its
related stock market. This was referred to as the South Sea
Bubble (after the name of the company involved). At one
point in the trading of its shares, the company was worth
more than £300 million ($500 million), twice the value of all
of the land in England at the time.
 The outcome of the South Sea Bubble was the government
effectively banning companies from raising public funds.*
 It was not until the mid-1800s that the UK passed laws *More recent market
allowing limited liability companies to issue shares. This collapses include
the savings and loan
helped fund the Industrial Revolution and, in particular, the
crisis of the 1980s,
building of a national railway network. Greater emphasis was
the dot-com bubble of
placed on the rights and protection of the shareholder, as such the 1990s, the sub-
shareholders (the owners) employed managers to run (control) prime crisis of 2007/08
the business for them (rather than run it themselves). and the subsequent
 The 14th Amendment to the US Constitution, ratified in 1868, banking crisis and
gave corporations the same rights as an individual and, in the credit crunch.
UK, Solomon v Solomon enshrined the same concept into case
law—that corporations were separate legal bodies from their
managers and owners. Thus commenced the so-called divorce
of control from ownership.
 Throughout the early- and mid-1900s in the UK, various
Companies Acts were passed incorporating some governance
elements on regulating the requirement of companies to
produce audited financial statements, concerning the duties
of directors and the rights of shareholders. In addition,
the London Stock Exchange placed further governance
requirements on listed companies through their listing rules.
 From the 1970s–'80s, there has been a substantial growth in
the number of corporations, their size, global trading and power.
Many government-controlled utilities were privatised (especially
in the UK), creating millions of additional shareholders, further
widening the gulf between ownership and management.

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 Initially this did not seem to be of concern to shareholders

(many writers commented on an apparent malaise of
shareholders at this time which allowed directors to gain
greater control over companies). However, a series of UK
corporate scandals in the early 1990s (e.g. Polly Peck, BCCI,
Maxwell, British Gas and Barings Bank) acted as the spur to
developing a detailed corporate governance code (the UK
Combined Code) for listed companies. In the US, Enron and
WorldCom had a similar effect, leading to the Sarbanes-Oxley
Act (2002), and a review/update of the UK Combined Code in
2003, 2006 and 2010 (following the banking crisis) when it
was renamed the UK Corporate Governance Code.

1.2 Meaning
 A specific definition of corporate governance is difficult
because of the many different legal jurisdictions, corporate
structures, cultures, moral beliefs, application of ethics and
conditions which affect organisations throughout the world.
 There is a wide range of definitions, from a classic narrow view Classic definitions
stem from how
that it is restricted to the relationship between a company
the shareholders
and its shareholders (agency theory), to the modern view
(principals) can
that corporate governance is a complex web of direct, indirect influence managers
and ever-changing relationships between the entity and its (agents) to act in their
stakeholders (stakeholder theory). best interests. The
 Corporate governance has been defined and explained as: core of agency theory
lies in the separation
 "The way in which organisations are directed and controlled."
of ownership (by
—Cadbury Report, 1992 shareholders)
 "It is the relationship among various participants in and control (by
determining the direction and performance of corporations." management). The
shareholders appoint
—Monks and Minow, 1995
the directors and
 "The system by which business corporations are directed delegate to them
and controlled. The corporate governance structure the responsibility
specifies the distribution of rights and responsibilities among for managing the
different participants in the corporation … and spells out company on their
the rules and procedures for making decisions on corporate behalf. The directors
affairs. By doing this, it also provides the structure through are therefore
which the company objectives are set and the means of accountable to the
attaining those objectives and monitoring performance." shareholders.
—Organisation for Economic Co-operation and Development
(OECD), emphasis added
 "Corporate governance is concerned with holding the balance
between economic and social goals and between individual
and communal goals … the aim is to align as nearly as
possible the interests of individuals, corporations and society."
—Cadbury Report, World Bank, 1999
 "Corporate governance is the system by which companies
are directed and managed. It influences how the objectives
of the company are set and achieved, how risk is monitored
and assessed and how performance is optimised. Good
corporate governance structures encourage companies
to create value (through entrepreneurism, innovation,
development and exploration) and provide accountability
and control systems commensurate with the risks involved."
—Australian Securities Exchange 2003

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 "The system of checks and balances, both internal and

external to companies, which ensures that companies
discharge their accountability to all stakeholders and act in a
socially responsible way in all areas of their business activity."
—Jill Solomon, 2004
 "The ethical corporate behaviour by directors or others
charged with governance in the creation of wealth for all
stakeholders. It is the way of promoting corporate fairness,
transparency, independence, integrity and accountability."
 These definitions identify a number of critical elements that
reflect corporate governance best practice:
 A framework through which strategic, tactical and operational
objectives are set (taking into account both internal and
external influences) and performance is optimised.
 Strong internal control and risk management procedures
(the reduction and management of risk). Best practice: A Code
of Conduct should
 Corporate strategies set and executed in an ethical and
be established to
effective way taking into account stakeholders' interests. guide executives
 Fairness, transparency, independence, integrity and in maintaining the
accountability are essential to ensure market confidence and company's integrity
attract appropriate investment. and preventing
 Application of substance over form; the spirit as well as the unethical practices.
letter of the law.
 The organisation and its managers are accountable not only
to those who own the business (e.g. shareholders) but also
to a wider range of stakeholders.
 Governance is top-down driven and pervasive throughout
the organisation.
 No longer inward looking and no longer purely about current
period earnings. Sustainable development and sustainability
reporting have been evolving parallel to governance during
the 1990s and both are now intrinsically linked.

1.3 Underpinning Concepts*

Fairness

Openness and *See Session 26 Ethics

Reputation Transparency and Ethical Behaviour
for further discussion
of this area.

Integrity Independence
UNDERPINNING
CONCEPTS

Judgement Probity and

Honesty

Accountability Responsibility

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1.4 Key Issues

 A brief review of the contents page of the UK Corporate
Governance Code provides an insight into those areas
considered to be key issues:
 Directors─duties, functions, appointment, induction,
Best practice:
continuing professional education and performance appraisal.
 Functions reserved
 The Board─composition, balance, committees, roles of to the board should
the CEO and chairman, role of non-executive directors, be formalised and
appointment of new directors to the board, disclosed.
re-election of directors to the board and succession  Roles of CEO and
planning for board members. and chairman
 Remuneration policy (established by the remuneration should not be
committee)─appropriate to attract, retain and motivate exercised by the
directors, strong links to performance, service contracts, same individual.
compensation.  Directors'
 Reliability of financial reporting and external auditing appointments
should be in writing.
(audit committee):
 Remuneration
— board to present a balanced and understandable
policies should be
assessment of the company's position and maintain a disclosed.
sound system of internal control (risk management);
 Integrity in financial
— audit committee to monitor the integrity of the financial reporting should
statements, to review the internal financial controls, be independently
internal controls and risk management systems and to verified.
monitor the internal and external auditors.  Shareholders
 Rights and responsibilities of shareholders─satisfactory should be able to
dialogue, communication of shareholder views to the board, exercise their rights
constructive use of the annual general meeting (AGM), effectively.
considered use of voting rights.

1.5 Rules-or Principles-Based

The two basic approaches to corporate governance are rules-based
and principles-based.

1.5.1 Rules-Based

Example 1 Rules-Based Governance

Suggest FOUR elements of a rules-based governance system.

Solution
1.

2.

3.

4.

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1.5.2 Principles-Based
 Developed as a set of guidelines rather than rules.
 Some flexibility given through a "comply or explain" approach.
This allows companies to explain (in their financial statements)
why they consider that a particular aspect of the governance
code is not applicable to them.
 The market decides what financial penalty is applied to the
company through discounting its share price in relation to those
considered to have good corporate governance structure.
 Updated and modified through an operational and consultation
process with all interested parties.
 Can react much quicker to emerging events than a rules-
based system.

2 Corporate Governance Recommendations

2.1 Development
 Key factors in many of the financial scandals of the latter half
of the 1900s and the first decade of 2000 led directly to the
development of corporate governance codes:
 Lack of oversight of key roles. For example, no effective
The respective roles
control over the CEO (through, for example, an effective board
and responsibilities
of directors, independent non-executive directors, separate
of the board and
independent monitoring committees) led to a dominant CEO management should
(Maxwell, Enron, WorldCom, Conrad Black, RBS) who tended be published.
to treat the organisation as their own personal asset.
 No segregation of key roles (e.g. where the CEO and the
chairman of the board of directors is the same individual,
there is a significant opportunity for abuse of power).
 Lack of effective supervision (e.g. key employees trusted
in what they are doing because they appear to be making
good money for the organisation or because nobody really
understands what it is they are doing). (Nick Leeson and
Barings Bank is an excellent example.)*

*In some cases, unethical behaviour by employees is just ignored

(and thus encouraged) because they are making good profits for the
business. In Enron, electricity traders deliberately engineered power
shortages in California so they could sell higher-priced electricity to
the state.
In other cases, such behaviour is directly encouraged (e.g. selling
financial products the company knows is unsuitable for the client).
Such "mis-selling" effectively crosses the line into corporate fraud.

 Poor independent scrutiny. For example, external auditors

may be reluctant to raise difficult questions because of the
fear of losing the client and the (often larger) non-audit
fees. Alternatively, the CEO/CFO may attempt to direct the
scope of internal audit work (usually away from areas they
do not wish the internal audit to see).
 Ignoring or not seeking stakeholders' views.

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 Short-termism (e.g. policies based on short-term factors

to increase profits to meet bonus targets/increase share
price; share option schemes) rather than longer-term
sustainability and growth.
 Inappropriate compensation. For example, high increases
in directors' salaries while the company is underperforming,
termination payments which make it costly for shareholders
to remove directors, use of "poison pills" to prevent
takeovers (thus loss of jobs by the directors) which
normally would be in the interests of the shareholders.
 Misleading and contradictory financial information
(e.g. providing different stakeholders with different,
misleading and sometimes contradictory information in the
hope that "at the end of the day, all will be well").
 Thus the vast majority of corporate governance code
provisions attempt to minimise these risks.
 Note that corporate governance codes apply to listed
companies, but easily can be applied as best practice to unlisted
companies (especially the larger companies) and to any form of
organisation (e.g. public sector, partnerships, NGOs).
 The key recommendations are briefly discussed below using
the UK Corporate Governance Code as an example.

2.2 Board of Directors

 Every company should be headed by an effective board with
separate roles for the chairman of the board and the chief
executive officer.
Best practices:
 An organisation's board:  A board needs
 is collectively responsible for promoting the success of the effective
company by directing and supervising the company's affairs composition, size
(this includes monitoring the CEO); and commitment
 should provide entrepreneurial leadership of the company, to adequately
discharge its duties.
within a framework of prudent and effective controls which
enable risk to be assessed and managed (this includes  Majority, including
the chairman,
monitoring effectiveness of the controls through internal
should be
audit, etc);
independent.
 should set the company's strategic aims (taking into
account stakeholder claims), ensure that the necessary
financial and human resources are in place for the company
to meet its objectives and review management performance
(this includes succession planning, recruitment, training and
development, appraisals, rewards); and
 should set the company's values and standards to ensure Best practices:
that its obligations to its stakeholders and others are  The process for
understood and met, including effective communication to performance
all stakeholders. evaluation of
the board, its
2.3 Non-executive Directors committees and
directors should be
 Non-executive directors (NEDs) are not involved in the disclosed.
day-to-day functions of the organisation (as are executive  Shareholders should
directors). They must be independent of the organisation be encouraged
in that the only relationship they have (or have had) with to participate in
the organisation is as non-executive directors compensated general meetings.
only with related salary (no bonus, no share options, no past
business or directorship connections, no family connections,
no material share holdings).

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 Their role is to:

 provide advice and direction to a company's management in
the development and evaluation of its strategy;
 monitor the company's management in strategy
implementation and performance;
 monitor the company's legal and ethical performance;
 monitor the veracity and adequacy of the financial and
other company information provided to investors and other
stakeholders;
 assume responsibility for appointing, evaluating and, where
necessary, removing senior management; and
 plan succession for top management.
 They are expected to:
 contribute to and challenge the direction of strategic strategy;
 scrutinise executive management's performance in meeting
goals and objectives;
 monitor performance reporting;
Large investors can
 represent shareholders' interests to avoid agency issues influence corporate
which reduce shareholder value; governance by helping
 ensure robust financial and risk management systems; to ensure transparency
and accountability
 ensure accurate financial information;
and avoiding conflicts
 be responsible for determining appropriate levels of of interest between
remuneration for executives; owners and managers.
 play a key role in appointing and removing senior managers Unlike small investors
and in succession planning; they can avoid being
controlled by the will of
 take direct responsibility for shareholder concerns (one or
the board by exercising
more NEDs); and their voting rights (e.g.
 link their role with that of institutional shareholders. in electing directors to
 Under current good practice, the board is expected to be the board).
composed of at least 50% NEDs.

2.4 Remuneration Committees

 Directors' remuneration has been a major issue for many
years, particularly with the increase in global international
organisations. Primarily the issue revolves around directors An over-dominant
"abusing" their position to reward themselves with what executive who
many consider to be excessive increases and perks in their pursues personal
compensation arrangements—rewarding themselves despite objectives is just one
example of an agency
poor results and underperformance of share price.*
issue. Excessive
remuneration is an
obvious cost of the
agency relationship
which reduces
shareholder value.
*Many directors have used compensation as a form of protection
against being sacked or losing their job as the result of a takeover.
Contract length and termination payments were designed to make
it very expensive to remove a director. Good corporate governance
practice now recommends a one-year contract rather than a three-
or even five-year rolling contract and that termination payments
should only be triggered following specific events as determined by
the remuneration committee.

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 Good corporate governance practice means an organisation

needs to:
 establish a reward policy which attracts, retains and
motivates directors to run the company successfully and
achieve the long-term interests of shareholders;
 ensure that the performance elements of remuneration form
a significant proportion of the total remuneration package;
 design remuneration packages to align director interests with
those of the shareholders and to give executive directors
appropriate incentives to perform at the highest levels;
 avoid paying more than necessary;
 ensure that benefits reflect performance and success; and
 ensure that full and transparent disclosure is made of the
overall remuneration policy and detail of individual director's
compensation arrangements (this will include basic salary, Best practices:
bonus elements, share and other option schemes, pension
 The structure of
scheme details, joining payments, termination arrangements).
non-executive
 The UK Corporate Governance Code recommends that remuneration
organisations establish a remuneration committee to set should be clearly
remuneration, pension and compensation payments for the distinguished from
chairman and all executive directors. that of executives.
 The committee should only consist of independent NEDs.  Thresholds for
 The terms of reference made available (e.g. disclosed in the payments of equity-
based executive
financial statements).
remuneration
 The committee should also recommend and monitor should be
remuneration for senior management (e.g. next level below approved by the
the board). shareholders.
 Independent consultants may be appointed to assist the
committee.
 Considerations to be taken into account by the remuneration
committee when looking at each director's compensation include:
 the job itself;
 the skills of the individual;
 the past performance of the individual;
 overall contribution (and links) to company strategy;
 market rates;
 level of basic salary;
 performance-related elements (including ethical, social
responsibility and sustainability);
 pensionable elements and retirement benefits;
 entry payments, length of contract and termination payments;
 position relative to other organisations; and
 motivation of director required.

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2.5 Audit Committees

 Audit committees have developed into a core element of the
oversight role in good corporate governance. The aim, under
corporate governance, is for them to ensure market, public
and stakeholder confidence in high-quality financial reporting.
 The committee will be able to carry out a thorough and
detailed review of audit matters, both internal and external,
thus enhancing the environment for greater external
confidence in the entity. Their role is divided into three
areas─financial statements and control, external auditors,
internal auditors.
 As most corporate governance codes require the audit
committee to comprise 100% independent NEDs (at least
one of whom must have recent, relevant, financial accounting
experience), the NEDs can contribute independent judgement Best practice: The
on matters of critical importance in running the enterprise chairman of the
(e.g. investment decisions, risk analysis) and play a positive committee should
role in areas for which their skills are particularly fitted. The not be the chairman
external and internal auditors will thus have a direct link with of the board.
non-executive directors.*

*The chief executive of the enterprise and the chair of the audit
committee must particularly develop a respected, transparent,
trusted and professional working relationship.

 Effective audit committees need to be able to investigate

issues on their own initiative, rather than as directed by the
CEO. They must be clear about what they need to know and
determined to receive the information they require.
 The audit committee should not seek to take an executive role
but should aim to be satisfied that management has properly
fulfilled its responsibilities. In doing so, the committee
members must have a sound understanding of the entity,
the way it operates, the environment it operates in and be
independent of the company.
 Although the role of the audit committee considers the
risks and controls over the financial reporting process, the
committee also must consider the tax, environmental, legal
and other regulatory matters which have a material effect on
the financial statements.
 Corporate governance codes will not change the mindset of
a CEO/CFO determined to carry out a fraud. But an effective
audit committee (together with effective internal and external
auditing) should act as a significant deterrent and minimise
the opportunities for destructive fraud to remain undetected
over time.

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2.5.1 Financial Statements and Controls

 Ensure that internal control properly protects shareholder
interests and that financial reporting is accurate, timely
and complete.
 Provide oversight, assessment and review of the board and
its functions.
 Monitor the integrity of the financial statements and
announcements relating to the company's financial
performance, including review of significant financial
reporting judgements.
 Review the company's internal control, internal financial
controls and risk management systems.
 Monitor and review the effectiveness of the company's internal
audit function.

2.5.2 External Auditor

 Recommend to the board the appointment, re-appointment
and removal of the external auditor. If the board refuses to
accept such recommendations, it is required by the UK Code
of Corporate Governance to explain why to shareholders.
 Approve the remuneration and terms of engagement of the
external auditor.
 Review and monitor the external auditor's independence
and objectivity.
 Review the effectiveness of the audit process, including
discussing the scope of the audit (strategy, risks, materiality,
resources and work programmes).
 Review of the representation and management letters and
actions taken.
 Discussing major issues arising from the audit, key accounting
and audit judgements, levels of error identified during the
audit and why unadjusted errors were not adjusted.
 Develop and implement policy on the engagement of the
external auditor to supply non-audit services (e.g. approving
or rejecting any additional services required).

Best practice: The external auditor should attend the annual general
meeting and answer shareholders' questions about the conduct of
the audit and the content of the auditor's report.

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2.5.3 Internal Audit

 Monitor and assess the role and effectiveness of the internal
audit function in the overall context of the company's risk
management system.
 Approve the appointment or termination of the head of
internal audit.
 Ensure that the internal auditor has direct access to the board
chairman and to the audit committee and is accountable to the
audit committee.
 Review and assess the annual internal audit work plan.
 Receive a report on the results of the internal auditor's work
on a periodic basis.
 Review and monitor management's responsiveness to the
internal auditor's findings and recommendations.
 Meet the head of internal audit at least once a year without
management's presence.
 Review arrangements which allow "whistle-blowing" by staff of
the company.

Example 2 Audit Committee Disadvantages

Suggest THREE disadvantages of audit committees.

Solution

1.

2.

3.

2.6 Public Oversight

 Control, supervision and oversight of the financial reporting
and auditing process was originally carried out by various
professional bodies which (as a group in their jurisdictions
such as the UK and the US) also issued various financial
reporting and auditing standards.
 As codes of corporate governance were developed (the UK's
corporate governance codes were the first in 1992), independent
oversight bodies were established to increase public confidence
in implementation and effectiveness of the code.
 Public oversight means, in broad terms, the review, checks
and balances over applicable procedures and application
of rules by members of the public or independent officials
representing the public interest.

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 As an example of a public oversight role, the Financial

Reporting Council (FRC) is the UK's independent regulator
responsible for promoting confidence in corporate reporting
and governance. The roles of the FRC include:
 promoting high standards of corporate governance (through
developing the UK Corporate Governance Code);
 setting, monitoring and enforcing accounting and auditing
standards (effectively IFRS and ISA);
 statutory oversight and regulation of auditors; and
 operating an independent investigation and discipline
scheme for public interest cases.
 The bodies in the FRC charged with achieving these
aims include:
 the Accounting Standards Board;
 the Auditing Standards Board;
 the Professional Oversight Board─oversight of the regulation
of the auditing and accounting professions and monitoring
of the quality of the auditing function; and
 the Monitoring Committee—seeks to ensure (through review
of published financial statements and other information) that
financial information reported by public and large private
companies complies with relevant accounting requirements.
 The FRC's strategic outcomes aim to ensure that:
 UK companies with a primary listing in the UK are led in
a way which facilitates entrepreneurial success and the
management of risk.
 Corporate reports contain information which is relevant,
reliable, understandable and comparable and are useful for
decision-making (including stewardship decisions).
 Users of audit reports can place a high degree of reliance
on the audit opinion, including whether financial statements
show a true and fair view.
 Clients and employers of professionally qualified
accountants and of accountancy firms can rely on them to
act with integrity and competence and in the public interest.
 It is an effective, accountable and independent regulator
which actively helps to shape the UK's approach to
corporate reporting and governance and to influence EU
and global approaches.*

*Following the Enron scandal in 2005 (which led directly to a

substantial strengthening of corporate governance and public
oversight through the Sarbanes-Oxley Act in the US), IFAC (see
Session 12) established the international Public Interest Oversight
Board (PIOB) to increase confidence that its activities, including
standard setting, respond to the public interest. Part of the PIOB's
role is to ensure that international auditing and assurance, ethics
and education standards for the accountancy profession are set in a
transparent manner which reflects the public interest.

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Session 9 • Governance and Social Responsibility F1 Accountant in Business

3 Corporate Social Responsibility

3.1 Concept

Corporate social responsibility─the continuing commitment

by a business to behave ethically and to contribute to economic
development while improving the quality of life of the workforce and
their families, the local community and society at large. It refers to
dealing with all the effects which a company may have on society in
a responsible way.

 The idea of corporations having a responsibility to society

has existed ever since they started to affect communities in
which they operated. The "industrial revolutions" of the 1800s
initially brought this concern to a national level by rallying for
laws and regulations that changed, for example, the working
conditions of employees.
 Corporate Social Responsibility (CSR) as a discipline
developed from the mid-1950s. As companies grew from
having just a local effect to national and (eventually) global
effects (especially from the 1960s), so the global awareness
of their impacts on stakeholders (e.g. suppliers, customers,
communities, societies and the environment) has grown
beyond just local considerations.
 In most jurisdictions, CSR is not covered by laws, regulations
or codes (e.g. Companies Acts or Codes of Corporate
Governance) although non-mandatory guidelines exist
(e.g. the Global Reporting Initiative www.globalreporting.org).
It is purely voluntary best practice driven by the fact that in
a global environment, brands and business reputation are
essential to an organisation's success.
 Organisations are vulnerable to reputation risk (e.g. bad
publicity about a product or practice) which can result in
damage to consumer (and other stakeholder) trust and thus
shareholder value. Consumers will avoid what they see as
irresponsible; CSR is seen as one way to minimise that risk.
 Thus many consider CSR to be enlightened self-interest on the
part of organisations.
 Ethically sound organisations attract better business
(e.g. customers, suppliers, additional finance). Those
considered unsound are boycotted.
 Employees are more attracted to work for socially
responsible companies and are more committed to them.
 Positive contribution to society will be a long-term investment
in a safer, better-educated and more equitable community
creating a more stable context in which to do business.
 All of the above will result in greater long-term wealth
generated by the business (e.g. a higher relative share price).

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F1 Accountant in Business Session 9 • Governance and Social Responsibility

 Milton Friedman argued that a society determines and meets

its needs and wants through the market place where the
self-interest pursuit by business happens to result in society
getting what it wants. Corporations have no responsibilities
other than making a profit for shareholders. Only human
beings have moral responsibility for their actions. Social
issues are the province of the state and not corporations,
thus corporate social responsibility as an end in itself is not
appropriate—"The business of business is … business."

3.2 Factors
 Archie Carroll (The four faces of corporate citizenship, 1998)
suggested a four-part model of CSR covering the expectations
placed on organisations by society:

PHILANTHROPIC Wished for

ETHICAL Desired

LEGAL Essential

ECONOMIC Required

 Economic responsibility (required)─reasonable return to

shareholders, safe and fairly paid employment, and quality
products at a fair price.
 Legal responsibility (essential)─follow the letter and spirit
of the law applicable to the organisations, its dealings, the
environment and interaction with stakeholders.
 Ethical responsibility (desired)─doing what is right, just
and fair over and above what is required by law or economic
considerations.
 Philanthropic (wished for)─the discretionary behaviour of
organisations to improve the lives of others who have no
direct stake in the organisation.
 In dealing with these, boards would need to consider and
provide CSR reporting on:
 ethical practices;
 ecology, environmental impact and protection;
 current and future needs of society;
 product design and customer relations; and
 employees, communities and human rights.

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Session 9 • Governance and Social Responsibility F1 Accountant in Business

 Under the Global Reporting Initiative (www.globalreporting.org),

sustainability is the key CSR concept.*

Sustainable development─development that meets the needs of

the present without compromising the ability of future generations to
meet their needs.
It is not a fixed state of harmony, but rather a process of change in
which exploitation of resources, the direction of investments, the
orientation of technological development and institutional change
are made consistent with future as well as present needs.
This definition comes from the Bruntland Report (1987)
www.un-documents.net/wced-ocf.htm. It has become the standard
definition when considering economic and business effects on the
environment (e.g. oil consumption is not sustainable (it cannot be
replaced) but solar power is).

*A more popular conception of sustainability is the capacity to endure.

A practice is sustainable if it will be able to be continued for the
foreseeable future. Thus, where an organisation or country aims to
reduce its carbon emissions to a more acceptable level, will that target
be sustainable? Will they be able to continually, year by year, improve
their processes and procedures to enable the target to be met?

 Under the Global Reporting Initiative (GRI), sustainability

reporting covers, for example, the following key performance
indicators:* *To fully understand
 Economic─customers, suppliers, employees, providers
the concept of CSR
and sustainability
of capital. reporting, it is
 Environmental─materials, energy, water, biodiversity, useful to review an
emissions, suppliers, compliance, transport. organisation's reports
 Labour practices─employment, relations, health and safety, (e.g. www.btplc.com).
training, education, diversity, opportunities.
 Human rights─strategy, development, non-discrimination,
freedom of association, child labour, indigenous rights.
 Society─community, bribery and corruption, political
contributions, competition and pricing.
 Product responsibility─customer health and safety,
advertising, respect for safety.

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F1 Accountant in Business Session 9 • Governance and Social Responsibility

3.3 Stakeholder Considerations

 The CSR thesis is that companies will build shareholder
value by engaging with and possibly satisfying the desires of
stakeholders other than legal owners.

Illustration 1 Royal Dutch Shell

In 1995, Royal Dutch Shell (Shell) decided to dispose of an oil drilling

platform, Brent Spar, by sinking it in the North Sea. After this
had become public knowledge, Greenpeace activists occupied the
platform. Following adverse international publicity, a major consumer
boycott of its products and criticism from European leaders, Shell
decided to abandon the idea of dumping the platform in the sea.
Also in 1995, the company was subject to further significant criticism
because of its roll in Nigeria and relations with the military regime
governing at that time.
In 1996, Shell undertook extensive market research and stakeholder
consultation to establish how it was perceived. The resulting report
was very unpleasant reading for the board of Shell—the organisation
was basically considered as a corporate villain with very little public
support.
The action taken by the board was considered to be radical—the
board more or less completely re-wrote the company's General
Business Principles to take into account a very broad range of ethical
issues and stakeholders. The board recognised that the traditional
model of scientific decision-making was no longer valid when dealing
with the many and varied social, environmental and ethical issues of
the world in which it operated.
The board thus committed itself to a very high level of stakeholder
consultation, engagement, sustainability, CSR reporting, Web forums
(e.g. "Tell Shell"), open meetings on key events and activities, Web
discussion forums ("Shell Dialogue") and open websites where
constructive criticism is encouraged. In doing so, the company moved
from a DAD framework—decide, announce, deliver—to DDD—dialogue,
decide, deliver. Shell has recognised that the company no longer lives
in a "trust-me" world but one in which it needs to show stakeholders
how and why Shell should be trusted, a "show-me" world.
And Brent Spar? In 1999, after an extensive consultation programme,
the platform was recycled as the base for a quay in Norway—at twice
the cost of disposal at sea. However, Shell shareholders found this
well worth the money spent to have turned Shell into a company that
improved shareholder wealth by making good sustainability decisions.

 As the Shell illustration shows, it is essential for organisations

to identify the key stakeholders and establish their interests.
Session 2 discussed in detail the various categories of
stakeholders, and Illustration 1 shows that providing forums
and communication channels for them may be a good way to
understand their interests.
 Analysing the various stakeholders (Mendelow grid) and their
claims will establish the potential sources of risk, influence
(both negative and positive) and possible disruption. It also
will be necessary to identify those stakeholders whose claims
may be in conflict, as these will need to be closely managed.
 The organisation should consider CSR issues which create
business value (or at least minimise business loss), are
linked to the company's core business and promote long-run
sustainability rather than just reactively conceding to external
stakeholder pressure.

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Session 9 • Governance and Social Responsibility F1 Accountant in Business

 CSR activities also should be linked to the core competencies

of the firm and be systematically assessed, evaluated and
communicated to stakeholders. The aim is to achieve social
responsibility, sustainability and growth in profits.*

*In dealing with CSR, the GRI guidelines make it perfectly clear
that reports should be balanced and report on matters which are
of material concern to stakeholders—the good, bad and ugly should
be reported, regardless of the fact that the overall picture may not
be glowing.

 Carroll suggested four strategies which organisations could

take when dealing with CSR and stakeholder issues:
1. Proactive─a strategy which a business follows where
it is prepared to take full responsibility for its actions
(e.g. discovering a fault in a product and recalling it
without being forced to, before any injury or damage is
caused or providing full and transparent reporting and
disclosure on its operations beyond any legal or ethical
requirement to do so).
2. Reactive─involves allowing a situation to continue
unresolved until the public, government or consumer
groups find out about it.
3. Defence─minimising or attempting to avoid additional
obligations arising from a particular problem.
4. Accommodation─taking responsibility for actions when,
for example, encouraged to do so by special interest
groups or the perception that a failure to act will result in
government intervention.
 In a "CNN world", being reactive and defensive are not
acceptable options. Being accommodative in certain situations
may well be too little, too late.

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 Session 9

Summary
 Corporate governance addresses the means by which organisations are directed and
controlled, involving a framework for decision-making processes.
 Nations typically address corporate governance through "codes" designed to protect
stakeholders and typically it includes:
• The composition, balance, committees and roles of various executive and non-executive
directors.
• Duties, functions, appointment, induction and appraisal of directors.
• Remuneration policy established by the remuneration committee appropriate to attract,
retain and motivate directors.
• Financial reporting reliability, with special consideration towards a balanced and
understandable discussion of the internal control system, as well as formation of an
audit committee to control and establish risk and ensure accurate, complete and
timely reporting.
• Shareholder rights and responsibilities, including the AGM.
 Codes may be rules-based, meaning that the code determines the exact method by which
companies will govern themselves.
 Codes may be principles-based, meaning that companies have some latitude over how they
achieve the desired end result. If principles-based, the company may have a "comply or
explain" requirement (as in the UK Code).
 The UK's independent regulator responsible for promoting confidence in corporate reporting
and governance is the Financial Reporting Council (FRC). The bodies in the FRC are:
• the Accounting Standards Board;
• the Auditing Standards Board;
• the Professional Oversight Board; and
• the Financial Reporting and Review Panel (FRRP).
 CSR addresses the need for organisations to behave ethically and to consider stakeholder
interests which extend past short-term financial gains.
 Sustainability is the key CSR concept with regard to the GRI. Sustainability concerns
meeting the needs of the present without compromising the ability of future generations to
meet their needs.

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 Session 9 Quiz
Estimated time: 15 minutes

1. Define "corporate governance". (1.2)

2. Identify FIVE of the nine key underpinning concepts in corporate governance. (1.3)

3. List the FIVE elements which form the key recommendations for most corporate
governance codes. (2)

4. State FOUR internal audit requirements placed on the audit committee by corporate
governance. (2.5)

5. Define "corporate social responsibility". (3.1)

6. Briefly describe the FOUR expectations suggested by Carroll which CSR places on the
organisation. (3.2)
7. Define "sustainability". (3.2)
8. Describe a "proactive" CSR strategy. (3.3)

Study Question Bank

Estimated time: 30 minutes

Priority Estimated Time Completed

Governance and Social

MCQ9 Responsibility in Business 30 minutes

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EXAMPLE SOLUTIONS
Solution 1—Rules-Based Governance
 Incorporated into the legal structure of the country.
 Applies to all entities within its scope, regardless of the size of
that entity.
 No exceptions are made.
 Can be considered as inflexible.
 Statutory penalties applied for non-compliance.
 Updated and modified through the legal process.

Solution 2—Audit Committee Disadvantages

May be seen as an unnecessary legal or regulatory burden placed on
the board─"we know how to run the company without anybody else
trying to tell us what to do".
Places an additional cost burden on the entity. The advantages
offered by having an audit committee must be effectively utilised
to ensure appropriate cost benefit (e.g. enhance public credibility,
experienced sounding board for the executive directors).
Audit committees will be effective only where they are able to operate
as intended by the various codes. Anything less than respect,
understanding of the role of the audit committee by the main board
and access to all information will diminish that effectiveness.
The demands now placed, for example by the UK Corporate
Governance Code and the Sarbanes-Oxley Act, on the time and
expertise of members of the audit committee are such that suitable
candidates (e.g. experience and qualification) may be harder to find.
The risks and burden of responsibilities being placed on members of
audit committees may result in a feeling that the "reward is not worth
the effort" or rather that the risks are too high. This may result in the
overall ability of the audit committee being less than what it should be.
It is not so much a disadvantage, more a fact of life, that what
the audit committee does not know or is able to find out remains
unknown—the "unknown unknowns". As when dealing with the
auditors, if a CEO is sufficiently determined to withhold information
from the auditors, other directors and the audit committee, it may be
difficult for such information to be uncovered and determined.*

*Many objections to audit committees were put forward when the

UK Corporate Governance Code was first introduced. However, the
majority of organisations affected by the Code now recognise the
significant benefits application has brought.

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