RECG 400

CORPORATE GOVERNANCE
The lesson will cover the following:
- Definition and meaning of corporate
governance.
- Scope of corporate governance
- Concepts underlying corporate governance.
 Definitions of corporate governance

- Corporate governance, the system by which

organisations are directed and controlled, is
based on a number of concepts, including
transparency, independence, accountability
and integrity.
- They are systems by which organisations are
directed and controlled.( Cadburry report)
• Cudburry report tilted Financial Aspects of
Corporate Governance.
• It is a report issued by the committee on the
Financial Aspects of Corporate Governance
chaired by Adrian Cudburry that sets out the
recommendations on the arrangements of
company boards and accounting systems to
mitigate corporate governance, risks and
failures.
• Corporate governance is a set of relationships
between a company’s directors, its
shareholders and other stakeholders.
• It also provides the structure through which
the objectives of the company are set, and the
means of achieving those objectives and
monitoring, performance are determined.
 Comments about the definitions
• The management, awareness, evaluation and
mitigation of risks is fundamental.
• The notion of overall performance is enhanced by
good supervision and management within set best
practice.
• Good governance provides a framework for an
organisation to pursue its strategy in an ethical and
effective way and offers safeguards against misuse of
resources (human, financial, physical and
intellectual).
d) Good governance is not just about externally
established codes, it also requires a willingness
to apply the spirit as well as the letter of the
law.
e)Good corporate governance can attract new
investment into companies, particularly in
developing nations. It should mean that
shareholders can trust those responsible for
running and monitoring the company.
f) Accountability is generally a major theme in all
governance frameworks, including accountability
not just to shareholders but also other stakeholders,
and accountability not just by directors but by
auditors as well.
g) Corporate governance underpins capital market
confidence in companies and in the
government/regulators/tax authorities that
administer them. It helps protect the value of
shareholders' investment.
 Governance in companies and non-
governmental organisations
• Governance is an issue for all corporate bodies, commercial and
not for profit, including public sector and non-governmental
organisations.
• Public sector organisations are organisations that are controlled
by one or more parts of the state. Their functions are often to
implement government policy in secretarial or administration
areas. Some are supervised by government departments (for
example hospitals or schools).
Others are devolved bodies such as local authorities,
nationalised companies (majority or all of the shares owned by
the government), supranational bodies or non-governmental
organisations.
• These organisations are in the public sector because
the control over a particular public service, utility or
public good is seen as so important that it cannot be
left to the profit-motivated sector, which may for
example seek to close socially vital loss-making
services such as bus routes.
• Objectives will be determined by the political leaders
in line with government policy. They are likely to
focus on value for money and service delivery
objectives, possibly underpinned by legislation.
• The level of control may be high, leading to accusations of excess
bureaucracy and cost. In many countries there are thousands of
charities and voluntary organisations that exist to fulfill a
particular purpose, maybe social, environmental, religious or
humanitarian. Funds are raised to support that purpose.
• Charities are not owned as such, but will be primarily responsible
to the donors of funds and the beneficiaries (those who receive
money or other aid) out of the charities' resources. Charities will
be subject to their own legal regime that grants privileges (for
example tax concessions) but imposes requirements on how
funds can be spent and the charities' assets managed.
 Underlying concepts of corporate
governance
i) Fairness
The directors' deliberations and also the
systems and values that underlie the
company must be balanced by taking into
account everyone who has a legitimate
interest in the company, and respecting their
rights and views.
ii) Transparency
Transparency means open and clear disclosure of relevant
information to shareholders and other stakeholders, also
not concealing information when it may affect decisions. It
means open discussions and a default position of
information provision rather than concealment.
Disclosure in this context obviously includes information in
the financial statements, not just the numbers and notes to
the accounts but also narrative statements such as the
directors' report and the operating and financial or
business review.
It also includes all voluntary disclosure that is
disclosure above the minimum required by
law or regulation.
Voluntary corporate communications include
management forecasts, analysts'
presentations, press releases, information
placed on websites and other reports such as
stand-alone environmental or social reports.
The main reason why transparency is so important relates
to the agency problem ,the potential conflict between
owners and managers.
Without effective disclosure the position could be unfairly
weighted towards managers, since they have far more
knowledge of the company's activities and financial
situation than owner/investors.
Avoidance of this information asymmetry requires not
only effective disclosure rules, but strong internal controls
that ensure that the information that is disclosed is
reliable.
Information also needs to be published in sufficient detail to
meet the needs of shareholders/owners.
Publication of abbreviated information may be counter-
productive and may give the impression of concealment rather
than openness.

Publication of relevant and reliable information reassures

investors and underpins stock market confidence in how
companies are being governed and thus significantly influences
market prices. International accounting standards and stock
market regulations based on corporate governance codes require
information published to be true and fair.
iii) Innovation
The concept of innovation in the approach to corporate governance
recognises the fact that the needs of businesses and stakeholders can
change over time. It also has an impact on how organisations respond
to meeting the 'comply or explain' requirement contained in various
codes of corporate governance that are currently in effect.
iv) Scepticism
An attitude that includes a questioning mind, being alert to conditions
which may indicate possible misstatement due to error or fraud, and a
critical assessment of audit evidence. This does not mean that all
management decisions and evidence have to be approached with
suspicion or mistrust; but that an open and enquiring mind must
always be employed.
v) Independence
Independence is the avoidance of being unduly
influenced by vested interests and being free
from any constraints that would prevent a
correct course of action being taken.
It is an ability to stand apart from inappropriate
influences and be free of managerial capture, to
be able to make the correct and
uncontaminated decision on a given issue.
• An important distinction generally with
independence is independence of mind and
independence of appearance.
• Independence of mind means providing an opinion
without being affected by influences compromising
judgment.
• Independence of appearance means avoiding
situations where an informed third party could
reasonably conclude that an individual's judgment
would have been compromised.
Independence is an important concept in relation to directors, in
particular freedom from conflicts of interest. Corporate governance
reports have increasingly stressed the importance of independent
nonexecutive directors, directors who are not primarily employed by
the company and who have very strictly controlled other links with it.
They should be in a better position to promote the interests of
shareholders and other stakeholders.
Freed from pressures that could influence their activities,
independent nonexecutive directors should be able to carry out
effective monitoring of the company and its management in
conjunction with equally independent external auditors on behalf of
shareholders.
• Non-executive directors' lack of links and limits on the time that
they serve as non-executive directors should promote avoidance of
managerial capture – accepting executive managers' views on trust
without analysing and questioning them.

vi) Probity/honesty
• Hopefully this should be the most self-evident of the principles.
• It relates not only to telling the truth, but also not misleading
shareholders and other stakeholders.
• Lack of probity includes not only obvious examples of dishonesty
such as taking bribes, but also reporting information in a slanted
way that is designed to give an unfair impression.
viii) Responsibility
• Responsibility means management accepting the credit
or blame for governance decisions. It implies clear
definition of the roles and responsibilities of the roles
of senior management.

• The South African King report stresses that for

management to be held properly responsible, there
must be a system in place that allows for corrective
action and penalising mismanagement.
• Responsible management should do, when
necessary, whatever it takes to set the
company on the right path.
• King states that the board of directors must
act responsively to, and with responsibility
towards, all stakeholders of the company.
 Accountability
• Corporate accountability refers to whether an
organisation (and its directors) is answerable in some
way for the consequences of their actions.
• Directors being answerable to shareholders have always
been an important part of company law, well before the
development of the corporate governance codes. For
example companies in many regimes have been required
to provide financial information to shareholders on an
annual basis and hold annual general meetings.
• Making accountability work is the
responsibility of both parties.
• Directors do so through the quality of
information that they provide whereas
shareholders do so through their willingness
to exercise their responsibility as owners,
which means using the available mechanisms
to query and assess the actions of the board.
 Reputation
• Reputation is determined by how others view a
person, organisation or profession.
• Reputation includes a reputation for competence,
supplying good quality goods and services in a timely
fashion, and also being managed in an orderly way.
• However a poor ethical reputation can be as serious
for an organisation as a poor reputation for
competence.
The consequences of a poor reputation for an organisation can
include:
- Suppliers and customers unwillingness to deal with the
organisation for fear of being victims of sharp practice.
- Inability to recruit high-quality staff .
- Fall in demand because of consumer boycotts.
- Increased public relations costs because of adverse stories in
the media.
- Increased compliance cost because of close attentions from
regulatory bodies or external auditors .
- Loss of market value because of a fall in investor confidence.
 Judgement
• Judgement means that the board making decisions
that enhance the prosperity of the organisation.
• This means that board members must acquire a broad
enough knowledge of the business and its
environment to be able to provide meaningful
direction to it.
• This has implications not only for the attention
directors have to give to the organisation's affairs, but
also the way the directors are recruited and trained.
Integrity
• 'Integrity means straightforward dealing and completeness.
What is required of financial reporting is that it should be honest
and that it should present a balanced picture of the state of the
company's affairs. The integrity of reports depends on the
integrity of those who prepare and present them.' (Cadbury
report)
• Integrity means that holders of public office should not place
themselves under any financial or other obligation to outside
individuals or organisations that might influence them in the
performance of their official duties. (UK Nolan Committee
Standards on Public Life )
• Integrity can be taken as meaning someone of high
moral character, who sticks to strict moral or ethical
principles no matter the pressure to do otherwise.
• In working life this means adhering to the highest
standards of professionalism and probity.
Straightforwardness, fair dealing and honesty in
relationships with the different people and
constituencies whom you meet are particularly
important.
• The Cadbury report definition highlights the
need for personal honesty and integrity of
preparers of accounts. This implies qualities
beyond a mechanical adherence to accounting or
ethical regulations or guidelines.
• At times accountants will have to use judgement
or face financial situations which aren't covered
by regulations or guidance, and on these
occasions integrity is particularly important.
• Integrity is an essential principle of the corporate
governance relationship, particularly in relationship
to representing shareholder interests and exercising
agency .
• Monitoring and agency costs can be reduced if there
is trust in the integrity of the agents.
• In addition we have seen that a key aim of corporate
governance is to inspire confidence in participants in
the market and this significantly depends upon a
public perception of competence and integrity.
• Public sector accountability The accountability
relationship will be different for bodies owned or run
by national or central government.
• The nature of the relationship may be clear – that
government determines objectives.
• How accountability is demonstrated and enforced may
depend though on how coherent the objectives are.
• The main problem will often be where the body's main
objectives are non-economic, but the government also
wishes to limit the amount it spends on the body.