Download ACCA P1 Short Notes 2018
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Corporate governance is “the system by which organizations are directed and controlled.” (Cadbury report)
“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.” (OECD)
Note: Governance should NOT be confused with management, which is concerned with running the business operations of the company whereas Governance is concerned about Leading the company and monitoring/controlling management decisions to ensure that company is achieving its objectives.
Purpose and objectives of corporate governance;
Corporate governance has both purposes and objectives.
• The basic purpose of corporate governance is to monitor those parties within a company which controls the resources owned by investors.
• The primary objective of sound corporate governance is to contribute to improved corporate performance and accountability in creating long-term shareholder value.
Separation of ownership
Problems arise with the governance when there is the separation of ownership and control (as in listed companies). The constitution of a company usually delegates the powers to manage the company to its directors and they become agent of the company so there need better control at TOP LEVEL to govern the company which should be in the best interest of its shareholders, however, the interest of other groups such as employees might also have influence on the directors.
Corporate Governance Issues;
What are the key issues in corporate governance, which establish how well or badly a company is governed? The main areas covered by codes of corporate governance are as follows:
• The role and responsibilities of the board of directors. The board of directors should have a clear understanding of its responsibilities and it should fulfill these responsibilities and provide suitable leadership to the company. Governance is therefore concerned with establishing what the responsibilities of the board should be, and making sure that these are carried out properly.
• The composition and balance of the board of directors. A board of directors collectively, and individual directors, should act with integrity, and bring independence of thought and judgment to their role. The board should not be dominated by a powerful chief executive and/or chairman. It is therefore important that the board should have a suitable balance, and consist of individuals with a range of backgrounds and experience.
• Financial reporting, narrative reporting, and auditing. The board should be properly
accountable to its shareholders and should be open and transparent with investors generally. To make a board properly accountable, high standards of financial reporting (and narrative reporting) and external auditing must be upheld. The major ‘scandals’ of corporate governance in the past have been characterized by misleading financial information in the company’s accounts – in the UK, for example, Maxwell Communications Corporation and Polly Peck International, more recently in Enron and WorldCom in the US and Parmalat in Italy. Enron filed for bankruptcy in 2001 after ‘adjusting’ its accounts. WorldCom, which collapsed in 2002 admitted to fraud in its accounting and its chief executive officer was subsequently convicted and jailed.
• Directors’ remuneration. Directors work for a reward. To encourage their commitment to achieving the objectives of their company, they should be given suitable incentives. Linking remuneration to performance is considered essential for successful corporate governance. However, linking directors’ pay to performance is complex, and remuneration schemes for directors have not been particularly successful. Directors’ pay is an aspect of corporate governance where companies are frequently criticised.
• Risk management and internal control. The directors should ensure that their company
operates within acceptable levels of risk, and should ensure through a system of internal control that the resources of the company are properly used and its assets are protected.
• Shareholders’ rights. Shareholders’ rights vary between countries. These rights might be weak, or might not be exercised fully. Another aspect of corporate governance is encouraging the involvement of shareholders in the companies in which they invest, through more dialogue with the directors and through greater use of shareholder powers – such as voting powers at general meetings of the company.
Underlying Principles of Corporate Governance
It refers to the state or quality that implies detachment, lack of biases, not to be influenced by any personal benefit or feelings. People holding the influencing positions should be independent as they are acting as the agents of shareholders.
Integrity means straightforward and honest dealing with all the business relationship. In a more general sense, it can be defined as “doing things right.” Following ethical guidelines and maintaining the highest degree of professionalism refers to integrity. It also highlights the issues of presenting information; however, the integrity of financial reports depends on the integrity of people who prepared them.
company’s decisions are taken by directors, therefore they must ensure that they have
necessary and sufficient information from a reliable source in order to make a sensible decision that will improve the profitability and maximizes shareholder’s wealth.
It means that directors should be personally responsible (liable) to perform the task as they have been given powers to run the company, however, some responsibilities are further delegated, by them, to executive management, but directors are responsible for the way in which those powers used. BODs are not expected to ignore their responsibilities. They should be responsible and are required to follow the “duties of directors” as set out in C.A.2006.
It means ‘answerable’. Directors should remain accountable for their work and are required to give explanations that how they performed their duties. This is an important part of company law. For example, directors should explain their duties and interpret the financial statements along with the questions of shareholders, in AGM.
This is an important part of corporate governance which must not only telling the truth but also not misleading the shareholders and stakeholders by presenting information partially or in a slanted manner (one-sided/partial).
All people affected by decisions (stakeholders) should be treated equally without any bias. In the context of corporate governance “fairness” refers to the principles that all the shareholders should receive fair treatment from directors, (such as one vote per share at AGM and the right to the same dividend per share).
This principle underpins transparency which means information should not be hidden from people who have right to access that information, clear, complete and transparent information (without hiding relevant facts and figures) is the right of stakeholders as their decision and investment analysis of the information supplied by the directors. This may suggest that companies should not just follow disclosure rules, but also add voluntary disclosures, if it adds transparency.
• In public sector, openness means telling the public, and not making decisions ‘behind
• In listed companies, openness includes such matters such as board information relevant for shareholders should be disclosed so that shareholders can take the decision.
The character of the company should be perceived as good by its stakeholders (interested
parties) and it is affected by the actions of the directors, therefore directors should avoid all those actions which may raise question mark on the reputation of the directors and of the company, they should protect their own reputation, company’s reputation and reputation of the professional body to which they relate.
This is the professional quality expected from a professional, which includes being alert to the possibility of any misstatement either due to error or fraud and should possess the attitude of the question and thereby providing the critical assessment of the evidence. For instance, UK Corporate governance guidance is in the advocacy for NEDs to apply skeptical attitude in order to challenge and scrutinize management of the organization effectively.
As the word implies, this refers to the things which should be unique and innovative and it will happen when a company transforms knowledge and ideas into new products, processes, and systems for the benefit of the organization and its shareholders. The corporate governance context highlights the importance of innovation by allowing the business to move towards modern techniques from the traditional and rigid approach and receiving information which is crucial for the purpose of innovation and betterment of the organization.
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