Ch5 Corporate governance and social responsibility

2004 Fall ACCA Paper 1.3

Study guide Separation between ownership and controlDefine corporate governance and social responsibility, and explain their importanceResponsibility of organisation in corporate governance and social responsibilityBest practice in effective corporate governanceHow organisation take account of social responsibility objectivesIdentify social and environmental responsibilities of business

2004 Fall ACCA Paper 1.3

1 Principles of corporate governance3 different views in the ownership-management relationshipStewardship theory: management of an organisation is the steward of its assetsAgency theory: management will act in an agency capacity, seeking to service their own interestStakeholder theory: management has a duty of care, not just to the owner, but also to the stakeholders.*R-12:#2

2004 Fall ACCA Paper 1.3

Governance principlesMinimize riskPromote integrityMaintain independence (of non-executive directors, internal and external auditors)Establish clear accountability Provide accurate and timely reportingEnsure adherence to strategic objectivesEncourage more proactive involvement of owners/members in effective managementFulfill responsibilities to all stakeholders fairly*R-12:#3; P562:#12

2004 Fall ACCA Paper 1.3

Principles vs. rulesDebate on corporate governance guidance should be in the form of principles or rules:Principles-based approachGuidance with exceptionsRelaxing the regulatory burden on companiesSupported by Hampel report in the UKPrinciples are so broad that they are of very little use as a guide to best corporate governance practiceRules-based approachStrict and easy to use

2004 Fall ACCA Paper 1.3

2 Development of CGCorporate governance is the system by which organisations are directed and controlled by senior officers.Elements in CG:Risk management and reductionManagement within best practice guidelines, good supervision AccountabilityFramework to pursue corporate strategy in an ethical and effective wayWillingness to apply the spirits as well as established codes

2004 Fall ACCA Paper 1.3

Driving forces of CG developmentIncreasing internationalisation and globalisationDifferential treatment of domestic and foreign investorsCharacteristics of individual countriesIssues in financial reportingAn increasing number of high profile corporate scandals

2004 Fall ACCA Paper 1.3

Development of UK CG1998 combined codeCadbury Committee 1992 (best practice)Greenbury Committee 1995 (directors remuneration)Hampel Committee 1996 (best practice)2003 combined codeTurnbull Committee 1999 (internal control and risk management)Higgs report 2003 (non-executive directors)Smith report 2003 (audit committees )

2004 Fall ACCA Paper 1.3

Features of poor CGDomination by a single individual (or small groupLack of involvement of boardLack of adequate control function No internal audit; not enough technical knowledgeLack of supervisionNo separation of key rolesLack of independent scrutiny by external and internal auditorsLack of contact with shareholdersRemuneration package not linked to resultsEmphasis on short-term profitabilityMisleading accounts and information*R-12:#5; R-50:#1

P161 Q&A

2004 Fall ACCA Paper 1.3

Risk of poor CGLarge loss; bankruptcy; close down of organisationReports on CGUKUS: Sarbanes-Oxley Act 2002Public Company Accounting Oversight Board: aimed to protect investors and other stakeholders by ensuring that the auditor of a company financial statements has adhered to strict guidelines.(R-13:#7)South Africa: King report

2004 Fall ACCA Paper 1.3

3 Role of the boardScope of roleDecisions on mergers and takeovers; acquisitions and disposals of assets and subsidiaries; investments; capital projects; bank borrowing; foreign transactions (above certain size)Oversee strategyMonitor CEOMonitor the human resourcesMonitor risks and control systemsEnsure effective communication*R-12:#6

2004 Fall ACCA Paper 1.3

Attributes of directorsThe board as a whole needs to contain a mix of expertise And show a balance between executive management and non-executive directors, and have a good demographic balance (*R-50:#3)New and existing directors should be appropriately trainedThe board should set up a nomination committee to oversee the process of board appointment and make recommendations to the board.

2004 Fall ACCA Paper 1.3

Directors should obtain appropriate information, both quantitative and qualitative, financial and non-financial, involving broader stakeholder interestsPerformance of the board should be assessed regularly, (separate appraisal of chairman and chief executive) with links to remuneration processDirectors should alter their behaviour to counter increase risk of legal actions and dismissal, by meeting the requirements of best practice Division of responsibilities at the head of an organisation requires roles of chair and chief executive to be held by two different people (not mandatory in UK) .

2004 Fall ACCA Paper 1.3

Non-executive directors

2004 Fall ACCA Paper 1.3

Non-executive directorsNon-executive directors have no executive (managerial) responsibilities.Role of non-executive directors:Contribute to and challenge the direction of strategyScrutinise the performance of managementEnsure the systems of risk management are robustDetermine levels of remuneration for executives Appointment and removal of senior managersNon-executive directors should provide a balancing influence, reducing conflicts of interest between management and shareholders, providing reassurance to shareholders.

2004 Fall ACCA Paper 1.3

Adv. of non-executive directorsHave external experience and knowledge Provide a wider perspective Act as a comfort factor for third partiesPlay certain roles they are well-suited to playProvide a strong, independent element on the board (dual nature): the most important advantage*R-13:8

2004 Fall ACCA Paper 1.3

Problems of non-executive directorsMay lack independencePrejudice against recruiting non-executive directors High-calibre non-executive directors may not provide the org. with what it needsMay have difficulty imposing their views upon the boardRole in preventing trouble is weakLimited time: the biggest problem*R-50:2

2004 Fall ACCA Paper 1.3

Number of non-executive directorsHaving a significant presence of non-executive directors on the board is important.PrincipleThe board should include non-executive directors of sufficient character and number for their views to carry significant weight.PrescriptiveNYSE listed companies should have a majority of non-executive directors.

2004 Fall ACCA Paper 1.3

Independence of non-executive directorsNo business, financial or other connection with the companyExcept fees and shareholdingsNot take part in share option schemesAppointments should be for a specified term and reappointment should not be automaticBoard as a whole should decide on their nomination and selectionMay take independent advice

2004 Fall ACCA Paper 1.3

Remuneration

2004 Fall ACCA Paper 1.3

RemunerationRemuneration policy (Greenbury committee)Directors remuneration should be set by independent members of the boardBonus should be related to measurable performanceThere should be full transparency of directors remunerationRemuneration committeeDetermine general policy and specific remuneration packagesStaffed by (non-executive directors + no personal interests + no conflicts of interest+ no day-to-day involvement in running the business)*R-50:#4; P563:#13

2004 Fall ACCA Paper 1.3

Establish remuneration arrangementsRemuneration package should be able to attract, retain and motivate directors, and also take into account shareholders interestsSensitive areasShare option schemesLength of service contractsPension consequencesOther considerationsDifferentials at management/director levelAbility of managers to leaveIndividual performanceCompanys overall performance

2004 Fall ACCA Paper 1.3

Audit committee

2004 Fall ACCA Paper 1.3

Duties of audit committee (p170-171)Liaison with external auditorsAppointment or removal of external auditors; consider their independence; discuss scope of audit; help obtain information; act as consultant; liaison between external auditors, internal auditors and finance director; deal with reservationsReview of internal auditStandards; scope; resources; reporting arrangements; work plan; resultsReview of annual accounts, financial reporting and various systems (R-51:#6)Review of internal control Monitor internal control system; legal compliance and ethics; address risk of fraud; review companys statement on internal control; consider recommendations of auditors; supervise transactionsReview of risk management: policy and arrangementinvestigations

2004 Fall ACCA Paper 1.3

Benefits of audit committee (p169)Improve the quality of financial reportingIncrease public confidence in financial statementsStrengthen the position of external auditorProvide a framework for external auditor to ensure independenceStrengthen the position of internal auditorHelp finance directorCreate a climate of control and reduce the opportunity for fraud

2004 Fall ACCA Paper 1.3

Effectiveness of audit committee (p169)In order to be effective, audit committee should:Well staffed: consist entirely of independent non-executive directors, and include at least one member with financial expertiseAvoid acting as a barrier between external auditors and executive boardAvoid executive board to abdicate its responsibilities in the audit areaAvoid falling under the influence of a dominant board member

2004 Fall ACCA Paper 1.3

4 Reporting on CG (in annual report)Required :Narrative statement of how companies applied principlesStatement of whether they compliedMay be required:Information about board of directorsReport on remuneration, audit and nomination committeeStatement that reviewed effectiveness of internal controlRelations with auditorsRelations with shareholdersStatement that company is a going concernSustainability reportOperating and financial review (OFR): R-13:#7

2004 Fall ACCA Paper 1.3

5 Corporate social responsibility (CSR)

Social responsibility are actions which the organization is not obliged to take, taken for the well-being of stakeholders and the public.Social responsibility and ethical behaviour are not the same thingTwo views about (5.2-5.3)Stakeholder view: many groups have a stake in what the organisation does. Against corporate social responsibility: business orgainsation is purely economic force *P563:#14; R-12:#1

2004 Fall ACCA Paper 1.3

Strategies for social responsibility (5.1.1)Proactive strategy: prepared to take full responsibility for its actions.Reactive strategy: allow situation to continue unresolved until the public, government or consumer groups find out.Defense strategy: minimise obligations arising from a particular problem.Accommodation strategy: take responsibility only when encouraged from special interest groups or government interventions.*R-13:#9

2004 Fall ACCA Paper 1.3

6 Ethics, law, governance and social responsibility

*R-13:#11

lawCorporate governanceSocial responsibilityethicsHighly regulated; companies must follow;Minimum level of behaviourLess regulated; listed companies must follow; others encouraged to followNo regulation; companies have a free choice; pressured to followNo regulation; companies have a free choice; expected to follow by society

2004 Fall ACCA Paper 1.3

Corporate governance and social responsibility may be viewed as additional rules and guidance for companies and individuals.Corporate governance and social responsibility bridge the gap between what the law requires and what society expects.

2004 Fall ACCA Paper 1.3

KAPLAN: definitionsCadbury report: corporate governance is the system by which companies are directed and controlled.OECD: corporate governance involves a set of relationships between a companys management, its board, its shareholders and other stakeholders. Corporate governance also provides the structure means of attaining those objectives and monitoring performance are determined.Sustainable development: companies should make decisions based not only on financial factors, but also on the social and environmental consequences of their actions.(R-51:#5) WBCSD: CRS is the continuing commitment by business to behave ethically and contribute to economic development while improving the quality of life of the workforce and their families as well as of the local community and society at large. (R-13:#10)

2004 Fall ACCA Paper 1.3