Role of Audit in Corporate Governance

8/8/2019 Role of Audit in Corporate Governance

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Hailey College of Banking and Finance

Corporate

GovernancePresented to: ABC

Presented by: XYZ

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Corporate Governance

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CORPORATE GOVERNANCE

Corporate governance is the set of processes, customs, policies, laws, and institutions affectingthe way a corporation (or company) is directed, administered or controlled. Corporate

governance also includes the relationships among the many stakeholders involved and the goals

for which the corporation is governed. The principal stakeholders are the shareholders, the boardof directors, employees, customers, creditors, suppliers, and the community at large.

Corporate governance is a multi-faceted subject An important theme of corporate governance isto ensure the accountability of certain individuals in an organization through mechanisms that try

to reduce or eliminate the principal-agent problem. A related but separate thread of discussionsfocuses on the impact of a corporate governance system in economic efficiency, with a strong

emphasis on shareholders' welfare. There are yet other aspects to the corporate governancesubject, such as the stakeholder view and the corporate governance models around the world.

There has been renewed interest in the corporate governance practices of modern corporations

since 2001, particularly due to the high-profile collapses of a number of large U.S. firms such asEnron Corporation and MCI Inc. (formerly WorldCom). In 2002, the U.S. federal government

passed the Sarbanes-Oxley Act, intending to restore public confidence in corporate governance.


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WHAT IS CORPORATE GOVERNANCE?

yBACKGROUND OF CORPORATEGOVERNANCE

Corporate governance is a relatively new term used to describe a process, which has been

practiced for as long as there have been corporate entities. This process seeks to ensure that the

business and management of corporate entities is carried on in accordance with the highestprevailing standards of ethics and efficacy upon assumption that it is the best way to safeguardand promote the interests of all corporate stakeholders.

The process of corporate governance does not exist in isolation but draws upon basic principles

and values which are expected to permeate all human dealings, including business dealings principles such as utmost good faith, trust, competency, professionalism, transparency and

accountability, and the list can go on Corporate governance builds upon these basic assumptionsand demands from human dealings and adopts and refines them to the complex web of

relationships and interests which make up a corporation. The body of laws, rules and practiceswhich emerges from this synthesis is never static but constantly evolving to meet changing

circumstances and requirements in which corporations operate. From time to time, crisis ofconfidence in effective compliance with, or implementation of, prevailing corporate governance

principles acts as a catalyst for further refinement and enhancement of the laws, rules andpractices which make up the corporate governance framework. The result is an evolving body of

laws, rules and practices, which seeks to ensure that high standards of corporate governancecontinue to apply.

At their earliest development, the business and management of corporate entities were governed

in accordance only with the basic principles of agency and trust, which included the requirementfor utmost good faith, transparency and accountability. However, with the growth in size of

corporate entities, increasing complexities of business environment and the absence of a formal

regulatory framework, basic agency and trust principles were found to be inadequate to fullysafeguard and promote the interests of stakeholders. These early experiences led to theintroduction of special laws to regulate registration of companies and the requirement for such

companies to conform to prescribed laws, rules and practices in the conduct of their business andmanagement. Also introduced at this time was the concept of limited liability the ultimate

instrument of shareholder protection which effectively limited maximum liability of theshareholder but did nothing to safeguard and promote the investment which the shareholder had

already made.


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Through this evolutionary process has emerged a complex system of laws, rules, and practicesdealing with every aspect of corporate governance. The process of evolution continues.

Some examples of corporate governance issues arising are the circumstances surrounding the

collapse of the South Sea Company (frequently referred to as the South Sea Bubble) inEngland in 1720. More recent examples are the Taj Company Scandal in Pakistan and the Enron

Scandal in the United States. Many other Pakistani and international examples exist.

yDEFINITION OF CORPORATEGOVERNANCE

The term corporate governance came into popular use in the 1980's to broadly describe thegeneral principles by which the business and management of companies were directed and

controlled. Although its use is now common, and the objectives to be achieved thereby generallyunderstood, there is no universally accepted definition of corporate governance. Although the

utility of definitions is invariably exaggerated, definitions do have the advantage of providing ageneral framework for discussion and debate. For this purpose, and in view of the comparative

infancy of the subject in Pakistan, a limited discussion of the definition of corporate governanceis provided below.

Governance is the manner by which a function is conducted, and hence corporate governance isthe manner by which corporations are and should be conducted. The term contains manyattributes of which trust, transparency and accountability are fundamental aspects. It includes all

aspects that are significant to decision making in a company.

A basic definition of corporate governance, which has been widely recognized, was given in areport by the committee under the chairmanship of Sir Adrian Cadbury tiled (the Cadbury

Report):

The Financial Aspects of Corporate Governance

Corporate governance is the system by which companies are directed and controlled. Boards ofdirectors are responsible for the governance of their companies. The shareholders' role in

governance is to appoint the directors and the auditors and to satisfy themselves that anappropriate governance structure is in place. The responsibilities of the directors include setting

the company's strategic aims, providing the leadership to put them into effect, supervising themanagement of the business and reporting to shareholders on their stewardship. The Board's

actions are subject to laws, regulations and the shareholders in general meeting. Thisdefinition of corporate governance has been endorsed in various otherdiscourses on the subject,


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including the 1998 final report of the Committee on Corporate Governance (the Hampel Report)

by Sir Ronald Hampel.

This definition of corporate governance has been endorsed in various other discourses on thesubject, including the 1998 final report of the Committee on Corporate Governance (the Hampel

Report) by Sir Ronald Hampel.

Other definitions include that by the International Chamber of Commerce in its web based guideto corporate governance for business managers:

Corporate governance is the relationship between corporate managers, directors and providersof equity, and institutions who save and invest their capital to earn a return. It ensures that the

Board of directors is accountable for the pursuit of corporate objectives and that the corporationitself conforms to the law and regulations.

The Organization for Economic Cooperation and Development provides another perspective in

its Principles of Corporate Governance by addressing five areas: (i) the rights and responsibilitiesof shareholders; (ii) the role of the stakeholders; (iii) the equitable treatment of shareholders; (iv)

disclosure and transparency; and (v) the duties and responsibilities of the Board.

Kenneth Scott of Stanford Law School, (March 1999) states:

In its most comprehensive sense, corporate governance includes every force that bears onthe decision-making of the firm. That would encompass not only the control rights of

stockholders, but also the contractual covenants and insolvency powers of debt holders, the

commitments entered into with employees and customers and suppliers, the regulations issued bygovernmental agencies, and the statutes enacted by parliamentary bodies. In addition, the firm'sdecisions are powerfully affected by competitive conditions in the various markets in which it

operates. One could go still further, to bring in the social and cultural norms of the society. Allare relevant, but the analysis would become so diffuse that it risks becoming unhelpful as well as

unbounded.

Taken together, all definitions of corporate governance lead to the basic idea, which refers to thesystem by which companies are directed and controlled, focusing on the responsibilities of

directors and managers for setting strategic aims, establishing financial and other policies andoverseeing their implementation, and accounting to shareholders for the performance and

activities of the company with the objective of enhancing its business performance andconformance with the laws, rules and practices of corporate governance.

Corporate governance is also the mechanism by which the agency problems of corporation

stakeholders, including the shareholders, creditors, management, employees, consumers and thepublic at large are framed and sought to be resolved.


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yBENEFITS OF CORPORATEGOVERNANCE

Good and proper corporate governance is considered imperative for the establishment of aCompetitive market. There is empirical evidence to suggest that countries that have implemented

good corporate governance measures have generally experienced robust growth of corporatesectors and higher ability to attract capital than those which have not.

Radical changes have taken place in world economies over the past two decades. This change

has also affected Asia. The most palpable developments can be observed in capital markets,which today demand companies that offer more transparency, stricter auditing, and more rights

for minority shareholders, all of which are aspects of better corporate governance.

CORPORATE GOVERNANCE IN

PAKISTAN

In March 2002, the Securities and Exchange Commission of Pakistan (the SEC) issued the Codeof Corporate Governance (the Code) to establish a framework for good governance of companies

listed on Pakistan's stock exchanges. In exercise of its powers under Section 34(4) of theSecurities and Exchange Ordinance, 1969, the SEC issued directions to the Karachi, Lahore and

Islamabad stock exchanges to incorporate the provisions of the Code in their respective listingregulations. As a result, the listing regulations were suitably modified by the stock exchanges.

The Code is a compilation of best practices, designed to provide a framework by whichcompanies listed on Pakistan's stock exchanges are to be directed and controlled with the

objective of safeguarding the interests of stakeholders and promoting market confidence; in otherwords to enhance the performance and conformance of companies. In doing this, the Code

draws upon the experience of other countries in structuring corporate governance models, inparticular the experience of those countries with a common law tradition similar to Pakistan's.

The Code of Best Practice of the Cadbury Committee on the Financial Aspects of CorporateGovernance published in December 1992 (U.K.), the Report of the Hampel Committee on

Corporate Governance published in January 1998 (U.K.), the Recommendations of the King'sReport (South Africa), and the Principles of Corporate Governance published by the


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Organization for Economic Cooperation and Development in 1999 have been important

documents in this regard.

The Code is a first step in the systematic implementation of principles ofgood corporate

governance in Pakistan. Further measures will be required, and arecontemplated by the SEC, torefine and consolidate the principles and to educate stakeholders of the advantages of strict

compliance. Ultimately, a change in the way in which directors, managers, auditors,

shareholders, and other stakeholders in Pakistan perceive corporate entities and their respective

roles in their conductand control would be desirable this will necessitate a change of corporate

culture,which must not only be incremental but necessarily relevant. This study is acontribution

towards this effort.

yTHE PAKISTANI CORPORATIONThe evolution of the Pakistani corporate entities has, historically, closely followed the path takenby English corporate entities. The English Companies Act, 1844 provided the initial impetus to

the development of corporations in undivided India. In 1855, the Joint Stock Companies Act wasenacted in undivided India, which, for the first time, provided for registration of companies. This

was followed by the Indian Companies Act, 1882 and later by the Indian CompaniesConsolidation Act, 1913. Upon independence, Pakistan inherited the Indian Companies

Consolidation Act, 1913. In 1949, this Act was amended in certain respects, including its name,whereafter it was referred to as the Companies Act, 1913. Until 1984, when the Companies

Ordinance, 1984 (the Companies Ordinance) was promulgated, following lengthy debate,Pakistani companies were established and governed in accordance with the provisions of the

Companies Act, 1913.

Even today, under the Companies Ordinance, many provisions remain unaltered from thosecontained in the Companies Act, 1913 and its precursors. As a result, development of corporate

law in Pakistan continues to be influenced by English company law. This has been made possiblebecause of one of the rules of statutory interpretations, according to which if statutory provisions

are consolidated or are similar or identical to previous provisions it is legitimate to refer to case

law interpreting such provisions. This rule has been recognized by Pakistani courts.

Notwithstanding the long experience of corporations borrowed from English law and as

developed in undivided India, the circumstances that have influenced and contributed to theevolution of the Pakistani corporation and corporate culture have been fundamentally different

from those prevailing at any time in England or in undivided India and for that matter most otherdeveloping and developed countries. The period immediately following independence of

Pakistan had thrown up quite unique challenges and opportunities for the manner in which


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corporations and corporate culture was to develop in Pakistan. The familycompany became and

remains central to that development. In addition, the oldest stock exchange in Pakistan wasincorporated in 1949 - two years after independence. Stock exchanges in Lahore and Islamabad

have developed evenlater.

Corporate entities in Pakistan are primarily regulated by the SEC under the CompaniesOrdinance, the Securities and Exchange Ordinance, 1969, the Securities and Exchange

Commission of Pakistan Act, 1997, and the various rules and regulations made thereunder. Inaddition, special companies may also be regulated under special laws and by other regulators, in

addition to the SEC. In this way, listed companies are also regulated by the stock exchange atwhich they are listed; banking companies are also regulated by the State Bank of Pakistan;

companies engaged in the generation, transmission or distribution of electric power are alsoregulated by the National Electric Power Regulatory Authority; companies engaged in providing

telecommunication services are also regulated by the Pakistan Telecommunication Authority;and oil and gas companies are also regulated by the Oil and Gas Regulatory Authority. This list

is not exhaustive.

yTHE ORIGIN OF CORPORATEGOVERNANCE IN PAKAISTAN

The SEC, since it took over the responsibilities and powers of the erstwhile Corporate LawAuthority in 1999, has been acutely alive to the changes taking place in the international business

environment, which directly: and indirectly impact local businesses. As part of its multi-dimensional strategy to enable Pakistan's corporate sector meet the challenges raised by the

changing global business scenario and to build capacity, the SEC has focused, in part, onencouraging businesses to adopt good corporate governance practices. This is expected to

provide transparency and accountability in the corporate sector and to safeguard the interests ofstakeholders, including protection of minority shareholders' rights and strict audit compliance.

In December 1998, the Institute of Chartered Accountants of Pakistan (the ICAP) took the

initiative to develop a framework of good governance in Pakistan. A committee representing the

SEC, ICAP, the Institute of Cost and Management Accountants of Pakistan and the stockexchanges was established. A subcommittee was formed to undertake the task of formulatingrecommendations for drawing up a draft code of corporate governance. On March 28, 2002, after

a process of consultation with stakeholders, the draft code was finalized and issued by the SEC.The SEC, in exercise of its powers under Section 34(4) of the Ordinance, issued directions to the

Karachi, Lahore and Islamabad stock exchanges to insert the provisions of the Codeappropriately in their respective listing regulations. Through this measure, the Code was


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incorporated into the respective listing regulations of the stock exchanges and is now applicable

to all listed companies.The Code is a compilation of principles of good governance and a combined code of good

practices. The Code provides a framework tailored to address the complexities of the corporatesector in Pakistan and also draws together recognized best practices as embodied in various

prominent international models of corporate governance.

Compliance with the provisions of the Code is mandatory except for two that are voluntary innature. The mandatory provisions deal with such matters as directors' qualifications and

eligibility to act as such, their tenure of office, responsibilities, powers and functions, disclosureof interest, training, meetings of the Board of directors and the business to be conduct by it, thequalifications, appointment and responsibilities of Chief Financial Officer (CFO) and company

secretary, the appointment and responsibilities of the Audit Committee, the appointment andresponsibilities of internal and external auditors, and compliance by listed companies with the

Code. The two voluntary provisions pertain to the appointment of independent non-executivedirectors and those representing minority interests on the Board of directors and the restriction

for brokers to be appointed as directors of listed companies.

THE NEED FOR CORPORATE

GOVERNANCE

The popularity and development of corporate governance frameworks in both the developed anddeveloping worlds is primarily a response and an institutional means to meet the increasingdemand of investment capital. It is also the realization and acknowledgement that weak corporate

governance systems ultimately hinder investment and economic development. In a McKinseysurvey issued in June 2000, investors from all over the world indicated that they would pay large

premiums for companies with effective corporate governance. A number of surveys of investorsin Europe and the US support the same findings and show that investors eventually reduce their

investments in a company that practices poor governance.

Corporate governance serves two indispensable purposes. It enhances the performance ofcorporations by establishing and maintaining a corporate culture that motivates directors,

managers and entrepreneurs to maximize the company's operational efficiency thereby ensuringreturns on investment and long term productivity growth. Moreover, it ensures the conformance

of corporations to laws, rules and practices, which provide mechanisms to monitor directors' andmanagers' behaviour through corporate accountability that in turn safeguards the investor

interest. It is fundamental that managers exercise their discretion with due diligence and in the best interest of the company and the shareholders. This can be better achieved through

independent monitoring of management, transparency as to corporate performance, ownershipand control, and participation in certain fundamental decisions by shareholders.


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Dramatic changes have occurred in the capital markets throughout the past decade. There hasbeen a move away from traditional forms of financing and a collapse of many of the barriers to

globalization. Companies all over the world are now competing against each other for newcapital. Added to this is the changing role of institutional investors. In many countries corporate

ownership is becoming increasingly concentrated in institutions, which are able to exercisegreater influence as the predominant source of future capital. Corporate governance has become

the means by which companies seek to improve competitiveness and access to capital andborrowing in a local and global market.

Effective corporate governance allows for the mobilization of capital annexed with the promotion of efficient use of resources both within the company and the larger economy. It

assists in attracting lower cost investment capital by improving domestic as well as internationalinvestor confidence that the capital will be invested in the most efficient manner for the

production of goods and services most in demand and with the highest rate of return. Goodcorporate governance ensures the accountability of the management and the Board in use of such

capital. The Board of directors will also ensure legal compliance and their decisions will not be based on political or public relations considerations. It is understood that efficient corporate

governance will make it difficult for corrupt practices to develop and take root, though it may noteradicate them immediately. In addition, it will also assist companies in responding to changes in

the business environment, crisis and the inevitable periods of decline.

Corporate governance is the market mechanism designed to protect investors' rights and enhanceconfidence. Throughout the world, institutions are awakening to the opportunities presented by

governance activism. As a result, Boards and management are voluntarily and proactively takingsteps to improve their own accountability. Simply put, the corporations, including Pakistani

corporations, have begun to recognize the need for change for positive gain. Along with

traditional financial criteria, the governance profile of a corporation is now an essential factorthat investors and lenders take into consideration when deciding how to allocate their capital.The more obscure the information, the less likely that investors and lenders would be attracted

and persuaded to invest or lend. The lack of transparency, unreliable disclosure, unaccountablemanagement and the lack of supervision of financial institutions (all of which are the

consequences of inadequate corporate governance) combine to infringe investors' rights. Poorcorporate governance has a tendency to inflate uncertainty and hamper the application of

appropriate remedies.

Transparency can be achieved through three key market elements: openness, accounting

standards, and compliance reporting. Efficient markets depend upon investor confidence in theaccuracy and openness of information provided to the public. Also, compliance with

internationally recognized accounting standards is necessary to ensure that investors caneffectively analyze and compare company data. With incorporation of the Code in the listing

regulations of the Pakistan's stock exchanges, listed companies are now under an obligation toact transparently.


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Accountability describes the Board of director's duty to shareholders. In particular, the Board

of directors has a special duty and responsibility to develop the company's strategic vision,ensuring the enhancement of long-term share values. In doing so, the Board and management

should be open and accessible to inquiry by shareholders and other stakeholders about thecondition and performance of the company and should disclose how key decisions were made,

including those that affect executive compensation, strategic planning, nomination andappointment of directors and appointment and succession of managers and financial controls.

Initially, principles of corporate governance were more specifically framed to facilitate the socalled agency problems that were a consequence of the separation of ownership and

management in publicly owned corporations. As the ownership of corporations is widelydispersed, management of the corporation is vested in directors who act as agents for the owners,

(the shareholders). From this stems the theory that the interest of the shareholder is notdetermined or protected by any formal instrument, unlike the interest of most stakeholders and

investors which can generally and adequately be protected through contractual rights andobligations with the company. It is, for this reason, that corporate governance is primarily

directed at the effective protection of shareholder interests.

The corporate governance system specifies the rights of the shareholder and the steps available ifmanagement breaches its responsibilities established on equitable principles from this springs the

the equity contract In addition to the applicable general law, the equity contract is createdunder Section 31 of the Companies Ordinance. Similar provision exists under the English

Companies Act, namely Section 14.

The inability or unwillingness to make credible disclosure constitutes a bad equity contract

which potentially makes it difficult for the market to distinguish good risk from bad resulting inan inability to attract investors. The long term consequences of such inabilities prove to have acrippling effect, not only on corporations, but also on the stock market as it blocks crucial

liquidity of the stock market, with the resultant weakening of the entire financial system.Consequently, the increased cost of capital reallocates financing and the capital market towards

debt. A distinctive characteristic of the Pakistani corporate culture, however, is the pyramidalownership structure and corporations with concentrated ownership enabling large shareholders to

directly control managers and corporate assets. Thus the need for corporate governance shouldnot, perhaps, arise under the prevailing structure as the conflict of interest that emerges gives rise

to the expropriation problem as opposed to the agency problem. It is imperative, however,at this stage, to acknowledge the rapid developments that are taking place within the Pakistan

corporate culture and the fading out of the traditional and more conventional corporateformation. Furthermore, a good governance system is required for such institutions as the

success of any institution is a combined effort comprising of contributions from a range ofresource providers including employees and creditors. It is for this reason that the role of the

various stakeholders cannot go ignored and their rights and the corporations' obligations must bedetermined. Financing of any kind, whether for publicly traded companies or privately held and

state owned companies, can only be made possible through the exercise of good corporategovernance.


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PARTIES OF CORPORATE

GOVERNANCE

Parties involved in corporate governance include the regulatory body (e.g. the Chief Executive

Officer, the board of directors, management, shareholders and Auditors). Other stakeholders whotake part include suppliers, employees, creditors, customers and the community at large.

A corporation enjoys the status of a separate legal entity; however, the formation of a publiclisted company is such that its success is dependant upon the performance of a contribution of

factors encompassing a number of stakeholders. Astakeholderis a person (including an entityor group) that has an interest or concern in a business or enterprise though not necessarily as an

owner. The ownership of listed companies is comprised of a large number of shareholders drawnfrom institutional investors to members of public and thus it is impossible for it to be managed

and controlled by such a large number of diversified minds. Hence, management and control isdelegated by the shareholders to agents called the Board of directors. In order to achieve

maximum success, the Board of directors is further assisted by managers, employees,contractors, creditors, etc. Therefore it is imperative to recognize the importance of stakeholders

and their rights. Communication with stakeholders is considered to be an important feature ofcorporate governance as cooperation between stakeholders and corporations allows for the

creation of wealth, jobs and sustain ability of financially sound enterprises. It is the Board's dutyto present a balanced assessment of the company's position when reporting to stakeholders. Both

positive and negative aspects of the activities of the company should be presented to give anopen and transparent account thereof.

The annual report is a vital link and, in most instances, the only link between the company andits stakeholders. The Companies Ordinance requires directors to attach in the annual report adirectors' report on certain specific matters. The Code expands the content of the directors' report

and requires greater disclosure on a number of matters that traditionally were not reported on.The aim is for the directors to discuss and interpret the financial statements to give a meaningful

overview of the enterprise's activities to stakeholders and to give users a better foundation onwhich to base decisions. Specific emphasis has been placed upon the fiduciary obligations of

directors and hence the need to understand the implications of such obligations also arises.

Apart from the above, stakeholder communication should consist of a discussion andinterpretation of the business including:

y its main features;y uncertainties in its environment;y its financial structure and the factors relevant to an assessment of future prospects; andy other significant items which may be relevant to a full appreciation of the business.


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The discussion should go beyond a mere analysis of the results for the year. It should cover

trends and changes, profit forecasts and future projections as well as information and eventsbeyond the balance sheet date that are relevant to a full appreciation of the company's affairs.

Recognition of stakeholders, globally, has gained eminence over the past few years. A lot of

research has been carried out and strategy developed for the purpose of protecting stakeholders'rights with the objective to keep the stakeholders informed about aspects of companies'

performance and operations. The focus has been on improved transparency and disclosure so thatstakeholder communication per se

y Is clear and concise that can be readily understood by the average stakeholder;y is objective, unbiased and balanced and covers positive as well as negative aspects;y deals with comments made in previous communications and whether or not these have

been borne out by events;

y follows a top-down structure by discussing individual aspects of the business in thecontext of the business as a whole;

y is a narrative rather than a numeric analysis although figures should be used whereappropriate;

y interprets ratios or numeric information in relation to the financial statements;y looks toward the future as well as reviews the past;y Is prompt, relevant, open and transparent. Substance should take precedence over legal

form.

In corporations, the Shareholder delegates decision rights to the manager to act in the principal's

best interests. This separation of ownership from control implies a loss of effective control byshareholders over managerial decisions. Partly as a result of this separation between the two

parties, a system of corporate governance controls is implemented to assist in aligning theincentives of managers with those of shareholders. With the significant increase in equity

holdings of investors, there has been an opportunity for a reversal of the separation of ownershipand control problems because ownership is not so diffuse.

A Board of Directors often plays a key role in corporate governance. It is their responsibility to

endorse the organisation's strategy, develop directional policy, appoint, supervise and remuneratesenior executives and to ensure accountability of the organisation to its owners and authorities.

All Employees have some responsibility for implementation of effective internal control

procedures as part of their accountability for achieving objectives. They collectively should have

the necessary knowledge, skills, information and authority to operate the company. This willrequire an understanding of the company, its objectives, the industries and markets in which itoperates, and the risks it faces. Their endeavors towards these requirements will contribute

positively to the performance of the company and success will ensure job stability andsatisfaction. A secure work environment and one that protects and safeguards the rights of

employees is a means by which to attain optimum levels of performance. The Code requires thata statement of ethics and business practices must be prepared and circulated annually by the


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Board of directors of every listed company to establish a standard of conduct for directors and

employees.

Contractual stakeholders like customers, contractors and sub-contractors are fundamental for

any corporation. A relationship based on trust develops between the corporation and suchstakeholders and it is normal, especially where transactions are frequent, for credit to be

extended. Past experience with the company establishes the basis for the development of suchtrust; however a framework that protects the interest of the creditor is essential in instances

where the trust has yet to develop or in the event of disputes, which may arise. When extendingcredit, the creditor must be satisfied and convinced that an efficient and speedy system for

recoveries has been outlined in order to provide redress if the need arises. In terms of theCompanies Ordinance, creditors may nominate directors on the Board of the borrower. Throughtheir nominee, creditors can play a significant role in the corporate governance framework.

All parties to corporate governance have an interest, whether direct or indirect, in the effective

performance of the organization. Directors, workers and management receive salaries, benefitsand reputation, while shareholders receive capital return. Customers receive goods and services;

suppliers receive compensation for their goods or services. In return these individuals providevalue in the form of natural, human, social and other forms of capital.

A key factor is an individual's decision to participate in an organisation e.g. through providing

financial capital and trust that they will receive a fair share of the organisational returns. If some parties are receiving more than their fair return then participants may choose to not continue

participating leading to organizational collapse.

PRINCIPLES OF CORPORATE

GOVERNANCE

Key elements of good corporate governance principles include honesty, trust and integrity,openness, performance orientation, responsibility and accountability, mutual respect, and

commitment to the organization.

Of importance is how directors and management develop a model of governance that aligns thevalues of the corporate participants and then evaluate this model periodically for its

effectiveness. In particular, senior executives should conduct themselves honestly and ethically,especially concerning actual or apparent conflicts of interest, and disclosure in financial reports.

Commonly accepted principles of corporate governance include:

* Rights and equitable treatment of shareholders: Organizations should respect the rights of


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shareholders and help shareholders to exercise those rights. They can help shareholders exercise

their rights by effectively communicating information that is understandable and accessible andencouraging shareholders to participate in general meetings.

* Interests of other stakeholders: Organizations should recognize that they have legal andother obligations to all legitimate stakeholders.

* Role and responsibilities of the board: The board needs a range of skills and understandingto be able to deal with various business issues and have the ability to review and challenge

management performance. It needs to be of sufficient size and have an appropriate level ofcommitment to fulfill its responsibilities and duties. There are issues about the appropriate mix

of executive and non-executive directors.* Integrity and ethical behaviour: Ethical and responsible decision making is not only

important for public relations, but it is also a necessary element in risk management and avoiding

lawsuits. Organizations should develop a code of conduct for their directors and executives that promotes ethical and responsible decision making. It is important to understand, though, that

reliance by a company on the integrity and ethics of individuals is bound to eventual failure.Because of this, many organizations establish Compliance and Ethics Programs to minimize the

risk that the firm steps outside of ethical and legal boundaries.* Disclosure and transparency: Organizations should clarify and make publicly known the

roles and responsibilities of board and management to provide shareholders with a level ofaccountability. They should also implement procedures to independently verify and safeguard

the integrity of the company's financial reporting. Disclosure of material matters concerning theorganization should be timely and balanced to ensure that all investors have access to clear,

factual information.

Issues involving corporate governance principles include:

* internal controls and internal auditors

* the independence of the entity's external auditors and the quality of their audits* oversight and management of risk* oversight of the preparation of the entity's financial statements

* review of the compensation arrangements for the chief executive officer and other seniorexecutives

* the resources made available to directors in carrying out their duties* the way in which individuals are nominated for positions on the board

* dividend policy

Nevertheless "corporate governance," despite some feeble attempts from various quarters,remains an ambiguous and often misunderstood phrase. For quite some time it was confined only

to corporate management. That is not so. It is something much broader, for it must include a fair,efficient and transparent administration and strive to meet certain well defined, written

objectives. Corporate governance must go well beyond law. The quantity, quality and frequencyof financial and managerial disclosure, the degree and extent to which the board of Director

(BOD) exercise their trustee responsibilities (largely an ethical commitment), and thecommitment to run a transparent organization- these should be constantly evolving due to

interplay of many factors and the roles played by the more progressive/responsible elementswithin the corporate sector. John G. Smale, a former member of the General Motors board of


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directors, wrote: "The Board is responsible for the successful perpetuation of the corporation.

That responsibility cannot be relegated to management."[7] However it should be noted that acorporation should cease to exist if that is in the best interests of its stakeholders. Perpetuation

for its own sake may be counterproductive.

INDEPENDENT AUDIT

y What Does Independent AuditorMean?

An external auditor with a certified public accounting designation that qualifies him or her toprovide an auditor's report.

y INDEPENDENT AUDIT FUNCTIONIntroduction:

Audits of local government management functions and financial operations are a key source ofinformation on practices that are either corrupt or susceptible to corruption . While it is common

practice to have a central office at the national/federal level to monitor the effectiveness andefficiency of governmental programmes, local government (as well as other government

departments) would be well served in having its own audit department. In order to be effective aswell as credible, an audit department or agency needs to be both well funded and to have a

certain independence.

Purpose:

The overall purpose of an audit function is to provide for verification of records, processes or

functions in a sufficiently independent manner from the institution or subject being audited inorder to add its value and improve its operations. Specifically, its objectives are:

y To independently identify information which is essential to develop an overallpicture of the institution/local authority.

y To identify any weaknesses or administrative flows which otherwise would not beidentified due to unwillingness or inability by insiders of the institutions.


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y To identify strengths and weaknesses of the administrative structures in order toinform decisions on overall strengthening of the institution.

y To provide baselines on which reforms can be assessed.y To provide the government (other governing bodies) and general public with

credible information that result in public faith or trust of the institution and/or

pressure for any reforms to address problems identified.

Linkage to Transparency:

The underlying principle of auditing is disclosure of administrative processes and financial practices in any organization. This exercise aims at building transparency and enhancing

accountability of key officials and decision makers within the organization being audited.Positive findings of an independent audit can go a long way in building public trust in the

organization, while negative findings can serve to catalyse change.

How itWorks The Key Elements:

Auditors, both internal and external, have the general responsibilities of investigatingadministrative and financial practices and developing factual reports. They can and often do

make recommendations or refer findings to other bodies for action. The real powers of auditingis in the fact that audit reports are made public. Key aspects of the audit function are described

below.

Scope. Auditing can be quite specific, wherein which auditors are mandated to carry outspecified tasks, such as only examining only administrative procedures of an organization.

Alternatively, the scope of the audit can be wide-ranging, covering administrative, legal,financial and other practices, i.e., an overall audit of the organization or local authority.

Selection of auditors. The important factors in choosing auditors include the level of expertise

needed, degree of autonomy and resistance to undue influence. Audits may be carried out byspecialised units within the local authority or government, or by external specialised auditing

agencies. Auditors must also be financially and budgetary independent in accomplishing theirtasks.

Audit procedures. Auditors are also better safeguarded against oversights or abuses by theagency being audited if audit methods and procedures are standardised. Such standards are

available universally and are meant to provide a framework for performing and promoting value-added audit activities that improve the operations of agencies/local authorities.


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Dissemination of audit report. Audit reports must be made available to stakeholders in the city

or community. As stated earlier, these can help in building accountability and enhancing trust inpublic agencies, or in reinforcing the need for change.

MECHANISMS AND CONTROLS

Corporate governance mechanisms and controls are designed to reduce the inefficiencies thatarise from moral hazard and adverse selection. For example, to monitor managers' behaviour, an

independent third party (the external auditor) attests the accuracy of information provided bymanagement to investors. An ideal control system should regulate both motivation and ability.

INTERNAL CORPORATE GOVERNANCE

CONTROLS

Internal corporate governance controls monitor activities and then take corrective action toaccomplish organisational goals. Examples include:

* Monitoring by the board of directors: The board of directors, with its legal authority to hire,

fire and compensate top management, safeguards invested capital. Regular board meetings allow

potential problems to be identified, discussed and avoided. Whilst non-executive directors arethought to be more independent, they may not always result in more effective corporategovernance and may not increase performance. Different board structures are optimal for

different firms. Moreover, the ability of the board to monitor the firm's executives is a functionof its access to information. Executive directors possess superior knowledge of the decision-

making process and therefore evaluate top management on the basis of the quality of itsdecisions that lead to financial performance outcomes, ex ante. It could be argued, therefore, that

executive directors look beyond the financial criteria.* Internal control procedures and internal auditors: Internal control procedures are policies

implemented by an entity's board of directors, audit committee, management, and otherpersonnel to provide reasonable assurance of the entity achieving its objectives related to reliable

financial reporting, operating efficiency, and compliance with laws and regulations. Internalauditors are personnel within an organization who test the design and implementation of the

entity's internal control procedures and the reliability of its financial reporting* Balance of power: The simplest balance of power is very common; require that the President

be a different person from the Treasurer. This application of separation of power is furtherdeveloped in companies where separate divisions check and balance each other's actions. One

group may propose company-wide administrative changes, another group review and can vetothe changes, and a third group check that the interests of people (customers, shareholders,


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employees) outside the three groups are being met.

* Remuneration: Performance-based remuneration is designed to relate some proportion ofsalary to individual performance. It may be in the form of cash or non-cash payments such as

shares and share options, superannuation or other benefits. Such incentive schemes, however, arereactive in the sense that they provide no mechanism for preventing mistakes or opportunistic

behaviour, and can elicit myopic behaviour.

EXTERNAL CORPORATE

GORVERNANCE CONTROLS

External corporate governance controls encompass the controls external stakeholders exerciseover the organisation. Examples include:

* competition

* debt covenants* demand for and assessment of performance information (especially financial statements)

* government regulations* managerial labour market

* media pressure* takeovers

PROBLEMS OF CORPORATEGORVERNANCE

* Demand for information: In order to influence the directors, the shareholders must combinewith others to form a significant voting group which can pose a real threat of carrying resolutions

or appointing directors at a general meeting.* Monitoring costs: A barrier to shareholders using good information is the cost of processing

it, especially to a small shareholder. The traditional answer to this problem is the efficient markethypothesis (in finance, the efficient market hypothesis (EMH) asserts that financial markets are

efficient), which suggests that the small shareholder will free ride on the judgements of largerprofessional investors.

* Supply of accounting information: Financial accounts form a crucial link in enablingproviders of finance to monitor directors. Imperfections in the financial reporting process will

cause imperfections in the effectiveness of corporate governance. This should, ideally, becorrected by the working of the external auditing process.


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THE ROLE AUDIT AND AUDITORS

IN CORPORATE GOVERNANCE

The need for good corporate governance in Pakistan is unmistakable. Over the last many years,the economy has been largely volatile and marred with low investor confidence, tough global

competition and lack of foreign investment. Among others, one of the major causes has been thelack of transparency and accountability in the corporate sector. What we seek is transparency

the ability of an investor to "see through" a company's financial statements the company's trueresult of operations. Transparency requires that companies follow generally accepted accounting

principles (GAAP) in a fashion that assures consistency and comparability. The Asian FinancialCrisis in the late 1990s revealed the vulnerability of economies to structural weaknesses in

governance systems. It has become evident that prudent management and sound code of ethicscould have prevented the economic meltdown in the Newly Industrialized Countries (NICs). It

therefore became imperative that preventive measures should be readily introduced in Pakistan toavoid any economic shock.

Corporate Governance can be approached through several dimensions: accountability,

transparency and disclosure. All these pertain to the role of Board of Directors fulfilling their

duties as envisaged in the Companies Ordinance, 1984. Others are more directly related to theoverall Development process in Pakistan as they have to do with compensation systems and withthe large-scale education process needed to catch up on market-based skills and attitudes.

Adjusting to global standards and adopting best practices is an imperative for Pakistan that goeswell beyond corporate governance.

At this point it is pertinent to mention that it is not the regulator alone who can bring about

effective corporate governance; the auditors play a key role in meeting the objective. In order foraudit committees to fulfill their role as watchdogs over the financial reporting process, members

of the audit committee need to receive important information about the company's businessactivities and the proper accounting for those activities. This implies that any good audit is a

function of good accounts and good accounts come from full disclosures which clearly show thefinancial health of the company. When we talk about attitude of companies towards corporate

governance, the people who come to our mind are the Board of Directors and the management ofany company since they are the ones overseeing: the operations of the company, whether there is

proper risk management and whether proper books of accounts are being maintained. The Boardof Directors represents the interest of the shareholders and they should feel full responsibility

towards them.


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However, the role of auditors is to ensure whether Board of Directors and the management areacting responsibly towards the shareholders investment interests i.e. no leakages are taking

place on the investment side; no wastages on the expenditure side and is there propriety of theexpenditure or not. By maintaining vigilance and objectivity the auditors can add value to

shareholders by ensuring that the company's internal controls are strong and effective. And by

working with the members of the audit committee and in liaison with internal auditors in canfacilitate a more effective oversight of the financial reporting process by the Board of Directors.

An important issue which needs to be addressed here is the independence of external auditors in

the execution of their audits. They have to perform their obligation in the most independent andreliable manner to provide investing public with the level of assurance enabling them to make

their decisions on the basis of these financial statements. The independent public accountantperforming this special function owes allegiance to the corporation's creditors and stockholders,

as well as the investing public. This public watchdog function demands that the accountantmaintain total independence from the client at all times and requires complete fidelity to the

public trust.

The Code of Corporate Governance primarily aims to establish a system whereby a company isdirected and controlled by its directors in compliance with the best practices enunciated by the

Code so as to safeguard the interests of diversified stakeholders i.e. investors, creditors,

employees, managers, and regulators. It proposes to restructure the composition of the board ofdirectors in order to introduce representation by minority shareholders and broad-basedrepresentation by executive and non-executive directors. It seeks to achieve the objectives of

good corporate governance by recommending strengthening of corporate working, internalcontrol system and external audit requirements. The Code emphasizes openness and transparency

in corporate affairs and the decision-making process and requires directors to discharge theirfiduciary responsibilities in the larger interest of all stakeholders in a transparent, informed,

diligent, and timely manner.


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CONCLUSION

In conclusion, good corporate governance is largely the result of a sound internal monitoring

system, an effective regulatory environment and adequate disclosure requirements. Thesignificance of mandatory compliance with laws and regulations through a strict monitoring and

regulatory system is crucial. However, it alone cannot promote effective governance. Voluntaryadaptation is imperative in developing good corporate culture that breeds good corporate

governance.

Documents

Role of Audit in Corporate Governance