03 - Corporate Governance - 2015-16

7/26/2019 03 - Corporate Governance - 2015-16

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Audit and assurance

Lecture 3

Corporate governance

The lecture uses the UK CG Code as an example

(Overseas campuses: UK, Hong Kong SAR, Malaysian, Vietnamese, Sri

Lankan and Singaporean respective Codes may be studied)

AA - CG 1


2/96

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This lecture will consider

1. The nature of corporate governance (CG)2. Codes of CG

3. CG and the Directors

4. CG and the auditor

Appendices. These slides are background material

June 2015 AA - CG 2


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CG is part of corporate responsibility Corporate responsibility has a much broader focus

The main focus of CG is on the fiduciary duties of directors

to shareholders, and secondarily to other stakeholders

..to protect and advance the interests of shareholders

through setting the strategic direction of a company

and appointing and monitoring capable managementto achieve this Walker Review, 2009

June 2015 AA - CG 3


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GREENWICH1. Corporate governance (cont.)

The systemby which companies are directed

and controlled for the benefit of the

shareholders. In some jurisdictions, the scope

of benefit includes multiple stakeholders Blowfield and Murray, 2008

There are substantial differences in definitionaccording to which country is considered Solomon, 2010

June 2015 AA - CG 4


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1. The Importance of Corporate

Governance

Corporate Governance is important because:

The owners of a company and the people who manage the company are

not always the same (refer to appendix 2 if unsure about agency theory).

The day-to-day running of a company is the responsibility of the

directors and other management staff to whom they delegate. In some companies, the shareholders are fully informed about the

management of the business because they are directors themselves.

In other companies, shareholders only have an opportunity to find out

about the management of the company at the AGM (annual general

meeting).

AGMs are often very poorly attended.

For these reasons, there is the potentialfor conf l icts of interest between

management and shareholders.

June 2015 AA - CG 5


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2. International CG Codes

a. The OECD Principles

1999: Principles of Corporate Governance

In response to the growing awareness of the importance of good

corporate governance for investor confidence and national economic

performance

2004: Revised version issued

Because of corporate scandals after 1999

2014: Review launched (due September 2015)

An international benchmark Developed by officials from OECD and non-OECD countries,

businesses, professional bodies, trade unions, civil society

organisations and international standard-setting bodies

June 2015 AA - CG 6


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2a. The OECD Principles (cont.)

Good corporate governance is key to the integrity of

corporations, financial institutions and markets, and central to

the health of our economies and their stability OECD, January,2009

The World Federation of Exchanges*issued a resolution

acknowledging the important contribution of the OECD to the

development of standards of corporate governance

and strongly supporting the workof the OECD in this area -

WEF, October, 2008

*Regulated stock exchanges

June 2015 AA - CG 7


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Structure (six chapters)

1. Governments place in effective institutional and legal

framework to support good corporate governance practices

2. Protects and facilitates the exercise of shareholders rights

3. Equal treatment of all shareholders, including minority andforeign shareholders

4. The importance of the role of stakeholdersin corporate

governance

5. The importance of timely, accurate and transparentdisclosuremechanisms

6. Boardstructures, responsibilities and procedures

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The Principlesare non-binding because theirimplementation must be adapted to different legal,economic and cultural circumstances. This is a keystrength of the PrinciplesGovernments andregulators also need to find a balance between rulesand regulations on one hand and flexibility on theother hand

The legislation needed to enforce these standards isthe responsibility of individual governments

OECD, January, 2009

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2a. Summary of OECD Principles

of Corporate Governance

OECD Principles of Corporate Governance

I The corporate governance framework should:

promote transparent and efficient markets

be consistent with the rule of law

clearly articulate the division of responsibilities among different supervisory,

regulatory and enforcement authorities.

II The corporate governance framework should protect and facilitate the exercise of

shareholders rights.

III The corporate governance framework should:

ensure the equitable treatment of all shareholders, including minority andforeign shareholders.

ensure that all shareholders should have the opportunity to obtain effective

redress for violation of their rights.

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2a. Summary of OECD Principles

of Corporate Governance (cont.)

OECD Principles of Corporate Governance (cont.)

IV The corporate governance framework should:

recognise the rights of stakeholders established by law or through mutual

agreements

encourage active co-operation between corporations and stakeholders in

creating wealth, jobs and the sustainability of financially sound enterprises.

V The corporate governance framework should ensure that timely and accurate

disclosure is made on all material matters regarding the corporation, including the

financial situation, performance, ownership, and governance of the company.

VI The corporate governance framework should ensure: the strategic guidance of the company.

the effective monitoring of management by the board.

the boards accountabilityto the company and the shareholders



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When applying the OECD principles, in order to obtain the

best advantages countries may adopt a hybrid approach(i.e.

make some elements of corporate governance mandatory and

some voluntary.

For instance, in the UK,

companies are required to comply with legislation(such as

Companies Acts)

There is also a voluntary corporate governance code, the

UK Corporate Governance Code, which contains some

mandatoryelements for listed companies.



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2b. CG in the UK

Some history, legislation

Bubble Act 1720

Recognised the moral hazard of the relationship in theprinciple-agent

relationship

A key theme that was established and continues to today is that

directors are accountabletoshareholders

Companies Act (CA) 1844

Required auditedbalance sheet(a value statement at year-end) to be

presented to shareholders

Problem: Anyone could be the auditor (usually a shareholder)

CA 1856

The CA 1844 audit provision was removed

Led to many cases accusing directors of fraudulent behaviour

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2b. CG in the UK

Some history, legislation (cont.)

CA 1900

Reintroduction of balance sheet audit

Auditor to be appointed by shareholders

CA 1929 P&L a/crequired

Shows how the company has fared over the year.

CA 1948; CA 1967

Required auditor to be qualified Auditor to express an opinion

A lot of disclosuresto shareholders required

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2b. CG in the UK

Some history, legislation(cont.)

CA 1981

Aspects of GAAPintroduced into law

Directors reportto be audited

Directors report to contain comment on the companiesfuture development

Small and medium sized companies exemptions

CA 1985; CA 1989; CA 2006 (Mainly consolidation)

Directors duty of competence (Common Law) codified

Negligence where a failure of a reasonable standard of competence

IFRS for listed companies

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2b. CG in the UK

Some history, legislation(cont.)

One of the governments roles in a capitalist economy

To protect thepublic interest

Most of the statutes were in response of a public

scandal Usually involving fraudulent activity

Thus legislation has attempted to make directors

increasingly more accountable to shareholders over time

Note: The above history of the development of UK statutes related to

directors responsibilities will not be examined

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2b. The history of CG in the UK

The Cadbury Report, 1992

Public concern over several corporate failures

Particularly the Polly Peck and Maxwell CommunicationsCorporation cases in 1991

The rapid growth in executive remuneration and conflicts

of interest between directors and shareholders

The Stock Exchange and CCAB therefore initiatedthe Cadbury enquiry

Corporate governance (CG) - not a new thing

Cadbury was based on existing good CG behaviour

It may thus be considered a codification exercise of goodCG practice in the UK in 1992

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2b. CG in the UK

The Code of Best Practice (1992)

A voluntary code, based on the Cadbury Report But for listed companies a compliance statement was

required

Comply or explainPrinciples rather than rules

Many reports followed

Greenbury 1995; Hampel 1998; Turnbull 1999; Higgs

2003; Tyson 2003; Smith 2003

The Code now called the UK CG Codeand isreviewed bi-annually

The most recent being in September 2014by the FinancialReporting Council and can be found on the FRC website.

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2b. CG in the UKThe UK Corporate Governance Code (2014)

Corporate governance is about what the board of a

company does and how it sets the values of the company

It is to be distinguished from the day to day operational

management of the company by full-time executives.

The Code is a guide to a number of key components of

effective board practice. It is based on the underlying

principles of all good governance: accountability, transparency, probity and focus on the

sustainable success of an entity over the longer term



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2b. CG in the UKThe UK Corporate Governance Code

The main principles of the code concern directors...

Leadership

Effectiveness

Accountability

Remuneration

Relations with shareholders

Refer to the slides in appendix 1 for more details



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2b. CG in the UKThe UK Corporate Governance Code (cont.)

The Directors main principle is to ensure

Every company should be headed by an effective board,

which is collectively responsiblefor the long-term success

of the company

The Turnbull Guidance and Smith Guidance

Detailedguidance that accompanies the Code (revised

September, 2005)

The Turnbull and Higgs reports are particularly important At this point we need to re-consider what risk

management,systems and internal controlare



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2b Systems and internal control (IC)

The basic idea

A system such

asAccounting (a sale);

Production (manufacturing);

Maintenanceand systems to

ensure corporate governance

To ensure systems

work internal

controls are built

in (checks,

authorisations,

reconciliations)

If systems are

good and all

controls are

followed the

objectivewill

be achieved

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I. Control environment

I. Attributes (such as knowledge, skills, integrity,

ethical values...) and competence and structure

of the workforce...

II. Risk assessment

The tools to identify, analyse and manage risks

of the entity Includes sales, production, marketingand

financial activities

2b Components of internal controlThe COSO Framework, 1992 (COSO 1*)* Subsequent versions of COSO are of more value in rule-based codes

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III. Control activities

The carrying out of policies and proceduresestablished by management to achieve corporate

objectivesIV. Information and communications

For management and control of entity

V. Monitoring

In order to react to changing conditions

2b Components of internal controlThe COSO Framework, 1992 (COSO 1) (cont.)

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Communication

and information

Risk assessment

Control

environment

Control

activities

Monitoring

2b Components of internal controlThe COSO Framework, 1992 (COSO 1) (cont.)

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2b CG in the UK

The Turnbull Report, 1999

back to Turnbull

Internal Control: Guidance for Directors on the

Combined Code, 1999

Focused on aspects of internal control(IC) related to CG

That is, ICs that ensure directors act in line with the Code

Although COSO (Treadwell) established the COSO model,

Turnbull set up the first Code of IC directly addressed to

CG Consistent with the Code in 1999, Turnbull maintained

the voluntary, principles-based stance

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2b CG in the UK

The Turnbull Report, 1999

Note at this point that subsequent COSO models have

been developed, but felt not to be relevant as they

lean towards more rule-based regimes (such as the

USA). COSO 1 (the pyramid) still forms the

underpinning of international ISAs and matches UK

CG (Turnbulls) approach.

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2b CG in the UK

The Higgs Report, 2003

Government concern over effectiveness of non-

executive directors (NEDs)

Government sponsored this report after overseas failures,

such as Parmalat (Italy) and Enron (USA) The role of the audit committeeand NEDs were

reviewed and changes made to the Code

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2b Key elements of The UK

Corporate Governance Code

Every listed company should have a board of directors to lead

and control the company.

There should be a clear division of responsibilities between the

chairman and the chief executive officer of the company to

ensure that a single person does not have unbridled power.

There should be a balance between executive and non-executive

(who are often part-time and independent) members of the

board, to ensure that small groups of individuals cannot

dominate proceedings.



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The board should receive timely information that is of sufficient

quality to enable it to carry out its duties.

Appointments to the board should be the subject of rigorous,

formal and transparent procedures.

All directors should submit themselves for re-election at regular

intervals, subject to satisfactory performance.

Remuneration levels should be sufficient to attract, retain and

motivate directors of the quality required to run the company.



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There should be formal and transparent procedures fordeveloping policy on directors remuneration.

The board should ensure that a satisfactory dialogue with

shareholders occurs.

Boards should use the annual general meeting to communicate

with private investors and encourage their participation.

Institutional shareholders should ensure that they use their votes

and enter into a dialogue with the company based on a mutual

understanding of objectives.



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The board should publish a balanced and understandableassessment of the companys position and future prospects.

Internal controls should be in place to protect the shareholders

wealth.

Formal and transparent arrangements for applying financial

reporting and internal control principles and for maintaining an

appropriate relationship with auditors should be in place.

The board should undertake a formal and rigorous examination

of its own performance each year.



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The directors of a company

should set companypolicy, including riskpolicy

are responsible for the companys systems andcontrols

should make sure they set enough timeaside and

that they have the necessary experienceand skill,

to do this effectively.



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Policy

Directors are responsible ultimately for managing the company

Includes setting strategy

Setting and approving budgets

Managing the companys people

Maintaining company assets and

Ensuring corporate governance rules are kept

Important element of setting strategies is determining andmanaging risks.

Internal audit has a role in this area



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Policy (cont.)

The UK Corporate Governance Code requires that there is

a clear division of responsibility at the head of a company

between the chairmanand the chief executive. requires that no one individual has unfettered powers of

decision.

the chairman also has to meet the same independence criteria

as non-executive directors

Chairman should not be former chief executive of the same

company except in exceptional circumstances.



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Systems, controls and monitoring

Directors are responsible

for the systems put in place to achieve the company policies

for controls put in place to mitigate risks

for monitoringthe effectiveness of systems and controls

Internal auditors have an important role in this area but important to note

that the directors are responsible for determining whether to have an

internal audit department to assist them in monitoring in the first place.

Under the UK Corporate Governance Code, UK boards (through the audit

committee) are required to consider annually whether an internal auditdepartment is required.

If there is no internal audit function, the reasons for not having one need to

be explained in the annual report.



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Non-executive directors are directors who do nothave day-to-day operational responsibility for

the company.

are not employees of the company or affiliated with it in any other way.

may have a particular role in some sensitive areas such as: company reporting

nomination of directors and

remuneration of executive directors.

UK Corporate Governance Code recommends that the board contains

some non-executive directors to ensure that it exercises objective

judgement.

Also requires an appropriate combination of executive and non-executive directors

on the board and recommends that at least half the board should comprise non-

executive directors.



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3. Directors and

Internal Control Effectiveness

Directorsof a company are responsiblefor ensuring that a

companys risk management and internal control systems

are effective.

Internal controls are essential to management, as they

contribute to:

Safeguarding the companys assets

Helping to prevent and detect fraud

Safeguarding the shareholders investment

Helps the business to run efficiently

Reduces identified risks

ensure reliability of reporting and compliance with laws



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3. Directors responsibilities for

internal control

Ultimate responsibility for a companys system of

internal controls lies with the board of directors.

Board of directors should set procedures of internal control

and regularly monitor the system operates as it should.

Setting up an internal control system will involve assessing

the risksfacing the business so that systemcan be

designedto ensure those risks are avoided.

Internal controls systems will always have inherent limitations

(possibility of human error or chance that staff will collude in

fraud)



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3. Directors responsibilities for

internal control (cont.)

Once the directors have set up system of internal control, they

are responsible for reviewingit regularly to ensure that it still

meets its objectives.

In order to ensure that they carry out their review function

properly, the board may decide to employ an internal audit

function to undertake this task.

When deciding whether an internal audit function is required, directors

will need to consider the extent of systems and controls, and

the relative expense of obtaining checks from other parties, such as the external

auditors



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3. Directors responsibilities for internalcontrol and the UK CG Code

In the UK, if the board does not see the need for an internal

audit function, the UK Corporate Governance Code requires

companies to consider the need for one annually

Therefore, need for internal audit is regularly reviewed.

Same code also recommends that the board of directors

reports on its review of the companys risk management and

internal controls systems as part of the annual report.

Statement should be based on an annual assessment of internal

control which should confirm that the board has considered all

significant aspects of internal control.



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Audit committees

An independent sub-committee of the Board of Directors

Helps a company maintain objectivity with regard to

financial reporting and the audit of financial statements. Membership

Non-executive directors (NED)

Minimum three (two for smaller companies)

At least one with recent, relevant financial experience

Written terms of reference


Audit Committees

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Terms of reference include:

Monitoring the integrity of the financial statements

Review internal control (IC)

Monitor and review internal audit (IA)

Recommend the appointment of auditors

Monitor and review the external auditor

Decide on non-audit services (NAS) provision by the

external auditors


Audit Committees (cont.)

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Board of Directors

NEDs

Audit

Committee

Executive

Directors

Auditors Other duties

Shareholders

(Owners)

4. Audit CommitteesA part of IC

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4. The Audit Committee

Audit

Committee

Auditors Other duties

Internal audit

External audit

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a) The executive directors may not understand the purpose of

an audit committee and may perceive that it detracts from

their authority.

b) There may be difficulty selecting sufficient non-executive

directors with the necessary competence in auditing mattersfor the committee to be really effective.

c) The establishment of such a formalised reporting procedure

may dissuadethe auditors from raising matters of judgement

and limit them to reporting only on matters of act.d) Costsmay be increased.

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4. Auditors responsibilities for internal

control and the UK CG Code

In summary, the auditors should review the

statements made concerning internal control

in the annual report to ensure that they appear

trueand are not in conflict with the audited

financial statements.

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4. Communication with those

charged with governance

Auditors shall communicate specific matters to

those charged with governance and ISA 260

provides guidance to auditors in this area.

Those charged with governance is defined by ISA 260 as

the person(s) or organisation(s) with the responsibility for

overseeing the strategic direction of the entity and

obligations related to the accountabilityof the entity.

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4. Importance of Communication with

those charged with governance

It assists the auditor and those charged with governance to

understand audit-related matters in context and allows them

to develop a constructive working relationship.

It allows the auditor to obtain information relevant to the

audit.

It assists those charged with governance to fulfil their

responsibilityto oversee the financial reporting process,

thus reducing the risks of material misstatement in the


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4 Matters to be communicated by


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4. Matters to be communicated by

auditors to those charged with

governance

The following matters shall be communicated to those charged

with governance:

Auditors responsibilities in relation to the financial statement audit

Planned scope and timing of the audit

Significant findings from the audit

Auditor Independence

The auditor shall communicate with those charged with

governance on a timely basis. A written communication of key issues will usually be stated in a

report to management setting out significant deficiencies encountered

in internal control discovered during the audit, the implications of the

deficiencies and related recommendations.June 2015 AA - CG

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At this stage of the course, some concepts may be unclear

As you progress through the course keep these key points in mind

1. All systems have ICs that should ensure that objectives are achieved

2. There is a globally accepted model of IC (COSO)

3. Statutory auditors are mainly interested in the systems that relate tothe FSs (i) the accounting system and (ii) the CG system. Most of

your studies will focus on the accounting system.

4. A great deal of an internal auditors time nowadays is spent on CG

and risk work (lecture 5)

5. Audit committees (part of CG) enhance independence - a keyconcept in auditing

6. Directors and auditors respective duties (lectures 1 and 2)


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Institutional investors own over 70% of shares on the UK

stock market

Traditionally they have not got involved in the governance of

companies In recent years however, they have become more active

Using their votes, meeting with directors and intervening in

company decisions

A particular are where they have been active is directorsremuneration

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The board of directors is at the apex of control of

companies

The way in which board tasks are carried out will

have a large impact on company performance Board structure is of crucial importance

Board structure will impact on the quality of these

board tasks

The key aspects of board structure and board tasks

are shown on following slide

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6. Summary

Corporate governance is the system by which companies aredirected and controlled. Good corporate governance is

important because the owners of a company and the people

who manage the company are not always the same.

The OECD Principles of Corporate Governance set out therights of shareholders, the importance of disclosure and

transparency and the responsibilities of the board of directors.

The UK Corporate Governance Code contains detailed

guidance for UK companies on good corporate governance. An audit committee can help a company maintain objectivity

with regard to financial reporting and the audit of financial

statements.

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6. Summary (cont.)

The directors of a company are responsible for ensuring that acompanys risk management and internal control systems are

effective.

Auditors shall communicate specific matters to those charged

with governance and ISA 260 provides guidance to auditors inthis area.

Institutional shareholders, who dominate the London Stock

Exchange, have taken a more active role in the affairs of listed

companies in recent years. Activism takes the form of using their votes, meetings with directors

and intervention in a companys affairs.

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Homework

Read the set text (Chapter 3), browse the following

slides (appendix) and some of the sites given in the

references section below

Do the quick quiz and Q4 For the tutorial

Read about internal control (use any texts and websites)

Make sure you understand the objectives of an internal

control system

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Further reading and reference

FRC (2014) UK Corporate Governance Code https://www.frc.org.uk/Our-Work/Codes-Standards/Corporate-governance/UK-Corporate-

Governance-Code.aspx

FRC (2005) Internal control - revised guidance for directors on the combined code

https://www.frc.org.uk/getattachment/5e4d12e4-a94f-4186-9d6f-19e17aeb5351/Turnbull-guidance-

October-2005.aspx

ICAEW (2014) UK Corporate Governance Code http://www.icaew.com/en/library/subject-gateways/corporate-governance/codes-and-reports/uk-

corporate-governance-code

ICPAI (2011) Ten To-Dos for Audit Committees in 2011

http://www.accountingnet.ie/business_finance/Ten_To-Do_s_for_Audit_Committees_in_2011.php

FRC (ICPAI) (2011)FRC Acts to Increase Transparency in Corporate Reporting

http://www.accountingnet.ie/financial_reporting/FRC_acts_to_increase_transparency_in_corporate_re

porting_printer.php

ICGN (2009) Global Corporate Governance Principles

http://www.icgn.org/files/icgn_main/pdfs/best_practice/icgn_cro_guidelines_%28short%29.pdf

http://www.ecgi.org/codes/documents/calpers.pdf

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https://www.frc.org.uk/Our-Work/Codes-Standards/Corporate-governance/UK-Corporate-Governance-Code.aspxhttps://www.frc.org.uk/Our-Work/Codes-Standards/Corporate-governance/UK-Corporate-Governance-Code.aspxhttps://www.frc.org.uk/getattachment/5e4d12e4-a94f-4186-9d6f-19e17aeb5351/Turnbull-guidance-October-2005.aspxhttps://www.frc.org.uk/getattachment/5e4d12e4-a94f-4186-9d6f-19e17aeb5351/Turnbull-guidance-October-2005.aspxhttp://www.icaew.com/en/library/subject-gateways/corporate-governance/codes-and-reports/uk-corporate-governance-codehttp://www.icaew.com/en/library/subject-gateways/corporate-governance/codes-and-reports/uk-corporate-governance-codehttp://www.accountingnet.ie/business_finance/Ten_To-Do_s_for_Audit_Committees_in_2011.phphttp://www.accountingnet.ie/financial_reporting/FRC_acts_to_increase_transparency_in_corporate_reporting_printer.phphttp://www.accountingnet.ie/financial_reporting/FRC_acts_to_increase_transparency_in_corporate_reporting_printer.phphttp://www.icgn.org/files/icgn_main/pdfs/best_practice/icgn_cro_guidelines_(short).pdfhttp://www.ecgi.org/codes/documents/calpers.pdfhttp://www.ecgi.org/codes/documents/calpers.pdfhttp://www.icgn.org/files/icgn_main/pdfs/best_practice/icgn_cro_guidelines_(short).pdfhttp://www.accountingnet.ie/financial_reporting/FRC_acts_to_increase_transparency_in_corporate_reporting_printer.phphttp://www.accountingnet.ie/financial_reporting/FRC_acts_to_increase_transparency_in_corporate_reporting_printer.phphttp://www.accountingnet.ie/business_finance/Ten_To-Do_s_for_Audit_Committees_in_2011.phphttp://www.accountingnet.ie/business_finance/Ten_To-Do_s_for_Audit_Committees_in_2011.phphttp://www.accountingnet.ie/business_finance/Ten_To-Do_s_for_Audit_Committees_in_2011.phphttp://www.icaew.com/en/library/subject-gateways/corporate-governance/codes-and-reports/uk-corporate-governance-codehttp://www.icaew.com/en/library/subject-gateways/corporate-governance/codes-and-reports/uk-corporate-governance-codehttp://www.icaew.com/en/library/subject-gateways/corporate-governance/codes-and-reports/uk-corporate-governance-codehttp://www.icaew.com/en/library/subject-gateways/corporate-governance/codes-and-reports/uk-corporate-governance-codehttp://www.icaew.com/en/library/subject-gateways/corporate-governance/codes-and-reports/uk-corporate-governance-codehttp://www.icaew.com/en/library/subject-gateways/corporate-governance/codes-and-reports/uk-corporate-governance-codehttp://www.icaew.com/en/library/subject-gateways/corporate-governance/codes-and-reports/uk-corporate-governance-codehttp://www.icaew.com/en/library/subject-gateways/corporate-governance/codes-and-reports/uk-corporate-governance-codehttp://www.icaew.com/en/library/subject-gateways/corporate-governance/codes-and-reports/uk-corporate-governance-codehttp://www.icaew.com/en/library/subject-gateways/corporate-governance/codes-and-reports/uk-corporate-governance-codehttp://www.icaew.com/en/library/subject-gateways/corporate-governance/codes-and-reports/uk-corporate-governance-codehttp://www.icaew.com/en/library/subject-gateways/corporate-governance/codes-and-reports/uk-corporate-governance-codehttp://www.icaew.com/en/library/subject-gateways/corporate-governance/codes-and-reports/uk-corporate-governance-codehttp://www.icaew.com/en/library/subject-gateways/corporate-governance/codes-and-reports/uk-corporate-governance-codehttp://www.icaew.com/en/library/subject-gateways/corporate-governance/codes-and-reports/uk-corporate-governance-codehttp://www.icaew.com/en/library/subject-gateways/corporate-governance/codes-and-reports/uk-corporate-governance-codehttp://www.icaew.com/en/library/subject-gateways/corporate-governance/codes-and-reports/uk-corporate-governance-codehttps://www.frc.org.uk/getattachment/5e4d12e4-a94f-4186-9d6f-19e17aeb5351/Turnbull-guidance-October-2005.aspxhttps://www.frc.org.uk/getattachment/5e4d12e4-a94f-4186-9d6f-19e17aeb5351/Turnbull-guidance-October-2005.aspxhttps://www.frc.org.uk/getattachment/5e4d12e4-a94f-4186-9d6f-19e17aeb5351/Turnbull-guidance-October-2005.aspxhttps://www.frc.org.uk/getattachment/5e4d12e4-a94f-4186-9d6f-19e17aeb5351/Turnbull-guidance-October-2005.aspxhttps://www.frc.org.uk/getattachment/5e4d12e4-a94f-4186-9d6f-19e17aeb5351/Turnbull-guidance-October-2005.aspxhttps://www.frc.org.uk/getattachment/5e4d12e4-a94f-4186-9d6f-19e17aeb5351/Turnbull-guidance-October-2005.aspxhttps://www.frc.org.uk/getattachment/5e4d12e4-a94f-4186-9d6f-19e17aeb5351/Turnbull-guidance-October-2005.aspxhttps://www.frc.org.uk/getattachment/5e4d12e4-a94f-4186-9d6f-19e17aeb5351/Turnbull-guidance-October-2005.aspxhttps://www.frc.org.uk/getattachment/5e4d12e4-a94f-4186-9d6f-19e17aeb5351/Turnbull-guidance-October-2005.aspxhttps://www.frc.org.uk/getattachment/5e4d12e4-a94f-4186-9d6f-19e17aeb5351/Turnbull-guidance-October-2005.aspxhttps://www.frc.org.uk/getattachment/5e4d12e4-a94f-4186-9d6f-19e17aeb5351/Turnbull-guidance-October-2005.aspxhttps://www.frc.org.uk/getattachment/5e4d12e4-a94f-4186-9d6f-19e17aeb5351/Turnbull-guidance-October-2005.aspxhttps://www.frc.org.uk/getattachment/5e4d12e4-a94f-4186-9d6f-19e17aeb5351/Turnbull-guidance-October-2005.aspxhttps://www.frc.org.uk/getattachment/5e4d12e4-a94f-4186-9d6f-19e17aeb5351/Turnbull-guidance-October-2005.aspxhttps://www.frc.org.uk/getattachment/5e4d12e4-a94f-4186-9d6f-19e17aeb5351/Turnbull-guidance-October-2005.aspxhttps://www.frc.org.uk/getattachment/5e4d12e4-a94f-4186-9d6f-19e17aeb5351/Turnbull-guidance-October-2005.aspxhttps://www.frc.org.uk/getattachment/5e4d12e4-a94f-4186-9d6f-19e17aeb5351/Turnbull-guidance-October-2005.aspxhttps://www.frc.org.uk/Our-Work/Codes-Standards/Corporate-governance/UK-Corporate-Governance-Code.aspxhttps://www.frc.org.uk/Our-Work/Codes-Standards/Corporate-governance/UK-Corporate-Governance-Code.aspxhttps://www.frc.org.uk/Our-Work/Codes-Standards/Corporate-governance/UK-Corporate-Governance-Code.aspxhttps://www.frc.org.uk/Our-Work/Codes-Standards/Corporate-governance/UK-Corporate-Governance-Code.aspxhttps://www.frc.org.uk/Our-Work/Codes-Standards/Corporate-governance/UK-Corporate-Governance-Code.aspxhttps://www.frc.org.uk/Our-Work/Codes-Standards/Corporate-governance/UK-Corporate-Governance-Code.aspxhttps://www.frc.org.uk/Our-Work/Codes-Standards/Corporate-governance/UK-Corporate-Governance-Code.aspxhttps://www.frc.org.uk/Our-Work/Codes-Standards/Corporate-governance/UK-Corporate-Governance-Code.aspxhttps://www.frc.org.uk/Our-Work/Codes-Standards/Corporate-governance/UK-Corporate-Governance-Code.aspxhttps://www.frc.org.uk/Our-Work/Codes-Standards/Corporate-governance/UK-Corporate-Governance-Code.aspxhttps://www.frc.org.uk/Our-Work/Codes-Standards/Corporate-governance/UK-Corporate-Governance-Code.aspxhttps://www.frc.org.uk/Our-Work/Codes-Standards/Corporate-governance/UK-Corporate-Governance-Code.aspxhttps://www.frc.org.uk/Our-Work/Codes-Standards/Corporate-governance/UK-Corporate-Governance-Code.aspxhttps://www.frc.org.uk/Our-Work/Codes-Standards/Corporate-governance/UK-Corporate-Governance-Code.aspx


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Further reading (cont.)

ICAEW (2008) The Impact of Audit Committees on Auditing http://www.icaew.com/index.cfm/route/161273/icaew_ga/Technical_and_Business_Topics/Thought_

Leadership/Audit_Quality_Forum_Evolution/The_impact_of_audit_committees_on_auditing__Audit

_Quality_Forum__Evolution__ICAEW/pdf

CalPERS (2008) Global Corporate Governance Principles

http://www.ecgi.org/codes/documents/calpers.pdf

Monks and Minnow (2008) Corporate Governance Wiley

IoD (2009) Selecting, appointing and training non-executive directors

http://www.iod.com/Mainwebsite/Resources/Document/selectingnxd.pdf

Blowfield and Murray (2008) Corporate Responsibility Oxford

Solomon (2010) Corporate Governance and Accountability3rd.edn.Wiley

FRC (2006) Good practice suggestions from the Higgs report http://www.frc.org.uk/documents/pagemanager/frc/Suggestions%20for%20good%20practice%20from

%20the%20Higgs%20Report%20June%202006.pdf

OECD (2004)Principles of Corporate Governance

http://www.oecd.org/corporate/oecdprinciplesofcorporategovernance.htm

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Further reading (cont.)

Commonwealth Secretariat (1999)Principles for corporate governance in theCommonwealth

http://www.ecgi.org/codes/documents/cacg_final.pdf

Also look for [PPT] Asia Region Corporate Governance Roadmap Workshop -IFC Home at:

http://www.ifc.org/searchresults.html?cx=009183910618791464029%3Aik2jtgcdpms&cof=FORID%

3A11&ie=&q=commonwealth&=go#1084

European Corporate Governance Institute http://www.ecgi.org/codes/all_codes

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http://www.ecgi.org/codes/documents/cacg_final.pdfhttp://www.ifc.org/searchresults.html?cx=009183910618791464029:ik2jtgcdpms&cof=FORID:11&ie=&q=commonwealth&=gohttp://www.ifc.org/searchresults.html?cx=009183910618791464029:ik2jtgcdpms&cof=FORID:11&ie=&q=commonwealth&=gohttp://www.ecgi.org/codes/all_codeshttp://www.ecgi.org/codes/all_codeshttp://www.ecgi.org/codes/all_codeshttp://www.ifc.org/searchresults.html?cx=009183910618791464029:ik2jtgcdpms&cof=FORID:11&ie=&q=commonwealth&=gohttp://www.ifc.org/searchresults.html?cx=009183910618791464029:ik2jtgcdpms&cof=FORID:11&ie=&q=commonwealth&=gohttp://www.ecgi.org/codes/documents/cacg_final.pdf


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Appendix 1

The UK Corporate Governance Code, 2014

The Code

Section A

Leadership

Section B

Effectiveness

Section C

Accountability

Section D

Remuneration

Section E

Relationswith

shareholders

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The UK Corporate Governance Code2014

Introductory sections

The Preface

The Code is limited; it is a guide ingeneralterms

to principles, structure and processes.

It cannotguaranteeeffective board behaviour

The spirit of the Code

Directors are responsible for governance of a specific

entity

This requires continuing and high quality effort

The Codes function is to helpthe directors

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Introductory sections (cont.)

The Preface (cont.)

The Code recommendsthat, in the interests of

greater accountability, alldirectors (of FTSE 350*

companies) should be subject to annual re-election

* The FTSE 350 is a market index incorporating the largest 350 companies bycapitalisation listed on London Stock Exchange

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The Concept of comply or explain

The Code consists of variousprinciples

Principles need not be followed if there are good

reasons Compare a rule-based approach

However, if principles are breached one rule does apply:

explain your actions

The LSE Listing Rulesrequirecompanies to applythe Main Principles and report to shareholders

on how they have done so

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The Concept of comply or explain (cont.)

Companies and shareholdersboth have

responsibility for ensuring that comply or

explain remains an effective alternative to arules-based system

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The Code

Section A

Leadership

Section B

Effectiveness

Section C

Accountability

Section D

RemunerationSection E

Relationswith

shareholders

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The Combined Code on Corporate Governance

SectionA - Leadership

A1 - The role of the board

Main principles

Every company should be headedby an effective

board, which is collectivelyresponsible for the long-

term success of the company Key supporting principles

The board give entrepreneurial leadership

Set strategic aims and provide resources to achieve

company objectives

Establish companys values andstandards

Code provisionsvisit website for details

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Section ALeadership (cont.)

A2Division of responsibilities

Main principle Responsibilities for running the board and running the business

should separated

Code provision Running the board (chairman) and running the business (chief

executive) should be undertaken by different directors

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A3The chairman

Main principle Responsibility for leadership of the board

Supporting principle Visit website for details

Code provision Independence criteria must be considered (see B.1.1)

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A4Non-executive directors (NEDs)

These are directors that do not undertake executive decision-making

Main principle

NEDs challenge and advise on strategy proposals

Supporting principles

NEDs scrutinise performance, controls and risk

management

Determine executive directors remuneration

Code provision Visit website for details

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The Code

Section A

Leadership

Section B

Effectiveness

Section C

Accountability

Section D

RemunerationSection E

Relationswith

shareholders

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Section BEffectiveness

B1Composition of the board

Main principle

Directors should have an appropriate balance of skills,

experience, independence and knowledge


Appropriate size of board

Appropriate mix of EDs and NEDs

No individual or small group can dominate

Code provisions

Relate to independence and the proportion of NEDs Visit website for details

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Section BEffectiveness (cont.)

B2Appointment of directors

Main principle

There should be a formal, rigorous and transparent

procedure for the appointment of new directors to theboard


Candidate search by merit

Orderly succession

Code provisions Visit website for details

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B3Commitment

Main principle All directors should receive induction on joining the board and

should regularl y update and refresh their skills and knowledge

Code provisions

Visit website for details

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B4Development

Main principle All directors should be able to allocate sufficient time to the

company to discharge their responsibilities effectively

Supporting principles Directors skills and knowledge must be updated

Code provisions


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B5Information and support

Main principle The board should be supplied in a timely manner with information

in a form and of a quality appropriate to enable it to discharge its

duties

Supporting principles Visit website for details


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B6Evaluation

Main principle The board should undertake a formal and rigorous annual

evaluation of i ts ownperformance and that of its committees and

individual directors

Supporting principles Chairman evaluates performance and proposes new members and,

or resignations of current directors


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B7Re-election

Main principle FTSE 350 companies: All directors should be submitted for annual

re-election

Other companies, not more than three yearly


20

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The UK Corporate Governance Code,2014

The Code

Section A

Leadership

Section B

Effectiveness

Section C

Accountability

Section D

Remuneration

Section E

Relationswith

shareholders

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The UK Corporate Governance Code

Section CAccountability

C1Financial and business reporting Main principle

The board should present a balanced and understandable

assessment of the companys position and prospects

Supporting principle

Responsibility extends to statutory and other reports

Code provisions

Directors and auditors should explain their respective duties in annual

report

Report on the business model and going concern status

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Section CAccountability (cont.)

C2Risk management and internal control This section refers the reader to the Turnbull guidance

Main principle

The board should determine acceptable risks And maintain sound risk management and internal controls

Code provision

Annual review and report of financial, operational and compliance

controls and risk management systems

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Section CAccountability (cont.)

C3Audit committee and auditors(Smith Guidance)

Main principle

Establish corporate reporting, risk management and internal control

systems

Maintain relations with external auditors

Code provisions

Audit committee (minimum three NEDstwo for smaller entities)

Audit committee must have duties in writing

Monitor internal audit

Auditor related recommendations (appointment, removal)

Annual report on non-audit services provided by auditor

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The Code

Section A

Leadership

Section B

Effectiveness

Section C

Accountability

Section D

Remuneration

Section E

Relations withshareholders

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Section DRemuneration

D1The level and components of remuneration

Main principle

Not more than necessary for the purpose

Substantially linked to performance

Supporting principles Performance related elements should promote the long term success of

the entity

Remuneration committee to be sensitive to pay conditions

Code provision

Schedule A of the Code gives advice on remuneration NED remuneration should relate to the time and commitmentgiven

Commitments of early contract termination must be considered

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Section DRemuneration (cont.)

D2Procedure

Main principle

Formal and transparent procedure

No director vote on own remuneration


Remuneration committee appoints consultants

Code provision

A Remuneration committee is requiredNEDs (minimum three [two])

Responsible for remuneration Share-holder approval on long-term schemes

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The Code

Section A

Leadership

Section B

Effectiveness

Section C

Accountability

Section D

Remuneration

Section E

Relations withshareholders

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Section ERelations with shareholders

E1Dialogue with shareholders Main principle

Dialogue on understanding of objectives


Awareness of shareholder opinion

Code provisions

Communication of views between all executive and NEDs


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Section ERelations with shareholders (cont.)

E2Constructive use of the AGM Main principle

Should be used to communicate with investors and encourage

participation

Code provisions

Resolutions should be presented individually

Audit,, remuneration and nomination committee chairmen should

attend

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Schedules

Schedule A

The design of performance-related remuneration

for executive directors

Schedule B

Disclosure of corporate governance arrangements

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Appendix 2 Notes on Agency

Theory and CG

The Cadbury Report on financial aspects of corporategovernance, commissioned by the UK government,

identified the following various stakeholders in

companies.

Directors: responsible for corporate governance.

Shareholders: linked to the directors by the


Other relevant parties: such as employees,

customers and suppliers (stakeholders).

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Theories view subjects from different

perspectives

Two major theoretical approaches used to explain

CG are...

Agency theory

Stakeholder theory

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Agency theoryPrincipal (P)

Agent (A)

Stewardship accounting Owners, shareholders(P)

Directors, stewards, managers(A)

The agency problemSeparation of ownership (P) and control (A)

Objectives of P and A may be different

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Control

The (Annual) General Meeting (AGM)

Should be the time for agents to account for themselves

Practical problems

Large ownership base (shareholders)

Owners interested in return not control

Short-termism (rather than maximising long-termreturns)

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Short-termism

Agents (directors)

Bonuses, salaries, benefits-in-kind

Residual losses Using company assets for private use, taking time off...

Principals (investors)

Churning

Focus on profit from share dealing, rather than the success ofthe company itself

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The exchange relationship (March and Simon, 1958)

Anybody, organisation, or even thing (animals,

environment) that is in some way involved with

the give and take of the presence of anorganisation in society

Contributions and inducements

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Specifically considering financial reportingaspects:

The Corporate Report (ASSC*, 1975)

The fundamental objective of corporate reports isto communicate economic measurements of, and

information about, the resources and performance

of the reporting entity useful to those having

reasonable rights to such information

* The original UK accounting standards body, now theFRC

June 2015 AA - CG

95

UNIVERSITYStakeholder theory (cont.)


96/96

of

GREENWICH

y ( )The Corporate Report ASSC, 1975

The Corporate Report questioned: Who should report what to whom?

Public accountability

Users of corporate reports...

1. Equityholders

2. Loan creditors

3. Employees

4. Analysts and advisors

5. Business contacts

6. Government

7 The public

03 - Corporate Governance - 2015-16

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