Chapter CORPORATE GOVERNANCE RESPONSIBILITIES AND ACCOUNTABILITIES Expected Learning Outcomes After studying the chapter, you should be able to... 4. Explain the relevance of good governance to both large publicly-listed companies and SMEs 2. Know the relationship between shareholders or owners and other stakeholders 3. Identify the parties involved in Corporate Governance 4, Describe the respective broad rate and specific responsibilities of the different parties in a corporate setting QVBsCHAPTER 2 CORPORATE GOVERNANCE RESPONSIBILITIES AND ACCOUNTABILITIES INTRODUCTION Many of the characteristics of good governance described in Chapter | are relevant to both SME's and large listed public companies. As an organization grows in size and influence, these issues become increasingly important However, it is also important to recognize that good corporate governance is based on principles underpinned by consensus and continually developing notions of good practice. There are no absolute rules which must be adopted by all organizations. "There is no simple universal formula for good governance” Instead emphasis is many localities, has been to encourage organizations to give appropriate attention to the principles and adopt approaches which are tailored to the specific needs of an organization at a given point in time When corporate governance is discussed, it is often spoken of in terms of a company's corporate governance framework. The key elements within an effective governance framework, and the issues relating to each element, are set out on the following pages and are relevant to organizations large and small, in both the private and the public sectors. The table provides a useful structure for any company to consider its own approach to corporate governance and the matters which may assist it achieve its strategic objectives, Many of the matters listed may not be directly relevant in all situations and some may not, in particular circumstances, be within the board's control, but it provides a useful context in which any organization can consider its governance needs so that they might be most appropriately addressed The essence of any system of good corporate governance is to allow the board and management the freedom to drive their organization forward and to exercise that freedom within a framework of effective accountability.ponsibilities and Accountabilities 17 Corporate Governan RELATIONSHIP BETWEEN SHAREHOLDERS / OWNER(S) AND OTHER STAKEHOLDERS The relationship between the shareholders / owners, management and other stakeholders in a corporation is shown below Public Corporation Stakeholders Board of | “Shareholders 7 Directors Owners Executive | External a Delegate Management Auditors [Shareholders 7” | [Owners Responsibilities | [~ Operational ||| Accountabiities| [~~ Regulalors Management fea [ine] [Siceiyand | Auditors Others | Governance starts with the shareholders/owners delegating responsibilities through an elected board of directors to management and, in tun, to operating units with oversight and assistance from internal auditors. The board of directors and its audit committee oversee management and, in that role, are expected to protect the shareholders’ rights. However, it is important to recognize that management is part of the governance framework; management can influence who sits on the board and the audit committee as well as other governance controls that might be put into place In return for the responsibilities (and power) given to management and the board. governance demands accountability back through the system to the shareholders. However, the accountabilities do not extend only to the shareholders. Companies also have responsibilities to other stakeholders, Stakeholders can be anyone who is influenced, whether directly or indirectly, by the actions of a company Management and the board have responsibilities to act within the laws of society and to meet various requirements of creditors, employees and the stakeholders.18 Chapter 2 - A broad group of stakeholders has an interest in the quality of corporate governance because it has a relationship to economic performance and the quality of financial reporting, For example, itis likely that many employees have significant funds invested in pension plans. Those pension plans are designed to protect the Financial interests of those employees in their retirement, We use the word society in the diagram to indicate those broad interests. In a similar fashion, employees and creditors have a vested interest in the organization and how it is governed. Regulators are a response to society's wishes to ensure that nizations, in their pursuit of returns for their owners, act responsibly and operate in compliance with relevant laws While shareholders / owners delegate responsibilities to various parties within the corporation, they also require accountability as to how well the resources that have been entrusted to management and the board have been used. For example, the owners want accountability on such things as: * Financial performance © Financial rranspareney — financial statements that are clear with full disclosure and that reflect the underlying economics of the company * Stewardship, including how well the company protects and manages the resources entrusted to it © Quality of internal control * Composition of the board of directors and the nature of its activities, including information on how well management incentive systems are aligned with the shareholders’ best interests The owners want disclosures from management that are accurate and objectively verifiable. For instance, management has & responsibility to provide financial reports, and in some cases, reports on internal control effectiveness. Management has always had the primary responsibility for the accuracy and completeness of an organization's financial statements, From a financial reporting perspective, it is management's responsibility to + Choose which accounting principles best portray the economic substance of company transactions: + Implement a system of internal control that assures completeness and accuracy in financial reporting Ensure that the financial statements contain accurate and complete disclosureCorporate Govern: PARTIES INVOLVED IN CORPORATE GOVERNAN' ccountabilities 19 ance Responsibilities and A. E: THEIR RESPECTIVE BROAD ROLE AND SPECIFIC RESPONSIBILITIES Corporate governance and _finane ial reporting reliability are receiving, considerable attention from a number of parties including regulators, standard setting bodies, the accounting profession, lawmakers and financial statement users, 1 Party ~_ Overview of Responsibilities i. Shareholders Broad Role | Provide effective oversight through election of board members, approval of mgjor initiatives such as buying or selling stock, annual | feports on management compensation, from the board. | 2. Board of Directors Broad Role. ‘The major representative of stockholders to ensure that the organization is run according to the organization's charter and that there is proper accountabilty, ‘Specific activities include among others. | Overall Operations Establishing the organization's vision, mission, values and ethical standards Delegating an appropriate level of authority to management Demonstrating leadership. ‘Assuming responsibilty or the business ‘elationship with CEO including his or her appointment, succession, performance remuneration and dismissal Overseeing aspects of the employment of the management team including management remuneration, performance and succession planning Recommending auditors and new directors 10 shareholders Ensuring effective communication with shareholders other stakeholders Crisis management Appointment of the CFO and corporate secretary.20_Chapter 2 Performance Ensuring the organization's long term viability and enhancing the financial position * Formulating and overseeing implementation of corporate strategy ‘Approving the plan, budget and corporate policies Agreeing key performance indicators (KPIs) ‘+ Monitoring assessing assessment, performance of the organization, the board itself, management and major projects ‘+ Overseeing the risk management framework and ‘monitoring business risks ‘+ Monitoring developments in the industry and the operating environment * Oversight of the and organization, including its Control and accountability systems, ‘+ Approving and monitoring the progress of major capital expenditure, capital management and acquisitions and divestitures. Compliance / Legal Conformance Understanding and protecting the organization's financial position + Requiring end monitoring legal and regulatory compliance including compliance with accounting standards, unfair trading legislations, occupational health and safety end environmental standards. Approving annual financial reports, annual reports ‘and other public documents / sensitive reports, + Ensuring an effective system of internal controls exists and is operating as expected. T_ Non-Executive or Independent Directors Broad Role: | The same as the broad role ofthe entire board of directors ‘Specific activities imclude among others © tounderstand the organization, its business, its ‘operating environment and its financial position ‘+ to-apply expertise and stills in the organization's best interests, * _lo.assist management to keep performance objectives at the top of its agenda,Corporate Governance Responsibilities and Acc | © to understand that hismher role is not to act as auditor, nor to act as a member of the management team, «lo respect the collective, cabinet nature of the board's decisions, + toprepare for and attend board meetings, #10 seek information on a timely basis to ensure that he!she is in a position to contribute to the discussion when a matter comes before the board, ‘or alert the chairman in advance to the need for further information in relation to a particular matter, and | + __to-ask appropriate questions relative to operations Management | Broad Role Operations and accountabilty. Manage the organization effectively; provide accurate and timely reports to shareholders and other stakeholders, Specific activities include among others: ‘© recommend the strategic direction and translate the strategic plan into the operations ofthe business + manage the company’s human, physical and financial resources to achieve the organization's objectives — run | the business + assume day to day responsibilty forthe organization's | conformance with relevant laws and regulations and its compliance framework * develop, implement and manage the organization's risk management and internal contol frameworks ‘+ develop, implement and update policies and procedures ‘+ be alert to relevant trends in the industry and the ‘organization's operating environment ‘provide information to the board + ectas conduit between the board and the organization * developing financial and other reports that meet public, stakeholder and regulatory requirements22_ Chapter 2 5 Audit Committees of the Board of Directors Broad Role Provide oversight ofthe internal and external audit function and the process of preparing the annual fnancial statements as well as public reports on internal control ‘Specific activties include among others. ‘+ Selecting the external audit frm * Approving any non-audit work performed by the audit firm ‘+ Selecting and / or approving the appointment of the Chief Audit Executive (Internal Auditor) ‘+ Reviewing and approving the scope and budget of the internal audit function Discussing audit findings with internal auditor and external auditor and advising the board (and management) on specific actions that should be taken 6 Regulators a Board of Accountancy Broad Role! Set accounting and auditing standards dictating underlying financial reporting and auditing concepts; set the expectations of ‘audit quality and accounting quality Specific activities include among others: ‘+ Conducting CPA Licensure Board Examinations Approving accounting principles © Approving auditing standards * Interpreting previously issued standards implementing quality control processes to ensure audit quality © Educating members on audit and accounting requirementsb. Securities and Exchange ‘Commission Corporate Governance Responsibilities and Accountabilities 23 Broad Role: Ensure the accuracy, timeliness and fairness of public reporting of financial and other information for public companies. Specific activities include among ot! * Reviewing filings with the SEC + Interacting withthe Financial Reporting Standards Counc in setting accounting standards ‘+ Specifying independence standards required of auditors, thal report on public financial statements ‘+ Identity corporate frauds, investigate causes, and suggest remedial actions 7 External Auditors Broad Role: | Perform audits of company financial statements to ensure that the statements are free of material misstatements including misstatements that may be due to fraud ‘Specific activities include among others. + Audit of public company financial statements ‘+ Audits of nonpublic company financial statements + _ Other services such as tax or consulting 8 Internal Auditors | Broad Role: Perform audits of companies for comphance with company policies and laws, audits to evaluate the efficiency of operations, and Periodic evaluation and tests of controls, Specific activities include among others. + Reporting results and analyses to management {including operational management) and audit committees + Evaluating int controls,24 Chapter 2 REVIEW QUESTIONS Questions 1, “Small business enterprises do not need good governance Do you agree? Explain 2. Does good governance require absolute rules that must be adopted by all organizations? 3. What is the essence of any system of corporate governance? 4, Where does the board of directors derive its authority? 5. To whom is the board of directors accountable? 6. On what aspects do shareholders demand accountability from the board of directors? 7. What is management’s responsibility as far as financial reporting is concerned? 8. Describe the broad role of the shareholders in a corporation. 9. Describe the broad role of the Board of Directors, 10. What are the specific activities of the board of directors? Muliiple Choice Questions 1 Approving annual financial reports and other public documents are specific responsibilities of ment a. Manag b. Board of directors ¢. Shareholders d, Employeesi _Corporate Governance Responsibilities and Accountabilities 25 Providing oversight of the internal and external audit function, the process of preparing the annual financial statements and public reports on intemal control are the responsibility of a, Board of di b. Chief executive officer Chief financial officer selors Audit committee of the board of directors Who is responsible for ensuring the accuracy. timel reporting of fina a. External auditors ies of public cial and other nformation for public companies? b. Securities and exchange c. Shareholders 4, Board of Accountaney commission Who performs audit of companies for compliance with company policies and laws, audits efficiency of operations and periodic evaluation and tests of controls? a. External auditors b. Internal auditors c. Commission on audit d. Chief accountant An independent director is expected to a. Apply expertise and skills in the corporations best interest b. Asset management to keep performan agenda c. Respect the collective, cabinet nature of the board’s decision Act as conduit between the board and the organization, e objectives at the top of