Bachelor Degree

Corporate Governance and Ethics

Module
BOTSWANA OPEN UNIVERSITY (BOU)
BCG 732
ACKNOWLEDGEMENTS

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Contents
UNIT 1: INTRODUCTION TO CORPORATE GOVERNANCE.............................. 7
Topic 1: Contextualising Corporate Governance ........................................ 8
1.2 Definition of Corporate Governance ........................................................... 9
1.3 Historical Background of Corporate Governance ....................................... 10
1.4 The Importance of Corporate Governance ............................................... 14
1.5 The Main Aim of Corporate Governance ................................................... 16
1.6 Objectives of Corporate Governance ........................................................ 17
1.7 Impact of Corporate Governance............................................................. 18
Topic 2: Corporate Governance Systems ................................................... 22
2.2 The Evolution of the Modern Corporation ................................................. 23
2.3 Corporate Governance Systems............................................................... 24
Topic 3: Corporate Governance: Principles and Framework .................... 34
3.2 Principles of Corporate Governance ......................................................... 36
3.3 The Link between Corporate Governance Principles and Law .................... 38
3.4 The UK Corporate Governance Code........................................................ 39
3.5 King III Report ....................................................................................... 41
3.6 The Organisation for Economic Cooperation and Development .................. 46
3.7 Botswana Corporate Governance Code .................................................... 48
3.8 The Basis for an Effective CG framework. ................................................ 49
Topic 4: IT Governance ............................................................................... 52
4.2 IT Governance in King III ....................................................................... 53
4.4 IT Governance Stakeholders ................................................................... 56
4.5 Scope of IT Governance ......................................................................... 56
Topic 5: Globalisation and Corporate Governance ................................... 58
5.2 Understanding Globalisation in Relation to Corporate Governance ............. 59
5.3 Deregulation and Globalisation ................................................................ 59
5.4 Need of Integrity in Today‘s Global Economy ........................................... 60
5.5 Global Governance and Sustainable Development .................................... 61
5.6 Globalisation and New World Order ......................................................... 63
5.7The Significance of the Issue ................................................................... 64
5.8 Regional and Sub-Regional Organisations. ............................................... 64

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UNIT 2: CORPORATE GOVERNANCE STAKEHOLDERS ................................. 67
Topic 1: General Aspects of Stakeholder Management ............................ 68
1.2 Defining a Stakeholder ........................................................................... 69
1.3 Stakeholder Theory ................................................................................ 70
1.4 Objectives of Corporate Governance in Relation to Stakeholders ............... 72
1.5 Classifications of Stakeholders................................................................. 72
1.6 Conflicts with Stakeholders ..................................................................... 73
1.7 Managing Stakeholder Conflicts ............................................................... 74
1.8 Types of Stakeholder Power .................................................................... 76
1.9 Stakeholder Analysis............................................................................... 76
Topic 2: Key Internal and External Actors ................................................ 81
2.2 Internal Players .................................................................................. 82
2.3 External Stakeholders ............................................................................. 85
Topic 3: Directors ........................................................................................ 91
3.2 Defining a Director ................................................................................. 92
3.2 Duties of Directors ................................................................................. 92
3.3 Directors Restrictions .............................................................................. 96
3.4 Director‘s Compensation...................................................................... 97
3.5 Composition of the Board ....................................................................... 98
Topic 4: The Board and Strategy Formulation ........................................ 101
4.2 Role of the Board in Context ................................................................. 102
4.1 The Process of Strategy Development ................................................ 103
4.4 Strategy Implementation and Monitoring ............................................... 105
4.5 The Role of the Board in Different Types of Organisations ...................... 105
4.6 The Management-Board Relationship in Strategy formulation .................. 106
UNIT 3: CORPORATE REPORTING .............................................................. 110
Topic 1: Financial Reporting ..................................................................... 111
1.2 Defining Financial Reporting ................................................................. 112
1.3 Importance of Financial Reporting ......................................................... 113
1.4 Limitations of Financial Statements ....................................................... 114
1.5 Integrated Reporting ............................................................................ 115
1.6 Sustainability Reporting ........................................................................... 117

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 Topic 2: Internal Controls......................................................................... 122
2.2 Defining Internal Controls ..................................................................... 123
2.3 Components of Internal Controls ........................................................... 123
2.4 The Internal Audit Function and Internal Controls .................................. 126
2.5 Controls Over Financial Reporting.......................................................... 126
2.6 Limitations of Internal Controls ............................................................. 126
2.7 Fraud .................................................................................................. 127
Topic 3: Risk Management ....................................................................... 131
3.2 Nature and Concept of Risk .................................................................. 132
3.3 Corporate Risk Management ................................................................. 132
3.4 Objectives of Risk Management ............................................................ 132
3.5 Classifications of Risk ........................................................................... 133
3.6 Risk Appetite........................................................................................ 136
3.7 Risk Management ................................................................................. 136
3.8 Attitudes Towards Risk ......................................................................... 137
3.9 Risk Management Frameworks .......................................................... 137
3.10 Risk Committee .................................................................................. 138
Topic 4: Auditing ....................................................................................... 142
4.2 Role of Audit ........................................................................................ 143
4.3 The Audit Committee............................................................................ 144
4.4 The Internal Audit Function .................................................................. 146
4.5 Role of Internal Audit in Corporate Governance...................................... 149
4.6 External Audit ...................................................................................... 149
UNIT 4: BUSINESS SUSTAINABILITY, CSR AND ETHICS .......................... 151
Topic 1: Business Sustainability ............................................................ 152
1.2 Definition of Sustainability .................................................................... 153
1.3 Sustainability and Corporate Social Responsibility ................................... 157
1.4 The Challenges for Corporate Sustainability - Energy, Water and Waste .. 158
1.5 Life Cycle of Goods............................................................................... 160
1.6 Why Sustainability Is Good for Business................................................. 163
1.7 How governments can encourage sustainability ..................................... 164
1.8 Sustainability Standards ........................................................................ 164

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Topic 2: Corporate Social Responsibility ................................................. 166
2.2 Definition of Corporate Social Responsibility ........................................... 167
2.3 The Social Contract .............................................................................. 167
2.4 CSR Frameworks .................................................................................. 169
2.5 Benefits of Corporate Social Responsibility ............................................. 171
Topic 3: Moral and Ethical Codes of Conduct .......................................... 174
3.2 Ethical Code of Conduct ........................................................................ 175
3.3 Moral Theories ..................................................................................... 175
3.4 Taxonomy of Ethical Approaches ........................................................... 176
3.5 Table Connecting Theory to Domain ...................................................... 177
3.6 Virtue Ethics ........................................................................................ 179
Topic 4: Business Ethics............................................................................ 186
4.2 Ethics .................................................................................................. 187
4.3 Framework for Ethical Decision Making .................................................. 187
4.4 Importance of Ethics to a Business ........................................................ 199
4.5 Controlling Ethics ................................................................................. 199
4.6 Professional Ethics ............................................................................ 203
4.7 Values for Professional Ethics ................................................................ 204
Topic 5: Ethical Leadership in Organisations .......................................... 206
5.2 Leadership: Ethics at the Organisational Level .................................... 207
5.3 Stewardship and Servant Leadership Styles ........................................... 211
5.3 Dark Side of Organisational Leadership .................................................. 214

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UNIT 1: INTRODUCTION TO CORPORATE GOVERNANCE

INTRODUCTION

Governance explains how organisations are managed and to the purpose of

governing. For example governance of Botswana as country, refers to the powers
and actions of the legislature, the executive and the judiciary. It is concerned with
procedures and practices for trying to ensure that a company is run in such a way
that it achieves its objectives without violating the rights of others. This could be to
maximise the wealth of its owners (the shareholders), subject to various guidelines
and constraints and with regard to the other groups with an interest in what the
company does. Ethics are laid down to guide those managing the organisations.
Other groups with an interest in how the company acts include suppliers, financiers,
employees, customers, the families of employees and the general public. In this unit
we will study the underlying principles and frameworks that are relevant to
corporate governance.

UNIT OBJECTIVES

After studying this unit you should be able to:

 Define corporate governance

 State the principles of corporate governance
 Explain the framework of corporate governance
 Apply the principles of corporate governance in resolving organisational problems

UNIT CONTENTS

Topic 1: Contextualising Corporate Governance

Topic 2: Approaches to Corporate Governance
Topic 3: Principles of Corporate Governance
Topic 4: The Corporate Governance Framework

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Topic 1: Contextualising Corporate Governance

1.0 Introduction

The concept of governance has evolved over time to include various aspects of an
organisation. From one perspective, it can simply be defined as the ways in which
suppliers of finance assure themselves of the safety of their investment. Much of the
earlier literature on corporate governance focused on this aspect and in particular,
the control of executive itself and protection of shareholder interests in instances
where control and ownership is separated. However, later, more recent conceptions
of governance cover a wider scope. Therefore governance in its latest form can be
more accurately characterised as the mobilisation of all organisational resources and
the conflict resolution among its stakeholders. This topic defines corporate
governance and lays the foundation for the rest of the module. The importance and
key issues in corporate governance are introduced.

1.1 Objectives

After studying this topic you should be able to:

 Define corporate governance

 Outline the history of corporate governance
 Explain key issues in corporate governance

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1.2 Definition of Corporate Governance
‗Governance‘ refers to the way in which an organisation is administered and the
purpose of governing the organisations. The governance of Botswana as a country,
for example, refers to the powers and actions of the legislature, the executive and
the judiciary. Governance might not be an easy concept to understand. In the case
of governing a country, it would be concerned with who has the power to rule and
what the leaders of the country should be trying to achieve. The government of a
democratic country presumably sets itself the objective of protecting its people and
acting in their best interests. Powers are shared between the legislative, executive
and judiciary, but a matter of debate is how these powers should be shared and
exercised.

And now to relate the governance of a country to that of a company; in terms of

attributes, a country has citizens while a company has members. The members of a
company are its owners, the ‗equity‘ shareholders or ―the members‖. Think of how
citizens exercise their rights as guaranteed by their constitution. Members of a
company also have similar powers guaranteed under the company constitution. The
citizens of a country, even in a democracy, have relatively few powers. Power is in
the hands of the Parliament and the executive (the government). In a similar way,
shareholders have relatively few powers, which are restricted mainly to certain
voting rights. Power is in the hands of the Board of directors. , Membership changes,
as investors buy and sell the company‘s shares.

One can therefore, deduce that Corporate Governance, refers to the way in which
companies are governed and why they are governed. It is concerned with
procedures and practices for trying to ensure that a company is run in such a way
that it achieves its objectives. This could be to maximize the wealth of its owners
(the shareholders), subject to various guidelines and constraints and with regard to
the other groups with an interest in what the company does.

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Corporate governance is therefore concerned with how powers are shared and
exercised by different groups, to ensure that the objectives of the company are
achieved without violating others‘ rights. Aspects of corporate governance include:
 The rights of shareholders and other interest groups such as the employees,
 How powers are shared and exercised by the directors, and
 How the holders of power in a company should be held accountable for their
omissions and actions.
To further understand the concept of corporate governance, it is useful to be aware
of what it is not. Corporate governance is not primarily concerned with the day-to-
day management of operations by business executives. The powers of executive
managers to direct business operations are one aspect of governance. Similarly,
corporate governance is not concerned with formulating business policy, although
the Board of directors is expected to take strategic decisions.

1.3 Historical Background of Corporate Governance

The demand for better practices in corporate governance began in the UK in the late
1980s and early 1990s. This necessitated the constitution of Committee on the
Financial Aspects of Corporate Governance. The outcome of their findings was the
‗Cadbury Report‘ which was published in 1992, and was later described as ‗a
landmark in thinking on corporate governance‘. The Report included a Code of Best
Practice, and UK listed companies came under pressure from City institutions to
comply with the requirements of the Code. The initial UK Corporate Governance
Cadbury and associated reports mostly emphasised on financial and internal controls
in companies.

In 1994 South Africa‘s (first) King I Report 1994 was released. Unlike its
counterparts in other countries at the time, the King I Report 1994 went beyond the
financial and regulatory aspects, by advocating the principles of good financial,
social, ethical and environmental practice, which link businesses with the society and
stakeholders in which it operates. The code to the King I Report applied to all
companies listed on the stock exchange, Johannesburg Securities Exchange (JSE).

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The King II Report was released in 2002 and thereafter the JSE Limited listing
requirements were substantially amended to, in addition to the ―comply or explain‖
principle which is applicable to the provisions of the King II Report 2002, obliged
listed companies to comply with certain requirements, such as the separation of the
roles of Managing Director and Chairperson.
The King III Report, the Companies Act 71 of 2003, as amended, and the updated
JSE
Limited Listings Requirements have ensured that South African enterprises apply
corporate governance standards which are at a level comparable to those followed
by major trading nations. The South African King III Report emphasises more on
social and ethical matters.

In Botswana, the Botswana Accountancy Oversight Authority (BAOA) was

established by the Financial Reporting Act, 2010 as the independent oversight body
of the accounting and auditing profession; to regulate the reporting of financial
matters of Public Interest Entities (PIEs) and the corporate sector; and for matters
incidental thereto. BAOA carried out a research and concluded that King III would
be the most suitable for Botswana.

The United States appeared to show little concern for better corporate governance
until the 1990s, although there were some activist institutional shareholders such as
Calpers. Investigation into the collapse of major companies prompted corporate
governance measures. The collapse of the energy company Enron followed by a
number of other corporate collapses and governance scandals necessitated change.
Recommendations for change were proposed by the New York Stock Exchange, and
statutory provisions on corporate governance were introduced in 2002 with the
Sarbanes–Oxley Act.

The OECD monitors progresses in corporate governance in European member

countries.
Recent events in individual countries are available at the OECD web-site,
[Link]/daf/governance/[Link].

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Further reiterations and discussions of each of the Corporate Governance Codes
above will be included in later topics.

The following case study illustrates major corporate governance failures in

organisations.

Enron Case Study

Enron was created in 1986 by Ken Lay to capitalise on the opportunity he saw
arising out of the deregulation of the natural gas industry in the USA. What started
as a pipelines company was transformed by the vision of a McKinsey consultant, Jeff
Skilling, who had the idea of applying models used in the financial services industry
to the deregulated gas industry.

He persuaded Enron to set up a Gas Bank through which buyers and sellers of
natural gas could transact with each other using an intermediary (Enron) whose
contractual arrangements would provide both parties with reliability and
predictability regarding pricing and delivery. Enron duly recruited him to run this
business and he rapidly built up a major gas trading operation through the early
nineties.

During this time Enron was extending its pipeline operations into a wider power
supply business, initially in the USA and then on an international scale, completing a
large plant at Teesside in the UK and contracting to build a huge plant near Mumbai
in India. In due course it had deals all round the globe, from South America to
China. The hard driving expansion of Enron‘s power business worldwide created a
global reputation for Enron.

Skilling‘s vision was to transform Enron into a giant, asset-light operation, trading
power generally and his next target was trading electricity. Lay was lobbying
Washington hard to deregulate electricity supply and in anticipation he and Skilling
took Enron into California, buying a power plant on the west coast.

Enron‘s national reputation rested on the rapid expansion of its domestic business
and its steadily growing revenue and earnings from trading. So on the back of his
track record, Skilling was appointed Chief Operating Officer by Ken Lay and he then
embarked upon transforming the whole of Enron to reflect his vision.

Observing the dotcom boom, Skilling decided Enron could create a business based
on a broadband network which could supply and trade bandwidth and he set out to
build this at a great pace.

However, the experiment in deregulation in California didn‘t work well and in due
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course was reversed with recriminations all round. Moreover, the international
business expansion wasn‘t underpinned by adequate administration and many of the
contracts later turned bad.

So Enron then took the decision to build on its international presence by becoming a
global leader in the water industry and bought a big water company in the UK,
following it up with a big deal in Argentina.

At this point, around 2000, Enron‘s reputation was still riding high and Lay and
Skilling were looked up to as visionary thinkers and top business leaders.

However, as we see elsewhere in this case study, the rapid expansion had run well
ahead of Enron‘s ability to fund it, and to address the problem, it had secretly
created a complex web of off-balance sheet financing vehicles. These, unwisely,
were ultimately secured, and hence dependent, on Enron‘s rapidly rising share
price.

Also, its hard driving culture was underpinned by incentive schemes which promised,
and delivered, huge rewards in compensation packages to outstanding performers.
The result was that, to achieve results, aggressive accounting policies were
introduced from an early stage. In particular, the use of mark to market valuation on
contracts produced artificially large earnings, disguising for some years underlying
poor profitability in major parts of the business.

This, of course, meant that Enron was not generating adequate cashflow, while
spending extravagantly on expansion, and eventually it blew up suddenly and
dramatically. Colleagues of this author who met Lay and had dealings with Enron
confirm that there was scepticism in the market about Enron‘s profitability and its
cash position. Suspicions grew that Enron‘s earnings had been manipulated and in
late summer 2001 it emerged that its Chief Finance Officer had privately made
himself rich at Enron‘s expense through the off-balance sheet vehicles. About this
time the dotcom boom ended suddenly and for Enron, this coincided with the
international power business going radically wrong, the broadband business having
to be shut down, the water business collapsing and the electricity services business
getting into serious trouble in California. Enron‘s share price started to slide and
Skilling, appointed Chief Executive Officer in January 2001, resigned in August.

Enron‘s share price then rapidly declined, triggering repayment clauses in the
financing vehicles which Enron couldn‘t handle. Its credit rating went to junk status,
which caused the share price to collapse and triggered further crystallising of debt
obligations. Banks refused further finance, suppliers refused to supply and
customers stopped buying.

At the beginning of December 2001, Enron filed for the biggest bankruptcy the USA
had yet seen.

This, in turn, took down one of the largest accounting firms in the world, Arthur
Andersen, which was deemed to have so compromised its professional standards in

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its dealings with its client Enron that it was in many ways complicit in Enron‘s
criminal behaviour.

Dembinski, P. H., Lager, C., Cornford, A., & Bonvin, J. M. (Eds.). (2005). Enron and
world finance. Palgrave Macmillan.

Activity 1.1
a. Outline some of the CG failures from Enron.
b. Discuss how having a robust CG system in place would have helped curb the
failures you identified above.
c. What are lessons that can be drawn from the Enron case?

The next section is on the importance of corporate governance.

1.4 The Importance of Corporate Governance

There are three key areas of corporate governance.

a. Good corporate governance has to harmonize the interests of its

stakeholders.

Although a company exists as a juristic person, in reality it is the organised,

collective effort of many different individuals. It is controlled by a Board of directors,
in the interests of its owners, that is, the members. The interests of the Board and
the members ought to clash, but in practice they may be at odds with each other.
The challenge of good corporate governance is to find a way in which the interests
of members, directors and other interest groups can all be sufficiently satisfied.
Corporate governance is a matter of much greater importance for large public
companies, where the separation of ownership from management is much wider
than for small private companies in which the owners and managers are the same
persons. Institutional investors hold vast portfolios of shares and other investments.
Investors need to know that their money is reasonably safe. Should there be any
doubts about the integrity or intentions of the individuals in charge of a company,

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the value of the company‘s shares will be affected and the company will have
difficulty raising any new capital.

Weak corporate governance in an organisation generally, makes it more difficult to

attract investment. It might seem self-evident that good (or adequate) corporate
governance supports capital markets. However, the motivation for the development
of many, but not all codes of best practice and stricter regulatory regimes has been
attributed to scandals and setbacks, where evidence of bad corporate governance
has emerged, and company share prices and the stock market generally have
suffered as a consequence.

b. Foreign Investment

The need for good corporate governance is now a matter of international concern
with major investors preferring investments in companies and countries with good
governance. It is important to be aware, however, that although corporate
governance has become a matter of some interest in many countries, the pace of
change and the nature of corporate governance vary substantially between
countries. Much of the pressure for change has come from institutional investors,
particularly in the US, which have invested in companies situated and registered in
other countries. Investors expect to be allowed to exercise their right to vote and to
be treated on an equal footing with other equity shareholders. In many developing
countries, there has been substantial investment by multinational companies, such
as international banks. As may be expected US and UK multinationals have
established a system of corporate governance within their subsidiaries, which follows
the same system followed by the parent company. Multinationals have become
increasingly aware of their reputation in markets in other countries, and they are
accordingly alert to the demands of pressure groups and governments in the
countries where they have operating subsidiaries.

c. Achieving Objectives

A company should have objectives. Some of these, such as the reasons for its
existence, may be set out in its written constitution. Before enactment of the

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Companies Act 2003, it was known as the (Memorandum and Articles of
Association). Other objectives may be implied or assumed, rather than clearly
documented. A company should be managed in a way that moves it towards the
achievement of its objectives. It should be seen to be making progress in its
objectives. Following are some reasons for having objectives:
 It limits the task, and removes all ambiguity and difficulties of interpretation.
 It ensures that measurement is possible, so that the quality and effectiveness
of the project can be determined.
 It provides a summary of the project, which can serve as a conceptual
scaffold for project monitoring and appraisal.
 Links the identified needs and delivery so that the project can be validated.
 Provide a first point of reference for any investigations or review of project.

1.5 The Main Aim of Corporate Governance

Corporate governance has various objectives to strengthen investor's confidence and
intern leads to fast growth and profits of companies. These are mentioned below:

i. To balance the interest of shareholders, business stakeholders and the entire

community.
ii. To maintain the relationship between shareholders, all the stakeholders and
leadership (directors and management).
iii. To pinpoint fiduciary duties and responsibilities of directors.
iv. To conform and comply with both internal and external corporate policies.
v. To ensure effective business performance and distribution of equitable
benefits to all the interested stakeholders.
vi. To maintain sustainable development that will promote social and economic
welfare, for the benefit of the entire community.

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1.6 Objectives of Corporate Governance

The fundamental objective of corporate governance is to promote and maximise

shareholder value and protect the interest of other stake holders. World Bank
described Corporate Governance as blend of law, regulation and appropriate
voluntary private sector practices which enables the firm to attract financial and
human capital to perform efficiently, prepare itself by generating long term economic
value for its shareholders, while respecting the interests of stakeholders and society
as a whole..

a. Maximise shareholders wealth

The main objective of corporate governance is to protect the long-term interests of

the shareholders. Ira Millstein, in his book, "Corporate Governance: Improving
Competitiveness and Access to Capital in Global Markets," mentions that firms with
strong corporate governance structures are seen to have higher valuation premiums
attached to their shares. This shows that good corporate governance is perceived by
the market as an incentive for shareholders to invest in the company.

b. Maximisation of profitability and efficiency of the business

In a competitive marketplace, a business executive must learn to achieve a

satisfactory level of profitability. Increasing profitability involves determining which
areas of a financial strategy are working and which ones need improvement.
Understanding the key factors determining profitability assists managers in
developing an effective profitability strategy for their [Link] Sales, pricing, and
expenses and cost of staying in business.

c. Responsible and ethical corporate conduct to ensure sustainability

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Corporate ethics are very pivotal in determining the progress or failure of an
organisation. The effect of company‘s reputation helps to define a business model
that will thrive even in adversity. In an organisation, a code of ethics is a set of
principles that guide the organisation in its programs, policies and decisions for the
business. The ethical philosophy an organisation uses to conduct business can affect
the reputation, productivity and bottom line of the business.

d. Control of management and operations that is in the best interest of

the company

Controlling is an indispensable component of the management process. Changes in

business environment and growing demands on goal-oriented corporate
management, making in depth knowledge of key controlling tools is an essential
prerequisite for achieving success. Managers need to know the value of assets and
liabilities under their management and control in order to make sure that values are
maintained as this factures affects company‘s success or failure.

Activity 3.2
a. How does a good corporate governance objective promote business development?
b. Why is it necessary to have long term goals for corporate strategy?

1.7 Impact of Corporate Governance

a. Business responsibilities; beyond shareholders towards stakeholders

Today the operations of business enterprise affect a wide spectrum. The resources
they make use of are not limited to those of the proprietors and the impact of their
operations is also felt by various stakeholders who are connected with the business
[Link] the customers, employees, suppliers, competitors, community and
shareholders.

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This implies that the claims of various interested parties will have to be balanced,
not on the narrow ground of what is best for the shareholders alone but from the
point of view of what is best for the community at large.

It must produce the maximum goods of good quality, ensure smooth supplies at
competitive prices, pay tax, shun malpractices, and pay fair and equitable
remuneration to employees and reasonable dividend to shareholders and hence
businesses share a role in shaping the future of the global community.

b. Economic and social impact of business on innovation and

community

Business establishments, whether small, medium or large should contribute to the

social development of the community by providing employment and raising the
purchasing power of the community. Therefore management should ensure the
following:

 Effective utilization of scarce resources and developing alternatives, wherever

possible.
 Improve the efficiency of business operations, by training employees to improve
their skills and ensure research and development of new product quality at fair
prices.
 Provide sufficient information about the products, including their adverse effects,
risks and care to be taken while using the products.
 Maintain effective distribution system and make goods easily available
 It is also the duty of the business to undertake new investment and promote the
dispersal of economic activities through ancillarisation and the setting up of new
industries in backward areas so as to spread enterprise and empower, employ
and improve the living standards of the community.

c. Spirit of trust

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Businesses should act in good faith to create trustworthiness by keeping its promises
and promoting transparency and accountability to both internal and external
stakeholders. This will not only ensure creditability and stability, but will also ensure
smoothness and efficiency of its transactions.

d. Respect for rules

To promote free trade, ensure fair and equitable competition and avoid trade
frictions with all participants, businesses should respect domestic and international
rules which govern their contractual relationships and operations.

e. Multilateral trade support

Global trade is very important for the development of all businesses and therefore
businesses should support multilateral trade systems of the general agreement on
tariffs and trade (GAAT) World trade organisation (WTO) and similar international
agreements. Their cooperation will promote and enhance progressive and judicious
liberation of trade and relax those domestic measures that unreasonably hinder
international trade, while giving due respect to national policies and objectives.

f. Environmental respect

Business has a lot of responsibility to communities around its location and to the
society at large. It should take appropriate steps to prevent environmental pollution
and preserve the ecological balance, rehabilitate the population displaced by the
business operations, if any, and promote sustainable development so as to prevent
wasteful use of natural resources.

g. Avoidance of illicit operations

It is good practice for all businesses to operate objectively, legally, transparently and
to be accountable. Therefore, business managers or employees should not involve
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themselves in illegal practices such as arms trade, manufacture or sell materials
used by terrorists, drug trafficking organised crime or accepting bribes, money
laundering and other corrupt practices.

Summary

Corporate Governance is a tool used for accountability of management to various

stakeholders. The need for CG was highlighted by numerous organisational scandals
where directors abused their power and misled stakeholders. The Enron case study
was just one example of what could go wrong when there are lax or even no CG
systems in place. One of the main aims of CG is to balance the interest of
shareholders, business stakeholders and the entire community. As was
demonstrated in the Enron case study there was a weak CG system and that allowed
for many of the abuses outlined.

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Topic 2: Corporate Governance Systems

2.0 Introduction

The world‘s strongest market economies have evolved under one of the three major
corporate governance systems discussed in this topic. The frameworks within which
they operate are determined by the legal, regulatory, institutional and political
environments that have resulted in the consistent systems that define the corporate
control mixes. These corporate governance systems evolved to meet the prevailing
corporate missions of the companies in those countries and so they each have
different underlying modus operandi. In other words, the corporate structures of
companies in a country depend on the initial structures with which that economy
began. In this topic, we will take a closer look at the three main corporate
governance systems that exist today. In order to fully comprehend the discussions it
is important firstly to understand how today‘s organisations evolved to what they are
now and the concerns that have led to the different governance systems.

2.1 Objectives

After studying this topic you should be able to:

 Identify the key identifying characteristics of the three governance systems

 Compare and contrast the governance systems
 Discuss the evolution of the modern corporation

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2.2 The Evolution of the Modern Corporation
Corporations have existed since the beginning of trade that is 150,000 years ago.
From small beginnings they assumed their modern form in the 17th and 18th
centuries with the emergence of large, European-based enterprises, such as the
British East India Company. During this period of colonization, multinational
companies were seen as agents of civilization and played a pivotal role in the
economic development of Asia, South America, and Africa. By the end of the 19th
century, advances in communications had linked world markets more closely, and
multinational corporations were widely regarded as instruments of global relations
through commercial ties. While international trade was interrupted by two world
wars in the first half of the twentieth century, a more closely bound world economy
emerged in the aftermath of this period of conflict.

Over the last 20 years, the perception of corporations has changed. As they grew in
power and visibility, they came to be viewed in more ambivalent terms by both
governments and consumers. Almost everywhere in the world, there is a growing
suspicion that they are not sufficiently attuned to the economic well-being of the
communities and regions they operate in and that they seek to exploit their growing
power in relation to national government agencies, international trade federations
and organisations, and local, national, and international labor organisations.

The rising awareness of the changing balance between corporate power and society
is one factor explaining the growing interest in the subject of corporate governance.
Once largely ignored or viewed as a legal formality of interest mainly to top
executives, boards, and lawyers, corporate governance for some time now has been
a subject of growing concern to social reformers, shareholder activists, legislators
and regulatory agencies, business leaders, and the popular press.

Shareholders, increasingly upset about outsized executive compensation deals and

other governance issues, argue that too many boards are beholden to management
and neglect shareholder interests. CEOs complain that having to play the ―Wall
Street expectations‖ game distracts them from the ―real‖ strategic issues and erodes
their companies‘ long-term competitiveness. Employees worry about the impact of
management practices, such as off-shoring and outsourcing on pay, advancement
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opportunity, and job security. Meanwhile, outside stakeholders, focused on issues
such as global warming and sustainability, are pressing for limits on corporate
activity in areas like the harvesting of natural resources, energy use, and waste
disposal. Increasingly, they are joined by civic leaders concerned by the continuing
erosion of key societal values or threats to the health of their communities.

Behind these concerns lie a number of fundamental questions. Who ―owns‖ a

corporation? What constitutes ―good‖ governance? What are a company‘s
responsibilities? To shareholders? To other stakeholders, such as employees,
suppliers, creditors, and society at large? How did Wall Street acquire so much
power? And, critically, what are the roles and responsibilities of boards of directors?

Source: Aguilera, Williams, Conley, & Rupp, (2006)

Figure 2.1: Socio-political view of corporate governance

2.3 Corporate Governance Systems

The German and Japanese corporate governance systems are very different from
that in the United States. Knowing how they function is important. The German and
Japanese economies play host to many of the world‘s largest corporations.
Moreover, their governance systems have had substantial spill over effects beyond

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their respective borders. Many countries in Europe, such as Austria, Belgium,
Hungary, and, to a lesser extent, France and Switzerland, and much of northern
Europe, evolved their governance systems along Germanic, rather than Anglo-
American, lines. Moreover, the newly liberalizing economies of Eastern Europe
appear to be patterning their governance systems along Germanic lines as well. The
spillover effects of the Japanese governance system are increasingly evident in Asia
where Japanese firms have been the largest direct foreign investors during the past
decade. In contrast, variants of the Anglo-American system of governance are only
found in a few countries, such as the United Kingdom, Canada, Australia, and New
Zealand. The corporate governance systems differ in their:
 Ownership structures of equity
 Structures of corporations
 Role of the banking system in the economies
 Business circumstances
 Efficient functioning of capital markets
 Level of competition in both domestic and international product and capital
markets.

2.3.1 The US Corporate Governance System (Anglo-American System)

Today‘s U.S. corporate governance system is best understood as the set of fiduciary
and managerial responsibilities that binds a company‘s management, shareholders,
and the board within a larger societal context defined by legal, regulatory,
competitive, economic, democratic, ethical, and other societal forces. For the greater
part of the 20th century, when managerial capitalism prevailed, executives had a
relatively free rein in interpreting their responsibilities toward the various corporate
stakeholders and, as long as the corporation made money and its operations were
conducted within the confines of the law, they enjoyed great autonomy. Boards of
directors, mostly selected and controlled by management, intervened only
infrequently, if at all. Indeed, for the first half of the last century, corporate
executives of many publicly held companies managed with little or no outside
control.

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Figure 2.2: Anglo-American System of Governance

In the 1970s and 1980s, however, serious problems began to surface, such as
exorbitant executive payouts, disappointing corporate earnings, and ill-considered
acquisitions that amounted to little more than empire building and depressed
shareholder value. Led by a small number of wealthy, activist shareholders seeking
to take advantage of the opportunity to capture underutilized assets, takeovers
surged in popularity. Terms, such as leveraged buyout, dawn raids, poison pills, and
junk bonds, became household words. Of lasting importance from this era was the
emergence of institutional investors who knew the value of ownership rights, had
fiduciary responsibilities to use them, and were big enough to make a difference.
And with the implicit assent of institutional investors, boards substantially increased
the use of stock option plans that allowed managers to share in the value created by
restructuring their own companies. Shareholder value, therefore, became an ally
rather than a threat.

The year 2001 will be remembered as the year of corporate scandals. The most
dramatic of these occurred in the United States—in companies such as Enron,
WorldCom, Tyco, and others—but Europe also had its share, with debacles at
France‘s Vivendi, the Netherlands‘ Ahold, Italy‘s Parmalat, and ABB, a Swiss-Swedish

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multinational company. Even before these events fully unfolded, a rising number of
complaints about executive pay, concerns about the displacement of private-sector
jobs to other countries through off-shoring, and issues of corporate social
responsibility had begun to fuel emotional and political reactions to corporate news
in the United States and abroad. The government, regulatory authorities, stock
exchanges, investors, ordinary citizens, and the press all started to scrutinize the
behavior of corporate boards much more carefully than they had done before. The
result was a wave of structural and procedural reforms aimed at making boards
more responsive, more proactive, and more accountable, and at restoring public
confidence in their business institutions. The major stock exchanges adopted new
standards to strengthen corporate governance requirements for listed companies;
then Congress passed the Sarbanes-Oxley Act of 2002, which imposes significant
new disclosure and corporate governance requirements for public companies, and
also provides for substantially increased liability under the federal securities laws for
public companies‘ executives and directors; and the SEC adopted a number of
significant reforms.

[Link] Key features of the Anglo-American Model

a. Single tier governance : Each company has a single Board that includes ―insiders‖
also known as ―executive‖ directors who are either employed by the company or
have significant ties to corporate management, together with ―outsiders‖ or ―non-
executive‖ directors who have no direct relationship with the company or its
management.
b. Leadership Duality: Company CEOs are empowered to serve as Chair of their
corporate Board, which is prohibited in two-tier governance systems. Depending
upon one‘s viewpoint, this either increases board responsiveness to corporate
concerns or reduces board independence.
c. Standing Committees: US Boards typically create permanent committees such as
Audit, Compensation and Nomination, ideally overseen by non-executive
Boardmembers and often required by law or exchange listing requirements.

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d. Minority Shareholder Rights: Special regulatory provisions ensure that minority
shareholders are allowed to participate in governance structures, including voting
rights.
e. Disclosure and Communication: The US has comprehensive disclosure
requirements across a wide range of information and a complex, well-regulated
system for shareholder communications.

2.3.2 The German Corporate Governance System

The goals of German corporations are clearly defined in German corporation law.
Originally enacted in 1937, and subsequently modified in 1965, German corporate
law defines the role of the board to govern the corporation for the ―good of the
enterprise, its multiple stakeholders, and society at large.‖ Until the 1965 revision,
the German corporate law said nothing specific about shareholders. The law also
provides that if a company endangers public welfare and does not take corrective
action, it can be dissolved by an act of state. Despite the relatively recent
recognition that shareholders represent an important constituency, corporate law in
Germany makes it abundantly clear that shareholders are only one of many
stakeholder groups on whose behalf managers must run the firm.

Large public German companies—those with more than 500 employees—are

required to have a two-tier board structure: a supervisory board (Aufsichtsrat) that
performs the strategic oversight role and a management board (Vorstand) that
performs an operational and day-to-day management oversight role. There are no
overlaps in membership between the two boards. The supervisory board appoints
and oversees the management board. In companies with more than 2,000
employees, half of the supervisory board must consist of employees, the other half
of shareholder representatives. The chairperson of the supervisory board is,
however, typically a shareholder representative and has the tie-breaking vote. The
management board consists almost entirely of the senior executives of the company.
Thus, management board members have considerable firm-and industry-specific
knowledge. The essence of this two-tiered board structure is the explicit

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representation of stakeholder interests other than that of shareholders: No major
strategic decisions can be made without the cooperation of employees and their
representatives

The ownership structure of German firms also differs quite substantially from that
observed in Anglo-American firms. Intercorporate and bank shareholdings are
common, and only a relatively small proportion of the equity is owned by private
citizens. Ownership typically is more concentrated: Almost one quarter of the
publicly held German firms has a single majority shareholder. Also, a substantial
portion of equity is ―bearer‖ rather than ―registered‖ stock. Such equity is typically
on deposit with the company‘s hausbank, which handles matters such as dividend
payments and record keeping. German law allows banks to vote such equity on
deposit by proxy, unless depositors explicitly instruct banks to do otherwise. Because
of inertia on the part of many investors, banks, in reality, control a substantial
portion of the equity in German companies. The ownership structure, the voting
restrictions, and the control of the banks also imply that takeovers are less common
in Germany compared to the United States as evidenced by the relatively small
number of mergers and acquisitions. When corporate combinations do take place,
they are usually friendly and arranged deals. Until the recent rise of private equity,
hostile takeovers and leveraged buyouts were virtually non-existent; even today
antitakeover provisions, poison pills, and golden parachutes are rare.

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Figure 2.3: German System of Governance

2.3.3 The Japanese Corporate Governance System

The Japanese economy consists of multiple networks of firms with stable, reciprocal,
minority equity interests in each other, known as Keiretsus. Although the firms in a
keiretsu are typically independent companies, they trade with each other and
cooperate on matters, such as governance. Keiretsus can be vertical or horizontal.
Vertical Keiretsus are networks of firms along the supply chain; horizontal Keiretsus
are networks of businesses in similar product markets. Horizontal Keiretsus typically
include a large main bank that does business with all of the member firms and holds
minority equity positions in each.

Like Anglo-American companies, Japanese firms have single-tier boards. However, in

Japan a substantial majority of board members are company insiders, usually
current or former senior executives. Thus, unlike the United States, outside
directorships are still rare, although they are becoming more prevalent. The one

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exception to outside directorships is the main banks. Their representatives usually sit
on the boards of the Keiretsu firms with whom they do business. In contrast to the
German governance system where employees and sometimes suppliers tend to have
explicit board representation, the interests of stakeholders other than management
or the banks are not directly represented on Japanese boards.

Share ownership in Japan is concentrated and stable. Although Japanese banks are
not allowed to hold more than 5% of a single firm‘s stock, a small group of four or
five banks typically controls about 20% to 25% of a firm‘s equity. As in Germany,
the market for corporate control in Japan is relatively inactive compared to that in
the United States. Bradley, Schipani, Sundaram, and Walsh (1999) found that
disclosure quality, although considered superior to that of German companies, is
poor in comparison to that of U.S. firms. Although there are rules against insider
trading and monopolistic practices, the application of these laws is, at best, uneven
and inconsistent.

Figure 2.4: Japanese System of Governance

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2.3.4 German versus Japanese Governance System
As Bradley et al. (1999) observe, although there are significant differences, there is
also a surprising degree of similarity between the German and Japanese governance
systems. Similarities include the relatively small reliance on external capital markets;
the minor role of individual share ownership; significant institutional and
intercorporate ownership, which is often concentrated; relatively stable and
permanent capital providers; boards comprising functional specialists and insiders
with knowledge of the firm and the industry; the relatively important role of banks
as financiers, advisers, managers, and monitors of top management; the increased
role of leverage with emphasis on bank financing; informal as opposed to formal
workouts in financial distress; the emphasis on salary and bonuses rather than
equity-based executive compensation; the relatively poor disclosure from the
standpoint of outside investors; and conservatism in accounting policies. Moreover,
both the German and Japanese governance systems emphasize the protection of
employee and creditor interests, at least as much as the interests of shareholders.
The market for corporate control as a credible disciplining device is largely absent in
both countries, as is the need for takeover defenses because the governance system
itself, in reality, is a poison pill.

However, ss recent history has shown, the stakeholder orientation of German and
Japanese corporate governance is not without costs. The central role played by both
employees (Germany) and suppliers (Japan) in corporate governance can lead to
inflexibility in sourcing strategies, labour markets, and corporate restructurings. It is
often harder, therefore, for firms in Germany and Japan to move quickly to meet
competitive challenges from the global product-market arena. The employees‘ role in
governance also affects labour costs, while a suppliers‘ role in governance, as in the
case of the vertical Keiretsu in Japan, can lead to potential problems of implicit or
explicit vertical restraints to competition, or what we would refer to as antitrust
problems. Finally, the equity ownership structures in both systems make takeovers
far more difficult, which is arguably an important source of managerial discipline in
the Anglo-American system.

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2.4 Summary

In this topic, the different corporate governance systems and their characteristics
were explored. Some of the ways in which they converge was also highlighted,
especially the German and Japanese governance systems. Due to this high degree of
similarity between the Germanic and Japanese systems rather than the Anglo-Saxon
model, there are commonly two systems that are often referred to more broadly, the
market based system and the group-based systems. The market based systems
refers to Anglo-Saxon model whereas the group-based systems refers to the non-
Anglo-Saxon models. Though these distinct models exist, there has been much
evidence of convergence of models by different countries. This is due, in large part
to the prescription of international corporate governance codes by organisations
such the International Monetary Fund, the World Bank and the Organisation of
Economic Co-operation and Development.

References

Aguilera, R. V., Williams, C. A., Conley, J. M., & Rupp, D. E. (2006). Corporate
governance and social responsibility: A comparative analysis of the UK and the US.
Corporate Governance: an international review, 14(3), 147-158.

Ovsiannikov, K. (2017). Corporate Governance Reforms in Japan: Instilling the New

Regime. Cogent Business & Management, 4(1), 1300993.

Tamas-Szora, L. (2011). Convergence of Corporate Governance Systems (Doctoral

dissertation, uniwien), p 7.

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Topic 3: Corporate Governance: Principles and Framework

3.0 Introduction

Corporate Governance Frameworks outline standards of accountability and

transparency that stakeholders and general public, are expected to follow. It
prescribes the principles, elements and mechanisms used for effective governance.
The frameworks guide the need for continual performance improvement and better
service delivery, balanced with the need to meet corporate obligations and legislative
requirements. Organisations must continually evolve governance arrangements to
ensure that service delivery objectives are met effectively, efficiently and
transparently. Every organisation has a duty to carry out activities according to
required practice, considering, all stakeholders and the rule of law.

The frameworks provides a balance between performance and accountability to

ensure that the results are achieved effectively, resources are used in the best and
most efficient ways, capture opportunities to improve organisational development
and growth, act with integrity and ethically promoting the best interests of all
stakeholders, and making decisions which are transparent, backed with clear roles,
responsibilities and procedures. In addition good corporate governance principles
ensure standardized structures, processes, cultures and systems that promote the
successful operation of business organisations not only locally, but also regionally
and globally. In this topic we will explore the corporate governance principles and
frameworks.

3.1 Objectives

After studying this topic you should be able to:

 Identify and discuss the principles of Corporate Governance

 Critically analyse how corporate governance principles influence business
operations
 Understand and formulate the objectives and goals of corporate governance
 List and explain the key aspects of the UK CG Code, the King III report and the
OECD.

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 Describe how the above CG codes influences effective governance framework.
 Explain the reasons for adoption of the King III in Botswana.
 Discuss the basis of an effective CG code.

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3.2 Principles of Corporate Governance

a. Rights and equitable treatment of shareholders

The corporate governance framework should protect and facilitate the exercise of
shareholders‘ rights and ensure the equitable treatment of all shareholders, including
minority and foreign shareholders. All shareholders should have the opportunity to
obtain effective redress for violation of their rights.

Basic shareholder rights, including the right to information and participation through
the shareholder meeting in key company decisions, disclosure of control structures,
such as different voting rights ,information technology at shareholder meetings, the
procedures for approval of related party transactions and shareholder participation in
decisions on executive remuneration.

b. Disclosure and transparency

The corporate governance framework should ensure a timely and accurate disclosure
on all material matters regarding the corporation, including the financial situation,
performance, ownership, and governance of the company.

Businesses should act in good faith to create trustworthiness by keeping its promises
and promoting transparency and accountability to both internal and external
stakeholders. This will not only ensure creditability and stability, but will also ensure
smoothness and efficiency of its transactions.

A principle of good governance is that stakeholders should be informed about the

company‘s activities, what it plans to do in the future and any risks involved in its
business strategies.

Disclosure of material matters concerning the organisation‘s performance and

activities should be timely and accurate to ensure that all investors have access to
clear, factual information which accurately reflects the financial, social and
environmental position of an organisation. Organisations should clarify and make the

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roles and responsibilities of the board publicly known and ensure that management
provides shareholders with a level of accountability.

c. Integrity and ethical behaviour

A culture of integrity creates a highly valued work environment; it impacts the

quality of corporate governance; and it provides a foundation for solid long-term
compassionate, transparent, honest, and ethical behaviour. It is in good practice for
all business operations to be objective, legal, transparent and accountable.
Therefore its managers or staff should not involve themselves in illegal business
operations.

d. Roles and responsibilities of the board

The corporate governance framework should ensure the strategic guidance of the
company, the effective monitoring of management by the board, and the board‘s
accountability to the company and its shareholders.

It provides guidance with respect to key functions of the board of directors,

including the review of corporate strategy, selecting and compensating
management, overseeing major corporate acquisitions and divestitures, and
ensuring the integrity of the corporation‘s accounting and financial reporting
systems. Other issues include the role of the board of directors in risk management,
tax planning and internal audit.

e. Interests of other stakeholders.

The corporate governance framework should recognise the rights of stakeholders

established by law or through mutual agreements and encourage active co-operation
between corporations and stakeholders in creating wealth, jobs, and the
sustainability of financially sound enterprises.

The Principles encourage active co-operation between corporations and stakeholders

and underline the importance of recognising the rights of stakeholders established

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by law or through mutual agreements. It supports stakeholders‘ access to
information on a timely and regular basis and their rights to obtain redress for
violations of their rights

Activity 3.1

a. Explain each of the five principles of CG.

b. Discuss how governance principles influence effective business operations.

3.3 The Link between Corporate Governance Principles and Law

There is always a link between good governance and law. Good governance is not
something that exists separately from the law. It is entirely inappropriate to unhinge
governance from the law. The starting point of any analysis on this topic is that
directors and management must discharge their legal duties. These are grouped into
two categories, namely duty of care, skill and diligence, and fiduciary duties.

Corporate governance mainly involves the establishment of structures and

processes, with appropriate checks and balances that enable directors to discharge
their legal responsibilities.

In assessing the standard of appropriate conduct, a court will take into account all
relevant circumstances, including what is regarded as the normal or usual practice in
the particular situation.

Criteria of good governance, governance codes and guidelines will be relevant in the
determination of what is regarded as an appropriate standard of conduct. The more
established certain governance practices become, the more likely a court would
regard conduct that conforms with these practices as meeting the required standard
of care.

Corporate governance practices, codes and guidelines lift the bar of what are
regarded as appropriate standards of conduct.

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Consequently, any failure to meet a recognised standard of governance, albeit not
legislated, may render a board or individual director liable at law.

Around the world hybrid systems are developing. In other words, some of the
principles of good governance are being legislated. In an ‗apply or explain‘ regime,
principles override practices. Now some principles and practices are law and there
has to be compliance with the law. Also, what was the common law is being restated
in statutes

3.4 The UK Corporate Governance Code

The UK Corporate Governance Code (formerly known as the Combined Code), sets
out standards of good practice for listed companies on board composition and
development, remuneration, shareholder relations, accountability and audit. The
code was published by the Financial Reporting Council (FRC). The UK CG code is
composed of six reports namely;

 The Cadbury Report (1992): The report covers three areas, Directors, Auditing
and Shareholders.
 The Greenbury Report (1995): It addresses a growing concern about the level of
director remuneration.
 The Hampel Report (1998): The intention was to ‗combine, harmonise and clarify‘
the Cadbury and Greenbury recommendations and create an overall code of
corporate governance
 The Turnbull Report (1999): Set out best practice on internal control for UK listed
companies
 The Smith Report (2003): Offers guidance on audit committees
 The Higgs Report (2003): Dealt with the role and effectiveness of non-executive
directors

These reports will be explained further in topic areas to which they pertain.

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3.4.1 The Main Principles of the UK CG Code

a. Leadership

Every company should be headed by an effective board which is collectively

responsible for the long-term success of the company. There should be a clear
division of responsibilities at the head of the company between the running of the
board and the executive responsibility for the running of the company‘s business. No
one individual should have unfettered powers of decision. The chairman is
responsible for leadership of the board and ensuring its effectiveness on all aspects
of its role. As part of their role as members of a unitary board, non-executive
directors should constructively challenge and help develop proposals on strategy.

b. Effectiveness

The board and its committees should have the appropriate balance of skills,
experience, independence and knowledge of the company to enable them to
discharge their respective duties and responsibilities effectively. There should be a
formal, rigorous and transparent procedure for the appointment of new directors to
the board. All directors should be able to allocate sufficient time to the company to
discharge their responsibilities effectively. All directors should receive induction on
joining the board and should regularly update and refresh their skills and knowledge.
The board should be supplied with quality information in a timely manner in a form
appropriate to enable it to discharge its duties. The board should undertake a formal
and rigorous annual evaluation of its own performance and that of its committees
and individual directors. All directors should be submitted for re-election at regular
intervals, subject to continued satisfactory performance.

c. Accountability

The board should present a fair, balanced and understandable assessment of the
company‘s position and prospects. The board is responsible for determining the
nature and extent of the significant risks it is willing to take in achieving its strategic

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objectives. The board should maintain sound risk management and internal control
systems. The board should establish formal and transparent arrangements for
considering how they should apply the corporate reporting, risk management and
internal control principles and for maintaining an appropriate relationship with the
company‘s auditors.

d. Remuneration

Levels of remuneration should be sufficient to attract, retain and motivate directors

of quality required to run the company successfully, but a company should avoid
paying more than is necessary for this purpose. A significant proportion of executive
directors‘ remuneration should be structured so as to link rewards to corporate and
individual performance. There should be a formal and transparent procedure for
developing policy on executive remuneration and for fixing the remuneration
packages of individual directors. No director should be involved in deciding his or her
own remuneration.

e. Relations with Shareholders

There should be a dialogue with shareholders based on the mutual understanding of

objectives. The board as a whole has responsibility for ensuring that a satisfactory
dialogue with shareholders takes place. The board should use the Annual General
Meeting (AGM) to communicate with investors and to encourage their participation.

(Source: the UK Corporate Governance Code, 2012)

3.5 King III Report

The King III Report 2009 emphasized the requirement for innovativeness with
integrity in the interest of the society, environment and stakeholders. It stresses the
need for management to be accountable to the Board of Directors, while building
relationships with and developing the interests of stakeholders, which include
shareholders, employees and lenders.

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3.5.1 The key aspects of the King III Report

a. Strategic and Ethical Leadership

Good governance is essential to ensure effective leadership. It should be

characterised by the ethical values of responsibility, accountability, fairness and
transparency. Responsible leaders direct company strategies and operations with a
view to achieving sustainable economic, social and environmental performance.

b. Sustainability

It should be understood that business, society and nature are interconnected in

complex ways and the sustainability of the company in this environment should be
the primary moral and economic imperative. Sustainability of the business as a
continuing entity is considered to be of great importance to stakeholders.
Sustainability includes, but is not restricted to, matters under the following headings:
 Economic
 Health;
 Safety;
 Environmental;
 Ethical;
 Social;

c. Corporate Citizenship

A company is an association of persons who have all invested in an entity with a

common interest and hence should operate in a sustainable manner. The law
imposes responsibilities upon its directors and staff to manage and safeguard all
stakeholders‘ interest and rights. The board and each individual director should have
a working understanding of the effect of the applicable laws, rules, codes and
standards on the company and its businesses.

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 d. The Governance of Risk

Risk Management is the processes which aim to assist organisations to understand,

evaluate and take action on their risks with a view to increase the probability of their
success and reducing the likelihood of failure.
Effective risk management gives assurance to shareholders, customers, employees
and society at large that a business is being effectively managed and helps the
company or organisation confirm its compliance with corporate governance
requirements

e. The Governance of Information

Information governance is the activities and technologies that organisations employ

to maximise the value of their information while minimizing associated risks and
costs. Organisations should have an effective information governance strategy that
aligns with their overall risk management strategy, and that can be effectively
operationalized to leverage and protect information assets and accomplish broader
business objectives.

f. Compliance with laws, rules, codes and standards

Legal compliance is the process or procedure to ensure that an organisation follows

relevant laws, regulations and business rules in line with relevant Acts. Hence the
company should comply with the applicable laws and ensure adherence to rules,
policies, codes and standards in accordance to the law.

g. Internal Audit

The primary role of auditing is to check whether the financial information given to
investors is reliable. Hence risk based auditing should be implemented that directs

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internal audit to deal with strategic operational, financial and sustainability issues so
as to offer value to all interested parties.

h. Governing Stakeholder Relationships

Effective management of relationships with stakeholders is crucial to resolving issues

facing organisations as it will influence stakeholder attitudes, decisions, and actions
which will promote mutual benefit, motivation and cooperation for organisations
goodwill and competitive advantage.

i. Integrated Reporting and Disclosure

An integrated report is a concise communication about how an organisation‘s

strategy, governance, performance and prospects lead to the creation of value over
the short, medium and long term. Therefore it assists business to think holistically in
their strategic plans, come up with good decisions and manage major risks in order
to build investor and stakeholder confidence for the improvement of future
performance.

j. Business Rescue

This is a process of introducing an entirely new process of restructuring companies

in financial distress.
When a company is facing financial problems, whether it is inadequate cash flow,
falling sales or excessive debt, restructuring strategies should be established so as to
develop and implement necessary measures to ensure recovery and sustainable
success.

k. Alternative Dispute Resolutions

Alternative Dispute Resolution is commonly used as an option that allows people to

resolve disputes outside of court in a cooperative and mutual manner.

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The most common forms of alternative dispute resolution processes are Conciliation,
Mediation, Arbitration, and Case Evaluation. A trained and impartial person decides
or helps the parties reach resolution of their dispute together. Mediators can often
assist parties in resolving disputes without having to go to court proceedings.

l. Internal Financial Controls

Effective and reliable internal control forms the basis for compliance with sound and
prudent business practices in organisation‘s operations.
This is the procedures or practices within an organisation that ensures that the
organisation achieves the targets set in the strategy, uses resources economically
and the information in support of management decisions is reliable. Internal control
also ensures that risk management, custody of client assets and protection of
property is adequately arranged. Conformance to regulations and approved ethics
principles, too, are ensured through internal control.

m. Solvency and Liquidity

Solvency relates to the assets of the company, being fairly valued, equal or
exceeding the liabilities of the company. Liquidity relates to the company being able
to pay its debt as they become due in the ordinary course of business for a period of
12 months.

n. Remuneration of Directors and Senior Executives

Effective and fair remuneration should be provided to the directors and senior
executives responsibly and this should be disclosed and the remuneration policy
should be approved by the shareholders to ensure transparency.

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3.6 The Organisation for Economic Cooperation and Development
The Organisation for Economic Cooperation and Development (OECD) is an
international organisation that brings together the governments of countries
committed to democracy and the market economy to support sustainable economic
growth, boost employment, raise living standards, maintain financial stability, assist
other countries‘ economic development, and contribute to growth in world trade.

The Principles of OECD are a living instrument offering non-binding standards and
good practices as well as guidance on implementation, which can be adapted to the
specific circumstances of individual countries and regions. The OECD offers a forum
for ongoing dialogue and exchange of experiences among member and non-member
countries. To stay abreast of constantly changing circumstances, the OECD will
closely follow developments in corporate governance, identifying trends and seeking
remedies to new challenges.

3.6.1 Corporate governance aspects of OECD guidelines

OECD Principles emphasise the need for effective regulatory systems that ensure
that the potential for damaging conflicts of interest remains limited and that there is
a level playing field among the major participants in corporate governance, such as,
the protection of minority shareholders. Effective implementation and enforcement
require that laws and regulations are designed in a way that makes them possible to
implement and enforce in an efficient and credible fashion. Supervisory, regulatory
and enforcement authorities should have the power, integrity and resources to act
professionally and objectively. The division of authority and responsibility between
agencies and supervisory bodies should be well defined and they should pursue their
function in an unbiased and equitable manner to prevent conflicts and create a
conducive business environment to all interested parties.

a. The rights and equitable treatment of shareholders and key

ownership functions

The corporate governance framework should protect and facilitate the exercise of
shareholders‘ rights and ensure the equitable treatment of all shareholders, including
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minority and foreign shareholders. All shareholders should have the opportunity to
obtain effective redress for violation of their rights.

b. Institutional investors, stock markets, and other intermediaries

 Institutional investors acting in a fiduciary capacity should disclose their
corporate governance and voting policies with respect to their investments,
including the procedures that they have in place for deciding on the use of their
voting rights.
 Votes should be cast by custodians or nominees in line with the directions of the
beneficial owner of the shares.
 Institutional investors acting in a fiduciary capacity should disclose how they
manage material conflicts of interest that may affect the exercise of key
ownership rights regarding their investments.
 The corporate governance framework should require that proxy advisors,
analysts, brokers, rating agencies and others that provide analysis or advice
relevant to decisions by investors, disclose and minimise conflicts of interest that
might compromise the integrity of their analysis or advice.
 Insider trading and market manipulation should be prohibited and the applicable
rules enforced.
 Stock markets should provide fair and efficient price discovery as a means to
help promote effective corporate governance.

c. The role of stakeholders in corporate governance

The corporate governance framework should recognise the rights of stakeholders

established by law or through mutual agreements and encourage active co-operation
between corporations and stakeholders in creating wealth, jobs, and the
sustainability of financially sound enterprises.

d. Disclosure and transparency

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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.

e. The responsibilities of the board

The corporate governance framework should ensure the strategic guidance of the
company, the effective monitoring of management by the board, and the board‘s
accountability to the company and the shareholders.

3.7 Botswana Corporate Governance Code

Botswana recently developed its own corporate governance code. Prior to this, the
Botswana Stock Exchange (BSE) had its own ―Code of Best Practice‖ which was
developed based on the Corporate Governance code of the Institute of Chartered
Accountants of Sri Lanka and the King Report of 2002. The new national code is
more detailed and has retained all the key principles of the BSE Code of Best
Practice. The BSE has adopted this new national code and made it part of its listings
requirements. The Botswana Corporate Governance Code itself was developed and
adopted to address perceived gaps in the existing governance structures in its
context.

3.7.1 Reasons for Adapting King III in Botswana

The Botswana Accountancy Oversight Authority (BAOA) was established by the
Financial Reporting Act, 2010 as the independent oversight body of the accounting
and auditing profession; to regulate the reporting of financial matters of Public
Interest Entities (PIEs) and the corporate sector; and for matters incidental thereto.

BAOA carried out a research and concluded that King III would be the most suitable
for Botswana, for the following reasons:

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 the flexibility and all-encompassing nature of its application arising from the
―apply or explain‖ principle, which enables the board of an entity to apply a
recommendation of King III differently or apply another practice and still achieve
the objective of the overarching corporate governance principles of fairness,
accountability, responsibility and transparency;

 many entities listed on the Botswana Stock Exchange have adopted the King Code
of Corporate Governance;

 PEEPAs Guidelines of improving shareholder oversight (corporate governance)

over parastatals are all accommodated in the King III report;

 All the principles in the Botswana Code of Corporate Governance are based on the
―apply or explain‖ basis, embodied in King III;

 Foreign subsidiaries of local companies are required to apply the King III code to
the extent prescribed by the holding company and subject to entity-specific
foreign legislation;

 King III clearly differentiates corporate governance principles that must, should,
or may, be complied with.

 A benchmarking exercise of King III against two other principles-based corporate

governance systems; the Botswana Code and the UK Code revealed that King III
is much more encompassing.

3.8 The Basis for an Effective CG framework.

 The corporate governance framework should be developed with a view to its
impact on overall economic performance, market integrity and the incentives it
creates for market participants and the promotion of transparent and well-
functioning markets.

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 The legal and regulatory requirements that affect corporate governance
practices should be consistent with the rule of law, transparent and enforceable
 The division of responsibilities among different authorities should be clearly
articulated and designed to serve the public interest.
 Stock market regulation should support effective corporate governance.
 Supervisory, regulatory and enforcement authorities should have the authority,
integrity and resources to fulfil their duties in a professional and objective
manner. Moreover, their rulings should be timely, transparent and fully
explained.
 Cross-border co-operation should be enhanced, including through bilateral and
multilateral arrangements for exchange of information.

Summary

Corporate governance is a process, relation and mechanism set up for the

corporations and firms based on certain guidelines and principles by which a
company is controlled and directed. The principles provided in the system ensure
that the company is governed in a way that is able to set and achieve its goals and
objectives in the context of the social, regulatory and market environment, and is
able to maximise profits and also benefit those whose interest is involved in it, in the
long run.

The corporate governance framework should promote transparent and efficient

markets, be consistent with the rule of law and clearly articulate the division of
responsibilities among different supervisory, regulatory, and enforcement authorities.
It should ensure the strategic guidance of the company, the effective monitoring of
management by the board, and the board‘s accountability to the company and the
shareholders.

The formulation of King III is essential and represents a significant advancement in

good corporate governance framework that promotes responsible corporate
citizenship, ethical relationship between the company and the society in which it
operates.‖ The notion of corporate citizenship is not new, but King III gives it more
light and clear expression than ever before, while continually highlighting the

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unbroken chain that links the law, ethical leadership, company strategy and
sustainability.

References

Council, F. R. (2010). The UK corporate governance code. London: Financial

Reporting Council.

Council, F. R. (2012). The UK stewardship code. Financial Reporting Council,

London, Tech. Rep.

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Topic 4: IT Governance

4.0Introduction

Corporate Governance in general has taken on even greater significance. IT has a

fundamental role to play in refining corporate governance practices, because critical
business processes are usually automated and directors rely on information provided
by IT systems for their decision making. With the progression of direct link between
organisations and their suppliers and customers, and more and more focus on how
IT can be used to add value to business strategy, the need to effectively manage IT
resources and avoid IT failures and poor performance has never been greater. The
current climate of cost reduction and budget restriction has resulted in new norm –
there is an expectation that IT resources should always be used as efficiently as
possible and that steps are taken to organise these IT resources ready for the next
cycle of growth and new IT developments.

Analysts currently agree that probably the biggest risk and concern to top
management today is failing to align IT to real business needs, and a failure to
deliver, or be seen to be delivering, value to the business. Since IT can have such a
dramatic effect on business performance and competitiveness, a failure to manage
IT effectively can have a very serious impact on the business as a whole.

4.1 Objectives

After studying this topic you should be able to:

 Identify IT governance stakeholders

 Explain the importance of IT governance for organisations
 Outline the IT Governance principles in the King III Report
 Discuss the relevance and scope of IT governance in an organisation

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4.2 IT Governance in King III

King III brings IT governance clearly into the corporate governance arena and says:

"Information systems were used as enablers to business, but have now become
pervasive in the sense that they are built into the strategy of the business. The
pervasiveness of IT in business today mandates the governance of IT as a corporate
imperative‖.

To many companies, IT has turned out to be an integral part of the business and is
vital to support, sustain and grow the business. IT is not just an operational enabler
for a company, but a important strategic asset to create opportunities and to gain
competitive advantage. Consequently, companies have made, and continue to make
a significant investment in IT.

Nearly all elements, aspects and processes of a company include some form of
automation. This has resulted in companies relying enormously on IT systems.

Additionally, the advent and evolution of the internet, e-commerce, on-line trading
and electronic communication have also led companies to prefer conducting their
business electronically and perform transactions instantly. These developments also
bring about significant risks and should be well governed and controlled.

The King III, deals with IT governance in detail in for the first time. The IT
governance chapter (Chapter 5) is dedicated to providing the most salient aspects of
IT governance for directors. Due to the broad and ever-evolving nature of the
discipline of IT governance, the chapter does not try to be the definitive text on this
subject but rather to create a greater degree of awareness at director level.

There is no doubt that the complexity of IT systems do create operational risks and
when one outsources IT services, for instance, this has the potential to increase risk
because confidential information is outside the company.

Consideration has to be given to the integrity and availability of the functioning of

the system; possession of the system; authenticity of system information; and

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assurance that the system is usable and useful. Concerns include, access,
unauthorized use, disclosure, disruption or changes to the information system.

In fulfilling their duty of care, directors should ensure that cautious and reasonable
steps have been taken with regard to IT governance. Due to inadequacies in
legislation, International guidelines have been developed through organisations such
as IT Governance Institute (ITGI) and Information Systems Audit and Control
Association (ISACA)® Control Objectives for Information and Related Technologies
(COBIT® and Val IT), the ISO authorities (e.g.: ISO38500) and various other
organisations such as Open Compliance and Ethics Group's(OCEG).

These instruments may be used as a framework of audit for the adequacy of the
company‘s information governance for instance. Every invention calls for appropriate
regulatory management. However, companies should keep abreast with the rapidly
expanding regulatory requirements associated with the fast evolving inventions in
information technology.

4.2.1 IT Governance Principles in King III

 The board should be responsible for information technology (IT) governance

 IT should be aligned with the performance and sustainability objectives of the
company
 The board should delegate to management the responsibility for the
implementation of an IT governance framework
 The board should monitor and evaluate significant IT investments and
expenditure
 IT should form an integral part of the company‘s risk management
 The board should ensure that information assets are managed effectively
 A risk committee and audit committee should assist the board in carrying out its
IT responsibilities

4.3 Relevance of IT Governance

IT Governance has become very relevant for a number of reasons:

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 In the wake of Enron and other corporate scandals, ―Governance‖ generally
has taken on even greater significance. IT has a pivotal role to play in
improving corporate governance practices.
 Management‘s awareness of IT related risks has increased.
 The focus on IT costs in all organisations.
 The growing realisation that more management commitment is needed to
improve the management and control of IT activities.
 The general lack of accountability and not enough shared ownership and clarity
of responsibilities for IT services and projects. The communication between
customers (IT users) and providers has to improve and be based on joint
accountability for IT initiatives.
 The widening gap between what IT departments think the business requires
and what the business thinks the IT department is able to deliver.
 Organisations need to obtain a better understanding of the value delivered by
IT, both internally and from external suppliers. Measures are required in
business (the customer‘s) terms to achieve this end.
 Top management wants to understand ―how is my organisation doing with IT
in comparison with other peer groups?‖
 Management needs to understand whether the infrastructure underpinning
today‘s and tomorrow‘s IT (technology, people, processes) is capable of
supporting expected business needs,
 Because organisations rely more and more on IT, management needs to be
more aware of critical IT risks and whether they are effectively managed.
Furthermore, lack of clarity and transparency when taking significant IT
decisions, can lead to reluctance to take risks and a failure to seize technology
opportunities.
 And finally, the realisation that because IT is complex and has its own fast
changing and unique conditions, the need to apply sound management
disciplines and controls is even greater.

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4.4 IT Governance Stakeholders
IT governance Stakeholders include:
 Top level business leaders such as the Board, Executive, non-Execs, and
especially heads of Finance, Operations and IT.
 Those that have a responsibility for investor and public relations.
 Internal and external auditors and regulators.
 Middle level business and IT management.
 Key business partners and suppliers.
 Shareholders.
 Customers.

4.5 Scope of IT Governance

As a discipline, IT Governance is comparatively a new concept and is still evolving.
IT Governance is more than just an IT issue, which interests only the IT role. On a
wider sense it is a part of the inclusive governance of an organisation, but with a
refined focus on improving the management and control of Information Technology
for the benefit of the primary stakeholders. Consequently, it is the responsibility of
the Board of Directors to ensure that IT along with other critical activities is
adequately governed. Although the principles are not new, actual implementation
requires new thinking because of the special nature of IT.
IT Governance spans the culture, organisation, policy and practices that provide for
IT management and control across five key areas:
i. Alignment: To provide for strategic direction of IT and the alignment of IT and
the business with respect to services and projects.
ii. Value delivery: To confirm that the IT/Business organisation is designed to drive
maximum business value from IT. Oversee the delivery of value by IT to the
business, and assess Return On Investment (ROI).
iii. Risk Management: To ascertain that processes are in place to ensure that risks
have been adequately managed. Include assessment of the risk aspects of IT
investments.

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iv. Re s o u r c e Management: To provide high-level direction for sourcing and use
of IT resources. Oversee the aggregate funding of IT at enterprise level. Ensure
there is an adequate IT capability and infrastructure to support current and
expected future business requirements.
v. Performance Measurement: To verify strategic compliance, i.e. achievement of
strategic IT objectives. Review the measurement of IT performance and the
contribution of IT to the business (i.e. delivery of promised business value).

Summary

Most corporations in the 21st century rely heavily on their IT infrastructure for the
conduct of business. Due its pervasive nature, governance related specifically to IT
use, plays an important role in assuring that business objectives are achieved. In
this topic the IT governance framework was alluded to as well the importance of IT
governance.

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Topic 5: Globalisation and Corporate Governance

5.0 Introduction

Corporate governance in a globalized economy has become one of the most

important topics for the business environment and governments. A proper
implementation of corporate governance regulations by companies is advantageous
to both companies and the countries. A high quality status of corporate governance
ensures low capital cost, increase in financial capabilities and liquidity, ability of
overcoming crises more easily and prevention of the exclusion of soundly managed
companies from the capital markets.

Global governance is collective efforts to identify, understand or address

worldwide problems that go beyond the capacities of individual states to solve. It
capacitates the international system at any moment, to provide government-like
services and public goods in absence of a world government. Thus, it is the
combination of informal and formal values, rules and norms, procedures, practices
and policies, and organisations of various types that offer a surprising and
desirable degree of global order, stability and predictability .

5.1 Objectives

After studying this topic you should be able to:

 Explain how globalization relates to corporate governance

 Discuss global governance and its relation to sustainable development
 Identify and explain regional bodies mandated with governance

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5.2 Understanding Globalisation in Relation to Corporate Governance
Global governance is a complex of formal and informal institutions, mechanisms,
relationships, and processes between and among states, markets, citizens and
organisations, both inter- and non-governmental, through which collective interests
on the global plane are articulated, right and obligations are established, and
differences are mediated.

Global economic integration has been a driving force behind the rapid progress of
developing and disseminating good corporate governance practices and standards.
Investors, regulators, shareholders, directors, executives, and the media have all
played important roles in this change process, especially within the context of
emerging markets.

There are about 6,000 companies and stakeholders worldwide adopting sustainable
and socially responsible policies within the framework of the United Nations Global
Compact since its creation in 2000, of which more than half are from emerging
markets. As agents of change and industry leaders, all these signatories recognize
that managing non-financial issues based on shared responsibility and collaboration
is not just central to their competitiveness and global brands, but even more
importantly, to the modernization of the countries and societies where they operate.
Improving good governance is a never ending challenge with unlimited room for
innovation, but are building and scaling up from a higher benchmark of corporate
governance standards and ethical values that were absent in the past decades.

5.3 Deregulation and Globalisation

New communication and distribution technologies, and the removal of trade and
investment barriers, have created truly global markets with global competition for
goods, services and capital, and even corporate control (as shown by the recent
boom in cross-border mergers and acquisitions). A whole new level of economic
interdependence is emerging, as evidenced by the EU and AU and other
intergovernmental Free Trade Agreement across the globe. Deeper and broader

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cross-border business relationships between nations signal significant changes to all
aspects of society, from culture to labour markets and political focus.

Communication fosters trade and business. Technology rapidly connects people,

which promotes businesses working and expanding all around the world.
Unsurprisingly, as technology and communication has expanded, so has global
trade.

5.4 Need of Integrity in Today’s Global Economy

The OECD was established more than 50 years ago on the belief that economic
development and prosperity were the keys to preserving citizens‘ liberty and general
well-being. The founding members recognised that economic growth should be
sustainable and bring the greatest amount of good to the greatest number of
people. They agreed this required governments‘ commitment to work, both at home
and abroad, to create the conditions for free, fair, and open markets. But this also
entails that those who operate in such markets play by the rules. Many of the
standards, practices and recommendations developed at the OECD to promote fair
and open markets have been reflected in national laws and regulations. However,
implementation of these frameworks to business conduct, remains a challenge in
many respects.

Given the role business plays in everyday citizens‘ lives, it is integral to the OECD‘s
goal of achieving a stronger, cleaner and fairer world economy that it focuses on
corporate behaviour, as it is doing in a number of OECD Committees, including the
OECD Corporate Governance Committee, the Working Party on State Ownership and
Privatisation Practices, the Competition Committee, the Working Party on
Responsible Business Conduct, the Working Group on Bribery in International
Business Transactions, and the Committee on Financial Markets.

The importance of business integrity has never been as clear as it is in today‘s

hyper-connected world economy. In the last half century, globalisation has resulted
in significant positive impacts, including higher productivity and efficiency, increased
average incomes, more competition and a greater variety of goods and services.

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The extent to which businesses are operating across borders is also increasing at an
exponential rate. The share of trade in global GDP has tripled since 1950, and the
level of outward FDI relative to GDP in OECD countries has quadrupled since the
early 1970s. Most citizens live now in a global market where the level of activity
generated by global businesses is unprecedented. In 1980, the world‘s 1 000 largest
publicly listed companies had a total market capitalisation of USD 900 billion
(equivalent to USD 2.4 trillion in 2012 dollars). By 2012, their market capitalisation
had risen to USD 28 trillion. A 2014 business survey shows that the top 100 listed
companies have reached a combined market capitalisation of more than USD 15
trillion. Many multinational enterprises‘ turnovers are now larger than countries‘
GDPs.

5.5 Global Governance and Sustainable Development

As the world becomes more interdependent, global governance, including global
economic governance and the governance of the global commons, is increasingly
relevant for achieving sustainable development. Deepening economic globalization,
increasing migration, trade and capital flows, climate change and increased activities
in the global commons (that is, those resource domains that do not fall within the
jurisdiction of any one particular country, and to which all nations have access)
make individual states more susceptible to policies adopted by others. Therefore,
increased coherence, coordination and collective decision-making at the global level,
grounded in international human rights standards and guided by the human rights
commitments of the international community, are necessary.

The new global partnership for development in the post-2015 development

framework provides an opportunity to address these global economic, social and
environmental issues in a coordinated, coherent and collaborative manner. In this
way, the global partnership can promote a more effective, coherent, representative
and accountable global governance regime, which should ultimately translate into
better national and regional governance, the realization of human rights and
sustainable development.

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Achieving these objectives would require a partnership at the global level between
all countries, multilateral organisations, civil society and other stakeholders. At the
same time, putting in place an enabling and inclusive system of global governance
would create an international enabling environment and would thus strengthen the
global partnership for development in many ways, translating into a more coherent
framework for achieving sustainable development at regional and national levels.

The governance of the global commons represents a specific aspect of global

environmental governance. Stewardship of the global commons cannot be carried
out without global governance. Global commons have been traditionally defined as
those parts of the planet that fall outside national jurisdictions and to which all
nations have access. International law identifies four global commons, namely the
High Seas, the Atmosphere, the Antarctica and the Outer Space. These resource
domains are guided by the principle of the common heritage of mankind. Resources
of interest or value to the welfare of the community of nations – such as tropical rain
forests and biodiversity - have lately been included among the traditional set of
global commons as well, while some define the global commons even more broadly,
including science, education, information and peace. The implementation of the
common heritage principle and common responsibilities relates directly to the four
key enabling factors which have been identified as cornerstones of the Post-2015
development agenda: inclusive social development, inclusive economic development,
environmental sustainability and peace and security.

To achieve coherence in global governance, all the three dimensions of sustainable

development – sustainable economic growth, social inclusion and protection of the
environment and the global commons – need to be integrated at the global level.

Activity 5.1
a. What do you understand by the term global governance
b. Discuss the need for global governance as the key factor in sustainable
development and business integration.

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5.6 Globalisation and New World Order
New Thinking for a New Era, program on international institutions and global
governance aims to assist the architects of U.S. foreign policy and their counterparts
in other countries and in regional and global organisations in drafting the blueprints
for new structures of international cooperation that are more closely tailored to
global realities, consistent with long-term U.S. national interests, and sensitive to
historic U.S. concerns about domestic sovereignty and international freedom of
action. The program‘s approach to global governance will remain a pragmatic and
flexible one, emphasizing customized solutions rather than ―one-size-fits-all‖
responses.

The Council on Foreign Relations (CFR) has launched a comprehensive five-year

program on international institutions and global governance. The purpose of this
cross-cutting initiative is to explore the institutional requirements for world order in
the twenty-first century. The undertaking recognizes that the architecture of global
governance, largely reflecting the world as it existed in 1945—has not kept pace
with fundamental changes in the international system, including but not limited to
globalisation. Existing multilateral arrangements thus provide an inadequate
foundation for addressing today‘s most pressing threats and opportunities and for
advancing U.S. national and broader global interests. The program seeks to identify
critical weaknesses in current frameworks for multilateral cooperation; propose
specific reforms tailored to new global circumstances; and promote constructive U.S.
leadership in building the capacities of existing organisations and in sponsoring new,
more effective regional and global institutions and partnerships.

Globalisation is currently the catchphrase for the perils and promises facing
humanity in the 21st century. Globalisation is generally understood as economic,
political, and social integration of states and societies, both horizontally and vertically
in tighter webs of interdependence.

Globalisation is a process and not a qualitatively different end-state where politics

has receded and the market has taken over. Integration of national states in the
global economy is currently taking place via at least two major visible and

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measurable processes i.e. the rapid spread of foreign capital and trade and the
spread of the ideas of political democracy and market economy to an extent never
before witnessed in modern history.

5.7The Significance of the Issue

The creation of new frameworks for global governance will be a defining challenge
for the twenty-first century world, and the attitude of the United States will be
among the most important factors in determining the shape and stability of the
world order that results from these efforts. The need for a reformed, robust system
of multilateral cooperation has never been more obvious. Today‘s global agenda is
dominated by a host of issues—from terrorism to climate change to the proliferation
of weapons of mass destruction—that no single country, no matter how powerful,
can address on its own. Tomorrow‘s challenges and policy agendas will only be more
transnational in scope. At the same time, existing multilateral institutions are
increasingly divorced from global realities, hindering their capacity to deliver global
public goods and mitigate global ―bads.‖ Since the end of the Cold War, world
politics have been transformed in fundamental ways.

5.8 Regional and Sub-Regional Organisations.

One of the hallmarks of the past two decades has been the formation, deepening,
and enlargement of formal regional organisations in many corners of the globe. The
mandates, competencies, capacities, and effectiveness of these heterogeneous
bodies vary enormously. The United States has a critical interest, and a central role
to play in ensuring that these bodies play their full and appropriate role in managing
global insecurity and in providing public goods for their respective regions. The
regions and organisations are as follows.

 Europe, including the North Atlantic Treaty Organisation, the European Union,
and the Organisation for Security and Co-operation in Europe (OSCE).
 Asia-Pacific, including the Asia-Pacific Economic Cooperation (APEC) forum, the
Association of Southeast Asian Nations (ASEAN), the ASEAN Regional Forum, and
potential sub-regional security architecture for Northeast Asia.

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 Africa, notably the African Union (including its new Peace and Security Council),
the New Partnership for African Development (NEPAD), the Economic Community
of West African States (ECOWAS), the Southern African Development Community
(SADC),the East Africa Community (EAC) and other relevant organs.
 South and Central Asia, including the South Asian Association for Regional
Cooperation (SAARC), the Shanghai Cooperation Organisation (SCO), and other
potential multilateral arrangements for these two sub-regions.
 Latin America, including the Organisation of American States, the Summit of the
Americas, sub-regional trade groupings (e.g., NAFTA, CAFTA, Mercosur), and
potential groupings of like-minded countries to manage transnational challenges
like energy security, migration and narcotics.
 The Middle East, including the G-8 sponsored Forum for the Future, the Arab
League, and the Organisation of the Islamic Conference (OIC).

Summary

Globalisation and governance primarily deals with the interconnection of sovereign

nations through trade and capital flows, harmonization of the economic rules,
creation of structural support and facilitate interconnection and the development of a
global market, which allow flow of foreign investment, both direct and portfolio. To
assure these corporate financiers that their investment would be secured, there is
need for good corporate governance, which involves a network of relationships
between corporate managers, directors and the stakeholders.

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References

Carati, G., & Tourani Rad, A. (2000). Convergence of corporate governance systems.
Managerial Finance, 26(10), 66-73.

Tamas-Szora, L. (2011). Convergence of Corporate Governance Systems (Doctoral

dissertation, uniwien).

Jensen, M. C. (2010). Value maximisation, stakeholder theory, and the corporate

objective function. Journal of applied corporate finance, 22(1), 32-42.

Mendelow, A. L. (1987). Stakeholder analysis for strategic planning and

implementation. WR King, and DI Cleland, Strategic Planning and Management
Handbook, New York: Van Nostrand Reinhold Company.

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UNIT 2: CORPORATE GOVERNANCE STAKEHOLDERS
INTRODUCTION

In the previous unit the importance and consideration of various stakeholders was
alluded to. It has been prevailing consensus that shareholders are the main drivers
of corporate action or inaction, that management has a duty to optimise the
performance of the organisation on behalf of shareholders. The successes of such
actions/inactions are gauged by various financial performance metrics such as the
share price, dividends, earnings per share etc. However, there is a shift in this idea
to be more aligned with 21st century dynamics. Organisations are increasingly being
viewed as set up for the progression of societal interests above all else. This
consequently and necessarily means that shareholders do not hold privileges in the
influence of decision making by management. This unit looks at some of the
important stakeholders, internal and external to the organisation, as pertains to
corporate governance and their role in the organisation.

UNIT OBJECTIVES

After studying this unit you should be able to:

 Define and outline different stakeholders

 Identify the role of various stakeholder
 Explain the duties and functions of directors
 Discuss specific aspects of stakeholders

UNIT CONTENT

Topic 1: General Aspects of Stakeholder Management

Topic 2: External and Internal Actors
Topic 3: Directors
Topic 4: The Board and Strategy Formulation

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Topic 1: General Aspects of Stakeholder Management

1.0 Introduction

There are two important aspects of stakeholder governance for keen consideration,
scope and power. The power and scope is concerned with how much sway certain
stakeholder groups have over an organisation. The strategic management of
different stakeholders is often critical to the success of the business and so it is
necessary to understand the power dynamics between the organisation and other
various parties. When there are conflicts between the organisation and stakeholders,
as is often the case, what decision processes are to be undertaken to ensure the
best outcome? If there are various stakeholders with different expectations of the
organisation, who do you prioritise? These are some of the aspects that will be
looked into in this topic. We begin first by defining a stakeholder and outlining the
stakeholder theory underpinning the rest of the topic.

1.1 Objectives

After studying this topic you should be able to:

 Define a stakeholder
 Explain the stakeholder theory
 Outline the objectives of CG in relation to stakeholders
 Discuss some conflicts that can occur between management and stakeholders.
 Conduct a stakeholder analysis

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1.2 Defining a Stakeholder
Although there are various definitions of stakeholders, the one most commonly used
is ―Any group or individual who can affect or is affected by the achievement of the
organisation‘s objectives‖. We can deduce from this definition that a stakeholder of
an organisation can encompass many different groups and individuals. Each
stakeholder or stakeholder group can therefore expect the company to behave or act
in a particular way, with regard to the stakeholders‘ interests. Stakeholders can also
expect to have some say in certain decisions of the company and some of the
actions it takes. The balance of power between different stakeholder groups, and
the way in which power is exercised, are key issues in corporate governance. The
most common stakeholders are depicted in figure 1.1 below:

Figure 1.1 Stakeholder Map

Specific stakeholders will be discussed in Topic 2 of this Unit.

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1.3 Stakeholder Theory
Although the recognition of stakeholder obligations has been with us since the birth
of the modern corporate form, the development of a coherent stakeholder theory
awaited a shift in legal thinking from a perspective on shareholders as ―owners‖ to
one of ―investors,‖ more on par with providers of other inputs that a company needs
to produce goods or services. Whereas the ownership perspective, rooted in
property law, provides a natural basis for the primacy of shareholder rights, the view
of the corporation as a bundle of contracts permits a different view of the fiduciary
obligations of corporate managers.
Freeman and McVea (2001) describe stakeholder management as follows:

The stakeholder framework does not rely on a single overriding management

objective for all decisions. As such it provides no rival to the traditional aim of
―maximizing shareholder wealth.‖ To the contrary, a stakeholder approach rejects
the very idea of maximizing a single-objective function as a useful way of thinking
about management strategy. Rather, stakeholder management is a never ending
task of balancing and integrating multiple relationships and multiple objectives.

To pragmatists, the rejection of a single criterion for making corporate decisions is

problematic. Directors occasionally face situations in which it is impossible to
advance the interests of one set of stakeholders and simultaneously protect those of
others. Whose interests should they pursue when there is an irreconcilable conflict?
Consider the decision whether or not to close down an obsolete plant. The closing
will harm the plant‘s workers and the local community but will benefit shareholders,
creditors, employees working at a more modern plant to which the work previously
performed at the old plant is transferred, and communities around the modern plant.
Without a single guiding decision criterion, how should the board decide?

The problem is not just one of uncertainty or unpredictability. Ultimately, the

stakeholder model is flawed because of its failure to account adequately for what
Bainbridge (1994) calls ―managerial sin.‖ The absence of a single decision-making
criterion allows management to freely pursue their own self-interest by playing

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shareholders off against non-shareholders. When management‘s interests coincide
with those of shareholders, management can justify its decision by saying that
shareholder interests prevailed in this instance, and vice versa. The plant closing
decision described above provides a useful example: Shareholders and some non-
shareholder constituents benefit if the plant is closed, but other non-shareholder
constituents lose. If management‘s compensation is tied to firm size, we can expect
it to resist any downsizing of the firm. The plant will likely stay open, with the
decision being justified by the impact of closing on the plant‘s workers and the local
community. In contrast, if management‘s compensation is linked to firm profitability,
the plant will likely close, with the decision being justified by management‘s concern
for the firm‘s shareholders, creditors, and other constituencies that benefit from the
closure decision.

It has been argued that shareholders, in fact, are more vulnerable to management
misconduct than non-shareholder constituencies. Legally, shareholders have
essentially no power to initiate corporate action and, moreover, are entitled to vote
on only very few corporate actions. Rather, formal decision making power resides
mainly with the board of directors. In effect, shareholders, just like non-shareholder
constituencies, have but a single mechanism by which they can ―negotiate‖ with
management: withholding their inputs (capital). But withholding inputs may be a
more effective tool for non-shareholders than it is for shareholders. Some firms go
for years without seeking equity investments. If the management groups in these
firms disregard shareholder interests, the shareholders have no option other than to
sell out at prices that will reflect management‘s lack of concern for shareholder
wealth. In contrast, few firms can survive for long without regular infusions of new
employees and new debt financing. As a result, few management groups can
prosper while ignoring non-shareholder interests. Non-shareholder constituencies are
more often effective in protecting themselves through the political process.
Shareholders—especially individuals—typically have no meaningful political voice. In
contrast, cohesive, politically powerful interest group represent many non-
shareholder constituencies. Unions, for example, played a major role in passing state
antitakeover laws. Environmental concerns are increasingly a factor in regulatory

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actions. From this point of view, it can be argued that an explicit focus on balancing
stakeholder interests is not only impractical but also unnecessary because non-
shareholder constituencies already have adequate mechanisms to protect
themselves from management misconduct.

1.4 Objectives of Corporate Governance in Relation to Stakeholders

In Topic 1 of Unit 1we discussed the objectives of corporate governance. Underlying
these objectives is the idea that the company should be operated in a manner that
satisfies all stakeholders. It is noteworthy to explicate the objectives as they
specifically pertain to stakeholders as the protection of rights of stakeholders is an
important concept in corporate governance.

 To balance demands & needs of stakeholders.

 To reconcile conflicting demands of stakeholders.
 To reduce temptation by more powerful stakeholders to take decisions to further
their personal interests at the expense of other stakeholders.
 To provide protection to the owners of the company against loss due to actions
of executive personnel.
 To help develop measures to prevent financial prejudice to owners (outsiders)
due to action of agents (insiders) or executives.
 To help develop measures for redress should the executives cause financial
prejudice to the owners.
 To reduce conflict between various pairs of stakeholders e.g. shareholders & the
board.

1.5 Classifications of Stakeholders

Stakeholders can be grouped into different categories

a. Internal vs External Stakeholders

Examples of internal stakeholders are employees and managers within the

organisation that can exert an immediate and strong influence over the organisation.

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Examples of external stakeholders include investors, the local community, and the
government. This may seem a simple classification but with increasing complexity of
modern organisations, the delineation between the two can be a grey area. For
example, a supplier may be a subsidiary within the same group or an employee may
be a subcontractor.

b. Primary vs Secondary Stakeholder

A primary stakeholder is a person who has a formal and contractual relationship

exists with an organisation. Whereas, a secondary stakeholder has no contractual
relationship with an organisation.

1.6 Conflicts with Stakeholders

It is often difficult for an organisation to consider the rights of all shareholders
equally. This is because there are usually conflicts that arise among different
stakeholders and hence the difficulty in equal consideration. Conflicts arise when the
needs of some stakeholders group compromises the expectations of others.
Consequently not everyone can be pleased with the decisions made by the board of
directors. Some examples of conflicts are:

 Customers demanding higher quality products. This would result in higher costs
thus affecting profits negatively resulting in a lower return to shareholders.
 Employees demanding higher salaries versus the need to control costs within an
organisation.

Activity 1.1
What other conflicts with stakeholders can you think of?

The following report elucidates the real money costs of stakeholder conflicts that can
occur.

The direct cost of community conflict in the extractives industry is high,

according to a 2014 report by the Corporate Social Responsibility
Initiative (CSRI) at Harvard Kennedy School

One conflict led to stoppages that cost a project $100m in a single year. In another

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case, a conflict that shut down power lines caused an entire operation to halt at a
cost of $750,000 a day.

In the case of initial mineral exploration (early reconnaissance work), interviewees

estimated that $10,000 is lost for every day of delay – through lost wages and the
costs of maintaining an exploration camp. For advanced exploration, involving
drilling and delineation of ore-bearing rocks, up to $50,000 a day can be lost if
programmes are placed on standby.

For one company, the working assumption is that 5% of an asset manager‘s time
should be spent managing social risk. Yet for one of its subsidiaries in an African
country, it is in fact 10% to 15%, and in one Asia-Pacific country, it is 35% to 50%.
Company staff successfully used these figures to make the case to management for
upfront social risk planning in a new operation the company was developing in the
Middle East and North Africa region.

A former senior manager of one extractives operation estimated he spent only a

third of his time ―actually doing my job‖, with the rest spent managing internal staff
and external community issues
arising from conflict.

Source: Harvard Kennedy School [Link]

engagement/case-study-cost-community-conflict

1.7 Managing Stakeholder Conflicts

There are four approaches, proposed by Cyert and March, to managing conflict
among stakeholders.

 Satisficing: This is a strategy aimed at obtaining a satisfactory or adequate

solution rather than the optional solution. Compromise is reached through
negotiation with different stakeholders.
 Sequential attention: As the term suggests, stakeholders concerns are
attended to sequentially to ensure that everyone gets their turn for a satisfactory
outcome.
 Side Payments: Management compensates stakeholders whose concerns have
not been tended to. This may be financial or otherwise.
 Exercise of Power: Influential stakeholders can exert their power over other
stakeholders in order to achieve their objectives. For example, shareholders may
use their voting rights.

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Jensen believes the inherent conflict between the doctrine of shareholder value
maximisation and the objectives of stakeholder theory can be resolved by melding
together ―enlightened‖ versions of these two philosophies:

Enlightened value maximisation recognizes that communication with and motivation

of an organisation‘s managers, employees, and partners is extremely difficult. What
this means in practice is that if we simply tell all participants in an organisation that
its sole purpose is to maximise value, we will not get maximum value for the
organisation. Value maximisation is not a vision or a strategy or even a purpose; it is
the scorecard for the organisation. We must give people enough structure to
understand what maximizing value means so that they can be guided by it and
therefore have a chance to actually achieve it. They must be turned on by the vision
or the strategy in the sense that it taps into some human desire or passion of their
own for example, a desire to build the world‘s best automobile or to create a film or
play that will move people for centuries. All this can be not only consistent with
value seeking, but a major contributor to it.

And,

Indeed, it is a basic principle of enlightened value maximisation that we cannot

maximise the long term market value of an organisation if we ignore or mistreat any
important constituency. We cannot create value without good relations with
customers, employees, financial backers, suppliers, regulators, and communities. But
having said that, we can now use the value criterion for choosing among those
competing interests. I say ―competing‖ interests because no constituency can be
given full satisfaction if the firm is to flourish and survive. Moreover, we can be sure
again, apart from the possibility of externalities and monopoly power that using this
value criterion will result in making society as well off as it can be.

Even though shareholder value maximisation is increasingly being challenged on

pragmatic as well as moral grounds, its roots in private property law, however—a
profound element in the American ethos—guarantee that it will continue to dominate

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the U.S. approach to corporate law for the foreseeable future. As a practical matter,
the courts have given boards increasing latitude in determining what is in the best
long-term interests of the corporation and how to take the interests of other
stakeholders into account. This latitude makes it imperative that directors openly
and fully discuss these issues and agree on a clear, unambiguous statement of
purpose for the corporation.

1.8 Types of Stakeholder Power

Corporate governance is concerned with how powers are shared and exercised by
different groups, to ensure that the objectives of the company are achieved without
violating others‘ rights. Aspects of corporate governance are the rights of
shareholders and other interest groups such as the employees, how powers are
shared and exercised by the directors, and how the holders of power in a company
should be held accountable for their omissions and actions.

Stakeholders can have varying degrees of influence on an organisation. There are

different types of powers that stakeholders can exert over an organisation. French
and Raven outlined the following powers that can be employed

 Coercive power: The ability to inflict punishment on a person through for

example warnings, dismissal or deterring said person from obtaining a reward.
This type of power is based on intimidation.
 Expert power: Being able to influence due to superior knowledge and expertise.
 Legitimate/Positional Power: The ability to influence coming from the position an
individual holds such as through job grade or title within a chain of command.
 Referent/Personal Power: In this instance an individual can exert influence
because of the respect and admiration garnered from others.

1.9 Stakeholder Analysis

Stakeholder analysis is a systematic approach to assessing the positions of others on
an issue in order to ascertain the level of support or opposition from others. It is a

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way of identifying key stakeholders in a system and assessing their interests and
likely influences.

Stakeholder analysis is important in decision-making situations that have to account

for various stakeholders each with competing interests and where resources are
limited.

1.9.1 The Process of Stakeholder Analysis

There are five steps used in conducting stakeholder analysis. The steps are
explained below:

Step 1: Identify and classify stakeholders –There are various ways that
stakeholders can be identified. Using more than one method will minimise the risk
that some stakeholders will not be identified. Management can use a combination of
the following methods:

 Identification by staff of key agencies and other knowledgeable individuals

 Identification through written records and population data.
 Stakeholder self-selection.
 Identification and verification by other stakeholders.

Step 2: Analyse and understand the values and aims of the identified
stakeholders - In order to understand the interests and characteristics of each
group stakeholders should be given an opportunity to express their concerns. A
method to record this can take various forms including:

 Brainstorming for idea generations within groups.

 Semi-structured interviews
 Referring to existing data on the stakeholder group

Step 3: Identify the patterns and contexts of interactions between

stakeholders- This step helps to understand relationships between stakeholders so
as to ascertain overlapping and divergent interests and thus potential trade-offs.
Stakeholders that have common interests also have collective power which should
be considered in decision making.

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Step 4: Prioritise Stakeholders - At this point, management is in a position to
assess the likely power potential of each stakeholder. Priorities should be based on
the power and influence of each of the stakeholders. Some stakeholders may be
more influential than others and some may have a heavy interest in the outcome of
the decision but have no power to exert any influence on the process. All this needs
to be taken into account.

Step 5: Develop strategies to manage stakeholders - Based on the level of

priority allocated to each stakeholder, strategies should be formulated to manage
them.

1.9.2 Mendelow’s Stakeholder Mapping

Mendelow‘s stakeholder mapping is a way of prioritising stakeholders according to
their interests and power. The amount of effort to manage a stakeholder depends
on which quadrant they fall into. The map considers two aspects, the power and
interests of stakeholders.

Interest in the organisation

Low High
Power over the
organisation

Low

Minimal Effort Keep Informed

High

Keep Satisfied Key Player

The order of priority is as follows:

1. Key Player
2. Keep Satisfied
3. Keep Informed

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 4. Minimal Effort

It is important to note that stakeholder mapping should be a continuous process

because stakeholder power may shift over time. A stakeholder may have an
increasing interest in a management decision and this should be accounted for.
Furthermore, the collective interests and powers of groups of stakeholders should be
considered. Alone, one stakeholder might not be able to exert any considerable
influence over a process but perhaps three or four together could be a formidable
force with need for special considerations.

1.9.3 Pros of Stakeholder Analysis

 It helps to enhance good public relations ahead of possible unpopular decision to
be made by an organisation.
 Helps to improve effectiveness of stakeholder management by prioritising those
with high bargaining power.
 Develops a clearer strategy for how to manage and build relations with various
stakeholders.
 Helps to curb the possibility of poor decision making by the organisation from the
perspective of stakeholders who can exert high influence.
 Stakeholders will have a better perception of the organisation because the
organisation is proactively managing their needs and expectations.

1.9.4 Cons of Stakeholder Analysis

 The organisation cannot please all stakeholders; therefore it is a balancing act.
 Managing stakeholders requires time and financial resources.
 The process of mapping stakeholders according to powers and interests is
subjective.
 Stakeholder analysis needs to be regularly undertaken due to shifting positions of
different groups.

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Summary

Stakeholders are a very important part of an organisation and it is equally important

to be able to manage those relationships in a manner that will advance the interests
of an organisation. Increasingly, many stakeholders other than shareholders are
becoming more prominent with different demands on an organisation. In that
respect organisations are faced with the problem of having to strategically manage
these relationships. In this topic we looked at stakeholder theory, the different
powers of stakeholder and stakeholder analysis. The concept of the stakeholder
does not end here. You will notice that mention is made of it in later units so you
might find it useful to really grasp the concepts here as you go forward.

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Topic 2: Key Internal and External Actors

2.0 Introduction

The modern corporations in the global economy are faced with various challenges in
business environment and hence have to come up with governance structures and
principles that will ensure the equitable distribution of rights and responsibilities
among different stakeholders and interested parties in the corporation. In
contemporary business corporations, the main external stakeholders groups are
shareholders, customers, trade creditors, suppliers, debt holders and the community
affected by business activities. Internal stakeholders are Board of directors,
executives and other employees.

Corporate Governance is concerned with holding balance between the economic and
social goals of individual and communities. The corporate governance framework is
there to encourage the efficient use of resources and equally to require
accountability for the stewardship of those resources. The aim is to align as nearly
as possible the interest of individuals, corporations and society (Sir Adrian Cadbury
in Global Corporate Governance Forum, World Bank 2000)

2.1 Objectives

After studying this topic you should be able to:

 Identify the key internal and external actors in an organisation

 Explain the interest and role that these actors play
 Discuss how the roles played by the internal and external actors relate with
corporate governance

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2.2 Internal Players

2.2.1Employee Representatives (Trade Unions)

Trade Unions are an important part of the governance contributories. The most
common way of providing employee representation (to the board) is through a trade
union. Trade unions represent employees in a workplace; membership is voluntary
and the influence of the union is usually proportional to the percentage of the
workplace that are its members.

Although it is often assumed to be in an adversarial relationship with management,

trade unions can play a very helpful role in corporate governance. The adversarial
assumption is probably unhelpful in many situations, as union members often share
the same objectives for the organisation, and share professional and ethical values
with management in carrying out the organisational strategy.

In terms of governance, trade unions are able to ‗deliver‘ the compliance of a

workforce. If a strategy needs a high level of commitment, a union can help to unite
the workforce behind the strategy and ensure everybody is committed to it. This can
also mean that management and workforce are seen as united by external
stakeholders which can make the achievement of strategies more likely. By collective
bargaining over pay and conditions, agreement usually signifies that the workforce
‗buys in‘ to the agreed strategy or activity.

A trade union can be a key player in the checks and balances of power within a
corporate governance structure. Where management abuses occur, it is often the
trade union that provides the first and most effective reaction against it which can
often work to the advantage of shareholders, especially when the abuse has the
ability to affect productivity. Unions are often good at highlighting management
abuses such as fraud, waste, incompetence and greed, all of which are unhelpful
traits in board members.

Linked to the above, trade unions help to maintain and control one of the most

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valuable assets in an organisation, the employees. Where a helpful and mutually
constructive relationship is cultivated between the union and employer, then an
optimally efficient industrial relations climate exists, thus reinforcing the productivity
of human resources in the organisation. In defending members‘ interests and
negotiating terms and conditions, the union helps to ensure that the workforce is
content and able to work with maximum efficiency and effectiveness.

2.2.2 The Company Secretary

In most countries, the appointment of a company secretary is a compulsory

condition of company registration. This is because the company secretary has
important responsibilities in compliance, including the responsibility for the timely
filing of accounts and other legal compliance issues. In addition to this responsibility
for compliance with relevant laws and regulatory frameworks, the company
secretary often advises directors of their regulatory, legal responsibilities and duties.
His or her primary loyalty is always to the company. This means that in any conflict
with another member of the company (such as a director), the company secretary
must always take the side most likely to benefit the company (rather than any single
director).

Technical knowledge is therefore an important part of this role. Because of this,

many countries‘ company law mandates that for a public company, the post-holder
must be a member of one of a list of professional accountancy or Law, company
secretary professional bodies (which include BICA & ACCA).

In Botswana, every private and public company should have a secretary who is
resident in Botswana. A secretary should be qualified and should give consent to
act as secretary. Subject to the constitution the board may appoint or remove a
secretary. An Auditor, sole director and an insolvent person cannot be the
secretary. For a non-exempt private company and public company (meaning a
company with a turnover of more than P 20 million or total assets of more than P 10
million - as of May 2013), a lawyer, qualified accountant (Botswana Institute of

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Accountants) and a member of Southern African Institute of Chartered Secretaries
and Administrators can be a company secretary.

A company Secretary should submit statutory forms to the Registrar, take

responsibility with directors for accounts, keep Registers of shareholders, Directors,
Secretaries, Charges, Directors' Interest, etc., attend meetings, minute the
proceedings and sign with the Chairman of directors as true copy of minutes, send
notices for meetings and maintain adequate system of correspondence, affairs and
activities of the company

The major roles of a company secretary include:

 Ensuring the timely and accurate filing of audited accounts and other documents
to statutory authorities (e.g. CIPA, government companies‘ agencies and tax
authorities)
 Maintaining the statutory registers (such as the share register)
 Providing members (e.g. shareholders) and directors with notice of relevant
meetings
 Organising resolutions for and minutes from major company meetings (like the
AGM) and keeping records from these and other meetings.

 Inducting new directors.

 Advising the Board on issues of compliance.

2.2.3 Sub-Board Management (Middle Management)

This is occasionally referred to as ‗middle‘ management, that is, managers below
board level who are a critical part of the governance system. The employees, led by
sub-board management, are mostly responsible for implementing strategies,
meeting compliance targets and collecting information and data on which board-
level decisions are made.

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The efficiency of sub-board management as part of a governance system partly
depends on the extent to which organisational activities are controlled and
coordinated. Rewarding collaborations arise when specialists work to achieve
organisational objectives in their own departments and are coordinated by an
effective board of senior managers and directors. There is ample scope for ‗strategic
drift‘, especially in large organisations, when this vital control and coordination is
ineffective.

2.3 External Stakeholders

2.3.1 Shareholders
The model of governance which the Anglo-American countries, including Botswana,
tend to follow is the ―Liberal Model.‖ The Liberal model gives priority to the interest
of the shareholder where, Shareholders and other investors (e.g. fixed-return
bond-holders) are the real owners of the company. Governance however, does not
dwell on servicing the needs of the owners only. They are nevertheless considered
the most important external actors in corporate governance. In the agency
relationship that exists between shareholders and directors, the shareholders are the
principals. They have the right to expect agents (directors) to act in their best
economic interests and to observe a fiduciary duty towards them.

Shareholders incur agency costs in monitoring the activities and actions of agents
(directors). These are the costs of monitoring and checking on directors‘ behaviour.
Examples of agency costs are attending relevant meetings (AGMs and EGMs),
studying company results and analysts‘ reports, and making direct contact with
companies through investor relations departments. When a shareholder holds shares
in many companies, the total agency costs can be prohibitive; shareholders
therefore encourage directors‘ rewards packages to be aligned with their own
interests so that they feel less need to continually monitor directors‘ activities.

The two types of shareholder include: small investors and institutional investors.
Small investors are individuals who hold shares in unit trusts, funds and individual

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companies. They typically buy, hold or sell small volumes and tend to have fewer
sources of information on companies than institutional investors. They also often
have narrower and less robust portfolios, which can mean that agency costs are
higher, as the individuals themselves study the companies they have invested in for
signs of changes in strategy, governance or performance.

Institutional investors are by far the largest investors in companies, and they
dominate the share volumes on most of the world‘s stock exchanges. Pension funds,
insurance companies, unit trust companies and similar financial institutions hold
large numbers of shares in individual funds with each fund being managed by a fund
manager. Individuals, either directly or through investment products (such as
pensions or endowments) buy into investment funds that are then managed, by
selectively buying, holding or selling shares and other investments. When the fund
grows or reduces in value, the member gains or loses value as a result. Fund
managers do have some influence over the companies that they hold shares in, with
greater influence obviously being associated with higher proportionate holdings.
Fund managers need to be aware of the performance and governance of many
companies in their funds, so agency costs can be very large indeed. To reduce
these, they make use of information from several sources on the companies and also
seek to have directors‘ benefit packages aligned with their own interests as much as
possible.

2.3.2 The Stock Exchanges

Shares are bought and sold through stock exchanges. Each of the main international
stock exchanges keeps an index of the value of shares on that exchange; this is the
most frequently quoted ‗number‘, referring to the total value of the shares on that
exchange. The Botswana Stock Exchange was established in 1989 and became the
Botswana Stock Exchange in 1994. It is governed by the Botswana Stock Exchange
Act.

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The BSE has about 35 market listings and 3 stock indices: the Domestic company
index (BSE DCI); the Foreign company index (BSE FCI), incorporating companies
which are dual listed on the BSE and another stock exchange; and the All Company
Index, which is a weighted average of the DCI and FCI. As well as equities, bonds
and Floating Rate Notes are also traded. Private investors are estimated to account
for fewer than 10% of the total market capitalisation. Foreign-based mining
companies make up over 90% of the total market capitalisation. In Botswana, it is a
stock exchange requirement that listed companies must comply with the King III
code on Corporate Governance.

In London, for example, the FTSE All Share (Financial Times Stock Exchange) index
is a measure of all of the shares listed in London. In New York, it is the Dow Jones
index and in Hong Kong, it is the Hang Seng index.

The value of any share on a stock exchange is calculated continuously, based on the
demand and supply of that share. Demand for shares is driven by the expected
future returns on that share which, in turn, is driven by expected company
performance. Information suggesting an increase in performance will tend to
increase demand for a given share, anything suggesting a deterioration in
performance will cause fewer shares to be demanded. The price of a share rises and
falls with supply and demand until the equilibrium price is achieved (when the same
number of shares is supplied and demanded). Any change in supply or demand will
then move the equilibrium price (ie the share price on the stock exchange).

In addition to listing, pricing and transacting share buying and selling, stock
exchanges can also have a role in the governance of the companies listed on the
exchange. Listing rules are sometimes imposed on listed companies and in many
cases, listing rules concern governance arrangements not covered elsewhere by
company law. In the UK, for example, it is a stock exchange requirement that listed
companies comply with the Combined Code on Corporate Governance which is not a
legal requirement but a stock exchange requirement. Other listing rules concern
reporting behaviour. In a rules-based jurisdiction, the law underpins corporate

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governance and reduces the need for stock market listing rules.

2.3.3 Regulators and Governments

In addition to company law and listing rules, some companies and industrial sectors
are subject to further external control by government appointed regulators or by
governments themselves. This usually applies to companies or sectors involved in
areas considered strategically or politically important by governments; these include
the control of monopolies or the supply of utilities (such as water or energy).

In some countries, this also applies to military equipment and medical supplies.
When this is the case, regulations typically applies to pricing and supply contracts. In
some countries, the host government owns many large companies, directly or
indirectly, wholly or partially. Nationalised companies are part of the economic fabric
of many developing countries but tend to feature less prominently in more
developed countries. It is generally believed that the profit motive, created by the
agency relationship in a conventional shareholder–director arrangement, creates and
stimulates greater economic efficiency than in nationalised companies.

Governments control corporate governance through the imposition of legislation and

the enforcement (through a judiciary) of common and statute laws. Governments
usually have a range of political and social objectives in mind when controlling
business, but they also rely heavily on tax revenues levied on company profits and,
where relevant, sales and other transaction taxes. One reason for the deregulation
of much economic activity is the need to increase tax revenues and create
employment by gaining the economic efficiencies offered by competition and
executive reward packages that are aligned to added shareholder value. In
Botswana the role of public/oversight bodies like the Attorney General‘s Chambers,
Directorate of Public Prosecutions, Directorate on Corruption and Economic Crime,
the media and voluntary bodies or associations that promote good governance like
Directors Institute of Botswana is acknowledged and enhanced.

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2.3.4 The Gatekeepers: Auditors, Security Analysts, Bankers, and Credit
Rating Agencies
The integrity of financial markets greatly depends on the role played by a number of
―gatekeepers‖ such as external auditors, analysts, and credit rating agencies in
detecting and exposing the kind of questionable financial and accounting decisions
that led to the collapse of Enron, WorldCom, and other ―misreporting‖ or accounting
frauds. A key question is whether we can (or should) rely on these gatekeepers to
perform their roles diligently. It can be argued that they should be relied on because
their business success depends on their credibility and reputation. The ultimate
users of the gatekeepers information are investors and creditors which if
gatekeepers provide them with fraudulent or reckless opinions, they will be
subjected to private damage suits. The problem with this view is that the interests of
gatekeepers are often more closely aligned with those of corporate managers than
with investors and shareholders. Gatekeepers, after all, are typically hired and paid
(and fired) by the very firms that they evaluate or rate, and not by creditors or
investors. Auditors are hired and paid by the firms they audit, credit rating agencies
are typically retained and paid by the firms they rate while lawyers are paid by the
firms that retain them. It was learned in the aftermath of the 2001 governance
scandals, until recently, the compensation of security analysts (who work primarily
for investment banks) was closely tied to the amount of related investments banking
business that their employers (the investment banks) do with the firms that their
analysts evaluate. A contrasting view, therefore, holds that most gatekeepers are
inherently conflicted and cannot be expected to act in the interests of investors and
shareholders. Advocates of this perspective also argue that gatekeeper conflict of
interest worsened during the 1990s because of the increased cross selling of
consulting services by auditors and credit rating agencies and by the cross selling of
investment banking services. Both issues are addressed by recent regulatory reforms
and the new rules address the restoration of the ―Chinese Wall‖ between investment
banks and security analysts, and mandate the separation of audit and consulting
services for accounting firms.

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Summary

In this topic we learnt about the key internal actors and external actors in an
organisation. The internal actors include employee representatives (trade unions),
sub-board management (middle management) and company secretaries. The
external stakeholders include the Gatekeepers: Auditors, Security Analysts, Bankers,
and Credit Rating Agencies, Regulators and Governments, The Stock Exchanges and
[Link] learned their interest and their role in governance.

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Topic 3: Directors

3.0 Introduction

A company is an artificial person (jurisdictional persona) having existence only in

contemplation of law and as such cannot act in its own capacity. Therefore there
must be some human agency to carry on the company‘s business. From a legal
perspective, the board of a public corporation is charged with setting a corporation‘s
policy and direction, electing and appointing officers and agents to act on behalf of
the corporation, and acting on other major matters affecting the corporation.

The corporate model separates ownership from control. The delegation of control
over the corporation‘s assets by its owners means that effective corporate
governance comes down to the appropriate motivation and good behaviour of a
company‘s board and management. The imposition of fiduciary duties is how the
common law responds to this delegation of authority to those two groups: to ensure
that they act in the best interests of the company and its shareholders when making
decisions about the actions that a corporation needs to take.

3.1 Objectives

After studying this topic you should be able to:

 Explain what a director is

 Outline the various duties of a director
 Discuss restrictions placed on directors
 Explain the roles of directors in various committees\

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3.2 Defining a Director
A director is the head of an organisation, either elected or appointed, who generally
has certain powers and duties in relation to management or administration. A
corporation‘s board of directors is composed of a group of people who are elected by
the shareholders to make important company policy decisions.

The Company‘s directors are undeniably the most noticeable group of performers in
corporate governance. In term of their engagement, they can either be executive or
non-executive directors (NEDs). The figures and proportion of executives to NEDs in
many places partly depends on the regulatory regime of the country. In countries
where governance rules have not received much cognisance, multi-national
companies align their constituting laws to their countries governance rules. It is
generally the case that investors and regulators prefer there to be more NEDs, as
their independent scrutiny of the company, its controls and strategies, provide a
more robust governance structure. In a unitary board structure, all directors share
legal responsibility for company activities and all are accountable to the
shareholders. In most countries, all directors are subject to retirement by rotation,
where they either step down or offer themselves for re-election (by the
shareholders) for another term in office.

3.2 Duties of Directors

In relation to accountability, the director‘s duty is two-fold, which is, to the

shareholders and to the regulatory authorities. Directors are collectively responsible
for the company‘s performance, controls, compliance and behaviour. This means
that the board of directors (BOD) must discuss and agree on strategies that to
maximise the long-term returns to the company‘s shareholders. They must also
comply fully with relevant regulatory requirements that will include legal, accounting
and governance frameworks.

Under companies Act directors are accountable for the acts they do on behalf of the
company. Besides the statutory duties, which the directors have to perform, to

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ensure strict compliance with the various provisions of the Act they also have certain
duties, which arise out of their fiduciary relationship with the company.

3.2.1 Fiduciary Duties of Directors

a. The Duty of Good Faith and Honesty

The fiduciary relationship between the director and the company are comparable to
those of a trustee. The law imposes these duties upon the directors so that they are
not allowed to capitalize their strategic positions in the company to serve their own
interest.

 A director shall at all times act honestly and use reasonable diligence in the
discharge of the duties of his or her office.
 An officer (including a director) shall not make use of any information by virtue of
his or her position as an officer (director) to gain directly or indirectly any
improper benefit for self or cause detriment to the company.

b. Duty of Care

The directors of a company are expected to perform their functions with reasonable
care and attention. They must discharge their duties and obligations with skill and
diligence as expected from a reasonable person of his or her knowledge and
experience. Duty of care can be summed up in the requirement that a director
should be present, informed, engaged, use good and independent judgment, utilize
expert advice and trusted information, refer to meeting minutes, and seek to stay
abreast of legal developments, good governance, and best practices. Directors
should also schedule and be prepared to discuss and review of budget issues,
executive compensation, legal compliance, and strategic direction.

c. Duties to Individual Members

Directors owe a duty to their company but not to individual members while carrying
out transactions with such members, whether, the directors act on behalf of the
company or on behalf of themselves. Directors are not trustees for individual
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shareholders. Therefore, directors, who purchase shares from members of their
company, are under no obligation to disclose any information that might induce the
members to demand higher price.

In certain cases, directors owe no fiduciary duty to the members but in certain
situations they do owe a duty to exercise reasonable skill and care in advising
members about a particular transaction relating to the company or its undertaking.

d. Duty to Disclose Personal Interest

The relationship between director and the company is that of an agent and a
principal; the former occupies a fiduciary position towards the latter. Therefore
directors are under a duty to ensure that their personal interest do not clash with
those of the company‘s interests. The law expects a director to discharge his or her
duties towards the company without any personal interest that benefits the director‘s
individual selfish gain.

e. Duty Towards Other Persons (i.e. Third Parties)

It is true that the directors are not personally liable for the contracts entered into, by
the third parties with the company, instead the company is held liable for such
transactions. Likewise if the contracts entered into by the company are ultra –vires
the company, then directors shall not be liable because such contracts are void in
law. But if the director enters into a contract with a third person in his or her own
name suppressing the fact that he is doing so in his capacity as a director of the
company, in that case he or she shall be personally liable to any loss caused to the
company on account of that contract.

3.2.2 Duty to Exercise Unfettered Discretion

Director cannot, without the consent of the company, restrain their discretion in
relation to the exercise of their powers as company representatives. This principle is

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applied even if there is no improper motive or purpose, and no personal advantage
that accrues to the director. A director must also not allow his or her judgment to be
interfered with and must objectively apply his mind to the business of the company.
Where he is appointed to represent certain shareholders he or she is still obliged to
exercise discretion and must act effectively to protect the interests of the company
even if they conflict with those of the people he or she represent.

Directors must exercise their powers for a proper purpose which means that they
should exercise their powers only for the purpose for which they are conferred. The
following duties may be distinguished with regards to purpose,
 Duty to exercise their powers in good faith in the interests of the company
 Duty not to exercise powers for an unauthorised or collateral purpose.

Directors should therefore use their powers for the company‗s benefit and not for
their own gain and should act within the confines of the company‗s Memorandum of
Association and all relevant legislation. Issues arise where the director, while acting
in good faith, is serving a purpose that is not regarded by the law as proper. In such
cases directors become liable even where they acted honestly.

3.2.3 Duty to Attend Board Meetings

Legally, directors are not bound to attend all board meetings but the companies Act
provides that the office of the director shall be vacated if the director is absent from
three consecutive board meetings or from all meetings of for a consecutive three
month period, whichever is longer, without obtaining leave of absence from the
Board.

Activity 3.1

a. Define the term director.

b. Explain the fiduciary duties of a director.

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3.3 Directors Restrictions

 Directors are restricted to derive material benefit for any transaction with the
company, which may be regarded as an interest. The director‘s interest should
be recorded in the Interest Register and recorded in minutes. Interest Register
can only be avoided if 100% of shareholders agree to it. Subject to the
constitution, interested director can attend the meeting, can sign the minutes,
can vote and do anything as if he is not interested.
 Company can avoid the contracts in which directors are interested within 6
months from the date on which shareholders are informed (either through
annual reports or otherwise) but the avoidance can't affect a third-party's
title. But if the company receives fair value then it cannot be avoided.
 A director having shares in a company, can buy and sell his/her shares at fair
value - not less than fair value when selling and not more than fair value while
buying. Otherwise, he is liable for the difference and should pay it over to the
other party. In Robinson v Randfontein Estates Gold Mining Co Ltd 1921
AD 168. The director of a company purchased property under circumstances
that showed that it was his duty to have acquired the property for the company
and not for himself. Thereafter the director resold the property to the company
at a profit. It was held that the company was entitled to claim from the director
the profit made by him.
 A sole director cannot resign without calling for a shareholders' meeting to
receive resignation and appoint one or more directors. Directors' acts are always
valid even if the director is disqualified or even if the appointment was
defective. A director is liable for his actions, even after resignation or removal or
disqualification. A director can be removed by being given a notice that states
that it is director‘s removal. Ordinary resolution is enough for public companies
but special resolution is necessary for private companies (subject to
constitution).
 A director‘s remuneration can be decided through a general meeting by ordinary
resolution but a company cannot give loans to directors. A director can only be
given a salary advance or travel advance.

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The following case illustrates the breach of the duty owed by the directors to the
company.

Industrial Development Consultants Ltd v Cooley [1972] 1 WLR 443.

Facts: Mr. Cooley was an architect employed as managing director of Industrial

Development Consultants Ltd., part of IDC Group Ltd. The Eastern Gas Board had a
lucrative project pending, to design a depot in Letchworth. Mr. Cooley was told that
the gas board did not want to contract with a firm, but directly with him. Mr. Cooley
then told the board of IDC Group that he was unwell and requested he be allowed to
resign from his job on early notice. They acquiesced and accepted his resignation.
He then undertook the Letchworth design work for the gas board on his own
account. Industrial Development Consultants found out and sued him for breach of
his duty of loyalty.

Held: Even though there was no chance of IDC getting the contract, if they had
been told they would not have released him. So he was held accountable for the
benefits he received. He rejected the argument that because he made it clear in his
discussions with the Gas Board that he was speaking in a private capacity; Mr.
Cooley was under no fiduciary duty. He had ‗one capacity and one capacity only in
which he was carrying on business at that time. That capacity was as managing
director of the plaintiffs.‘ All information which came to him should have been
passed on.

3.4 Director’s Compensation

Setting director pay typically is not done by the compensation committee of the
board. Rather, director pay decisions normally are made by the nominating
committee. The justification for this structure is twofold. First, it provides for a
separation of the director and executive compensation decisions. Second, it allows
the nominating committee to integrate compensation with board-building strategies.

The job of director has become significantly more challenging in recent years; it
demands stronger qualifications, requires more time, and increasingly carries

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personal financial risk. In this new governance climate, the pool of available
independent directors has shrunk and pushed up director pay. Directors are typically
paid with a mix of cash and equity, with equity representing about half of the total
direct compensation. Nonemployee chair and lead-director pay is generally
structured like that of other directors on the board (retainer, meeting fees, and
equity), while employee, non-CEO chairs are typically paid like an employee (salary,
incentives, and benefits). A majority of companies pay a premium to committee
chairs—especially audit and compensation committee chairs—reflecting the
increased time commitment and additional responsibility. With respect to the equity
component of director compensation, companies have reduced their reliance on
stock options and increased the use of full-value awards.

3.5 Composition of the Board

King III code requires that a company‘s non-executive Directors be independent and
the majority of independent non-executive.

The composition of the Board ensures a balance of authority that precludes any one
Director from exercising unfettered powers in decision-making. The necessary
committees should assist the BoD in fulfilling its responsibilities. These committees
include:

 Audit committee

The audit committee is charged with assisting the board in its oversight of (a) the
integrity of the company‘s financial statements and internal controls; (b) compliance
with legal and regulatory requirements, as well as the company‘s ethical standards
and policies; (c) the qualifications and independence of the company‘s independent
auditor and the performance of the company‘s internal audit function and its
independent auditors; and (d) preparing the audit committee report for inclusion in
the company‘s annual proxy statement. The committee typically consists of no fewer
than three members, all of whom must meet the independence and experience
requirements

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 Risk Committee

The risk committee will be discussed in more detail in Unit 3 of this module.

 Human Resources Committee

The objective of the HR Committee is to oversee the following functions: a.

Recruitment of key personnel b. Appraisals c. Compensation packages c. Service
conditions d. Discipline e. Succession

The specific responsibilities that the Committee carries out on behalf of the Board
are as follows:
 To review, monitor and makes recommendations to the Board on human
resource strategies and policies that pertain to staffing, compensation,
benefits, and related issues of strategic importance;
 To conduct an assessment of the performance of the Chief Functionary at
least on an annual basis. In addition to it, review the compensation on an
annual basis;
 To review and provide recommendations to the Board concerning the
approval or amendments to the Human Resource policy;
 To identify and meet the training/capacity building needs of existing staff;
 To report its actions and recommendations, if any to the Board after each
Committee meeting.

 Governance committee

The nominating (and governance) committee has multifacetted responsibilities and is

typically charged with recommending new candidates for the board of directors and
determining (a) the eligibility of proposed candidates, (b) reviewing the company‘s
governance principles and practices, (c) establishing and overseeing self-assessment
by the board, (d) recommending director compensation, and (e) implementing
succession planning for the CEO. The nominating (and governance) committee
normally consists of three or more independent directors; its members and chair are

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usually appointed by the board on the recommendation of the chairman of the
board.

 Other Ad Hoc committees

In addition to these standing committees, a growing number of companies make use

of ad hoc committees to address specific issues—a strategy committee to look at
different growth options, for example, or a finance committee to develop
recommendations to recapitalize the company. While ad hoc committees can be
useful, they should have clear sunset clauses to prevent their institutionalization or a
balkanization of the board on important issues.

Summary

The Board of directors is in charge of company affairs, they direct and control the
operations of the company. The management of the company as a whole, vests in
the Board to formulate business policies and keep a general supervision over their
execution within the objectives laid down in the memorandum and articles of the
company.

Directors and officers of a company are required to act in a manner that is honest
and in good faith. This should be done with a view to attaining the best interest of
the company and in this process they should exercise due diligence, care and skill
that any reasonable prudent person would exercise if placed in the same
circumstances. In acting in the best interest of the company the directors are
required to act only for the benefit of the company as a whole and not any individual
person be it a single or group of shareholders, (Sharon, 2004). As regards not acting
in a manner that will lead to a conflict of interest, a director is required to act in the
interest of the company as a whole rather than his own individual interests.

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Topic 4: The Board and Strategy Formulation

4.0 Introduction

We have already ascertained that most companies are managed by a board of

directors, appointed or elected by the shareholders as agents to run the company.
Every so often the directors are re-elected by the shareholders for their roles. This
re-election/re-appointment period is prescribed by company founding documents,
although it is recognised that the outcome of strategy decisions usually become
tangible in the medium to long term.

The pivotal role that Boards of Directors have to play in the promotion of
stakeholder democracy is increasingly translated into Boards seeking a larger role in
the formulation of business strategy. In support of this seemingly activist role,
Boards are placing emphasis on the importance of a well-crafted strategy in ensuring
improved business performance, in a manner consistent with the interest of all
stakeholders.

4.1 Objectives

After studying this topic you should be able to:

 Identify and explain the factors that contribute to the role played by the board in
strategy formulation.
 Identify the framework used by the board in developing strategy.
 Explain the process of strategy development.
 Explain the Management-Board relationship in the formulation of strategy.
 Discuss the role of the board in strategy formulation.

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4.2 Role of the Board in Context
Shareholders have to place trust in those acting on their behalf. It is rare but not
unknown for shareholders to lose confidence with the board and remove its
members en masse.
Moving forward it is necessary to recap the role of the board of directors as
stipulated by the King Report. This is as follows:
 To define the purpose of the company.
 To define the values by which the company will perform its daily duties.
 To identify the stakeholders relevant to the company.
 To develop a strategy combining all these factors.
 To ensure implementation of this strategy.

One will notice the relative importance of strategy in the board‘s role, this is because
it is necessary to re-evaluate the position of the company and ensure that it
shareholder‘s wealth is being maximised. This may have the implication of adjusting
the purpose or direction of the business or changing it completely.

The last two points above, indicate that directors need to ensure that there is a
long-term strategy in place and that it is sufficient to meet the needs of the
stakeholders. To that end, directors have to be involved in initiating and developing
strategy.

Kenneth Andrews (1980), wrote in relation to the board‘s responsibility:

―A responsible and effective board should require its management to draw up a

unique and durable corporate strategy, review it periodically for its validity, use it as
a reference point for all other board decisions and share with management the risk
associated with its adoption.‖

The framework within which the board should operate in developing strategy is
outlined below:

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 Strategic thinking deals with the collection, analysis, and discussion of
information about the environment of the firm, the nature of competition, and
business models.
 Strategic decision making is making a set of core directional decisions that
define fundamental choices concerning the business portfolio and the dominant
business model, which serve as the platform for the future allocation of limited
resources and capabilities.
 Strategic planning deals with the identification of priorities, setting objectives,
securing and allocating resources to execute the chosen directional decisions.
 Strategy execution is the implementation and monitoring of results and
appropriate corrective action. This phase of strategy development can involve the
allocation of funds, acquisitions, and divestitures. Nadler (2004)

In each of these stages, the board‘s role should be different. The table below
summarises the specific roles at each stage.

Stage in Developing Strategy Role played by the Board

Strategic thinking Advising and counselling about processes
followed and consideration of the internal
and external environment of the
Strategic decision making company
Strategic planning
Evaluation and decision making.
Strategy execution
Review and monitoring of progress.

4.1 The Process of Strategy Development

Step 1: Agreeing on company vision

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At this phase consideration is made of all the various stakeholders and the desired
goals that the company hopes to achieve. The vision statement should be
inspirational and provide a measure against which strategic options will be assessed.

Step 2: Viewing the opportunity space

Once the vision of the company has been ascertained, strategic options are
generated. This will answer questions related to how best to serve customers; which
technologies are used to produce products, what range of products to produce and
how to fend off competitors. Viewing the opportunity space is essentially, looking at
the external environment and determining the best course of action for the
company.

Step 3: Assessing the company’s business design and internal capabilities

This phase takes on an inward look of the company and assesses its internal
strengths and weaknesses. Examples of some of the internal resources are human
capital, financial capital and work processes. Internal resources are important for the
achievement of the company vision and should be considered in strategy
development.

Step 4: Determining the company’s future strategic intent

The last two phases are combined in this fourth phase in order to determine a way
forward for the company.

Step 5: Developing a set of business design prototypes

Once strategic intent has been identified business prototypes are developed for each
strategic option. These prototypes should be assessed against a set of criteria that

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measures success. Doing so will help to generate inherent challenges in particular
sets of strategic choices and can inform pre-emptive controls.

4.4 Strategy Implementation and Monitoring

Once strategy has been formulated it is important for the board to monitor the
implementation of the strategy. To this end, the board must develop a set of metrics
against which actual performance will be compared with planned performance. The
set of metrics developed should go beyond just financial measures and measure
performance across the whole spectrum of organisational activity. In the
consideration of metrics, short term outcomes, medium term outcomes and long
term outcomes should be accounted for.
 Short term outcomes: Metrics in this time period typically would indicate likely
performance measured over the next one to three years.
 Medium term outcomes: Within one to five years an organisation ought to have
a good idea for maintain and improving its rate of growth and return on capital.
 Long term outcomes: For the long term organisational metrics should indicate
the organisations ability to sustain profits from current activities and to identify
and exploit new areas from which growth can be anchored.

4.5 The Role of the Board in Different Types of Organisations

At this point we have already ascertained that the board is responsible for strategy
formulation, however, one may ask about the extent to which the board can go in
implementation of strategy. In this regard it is noteworthy that the role of the board
of directors in strategy formulation is not a prescriptive one as requirements will
differ from company to company. Some of the factors that determine the role that
the board will play in strategy formulation are:
 Stage of evolution of the company.
 Ownership pattern.
 Type of management.
 Size of the company.
 Composition of the board.
 Background of directors.

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 Role clarity of the board

To put this further into perspective let us compare the role of the board in strategy
formulation in a small and large business.

A small company may lack the depth of management necessary to develop strategy
and this role may, by default, fall to the board. For a larger firm, the role of the
board may be that of a judge, overseeing and ensuring that what management has
come up with stands up to scrutiny.

Activity 4.1
Select one factor from the list. In what way does it affect the role the board plays in
strategy development?

4.6 The Management-Board Relationship in Strategy formulation

The most effective boards work through committees and this is no different for the
particular function of strategy development and implementation. As a first move, it is
necessary for the board to have a strategy committee within the board that reports
to the full board. To optimise effectiveness, it is advisable that the committee is
constituted of outside, independent directors that will free them from biases that
result from claims to the organisations resources.

In order to facilitate the effectiveness of the role of strategic committee,

management in the organisation has to perform three essential aspects.

1. Have a set of objectives: objectives relate to what the company is trying to

achieve and should meet the SMART criteria. These objectives can be about the
company‘s industry ranking, return on shareholders‘ equity, earnings value,
market share.

Activity 4.2
Do you remember what the acronym SMART stands for?
Think of a company objective and see if it meets the SMART criteria.

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2. Develop a strategic philosophy/ corporate strategy: The philosophical beliefs in an
organisation embody the ways in which the objectives will be achieved. Without a
strategic philosophy, the objectives of the organisation become nothing more
than hopes and wishes of management. The philosophy guides individual strategic
business units (SBUs) so that the collective efforts of each of them are geared
towards achieving objectives. For example, being a ‗cost leader‘ can be a strategic
philosophy that all the SBUs can relate to so as to help in achieving an objective
of ―achieving a 20% market share within 5 years‘.

3. Continuous review of the corporate strategy is necessary and cannot be done

every five to ten years. Management should keep abreast of latest developments
in the market and inform the board of such information.

The pursuit of strategy development can be a tedious one as the role of the board
and management becomes intermingled. Following are some of the issues related
with interactions between the board and management.

 One party may feel that their turf is being invaded and this increases tension in
regards to the roles played in development of the strategy. It is important for
management and the board to recognise that their roles do not compete, but
that they are working towards a common goal, which is ultimately to satisfy the
stakeholder.
 Management may have the perception that the board lacks expert knowledge,
which is important for strategy development. This leads to the idea that the
board should, at best, have an advisory role. It is not unheard of that the board
expands its role into execution of strategy, which should essentially be left to
management.
 The lack of role clarity by the board in relation to strategy formulation creates
problems. More specifically, there is no clarity about whether the board co-owns
strategy with management or co-creates strategy with management.

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4.6.1 Co-owning Strategy vs Co-creating Strategy
It is widely accepted that the board should co-own strategy but the questions arises
of whether the board can co-own strategy without having had a hand in formulating
it with management, in other words, co-creating strategy. One of two approaches
transpires. The first being, management drafts a strategy which is then intensively
interrogated with the engagement of management and then finalised by the board.
Alternatively, the board can simply ratify or endorse the strategy that management
has come up with and that would satisfy the board in co-ownership. A balance
should be struck between the two approaches so that the board is not encroaching
on the role of management, as might be the case in the first situation, and that the
board is not abdicating its role by being too passive, as is with the second approach.

4.7 Role of the Chairperson of the Board

The chairperson of the board plays a pivotal role in strategy development as he/she
controls the board. The following are the roles that chairperson of the board plays in
the development of strategy:

 Setting the context for discussion on strategy.

 Setting the right tone at the top to promote healthy discussions.
 Promoting trust and transparency between the board and the management.
 Selecting the right directors who will contribute to quality discussion on strategy.
 Defining and communicating the role and expectation for each board member
and for management.
 Finalising the agenda for strategy meetings.
 Ensuring that all board members function as a team.
 Ensuring that all directors contribute to discussions on the strategy.
 Ensuring that motivations for each director are understood in order to extract
optimum value individually and as a team.
 Ensuring that board members and management do not compete.
 Understanding the board dynamics and politics that can hinder progress.
 Promoting a culture where there is no finger pointing.

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Summary

It seems self-evident that a board‘s role depends largely on the nature and the
strategic challenges of the company and the industry. The challenges faced by small,
private, or closely held companies are not the same as those of larger, public
corporations. In addition to their traditional fiduciary role, directors in small
companies are often key advisers in strategic planning, raising, and allocating
capital, human resources planning, and sometimes even performance appraisal. In
large public corporations, directors are focused more on exercising oversight than on
planning, capital allocation and control rather than on the raising of capital, and on
management development and succession activities rather than on broader human
resource responsibilities.

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UNIT 3: CORPORATE REPORTING
INTRODUCTION

UNIT OBJECTIVES

After studying this unit you should be able to:

 Explain the need for financial reporting, internal controls, risk management and
auditing.
 Identify the various committees responsible for the above functions.
 Discuss the processes of each of the aforementioned functions.
 Analyse the links between the functions discussed in this unit.

UNIT CONTENT

Topic 1: Financial Reporting

Topic 2: Internal Controls

Topic 3: Risk Management

Topic 4: Auditing

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Topic 1: Financial Reporting

1.0 Introduction

Financial reporting facilitates dissemination of information to various stakeholders to

inform them of the financial position and performance of the concerned
organisation. These reports are the outputs of the accounting and reporting system
of an organisation that help enhance strategic planning. But considering the number
of stakeholders involved, statutory and other regulatory requirements, Financial
Reporting is a very vital and critical task of an organisation. It is vital part of
Corporate Governance.

1.1 Objectives

After studying this topic you should be able to:

 Define financial reporting and outline the basic disclosure requirements of

financial reports.
 Explain the purpose and importance of financial reporting.
 Discuss the limitation of financial statements.
 Describe the concept of integrated reporting and its implications.
 Discuss sustainability reporting.

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1.2 Defining Financial Reporting
Financial reporting refers to the statutory disclosure of general purpose financial
information by limited liability entities through annual reports and accounts. It is
primarily concerned with communicating a true and fair view of the financial
performance and financial position of an entity to external parties.

Financial reporting is concerned with one of the five main principles of Corporate
Governance, i.e. disclosure and transparency.

Companies annual reports are much more complex than they used to be as they go
far beyond just numbers. Traditionally, the annual reports would comprise of mostly
a full set of financial statements including:

 A statement of comprehensive income

 A statement of financial position
 A statement of changes in equity
 A statement of cash flows
 Notes to the financial statements

Other disclosure requirements consist of:

 Quarterly & Annual reports (in case of listed companies)

 Prospectus (In case of companies going for IPOs)

 Management Discussion & Analysis (In case of public companies)

The International Accounting Standards Board (IASB) states that :

―The objective of financial statements is to provide information that is useful to a

wide range of users regarding the entity‘s financial position, financial performance,
changes in financial position and management‘s stewardship of the resources
entrusted to it‖.

(Users refer to stakeholders of an entity. Please refer to the topic on stakeholders in

a previous unit to refresh your memory on the different groups of stakeholders.)

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The following points sum up the objectives & purposes of financial reporting:-

 Providing information to management of an organisation that is used for the

purpose of planning, analysis, benchmarking and decision making.

 Providing information to investors, promoters, debt provider and creditors which

is used to enable them to make rational and prudent decisions regarding
investment, credit etc.

 Providing information to shareholders and the public at large in case of listed

companies about various aspects of an organisation.

 Providing information about the economic resources of an organisation claims to

those resources (liabilities and owner‘s equity) and how these resources and
claims have undergone change over a period of time.

 Providing information as to how an organisation is procuring & using various

resources.

 Providing information to various stakeholders regarding performance

management of an organisation as to how diligently and ethically they are
discharging their fiduciary duties and responsibilities.

 Providing information to the statutory auditors that in turn facilitates audit.

 Enhancing social welfare by looking into the interest of employees, trade unions
and Government.

Now let‘s discuss the importance of financial reporting.

1.3 Importance of Financial Reporting

The importance of financial reporting cannot be over emphasized as each and every
stakeholder needs it for multiple reasons and purposes. The following points
highlights why financial reporting framework is important:

 It helps an organisation to comply with various statues and regulatory

requirements. The organisations are required to file financial statements to,

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 Government Agencies. In case of listed companies, quarterly as well as annual
results are required to be filed to stock exchanges and published.

 It facilitates statutory audit. The Statutory auditors are required to audit the
financial statements of an organisation to express their opinion.

 Financial Reports forms the backbone for financial planning, analysis, bench
marking and decision making. Various stakeholders use these for the above
purposes.

 Financial reporting helps organisations to raise capital both domestically as well

as internationally.

 On the basis of financials, the public at large can analyse the performance of an
organisation as well as its management.

 For the purpose of, labour contract, government supplies etc., organisations are
required to furnish their financial reports & statements.

1.4 Limitations of Financial Statements

Knowing the financial performance, position and other information availed in the
financial statements is important. Yet due to the increased informational needs of
various stakeholders, the company still has to disclose more information to satisfy
these stakeholders. Financial statements alone are not enough to give a full picture
of an organisation and its operations. The limitations of financial statements are as
follows:

 Financial statements are historical in nature as they are concerned with past
performance.
 The qualitative aspects of a business are ignored.
 The figures presented are vulnerable to manipulation, i.e. there is always
concern of window dressing.

Because of the above limitations there arose a need for more disclosure of company
information. Various studies have shown that increased information to stakeholders
leads to better access to financing, lower cost of capital, better business relations
with customers and suppliers and greater trust from employees. Therefore,

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Corporate Reporting should provide all stakeholders with the information they
require to conduct business transactions. Over the years, reporting has transformed
to adapt to a volatile and complex external environment which now includes
elements such as the management commentary, governance disclosure and
footnotes to the financial statement. However, even with this additional reporting it
was found that information was insufficient for explaining elements of material non-
financial risk. Some researchers have proven that for some organisations financial
capital makes up only about 20% of the total value of the organisation. There are
other forms of capital that result in value for an organisation, Human Capital,
Intellectual Capital, Manufactured Capital, Social and Relationship Capital and
Natural Capital.

Activity 1.1
a. Define Financial Reporting and state the objectives and importance of Financial
Reporting.
b. Explain the need for financial reports for the following stakeholders:
i. Shareholders.
ii. The community
iii. Creditors

1.5 Integrated Reporting

The International Integrated Reporting Council defines integrated reporting as ―a
process founded on integrated thinking that results in a periodic integrated report by
an organisation about value creation over time and related communications
regarding aspects of value creation.‖ An integrated report is ―a concise
communication about how an organisation‘s strategy, governance, performance and
prospects, in the context of its external environment, lead to the creation of value in
the short, medium and long term.‖ Integrated Reporting was developed in response
to various stakeholders‘ needs for enhanced reporting that draws the link with
strategy, risks, KPIs and financial performance. This is one way that an organisation
signals a holistic view of the interests of all stakeholders.

According to the IIRC Framework the integrated report should address the following:
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 Organisational overview and operating context.
 Governance: governance structure and how it supports the creation of value in
the short, medium and long term.
 Business model: is the business model resilient?
 Risk and opportunities: how do these affect the organisation‘s ability to create
value and how are they being handled.
 Strategy and resource allocation.
 Performance: to what extent is strategy being achieved?
 Outlook: what are the uncertainties faced by the organisation in achieving its
strategy and what impact might that have for the future?
 Basis of presentation: how was material information presented and arrived at?

1.5.1 The Fundamental Concepts of Integrated Reporting

There are three fundamental concepts that underpin integrated reporting:

1. Value creation for the organisation and for others.

2. The capitals
3. The value creation process

1.5.2 Benefits of Integrated Reporting

 Helps gain a better understanding of the relationship between financial and non-
financial capital.
 There will be improved internal measurement and control systems for producing
reliable and timely nonfinancial information
 Helps reduce the gap between expectation and reality from external
stakeholders.
 Can be used as a platform for improved dialogue and engagement with
stakeholders.
 Promotes higher employee engagement through internal coordination and
collaboration.

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1.5.3 Costs of Integrated Reporting
 There are costs associated with collecting and analysing structured and
unstructured data:
- An organisation would have to invest in the development of new information
systems.
- New control systems and new processes have to be developed within the
organisation.
- Resources have to be dedicated to this function.
- Assurances have to be obtained from third parties.
- A need arises for skilled experts to incorporate all the data into the financial
reports.
 Integrated reporting may lead to proprietary disclosure costs emanating from
the dissemination of competitive information

1.6 Sustainability Reporting

A sustainability report presents the economic, environmental and social effects that a
corporation or organisation was responsible for during the course of everyday
business. Sustainability reporting aims to respond to the idea that companies can be
held accountable for sustainability. In 1987, the former Norwegian
Prime Minister, Gro Harlem Brundtland, chaired a World Commission on Environment
and Development to both formulate proposals and increase understanding of and
commitment to environment and development. The resulting Brundtland Commission
Report laid the groundwork for the concept of sustainable development. This was
defined as ―development that meets the needs of the present without compromising
the ability of future generations to meet their own needs.‖

With that in mind, the early adopters of sustainability reporting attempted to

construct a framework that could convey the good stewardship of companies,
primarily their social and environmental effects. Since then, sustainability reporting

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has evolved to include the ways in which sustainability practices of the company
benefit its profitability and longevity.
Indeed, adopting sustainable business practices may benefit business in many ways.
Companies can:
 save money by using less water and energy and reducing or recycling business
waste
 reduce insurance costs by limiting their exposure to environmental risks
 attract investors who prefer to work with businesses that are environmentally
and socially responsible
 reduce social risks, such as racial or gender discrimination
 improve customer sales and loyalty by enhancing reputation and brand value
 reduce the possibility of potentially costly regulation by proactively undertaking
sustainability initiatives
 attract and retain employees who share similar values
 strengthen their relationship with the community
 contribute to improving environmental sustainability

In short, sustainability reporting has evolved to describe both how the company‘s
practices contribute to the social good and how they add value to the company,
which ultimately provides better returns to its investors. The need for improved
reporting by corporations on sustainability developed over time.

1.6.1 Initial Sustainability Reports

Following the Brundtland Report, financial statement preparers began to ask how
they might communicate not just the financial status of a company‘s operations but
the social and environmental status as well. The concept of a triple bottom line, also
known as TBL or 3BL, was first proposed in 1997 by John Elkington to expand the
traditional financial reporting framework so as to capture a firm‘s social and
environmental performance. Elkington also used the phrase People, Planet, Profit to
explain the three focuses of triple bottomline reporting. By the late 1990s,
companies were becoming more aware of triple bottom line reporting and were
preparing sustainability reports on their own social, environmental, and economic

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impact. Another innovation was life-cycle or full-cost accounting. This reporting
method took a ―cradle to grave‖ approach to costing that put a price on the disposal
of products at the end of their lives and then considered ways to minimise these
costs by making adjustments in the design phase. This method also incorporated
potential social, environmental, and economic costs (externalities in the language of
economics) to attempt to identify all of the costs involved in production. For
example, one early adopter of life-cycle accounting, Chrysler Corporation, considered
all costs associated with each design phase and then made adjustments to the
design. When its engineers developed an oil filter for a new vehicle, they estimated
the material costs and hidden manufacturing expenses and also looked at liabilities
associated with disposal of the filter. They found that the option with the lowest
direct costs had hidden disposal costs that meant it was not the cheapest
alternative. Much of the early sustainability reporting movement was driven by
stakeholder concerns and protests.

Early study into the hows of sustainability reporting led researchers to suggest that
some performance indicators could be quantified. Figure 1.1 shows the sustainable
product indicators identified by Fiskel and colleagues with suggestions on how each
element of economic output might also be measured from an environmental or
societal stance.

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Fiskel‘s research suggests that different elements can be categorized as economic,
environmental, or societal. The study demonstrates how each element may have
quantifiable costs or indicators that can be measured and reported so that users will
be able to consider how those inputs and outputs contribute to the entire life cycle
of a product. Although Fiskel‘s model is rarely reported today, the creation of
quantifiable and measurable social and environmental standards is the basis of the
Sustainability Accounting Standards Board, which uses an approach similar to Fiskel‘s
model.

Summary

While no one disputes the need for transparency, honesty, and accuracy, corporate
governance is about much more than the accuracy of the financial statements.
Compliance is a means to an end. The numbers merely summarise and reflect the
full array of decisions—from strategy to structure to process—that guide a
corporation. Today‘s modern organisations have to deal with increased volatility,
uncertainty and complexity in their environments and as a result there are increasing
demands from various stakeholders. A more comprehensive tool for communicating
the company‘s position is necessary hence the integrated reporting. In order to get a

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better understanding of this topic, you may find it useful to have a refresher on the
module introduction to accounting.

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Topic 2: Internal Controls

2.0 Introduction

Internal corporate governance controls (internal controls) play a vital role in

ensuring the success of a business organisation and preventing corporate fraud.
Hence regular internal audits have to be carried out by auditors employed by the
organisation in order to assess the health of governance processes, operational
health and financial reporting.

Good internal control policies should also be implemented to ensure that the
organisation lives up to its obligations to investors, stakeholders, employees, the
environment, the government and the public at large. Proper implementation of
accounting principles and internal audit rules require that companies establish
adequate and functional internal controls to improve corporate governance
processes. These principles include generally accepted accounting principles and the
Institute of Internal Auditors standards.

2.1 Objectives

After studying this topic you should be able to:

 Define internal controls.

 Describe the five key components of internal controls.
 Explain the controls over financial reporting.
 Discuss the limitations of internal controls.
 Discuss the concept of fraud.

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2.2 Defining Internal Controls
We have already alluded to internal controls in previous topics so by now you should
have an idea of what they are. Under The Committee of Sponsoring Organisations
(COSO) of the Treadway Commission, Internal Control-Integrated Framework,
internal controls are defined as:

―A process, effected by an entity‘s BOD, management and other personnel, designed

to provide reasonable assurance regarding the achievement of objectives in the
following categories: - effectiveness and efficiency of operations; Reliability of
financial reporting; and Compliance with laws and regulations‖

The Turnbull Report (1999) that is part of the UK Corporate Governance Code
focuses on the review of internal controls. It prescribes some of the actions that
should be taken in order to ensure effectiveness, efficiency and compliance of
organisational processes.

2.3 Components of Internal Controls

There are five key components of internal controls:

i. Internal Control Environment

The control environment of an organisation is important due to its pervasive nature.

It determines the tone of ethical values, organisational culture, operating style, and
integrity that have a bearing on the organisation‘s internal controls as a whole.
Management should take reasonable steps to ensure that the control environment is
conducive for utmost organisational discipline. Some of the elements to be
addressed in this regards are

 Commitment to competence of employees at every organisation level.

 Participation by those charged with governance. Concern should be of the
composition of the BOD and the way in which they execute their governance
responsibilities.

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 Management philosophy and operating style. The operating style is influenced by
the formal structures within an organisation and the way in which authority is
exercised. Factors like attitude towards internal controls, and characteristics.
 Human resource policies and procedures. These have to do with the recruitment,
training, promotion, compensation and remedial actions of the organisations
which impacts on the quality of and competence of staff.
 Communication and enforcement of integrity, ethical values and organisational
culture.

ii. Risk Assessment Process

Risk assessment is concerned with identification and analysis of risks faced by an

organisation and their subsequent management. Conditions that could increase the
financial reporting risk are:

 Changes in the regulatory or operating environment

 Changes in personnel
 Implementation of a new or modified information system
 Rapid growth of an organisation
 Changes in technology affecting production processes or information systems
 Introduction of new lines of business, products, or processes

iii. Control Activities

 Segregation of duties: All three aspects of a transaction, ie. authorisation,
execution and recording, should not be done by the same person as this
leaves vulnerabilities of fraud.
 Information processing: This includes general controls that are pervasive and
application controls
 Physical safeguards: Physical security safeguards should ensure that only
personnel with due authority have access to assets.
 Organisational structure
 Record retention

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  Performance reviews

iv. Monitoring

This is a process of evaluating the quality of internal controls and ensuring that
controls are operationally effective. Monitoring can be done on an ongoing basis or
through separate evaluations.

v. Information and Communication

These are the processes or systems that support the identification, capturing and
exchange of information in a manner that facilitates the execution of duties by
employees.

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2.4 The Internal Audit Function and Internal Controls

The Internal Audit function is expected to report on the company‘s internal controls,
amongst other things. It stands to reason then, that management must be directed
to maintain such controls. One could expect these requirements to be detailed in the
company‘s role charters and delegation of authority. Companies should maintain an
effective governance, risk management and internal control framework.

King III provides a brief description of the content of such a framework and
associated activities:

Governance Instruments:

 Internal Audit and associated Charters

 Internal Audit Plan
 Internal Control Framework
 Internal Audit Report

2.5 Controls Over Financial Reporting

Controls fall into two broad categories:

 Preventative controls: These are designed to avoid the occurrence of a material

misstatement in the financial statements, e.g., segregation of duties.
 Detective controls: These are designed to discover material misstatements after
they have occurred, e.g., bank reconciliation.

2.6 Limitations of Internal Controls

 Human judgment- Faults in decision-making or human error may lead to
breakdowns in internal control e.g., errors in the design of computer processing
controls.
 Failure to understand or take action- There may be ineffective control because
individuals may not understand the purpose of a specific control.

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 Inappropriate management override of controls- Management may purposefully
override existing controls, thus making the system of controls ineffective. For
example, a sales director may choose to opt to extend credit to a long-standing
customer in order to create customer goodwill, in contravention of laid down
credit control procedures.
 Collusion by two or more people- leading to circumnavigation of controls.
 Management judgment- The nature and extent of risk the company chooses to
assume may be greater than the nature and extent of the controls it chooses to
implement.
 Cost benefit consideration- A sensible strategy will often need to be adopted in
this regard, especially in smaller companies. For example, the cost of employing
additional accounts staff to ensure adequate segregation of duties in relevant
areas may outweigh the maximum benefit to be derived from improved internal
control.
 Ability to cope with non-routine transactions- the ability to predict the likelihood
of non-routine transactions arising means that it is less likely that systems will be
designed to cope with such transactions.

2.7 Fraud
A fraud is a deliberate act for the express objective of obtaining an advantage or a
gain through deceit of other party/parties.

Types of fraud faced by an organisation:

 Non-existent employees: A payroll account is created and funds are transferred

to the fraudsters account.
 Expense claims: Employees inflate expenses.
 Stealing assets
 Collusion with external parties
 Teeming and lading: Those dealing with money ―borrow‖ and then return it
when auditors arrive. This is then covered up by mis-posting to debtor‘s account.

Fraud can be managed by ensuring a good system of internal controls and ensuring
that audits take place. It is important for every organisation to undertake a fraud

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risk assessment in order to ascertain the susceptibility of fraud to an organisation.
The suspicion of the presence of fraud is usually brought on under three conditions:

 Dishonesty by employees,
 Opportunity of fraud to occur, and
 Motivation for fraud to be committed.

2.7.1 Fraud Risk Management

It is often difficult to uncover fraud once it has occurred which is why numerous
companies have adopted a fraud risk management strategy that is usually divided in
three parts.

a. Fraud Prevention
Internal controls are key to fraud prevention, especially over cash and other financial
assets. The controls should make it difficult for employees to commit fraud. Some of
the controls over fraud prevention include:

- Staff supervision
- Approval and authorization
- Segregation of duties
- Accounting controls
- Strong recruitment procedures
- Adequate control environment
- Clear disciplinary procedures
- Fraud policy statement

b. Fraud Detection

As aforementioned, fraud detection is difficult. It is however, management‘s

responsibility to put in place detective controls for easier detection.

Take a top-down approach to your risk assessment, indicating the areas in which
fraud is likely to occur in your business and the types of fraud that are possible in

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 those areas. Develop fraud risk profiles as part of an overall risk assessment and
include necessary stakeholders and decision makers. In that pursuit the following
applies:

i. Test transactional data for possible indicators of fraud.

In order to effectively test and monitor internal controls, organisations need to

analyse all relevant transactions.

ii. Improve controls by implementing continuous auditing and

monitoring.

Strengthen controls over transaction authorizations and use continuous auditing and
monitoring to test and validate the effectiveness of your controls.

iii. Communicate the monitoring activity throughout an organisation.

If employees are informed that there are systems in place that alert to potential
fraud or breach of controls, and that every single transaction running through
the systems is monitored, then the organisation has a great preventative
measure.

iv. Provide management with immediate notification when things are

going wrong.

It is better to raise any issues right away than explain why they occurred later.
Create audit reports with recommendations on how to tighten controls or change
processes to reduce the likelihood of recurrence.

v. Fix any broken controls [Link] by segregation of duties in order to

make everyone responsible and accountable.

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vi. Expand the scope and repeat.

Re-evaluate the organisation‘s fraud profile, taking into account both the most
common fraud schemes and those that relate specifically to the risks that are
unique to one‘s organisation, and move your investigative lens. Investigate
patterns and fraud indicators that emerge from the fraud detection tests and
continuous auditing and monitoring.

Summary

Internal controls play an important role in corporate governance systems. Controls

help a company prepare an accurate and complete financial statements monthly,
quarterly and annually. An organisation may also hedge, or protect against,
operating risks by implementing functional controls. These risks may relate to
manufacturing activities and technological processes.

Internal controls are applied to identify and manage organisational risks, protect the
investments made by shareholders and safeguard corporate assets. Internal control
aims to enhance business operations and ensure the effectiveness of external and
internal reporting. In addition, an internal control system should be designed to
detect fraud and support management in complying with laws and regulations.

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Topic 3: Risk Management

3.0 Introduction

Risks exist for businesses as well as individuals. Organisations face various numbers
of risks and the environment is also too complex and dynamic to handle effectively.
The pure risk exposures now facing most organisations have become too large in
size and scope to rely on traditional management methods that do not integrate risk
management considerations into all aspects of their planning, organising and
controlling processes. The magnitude of risk varies in organisations as they operate
in different risk environment.

Businesses should identify and assess risk factors that relate to it in advance, so that
appropriate risk management can be put in place. Therefore a requirement of a risk
assessment process is that it can evaluate the extent to which the exposure to a risk
factor increases or decreases the expected vitality of earnings. This emphasises the
necessity of identifying risk factors with sufficient precision to enable efficient and
effective monitoring and control of various risks

3.1 Objectives

 Define risk and explain risk concept

 State the objectives and nature of risk management
 Explain different types of risks

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3.2 Nature and Concept of Risk
Risk is associated with the possibility that accidental or damaging events may occur
resulting in physical injury, loss or damage to property, a legal liability or financial
loss. Scholars in the field of risk management have defined risk as ―the possible
variation in an outcome from what is expected to happen‖. Risks are higher when
the situation makes it more likely that an adverse event will occur. Risk management
is concerned with identifying, assessing and controlling the risks facing a business
and incorporating the risk issues into decision making processes.

3.3 Corporate Risk Management

Corporate risk management is a process, affected by an organisation‘s board of
directors, management and other personnel, applied in strategy all over the
enterprise, designed to identify potential events that may affect an organisation, and
manage risks to be within its risk appetite, so as to provide reasonable assurance
regarding the achievement of organisational objectives. Corporate risk management
therefore includes the following fundamental issues:

 It is an on-going process encompassing the whole organisation.

 An integrative process affected by personnel at every level of an organisation.
 It is applied in strategic planning and includes organisational level portfolio risk
analysis.
 Provision of reasonable assurance to the organisational management and board
of directors.
 It is an effective way to achieve organisational objectives in more than one
separate but overlapping categories.

3.4 Objectives of Risk Management

Organisations come in different shapes and sizes and vary significantly in the level of
sophistication and degree of centralisation. The specific objectives of risk
management, therefore, differ naturally from one organisation to another and

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depend on a specific risk environment of the company. Some of the more general
for aspects of risk management include: -

a. Creation of Transparency

Ensure that the top management, the board of directors, the owners, and potential
investors can evaluate the organisation‘s significant exposures and appraise how
they are dealt with by the organisation.

b. Enhance risk awareness

Create an organisational structure where risk awareness is an integral part of all

management decisions and thus are taken into account when deciding on future
business venues and where all employees can effectively handle the exposures that
apply to their specific areas.

c. Control risk environment

 Minimise the probability – potential severity of the future losses
 Ensure adequate financial protection against adverse events
 Establish and maintain preparedness to deal effectively with significant adverse
events
 Minimise the overall ―total risk cost‖
 Focus on risk appetite
 Maximise the probability of success and minimize the risk of failure in reaching
organisational objectives

3.5 Classifications of Risk

Product risk: It addresses the possibility that customers will not buy the products
or services of a business as projected in demand and quantity or its demand may
drop drastically as a result of competitors product or service quality, close
substitutes provided in the market.

Macro – economic risk (economic risk): These are effects on business due to
unexpected changing economic conditions. Economic stagnation will result in a fall

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on consumer demand for goods and services and the business will suffer as the
sales returns decrease.

Technology risk: It can affect the production system, in line of research and
development, product design that companies provide or the methods they use to
produce purchase or deliver goods and services to customers.

Credit risk: Under lending, credit risk arises through the provision of loans and
contracts to support customer‘s obligations. In trading activities, credit risk results
from the possibilities that the party with whom the organisation is trading (counter
party) may not be able to fulfil its contractual obligation on or before the settlement
date. Hence it is that risk that a counter party to a financial transaction may fail to
perform according to the terms and conditions of the contract.

Market risk /Price risk: It is the risk of a decrease in value of financial portfolio as
a result of adverse movement in market variables such as prices, currency exchange
rates and interest rates. This is a general term for risk of an adverse movement in
market prices of shares and bonds or goods and services.

Interest rate risk: These are the risks of a loss that an organisation could suffer as
a result of adverse consequences due to fluctuations in interest rates. Most financial
institutions face interest rate risks. For example, when interest rates fluctuate, a
bank‘s income and expenses and economic value of its assets are affected. The
effect of these fluctuations is reflected in the bank‘s financial statements.

Foreign exchange risk: The possibility of making unexpected gains or losses from
the changes in a foreign exchange rate

Reputational risk: It is the risk of negative information about an organisation‘s

business practices and/ or internal controls being generated and exposed. Such
exposure may cause a decline in customer base and/or a reduction in revenue. A
threat can arise from reputational risk, where the activities of a firm could damage
its reputation and goodwill in the eyes of the customers.

Liquidity risk: Liquidity is an organisation ability to meet its financial obligations

within a given period of time. Hence liquidity risk is the possibility of an expected

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shortage of cash which could result in an inability to pay obligations when they fall
due or even insolvency unless additional sources of liquidity can be found.

Legal risk: This arises as a result of violations of or non – compliance with laws,
rules, regulations, prescribed policies and ethical standards. This risk also arises
when laws or rules governing certain products or activities of an organisation‘s
customers are unclear or untested. Noncompliance can expose the organisation to
fines, financial penalties, payment of damages, and the voiding of contracts. It can
also lead to diminished reputation, reduced franchise value, limited business
opportunities, restricted developments and an inability to enforce contracts. Hence
these are the risk that some will claim against the organisation through legal action.

Gearing risk: In case of non-financial companies, it is the risk of high borrowing in

relation to the amount of shareholder‘s capital in the business. High gearing
increases the risk of both volatility in earnings per share and insolvency due to
inability to meet debt repayment schedule.

Country risk: It arises when conditions or events in a particular country reduce the
ability of counterparties in that country to meet their obligations. These conditions
could include issues such as the imposition of exchange rate controls, a debt
moratorium, insufficient foreign exchange, political instability and social strife or civil
war.

Disaster risk: The possibility that an expected catastrophe may occur adversely
affecting the organisation such as fire, floods, terrorist attacks and ill health of key
executive.

Regulatory and political risk: This arises from the possibilities that unexpected
new laws or regulations might be introduced thus affecting the business and the
profitability of an organisation

Operational risk: It is the risk of loss occurring as a result of inadequate systems

and controls; human error; or management failure.

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3.6 Risk Appetite
Risk appetite is the financial amount which the organisation is prepared to accept
and tolerate as a financial loss in a given time period. These losses usually fall in low
– frequency / low – impact loss category. Although an organisation may make
financial provisions for these loses, they can be managed by internal control
measures. Hence risk appetite is the level of risk that a company is willing to take or
accept. Risk appetite is the willingness of an organisation to take on risks. It is also
called delimiting risks which means setting a limit or boundary to risks.

An organisation needs to know the magnitude of risks it faces and the extent to
which such risks can be safely tolerated. A good description of a company's risk
appetite will have qualitative as well as quantitative elements. On various issues, it
may include definitions of what is acceptable and what is not. When determining risk
appetite, it is recommended that the range of acceptable variation and the,
application of quantitative or qualitative terms (such as earnings at risk versus
reputation risk) is be stipulated.

Once the organisation's overall risk appetite has been clearly defined, the board and
executive management should communicate it broadly throughout the entire
organisation to ensure that all actions of the company are in line with the risk
appetite. At the same time, executive management should operationalize the risk
appetite in various steps and for all relevant risks and business units.

3.7 Risk Management

Organisations can select from one of the following courses of action to deal with
risks:

 Risk Transference: A risk exposure is identified and subsequently transferred to a

third party who is prepared to take the risk, e.g. an insurance company. When an
insurance company agrees to pay the potential losses of an insured, the effect of
the risk faced by the insured is transferred.

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 Risk Avoidance: This is where any activity that may lead to a high exposure is
identified and subsequently avoided. For example, in the 1980s many companies
decided not to extend their operations to South Africa, so as to avoid the risk of
political instability during Apartheid.

 Risk Reduction: Risk is identified and action taken to reduce its potential [Link]
many companies go to great lengths to promote employees‘ safety in order to
avoid the financial costs of injury and the down time and disruption of smooth
operations.

 Risk Acceptance: A specific risk is identified and accepted as part of daily

activities. This is usually the case when the odds are strongly against an event
happening or when the potential loss is low.

3.8 Attitudes Towards Risk

Risk Seeker: is an individual who prefers risk or is risk-loving as long as the risky
outcome brings the same expected income as a certain income.

Risker Averse: s a person who prefers a limited risk given a certain income with the
same expected value. Most people are risk averse.

Risk Neutral: A person is called risk neutral, if he is indifferent between a certain

given income and an uncertain income with the same expected value.

3.9 Risk Management Frameworks

A risk management framework is a systematic approach to identifying and managing
risks within a business. An example of such a framework is:

 Identification of risks: A risk committee is usually set up to address this issue.

 Risk appetite: The organisation must decide how much risk they are willing to
take on, this is usually done by directors. In practice there are different levels of
risk for different areas of the organisation.
 Risk quantification:
 Control

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 Monitor and review

3.10 Risk Committee

The Risk Committee (the ―Committee‖) is an independent committee of the Board of
Directors that has, as its sole and exclusive function, responsibility for the risk
management policies of the Corporation‘s global operations and oversight of the
operation of the Corporation‘s global risk management framework.

The risk committee advises the board on the group‘s overall risk appetite, reviews
and approves the Group‘s risk management strategy, advises the audit committee
and the board on risk exposures and reviews the level of risk within the group.

The Committee will assist the Board of Directors in fulfilling its oversight
responsibilities with regard to the risk appetite of the Corporation and the risk
management and compliance framework and the governance structure that supports
it. Risk appetite is defined as the level and type of risk a firm is able and willing to
assume in its exposures and business activities, given its business objectives and
obligations to stakeholders.

In carrying out its oversight responsibilities, each Committee member shall be

entitled to rely on the integrity and expertise of those persons providing information
to the Committee and on the accuracy and completeness of such information,
absent actual knowledge of inaccuracy.

The Committee will have the resources and authority appropriate to discharge its
responsibilities, including sole authority to retain and terminate the engagement of
such consultants or independent counsel to the Committee as it may deem
necessary or helpful in carrying out its responsibilities, and to establish the fees and
other terms for the retention of such consultants and counsel, such fees to be borne
by the Corporation.

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3.10.1 Composition of the Risk Committee
The Committee will consist of three or more independent directors. At least one
member of the Committee shall have experience in identifying, assessing, and
managing risk exposures of large and complex financial firms.

The Committee Chairman shall be a director who is:

 Not an officer or employee of the Corporation and has not been an officer or
employee of the Corporation within the last three years;
 Not a member of the immediate family of a person who is, or who has been an
executive officer of the corporation within the last three years and
 An independent director under Securities and Exchange Commission standards.

Committee members and the Committee Chairman:

a. Shall be appointed annually by the Board of Directors on recommendation driven

by Corporate Governance and Nominating Committee and
b. Serve at the pleasure of the Board. The Committee shall report directly to the
Board.

3.10.2 Committee Procedures

Except as limited by law, regulation or the rules of the specific corporations e.g.
Stock Exchange as they may decide, the Committee may form subcommittees for
any purpose that it deems appropriate and may delegate to such subcommittees or
to members of the Corporation's management such power and authority as it deems
appropriate, provided, however, that any such subcommittees shall meet all
applicable independence requirements and that the Committee shall not delegate to
persons other than independent directors any functions that are required — under
applicable law, regulation, or stock exchange rule — to be performed by
independent directors.

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The Committee shall meet as frequently as necessary to fulfill its duties and
responsibilities, but not less frequently than quarterly. A meeting of the Committee
may be called by its chairman or any two members of the Committee.

The Committee may meet in joint session with the Audit Committee of the Board
from time to time to discuss areas of common interest and significant matters
including, but not limited to, major investment portfolio issues, frauds, major
regulatory enforcement actions, major litigation or whistleblower matters, and
systemic technology issues.

The Committee may request any officer or employee of the Corporation, or any
special counsel or advisor, to attend a meeting of the Committee or to meet with
any members of, or consultant to, the Committee. The agenda for each Committee
meeting will provide time during which the Committee can meet separately in
executive session with management, the Chief Risk Officer, the Chief Compliance
Officer, the independent auditors and as a Committee to discuss any matters the
Committee or these groups believe should be discussed.

The Committee shall fully document and maintain records of its proceedings,
including risk management decisions. Minutes of its meetings will be approved by
the Committee and maintained on behalf of the Committee. The Committee shall
report its activities to the Board of Directors on a regular basis and make such
recommendations as it deems necessary or appropriate.

Summary

Businesses should identify and assess risk factors that relate to it in advance, so that
appropriate risk management can be put into place. Therefore a requirement of a
risk assessment process is that it can evaluate the extent to which the exposure to a
risk factor increases or decreases the expected vitality of earnings. This emphasizes
the necessity of identifying risk factors with sufficient precision to enable efficient
and effective monitoring and control of various risks

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Risk management is a strategic component and an integral element of corporate
governance. The board has a responsibly to ensure that the appropriate systems, for
risk management is in place and that such systems meet the requirements of the
company at any time. Effective risk control requires a well –supported risk management
programme with clearly defined risk management strategy that, in turn, should be
consistent with business strategies and objectives. It is important to note that controls
are established for the identified risks that the organisation intends to manage.

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Topic 4: Auditing

4.0 Introduction

One of the main principles in the UK Corporate Governance is Accountability. This

means that the Board is accountable to shareholders and management is
accountable to the Board. Furthermore, the Board has a duty of care, skill and
diligence amongst others. In pursuit of this, directors should appoint auditors or an
audit committee. Over the past decade there have been numerous international
scandals that have brought about the need for enhanced accountability. The UK
Corporate Governance Code launched the Cadbury Report and the Greenbury Report
where it prescribes that the board appoints an audit committee made of non-
executive directors among other thing. The Sarbanes Oxley Act 2002 was launched
in the USA to elucidate the role of the audit committee. The statutory requirements
of audited financial statements enhance the accountability of directors and ensure
that shareholder interests are safeguarded.

4.1 Objectives

After studying this topic you should be able to:

 Explain the role of audit in an organisation.

 Explain the importance of audit in the context of agency theory and
informational asymmetry
 Discuss the role of the audit committee within an organisation
 State and describe the role of the internal audit function.

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4.2 Role of Audit
Auditing is defined as:

―A public interest activity that provides assurance to the users of financial

statements that an independent professional has performed sufficient examination to
express an opinion on the fair presentation of those financial statements.‖

From this definition we can extract two main ideas. The first being, auditing is done
in order to ensure that a true and fair view of an entity‘s activities is presented in the
financial statements. Secondly, auditing is undertaken by independent individuals on
behalf of investors who rely on published financial statements for their assessment.

4.2.1 The Agency Theory

The main reason for auditing is the agency theory that asserts that a problem arises
when there is a split between management and ownership in an organisation. It
argues that managers are the custodians of an organisation (the agents) and its
operational activities and therefore have a duty to act in the best interest of the
shareholders (the principal). It is assumed that the organisation exists for the benefit
of its shareholders who are interested in the maximisation of their wealth. However,
management is unlikely to be purely on the pursuit of shareholder wealth
maximisation as this may go against their self-interest. We have seen many
evidences of this in practice, where certain actions by directors have ended in the
closure of large corporations. An assumption made in the agency theory is that both
the agent and the principal are assumed to be rational economic persons, meaning
they both are motivated by self-interest. The agency theory seeks to provide a
means through which optimal performance by the agent on behalf of the principal is
enhanced.

4.2.2 Information Asymmetry

Information asymmetry is a situation where two parties have access to different
levels of information, namely management who are involved in the day to day

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running of the business and shareholders who rely on reporting by management.
Information asymmetry has two aspects.

 Moral Hazard: a moral hazard is where owners are unable ascertain the true
efforts made by management in pursuit of their contract (maximising shareholder
wealth) which inevitably creates a ‗hazard‘ of complacency on the side of
management. Managers can conceal their bad behaviour through for example,
misrepresenting the outcomes of actions they have taken in financial statements.
 Adverse Selection: whereas moral hazard relates to actions that have already
been taken by management and concealing the outcomes, adverse selection deals
with concealing information before decisions are made. Managers are incentivised
to do this so that shareholders are not able to assess their actions accurately in
the future. To elaborate further, one is unable to properly ascertain whether the
right decision was made because they do not have the same information available
to them as management did before the action was taken.

Informational asymmetry means that in order for shareholders to rely on financial

statements produced by management they have to incur monitoring costs. Auditing
is one such cost. The auditing of financial statements helps to safeguard the
interests of shareholders who are not involved in the operational activities of an
organisation.

4.3 The Audit Committee

Activity 4.1
Why do you think the audit committee should be made up of NEDs (non-executive
directors) as opposed to EDs (executive directors)

The Smith Report of 2003, which is part of the UK Corporate Governance Code,
specifically focuses on the audit committee and lays out the following prescriptions:

 The Chairman of the Board cannot be a member of the audit committee.

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 At least one of the members on the committee should have relevant expertise in
financial management.
 Appointments should last for 3 years but is extendable.

 The committee should be report directly to the Board to ensure independence.

 There should be a minimum of three meetings a year (audit plan review, interim
statement review, full annual report review).

 There should be a minimum of one meeting with external and internal auditors
without management to discuss audit issues.

 The key roles are oversight, assessment and review, or preparing the audit plan
and carrying out the audit.
 The committee should review the company‘s internal financial controls.

 The committee should monitor and review the internal audit function.

 The committee is responsible for the oversight of the external auditors and have
procedures to ensure their independence.
 Chairman of the committee should be present at AGM to answer audit related
issues.
 Details of the committee‘s role, names and qualifications of members, how
responsibilities were discharged, non-audit services provided by external auditors
and how independence was safeguarded.

The audit committee forms part of the principles of good governance under
accountability and audit. An organisation is expected to make formal and
transparent arrangements for considering how they should apply the financial
reporting and internal control principles and for maintaining an appropriate
relationship with the auditors.

4.3.1 Role of the Audit Committee

The main role of an effective audit committee is to ensure oversight in three specific
areas as depicted in the following diagram.

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 Conduct and integrity of
Financial Reporting

OVERSIGHT
Oversight of and
Risk Management,
communication with
including internal
independent auditors,
accounting and
both internal and
disclosure controls
external

Figure 4.1: The role of the audit committee

4.4 The Internal Audit Function

Internal audit can be defined as ―An independent, objective assurance and
consulting activity designed to add value and improve an organisation‘s operations.
It helps an organisation to accomplish its objectives by bringing a systematic,
disciplined approach to evaluate and improve the effectiveness of risk management,
control and governance processes‖. Essentially, it is an appraisal or monitoring
activity established by the BOD for the review of the accounting and internal control
systems.

The definition encompasses the main functions that are performed by internal audit.
Which are:

1. Provides Assurance: this service is given to stakeholders who are assured of

the effectiveness and efficiency of the organisations policies, operations and
compliance with regulatory obligations.
2. Assessment and recommendations: The audit team assesses the current
internal controls, governance processes and risk management of an organisation
and makes recommendations to the board for more effectiveness and efficiency
in decision making.

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4.4.1 Scope of Internal Audit
The Scope of the Internal Audit function in an organisation is broad. It covers the
following:

 Compliance Audits (internal controls): In order to achieve objectives of

an organisation, compliance with policies and procedures is necessary. In relation,
auditing would include identification of controls, testing controls and reporting on
controls.

 Fraud Investigation: If fraud has been identified further investigation is

needed in order to ascertain the cause and extent of the fraud.

 Management Audits: This would include a review of managers‘ and their

division‘s performance. More specifically, it may entail a review of the achievement
of targets, adherence to rules and procedures, staff performance, operational
efficiency etc.

 Post Implementation: At the end of a project an appraisal is needed to

determine if project objectives were met. This is usually done by a project manager
but in some instances and independent project review is conducted by the audit
department. Some factors that may come under review are on time delivery,
effectiveness of the project manager, suitability of the project plan, on budget
delivery and errors or issues of the project.

 Social and Environmental Audits: This type of audit focuses on the

organisation‘s performance related to Corporate Social Responsibility and
environment issues. This topic will be covered in more detail later. The audit focuses
on adherence to social and environmental targets and procedures.

 Value for Money Audits: These types of audits are more common in non-
profit organisations. Auditors will examine the Effectiveness, Efficiency and Economy
of a department and recommend improvements.
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4.4.2The Internal Audit Process
1. Establish and communicate the scope of the objectives to management.
2. Develop an understanding of the business area under review
3. Describe the key risks to the business for the period under review.
4. Identify existing control procedures for the risks identified.
5. Develop and execute a risk based sampling and testing approach to determine if
controls where adequate and effective for management of risks for the period
under review
6. Report the problems identified.
7. Negotiate action plans with management to address problems.
8. Follow up on reported finding.

4.4.3 Ensuring Effectiveness of an Internal Audit

a. Independence
Internal Audit is an independent function from management, therefore they do not
report to management. It is important for internal auditors to have a reporting line
which is independent of the function on which they are reporting so as to maintain
their objectivity and independence. In order to maintain independence:
- The head of internal audit must report to a high level, ie. The Audit Committee or
Chairman.
- The activities of internal audit must not be interfered with.
- The head of internal audit must communicate directly with the BOD through the
audit committee

b. Ethics

This topic will be addressed in greater detail later in this module. However, it is
noteworthy to state that in order to be effective auditors must operate with high
ethical standards.

c. Other Elements of Effective Internal Audit

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 Adequate numbers of audit staff
 Suitably skilled audit staff
 Standardised and robust audit procedures
 Authority to investigate
 Clear leadership
 Review of the whole organisation

4.5 Role of Internal Audit in Corporate Governance

Often, mention is made of the four pillars of Corporate Governance including, the
BOD, Management, External Auditors and Internal Auditors. The role that internal
audit plays in corporate governance relates to the extent it contributes to the audit
committee in effectively performing its responsibilities.

Activity 4.1
a. Explain the role of the audit committee within an organisation.
b. Discuss the process of internal audit within an organisation.
c. Explain why the audit committee should be made up of NEDs (non-executive
directors) as opposed to EDs (executive directors).

4.6 External Audit

―An external audit is an audit of the financial statements expressing an opinion on
whether the organisation‘s financial statements are free from material
misstatements, whether due to fraud or error.‖

The audit committee has specific responsibilities in respect of the external auditors,
including recommending the appointment, reappointment and removal of the
external auditor, approving fees paid for audit and non-audit services, and agreeing
on the terms of engagement with the external auditor.

One of the key issues in auditing is that the audit committee should annually assess
the independence, objectivity and effectiveness of the external audit process,
considering of the ethical framework applicable in the jurisdiction in which the
organisation is operating. The audit committee should report annually to the board

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on their assessment with a recommendation on whether to propose to the
shareholders that the external auditor be reappointed. The audit committee section
of the annual report should also discuss the annual assessment of the external audit
process by the audit committee and also include information on the length of tenure
of the current audit firm, when a tender was last conducted, and any contractual
obligations that acted to restrict the audit committee‘s choice of external auditors.

In relation to potential threats to objectivity, the audit committee should seek

reassurance that the auditors and their staff have no financial, business,
employment or family and other personal relationship with the company which could
adversely affect the auditor‘s independence and objectivity. The audit committee
should seek from the audit firm, on an annual basis, information about policies and
processes for maintaining independence and monitoring compliance with relevant
requirements, including current requirements regarding the rotation of audit
partners and staff.

Summary

Corporate governance involves decision making, accountability, and monitoring

which require relevant and reliable information with Accountability which involves
measuring, reporting, and transparency. Monitoring also involves systems and
feedback and hence Auditor‘s primary role is to check whether the financial
information given to investors is reliable as stakeholders rely on financial statements
to make economic decisions. Audit provides confidence, adds value and reduces
uncertainty and risk.

To meet its obligations to shareholders, the board must ensure that it receives
relevant and reliable information. The Audit Committee and the Auditors need to
maintain an ongoing dialogue independent of management and the rest of the
board.

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UNIT 4: BUSINESS SUSTAINABILITY, CSR AND ETHICS

INTRODUCTION

Some of the more contemporary issues in corporate governance involve business

sustainability, corporate social responsibility (CSR) and ethics. All of which are
concerned with enhanced accountability towards stakeholders other than
shareholders. While some are of the opinion that pursuing CSR activities or following
sustainability practices is counter intuitive to an organisations bottom line and
consequently to the shareholder maximisation objective, others are offer a more
nuanced perspective. Some scholars believe that business sustainability, business
ethics and CSR may counter intuitively increase shareholder wealth. In this final unit
of the module we will explore how these three components affect business and
highlight the importance of each of them for the modern corporation.

OBJECTIVES

After studying this unit you should be able to:

 Explain business sustainability

 Identify corporate social responsibility
 Determine moral and ethical codes of conduct
 Apply ethics in organisations

UNIT CONTENT

Topic 1: Business Sustainability

Topic 2: Corporate Social Responsibility
Topic 3: Moral and Ethical Codes of Conduct
Topic 4: Business Ethics
Topic 5: Ethical Leadership in Organisations

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Topic 1: Business Sustainability

1.0 Introduction

There is growing recognition across the business world that the reductionist ‗mind
set‘ founded on unlimited economic growth impervious to the social and
environmental impacts of commercial activities will not resolve the converging
environmental, social and economic crises now faced by the global community. An
ever growing number of Boards and CEOs are grappling with a notion of
sustainability and attempting to define precisely what it means for their business.

The primary aim of this topic is to capture this transition and define what businesses
are doing to adopt a more sustainable approach. Looking at some case studies, the
topic will attempt to demonstrate how individual businesses are attempting to align
their activities to address global sustainability challenges such as climate change and
carbon reduction, energy and water scarcity and poverty reduction.

1.2 Objectives

After studying this topic you should be able to:

 Define business sustainability

 Differentiate Business Sustainability from Corporate Social Responsibility
 Understand the Challenges for Corporate Sustainability
 Illustrate the life cycle of goods
 Explain why sustainability is good for business
 Discuss how governments can encourage sustainability

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1.2 Definition of Sustainability

Policy-makers and decision-makers working to address environmental and

development issues have traditionally used the terms ‗sustainability‘ and ‗sustainable
development‘ almost interchangeably. Both terms have the word ‗sustain‘ at their
roots, which is used in everyday language. It is a word derived from Latin words–
‗sub‘ and ‗tenere‘ where ‗sub‘ meant under or towards and ‗tenere‘ to hold or keep.

There are several detailed meanings defined in most dictionaries, depending on the
context. Most of them imply supporting or keeping going. ‗Keeping going‘ does not
of course mean the same thing as ‗keeping‘ though some notions of sustainability
appear to confuse the two. One understanding is that sustaining implies something
that persists but it does not imply something that is static or unchanging. It implies
something dynamic and can also imply a radical change in people‘s practices rather
than continuing with ‗business as usual‘.

There are many types of sustainability being ecological, economic, financial, social,
political, and institutional, depending on what is being sustained. Moreover,
definitions of sustainability vary enormously. Here is a sample of definitions of
sustainability:

 "Sustainable means using methods, systems and materials that won't deplete
resources or harm the natural cycles" (Rosenbaum, 1993).

 ―Sustainability identifies a concept and attitude in development that looks at a

site's natural land, water, and energy resources as an integral aspects of the
development" (Vieira, 1993)

 "Sustainability integrates natural systems with human patterns and celebrates

continuity, uniqueness and place making" (Early, 1993).

Perhaps the single most accepted definition of sustainability emanated in 1987 from
the Brundtland Report. Entitled ‗Our Common Future‘, the report attempted to
identify a path for sustainable development embracing both multilateralism and

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interdependence of nations and placing environmental issues firmly on the political
agenda. The report summarised sustainability as follows:

 "Meeting present needs without compromising the ability of future

generations to meet their needs" (World Commission on Environment and
Development, 1987).

The definition of sustainability outlined in the Brundtland report contains two key
concepts. Firstly, the concept of needs, in particular the essential needs of poverty-
stricken populations across the globe, to which overriding priority should be given.
Secondly, the idea of limitations imposed by the state of technology and social
organisation on the ability of the environment to meet present and future needs.

Sustainability can be represented diagrammatically in many ways. Figure 1.1 is one

that many people find meaningful, and it implies that there are three pillars of
sustainability - economic viability, environmental protection and social equity. Other
dimensions besides environmental, economic and social could be represented. For
instance, in a more developed form of the figure, ‗technical feasibility‘, ‗political
legitimacy‘ and ‗institutional capacity‘ could also be included. However, throughout
this topic, you will see that these three components of sustainability will be referred
to routinely.

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Figure 1.1: Sustainable development: where ecological, economic and social aspects
overlap.

Complicating further the issue of definition of sustainability is the tendency of

businesses to define sustainability in relation to what it means to that business.
These definitions will frequently refer to the efficiency and reduction of resources,
carbon management, ethical sourcing and treatment of staff, all concepts that will
be explored later in the module.

It soon became apparent that large corporations tend to define sustainability in a

manner that makes sense to them but in many aspects differs from more established
definitions of sustainability and sustainable development.

Activity 1.2
Read the following case on climate change
Climate is the biggest risk to business (and the world)

Companies and investors are waking up to the dangers posed by climate change and
extreme weather. Many now consider environmental risks, such as droughts and
wildfires, to be even more dangerous than turbulent markets, cyberattacks or
geopolitical snafus. Business leaders and experts surveyed by WEF said that extreme

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weather, migration caused by climate change and natural disasters are the three
risks they're most likely to face in 2019. Each of the climate-related risks also ranks
among the top five issues in terms of potential impact. "There is more investor
pressure and more requirements on companies," said John Drzik, president of global
risk and digital at insurance broker Marsh. "They have already been facing pressure
from consumers to make their products more climate friendly, but the amplified
investor pressure is new."

Climate risks
Natural disasters and extreme weather caused around $160 billion worth of damage
in 2018, according to reinsurance company Munich RE. Control Risks, a consultancy,
predicts that figure will be surpassed in 2019. "From storms to floods to droughts
and forest fires, the costs of interrupted production, distribution, sales and travel will
skyrocket in 2019," the group said in its annual risk report. Climate disasters point to
several areas where businesses face increased risks. The first is supply chains. A
report from University of Maryland and software firm Resilinc showed that global
supply chain disruptions caused by weather doubled in 2017. The risk doesn't affect
just the developing world, where infrastructure is often weaker. Hurricanes Harvey,
Irma and Maria combined that year to make the United States the most disrupted
region for the first time.

The most dramatic example of a company coming under pressure from risks related
to the environment is Pacific Gas and Electric. The California utility company is facing
billions of dollars in claims over the deadly 2018 Camp Fire, and it said earlier this
week that it would file for bankruptcy on January 29. The company cited at least $7
billion in claims from the Camp Fire, which caused 86 deaths and destroyed 14,000
homes. It is believed the fire was started when a PG&E power line came in contact
with nearby trees. In the bankruptcy filing, the company cited the "significant
increase in wildfire risk resulting from climate change" as one of the reasons for its
decision. "We simply wouldn't be seeing the catastrophic weather events we've
witnessed in recent years if not for the amplifying effect of climate change," said
Michael Mann, director of the Penn State Earth System Science Center.

Business response
Top investors are demanding that more companies draw up environmental action
plans. They're also asking CEOs to consider risks to their businesses caused by
shifting consumer attitudes towards climate change. Alison Martin, the chief risk
officer at Zurich Insurance Group, said it doesn't matter whether the company's
leadership "believes in climate change or [what they think] the causes of it are." "If
you were a plastic straws manufacturer a few years ago thinking about your strategy
going forward, maybe you weren't anticipating that consumer sentiment could so

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quickly and so radically move against you," she said. Shareholders are becoming
increasingly vocal. Norway's $1 trillion sovereign wealth fund launched a big push for
sustainability in September, saying it will be using its power as the world's biggest
stockholder to influence companies to behave more responsibly. Last month,
investors managing assets worth $32 trillion called on businesses to step up efforts
to tackle climate change. In a landmark climate report last year, the United Nations
last year called for "rapid, far-reaching and unprecedented changes in all aspects of
the society." It warned that the world has only 12 years to avert a climate disaster.
Drzik said the UN timeline made companies wake up to the urgency. "View of risks
tends to be dominated by the short-term horizon, and climate is still seen as more
long-term than geopolitical risk ... but that report has started to pull more focus on
it," he said. Maersk (AMKBY), the world's biggest shipping company, recently said it's
aiming to be carbon neutral by 2050 and urged other shipping companies to do the
same. Last month, Shell became the first energy company to link executive pay and
carbon emissions.
Source: [Link]
wef-davos/[Link])

a. According to the above case why are businesses concerned about climate change
b. Is what you read in the case an issue of concern to you and why?

1.3 Sustainability and Corporate Social Responsibility

The definition of sustainability is further complicated in the corporate context rather

than clarified. Corporations talk of sustainability in a variety of ways applying to a
broad range of topics – financial, social or environmental. Purists would argue that it
is often applied inappropriately to encompass notions of durability and resource
efficiency. Perhaps even more confusing is the use by many business leaders of the
term interchangeably with notions of corporate responsibility (CR) and corporate
social responsibility (CSR).

Corporate social responsibility (CSR, also called corporate conscience, corporate

citizenship, social performance, or sustainable responsible business/Responsible
Business) is a form of corporate self-regulation integrated into a business model.
CSR policy functions as a built-in, self-regulating mechanism whereby a business

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monitors and ensures its active compliance with the spirit of the law, ethical
standards, and international norms. The goal of CSR is to embrace responsibility for
the company's actions and encourage a positive impact through its activities on the
environment, consumers, employees, communities, stakeholders and all other
members of the public sphere who may also be considered as stakeholders.

The term "corporate social responsibility" came into common use in the late 1960s
and early 1970s after many multinational corporations formed the term stakeholder,
meaning those on whom an organisation's activities have an impact. It was used to
describe corporate owners beyond shareholders as a result of an influential book by
R. Edward Freeman, Strategic management: a stakeholder approach in 1984.
Proponents argue that corporations make more long-term profits by operating with a
perspective, while critics argue that CSR distracts from the economic role of
businesses. Others argue that CSR is merely window-dressing, or an attempt to pre-
empt the role of governments as a watchdog over powerful multinational
corporations.

CSR is titled to aid an organisation's mission as well as guide what the company
stands for, and how it will uphold its consumers. Development business ethics is one
of the forms of applied ethics that examines ethical principles and moral or ethical
problems that can arise in a business environment. ISO 26000 is the recognized
international standard for CSR. Public sector organisations (the United Nations for
example) adhere to the triple bottom line (TBL). It is widely accepted that CSR
adheres to similar principles but with no formal act of legislation. The UN has
developed the Principles for Responsible Investment as guidelines for investing
entities.

1.4 The Challenges for Corporate Sustainability - Energy, Water and Waste

1.4.1 Energy and Energy Efficiency

The greatest challenge facing businesses and the community today is access to safe,
clean and sustainable energy supplies. Historically energy has been vital to the
functioning and development of human societies. Humanity learnt how to exploit
energy in fossil fuels in the nineteenth and twentieth centuries. These provided the
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power that drove the industrial revolution, bringing unparalleled increases in
affluence and productivity to millions of people throughout the world. There is a
mounting realization that the world‘s energy systems will need to be changed
drastically if they are to supply our energy needs sustainably on a long-term basis in
the third millennium. Many businesses are at the forefront of this challenge and
energy management and energy efficiency are at the top of their sustainability
agenda.

([Link]
gy_and_energy_efficiency.html)

Energy sources and environmental impact

Fossil fuel comprises coal, natural gas, petroleum, shale oil, and bitumen which all
have carbon. Fossil fuel was created by environmental processes from the remains
of carbon-based substance produced by photosynthesis hundreds of millions of years
ago. Fossil fuels are the main sources of heat and electrical energy. Man has been
using coal for a long period of time. Initially coal was used to generate heat, and
then to generate electrical energy. All these fuels contain carbon, hydrogen, oxygen,
metal, sulfur and nitrogen compounds. When fossil fuels are burnt different
pollutants like fly ash, sulfur oxides, nitrogen oxides and volatile organic compounds
are emitted and fly ash has different trace elements (heavy metals).

Gross emission of pollutants is tremendous all over the world. The atmosphere is full
of pollutants such that they can affect man and his environment. Air pollution also
contaminates water and damages the soil. Wet and dry deposition of inorganic
pollutants leads to acidification of environment. This affects people‘s health, increase
corrosion and destroy cultivated soil and forests.

Most of the plants in the early period of vegetation, especially coniferous trees are
not resistant to pollutant. Extensive forest damage has been reported in Europe and
North America. Other problems connected with human activities, are the emission of
volatile organic compounds to the atmosphere. These emissions cause stratospheric
zone depletion, ground level photochemical ozone formation, toxic or carcinogenic

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human health effects, and growth of the global greenhouse effect, accumulation and
persistence in the environment, (Chmielewski 2014).

All the above shows that humanity should create a sustainable energy for future use
and while doing so they should consider:

1. Implementation of significantly enriched technologies for exploiting the fossil and

nuclear fuels, to ensure that their use, if continued, creates much lower
environmental and social impact;
2. Development and deployment of renewable energy sources on a much wider
scale and
3. Make major developments in the efficiency of energy conversion, distribution and
use.

([Link]
gy_and_energy_efficiency.html)

1.5 Life Cycle of Goods

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Source [Link]
change-and-life-cycle-stuff_.html

Stage 1: Materials Extraction

All products are made with raw materials such as trees or are picked from the earth,
then transported and processed. These events use a large amount of energy. Fossil
fuels are burnt to create this energy and this results in greenhouse gas emissions.
Businesses should rather recycle instead of extracting and processing raw materials
as recycling uses less energy. A green consumer can buy products made with
recycled content to encourage manufacturers to make more recycled-content
products available.

Stage 2: Manufacturing

Making a product with fewer materials or with recycled materials saves energy. A
green consumer should reduce buying of new goods and can reduce waste through
buying durable goods and reuse them, repair, share, and donate those products.

Stage 3: Distribution

Final products have to be transported to a distribution center or warehouse, then to

stores and homes. Further each product life cycle stage of a product need
transportation either by plane, truck, or rail which need the use of fossil fuels for
energy, which can contribute to global climate change. A green consumer should
consider buying locally produced goods and this might decrease greenhouse gas
emissions associated with transport. Also a green consumer should plan ahead to
reduce the number of times they drive to the store.

Stage 4: Usage

Using a product might need energy hence a green consumer should buy appliances
that are energy efficient—such as products with the ‗energy star‘ label. In addition
some consumable products are invented to reduce energy use, such as detergents
that are formulated to work well in cold water and this decreases the demand for

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energy needed to heat water. A green consumer should unplug cell phone
rechargers and video game consoles, whenever they can.

Stage 5: End-of-Life Management

End-of-life management is what happens to our goods after they have been used.
How we manage our goods at the end of their current life can make a big difference
in our environmental footprint. A green consumer can use the following ways to
manage used goods.

a. Reuse
Reusing a good inhibits the necessity to make the product from scratch and this
saves resources, energy and prevents pollution. A green consumer can donate
used electronics (CD players, DVDs, VCRs) to charitable organizations, nursing
homes, libraries, or hospitals.

b. Recycle
Recycling saves energy as making goods from recycled materials needs less
energy than making goods from raw materials. Further recycling paper products
also preserves forests so they can continue to remove carbon dioxide from the
atmosphere. A green consumer should learn how to recycle.

c. Compost
Compost can help increase soil water retention, decrease erosion, and replace
chemical fertilizers. When organic materials like food scraps decompose in the
anaerobic conditions of a landfill, they produce methane, a greenhouse gas over
20 times more potent than carbon dioxide. During composting, the material
decomposes in the presence of oxygen, avoiding methane production. A green
consumer can make compost pile using food scraps, yard trimming and other
organic waste.

d. Energy Recovery

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 Energy recovery from waste is the conversion of non-recyclable waste materials
into useable heat, electricity, or fuel through a mixture of processes. Converting
non-recyclable waste materials into electricity and heat mostly through
combustion or landfill gas recovery is a source of renewable energy and
decreases carbon emissions. A green consumer should be waste conscious.

e. Landfill
When natural materials go to a landfill they decay and produce methane gas, a
greenhouse gas that is more than 20 times more powerful than carbon dioxide.
Many landfills collect landfill gas and use it to produce electricity or as a fuel for
equipment such as boilers.

1.6 Why Sustainability Is Good for Business

The notion that the environment should be treated as a person is relatively new. But
given the prominence of the environmental movement worldwide, no well-managed
business today should be conducted without an awareness of the tenuous balance
between the health of the environment and corporate profits. It is quite simply good
business practice for executives to be aware that their enterprise‘s long-term
sustainability, and indeed its profitability, depends greatly on their safeguarding the
natural environment. Ignoring this interrelationship between business and the
environment not only elicits public condemnation and the attention of lawmakers
who listen to their constituents, but it also risks destroying the viability of the
companies themselves. Virtually all businesses depend on natural resources in one
way or another. Progressive corporate managers recognize the multifaceted nature
of sustainability—a long-term approach to business activity, environmental
responsibility, and societal impact. Sustainability affects not only the environment
but also other stakeholders, including employees, the community, politics, law,
science, and philosophy. A successful sustainability program thus requires the
commitment of every part of the company. For example, engineers are designing
manufacturing and production processes to meet the demands of companies
dedicated to sustainability, and the idea of company-wide sustainability is now

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mainstream. Many of the largest companies in the world see sustainability as an
important part of their future survivability.

1.7 How governments can encourage sustainability

 Protect and restore key ecosystems
 Support small agricultural producers
 Promote green energy
 Combat short lived climate pollutantants
 Bet on adaptation not just mitigation
 Introduction of ecological tax reforms
 Use of complementary currencies

([Link]
n_from_the_grassroots_up.html)

[Link]
change)

1.8 Sustainability Standards

The International Organisation for Standardization, or ISO, is an independent NGO
and the world‘s largest developer of voluntary international business standards. More
than twenty thousand ISO standards now cover matters such as sustainability,
manufactured products, technology, food, agriculture, and even healthcare. The
adoption and use of these standards by companies is voluntary, but they are widely
accepted, and following ISO certification guidelines results in the creation of
products and services that are clean, safe, reliable, and made by workers who enjoy
some degree of protection from workplace hazards. In the environmental area, the
ISO 14000 series of standards promotes effective environmental management
systems in business organisations by providing cost-effective tools that make use of
best practices for environmental management. These standards were developed in
the 1990s and updated in 2015; they cover everything from the eco-design (ISO
14006) of factories and buildings to environmental labels (ISO 14020) to limits on
the release of greenhouse gasses (ISO 14064). While their adoption is still voluntary,
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a growing number of countries allow only ISO 14000-certified companies to bid on
public government contracts, and the same is true of some private-sector
companies.

Another type of sustainability standard with which businesses may elect to comply is
LEED certification. LEED stands for Leadership in Energy and Environmental Design,
and it is a rating system devised by the U.S. Green Building Council to evaluate a
structure‘s environmental performance. The most famous example is the Empire
State Building in New York City, which was awarded LEED Gold status (for existing
buildings). The LEED certification was the result of a multimillion-dollar rebuilding
program to bring the building up to date, and the building is the tallest in the United
States to receive it. There are dozens of other examples of large commercial
buildings, such as the Wells Fargo Tower in Los Angeles, as well as thousands of
smaller buildings and residential homes. LEED certification is the driver behind the
ongoing market transformation towards sustainable design in all types of structures,
including buildings, houses, and factories

Summary

In this topic we learned the many definitions of sustainability and the challenges
associated in defining it. We were able to differentiate sustainability from corporate
social responsibility. We showed the product life cycle and how governments and
consumers can encourage sustainability. Additionally we learned why sustainability is
good for business.

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Topic 2: Corporate Social Responsibility

2.0 Introduction

Corporate Social Responsibility (CSR) is a growing business custom that includes

sustainable development into a firm‘s business model with a constructive effect on
the social, economic and environmental factors. Stakeholders have started to factor
in CSR when selecting a brand or a company. These stakeholders are holding
businesses responsible for the implementation of social change in regard with their
business beliefs, practices and profits. Many organisations focus on four broad CRS
categories being environmental efforts, philanthropy, ethical labor practices and
voluntarism. In this topic we will focus on CSR and what it entails for business

2.1 Objectives

After studying this topic you should be able to:

 Define corporate social responsibility

 Explain the social contract
 Understand the CSR frameworks
 Comprehend the benefits of corporate social responsibility.

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2.2 Definition of Corporate Social Responsibility
Corporate Social Responsibility (CSR) is a term that has gained prominence in the
corporate world. It is the idea that organisations should be aware of the impact of
their actions on people and to act in the best interests of society. Its emphasis is on
the needs and wants of all stakeholders as opposed to just shareholders. Some
synonyms that come to mind are ―Corporate conscience‖, ―Corporate Citizenship‖,
Corporate Accountability etc. CSR is an extended model of corporate governance
based on the fiduciary duties owed to all the firm‘s shareholders.

There are four dimensions of CSR, which serve as a framework for the development
of practices for organisations. They are as follows:

 Economy: Organisations must strive to improve the local economy in which they
operate. Organisations can achieve this by paying taxes, hiring staff from the
local community and funding local community projects.
 Ethics: This refers to doing the right thing. This will be addressed in more detail
in this unit.
 Philanthropy: An organisation can get involved in charities that benefit society.
 Legal: Compliance with laws and regulations is essential.

2.3 The Social Contract

Jean-Jacques Rousseau promulgated the idea of a social contract in 1762 in a book
titled ―The Social Contract‖. In it he posits that individuals give up certain rights to
government so they can be managed for the greater good of all citizens. However,
recently, the social contract terms is used to highlight the relationship that
organisations have with society in general. There is a give and take relationship
between a company and the broader society as depicted below:

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 Government Society

The
organisation

Other Groups
organisations

Individuals

Figure 2.1: The social contract

The stakeholder theory was driven by the social contract. Revisit Unit 2 of this
module as a refresher on stakeholders. The main tenant of the social contract as
relates to the organisation is the issue of sustainability.

A social contract differs from other contracts because it is hypothetical. Businesses

and societies have never sat down in a room and hammered out a contract outlining
their relation. But this hypothetical contract provides a good means of making sense
out of the relation that has gradually evolved between societies and businesses.
Forget for a moment the historical details of the relation between business and
society. If this relation is summarized as a contract, what does society give to a
business? What does a business give to society? Do these two institutions trust one
another or do they each adopt means to monitor and control the other? What are
these means? Treating the relation between business and society as a contract
between two mutually consenting agents or actors does get some of the facts
wrong. But it provides a useful "heuristic" device, i.e., a framework that will help us

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to summarize, structure, and, in a work, make sense of the relation between the
two. Moving from the terms of this "contract" you will be able to develop a
framework for understanding the social responsibilities of business corporations.

2.4 CSR Frameworks

2.4.1 Shareholder View

From Milton Friedman, "The Social Responsibility of Business is to Increase Its

Profits." "But the doctrine of "social responsibility" taken seriously would extend the
scope of the political mechanism to every human activity. It does not differ in
philosophy from the most explicitly collectivist doctrine. It differs only by professing
to believe that collectivist ends can be attained without collectivist means. That is
why, in a book titled ‗Capitalism and Freedom‘, it is called a "fundamentally
subversive doctrine" in a free society, and it is said that in such a society, "there is
one and only one social responsibility of a business, that is to use its resources and
engage in activities designed to increase profits as long as it stays within the rules of
the game, which is to say, engage in an open and free competition without
deception or fraud," 1970 by New York Times Company.

2.4.2 Stakeholder View

 A stakeholder must be distinguished from a stockholder. The latter owns a share

of the corporation. On the other hand, a stakeholder is any group or individuals
that have a vital interest in the doings of the corporation. Hence the stockholder
is a stakeholder of the corporation whose vital interest is the share ownership of
the corporation and the money invested in this share.
 There are several stakeholders of the corporation. They include (1) employees,
(2) customers, (3) suppliers, (4) local community, (4) surrounding governments,
(5) the surrounding human and natural environment, and (6) the corporation's
managers. (In some situations there are other stakeholders such as competitors.)
 Stakeholder theory requires that the corporation recognize and respect the vital
interests of each of its surrounding stakeholders. There is a frequent issue in

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 proposing stakeholder rights and assigning to others correlative duties to
recognize and respect these rights.
 Stakeholder theory also requires that the corporation integrate interests where
possible, mediate or broker conflicts between interests, and only trade of
competing interests when it is absolutely necessary and when more conciliatory
efforts have already been made and have failed.
 See Evan and Freeman 1988

2.4.3 Werhane's Alliance Approach

 Werhane's alliance approach is similar to the stakeholder approach in that it

recognizes several groups that surround the corporation and have vital interests
that depend on the doings of the corporation. These surrounding groups are
more or less the same as those in the stakeholder approach: owners, managers,
employees, customers, suppliers, local communities, governments and the
environment.
 But Werhane makes two significant departures from the stakeholder approach.
First, she uses moral imagination to distance the corporation from the problem
solving process. The lens of problem solving refocuses on each of the other
stakeholders. Whereas for stakeholder theory the corporation is the center of
analysis and is visualized as surrounded by its stakeholders, the alliance
approach decentralizes the corporation and alternatively visualizes each
stakeholder as the center for the purpose of framing problems and generating
solutions.
 Second, the alliance approach sees the corporation as part of a system of
interrelated and interdependent parts. Hence, each problem situation presents a
system formed of the corporation, owners, managers, employees, suppliers,
customers, local communities, and governments. Problems emerge from value
conflicts within and between the constituent parts of the system. They are solved
through the cooperation of the different constituencies of the alliance.
 While this approach does not lend itself to algorithms or rules, it does promise
solutions by highlighting and facilitating moral imagination both in the framing of
problems (problems are posed in terms of framings from multiple perspectives)

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 and in terms of the generation of solutions (multiple problem framings help us to
visualize new solution horizons).
 See Werhane, 2007 and 2008.

2.5 Benefits of Corporate Social Responsibility

One of the main benefits of CSR is that it helps build stronger relations with the
community through stakeholder engagements. By having an open and continuous
dialogue with various stakeholders, an organisation lends credence to its
trustworthiness. In the long run, this helps garner support for any new project that a
company embarks on and because of the support it gets from the stakeholders
prospects of sustainability of such projects improves. In more specific terms, the
following are more of the benefits of CSR.

2.4.1 Enhanced Brand and Reputation

Customers are often drawn to companies with strong CSR activities. CSR improves
the image of the organisation and in turn it can capitalise on by attracting more
capital and trading partners. By engaging in CSR activities, an organisation
communicates that it cares about the community and this can offset possible
negative images from rare events that may occur in the future.

2.4.2 Reduction in Operation Costs

There are instances where doing what is right and responsibly converges with doing
what is cost effective. An example of this is reducing packaging materials or planning
the optimum route for delivery trucks. This does not only reduce the economic
impact of an organisation but helps with efficiency, thus reducing costs.

2.4.3 Attracting New Customers

Customers can sometimes be attracted to companies that are deemed to be

investing in their communities. Some employers too, assess a company to see if
their personal values align with that of the company. The company can then be able

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to attract and retain employees thus saving on recruitment and training costs due to
a reduction in turnover.

2.4.4 Balances Power with Responsibility

Modern organisations wield a great deal of power and those with power ought to
use it judiciously. By being responsible, organisations are able to generate goodwill
with community members.

2.4.5 Discourages Government Regulation

When companies are socially responsible, government is dissuaded from regulating

them as they have some assurances that they are self-regulating. By their own
actions, companies can discourage government restrictions, which can negatively
impact them.

2.4.6 It Promotes Long Run Profit

It has been asserted that companies that are socially responsible often enjoy better
long run profits than those that are not. This is a consequence of good relations with
the community and image perceptions.

2.4.7 Recognises Business Moral Obligations

Some scholars have argued that organisations have moral obligations to help
society. This viewpoint encompasses the idea that this obligation should supersede
the priority of profit making.

Case study of CSR

Nike Lists Abuses at Asian Factories

Nike has been the subject of sweatshop allegations for long, yesterday it produced
the most comprehensive picture yet of the 700 factories that produce its footwear
and clothing, detailing admissions of abuses, including forced overtime and restricted
access to water.

The company has published a 108-page report, available on its website, the first
since it paid $1.5m to settle allegations that it had made false claims about how well
its workers were treated. For years activists have been pressing Nike and other
companies to reveal where their factories are in order to allow independent

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monitoring. Nike lists 124 plants in China that are contracted to make its products,
73 in Thailand, 35 in South Korea, 34 in Vietnam and others in Asia. It also produces
goods in South America, Australia, Canada, Italy, Mexico, Turkey and the US. It
employs 650,000 contract workers worldwide.

The report admits to widespread problems, particularly in Nike's Asian factories. The
company said it audited hundreds of factories in 2003 and 2004 and found cases of
"abusive treatment", physical and verbal, in more than a quarter of its South Asian
plants.

Between 25% and 50% of the factories in the region restrict access to toilets and
drinking water during the workday. 25% to 50% of workers are denied at least one
day off in seven days. In more than half of Nike's factories, the report said that
employees worked more than 60 hours a week. In up to 25%, workers refusing to
do overtime were punished. Wages were also below the legal minimum wage at up
to 25% of factories.

Michael Posner, the executive director of the organisation for Human Rights First,
described the report as "an important step forward" and praised Nike for its
transparency. But he added: "The facts on the ground suggest that there are still
enormous problems with these supply chains and factories thus what is Nike doing
to change the picture and give workers more rights?" Nike has joined the Fair
Labour Association, a group that includes other footwear and clothing makers, as
well as NGOs and universities, which conducts independent audits designed to
improve standards across the industry. The company said it needed further
cooperation with other members of the industry." We do not believe Nike has the
power to single-handedly solve the issues at hand," the company said in the report.

Mr Posner said retailers such as Wal-Mart bore huge responsibility for keeping prices
low and consequently compounding poor working conditions in factories overseas.
He said that the likes of Nike and Adidas needed to work together to gain some kind
of counterweight.
[Link]
oney

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Topic 3: Moral and Ethical Codes of Conduct

3.0 Introduction

A framework of the ethical principles that direct decisions and the behaviour in an
organisation is called a code of ethics and professional conduct. These principles
guide employees on how to behave at work. They also give a guide on how to
handle workplace harassment, safety and conflicts of interest.

3.1 Objectives

After studying this topic you should be able to:

 Identify ethical codes of conduct

 Interpret moral theories
 Prepare taxonomy of ethical approaches
 Apply theory to practice
 Describe virtue ethics

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3.2 Ethical Code of Conduct
A code of ethics (code of conduct, statement of business practice, or a set of
business principles) is useful for establishing and articulating the corporate values,
responsibilities, obligations, and ethical ambitions of an organisation and the way it
functions. It provides guidance to employees on how to handle situations that pose
a dilemma between alternative, right courses of action or consider right or wrong
when faced with pressure. A good code of ethics should be signed by the CEO and
endorsed by the board of directors. It should focus on the values that are important
to top management in the conduct of a business, such as integrity, responsibility,
and reputation, and demonstrate a commitment to maintaining high standards both
within the organisation and in its dealings with others.

Without strong leadership and a willingness to listen to bad news as well as good
news, managers do not have the feedback necessary to keep the organisation
healthy. Ethics codes have been put in place to encourage feedback loops to top
management. The best ethics codes are aspirational, or having an ideal to be
pursued, not legalistic or compliance driven. It is often noted that a code of ethics is
only as important as top management is willing to make it. If the code is just a
document that goes into a drawer or onto a shelf, it will not effectively encourage
good conduct within the corporation. The same is true of any kind of training that
the company undertakes. If the message is not continuously reinforced, or (worse
yet) if the message is undermined by management‘s actions, the real message to
employees is that violations of the ethics code will not be taken seriously, and that
the important things are profits and performance. The ethics code at Enron seems to
have been one of those ―3-P‖ codes that wind up sitting on shelves—―Print, Post,
and Pray.‖ Worse, the Enron board twice suspended the code in 1999 to allow
outside partnerships to be led by a top Enron executive who stood to gain financially
from them.

3.3 Moral Theories

There are three types of moral theories. They are described below:

1. Utilitarianism: This theory asserts that the moral value of an action lies in its
consequences or results.
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2. Deontology: This theory asserts that the moral value of an action lies, not in its
consequences, but in the formal characteristics of the action itself.
3. Virtue Ethics: This theory asserts that actions sort themselves out into virtuous or
vicious actions. Virtuous actions stem from a virtuous character while vicious
actions stem from a vicious or morally flawed character. Who we are is revealed
through what we do.

The Mountain Terrorist Scenario

You are in a remote mountain village. A group of terrorists has lined up 20 people
from the village. They plan on shooting them for collaborating with the enemy. Since
you are not from the village, you will not be killed. Taking advantage of your
position, you plead with the terrorists not to carry out their plan. Finally, you
convince the leader that it is not necessary to kill all 20. He takes a gun, empties it
of all its bullets except one, and then hands it to you. He has decided to kill only one
villager to set an example to the rest. As an honored guest and outsider, you will
decide who will be killed, and you will carry out the deed. The terrorists conclude
with a warning; if you refuse to kill the villager, then they will revert back to the
original plan of killing all 20. And if you try any "funny business," they will kill the 20
villagers and then kill you. What should you do?

Your Options

1. Take the gun, select a villager, and kill him or her.

2. Refuse the terrorists' offer and walk away from the situation.

3.4 Taxonomy of Ethical Approaches

There are many ethical approaches that can be used in decision-making. The
Mountain Terrorist Exercise is based on an artificial scenario designed to separate
these theoretical approaches along the lines of the different "horns" of a dilemma.
Utilitarian‘s tend to choose to shoot a villager "in order to save 19." In other words
they focus their analysis on the consequences of an action alternative and choose

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the one that produces the least harm. Deontologists generally elect to walk away
from the situation. This is because they judge an action on the basis of its formal
characteristics. A deontologist might argue that killing the villager violates natural
law or cannot be made into a law or rule that consistently applies to everybody. A
deontologist might say something like, "What right do I have to take another
person's life?" Virtue ethicists might try to imagine how a person with the virtue of
courage or integrity would act in this situation. (Williams claims that choosing to kill
the villager, a duty under utilitarianism, would undermine the integrity of a person
who abhorred killing.)

3.5 Table Connecting Theory to Domain

1. Row 1: Utilitarianism concerns itself with the domain of consequences, which tells
us that the moral value of an action is "coloured" by its results. The
harm/beneficence test, which asks us to choose the least harmful alternative,
encapsulates or summarizes this theoretical approach. The basic principle of
utilitarianism is the principle of utility: choose that action that produces the
greatest good for the greatest number. Cost/benefits analysis, the Pareto
criterion, the Kalder/Hicks criterion, risk/benefits analysis all represent different
frameworks for balancing positive and negative consequences under utilitarianism
or consequentialism.
2. Row 2: Deontology helps us to identify and justify rights and their correlative
duties. The reversibility test summarizes deontology by asking the question, "Does
your action still work if you switch (=reverse) roles with those on the receiving
end? "Treat others always as ends, never merely as means," the Formula of End,
represents deontology's basic principle. The rights that represent special cases of
treating people as ends and not merely as means include (a) informed consent,
(b) privacy, (c) due process, (d) property, (e) free speech, and (f) conscientious
objection.
3. Row 3: Virtue ethics turns away from the action and focuses on the agent, the
person performing the action. The word, "Virtue," refers to different sets of skills

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 and habits cultivated by agents. These skills and habits if consistently and widely
performed will support, sustain, advance different occupational, social, and
professional practices. (See Macintyre, After Virtue, and Solomon, Ethics and
Excellence, for more on the relation of virtues to practices.) The public
identification test summarizes this approach as: an action that is morally
acceptable if it is willingly and publicly associated given moral convictions.
Individual virtues that we will use this semester include integrity, justice,
responsibility, reasonableness, honesty, trustworthiness, and loyalty.

Table 5.1 Table connecting Theory to Domain

Covering All the Bases
Covering
Ethical Encapsulating Basic Application or
Ethical
Dimension Ethical Test Principles Bridging Tools
Approach
Principle of
Harm/Beneficence
Utility:
Benefit & cost
greatest
Consequences Utilitarianism (weigh harms Comparison Utility
good for
Maximisation
greatest
against benefits)
number
Reversibility (test Free & Informed
Deontology
Categorical Consent, Privacy,
(Duty-based,
Formal by reversing rolesImperative Property, Due
rights-based,
Characteristics Formula of Process, Free
natural law,
of Act between agent and End Speech,
social
Autonomy Conscientious
contract)
object of action) objection
Virtues are
means
between
extremes
with regard Integrity, justice,
Skills and Public Identification to agent and responsibility,
habits (impute moral action reasonableness,
Virtue Ethics
cultivated by import of action to -Virtues are honesty,
agent person of agent) cultivated trustworthiness,
dispositions loyalty
that promote
central
community
values

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3.6 Virtue Ethics

Virtues are dispositions that bring internal and external goods on which social or
professional practice is built. The constituents of a good practice are as follows:

 Participants: Are made up of individuals whose activities, attitudes, and goals

are integrated, shared, or overlap in significant ways.
 Rules and Procedures: Participants should occupy roles, which outline tasks
and procedures. Roles in a practice are coordinated such that they combine to
bring about complex ends beyond the capabilities of isolated individuals.
 Boundaries: Boundaries such as disciplinary and theoretical principles surround
practices and serve to distinguish one from the other.
 External Goals: Engineering serves public wellbeing that is medicine serves
health, law serves justice while business serve commerce.
 Internal Goals: Engineering has the internal goals of faithful agency (to client),
collegiality (to peers), and loyalty (to the profession or practice itself)

Virtue ethics has gone through three historical versions. Aristotle set the first virtue
called Virtue 1 in ancient Greece. While tied closely to practices in ancient Greece
that no longer exist today, Aristotle's version still has a lot to say to us in this day
and age. In the second half of the twentieth century, British philosophical ethicists
put forth a related but different theory of virtue ethics (virtue 2) as an alternative to
the dominant ethical theories of utilitarianism and deontology. Virtue 2 promised a
new foundation of ethics consistent with work going on at that time in the
philosophy of mind. Proponents felt that turning from the action to the agent
promised to free ethical theory from the intractable debate between utilitarianism
and deontology and offered a way to expand scope and relevance of ethics. Virtue 3
reconnects with Aristotle and virtue 1 even though it drops the doctrine of the mean
and Aristotle's emphasis on character. Using recent advances in moral psychology
and moral pedagogy, it seeks to rework key Aristotelian concepts in modern terms.
In the following, we will provide short characterizations of each of these three
versions of virtue ethics.

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3.6.1 Virtue 1: Aristotle’s Virtue Ethics

 Eudemonia. Happiness, for Aristotle, consists of a life spent fulfilling the

intellectual and moral virtues. These modes of action are auto-telic, that is, they
are self-justifying and contain their own ends. By carrying out the moral and
intellectual virtues for a lifetime, we realize ourselves fully as humans. Because
we are doing what we were meant to do, we are happy in this special sense of
eudemonia.
 Arête. Arête is the Greek word we usually translate as "virtue". But arête is more
faithfully translated as excellence. For Aristotle, the moral and intellectual virtues
represent excellences. So the moral life is more than just staying out of trouble.
Under Aristotle, it is centred in pursuing and achieving excellence for a lifetime.
 Virtue as the Mean. Aristotle also characterizes virtue as a settled disposition
to choose the mean between the extremes of excess and defect, all relative to
person and situation. Courage (the virtue) is the mean between the extremes of
excess (too much courage or recklessness) and defect (too little courage or
cowardice). Aristotle's claim that most or all of the virtues can be specified, as
the mean between extremes is controversial. While the doctrine of the mean is
dropped in Virtue 2 and Virtue 3, we will still use it in developing virtue tables.
(See exercise 1 below.) You may not find both extremes for the virtues you have
been assigned but make the effort nonetheless.
 Ethos. "Ethos" translates as character, which, according to Aristotle, composes
the seat of the virtues. Virtues are well settled dispositions or habits that have
been incorporated into our characters. Because our characters are manifested in
our actions, the patterns formed by these over time reveal who we are. This can
be formulated as a decision-making test, the public identification test. Because
we reveal who we are through our actions we can ask, when considering an
action, whether we would care to be publicly identified with this action. "Would I
want to be publicly known as the kind of person who would perform that kind of
action? Would I, through my cowardly action, want to be publicly identified as a
coward? Would I, through my responsible action, want to be publicly identified as
a responsible person? Because actions provide others with a window into our

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 characters, we must make sure that they portray us as the way we want to be
portrayed.
 Aesthesis of the Phonemes. This Greek phrase, roughly translated as the
perception of the morally experienced agent, reveals how important practice and
experience are to Aristotle in his conception of moral development. One major
difference between Aristotle and other ethicists (utilitarian‘s and deontologists) is
the emphasis that Aristotle places on developing into or becoming a moral
person. For Aristotle, one becomes good by first repeatedly performing good
actions. So morality is more like an acquired skill than a mechanical process.
Through practice we develop sensitivities to what is morally relevant in a
situation, we learn how to structure our situations to see moral problems and
possibilities, and we develop the skill of "hitting" consistently on the mean
between the extremes. All of these are skills that are cultivated in much the same
way as a basketball player develops through practice the skill of shooting the ball
through the hoop.
 Boletuses. This word translates as "deliberation." For Aristotle, moral skill is not
the product of extensive deliberation (careful, exhaustive thinking about reasons,
actions, principles, concepts, etc.) but of practice. Those who have developed the
skill to find the mean can do so with very little thought and effort. Virtuous
individuals, for Aristotle, are surprisingly unreflective. They act virtuously without
thought because it has become second nature to them.
 Atresia. Ross translates this word as "incontinence" which is outmoded. A better
translation is weakness of will. For Aristotle, knowing where virtue lies is not the
same as doing what virtue demands. There are those who are unable to translate
knowledge into resolution and then into action. Because arrases (weakness of
will) is very real for Aristotle, he also places emphasis in his theory of moral
development on the cultivation of proper emotions to help motivate virtuous
action. Later ethicists seek to oppose emotion and right action; Aristotle sees
properly trained and cultivated emotions as strong motives to doing what virtue
requires.
 Logos Aristotle's full definition of virtue is "a state of character concerned with
choice, lying in a mean, i.e. the mean relative to us, this being determined by a

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 rational principle, and by that principle by which [a person] of practical wisdom
would determine it." (Ross's translation in Nichomachean
 Ethics, 1106b, 36.) We have talked about character, the mean, and the person
of practical wisdom. The last key term is "logos" which in this definition is
translated by reason. This is a good translation if we take reason in its fullest
sense so that it is not just the capacity to construct valid arguments but also
includes the practical wisdom to assess the truth of the premises used in
constructing these arguments. In this way, Aristotle expands reason beyond logic
to include a fuller set of intellectual, practical, emotional, and perceptual skills
that together form a practical kind of wisdom.

3.6.2 Virtue 2

 Virtue 2 is agent centered. Contrary to deontology and utilitarianism which

focuses on whether actions are good or right, V2 is agent centered in that it
sees an action as an expression of the goodness or badness of the agent.
Utilitarianism focuses on actions, which bring about the greatest happiness for
the greatest number; deontology seeks those actions that respect the autonomy
of individuals and carry out moral obligations, especially duties. These theories
emphasize doing what is good or right. Virtue 2, on the other hand, focuses on
the agent's becoming or being good.
 Can Virtue 2 tell us how to act? Because V2 is agent-centered, critics claim
that it cannot provide insight into how to act in a given situation. All it can say is,
"Act the way a moral exemplar would act." But what moral standards do moral
exemplars use or embody in their actions? And what moral standards do we use
to pick out the moral exemplars themselves? Hurst house acknowledges that this
criticism hits home. However, she points out that the moral standards come
from the moral concepts that we apply to moral exemplars. They are individuals
who act courageously, exercise justice, and realize honesty. The moral concepts
"courage," "justice," and "honesty" all have independent content that helps
guide us. She also calls this criticism unfair: while virtue 2 may not provide any
more guidance than deontology or utilitarianism, it doesn't provide any less.

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 Virtue 2 may not provide perfect guidance, but what it does provide is favorably
comparable to what utilitarianism and deontology provide.
 Virtue 2 replaces Deontic concepts (right, duty, obligation) with
Aretaic concepts (good, virtue). This greatly changes the scope of ethics.
Deontic concepts serve to establish our minimum obligations. On the other hand,
aretaic concepts bring the pursuit of excellence within the purview of ethics.
Virtue ethics produces a change in our moral language that makes the pursuit of
excellence as an essential part of moral inquiry.

Finally, there is a somewhat different account of virtue 2 (call it virtue 2a) that can
be attributed to Alisdair MacIntyre. This version "historicizes" the virtues, that is,
looks at how our concepts of key virtues have changed over time. (MacIntyre argues
that the concept of justice, for example, varies greatly depending on whether one
views justice in Homeric Greece, Aristotle's Greece, or Medieval Europe.) Because he
argues that skills and actions are considered virtuous only in relation to a particular
historical and community context, he redefines virtues as those skill sets necessary
to realize the goods or values around which social practices are built and
maintained. This notion fits well with professional ethics because virtues can be
derived from the habits, attitudes, and skills needed to maintain the cardinal ideals
of the profession.

3.6.3 Virtue 3

Showing how the basic concepts of Virtue 1 can be reformulated to reflect current
research in moral psychology can best outline virtue 3.

1. Reformulating Happiness (Eudaimonia). Mihaly Csikcszentmihalyi has

described flow experiences (see text box below) in which autotelic activities play
a central role. For Aristotle, the virtues also are autotelic. They represent
faculties whose exercise is key to realizing the fullest potentialities as human
beings. Thus, virtues are self-validating activities carried out for themselves as
well as for the ends they bring about. Flow experiences are also important in
helping individuals to conceptualize the virtues in a professional context because

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 they represent a well-practiced integration of skill, knowledge, and moral
sensitivity.
2. Reformulating Values (Into Arête or Excellence). To carry out the full
project set forth by virtue 3, it is necessary to reinterpret key moral values such
as honesty, justice, responsibility, reasonableness, and integrity as excellent. For
example, moral responsibility has often been described as carrying out basic,
minimal moral obligations. As an excellence, responsibility becomes refocused on
extending knowledge and power to expand a range of effective, moral action.
Responsibility reformulated as an excellence also implies a high level of care that
goes well beyond what is minimally required.
3. De-emphasizing Character. The notion of character drops out to be replaced
by more or less enduring and integrated skills sets such as moral imagination,
moral creativity, reasonableness, and perseverance. Character emerges from the
activities of integrating personality traits, acquired skills, and deepening
knowledge around situational demands. The character that represent unity is
always complex and changing.
4. Practical Skill Replaces Deliberation. Moral exemplars develop skills, which,
through practice, become second nature. These skills obviate the need for
extensive moral deliberation. Moral exemplars resemble more skilful athletes
who quickly develop responses to dynamic situations than Hamlets stepping
back from action for prolonged and agonizing deliberation.
5. Greater Role for Emotions. Nancy Sherman discusses how, for Aristotle,
emotion is not treated as an irrational force but as an effective tool for moral
action once it has been shaped and cultivated through proper moral education.
To step beyond the controversy of what Aristotle did and did not say about the
emotions (and where he said it) the enhanced role for emotions is placed within
virtue 3. Emotions carry out four essential functions: (a) they serve as modes of
attention; (b) they also serve as modes of responding to or signalling value; (c)
they fulfil a revelatory function; and (d) they provide strong motives to moral
action. Nancy Sherman, Making a Necessity of Virtue: Aristotle and Kant
on Virtue (1997), U.K.: Cambridge University Press: 39-50.

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Summary

In this topic we talked about the ethical code of conduct. The ethical code of
conduct is statements of business practice, or a set of business principles. We also
learned about the three moral theories being utilitarianism, deontology and virtue
ethics. Further we learned about the taxonomy of ethical approaches and different
virtue ethics.

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Topic 4: Business Ethics

4.0 Introduction

Business ethics are the moral principles that direct a business in how it should
behave. Acting ethically means the ability to differentiate between right and wrong
so as to make the right choices. Some of the pillars of business ethics are trust,
quality, corporate citizenship, value creation and respect. In this topic we look at a
framework for ethics in the context of business by incorporating and applying the
concepts of topic 3 into the business environment.

4.1Objectives

After studying this topic you should be able to:

 Define ethics
 Explain the framework for ethical decision making
 Understand the importance of ethics in a business
 Demonstrate how to control ethics
 Apply professional ethics in real business

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4.2 Ethics
Ethics are code of moral principles that are followed regarding what is wrong and
right. Examples of ethical practices in organisations include:

- Avoiding bribery
- Concerned with safety of workers
- Practicing good professional conduct and honesty
- Respecting people‘s personal information.
- Fair treatment of workers
- Practicing appropriate and fair advertising.

Ethics essentially involves how we act, live, lead our lives, and treat others. Our
choices and decision-making processes and our moral principles and values that
govern our behaviors regarding what is right and wrong are also part of ethics.
Normative ethics refer to the field of ethics concerned with asking how should and
ought we live and act? Business ethics is applied ethics that focuses on real-world
situations and the context and environment in which transactions occur that is how
we should apply our values to the way we conduct business?

This section of the topic was adopted from The Open University of Hong Kong under
a Creative Commons Attribution-ShareAlike 4.0 License available at
[Link]

4.3 Framework for Ethical Decision Making

4.3.1 Problem Solving or Decision Making Framework (Analogy between

ethics and design)

Traditionally, decision-making frameworks in professional and occupational ethics

have been taken from rational decision procedures used in economics. While these
are useful, they lead one to think that ethical decisions are already "out there"
waiting to be discovered. In contrast, taking a design approach to ethical decision-
making emphasizes that ethical decisions must be created, not discovered. This, in
turn, emphasizes the importance of moral imagination and moral creativity. Carolyn
Whitbeck in Ethics in Engineering Practice and Research describes this aspect of

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ethical decision making through the analogy she draws between ethics and design
problems in chapter one. Here she rejects the idea that ethical problems are
multiple-choice problems. We solve ethical problems not by choosing between
ready-made solutions given the situation rather we use our moral creativity and
moral imagination to design these solutions. Chuck Huff builds on this by modifying
the design method used in software engineering so that it can help structure the
process of framing ethical situations and creating actions to bring these situations to
a successful and ethical conclusion. The key points in the analogy between ethical
and design problems are summarized in the table presented below.

Table 4.1 Analogy between design and ethics in problem-solving

Design Problem Ethical Problem
Construct a prototype that Construct a solution that integrates and realizes
optimizes (or satisfices) ethical values (justice, responsibility,
designated specifications reasonableness, respect, and safety)
Resolve conflicts between
Resolve conflicts between values (moral vs. moral
different specifications by means
or moral vs. non-moral) by integration
of integration
Test prototype over the different Test solution over different ethical considerations
specifications encapsulated in ethics tests
Implement tested design over Implement ethically tested solution over resource,
background constraints interest, and technical constraints

4.3.2 Problem Specifications

Problem specification involves exercising moral imagination to specify the socio-

technical system (including the stakeholders) that will influence and will be
influenced by the decision we are about to make. Stating the problem clearly and
concisely is essential to design problems. Getting the problem right helps structure
and channel the process of designing and implementing the solution. There is no
algorithm available to crank out an effective problem specification. Instead, we offer
a series of guidelines or rules of thumb to get you started in a process that is
accomplished by the skilful exercise of moral imagination.

[Link] Different Ways of Specifying the Problem

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 Many problems can be specified as disagreements. For example, you disagree
with your supervisor over the safety of the manufacturing environment.
Disagreements over facts can be resolved by gathering more information.
Disagreements over concepts (you and your supervisor have different ideas of
what safety means) require working toward a common definition.
 Other problems involve conflicting values. You advocate installing pollution control
technology because you value environmental quality and safety. Your supervisor
resists this course of action because she values maintaining a solid profit margin.
This is a conflict between a moral value (safety and environmental quality) and a
non-moral value (solid profits). Moral values can also conflict with one another in
a given situation. Using John Doe lawsuits to force Internet Service Providers to
reveal the real identities of defamers certainly protects the privacy and
reputations of potential targets of defamation. But it also places restrictions on
legitimate free speech by making it possible for powerful wrongdoers to intimidate
those who would publicize their wrongdoing. Here the moral values of privacy and
free speech are in conflict. Value conflicts can be addressed by harmonizing the
conflicting values, compromising on conflicting values by partially realizing them,
or setting one value aside while realizing the other (=value trade offs).
 If you specify your problem as a disagreement, you need to describe the facts or
concepts about which there is disagreement.
 If you specify your problem as a conflict, you need to describe the values that
conflict in the situation.
 One useful way of specifying a problem is to carry out a stakeholder analysis. A
stakeholder is any group or individual that has a vital interest at risk in the
situation. Stakeholder interests frequently come into conflict and solving these
conflicts requires developing strategies to reconcile and realize the conflicting
stakes.
 Another way of identifying and specifying problems is to carry out a socio-
technical analysis. Sociotechnical systems (STS) embody values. Problems can be
anticipated and prevented by specifying possible value conflicts. Integrating a
new technology, procedure, or policy into a socio-technical system can create
three kinds of problem. (1) Conflict between values in the technology and those in

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 the STS. For example, when an attempt is made to integrate an information
system into the STS of a small business, the values present in an information
system can conflict with those in the socio-technical system. (Workers may feel
that the new information system invades their privacy.) (2) Amplification of
existing value conflicts in the STS. The introduction of a new technology may
magnify an existing value conflict. Digitalizing textbooks may undermine
copyrights because digital media is easy to copy and disseminate on the Internet.
(3) Harmful consequences. Introducing something new into a sociotechnical
system may set in motion a chain of events that will eventually harm stakeholders
in the socio-technical system. For example, giving laptop computers to public
school students may produce long-term environmental harm when careless
disposal of spent laptops releases toxic materials into the environment.
 The following table helps summarize some of these problem categories and then
outlines generic solutions.

Table 4.2 Summary of problems with solution outline

Problem Type Sub-Type Solution Outline

Type and mode of gathering

Factual
information
Disagreement Concept in dispute and
Conceptual method for agreeing on its
definition

Moral vs. Moral

Non-moral vs. moral Value Partially Value

Conflict Trade Off
Non-moral vs. non- Integrative Integrative

moral

Corruption Strategy for Strategy for Value

Framing Social Justice maintaining restoring integrative,

Value Realization integrity justice design strategy

Intermediate Public Welfare, Realizing Value Removing Prioritizing

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Moral Value Faithful Agency, value conflicts values for
Professional trade offs
Integrity, Peer

[Link] Instructions for Using Problem Classification Table

1. Is your problem a conflict? Moral versus moral value? Moral versus non-moral
values? Non-moral versus non-moral values? Identify the conflicting values as
concisely as possible. Example: In Toysmart, the financial values of creditors
come into conflict with the privacy of individuals in the database: financial versus
privacy values.
2. Is your problem a disagreement? Is there a disagreement over basic facts? Are
these facts observable? Is it a disagreement over a basic concept? What is the
concept? Is it a factual disagreement that, upon further reflection, changes into a
conceptual disagreement?
3. Does your problem arise from an impending harm? What is the harm? What is its
magnitude? What is the probability that it will occur?
4. If your problem is value conflicts then can these values be fully integrated in a
value integrating solution? Or must they be partially realized in a compromise or
traded off against one another?
5. If your problem is a factual disagreement, what is the procedure for gathering the
required information, if this is feasible?
6. If your problem is a conceptual disagreement, how can this be overcome? By
consulting a government policy or regulation? (OSHA on safety for example.) By
consulting a theoretical account of the value in question? (Reading a philosophical
analysis of privacy.) By collecting past cases that involve the same concept and
drawing analogies and comparisons to the present case?

[Link] If you are having problems specifying your problem

 Try identifying the stakeholders. Stakeholders are any group or individuals with a
vital interest at stake in the situation at hand.

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 Project yourself imaginatively into the perspectives of each stakeholder. How does
the situation look from their standpoint? What are their interests? How do they
feel about their interests?
 Compare the results of these different imaginative projections. Do any
stakeholder interests conflict? Do the stakeholders themselves stand in conflict?
 If the answer to one or both of these questions is "yes" then this is your problem
statement. How does one reconcile conflicting stakeholders or conflicting
stakeholder interests in this situation?

[Link] Framing Your Problem

 We miss solutions to problems because we choose to frame them in one way

only.
 For example, the Mountain Terrorist Dilemma is usually framed in one way only :
as a dilemma, that is, a forced decision between two equally undesirable
alternatives. (Gilbane Gold is also framed as a dilemma: blow the whistle on Z-
Corp or go along with the excess pollution.)
 Framing a problem differently opens up new horizons of solutions. Your
requirement from this point on in the semester is to frame every problem you are
assigned in at least two different ways.
 For examples on how to frame problems using socio-technical system analysis see
module m14025.
 These different frames are summarized in the next box below.

[Link] Different Frames for Problems

 Technical Frame: Engineers frame problems technically, that is, they specify a
problem as raising a technical issue and requiring a technical design for its
resolution. For example, in the Hughes case, a technical frame would raise the
problem of how to streamline the manufacturing and testing processes of the
chips.
 Physical Frame: In the Laminating Press case, the physical frame would raise
the problem of how the layout of the room could be changed to reduce the white

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 powder. Would better ventilation eliminate or mitigate the white powder
problem?
 Social Frame: In the "When in Aguadilla" case, the Japanese engineer is
uncomfortable working with the Puerto Rican woman engineer because of social
and cultural beliefs concerning women still widely held by men in Japan. Framing
this as a social problem would involve asking whether there would be ways of
getting the Japanese engineer to see things from the Puerto Rican point of view.
 Financial or Market-Based Frames: The DOE, in the Risk Assessment case
below, accuses the laboratory and its engineers of trying to extend the contract
to make more money. The supervisor of the head of the risk assessment team
pressures the team leader to complete the risk assessment as quickly as possible
so as not to lose the contract. These two framings highlight financial issues.
 Managerial Frame: As the leader of the Puerto Rican team in the "When in
Aguadilla" case, you need to exercise leadership in your team. The refusal of the
Japanese engineer to work with a member of your team creates a management
problem. What would a good leader, a good manager, do in this situation? What
does it mean to call this a management problem? What management strategies
would help solve it?
 Legal Frame: OSHA may have clear regulations concerning the white powder
produced by laminating presses. How can you find out about these regulations?
What would be involved in complying with them? If they cost money, how would
you get this money? These are questions that arise when you frame the
Laminating Press case as a legal problem.
 Environmental Framing: Finally, viewing your problem from an environmental
frame leads you to consider the impact of your decision on the environment.
Does it harm the environment? Can this harm be avoided? Can it be mitigated?
Can it be offset? (Could you replant elsewhere the trees you cut down to build
your new plant?) Could you develop a short-term environmental solution to "buy
time" for designing and implementing a longer-term solution? Framing your
problem as an environmental problem requires that you ask whether this solution
harms the environment and whether this harming can be avoided or remedied in
some other way.

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4.3.3 Solution Generation

In solution generation, agents exercise moral creativity by brainstorming to come up

with solution options designed to resolve the disagreements and value conflicts
identified in the problem specification stage. Brainstorming is crucial to generating
nonobvious solutions to difficult and intractable problems. This process must take
place within a non-polarized environment where the members of the group respect
and trust one another. (See the module on the Ethics of Group Work for more
information on how groups can be successful and pitfalls that commonly trip up
groups.) Groups effectively initiate the brainstorming process by suspending criticism
and analysis. After the process is completed (say, by meeting a quota), then
participants can refine the solutions generated by combining them, eliminating those
that don't fit the problem, and ranking them in terms of their ethics and feasibility. If
a problem can't be solved, perhaps it can be dissolved through reformulation. If an
entire problem can't be solved, perhaps the problem can be broken down into parts
some of which can be readily solved.

[Link] Having trouble generating solutions?

 One of the most difficult stages in problem solving is to jump start the process of
brainstorming solutions. If you are stuck then here are some generic options
guaranteed to get you "unstuck."
 Gather Information: Many disagreements can be resolved by gathering more
information. Because this is the easiest and least painful way of reaching
consensus, it is almost always best to start here. Gathering information may not
be possible because of different constraints: there may not be enough time, the
facts may be too expensive to gather, or the information required goes beyond
scientific or technical knowledge. Sometimes gathering more information does not
solve the problem but allows for a new, more fruitful formulation of the problem.
Harris, Pritchard, and Rabins in Engineering Ethics: Concepts and Cases show how
solving a factual disagreement allows a more profound conceptual disagreement
to emerge.

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 Nolo Contendere. Nolo Contendere is a latin word meaning for not opposing or
contending. Your interests may conflict with your supervisor but he or she may be
too powerful to reason with or oppose. So your only choice here is to give in to
his or her interests. The problem with nolo contendere is that non-opposition is
often taken as agreement. You may need to document (e.g., through memos)
that your choosing not to oppose does not indicate agreement.
 Negotiate. Good communication and diplomatic skills may make it possible to
negotiate a solution that respects the different interests. Value integrative
solutions are designed to integrate conflicting values. Compromises allow for
partial realization of the conflicting interests. (See the module, The Ethics of Team
Work, for compromise strategies such as logrolling or bridging.) Sometimes it may
be necessary to set aside one's interests for the present with the understanding
that these will be taken care of at a later time. This requires trust.
 Oppose. If nolo contendere and negotiation are not possible, then opposition
may be necessary. Opposition requires marshalling evidence to document one's
position persuasively and impartially. It makes use of strategies such as leading
an "organisational change" or "blowing the whistle." For more on whistle-blowing
consult the discussion on whistle blowing in the Hughes case that can be found at
computing cases.
 Exit. Opposition may not be possible if one lacks organisational power or
documented evidence. Nolo contendere will not suffice if non-opposition
implicates one in wrongdoing. Negotiation will not succeed without a necessary
basis of trust or a serious value integrative solution. As a last resort, one may
have to exit from the situation by asking for reassignment or resigning.

[Link] Refining solutions

 Are any solutions blatantly unethical or unrealizable?

 Do any solutions overlap? Can these be integrated into broader solutions?
 Can solutions be brought together as courses of action that can be pursued
simultaneously?

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 Go back to the problem specification? Can any solutions be eliminated because
they do not address the problem? (Or can the problem be revised to better fit
what, intuitively, is a good solution.)
 Can solutions be brought together as successive courses of action? For example,
one solution represents Plan A; if it does not work then another solution, Plan B,
can be pursued. (You negotiate the problem with your supervisor. If she fails to
agree, then you oppose your supervisor on the grounds that her position is
wrong. If this fails, you conform or exit.)
 The goal here is to reduce the solution list to something manageable, say, a best,
a second best, and a third best. Try adding a bad solution to heighten strategic
points of comparison. The list should be short so that the remaining solutions can
be intensively examined as to their ethics and feasibility.

4.3.4 Solution Testing

 Reversibility: Is the solution reversible between the agent and key stakeholders?
 Harm/Beneficence: Does the solution minimize harm? Does it produce benefits
that are justly distributed among stakeholders?
 Publicity: Is this action one with which you are willing to be publicly identified?
Does it identify you as a moral person? An irresponsible person? A person of
integrity? An untrustworthy person?
 Code: Does the solution violate any provisions of a relevant code of ethics? Can it
be modified to be in accord with a code of ethics? Does it address any aspirations
a code might have? (Engineers: Does this solution hold paramount the health,
safety, and welfare of the public?)
 Global Feasibility: Do any obstacles to implementation present themselves at this
point? Are there resources, techniques, and social support for realizing the
solution or will obstacles arise in one or more of these general areas? At this
point, assess globally the feasibility of each solution.
 The solution evaluation matrix presented just below models and summarizes the
solution testing process.

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 Table 4.3 Summary of solution testing process
Global
Solution/ Harm/ Publicity/
Reversibility Code Feasi-
Test Beneficence Values
bility
Does the
Are there
solution
constraint
Is the solution produce the Does the Does the
or
reversible with best benefit/ solution solution
obstacles
Description stake-holders? harm ratio? Express and violate any
to
Does it honour Does the integrate code
realizing
basic rights? solution key virtues? provisions?
the
maximise
solution?
utility?
Best solution
Second Best
Worst

4.3.5 Solution Implementation

The chosen solution must be examined in terms of how well it responds to various
situational constraints that could impede its implementation. What will be its costs?
Can it be implemented within necessary time constraints? Does it honor recognized
technical limitations or does it require pushing these back through innovation and
discovery? Does it comply with legal and regulatory requirements? Finally, could the
surrounding organisational, political, and social environments give rise to obstacles
to the implementation of the solution? In general this phase requires looking at
interest, technical, and resource constraints or limitations. A Feasibility Matrix helps
to guide this process. The Feasibility Tests focus on situational constraints. How
could these hinder the implementation of the solution? Should the solution be
modified to ease implementation? Can the constraints be removed or remodeled by
negotiation, compromise, or education? Can implementation be facilitated by
modifying both the solution and changing the constraints?

Table 4.4 Feasibility Matrix

Resource Constraints Technical Constraints Interest Constraints
Personalities
Time Organisational
Cost Applicable Technology Legal

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Materials Manufacturability Social, Political, Cultural

[Link] Different Feasibility Constraints

1. The Feasibility Test identifies the constraints that could interfere with realizing a
solution. This test also sorts out these constraints into resources (time, cost,
materials), interest (individuals, organisations, legal, social, political), and
technical limitations. By identifying situational constraints, problem-solvers can
anticipate implementation problems and take early steps to prevent or mitigate
them.
2. Time. Is there a deadline within which the solution has to be enacted? Is this
deadline fixed or negotiable?
3. Financial. Are there cost constraints on implementing the ethical solution? Can
raising more funds extend these? Can they be extended by cutting existing costs?
Can agents negotiate for more money for implementation?
4. Technical. Technical limits constrain the ability to implement solutions. What,
then, are the technical limitations to realizing and implementing the solutions?
Could these be moved back by modifying the solutions or by adopting new
technologies?
5. Manufacturability. Are there manufacturing constraints on the solution at
hand? Given time, cost, and technical feasibility, what are the manufacturing
limits to implementing the solution? Once again, are these limits fixed or flexible,
rigid or negotiable?
6. Legal. How does the proposed solution stand with respect to existing laws, legal
structures, and regulations? Does it create disposal problems addressed in
existing regulations? Does it respond to and minimize the possibility of adverse
legal action? Are there legal constraints that go against the ethical values
embodied in the solution? Again, are these legal constraints fixed or negotiable?
7. Individual Interest Constraints. Individuals with conflicting interests may
oppose the implementation of the solution. For example, an insecure supervisor
may oppose the solution because he fears it will undermine his authority. Are
these individual interest constraints fixed or negotiable?

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8. Organisational. Inconsistencies between the solution and the formal or informal
rules of an organisation may give rise to implementation obstacles. Implementing
the solution may require support of those higher up in the management
hierarchy. The solution may conflict with organisational rules, management
structures, traditions, or financial objectives. Once again, determine if these
constraints are fixed or flexible?
9. Social, Cultural, or Political. The socio-technical system within which the
solution is to be implemented contains certain social structures, cultural traditions,
and political ideologies. How do these stand with respect to the solution? For
example, does a climate of suspicion of high technology threaten to create
political opposition to the solution? What kinds of social, cultural, or political
problems could arise? Are these fixed or can they be altered through negotiation,
education, or persuasion?

4.4 Importance of Ethics to a Business

Every organisation should hold itself up to high moral standards simply because it is
the right thing to do. However, there are some advantages of behaving ethically for
a business. They are as follows:

 They generate good feeling amongst staff.

 Avoid legal action.
 Avoid bad publicity
 A source of competitive advantage

This section of the topic was adapted from Rice University under a Creative
Commons Attribution 4.0 International License (CC BY 4.0) Download for free at
[Link]

4.5 Controlling Ethics

There are three main ways of controlling ethics within an organisation.

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Figure 4.1:A framework for classifying levels of ethical analysis.

4.5.1 Personal/Individual Ethics

Personal ethics are the moral principles that employees subscribe to. Such ethics will
reflect on the organisation, especially those in positions of seniority. An organisation
can control personal ethics through its recruitment process, by ensuring that they
hire individuals who have the desired personal ethics that are aligned with an
organisation.

Ethics are personal and unique to each individual. Ethical decision-making also
involves other individuals, groups, organisations, and even nations—stakeholders
and stockholders—as we later explain. Kenneth Goodpaster and Laura Nash
characterized at least three dimensions or levels of ethics that help explain how
individual and group values, norms, and behaviours of different stakeholders interact
and respond with the aim of bringing orderly, fair, and just relationships with one
another in transactions. This approach is illustrated in Ethical principles generally
codified into laws and regulations when there is societal consensus about such
wrong doing, such as laws against drunk driving, robbery, and murder. These laws,
and sometimes-unwritten societal norms and values, shape the local environment
within which individuals act and conduct businesses. At the individual level, a
person‘s values and beliefs are influenced by family, community, peers and friends,
local and national culture, society, religious—or other types of—communities, and

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geographic environment. It is important to look at individual values and ethical
principles since these influence an individual‘s decisions and actions, whether be it
decisions to act or the failure to act against wrongdoing by others. In organisations,
an individual‘s ethical stance may be affected by peers, subordinates, and
supervisors, as well as by the organisational culture. Organisational culture often has
a profound influence on individual choices and can support and encourage ethical
actions or promote unethical and socially irresponsible behaviour.

4.5.2 Organisational Culture

Organisational culture is the combination of beliefs, values and standards of
behaviour in an organisation. An ethical stance often emerges from within based on
the collective belief of what is wrong and what is right. In this regard the
organisational culture can be influenced in one way by having senior management
behaving in a manner that embodies the kind of ethical principles that are desirable
in the organisation. The values and mission statements can also reflect and
communicate to employees the type of behaviour that is desirable.

As figure 4.2 illustrates, culture plays an important integrating role in organisations

both externally and internally. Strategy, structure, people, and systems all are
affected by an organisation‘s culture, which has been referred to as the ―glue‖ that
holds an organisation together.

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Figure 2.2: Role of culture in an organisational alignment
Leadership, in particular, as stated earlier, exerts a powerful influence, along with
other factors, on culture. Schein noted that ―culture and leadership are two sides of
the same coin and one cannot understand one without the other. ‖Culture is
transmitted through and by the:
1. Values and styles that leaders espouse and practice,
2. Heroes and heroines that the company rewards and holds up as models,
3. Rites and symbols that organisations value, and
4. Way that organisational executives and members communicate among
themselves and with their stakeholders.
Heskett argues that culture ―can account for 20–30% of the differential in corporate
performance when compared with ‗culturally unremarkable‘ competitors.‖

4.5.3 Organisational Systems

Organisational systems are the internal processes that prescribe the way an
organisation operates. Ethical control can be built into organisational systems. For
examples

- Reward systems: rewarding good ethical behaviour.

- Recruitment systems: recruiting people with the right ethics.

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 - Ethical codes: prescribing behaviours that are to be followed.
- Ethical audits: periodic review of departmental ethics.
- Disciplinary procedures: employees should be reprimanded when they
stray from laid down ethical codes.

4.6 Professional Ethics

4.6.1 Integrity

This means acting fairly and honestly in all business dealings. For example one
should not intentionally mislead clients/customers by giving false information.

4.6.2 Objectivity

Conflicts of interest should be avoided in dealing with issues as this may cause
undue influence from other parties resulting in decision making not in the best
interest of the shareholders. Employees should exercise scepticism when receiving
information and verify the source and veracity of the information before using it.

4.6.3 Professional behaviour

A professional should not engage in activities that have the potential of bringing
disrepute to their profession. They should act politely and courteously. Laws and
regulations should not be violated.

4.6.4 Professional competence and due care

One‘s professional knowledge and skill should be maintained in order to allow them
to perform with competence. Performing work that one is not knowledgeable, skilled
or experienced enough is a violation. In order to maintain high professional
standards, individuals must seek to continuously develop themselves in order to
keep abreast with their profession.

4.6.5 Confidentiality

Employees should not disclose information about third parties, obtained in the
course of execution of their duties. Violations of confidentiality should only occur

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under certain circumstances, such as when there is a legal obligation to disclose this
information.

4.7 Values for Professional Ethics

 Definition -A value "refers to a claim about what is worthwhile, what is good. A

value is a single word or phrase that identifies something as being desirable for
human beings." Brincat and Wike, Morality and the Professional Life: Values at
Work (check out the reference)
 Reasonableness -Defusing disagreements and resolving conflicts through
integration. Characteristics include seeking relevant information, listening and
responding thoughtfully to others, being open to new ideas, giving reasons for
views held, and acknowledging mistakes and misunderstandings. (From Michael
Pritchard, Reasonable Children)
 Responsibility -The ability to develop moral responses appropriate to the moral
issues and problems that arise in one's day-to-day experience. Characteristics
include avoiding blame shifting, designing overlapping role responsibilities to fill
responsibility "gaps", expanding the scope and depth of general and situation-
specific knowledge, and working to expand control and power.
 Respect -Recognizing and working not to circumvent the capacity of autonomy
in each individual. Characteristics include honouring rights such as privacy,
property, free speech, due process, and participatory rights such as informed
consent. Disrespect circumvents autonomy by deception, force, or manipulation.
 Justice -Giving each his or her due. There are different types of justice. They
include distributive (dividing benefits and burdens fairly), retributive (fair and
impartial administration of punishments), administrative (fair and impartial
administration of rules), and compensatory (how to fairly recompense those who
have been wrongfully harmed by others).
 Trust -According to Solomon (year), trust is the expectation of moral behaviour
from others.
 Honesty -Truthfulness as a mean between too much honesty (bluntness which
harms) and dishonesty (deceptiveness, misleading acts, and mendaciousness).

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 Integrity -A meta-value that refers to the relation between particular values.
These values are integrated with one another to form a coherent, cohesive and
smoothly functioning whole. This resembles Solomon's account of the virtue of
integrity.

Summary

In this topic we learned about the ethics. We learned that ethics are defined as a
code of moral principles that are followed regarding what is wrong and right. Further
we learned about the framework to be followed when deciding on ethics in a
business setting. We learned that ethics are important in a business as they
generate good feeling amongst staff, helps a business to avoid legal action, avoid
bad publicity and they are a source of competitive advantage. We also learned how
ethics can be controlled and how professional ethics can be applied in the real
business.

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Topic 5: Ethical Leadership in Organisations

5.0 Introduction

Principles and standards in which businesses operate are called organisational ethics.
Business owners and executives show organisational ethics by fairness, compassion,
responsibility, honour and integrity. This topic builds on topic 4 that highlighted,
amongst other things, the importance of business ethics. In this topic, we look at
how ethics can be operationalized in a business through strategy and leadership by
management.

5.1 Objectives

After studying this topic you should be able to:

 Understand organizational leadership in relation to ethics

 Explain how ethics can be aligned to the overall strategy of a business
 Describe what servant leadership implies for an organisation
 Outline and discuss the problems of a lack of ethical leadership in an organisation

This topic was adapted from Rice University under a Creative Commons Attribution
4.0 International License (CC BY 4.0) Download for free at
[Link]

Page | 206
5.2 Leadership: Ethics at the Organisational Level
Organisational leadership is an important first step towards identifying and enacting
a purpose and ethical values that are central to internal alignment, external market
effectiveness, and responsibility toward stakeholders. The scholar Chester Barnard
defined values-based leadership approach in 1939 as one that inspires ―cooperative
personal decisions by creating faith in common understanding, faith in the
probability of success, faith in the ultimate satisfaction of personal motives, and faith
in the integrity of common purpose. Figure 5.1 illustrates how vision, mission, and
values are foundational in guiding the identification and implementation of the
strategic and operational questions and alignment of an organisation—which is a
major part of leadership.

Figure 5.1: Strategic organisational alignment

Leadership is defined as the ability to influence followers to achieve common goals

through shared purposes. Organisational leaders are responsible to a wide range of
stakeholders and stockholders as well as employees toward meeting the goals an
organisation. How responsibly and ethically they choose to do so depends on a
number of factors. From an ethical and related effectiveness perspective, the
leader‘s values count since these generally become the values of an organisation. A
leader‘s influence is referred to as ―the tone at the top.‖ While a leader‘s values
should align to those of the organisation, its vision and mission, this is not always

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the case, as we know from the crises discussed earlier when referring to the classical
failures at Enron, Tyco, WorldCom, Wells Fargo, and other notable companies.

Since leadership is the most important element in forming and directing an

organisation‘s strategy, culture, and governance system, it is often a shared
responsibility among other officers and followers that cascades throughout the
organisation. As an example, the widely acknowledged Ethisphere, a private firm
that evaluates firms‘ ethical behaviours and responsibilities, uses five criteria that
produce a single Ethics Quotient (EQ) score.
1. The first is a company‘s ethics and compliance program, which accounts for 35%
of the EQ.
2. The second criterion is whether or not and the extent to which ethics are
embedded into a company‘s culture.
3. The third element is corporate citizenship and responsibility, elements that
measure companies‘ environmental impact.
4. The fourth component is corporate governance—whether a firm‘s CEO and
board chair are held by one or separate people. An increased focus recently
emphasized diversity in board and leadership positions.
5. The fifth criterion is leadership, innovation, and reputation.

For ethical leaders, authenticity and integrity, in addition to their values, are also
important components of character and behaviour that must also be translated into
attitudes and actions toward followers, external stakeholders, and broader
communities. Leaders have a responsibility to show respect toward others, treat all
stakeholders fairly, work toward a common good, build community, and be honest.
These virtue-related values, also referred to as character-related, as discussed
earlier, help create an ethical corporation and environment:

5.2.1 Show Respect for Others

Respecting others requires leaders to recognize the intrinsic worth of others and
forces them to treat people as ends in themselves—never as means to an end. In
other words, people should be seen as valuable because of who they are (a

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universal principle), not only because of what they can do for others or how they
can help others advance. Showing respect for others includes tolerating individual
differences and affording followers the freedom to think independently, act as
individuals, and pursue their own goals. When a leader shows respect for followers
by providing them autonomy, subordinates can feel more useful, valued, and
confident.
Such a situation often leads to greater loyalty and productivity among subordinates.

5.2.2 Treat all Stakeholders Fairly

Ethical leaders strive to treat everyone fairly and justly when making. Equality is also
a top priority for ethical leaders and needs to factor prominently into their decision-
making. Ethical leaders must refrain from offering special treatment to others.
Failure to do so creates winners and losers—in-groups and out-groups—and can
breed resentment between those who receive special treatment and those who do
not. The only exception occurs when an individual‘s specific situation warrants
special treatment in order for a just outcome to be realized.

Preventing winners and losers from emerging is not always easy. Some situations
require the distribution of benefits and burdens, and such situations can test a
leader‘s ability to ensure that justice is achieved. Beauchamp and Bowie defined the
common principles that guide leaders facing such dilemmas, their findings can help
leaders allocate responsibilities fairly and justly. These principles stipulate that every
person must receive an equal share of opportunity according to his needs, rights,
effort, societal contributions, and performance.

5.2.3 Work Toward a Common Good

Mahatma Gandhi offers an example of what striving toward a common good entails.
Known for his commitment to nonviolent protests and mass civil disobedience, the
Indian activist and ideological leader spent 20 years in South Africa opposing
legislation that discriminated against Indians. He spent the remainder of his life in
India fighting for independence from foreign rule and working to reduce poverty and
taxation, liberate women, and end multiple forms of discrimination. He championed

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such causes not because he would personally benefit, but because a larger, more
substantial population would. Gandhi devoted his life to furthering social causes he
believed in and developed a personal sense of purpose and meaning that later
translated into a societal and then global ethic.

Ethical leaders strive to further social or institutional goals that are greater than the
goals of an individual. This responsibility requires the ethical leader to serve a
greater good by attending to the needs of others. This type of behaviour is an
example of altruism: a steadfast devotion to improving the welfare of others.
Altruistic behaviour may manifest in a corporate setting through actions such as
mentoring, empowerment behaviours (encouraging and enabling others), team
building, and citizenship behaviours (such as showing concern for others‘ welfare),
to name a few.

5.2.4 Build Community

Whole Foods Market, recently purchased by Amazon, is well known for its
community outreach programs on both local and global scales. Every Whole Foods
store donates to community food banks and shelters and throughout the year holds
―5% days,‖ when 5% of the day‘s net sales are donated to local non-profit or
educational organisations. Globally, the company established the Whole Planet
Foundation to combat world hunger and supports programs addressing issues such
as animal welfare, nutrition, and environmentally friendly production methods.

The efforts of Whole Foods to strengthen its stores‘ local and global neighbourhoods
are a perfect example of leaders building the community. When an ethical leader
focuses on the needs of others rather than self, other people will often follow suit.
This can lead to a strong contingent of followers working with the leader to achieve
a common goal that is compatible with the desires of all stakeholders. Furthering a
common goal means that no one can place his needs ahead of the group‘s goals and
an ethical leader cannot impose his will on others. A successful CEO who works with
many charities or other individuals to feed the homeless exemplifies a leader
building the community.

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5.2.5 Be Honest
Honesty is considered desirable by practically everyone, but it is sometimes unclear
what honesty actually demands of us. Being honest is not simply telling the truth
and avoiding deceitful behaviours; it requires leaders to be as open as possible and
to describe reality fully, accurately, and in sufficient detail. Telling the complete truth
is not always the most desirable action, however. Leaders must be sensitive to the
feelings and beliefs of others and must recognize that the appropriate level of
openness and candour varies depending on the situation.

According to a recent survey, 58% of people internationally trust companies, but

42% are less sure. Being more transparent with customers, stakeholders, and
stockholders should become a priority for leaders and boards of companies.
Dishonesty can be a disastrous practice for a leader. Dishonest leaders distort
reality, which can lead to unfavourable outcomes for all stakeholders. Researchers
Cialdini, Petia, Petrova, and Goldstein(year) found that dishonest organisations
suffer from tarnished reputations, decreased worker productivity, and various
damages related to increased surveillance. They concluded that the costs of
organisational dishonesty greatly outweigh any short-term gains from such
behaviour.

5.3 Stewardship and Servant Leadership Styles

Effective leaders, and followers, who lead by example and demonstrate virtuous
practices while demonstrating successful practices are more numerous than the
media or press reveal. Such examples are also entrepreneurs who practice both
stewardship and servant leadership. Their names are not always recognizable
nationally, but their companies, communities, and stakeholders know them very
well. For example, [Link]‘s recent 2017 list of top 10 leaders features four women
CEOs who go beyond the ―call of duty‖ to serve others while succeeding in business.
For example, Brittany Merrill Underwood. She was named in Yahoo‘s ―Best Person in
the World‖ series in 2014. Her company ―reinvests 100 percent of their profits to
support work opportunities, training, social programs, and the construction of

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training centers and water wells in impoverished communities throughout the
globe.‖
Aaron Feuerstein, a previous CEO of a manufacturing plant in Massachusetts, whose
example continues to represent both a steward and servant leadership style, also
represents a classic example of these leadership styles.
Servant Leadership Personified: Aaron Feuerstein at Malden Mills

Aaron Feuerstein, a third-generation owner of Malden Mills in Lawrence,

Massachusetts, suffered his factory burning to the ground on December 11, 1995.
Feuerstein had the option of using the insurance money to rebuild the plant, but he
instead paid the salaries and complete benefits of all the 3,000 workers for 6 months
while the factory was rebuilt. He later said that he had no other option than to help
the employees. His action was based on his study of the Talmud, and he presented
at Xavier University:
―I have the responsibility to the worker, both blue-collar and white-collar. I have an
equal responsibility to the community. It would have been unconscionable to put
3,000 people on the streets and deliver a deathblow to the cities of Lawrence and
Methuen. Maybe on paper our company is worthless to WallStreet, but I can tell you
it‘s worth more.‖
Feuerstein exemplified the two ethical leadership styles of stewardship and servant
leadership, which focus specifically on how leaders work with followers. (Ethical
leadership as a whole concerns the leader‘s characteristics and encompasses actions
in both the internal and external organisational environment.)

Source: Xavier University News and Events, ―Former Malden Mills CEO Aaron
Feuerstein speaking at
Heroes of Professional Ethics event March 30‖, March 24, 2009,
[Link]
Malden-Mills-CEO-Aaron-Feuerstein-speaking-at-Heroes-of-Professional-Ethics-event-
March-30&grp_id=1#.W6FLZPZFyUk

Questions
1. How does Aaron Feuerstein exemplify servant leadership principles?
2. If Feuerstein had decided to use the insurance money for other purposes, would
he have not been acting ethically?

Stewardship is concerned with empowering followers to make decisions and gain

control over their work. Servant leadership involves selflessly working with followers
to achieve shared goals that improve collective, rather than individual, welfare.
There is a wealth of information on both of these styles. We will briefly address both
here, as both involve treating followers with respect—a key component of ethical

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leadership—and endowing followers with the ability to grow both personally and
professionally.
The stewardship approach instructs leaders to lead without dominating followers.
Leaders who practice stewardship sincerely care about their followers and help them
develop and accomplish individual as well as organisational goals. Effective
stewardship breeds a team-oriented environment in which everyone works together.
Organisations led by steward leaders are marked by decentralized decision-making—
that is, leadership is not centered in one person, group, department, or
administrative unity rather power is distributed among all stakeholders.

Robert K. Greenleaf (year), who believed that leadership is a natural corollary of

service, formulated the servant-leadership approach. Servant leadership goes
beyond stewardship by requiring leaders to eschew personal accolades and devote
themselves entirely to a greater cause. Greenleaf stated, ―The essential quality that
separates servant leaders from others is that they live by their conscience—the
inward moral sense of what is right and wrong. That one quality is the difference
between leadership that works and leadership—like servant leadership—that
endures.‖ The following aspects are central to servant leadership:
1. Placing service before self-interest. The servant leader‘s primary concern is
helping others, not receiving recognition or financial reward.
2. Listening to others. Servant leaders recognize the importance of listening to the
ideas and concerns of stakeholders. They never attempt to impose their will on
others. This aspect allows servant leaders to strengthen relationships,
understand group needs and dynamics, and effectively allocate resources to
improve the group‘s welfare.
3. Inspiring through trust. As we discussed earlier, ethical leaders must be
trustworthy. It does not take much effort for servant leaders to be truthful
because they usually have strong moral convictions.
4. Working toward feasible goals. Servant leaders realize that one person cannot
solve all problems. They also tackle the most pressing issues facing their groups.
5. Helping others whenever possible. Servant leaders lend a helping hand when the
opportunity arises. An example is the district manager of a fast-food chain who

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 helps part-time employees flip burgers during a lunchtime rush hour. Another is
the director of a business unit who observes that a team is short of a member
and needs help in meeting the deadline. The director joins the team for the
afternoon to help meet the deadline.

Another way of understanding the distinguishing characteristics of servant leadership

is offered by DeGraaf, Tilley, and Neal (2001):

The main assumption is that true leadership should call us to serve a higher
purpose, something beyond ourselves. One of the most important aspects of
leadership is helping organisations and staff to identify their higher purpose. The
best test of the servant-leadership philosophy is whether or not customers and
staff grow as persons. Do customers become healthier, wiser, freer, autonomous,
more like selves or become ―servants‖? And, what is the effect on the least
privileged in society? Will they benefit? Or, at least, not be further deprived? To
achieve this higher purpose of public organisations, as a leader one must be
passionate about their desire to improve their community and self.

5.3 Dark Side of Organisational Leadership

However, and as noted earlier, not all leaders lead or model high standards or
values. Seven symptoms of the failure of ethical leadership provide a practical lens
to examine a leader‘s short sightedness:
1. Ethical blindness: They do not perceive ethical issues due to inattention or
inability.
2. Ethical muteness: They do not have or use ethical language or principles. They
―talk the talk‖ but do not ―walk the talk‖ on values.
3. Ethical incoherence: They are not able to see inconsistencies among values they
say they follow; e.g., they say they value responsibility but reward performance
based only on numbers.
4. Ethical paralysis: They are unable to act on their values from lack of knowledge
or fear of the consequences of their actions.

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5. Ethical hypocrisy: They are not committed to their espoused values. They
delegate issues that they are unwilling or unable to do themselves.
6. Ethical schizophrenia: They do not have a set of coherent values; they act one
way at work and another way at home.
7. Ethical complacency: They believe they can do no wrong because of who they
are. They believe they are immune.

Activity 5.1

1. What role does leadership play in how ethically organisations and its members
act and perform?
2. Explain what stewardship is and the role of servant leadership.

Summary
We learned that organisational leadership is an important first step towards
identifying and enacting a purpose and ethical values that are central to internal
alignment, external market effectiveness, and responsibility toward stakeholders.

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