SUMMARY MANAGEMENT CONTROL SYSTEM

CORPORATE GOVERNANCE AND BOARDS OF DIRECTORS

CHAPTER 13

CLASS Z

GROUP 5

1. Artika Indahsari 2017310023

2. Cornelia Oribel 2017310029

S1 ACCOUNTING

STIE PERBANAS SURABAYA

2019
 CORPORATE GOVERNANCE AND BOARDS OF DIRECTORS

The term corporate governance refers to the sets of mechanisms and processes that
help ensure that companies are directed and managed to create value for their owners while
concurrently fulfilling responsibilities to other stakeholders (e.g. employees, suppliers, and
society at large). Corporate governance is the set of processes, customs, policies, laws, and
institutions affecting the way a corporation is directed, administered or controlled. Corporate
governance also includes the relationships among the many stakeholders involved and the
goals for which the corporation is governed.
In Anglo-American economies, the primary governance mechanisms are provided by
equity markets and the structures that support them or result from them. These include laws
and regulations, boards of directors, external auditors, governance ratings, and takeover
threats. In some Western European and Asian economies, relatively more governance
influence is provided by concentrated ownership patterns, such as the Keiretsu in Japan, the
Chaebols in Korea, institutional investors in India, and state ownership in China.
Corporate governance is broader than management control, also covering control over
top management. Corporate governance focus is on controlling the behaviours of top
management, and through their direction, those of all the other employees in the firm. In the
meantime, regulations are frequently changing. Corporations and boards of directors must do
the best they can in environments that are often dynamic.
Corporate governance systems and management control systems (MCSs) are
inextricably linked. A corporate governance focus is slightly broader than a MCSs focus. A
MCSs focus takes the perspective of top management and asks what can be done to ensure
the proper behaviors of employees in the organization. The corporate governance focus is on
controlling the behaviors of top management (the so-called C-suite executives) and also,
although less directly, those of all the fi rm’s other employees. The links between corporate
governance and MCSs are obvious. Changes in corporate governance mechanisms and
practices will usually have direct and immediate effects on MCS practices and their
effectiveness.

Laws and Regulation

Corporations are legal entities. As such, they are subject to the laws and regulations of
the government jurisdictions in which they operate and those of the stock markets on which
their shares are traded. Corporate governance approaches and mechanisms vary widely across
countries.

Two corporate governance orientations:

 Anglo-American system: focuses on the primacy of shareholders as the beneficaries

of fiduciary duties.
 Continental European/Japanese system: a broader concern for the rights of other
stakeholders.
But even within these two broad types of systems, considerable variation exists in the
governance mechanisms used (e.g. board composition and structure) and the contexts in
which the mechanisms must work (e.g. laws, extent of merger-and-acquisition activity).
The legal system in the United States creates a fiduciary obligation for managers and
directors to act in the best interest of shareholders. The directors, the elected representatives
of the shareholders, are charged with overseeing the actions of management. Since the
shareholders are viewed as the residual claimants of the cash flows generated, the primary
goal is to maximize the value of the corporation. value creation is a long-run, future-oriented
concept, so it can easily be seen that treating all stakeholders well is also in the long-term
interest of the shareholders.
The Continental European/Japanese system of governance is aimed at ensuring that
the corporation is managed for the good of the enterprise, its multiple stakeholders, and
society at large. The shareholders are only one of many affected stakeholder groups. One
important effect of this legal difference is in the composition of the boards of directors. Large
German corporations, for example, are required to have a two-tier board structure, one that
provides strategic oversight and another that provides operational management oversight.

The Sarbanes-Oxley act of 2002

Sarbanes-Oxley is the most significant piece of legislation affecting corporate

governance practices to be passed in the US since the Securities Act of 1934, and it has
control implications beyond US borders. The goal was to improve the transparency,
timeliness, and quality of financial reporting. Regulation of auditing, independence of audit
committees, in-control rules (related to effectiveness of these controls). It will increase
control costs, but is not a safeguard to failures (day-to-day ethical behaviour is a management
matter).
SOX has had effects beyond US borders. All companies registered with the SEC must
comply with SOX whether their headquarters are based in the United States or abroad. In
addition, some countries, such as Canada and Japan, have adopted regulations similar to
SOX.
Among other things:
 The external auditing industry, which was formerly self-regulated, became highly
regulated by the federal government. SOX created the Public Company Accounting
Oversight Board (PCAOB) and gave it the authority, with oversight from the SEC, to
set auditing standards and to monitor auditors’ actions.
 The members of audit committees of companies’ boards of directors are required to
be independent and financially literate.
 Senior company managers, usually the CEO and CFO, are required to certify that they
had reviewed their company’s quarterly and annual financial statements; that the
financial statements are fairly presented, with no untrue statements or omissions of
material facts; that they acknowledge responsibility for disclosure controls and
procedures and internal controls over financial reporting; and that they have evaluated
those controls and procedures and disclosed any material changes or deficiencies to
the auditors and audit committee. Penalties for fraud and for obstructing an
investigation were broadened and made more severe.

Section 404 mandated an evaluation of the effectiveness of a company’s internal controls

by both management and the company’s external auditor and formal written opinions about
the effectiveness of those controls. In doing this evaluation, managers and auditors are
required to examine a broad range of internal controls over financial reporting, including
policies and procedures, audit committee effectiveness, integrity and ethical behavior
programs.
Boards of Directors

In publicly traded companies, shareholders typically diversify their risks and own a
portfolio of shares in numerous firms. Individually, they rarely have an incentive large
enough to devote the time and resources necessary to ensure that management is acting in the
best interest of the shareholders. The solution is for shareholders collectively to delegate their
authority to monitor management’s actions to a board of directors.
Boards of directors have a fiduciary duty to foster the long-term success of the
corporation for the benefit of shareholders, and also sometimes for debt holders. Elements:

1. Duty of care – duty to make/delegate decisions in an informed way

2. Duty of loyalty – duty to advance corporate over personal interests
3. Duty of good faith – duty to be faithful and devoted to the interests of the corporation
and its shareholders
4. Duty not to waste – duty to avoid deliberate destruction of shareholder value.

Boards must be independent and accountable to shareholders, and they must exert their
authority for the continuity of executive leadership with proper vision and values.

Two main control responsibilities:

 Safeguard the equity investors’ interest, particularly by ensuring that management

seeks to maximize the value of the shareholders’ stakes in the corporation.
 Protect the interests of other corporate stakeholders by ensuring that the employees in
the corporation act in a legally and socially responsible manner.

In the meantime, board members have to do the best job they can. But in deciding how to
structure their activities and how to act, boards of directors should follow some basic
principles.
1. First, they must comply with the relevant laws and regulations. To ensure this
compliance, they often have to rely heavily on their company’s lawyers both to
inform them of the relevant laws and to educate them about the implications of
those laws. If they are accused of wrongdoing, they will be judged in light of the
extent they upheld their duties of care, loyalty, and so on.
 2. Second, board members should try to follow what they believe to be best practice.
Consultants often play an important role in spreading and advocating such
(various) practices. That said, board members should keep in mind that so-called
experts often provide conflicting advice. Equally, evidence in many basic board-
related areas, including the desirability of splitting the chairman and CEO roles,
the optimum amount of equity involvement by board members, the right set and
mix of board member skills, and the right board size, is still equivocal.
Most boards have at least the following standing committees: audit committee, compensation
committee, and nominating and governance committees. Some also have other committees
that fit the needs of the company’s industry or operating situation. These might include some
combination of finance, investment, technology, public policy, environment, innovation,
corporate social responsibility, digital/social media, and/or risk management committees.

Audit Committees

They provide independent oversight over companies’ financial reporting processes,

internal controls, and independent auditors. They enhance a board’s ability to focus
intensively and relatively inexpensively on the corporation’s financial reporting-related
functions. Audit committees must be comprised of at least three independent members. An
audit committee charter must specify the scope of the committee’s responsibility and how it
carries out those responsibilities. They must be directly responsible for the appointment,
compensation, retention and oversight of the work of the external auditors.

While more research on audit committee effectiveness is needed, it is clear that audit
committees and their processes must be adapted to the requirements and resources of their
company and board. That said, some common practices suggest that audit committees
ascertain to do the following:
 Gain support and direction from the entire board of directors.
 Use agendas and follow formal work programs; keep minutes of meetings and
distribute them to the full board of directors; schedule meetings in advance so
participants have time to prepare.
 Have at least three members, but not too many more so that all members can be active
participants.
 Ensure that the committee is comprised of the “right” individuals. Define the
members’ responsibilities and expect members who no longer contribute
 appropriately to step down. Ensure that all members are independent of management,
financially literate, and engaged.
 Meet at least four times per year, including a pre-audit meeting and a post-audit
meeting. (Some experts consider the frequency and duration of meetings to be highly
reliable indicators of audit committee effectiveness.)
 Send a clear instruction to the independent auditor that the board of directors, as the
shareholder’s representative, is the auditor’s client and that management is not. (This
is a legal requirement of Sarbanes-Oxley.)
 Review all financial information; review interim, as well as annual, financial reports.
 Discuss with the independent auditor their qualitative judgments about the
appropriateness, not just the acceptability, of the organization’s accounting principles
and financial disclosure practices.
 Go beyond a “check-the-box” orientation to compliance with legal requirements. Deal
with the real issues of developing effective oversight and risk management practices.
 Be proactive. Participate in setting policies. Monitor the corporate code of conduct
and compliance with it. Ensure that the internal auditing involvement in the entire
financial reporting process is appropriate and properly coordinated with the
independent auditor.
 Secure access to resources as needed, such as for responding to crises or conducting
special investigations.

Compensation Committees

They deal with issues related to the compensation and benefits provided to
employees, and particularly top executives. They have fiduciary responsibilities for ensuring
that the company’s executive compensation programs are fair and appropriate to attract,
retain, and motivate managers and that they are reasonable in view of company economics
and the relevant practices of comparable companies. Compensation committees have
fiduciary responsibilities for ensuring that the company’s executive compensation programs
are fair and appropriate to attract, retain, and motivate managers and reasonable in view of
company economics and the relevant practices of comparable companies.
Those committees rely on the company’s HR function for staff support. In addition,
because the design of compensation plans can raise many complex issues, such as relating to
performance measures, types of compensation (e.g. cash and stock options) and
compensation structures (e.g. performance thresholds and vesting provisions), external and
internal compensation equity, and legal and tax considerations – compensation committees
often employ outside consultants to provide data or expertise that the company does not have
internally. Consultants often conduct industry compensation benchmarking studies and
provide advice regarding the design of compensation plans. Compensation committees
should retain full responsibility for overseeing the work of any compensation consultants they
hire.
Much criticism is currently being directed at compensation committees.29 Some of
this criticism stems from the large compensation, severance, and/or retirement packages that
have been offered to top executives. Other critics are more concerned with the weak links in
many companies between rewards and performance. Criticism is likely when the executives
are well compensated not only when their performance is seen as poor in an absolute sense,
but also when economic conditions are good even though their companies’ performance
lagged behind those of their closest competitors.