CM Week 1 and 2

Subject Code: BAGOSBUSX
Subject Title: GOVERNANCE, BUSINESS ETHICS, RISK MANAGEMENT

AND INTERNAL CONTROL
Subject Description: This course is intended to build understanding of students on

fundamental concepts of corporate governance, risk management
process, and internal control system. At the end of course, students
are expected to be competent on these fundamental concepts in
applying to actual corporate setting and on how to evaluate and
improve financial and operational processes of organization’s risk
management, control, and governance.
No. of Units: 3
Class Schedule: Synchronous: Thurs 09:00am – 11:00am; 11:00am – 01:00pm;

03:00pm-05:00pm
Asynchronous: Mon 09:00am – 11:00am; 11:00am – 01:00pm;

03:00pm-05:00pm
Course Learning Outcomes:

At the end of the course, the student must be able to:
1. Execute consolidation of simple financial statements.
2. Describe principles and characteristics of IFRS/IAS for consolidated financial statements.
3. Evaluate differences between IFRS/IAS and local GAAPs and apply intricate IFRS/IAS
requirements (e.g. IAS 12, IAS 21)
4. Apply acquired knowledge and skills to pass professional licensure / certifications and use
these skills for future job aspects.
5. Appraise ethical problems / issues in practical business and accounting situations and
recommended appropriate course action that adheres to the professional code of ethics.
About the Instructor:

She is a graduate of Bachelor of Science in Accountancy at Baliuag University batch 2014 with
honors (Cum Laude).
After passing the CPA Board Exam, she joined the accounting firm Punongbayan & Araullo, the
Philippine member firm of Grant Thornton International Ltd (GTIL), one of the world's leading
organizations of independently owned and managed accounting and consulting firms as an Audit
Associate.
She completed her Masters in Business Administration at Baliuag University in 2017. Until
recently, she is the Internal Auditor for Bela Star Distribution Systems Inc., one of the leading
commodities trading companies in North Central Luzon.
SM Baliwag Complex, Dona Remedios Trinidad Highway, Brgy. Pagala, Baliwag, Bulacan
(+63) 927-533-0342 – (+63) 923-949-5265 admissions-nubaliwag@nu.edu.ph
-Ms. Fideliz Arca Vidal, CPA, MBA
Contact Information:
Facebook Account: FIDELIZ ARCA VIDAL
Email Address: fcvidal@nu-baliwag.edu.ph
Contact Number: 0917-125-7539 (globe)
Topics:
Module 1: Fundamental Concepts of Corporate Governance
A. Corporate Governance
B. Corporate Governance Structure
C. Three Lines of Defense Model
D. Sarbanes Oxley Act of 2002
E. Practices of Governance, including internal control,
environment, ethical, cultural and compliance to laws and
regulations
DISLAIMER: The information content provided in this course material is designed to provide
helpful information on the subjects discussed. Some information’s are compiled from different
materials and summarized from different books. Some information’s are based on contributors'
perspective and understanding. References are provided for informational purposes only and do
not constitute endorsement of websites or other sources. Readers should be aware that the
websites/electronic references listed in this course material may change. Hence, the contributors do
not claim any information presented in the materials and do not reflect their own work.
MODULE 1:
Fundamental Concepts of Corporate Governance
I. Activity:
1. What is a stakeholder?
a. It is any person or group associated with the organization that receives profits.
b. It is any person or group associated with the organization that is employed by the
company.
c. It is any person or group that provides direction.
d. It is any person or group associated with the organization that has a stake in the
organization's output.
2. 1. A company's _____ may influence a diverse panel of stakeholders in different ways.

a. Performance
b. Decisions
c. Beliefs
d. Ethics
3. Which answer choice represents a display of social responsibility that could lead to
community benefits and increased loyalty to a company?
e. A company sponsors a recycling program and keeps 100% of the profit
f. A company provides limited time off for employees to volunteer on behalf of the
company
g. A company builds a dog park for local pet owners
h. A company allows employees to wear green every Tuesday and Thursday
II. Learning Outcomes

At the end of the topic the students should be able to:
1. Explain and illustrate The Three Lines of Defense Model by the Institute of Internal
Auditors (IIA)
2. Explain the different definitions of Corporate Governance
3. Explain and illustrate a standard Corporate Governance Structure
4. Discuss the two components of Governance (i.e., strategic direction and oversight)
5. Discuss the principles and practices of Governance, including control environment,
ethical culture, and compliance to laws, rules, and regulations
6. Know the composition of Sarbanes Oxley Act of 2002
7. Differentiate roles and responsibilities to Governance process
III. Content:
Definition of Terms
Board of Directors the governing body elected by the stockholders that exercises the corporate
power of a corporation, conducts all its business and controls its properties
Management a group of executives given the authority by the Board of Directors to implement the
policies it has laid down in the conduct of business of the corporation
Independent Director (ID) a person who is independent of management and the controlling
shareholder, and is free from any business or other relationship which could, or could reasonably be
perceived to, materially interfere with his exercise of independent judgement in carrying out his
responsibilities as a director.
Executive Director (ED) a director who has executive responsibility of day-to-day operations as
part of the whole of the organization.
Non-executive director (NED) a director who has no executive business activities in varied
industries, whereby the operations of such businesses are controlled and managed by a parent
corporate entity.
Conglomerate a group of corporations that has diversified business activities in varied industries,
whereby the operations of such businesses are controlled and managed by a parent corporate entity.
Internal Control a process designed and effected by the board of directors, senior management, and
all levels of personnel to provide reasonable assurance on the achievement of objectives through
efficient and effective operations; reliable, complete and timely financial and management
information; and compliance with applicable laws, regulations, and the organization’s policies and
procedures.
Enterprise Risk Management a process, effected by any entity’s Board of Directors, management
and other personnel, applied in strategy setting and across enterprise that is designed to identify
potential events that may effect, manage risks to be within its risk appetite, and provide reasonable
assurance regarding the achievement of entity objectives.
Related Party shall cover the company’s subsidiaries, as well as affiliates and any party, that the
company exerts direct or indirect control over or that exerts direct or indirect control over the
company
Related Party Transactions a transfer of resources, services, or obligations between a reporting

entity and a related party, regardless of whether a price is charged.
Stakeholders any individual, organization, or society at large who can either affect and/or be
affected by the company’s strategies, policies, business decisions and operations, in general.
CORPORATE GOVERNANCE
DEFINITION OF CORPORATE GOVERNANCE
Corporate governance is a relatively new field of study although a very relevant one
nowadays. Best practices has never been easy because of patchwork system of regulations, a mix of
successful corporate governance.
Corporate Governance refers to the way in which companies are governed and to what
purpose. It identifies who has power and accountability, and who makes decisions. It is, in essence,
a toolkit that enables management and the board to deal more effectively with the challenges of
running a company. Corporate governance ensures that businesses have appropriate decision-
making processes and controls in place so that the interests of all stakeholders (shareholders,
employees, suppliers, customers and the community) are balanced.
The SEC of the Philippines defined corporate governance the system of stewardship and
control to guide organizations in fulfilling their long-term economic, moral, legal and social
obligations towards their stakeholder. It is also a system of direction, feedback and control using
regulations, performance standards and ethical guidelines to hold the Board and senior management
accountable for ensuring ethical behavior – reconciling long-term customer satisfaction with
shareholder value – to the benefit of all stakeholders and society.
Governance at a corporate level includes the processes through which a company’s

objectives are set and pursued in the context of the social, regulatory and market environment. It is
concerned with practices and procedures for trying to make sure that a company is run in such a
way that it achieves its objectives, while ensuring that stakeholders can have confidence that their
trust in that company is well founded.
CHARACTERISTICS OF GOOD CORPORATE GOVERNANCE
OBJECTIVES OF CORPORATE GOVERNANCE

1. Fair and Equitable Treatment of Shareholders
2. Self-Assessment
3. Increase Shareholders’ Wealth
4. Transparency and Full Disclosure
BASIC PRINCIPLES OF EFFECTIVE CORPORATE GOVERNANCE
A. Transparency and Full Disclosures
• Does the board meet the information needs of the investing communities?
• Does it safeguard integrity in the financial reporting?
• Does the board have sound disclosure policies and practices?
ü Does it make timely and balanced disclosure?
ü Can an outsider meaningfully analyze the organization’s actions and
performance?
B. Accountability
• Does the board clarify its role and that of management?
• Does it lay solid foundations for management oversight?
• Does the composition mix of board membership ensure an appropriate range and mix of
expertise, diversity, knowledge and added value?
• Is the organization’s senior official committed to widely accepted standards of correct and
proper behavior?
C. Corporate Control
• Has the board built long-term sustainable growth in shareholders’ value for the corporation?
• Does it create an environment to take risk?
– Does it encourage enhanced performance?
– Does it recognize and manage risk?
– Does it remunerate fairly and responsibly?
– Does it recognize the legitimate interests of stakeholders?
– Are conflicts of interest avoided such that the organization’s best interests prevail at
all times?
CORPORATE GOVERNANCE STRUCTURE
AGENCY THEORY
Agency theory posits that corporations act as agents of its shareholders. That is,
shareholders invest in corporate ownership and thereby entrust their resources to the management of
the directors and officers of the corporation. In larger corporations, there is often a sharp divergence
between the short and long-term interest of officers and shareholders. This is primarily brought on
by short-term demand for profits and the asymmetry of information that officers and directors
possess compared with that of shareholders.
The divergence of interest between officer, director, and shareholder is thought to influence
the actions and decisions of officers and directors who may become detached from shareholder
interests.
Corporate governance rules seek to establish a legal framework similar to that of the agent-
principal relationship. These rules seek to align the incentives of officers and directors with those of
shareholders. They seek to establish norms and customs that prevent the adverse results of divergent
corporate interests. Further, agency theory lends itself to the duties that officers or director owe to
the corporation.
STAKEHOLDERS
- Shareholders
- Management
- Customers
- Suppliers
- Government
- Community
CORPORATE GOVERNANCE STRUCTURES

Corporations can have many different structures, but the most typical structure consists of
the shareholders, board of directors, officers and the employees. The structure of corporate
governance determines the distribution of rights and responsibilities between the different parties in
the organization and sets the decision-making rules and procedures. It is usually up to the
management board to decide how the company will develop.
Variables that can affect the foundations of a Board:
 The legal and regulatory obligations of the relevant geography – which may range from a
highly regulated environment that dictates board composition and responsibilities to no
applicable laws at all, depending on the country in which the business is based.
 The company’s ownership structure – which may range from a business closely held by a
few family members who see each other on a daily basis, to one with numerous,
geographically dispersed distant family members, to the inclusion of other investors, either
through private equity investment or publicly traded stock.
 The expectations and interests of key stakeholders including owners, other interested family
members (such as the owners’ likely heirs), customers, and insurers.
 The company’s attributes – size, resources, maturity, culture, and level of complexity.
COMPONENTS OF CORPORATE GOVERNANCE
STRATEGIC DIRECTION Corporate governance plays a critical role in strategy formulation and
strategic delivery. It defines the roles and responsibilities of the board and the executives. It also
determines how an organization is governed. This applies to several aspects of the business, such as
setting the organization’s vision, purpose and strategic goals, providing the right leadership and
culture for Management to reach those goals, and establishing clear parameters for measuring
performance.
Plus, the governance of strategy will help maintain a healthy relationship between the board,
management, and a diverse range of external stakeholders. This prevents conflict and ensures that
all parties are working towards the same collective goals.
OVERSIGHT refers to the actions taken to review and monitor public sector organizations and their
policies, plans, programs, and projects, to ensure that they:
 are achieving expected results;
 represent good value for money; and
 are in compliance with applicable policies, laws, regulations, and ethical standards.
Oversight is a critical governance function performed by boards of directors, committees, councils,

and external bodies. It is a safety net to ensure the following:
 Due diligence takes place before key decisions are made.

 Policies and strategies are being implemented as intended.
 Key risks are identified, monitored, and mitigated.
 Business processes and systems are working well.
 Expected results are being achieved.
 Value for money is obtained.
 Activities comply with policies, laws, regulations, and ethical standards.
 Developing areas of concern are being dealt with.
 Assets are being safeguarded.
 Continuous improvement is taking place.
THE THREE LINES OF DEFENSE MODEL BY IIA
THREE LINES OF DEFENSE MODEL

- the most effective when it is adapted with the objectives and circumstances of the
organization
- The governing body may establish committees to provide additional oversight for
aspects of its responsibilities (audit, finance, planning, and compensation)
Principles of Three Lines Model
1. Governance of an organization requires appropriate structures and processes

that enable:
a. Accountability by a governing body to stakeholders for organizational
oversight through integrity, leadership, and transparency
b. Actions (including managing risk) by management to achieve the

objectives of the organization through risk-based decision making and
application of resources
c. Assurance and advice by an independent internal audit function to
provide clarity and confidence and to promote and facilitate continuous
improvement through rigorous inquiry and insightful communication.
2. Governing Body Roles

a. Ensures appropriate structures and processes are in place for effective
governance
b. Ensures organizational objectives and activities are aligned with the
prioritized interests of stakeholders.
c. Delegates responsibility and provides resources to management to
achieve the objectives of the organization while ensuring legal,
regulatory, and ethical expectations are met.
3. Management and first- and second-line roles

a. Fist Line Roles- most directly aligned with delivery of products and/or
services to clients of the organization, and to include the roles of support
functions.
b. Second Line Roles- provide assistance with managing risk
4. Third Line Roles

*Internal Audit- Provides independent and objective assurance and advice on the
adequacy and effectiveness of governance and risk management through competent
application of systematic and disciplined processes, expertise, and insight.
5. Independence of the Third Line

Internal audit’s independence from responsibilities of management is critical to its
objectivity, authority, and credibility
 Unfettered access to people

 Resources and data needed to complete its work
 Freedom from bias or interference in the planning and delivery of audit
services
6. Creating and protecting value

 ALL roles working together collectively contribute to the creation and
protection of value when they are aligned with each other and with the
prioritized interests of stakeholders
KEY ROLES IN THE 3 LINES MODEL
A. Governing Body
- Accepts accountability to stakeholders for oversight of the organization
- Engages with stakeholders to monitor their interests and communicate
transparently on achievement of objectives
- Nurtures a culture promoting ethical behavior and accountability
- Establishes structures and processes for governance, including auxiliary
committees as required
- Delegates responsibility and provide resources to management for achieving
the objectives of the organization
- Determines organizational appetite for risk and exercises oversight of risk
management (including internal control)
- Maintains oversight of compliance with legal, regulatory, and ethical
expectations.
- Establishes and oversees an independent, objective, and competent internal
audit function
B. Management
First Line Roles
o Leads and directs actions (including managing risk) and application
of resources to achieve the objectives of the organization
o Maintains a continuous dialogue with the governing body, and reports
on: planned, actual and expected outcomes linked to the objectives of
the organization; and risk
o Establishes and maintains appropriate structures and processes for the
management of operations and risk (including internal control)
o Ensures compliance with legal and ethical expectations.
Second Line Roles

o Provides complementary expertise, support, monitoring, and
challenge related to the management of risk, including:
 The development, implementation, and continuous
improvement of risk management practices (including internal
control) at a process, systems, and entity level.
 The achievement of risk management objectives, such as:
compliance with laws, regulations, and acceptable ethical
behavior; internal control; information and technology
security; and quality assurance.
o Provides analysis and reports on the adequacy and effectiveness of
risk management (including internal control)
C. Internal Audit
o Maintains primary accountability to the governing body and
independence of management
o Communicates independent and objective assurance and advice to
management and governing body on adequacy and effectiveness of
governance and risk management (including internal control) to
support the achievement of organizational objectives and to promote
and facilitate continuous improvement
o Reports impairments to independence and objectivity to the
government body and implements safeguards as required.
D. External Assurance Providers

o Provide additional assurance to:
 Satisfy legislative and regulatory expectations that serve to
protect the interests of stakeholders.
 Satisfy requests by management and the governing body to
complement internal sources of assurance.
RELATIONSHIPS AMONG CORE ROLES
1. Governing Body & Management

a. Sets the direction of the organization by defining the vision, mission, values and
organizational appetite for risk
b. The CEO is typically the focal point for this communication, but other senior
managers may have frequent interactions with the governing body.
c. Organizations may wish and their regulators may require leaders of the second line
roles such as Chief Risk Officer (CRO) and a Chief Compliance Officer (CCO) to
have direct reporting line to the governing body
2. Management & Internal Audit

a. Internal audit is accountable to the governing body. However, independence does not
imply isolation.
b. There must be regular interaction between internal audit and management to ensure
the work of internal audit is relevant and aligned with the strategic and operational
needs of organization.
3. Internal Audit and Governing Body

a. Internal audit is the “eyes and ears” of the governing body
b. The governing body is responsible for oversight of internal audit which requires:
i. Ensuring an independent audit function is established
ii. Hiring and firing of Chief Audit Executive (CAE)
iii. Serving as the primary reporting line for the CAE
iv. Approving and resourcing the audit plan;
v. Receiving and considering reports from CAE
vi. Enabling free access by the CAE to the governing body including private
sessions without the presence of management
SARBANES OXLEY ACT OF 2002
 Named after its sponsors, Senator Paul Sarbanes, D-Md., and Congressman Michael Oxley,
R-Ohio. It's also called "Sarbox" or "SOX."3The statute became law on July 30, 2002.
The US Securities and Exchange Commission (SEC) enforces it.
 Cracks down on corporate fraud. It created the Public Company Accounting Oversight
Board to oversee the accounting industry.
 It banned company loans to executives and gave job protection to whistleblowers
 The Act strengthens the independence and financial literacy of corporate boards. It holds
CEOs personally responsible for errors in accounting audits.
 Many thought that Sarbanes-Oxley was too punitive and costly to put in place. They worried
it would make the United States a less attractive place to do business. In retrospect, it's clear
that Sarbanes-Oxley was on the right track. Deregulation in the banking industry contributed
to the 2008 financial crisis and the Great Recession.
 Section 404 and Certification
o Section 404 requires corporate executives to certify the accuracy of financial
statements personally. If the SEC finds violations, CEOs could face 20 years in jail.
o The SEC used Section 404 to file more than 200 civil cases, but only a few CEOs
have faced criminal charges.
o Section 404 made managers maintain “adequate internal control structure and
procedures for financial reporting." Companies' auditors had to “attest” to these
controls and disclose “material weaknesses.
 created a new auditor watchdog, the Public Company Accounting Oversight Board.
 It set standards for audit reports.
 It requires all auditors of public companies to register with them. The PCAOB inspects,
investigates, and enforces the compliance of these firms.
 It prohibits accounting firms from doing business consulting with the companies they are
auditing. They can still act as tax consultants, but the lead audit partners must rotate off the
account after five years.
PRACTICES OF GOVERNANCE
INTERNAL CONTROL Internal control refers to procedures or practices within an organization to

ensure that the organization achieves the targets set in the strategy, uses resources economically and
that 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 ethical principles, too, are ensured through internal
control.
ENVIRONMENT, ETHICAL & CULTURAL Traditionally speaking, the primary duty of a corporation
is to maximize profits on behalf of its shareholders. A public shift away from that mindset is
spreading, represented by the growing popularity of ESG, which stands for Environmental, Social,
and Corporate Governance. It is, in a nutshell, the implementation of a governance structure and
reporting system that evaluates a company's performance related to environmental and social
factors that go beyond the company’s duty to maximize profits.
How well a company performs related to conserving energy, water, and other natural resources,
protecting ecosystems and biodiversity, reducing carbon emissions, mitigating climate change, and
promoting resilience, among other factors.
Newer to corporate life and perhaps more susceptible to public scrutiny and opinion are the
concepts of social and environmental justice. Whether a company is union-friendly, provides fair
pay and leave, prioritizes worker health and safety, and proactively seeks a diverse workforce,
among others, are some of the ways it may be measured on social issues. Suppose a company
disrupts a vulnerable population's access to clean air, water, or cultural resources. Now more than
ever, they may face severe reputational consequences. In this way, environmental and social justice
issues dovetail. Increasingly, companies hire diversity, equity, and inclusion managers and
consultants to examine their internal practices and improve their social impacts to net positive
COMPLIANCE TO LAWS & REGULATIONS The Securities and Exchange Commission of the Philippines
had issued a memorandum to promote the development of a strong corporate governance culture and keep
abreast with recent developments in corporate governance among publicly-listed companies. (SEC
Memorandum Circular No. 19)
BOARD’S GOVERNANCE RESPONSIBILITIES
 Principle 1: The company should be headed by a competent, working board to foster the long-
term success of the corporation, and to sustain its competitive and profitability in a manner consistent
with its corporate objectives and the long-term best interests of its shareholders
 Principle 2: The fiduciary roles, responsibilities and accountabilities of the Board as provided
under the law, the company’s articles and by-laws, and other legal pronouncements and guidelines
should be clearly made known to all directors as well as to stockholders and other stakeholders.
 Principle 3: Board committees should be set up to the extent possible to support the effective
performance of the Board’s functions particularly with respect to audit, risk management, related party
transactions, and other key corporate governance concerns, such as nomination and remuneration. The
composition, functions and responsibilities established should be contained in a publicly available
Committee Charter.
 Principle 4: To show full commitment to the company, the directors should devote the time and
attention necessary to properly and effectively perform their duties and responsibilities, including
sufficient time to be familiar with the corporation’s business.
 Principle 5: The Board should endeavor to exercise objective and independent judgement on all
corporate affairs.
 Principle 6: The best measure of the Board’s effectiveness is through an assessment process. The
Board should regularly carry out evaluations to appraise its performance as a body, and assess whether
it possesses the right mix of backgrounds and competencies.
 Principle 7: Members of the Board are duty-bound to apply high ethical standards, taking into
account the interests of all stakeholders.
DISCLOSURE AND TRANSPARENCY
 Principle 8 : The company should establish corporate disclosure policies and procedures that are
practical and in accordance with best practices and regulatory expectations.
 Principle 9: The company should establish standards for the appropriate selection of an external
auditor, and exercise effective oversight of the same strengthen the external auditor’s independence
and enhance audit quality.
 Principle 10: The company should ensure that material and reportable non-financial and
sustainability issues are disclosed.
 Principle 11: The company should maintain a comprehensive and cost-efficient communication
channel for disseminating relevant information. This channel is crucial for informed decision-making
by investors, stakeholders and other interested users.
INTERNAL CONTROL SYSTEM AND RISK MANAGEMENT
 Principle 12: To ensure the integrity, transparency and proper governance in the conduct of its
affairs, the company should have a strong and effective internal control system and enterprise risk
management framework.
CULTIVATING A SYNERGIC RELATIONSHIP WITH SHAREHOLDER
 Principle 13: The company should treat all shareholders fairly and equitably and also recognize,
protect and facilitate the exercise of their rights.
DUTIES TO SHAREHOLDERS
 Principle 14: The rights of stakeholders established by law, by contractual relations and through
voluntary commitments must be respected. Where stakeholders’ rights and/or interests are at stake,
shareholders should have the opportunity to obtain prompt effective redress for the violation of their
rights.
 Principle 15: A mechanism for employees participation should be developed to create a symbiotic
environment, realize the company’s goals and participate in its corporate governance.
 Principle 16: The company should be socially responsible in all its dealings with the communities
where it operates. It should ensure that its interactions serve its environment and stakeholders in a
positive and progressive manner that is fully supportive of its comprehensive and balanced
development.
IV. Case Study: Enron Scandal
HISTORY. Enron was created in 1986 by Ken Lay to capitalize 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 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
Lay had dealings with Enron could confirm that there was skepticism 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 crystallizing 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 its dealings with its client
Enron that it was in many ways complicit in Enron’s criminal behavior.
ASSESSMENT. Enron wasn’t intended to be an unethical business at the very start.
However, one can see that the pursuit of personal wealth through rapid growth became the catalyst
that brought its downfall.
The principles of corporate governance necessitates a need for ethical culture. If Enron’s
culture is examined, one can see that it was declining very rapidly. Lay and Skilling pushed in all
the staff of Enron the goal of driving up the share price to the virtual exclusion of all others. T he
goal of achieving a long term satisfaction from a stable customer base took a distant second place to
signing up deals. In California, the customers were deliberately exploited by the traders to the
maximum extent their ingenuity could achieve. Even internally, the Chief Finance Officer’s funding
scheme was designed to make him rich at his employer’s expense.
Skiling had a vision of what he want Enron to be, a huge trading enterprise. This was
evidenced by his crazy launch into broadband, a field in which he had no personal knowledge or
experience and in which Enron had almost no capability or likelihood of raising the funds required
to implement the project. However, he wasn’t interested in management per se and allowed
operational management to wither.
Enron’s focus on shareholder wealth and other financial incentives led to lack of
transparency as the figures were washed and fiddled. Its growth was achieved through subterfuge
and deception.
• QUESTIONS:
1. What are Special Purpose Vehicles and How did they contribute to the financial
losses and debt of the company?
2. Assess how the company's corporate governance model contributed to the
company's eventual failure.
3. What are the corporate governance concepts and principles applicable in the case?
4. Make a conclusion and form recommendations by providing specific and realistic
solutions. Apply the concepts and principles learned.
V. Evaluation
1. The basic principle of “transparency and full disclosure” for effective corporate governance
responds positively to the following questions except.
a. Does the board of directors safeguard integrity in financial reporting?
b. Does the board meet the information needs of investment communities?
c. Can an outsider meaningfully analyze the firm’s actions and performance?
d. Has the board built long-term sustainable growth in shareholders’ value for the
corporation?
2. The basic principle of “accountability” for effective governance answers the following
questions positively, except
a. Does the board recognize and manage risk?
b. Does the board lay solid foundations for management oversight?
c. Does the composition mix of board membership ensure an appropriate range and risk
of expertise diversity, knowledge added value?
d. Does the board promote objective, ethical and responsible decision making?
3. “Transparency and full disclosure” principle advocates the following except

a. Sound disclosure polies and practices
b. Solid foundations for management oversight
c. Meeting the information needs of investment communities
d. Safeguard integrity in financial reporting
4. The rights of shareholders can be effectively upheld through the following measures except
a. By establishing an audit committee.
b. By designing and disclosing a communications strategy to promote affective
communications with shareholders.
c. By encouraging active participation at general meetings.
d. By requiring the external auditor to attend the annual general meeting and to answer
questions about the audit.
5. To safeguard integrity in financial reporting, the business firm should do the following
except
a. Establish an audit committee.
b. Request the external auditor to attend the annual general meeting.
c. Disclose the functions reserved to the board and those delegated to management.
d. Disclose the policy concerning trading in company securities by directors, officers
and employees.
6. To encourage enhanced performance by the board and management, it is recommended that
the following should be adopted except
a. Disclosure of the process for performance evaluation of the board, its committees,
individual directors and executives
b. A renumeration committee
c. Distinguish between non-executive director’s renumeration from that of executives.
d. Establish polies on risks oversight and management
7. The characteristics of good governance where fair legal framework is enforced impartially
are
a. Participation
b. Rule of Law
c. Equity
d. Accountability
VI. References
Cabrera, M. E. (2021). Corporate Governance, Business Ethics, Risk Management

and Internal Control. Manila, Philippines: GIC Enterprises & co., Inc.

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Subject Code: BAGOSBUSX

Subject Title: GOVERNANCE, BUSINESS ETHICS, RISK MANAGEMENT

Subject Description: This course is intended to build understanding of students on

Class Schedule: Synchronous: Thurs 09:00am – 11:00am; 11:00am – 01:00pm;

Asynchronous: Mon 09:00am – 11:00am; 11:00am – 01:00pm;

Course Learning Outcomes:

About the Instructor:

Module 1: Fundamental Concepts of Corporate Governance

2. 1. A company's _____ may influence a diverse panel of stakeholders in different ways.

II. Learning Outcomes

Related Party Transactions a transfer of resources, services, or obligations between a reporting

DEFINITION OF CORPORATE GOVERNANCE

Governance at a corporate level includes the processes through which a company’s

OBJECTIVES OF CORPORATE GOVERNANCE

BASIC PRINCIPLES OF EFFECTIVE CORPORATE GOVERNANCE

A. Transparency and Full Disclosures

CORPORATE GOVERNANCE STRUCTURE

CORPORATE GOVERNANCE STRUCTURES

Variables that can affect the foundations of a Board:

COMPONENTS OF CORPORATE GOVERNANCE

Oversight is a critical governance function performed by boards of directors, committees, councils,

 Due diligence takes place before key decisions are made.

THE THREE LINES OF DEFENSE MODEL BY IIA

THREE LINES OF DEFENSE MODEL

Principles of Three Lines Model

1. Governance of an organization requires appropriate structures and processes

b. Actions (including managing risk) by management to achieve the

2. Governing Body Roles

3. Management and first- and second-line roles

4. Third Line Roles

5. Independence of the Third Line

 Unfettered access to people

6. Creating and protecting value

Second Line Roles

D. External Assurance Providers

1. Governing Body & Management

2. Management & Internal Audit

3. Internal Audit and Governing Body

SARBANES OXLEY ACT OF 2002

INTERNAL CONTROL Internal control refers to procedures or practices within an organization to

BOARD’S GOVERNANCE RESPONSIBILITIES

DISCLOSURE AND TRANSPARENCY

INTERNAL CONTROL SYSTEM AND RISK MANAGEMENT

CULTIVATING A SYNERGIC RELATIONSHIP WITH SHAREHOLDER

IV. Case Study: Enron Scandal

3. “Transparency and full disclosure” principle advocates the following except

Cabrera, M. E. (2021). Corporate Governance, Business Ethics, Risk Management

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