ACCA P1 | Governance, Risk and Ethics

Study notes
Internal Actors in Corporate Governance
1. Directors 2. Company Secretary
3. Sub-board management 4. Employee representatives/unions

1. Directors
These are the most prominent group in corporate governance and their powers are set out in
the company’s constitution or articles. Under corporate governance best practice, there is a
distinction between the role of executive directors (who are involved full-time in managing the
company, and the non-executive directors (who primarily focus on monitoring and scrutinizing
the decisions of executive directors). UK Code of Corporate Governance recommends the
inclusion of independent non-executive directors on the board which should at least constitute
50% of the board members.

Legal responsibilities of Directors

The UK Companies Act 2006 sets out seven statutory duties of directors:
1. Act within their powers (as set out within the company’s constitution)
2. Promote the success of the company
3. Exercise independent judgement
4. Exercise reasonable skill, care and diligence
5. Do not accept benefits from third parties
6. Avoid conflict of interest
7. Declare an interest in a proposed transaction or arrangement.

All directors are collectively responsible for the company’s performance, controls, compliance
and behavior and therefore are responsible for each other’s decisions. In lay man terms, it
means that everyone is looking to ensure each member of the board does the job well.

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. This
gives shareholders a chance not to re-elect the underperforming directors.

2. 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 timely filing of accounts and other legal compliance
issues. It is his responsibility to ensure administrative responsibilities that come with PLCs are
adhered too. The company’s secretary most important roles will include the following:
1. Arranging meetings of shareholders and the board of directors.
2. Signing, authentication and maintenance of documents and registers.
3. General administrative duties.

Whatever the duties of the secretary, their ultimate loyalty must be to the company. This may
mean the secretary coming into conflict with, for example, a director or even the chief-
executive. If one of the directors has a clear conflict of interest between their duties to the
company and their personal interests, the company secretary should ensure that the board
minutes reflect the conflict. In many countries, the secretary must be a member of one of a list
of professional accountancy or company secretary professional bodies.

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3. Sub-board management
It is the employee led by sub-board management that implement strategies, meet compliance
targets and collect the information and data on which the board-level decisions are made. In
certain organizations, a ‘strategic drift’ may occur where organization losses sight of its actual
strategic purpose. It is the sub-management which can prevent the strategic drift by making
sure the policies decided by the board are actually followed through.

4. Employee representatives/trade unions

Trade unions represent employees in a workplace. Its membership is voluntary and its influence
depends on how many of the workforce are members. They may be concerned about aspects of
poor corporate governance; for example, failure by directors to communicate with employees or
failure to protect whistleblowers. Trade unions will also be concerned about a lax control and
risk environment, which may jeopardize health and safety or which permits bullying or
discrimination by managers or other employees. Unions are often good at highlighting
management abuses such as fraud, waste, incompetence and greed. Where a good
relationship exists between union and employer, productivity of employees tend to increase.

External Actors in Corporate Governance

1. Stock exchange 2. Institutional investors
3. Auditors 4. Regulators and governments

1. Stock Exchange
Shares are bought and sold in stock exchanges. Each keeps an index of the value of shares on
that exchange. In London, for example, the FTSE All Share (Financial Times Stock Exchange)
index is the measure of all the shares listed in London. In New York, it is the Dow Jones index
and in Pakistan it is the PSX (Pakistan Stock Exchange).

Listed rules are sometimes imposed on the listed companies often concerning governance
arrangements not covered elsewhere by company law. In the UK, for example, it is one of the
stock exchange requirements that listed companies comply with the combined code on
corporate governance.

Insider Trading
In most jurisdictions, it is a criminal offence for the directors and others to use the inside
information that they have for their own benefit through buying or selling shares in the stock
market. Inside information has been defined as information that is specific and precise which
has not yet been made public, and if made public would have a significant impact on the share
price.

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As well as being a criminal offence, it is also an abuse of directors’ role as agents, a clear
instance of directors deviating from their primary role for their own benefit as they are not
putting the interests of the shareholders first.

Unitary v Multi-tier Boards

Countries differ in their employment of various types of board structure. Companies in the UK
and US have tended towards unitary structures while Japanese and some European countries
have preferred two-tier or even multi-tier boards. The distinction refers to the ways in which
decision-making and responsibility is divided between directors. In a unitary structure, all of the
directors have a nominally equal role in board discussions but they also jointly share
responsibility (including legal affairs) for the outcome of those discussions. On a two-tier board,
the senior board acts as a ‘kitchen cabinet’ in which decisions are concentrated whilst other
directors, typically departmental managers, will be on the ‘operating board’ and brought into
board discussions where the senior (upper tier) board deem it appropriate.

Unitary Board
Under a unitary board structure, there is a single board of directors comprising executives and
non-executives directors

Advantages of Unitary Board -BEMEI

1. NEDs are empowered being accorded equal status to executive directors.
2. The presence of NEDs can bring independence, experience and expertise.
3. Often larger than a multi-tier board so more viewpoints are expressed and more robustly
scrutinized.
4. All participants have equal responsibility for management and strategic affairs of the
company.
5. Would ensure better relationships between executive and non-executive directors as a
single board promotes collaboration.

Disadvantages of Unitary Board -TB

1. NED or independent director cannot be expected to both manage and monitor.
2. The time requirement on NEDs may be onerous.

Multi-tier Board
By comparison, there are two separate boards under the multi-tier board structure:
- The management (operating) board which is responsible for day-to-day running of the
business comprising of executives only and led by the chief executive.
- The supervisory (corporate) board with a wider membership, responsible for the
strategic oversight of the organization and led by the chairman.

The supervisory board under a multi-tier structure will include representatives of major
shareholders, environmental groups, employees (possibly from trade unions) and finance
providers. These individuals, although not holding executive positions within the business, are
definitely not considered to be ‘independent’ and will be acting in the interest of their own
group.

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Under a multi-tier board structure, the two boards meet separately which means that the
discussions of the executives about running the company will not be heard by the higher board
members and vice versa. This is unlike the single board meeting that will be held for a unitary
board.

Advantages of Multi-tier Board -ASBF

1. A smaller board can act quicker and more decisively than a large unitary board where a
lot of discussions and scrutiny will take place before a decision is implemented.
2. Separation of duties between people managing and monitoring the company.
3. The supervisory board will take into consideration the benefits of all stakeholders and
just not the shareholders.
4. Separate meetings mean freedom of expression.

Disadvantages of Multi-tier Board -IEOW

1. The supervisory board may be ineffective after all as the information it receives would
be passed on via the executive management board.
2. Exclusion of executives from the supervisory board will limit the effectiveness of
discussions taking place in the supervisory board. Further, since decisions will be taken
without any consultation of the management team, the final strategy may not enjoy full
support from key departmental directors who would be expected to implement it.
3. Unitary board allows for more opinions to be taken into account before a decision is
finalized.
4. It can be argued that without any departmental directors, the supervisory board may
have inadequate understanding about the company’s operations which could lead to
inappropriate decisions being taken.

Director Induction Program

This is the responsibility of chairman. The overall purpose of indication is to minimize the
amount of time taken for the new director to become effective in his or her new job. There are
four major aspects of a director’s induction.
1. To convey to the new starter the organization’s norms, values and culture. This is
especially important when the new employee is from a different type of culture.
2. To communicate practical procedural duties to the new director including company
policies relevant to the new employee – his reporting lines (up and down), the way in
which work is organized in the department and practical matters.
3. To convey an understanding of the nature of the company, its operations, strategy, key
stakeholders (major customers, suppliers and competitors) and external relationships.
For a new director, an early understanding of strategy is essential and a sound
knowledge of how the company ‘works’ will also ensure that he or she adopts more
quickly to the new role.
4. To establish and develop the new director’s relationships with colleagues, especially
those with whom he or she will interact on a regular basis. The importance of building
good relationships early on in a director’s job is very important as early
misunderstandings can be costly in terms of the time needed to repair the relationship.

An adequate induction program will ensure that:

1. The director is aware of the company’s vision and culture.
2. Time taken for the director to start becoming productive.

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3. New directors feel welcomed and useful members of the team.
4. Directors are retained and turnover remains low.

CPD (Continuous Professional Development)

The Higgs report points out that to remain effective, directors should extend their knowledge
and skills continuously and therefore an effective CPD program be in place to ensure that all
directors are equipped to address the needs of the company at all times.

The chairman should address the development needs of the board as a whole with a view of
enhancing its effectiveness as a team.

The main objectives of CPD program will be as follows:

1. Maintain sufficient skills and ability.
2. To tackle challenges and changes within the business environment.
3. Improve board effectiveness.
4. Support personal development of directors.

The Higgs report suggests that a variety of approaches to training may be appropriate, including
lectures, case studies and networking groups.

Performance Appraisal
Appraisal of the board’s performance is an important control over it, aimed at improving board
effectiveness, maximizing strengths and tackling weaknesses. It should be seen as an essential
part of the feedback process within the company and may prompt the board to change its
methods and/or objectives. The UK Code of Corporate Governance recommends that
performance of the board and individual directors should be formally assessed once a year.

In order to be conducted effectively, the appraisal of the whole board will need to include:
1. A review of the board’s systems (conduct of meetings, work of committees, quality of
written documentation).
2. Performance measurement in terms of the standards it has established, financial
criteria, and non-financial criteria relating to the individual directors.
3. Assessment of the board’s role in the organization (dealing with problems,
communicating with stakeholders)

Separate appraisal of the performance of the chairman and the CEO should be carried out by
the non-executive directors, but all directors should have some form of individual appraisal.
Criteria that should be applied include the following:
1. Independence: free thinking, avoids conflict of interest.
2. Preparedness: knows key staff, organization and industry, aware of statutory and
fiduciary duties.
3. Practice: participates actively, questioning, insists on obtaining information, and
undertakes professional education.
4. Committee work: understands the process of committee work, exhibits ideas and
enthusiasm.
5. Development of the organization: makes suggestions on innovation, strategic direction
and planning, helps win the support of outside stakeholders.

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Departure from Office
A director may leave the office in the following ways:
1. Resignation (written notice may be required)
2. Not offering themselves for re-election when their term of office ends.
3. Failing to be re-elected
4. Death
5. Dissolution of the company.
6. Being removed from the office.
7. Prolonged absence meaning that director cannot fulfill duties (may be provided in law or
by company constitution)
8. Being disqualified (by virtue of the constitution or by the court)
9. Agreed departure, possibly with compensation for loss of office.

Retirement by Rotation
Directors are often required to retire from the board and seek re-election. In many jurisdictions,
it is once every three years. The provisions may be enshrined in law, but in most jurisdictions,
the company’s constitution or articles prescribe the rules on rotation. Directors will generally be
entitled to seek re-election if they have retired by rotation. However, retirement by rotation
provision allow shareholders a regular opportunity to vote directors out of the office.

Retirement by rotation has the following benefits for companies:

1. Shareholder rights:
Retirement gives shareholders a chance to judge the contribution of individual directors and
deny them re-election if they have performed inadequately. It is an important mechanism to
ensure directors accountability.

2. Evolution of the board:

Compulsory retirement of directors forces directors and shareholders to consider the need for
the board to change over time. The fact that only some directors retire each year means that, if
board changes are felt to be necessary, they can happen gradually enough to ensure some
stability.

3. Costs of contract termination:

By limiting the length of service period, the compensation paid to directors for loss of office
under their service contracts will also be limited. Contracts may well expired at the time the
director is required to retire and if then the director is not re-elected, no compensation will be
payable.

Director’s Remuneration
The purpose of director’s remuneration is to:
1. Attract and retain individuals (too low salary may be insufficient to attract suitable people).
2. Motivate them to achieve performance goals (often done by providing a part of the reward in the
form of a variable payment linked to corporate performance.

Elements of Director’s Remuneration

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1. Basic salary which is paid regardless of performance; it recognizes the basic market value of a
director. (Not linked to performance in the short run but year-to-year changes in it may be linked
to some performance measures). CCG recommends that the basic pay should be market
competitive and sufficient to attract suitable directors.

2. Short and long term bonuses and incentive plans: Directors may be paid a cash bonus for good
(generally accounting) performance. To guard against excessive payouts, some companies
impose limits on bonus plans as a fixed percentage of salary or pay.

3. Transaction bonuses tend to be much more controversial. Some chief executives get bonuses
for acquisitions, regardless of subsequent performance, possibly indeed further bonuses for
spinning off acquisitions that have not worked out. Alternatively, loyalty bonuses can be
awarded merely to reward directors or employees for remaining with the company. Loyalty
bonuses have been criticized for not being linked to the performance.

4. Share schemes: Directors may be awarded shares in the company with limits (a few years) on
when they can be sold in return for good performance.

5. Share options: Share options give directors the right to purchase shares at a specified exercise
price over a specified time period in the future. If the price of the shares rises so that it exceeds
the exercise price by the time the options can be exercised.

6. Pension and termination benefits including a pre-agreed pension value after an agreed number
of years’ service and any ‘golden parachute’ benefits when leaving.

7. Pension contributions are paid by most responsible employers, but separate directors schemes
may be made available at higher contribution rates than other employees. Further pensions to
directors are often performance related and dependent on the manner of leaving (sacked,
resigned).

8. Other benefits in kind such as cars, health insurance, use of company property, etc.

A reward package that only rewards accomplishments in line with shareholder value
substantially decreases agency costs and when a shareholder might own shares in many
companies, such as ‘self-policing’ agency mechanism is clearly of benefit.

Schemes such as share options will help align shareholder and director interest. A case where a
director exercises all of his share options may represent a decrease in goal alignment between
directors and shareholders.

In order to discourage directors from taking excessive risks to raise performance levels which
may lead to company failure, it is often encouraged that while setting the remuneration an
element of risk discount be incorporated into the package (discount risk could be introduced if,
for example, the internal audit function were to signal a high level of exposure to an unreliable
source of funding). However, doing so in practice may be difficult – it should be discussed in an
exam scenario where a director is seem making risky decisions.

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No executive director should be involved in deciding his or her own pay and CCG delegates this
responsibility to the remuneration committee which should comprise entirely of non-executive
directors.
In order to achieve a fairly balanced package, the remuneration committee needs to consider
how the package is balanced in different ways:
1. Fixed and variable elements
A pay package that is designed to retain directors, for example; when there is a very active
market for executives, is likely to include a high fixed element. As discussed above, however,
most governance reports stress the importance of reward depending to a significant degree on
corporate and individual performance. That said, too high a weighting towards variable,
performance-related elements, particularly if the targets set are tough, may disincentives
directors.

Remuneration of Non-Executive Directors

The International Corporate Governance Network (ICGN) issued guidance on the remuneration
of non-executive directors in 2010 and produced further draft guidance in 2012.

The ICGN focuses on recommending methods that preserve the independence of non-executive
directors. It suggests that an annual fee retainer or fixed hourly rate should be the preferred
method of cash remuneration. Fees can vary according to the responsibilities that non-
executive directors have and the demands made on their time. Non-executive directors who are
members of board committees could be reasonably paid higher fees, with chairs of board
committees being given additional amounts.

7 Positions along the Continuum: Gray, Owen & Adams

The stakeholder/stockholder debate can be represented as a continuum with the two extremes
representing the ‘pure’ versions of each argument. But as with all continuum construct, ‘real
life’ exists at a number of points along the continuum itself. It’s the ambiguity of describing the
different positions on the continuum that makes Gray, Owen and Adams ‘seven positions on
social responsibility’ so useful.

Pristine capitalists
At the extreme stockholder end is the pristine capitalist position. The value underpinning this
position is shareholder wealth maximization, and implicit within it is the view that anything that
reduces potential shareholder wealth is effectively theft from shareholders. As shareholders
have risked their money to invest in the business which also legally makes them the owner of
the business, only they have the right to determine the objectives and strategies of the
business. Agents (directors) that take actions, perhaps in the name of social responsibility that
may reduce the value of the return to shareholders, are acting without mandate and destroying
value for the shareholders.

Expedients
The expedient position share the same underlying value as of pristine capitalist (maximizing
shareholder wealth), but recognizes that some social responsibility expenditure maybe
necessary in order to better strategically position an organization as to maximize profits. A
company may adopt environmental policy or give money to charity if it believes that by doing so
will create a favorable image that will help its overall strategic positioning.

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Social contract position
The social contract position argues that businesses enjoy a license to operate and that license
is granted by the society as long as the business acts in such a way as to be deserving of that
license. Accordingly, businesses need to be aware of the norms (including ethical norms) in
society so that they can continually adapt to them. If an organization acts in a way that society
finds unacceptable, the license to operate can be withdrawn by society, as was the case with
Arthur Andersen after the collapse of Enron.

Social ecologist
Social ecologists go a stage further than the social contractarians in recognizing (regardless of
the view of the society) that business has a social and environmental footprint and therefore
bears some responsibility in minimizing the footprint it creates. An organization might adopt
socially and/or environmentally responsible policies not because it has to in order to be aligned
with the norms of society (as the social contractarians would say) but because it feels that it
has a responsibility to do so.

Socialists
Socialists see the business framework as one class (capitalists) manipulating and oppressing
another class (workers and socially oppressed). Business therefore acts to concentrate wealth
in a society. Business decision-making should no longer be determined by the requirements of
capitalism and materialism but should promote equality. Policies to enhance corporate social
responsibility will fail if they continue to take place in the existing framework. Business should
be conducted in a fundamentally different way, to redress the imbalances in society and
provides benefits to many stakeholders not just shareholders.

Radical feminists
Economic and social systems privilege masculine qualities such as aggression, conflict and
competition over feminine values such as co-operation and reflection. Developing corporate
social responsibility in the existing masculine framework won’t work. A fundamental
readjustment is required in the culture and structure of society with potentially far-reaching
implications of accountability relationships. Society needs to emphasize qualities traditionally
seen as feminine, such as equality, dialogue, compassion and fairness.

Deep ecologists
Human beings have no greater right to resources or life than other species and do not have the
rights to subjugate social and environmental systems. Economic systems that trade off threats
to the existence of species against economic objectives are immoral. Arguably businesses
cannot be trusted to maintain something as important as the environment. Existing economic
systems are beyond repair as they are based on the wrong values, privileging humans over non-
humans. A full recognition of all stakeholders would mean that business had to be conducted in
a completely different way.

What is Corporate Governance?

 Corporate governance can be defined as the way in which organizations are directed and
controlled.
 One of the biggest disadvantages of large corporation (usually public limited companies) is the
separation of ownership and control – which means that people who own the company
(shareholders) are usually not the ones who run the company (directors). This may mean that

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there is a chance that the directors of a company may pursue their own personal interests
instead of those of the shareholders. This is referred to as agency problem.

How sound corporate governance can make it more difficult for companies to fail? (Dec 12 Q2)
A sound system of corporate governance is capable of reducing company failures in number of
ways: -AREIIN
1. It reduces the issues caused by the agency problem and makes it less likely that management
will promote their own interests over those of shareholders.
2. It helps in identifying and managing wide range of risks.
3. It encourages a reliable and complete external reporting. Through this, the shareholders will
have the information of what is going within a company and will have an advanced warning of
issues that may arise.
4. It underpins investor confidence and gives shareholders a belief that their investment is being
managed properly.
5. It specifies a range of internal controls that will ensure the effective use of resources and the
minimization of waste, fraud and misuse of company assets. Internal controls are necessary for
maintaining the efficient and effective operation of a business.
6. It encourages and attracts new investments and makes it more likely that lenders will extend
credit and may even provide increased loan capital if needed.

Principle v Rule Based Codes

Rules-based corporate governance code

Rules-based corporate governance codes consist of a strict set of regulations which has to be
followed in any case. In rules-based approach to corporate governance, provisions are made in
law and a breach of any applicable regulation is therefore a legal offence. This means that
companies become legally accountable for compliance and are liable for prosecution in law for
failing to comply with the detail of corporate governance code or other provision. An example of
such a code would be the one followed by the listed companies in America.

ADVANTAGES
Clarity – since rules are rigid and
straightforward, companies know what to do
and what not to do.
Standardization – same rules for everyone.
Unlike principal-based codes they don’t apply
differently to different situations.
Non-compliance of rules results in penalties
which act as a deterrent against bad corporate
governance.
Rules are easier to understand and follow.
They are unambiguous.
DISADVANTAGES
Can encourage ‘box-ticking’ approach –
following rules only for the sake of following
them instead of understanding their true
essence.
Creates unnecessary administration burden on
companies.
One size doesn’t necessarily fit all.
Can be expensive for companies to follow all
the rules.

Principle-based corporate governance codes

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Principle-based corporate governance codes on the contrary consist of basic guidelines which
companies have to follow. Such codes are based on ‘comply or explain’ system which means
that companies failing to comply with the principles stated in the code are required to give valid
reasons for doing so. The combined codes of corporate governance followed in the UK along
with most other codes around the world are principle-based codes.

Corporate Governance Concepts

One view of corporate governance is that it is based on the following concepts:

1. Fairness
Directors while making decisions about company should take into account everyone who has a
legitimate interest in the company. This means that there should be no bias towards one party
when making decisions about the company.

2. Transparency
Transparency is the important quality of governance which specifies that companies should
disclose the material information to shareholders and other stakeholders unless there is a valid
and defensible reason to withhold it. It implies a default position of disclosure over the
concealment of information.

3. Independence
Independence is the avoidance of being unduly influenced by vested interests and being free
from any constraints that would prevent a correct course of action being taken.

4. Probity
Probity relates to not only telling the truth but also not misleading shareholders and other
stakeholders. Lack of probity not only includes obvious examples of dishonesty such as taking
bribes, but also reporting information in a slanted way that is designed to give an unfair
impression.

5. Responsibility
Responsibility means management accepting the credit or blame for governance decisions. It
also means the clear definition of roles and responsibilities within the senior management.

6. Accountability
Accountability means being answerable in some way for the consequences of actions. In the
context of code of corporate governance, board of directors is accountable to shareholders of
the company. This means that they are answerable to shareholders or what can be called as to
give account for their behavior and actions as appointees of the shareholders. One of the ways
through which shareholders can hold directors accountable is through AGM. Shareholders may
express their dissatisfaction by removing directors through vote once their term ends and they
stand for re-election.

7. Reputation
Reputation is determined by how others view a person, organization or profession. Reputation
includes reputation for competence, supplying goods and services in a timely fashion, and being
managed in an orderly way. However, a poor ethical reputation can be as serious for an
organization as poor reputation for competence. Poor reputation will result in:

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- Suppliers and customers unwillingness to deal with organization for fear of being victim of
sharp practice.
- Inability to recruit high-quality staff.
- Fall in demand because of consumer boycotts.
- Increase in public relations cost because of adverse stories in media.
- Increase in compliance costs because of close attention from regulatory bodies or external
auditors.
- Loss of market value as investor confidence will decline.

8. Judgement
Because corporate governance is based on decision-making, the ability to make sound and
balanced judgements is an important underlying principle. The board members must acquire
broad knowledge of company and its environment to be able to provide meaningful direction to
it. The decision-maker’s personal attitudes to risk, ethics and timescale of possible returns are
likely to be important factors in how a person judges a given decision.

9. Integrity
Integrity can be taken as meaning someone of high moral character who sticks to strict moral
or ethical principles no matter the pressure to do otherwise. In working life, this means
adhering to highest standards of professionalism and probity. Straightforwardness, fair dealing
and honesty in relationships with different people and constituencies whom you deal with is
particularly important. Integrity is an underlying and underpinning principle of corporate
governance and requires anybody representing shareholders to possess and exercise absolute
integrity at all times.

Corporate Governance and Agency Theory

Agency relationship is a contract under which two or more persons (principals) engage other
person (the agent) to perform some service on their behalf that involves delegating some
decision-making authority to the agent.

An agency relationship is one of trust between an agent and a principal which obligates the
agent to meet the objectives placed upon it by the principal.

Fiduciary Duty
Fiduciary duty is a duty of care and trust that one party owes to another, mainly defined as the
financial duty in a business context. It can either be a legal duty or a moral duty (or both). In
case of legal duty, it is legally required, for example, for a solicitor to act in the best interests of
a client, or for a nurse to act in the best interests of a patient. In some cases, the legal
responsibilities are blurred but ethical duty may remain. Many would argue, for example, that
people owe a fiduciary duty to certain ancient monuments or to the preservation of a unique
landscape.

The directors of a company owe a fiduciary duty to their shareholders under the agency
relationship. On the contrary, it could be argued that the directors morally owe a fiduciary duty
to other stakeholders affected by the business too.

The Agency Problem

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The agency problem stems for the separation of ownership and control leading to possible
conflict of interests between shareholders and directors. The agency problem therefore
concerns how shareholders control the directors to ensure that they act in their principal’s best
interests and not in their own personal interests, such as;
1. High salaries, benefits and easy to obtain bonuses (regardless of the company’s
performance – being rewarded for failure).
2. Excessive retirement benefits.
3. Golden parachute (meaning that directors get significant compensation in the event of
takeover).
4. Poison pills (making it difficult for a company to be taken over when doing so is actually in
the interest of the company and shareholders).
5. Hiring close personal relationships within the company when they are clearly unfit to serve.
6. Long-term contracts making it difficult to sack the directors.
7. Non-business use of assets.

Agency Costs
Because of agency problem, the shareholders incur ‘agency costs’ to monitor their agents
(directors) in order to ensure that they are working towards the success of the company instead
of pursuing their own personal interests. These costs include:
1. Costs of studying company data and results
2. Purchase of expert analysis
3. External auditor’s fee
4. Costs of devising and enforcing directors contracts
5. Time spent attending company meetings
6. Costs of direct intervention in the company’s affairs

If shareholders wouldn’t have to keep checking the managers, then there would be no agency
costs. Therefore, shareholders encourage directors reward packages to be aligned with their
own interests so that they feel lees need to continually monitor directors’ activities.

Agency costs can be expensive for shareholders only holding shares in few companies. For
large-scale investors, holding a portfolio containing the shares of many different companies, the
agency costs can be prohibitive. This illustrates the importance of minimizing agency costs by
aligning the interests of shareholders and directors.
Obtaining Public Listing
Following are the advantages and disadvantages of obtaining public listing:

Advantages
It opens the capital to the firm allowing it to
raise additional capital which wouldn’t be
possible through private equity sources.
Enhances its credibility as investors and the
general public is aware that by doing so it has
opened itself to a much higher degree of
Disadvantages
A distributed shareholding does place the firm
in the market for corporate control increasing
the likelihood that the firm will be subject to a
takeover bid.
There is also a much more public level of
scrutiny with a range of disclosure
requirements.
Financial accounts must be prepared in
accordance with IFRS or FASB and with the
relevant GAAP as well as the Companies Act.
Under the rules of the London Stock Exchange,

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ACCA P1 | Governance, Risk and Ethics
Study notes
public scrutiny than in the case of private firm.
companies must also comply with the
governance requirements of the combined
code.

Remuneration Reports
Remuneration reports are important because they provide shareholders with information about
how much the executive directors are paid and how their remuneration is configured. This is
important so that shareholders now how motivated the directors are and how well their rewards
are aligned to the interests of shareholders. If there are payments missing from remuneration
report, then shareholders are not receiving accurate information on how directors are being
rewarded. This, in turn, undermines the whole purpose of remuneration reporting as it is
intended to convey important disclosure to shareholders therefore violating the corporate
governance concept of transparency.

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