CPA PROGRAM

ETHICS AND
GOVERNANCE
FOURTH EDITION

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Published 2023 by John Wiley & Sons Australia, Ltd,
310 Edward Street, Brisbane Qld 4000,
on behalf of CPA Australia Ltd,
ABN 64 008 392 452
First edition published January 2010, reprinted July 2010, revised January 2011, July 2011, reprinted January 2012,
July 2012, updated January 2013, reprinted July 2013, updated January 2014, reprinted July 2014, revised January 2015,
updated January 2016
Second edition published May 2018
Third edition published November 2019
Fourth edition published November 2023
© 2001–2023 CPA Australia Ltd (ABN 64 008 392 452). All rights reserved. This material is owned or licensed by
CPA Australia and is protected under Australian and international law. Except for personal and educational use in the
CPA Program, this material may not be reproduced or used in any other manner whatsoever without the express written
permission of CPA Australia. All reproduction requests should be made in writing and addressed to: Legal, CPA Australia,
Level 20, 28 Freshwater Place, Southbank, VIC 3006, or legal@cpaaustralia.com.au.
Edited and designed by John Wiley & Sons Australia, Ltd
Printed carbon neutral by Finsbury Green
ISBN 9781922690135
Authors
James Beck Consultant
Courtney Clowes Director, KnowledgEquity
Craig Deegan Professor of Accounting, The University of Tasmania
Patrick Gallagher Managing Director, Governance Tax & Risk Pty Ltd
Alex Martin Consultant
Greg McLeod Consultant
Tom Ravlic Consultant
Roger Simnett Professor of Accounting, UNSW Australia Business School
Jennifer Tunny Senior Research Advisor, Effective Governance

Third edition updates

Karyn Byrnes Consultant
Ellie Chapple Professor of Accounting, Queensland University of Technology
Melanie Seifert Head of Short Courses, AGSM, UNSW Business School

Fourth edition updates

Katherine Christ Senior Lecturer, Accounting, University of South Australia
Tom Ravlic Consultant
Clare Payne Fellow for Trust and Ethics, EY and Honorary Fellow, The University of Melbourne
Liyu He Senior Lecturer, Accounting, Macquarie University

Advisory panel
James Beck Consultant
Thomas Clarke Professor of Management, UTS Business School, University of Technology Sydney
Mary Dunkley Associate Professor, Department of Accounting, Economics and Finance, Swinburne University of Technology
Alan Greenaway Australian Pharmaceutical Industries
Jennifer Lauber Patterson Frontier Impact Group
Mike Sewell Consultant
Marcia O’Neill Consultant
Eva Tsahuridu Consultant

CPA Program team

Member Education, CPA Australia

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ACKNOWLEDGEMENTS
ACKNOWLEDGEMENT OF COUNTRY
CPA Australia acknowledges the traditional owners and custodians of the lands on which we live. We pay
our respects to all Aboriginal and Torres Strait Islander peoples, and to Elders past and present of these
lands in which we live and learn, and extend this respect to the indigenous peoples and lands throughout
Australia and the world. We are committed to creating a future that embraces First Nations peoples for
present and future generations.

MODULE 1
Figure 1.2: © Brourard, F, Merriddee, B, Durocher, S & Burocher Neison, L 2017, ‘Professional
accountants’ identity formation: An integrative framework’, Journal of Business Ethics, vol. 142, no. 2,
pp. 225–8; Figure 1.3: © APESB (Accounting Professional and Ethical Standards Board); Extracts:
© ASIC (Australian Securities & Investments Commission). Reproduced with permission; © Gregor
Allan; © CPA Australia.

MODULE 2
Figures 2.1–2.3: © IFAC; Figure 2.4: © Eisenbeiss, SA 2012, ‘Table 1: The theoretical basis of the central
orientations of ethical leadership’, in ‘Re-thinking ethical leadership: An interdisciplinary integrative
approach’, The Leadership Quarterly, vol. 23, no. 5, pp. 791–808; Figure 2.6: © APESB (Accounting
Professional and Ethical Standards Board); Figure 2.8: © John Wiley & Sons; Figure 2.10: © CPA Australia
2022; Tables 2.5–2.7, 2.9–2.14 and extracts: © APESB (Accounting Professional and Ethical Standards
Board); Extracts: © State of New South Wales Department of Premier and Cabinet 2019; © Christensen,
BA 1996, ‘Kidders theory of ethics’, Journal of the American Society of CLU & ChFC, vol. 50, no. 4,
p. 29; © IFAC; © Supreme Court of Western Australia; © ASIC (Australian Securities & Investments
Commission). Reproduced with permission.

MODULE 3
Figure 3.4: © Oxford University Press; Figure 3.6 and extracts: © 2023 ASX Corporate Governance
Council; Figure 3.7: © State of Victoria Victorian Public Sector Commission; Table 3.4: © Bosch, H
1995, Corporate practices and conduct, 3rd edn, Pitman, Melbourne, p. 9. Reproduced with permission;
Table 3.10: © Commonwealth of Australia 2023; Extracts: © Federal Register of Legislation 2023;
© Financial Reporting Council 2018. Reproduced with permission; © State of New South Wales
Department of Justice; © Jensen, M & Meckling, W 1976, ‘Theory of the firm: Managerial behavior,
agency costs and ownership structure’, Journal of Financial Economics, vol. 3, no. 4, pp. 305–60; © OECD
(Organisation for Economic Co-operation and Development); © Australian Shareholders Association;
© Commonwealth of Australia; © State of New South Wales Department of Justice; © ASIC (Australian
Securities & Investments Commission). Reproduced with permission; © UK Financial Reporting Council;
© Commonwealth of Australia 2018, 2003; © John Halligan; © Commonwealth of Australia — APSC
(Australian Public Service Commission) 2007, Building Better Governance, Australian Government.

MODULE 4
Figure 4.1 and extracts: © OECD (Organisation for Economic Co-operation and Development);
Figure 4.2: © Australian Council of Superannuation Investors; Figure 4.3: © Commonwealth of Australia
2019; Extracts: © Kirkpatrick, G 2009, ‘The corporate governance lessons from the financial crisis’,
OECD Journal: Financial Market Trends, vol. 2009/1; © KPGM 2016; © Federal Register of Legislation
2023; © Wen, P 2013, ‘Penrice duo pass two-strike spill’, The Age, 26 January; © Liondis, G 2013, ‘Narev
signals end to CBA’s pay freeze’, The Australian Financial Review, 19 August; © 2023 ASX Corporate
Governance Council; © Australian Prudential Regulation Authority 2019; © Douglas McIntyre; © BHP
Group Limited; © Harper, J 2012, ‘PwC, Centro pitch in for investor losses’, Herald Sun, 11 May;
© ASIC (Australian Securities & Investments Commission). Reproduced with permission; © Parliament
of Australia 2019; © Australian Prudential Regulation Authority 2019; © IFAC; © European Central Bank
2021; © Ferguson, A 2015 ‘Opaque charity sector under fire for accounting failures’, The Australian
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ACKNOWLEDGEMENTS iii
Financial Review, 17 August; © Commonwealth of Australia 2014; © Fels, A 1999, ‘Compliance
programs: The benefits for companies and their stakeholders’, ACCC Journal, no. 24, pp. 14–18;
© Australian Human Rights Commission 2018; © Australian Fair Work Ombudsman; © New Zealand
Government; © European Union, https://eur-lex.europa.eu, 1998–2023; © Commonwealth of Australia;
© Trade Practices Commission 1991, ‘Consumer protection advertising’, Information circular no. 10,
Australian Government Publishing Service, Canberra; © Commercial Bank of Australia Ltd v. Amadio
(1983) 151 CLR 447; © Smith, M 2012, ‘Alarm bells ringing on DJs takeover approach’, Australian
Financial Review, 29 June; © Moran, S 2012, ‘ASIC’s focus on insider trading pays off in Hanlong case’,
The Australian, 1 August; © Drummond, A 2010, ‘Stocks dealer jailed for insider trading’, Sydney Morning
Herald, 2 December; © Griffiths, C 2011, ‘Bribery/anti-corruption: Shell’, The Lawyer, 18 March;
© Potter, B 2011, ‘News backs Murdoch despite shareholder threat’, Australian Financial Review, 21 July;
© Nakamoto, M 2012, ‘Former Olympus chief warns on governance’, Financial Times, 19 April. Used
under licence from the Financial Times. All Rights Reserved; © Australian Broadcasting Agency 2006;
© Financial Reporting Council.

MODULE 5
Figures 5.1, 5.5: © United Nations; Figure 5.6: © amfori; Table 5.2: © UN Principles for Responsible
Investment taken from www.unpri.org/introductory-guides-to-responsible-investment/an-introduction-to-
responsible-investment-screening/5834.article; Table 5.5: © GHG Protocol 2011, Corporate value chain
(scope 3) accounting and reporting standard, September, p. 28; Table 5.6 and extract: © European Union,
1995–2023; Table 5.7: © CER (Clean Energy Regulator); Table 5.9: © World Bank; Table 5.10: © ICAP
(International Carbon Action Partnership); Extracts: © Commonwealth of Australia 2023. All legislation
herein is reproduced by permission but does not purport to be the official or authorised version. It is
subject to Commonwealth of Australia copyright. The Copyright Act 1968 permits certain reproduction
and publication of Commonwealth legislation. In particular, s.182A of the Act enables a complete copy
to be made by or on behalf of a particular person. For reproduction or publication beyond that permitted
by the Act, permission should be sought in writing from the Commonwealth available from the Australian
Accounting Standards Board. Requests in the first instance should be addressed to the National Director,
Australian Accounting Standards Board, PO Box 204, Collins Street West, Melbourne, Victoria, 8007;
© US SIF (United States Sustainable Investment Forum); © UNPRI (United Nations Principles for
Responsible Investment); © Bank Australia; © Business Roundtable; © Federal Register of Legislation
2023; © UK Companies Act 2006; © Wesfarmers; © Origin Energy; © 2023 ASX Corporate Governance
Council; © OECD (Organisation for Economic Co-operation and Development); © United Nations Global
Compact; © World Resources Institute & World Business Council for Sustainable Development 2005;
© GRI Standards; © ISO (International Standards Organization) 2010, ISO 26000 Guidance on Social
Responsibility; © United Nations Division for Sustainable Development; © Pages 2 and 17 from IPCC,
2013: Summary for Policymakers. In: Climate Change 2013: The Physical Science Basis. Working
Group I Contribution to the Fifth Assessment Report of the Intergovernmental Panel on Climate Change
[TF Stocker, D Qin, GK Plattner, M Tignor, SK Allen, J Boschung, A Nauels, Y Xia, V Bex and PM
Midgley eds.]. Cambridge University Press, Cambridge, UK and New York, USA; © ASIC (Australian
Securities & Investments Commission). Reproduced with permission; © IFRS (International Financial
Reporting Standards); © KPMG; © EP Association.

GLOSSARY
Extracts: © Federal Register of Legislation 2023.

SUGGESTED ANSWERS
Tables 2.3, 2.5, 2.6 and extracts: © APESB (Accounting Professional and Ethical Standards Board);
Extracts: © Federal Register of Legislation 2023; © CPA Australia; © 2023 ASX Corporate Governance
Council; © UK Financial Reporting Council; © OECD (Organisation for Economic Co-operation and
Development); © Drummond, A 2010, ‘Stocks dealer jailed for insider trading’, Sydney Morning Herald,
2 December; © United Nations Global Compact.

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iv ACKNOWLEDGEMENTS
DISCLAIMER
These materials have been designed and prepared for the purpose of individual study and should not be
used as a substitute for professional advice. The materials are not, and are not intended to be, professional
advice. The materials may be updated and amended from time to time. Care has been taken in compiling
these materials, but they may not reflect the most recent developments and have been compiled to give
a general overview only. CPA Australia Ltd and John Wiley and Sons Australia Ltd and the author(s) of
the material expressly exclude themselves from any contractual, tortious or any other form of liability on
whatever basis to any person, whether a participant in this subject or not, for any loss or damage sustained
or for any consequence that may be thought to arise either directly or indirectly from reliance on statements
made in these materials.
Any opinions expressed in the study materials for this subject are those of the author(s) and not
necessarily those of their affiliated organisations, CPA Australia Ltd or its members.
As the supplier of third-party study guide materials to the publisher, CPA Australia is responsible for
the use of any materials for which the intellectual property is owned or controlled by a third party.

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ACKNOWLEDGEMENTS v
BRIEF CONTENTS
Subject Outline xi
Module 1: Accounting and Society 1
Module 2: Ethics 47
Module 3: Governance Concepts 121
Module 4: Governance in Practice 217
Module 5: Corporate Accountability 309

Glossary 385
Suggested Answers 391
Index 427

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CONTENTS
Subject Outline xi
MODULE 1
Accounting and Society 1 Summary 42
Preview 1
Part A: Accountants as members of a profession 3
Introduction 3
1.1 Public interest or self-interest? 3
Responsible decision making 3
1.2 Enlightened self-interest 7
1.3 Ideals of accounting —
entrepreneurialism and professionalism 8
1.4 What is a profession? 9
Self-regulation 11
From self-regulation to a co-regulatory
process 11
1.5 What is a professional? 12
1.6 The accounting profession — the
‘traditional’ view and the ‘market
control’ view 12
1.7 Trust and professions 13
1.8 Attributes of a profession 13
A systematic body of theory
and knowledge 13
An extensive education process 14
An ideal of service to the community 14
A high degree of autonomy
and independence 15
A code of ethics for members 17
A distinctive ethos or culture 17
Application of professional judgement 17
The existence of a governing body 19
1.9 The profession’s regulatory process 19
Accounting Professional and Ethical
Standards Board 19
The quality assurance process 20
Professional discipline 23
Summary 25
Part B: Interaction with society 28
Introduction 28
1.10 Accounting roles, activities
and relationships 28
Relationships and roles 28
Accounting work environments 29
1.11 Social impact of accounting 35
1.12 Credibility of the profession 37
Credibility under challenge 37
Key issues causing reduced credibility 37
Restoring credibility to accounting 40
1.13 Capability considerations 41
Business leadership capabilities 41
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Technical skills, knowledge
and experience 41
Soft skills, knowledge and experience 42
TSKE and SSKE — career perspectives 42
Review 44
References 44
MODULE 2
Ethics 47
Preview 47
Part A: Professional ethics 48
Introduction 48
2.1 Impact of ethical or unethical decisions 48
2.2 Ethics — an overview 49
2.3 Ethical challenges within the
accounting profession 51
Ethical challenges faced by members in
public practice and in business 52
Summary 55
Part B: Ethical theories 57
Introduction 57
2.4 Normative theories 57
Ethics of character 58
Ethics of conduct 58
2.5 Teleological (consequential) theories 59
Egoism 59
Utilitarianism 60
2.6 Deontological theories 62
Rights 62
Justice 63
2.7 Virtue ethics 64
Moral agency 65
Summary 65
Part C: Compiled APES 110 Code of Ethics
for Professional Accountants
(including Independence Standards) 67
Introduction 67
2.8 The public interest — ethics in practice 68
2.9 The APESB Code of Ethics (APES 110) 69
Part 1 of the Code — fundamental
principles and conceptual framework 69
Parts 2 and 3 of the Code — applying
the Code to members in business and
public practice 81
Part 4 of the Code — applying the
conceptual framework in the context of
audit, review and assurance
engagements 95
2.10 Examples of ethical failures
by accountants 103
Summary 104
Part D: Ethical decision making 106
Introduction 106
2.11 Factors influencing decision making 107
Individual factors 107
Organisational factors 108
Professional factors 111
Societal factors 111
2.12 Ethical decision-making models 113
APES GN 40 Ethical Conflicts in the
Workplace – Considerations for Members
in Business 113
Philosophical model of ethical decision
making 114
American Accounting Association
model 115
Summary 117
Review 118
References 119
Ethics websites 120
MODULE 3
Governance Concepts 121
Preview 121
Part A: Corporations 123
Introduction 123
3.1 Key features of corporations 123
Proprietary companies 124
Public companies 124
Proprietary v. public companies 124
3.2 Directors and other officers 126
Director identification numbers 126
Directors and their duties 126
Examples of the exercise of
directors’ duties 131
Director independence 134
Company secretaries and their duties 135
3.3 Nature of corporations and division of
corporate powers 136
Shareholder powers 136
Board powers 137
CEO powers 138
3.4 Theories of corporate governance 138
Stewardship theory 139
Agency theory 139
Agency issues and costs 140
Other governance theories 142
Summary 143
Part B: Corporate governance 145
Introduction 145
3.5 Importance of governance 146
Governance and performance 147
Accountants and effective governance 147
3.6 Corporate governance framework 148
Shareholders 148
The board 151
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viii CONTENTS
Auditors 157
Regulators 157
Stakeholders 159
Management 163
Summary 164
Part C: International perspectives on
corporate governance 166
Introduction 166
3.7 Global push for improved governance 166
Specific Australian changes
since 2001 168
3.8 Alternative international approaches
to governance 169
Market-based systems 170
Relationship-based systems — European
approaches 172
Relationship-based systems — Asian
approaches 174
Summary 176
Part D: Codes and guidance 178
Introduction 178
3.9 G20/OECD Principles of Corporate
Governance 178
Principle I. Ensuring the basis for an
effective corporate governance
framework 178
Principle II. The rights and equitable
treatment of shareholders and key
ownership functions 179
Principle III. Institutional investors, stock
markets, and other intermediaries 181
Principle IV. Disclosure
and transparency 181
Principle V. The responsibilities of
the board 182
Principle VI. Sustainability and
resilience 183
3.10 The UK Corporate Governance Code 185
3.11 ASX Corporate Governance
Council’s Corporate Governance
Principles and Recommendations 187
Understanding the ASX Principles 188
The ASX Principles and
recommendations 188
Summary 195
Part E: Non-corporates and governance 196
Introduction 196
3.12 Family-owned businesses, and small-
and medium-sized enterprises 196
3.13 Not-for-profit organisations 197
ACNC guidance 197
AICD guidance 199
Diversity in the not-for-profit sector 199
3.14 Public sector enterprises 200
The uniqueness of the public sector 201
Guidance for public sector
governance 202
3.15 Significance of the non-corporate
sector 204
Summary 205
Review 206
Appendix 3.1 206
References 214
MODULE 4
Governance in Practice 217
Preview 217
Part A: Corporate governance success
factors 218
Introduction 218
4.1 Mitigating the risk of financial failure 218
Common causes of corporate failure 218
Selection, monitoring, evaluation and
cessation of board appointments 221
Diversity 226
Executive remuneration
and performance 229
Compliance with the Corporations Act 235
Auditing the financial statements 236
Reviews of audit quality and
audit regulation 238
4.2 Improving corporate governance 240
Risk management 240
Independence of the chair of
the board 242
4.3 Continued evolution of corporate
governance 242
Updates to corporate governance codes
and principles 243
The impact of technology on corporate
governance 243
Sustainability reporting 244
4.4 Governance issues in the
non-corporate sector 244
Government bodies 244
Charities and not-for-profit sector 245
Summary 248
Part B: Operational obligations and oversight 250
Introduction 250
4.5 The legal system 250
The economy and the legal system 251
Fines and penalty units 254
Director penalty notices 255
Legal compliance and governance 255
4.6 Obligations to employees 257
Occupational health and safety 258
Fair pay and working conditions 258
Family and leave entitlements 260
Ethical obligations — employee
governance 260
4.7 Protecting the goods and services
market 262
Workable competition 262
Competition and stakeholders 263
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Regulating anti-competitive behaviour 264
Obligations to consumers
and customers 273
Summary 278
Part C: Protecting financial markets and
value in corporations 280
Introduction 280
4.8 Role of markets 280
The role of market regulators 281
The role of information and the media 281
The role of ratings agencies 283
4.9 Protecting financial markets 283
Insider trading 283
Market manipulation 285
The SLACIP Act 2022 292
4.10 Representation 292
The representational role of institutional
investors 294
Expanding ethics 297
Whistleblower protection 299
Disclosure of sustainability-related financial
information 302
Summary 303
Review 303
References 304
MODULE 5
Corporate
Accountability 309
Preview 309
Part A: Financial reporting and its limitations 313
Introduction 313
5.1 Scope of reporting 313
5.2 Elements of financial reporting 314
5.3 The practice of discounting future
cash flows 315
5.4 Relevance and faithful representation 316
5.5 Focus on short-term results 316
5.6 The entity assumption 317
Summary 317
Part B: The changing reporting landscape 318
Introduction 318
5.7 Recent events and forces 318
5.8 Sustainability incentives 319
Brand and reputation 320
Risk management incentives 321
External benefits of CSR reporting 322
5.9 Socially responsible investments 322
Social enterprises 324
5.10 Perceived corporate responsibilities
and accountability 324
5.11 Corporate social responsibility 328
5.12 Externalities, potential government
intervention and the role
of accounting 328
Summary 330
CONTENTS ix
Part C: Theories linked to CSR 332
Introduction 332
5.13 Enlightened self-interest 332
5.14 Stakeholder theory 333
Who are stakeholders? 333
Normative stakeholder theory 333
Managerial stakeholder theory 334
5.15 Organisational legitimacy 334
The social contract 335
Legitimacy theory 335
5.16 Institutional theory 335
Summary 336
Part D: The emergence of CSR 338
Introduction 338
5.17 Environmental sustainability 338
5.18 Social sustainability 340
5.19 Economic sustainability 341
5.20 Linking environmental, economic and
social sustainability 341
5.21 The board of directors’ responsibility
for sustainability and organisational
initiatives 343
5.22 Introduction to the key reporting
concepts 344
Accountability 344
Sustainability reporting 345
Natural capital 345
Natural capital accounting 345
Integrated reporting 345
Integrated thinking 345
Targets 345
Metrics 345
5.23 What is measurable? 346
Social reporting 346
Environmental reporting 347
Economic reporting 349
Summary 350
Part E: Corporate governance and
CSR reporting 351
Introduction 351
5.24 What is required? (mandatory
reporting) 351
Requirements embodied within the
Corporations Act and accounting
standards 352
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x CONTENTS
CSR-related corporate governance
disclosures 354
National Greenhouse and Energy
Reporting Act 354
Modern Slavery Act 2018 356
National Pollutant Inventory 356
Work Health and Safety Act 2011 356
5.25 Guidelines and non-mandatory
reporting 357
Dow Jones Sustainability Indices 358
Equator Principles 359
The Greenhouse Gas Protocol 360
The Global Reporting Initiative 361
International Organization for
Standardization 362
OECD Guidelines for Multinational
Enterprises on Responsible Business
Conduct 362
United Nations Global Compact 363
5.26 Other initiatives 364
Social audits 364
Corporate governance mechanisms aimed
at improving social and environmental
performance 366
Environmental management
accounting 367
Circular economy 368
5.27 Surveys of reporting practice 369
5.28 Examples of best practice and
innovative reporting 370
Summary 371
Part F: Climate change reporting 372
Introduction 372
5.29 The international response to climate
change risk 372
5.30 Climate change accounting techniques 373
5.31 Accounting for the levels of emissions 375
5.32 Corporate governance and
climate change 377
Summary 378
Review 379
References 380
Glossary 385
Suggested Answers 391
Index 427
SUBJECT OUTLINE
INTRODUCTION
The purpose of this subject outline is to:
• provide important information to assist you in your studies
• define the aims, content and structure of the subject
• outline the learning materials and resources provided to support learning
• provide information about the exam and its structure.
The CPA Program is designed around five overarching learning objectives to produce future CPAs who
will be:
• technically skilled and solution driven
• strategic leaders and business partners in a global environment
• aware of the social impacts of accounting
• adaptable to change
• able to communicate and collaborate effectively.

BEFORE YOU BEGIN

Important Information
Please refer to the CPA Australia website for dates, fees, rules and regulations, and additional learning
support at cpaaustralia.com.au/your-cpa-program.

SUBJECT DESCRIPTION
Ethics and Governance
Ethics and Governance is a core component of the knowledge and skill base of today’s professional
accountants. As key business decision makers, accountants must be proficient in regulatory regimes,
compliance requirements, and governance mechanisms to ensure lawful, ethical and effective corporate
behaviour and operations. A better understanding of ethics and corporate governance frameworks and
mechanisms links with the various roles and responsibilities outlined in other subjects of the CPA Program.
From an individual perspective, this subject provides candidates with the analytical and decision-making
skills and knowledge to identify and resolve professional and ethical issues. The skills and knowledge
obtained in this unit are also important for subjects that specialise in the functional disciplines of accounting
such as Australia Taxation, Financial Reporting, Strategic Management Accounting and Advanced Audit
and Assurance.
More than ever, today’s professional accountants are less involved in traditional accounting functions
and are more concerned with leadership and management. Today’s accountants are leaders in their field
providing key support to senior management and are directly involved in many important decisions. An
understanding of ethics and governance is essential to those in leadership roles, and to those who support
their leaders. This subject not only develops an awareness of corporate governance but also helps members
(and those whom they support) in discharging their stewardship functions.

Subject Aims
The aims of the subject are to:
• promote awareness of the ethical responsibilities of professional accountants, thereby enabling them to
identify and resolve ethical issues or conflicts throughout their career
• ensure professional accountants understand the importance of governance, including their role in
achieving effective governance
• improve understanding of the role of accounting, and of accountants, in providing information about
the social and environmental performance of an organisation.

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SUBJECT OUTLINE xi
SUBJECT OVERVIEW
General Objectives
On completion of this subject, you should be able to:
• explain, from a global perspective, the nature of the accounting profession and the roles of professional
accountants
• apply the key professional responsibilities of an accountant from the perspective of a member of
CPA Australia
• explain the importance of ethics and professional judgement
• describe key governance and regulatory frameworks, including international perspectives on corporate
governance and the roles of various stakeholders
• explain the expectations placed on various internal and external stakeholders arising from organisational
governance responsibilities
• ascertain various compliance and regulatory regimes impacting the global business environment
• identify the strategic, leadership and global issues impacting accountants and the accounting profession
• describe the nature, role and importance of corporate social responsibility, including climate change and
sustainable development.

STUDY GUIDE
Module Descriptions
The subject is divided into five modules. A brief outline of each module is provided below.
Module 1: Accounting and Society
Increasingly, professional accounting involves much more than the application of technical knowledge.
Accountants are responsible for providing information and advice that supports important decisions
affecting organisations, people and their lives, and society as a whole. With the privileges and benefits
that accompany professional status comes a variety of obligations, foremost of which is the obligation to
put the good of society ahead of personal interests.
This module considers what it means to be a professional accountant in the contemporary global business
environment, including the regulatory professional framework within which they operate. It examines the
wide range of capabilities and skills required of accountants, the various sectors in which accountants
work and the roles that accountants undertake. There is also an emphasis on what the profession must do
to ensure it enjoys the confidence and trust of society and fulfils its role as a positive social force.
Module 2: Ethics
This module explores ethics and ethical decision making in the professional and business context. In
other words, it discusses the practical implications of professional ethics based on the notion of the
public interest. The module provides an overview of various theories on ethics, each of which can
provide perspective and insights that help guide accountants when considering and resolving complex
ethical dilemmas.
The module describes key aspects of the Compiled APES 110 Code of Ethics for Professional
Accountants (including Independence Standards) (APES 110) and demonstrates how to apply this Code
when addressing specific ethical issues. The module also aims to create an understanding of the individual,
organisational, professional and societal factors that can influence an individual’s decision making.
Finally, the module examines decision-making models that provide a structured approach that can help
professional accountants to systematically analyse complex situations, exercise clear judgement and make
more consistent and ethically justifiable decisions.
Module 3: Governance Concepts
Module 3 outlines the key features of the corporate form. These features combine to shape approaches
to corporate governance — the system in place to operate and control the corporation. Good corporate
governance relates to corporate performance and ensures the social licence to operate is maintained. The
nature of corporate governance, evolving theories of corporate governance and key components found
in corporate governance frameworks are outlined. This includes consideration of relationships between
companies, boards of directors, managers, and other stakeholders including the community.
Codes and guidance on corporate governance in countries such as Australia and the UK are covered,
along with the role and impact of differing cultural approaches to corporate governance. Governance in
other sectors, including the public sector, is also referenced.
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xii SUBJECT OUTLINE

 The module highlights that professional accountants must have a strong understanding of governance
concepts to successfully fulfil their duties and obligations, and add value to corporations and entities of all
types and sizes.
Module 4: Governance in Practice
Module 4 builds on the corporate governance concepts presented in module 3 by explaining and, where
appropriate, demonstrating their practical application.
The module explores corporate governance factors relating to corporations, their boards, shareholders,
various other stakeholders and society at large. The role and operation of the board is considered,
including the role of diversity within the corporation and in the boardroom and its key role in enabling
informed decision making. The debate and responses arising from the international focus on remuneration
practices is considered. The module also examines a range of operational matters that are important within
corporations and in respect of which day-to-day attention to rules is required by both good practice and
regulation — including in relation to employment conditions and protections. The issues of data security
and privacy and the security of critical infrastructure are explored in relation to consumer and market
protection. There is a brief discussion that compares aspects of criminal and civil law followed by content
related to anti-competitive consumer market practices.
The module concludes with a brief exploration of financial market protection mechanisms, including
whistleblower legislation and sustainability-related financial disclosure.
Module 5: Corporate Accountability
The final module provides an explanation of corporate accountability together with information about
its history and evolution. Accountability is shown to be broader than just providing financial results,
and is linked to environmental, social and economic sustainability. The module explores the concept of
‘accountability’ and its direct relationship to both accounting and accountants. As part of this, it investigates
the limitations of traditional financial accounting and financial reporting in relation to the broader interests
of an array of stakeholders, in particular in terms of accounting for and reporting information about an
entity’s social and environmental performance.
The module examines the relationship between different, and sometimes conflicting, managerial
perspectives on corporate responsibilities and accountabilities. It also considers the important decisions
about ‘to whom’, ‘how’ and ‘what’ environmental and social information is to be reported. Different
theoretical perspectives are provided about ‘why’ organisations voluntarily report social responsibility
information.
The module then examines mandatory reporting requirements and some of the non-mandatory frame-
works that have been developed and adopted to demonstrate accountability beyond financial performance.

Module Weightings and Study Time Requirements

Total hours of study for this subject will vary depending on your prior knowledge and experience of the
course content, your individual learning pace and style, and the degree to which your work commitments
allow you to work intensively or intermittently on the materials. You will need to work systematically
through the study guide, readings and case studies, attempt all the questions (including knowledge checks),
and revise the learning materials for the exam. The workload for this subject is the equivalent of that for a
one-semester postgraduate unit.
An estimated 15 hours of study per week through the semester will be required for an average candidate.
Additional time may be required for revision. The ‘Weighting’ column in the following table provides an
indication of the emphasis placed on each module in the exam, while the ‘Recommended proportion of
study time’ column is a guide for you to allocate your study time for each module.
Do not underestimate the amount of time it will take to complete the subject.

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SUBJECT OUTLINE xiii

 TABLE 1 Module weightings and study time

Recommended proportion of
Module study time (%) Weighting (%)

1. Accounting and Society 15 15

2. Ethics 20 20

3. Governance Concepts 25 25

4. Governance in Practice 25 25

5. Corporate Accountability 15 15

100 100

LEARNING MATERIALS
Module Structure
The study guide is your primary examinable resource and contains all the knowledge you need to learn
and apply to pass the exam. The Ethics and Governance study guide includes a number of features to help
support your learning. These include the following.
Learning Objectives
A set of learning objectives is included for each module in the study guide. These objectives provide a
framework for the learning materials and identify the main focus of the module.
The objectives also describe what candidates should be able to do after completing the module.
Learning Resources
This section alerts you to some of the resources available to accompany this module on My Online Learning
and elsewhere online. Readings 1.1, 1.2, 1.3 and 4.1 are not assessable.
Examples
Examples are included throughout the study materials to demonstrate how concepts are applied to real-
world scenarios.
Questions (and Suggested Answers)
Questions provide you with an opportunity to assess your understanding of the key learning points. These
questions are an integral part of your study and should be fully utilised to support your learning of the
module content.
Key Points
The key points feature relates the content covered in the section to the module’s learning objectives.
Review
The review section summarises the main points covered in the module and places it in context with the
other modules studied.
References
The reference list details all sources cited in the study guide. You are not expected to follow up this
source material.
Glossary
The glossary contains a list of key terms used throughout the study guide. Please refer to the glossary for
definitions of these terms.

My Online Learning and Your eBook

My Online Learning is CPA Australia’s online learning platform, which provides you with access to a
variety of resources to help you with your study.
You can access My Online Learning from the CPA Australia website: cpaaustralia.com.au/your-cpa-
program/in-semester-support-and-learning-resources/my-online-learning.

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xiv SUBJECT OUTLINE

eBook
An interactive eBook version of the study guide will be available through My Online Learning. The eBook
contains the full study guide and features instructional media and interactive questions embedded at the
point of learning. The media content includes animations of key diagrams from the study guide and video
interviews with leading business practitioners.

GENERAL EXAM INFORMATION

All information regarding the Ethics and Governance exam can be found on My Online Learning. The
study guide is your primary examinable resource.

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SUBJECT OUTLINE xv
Pdf_Folio:xvi
MODULE 1

ACCOUNTING AND
SOCIETY
LEARNING OBJECTIVES

After completing this module, you should be able to:

1.1 describe the nature and attributes of a profession
1.2 explain the co-regulatory processes of the accounting profession
1.3 differentiate the roles, relationships and activities of accountants
1.4 evaluate the challenges faced by the accounting profession in the global context
1.5 explain the importance of soft and technical skills required of accountants.

LEARNING RESOURCES

Readings 1.1–1.3 can be accessed on My Online Learning.

• Reading 1.1: Extract from the Royal commission into misconduct in the banking, superannuation and financial
services industry: Final report
• Reading 1.2: ‘Profile: Roel van Veggel — The sweet sounds of success’ (IFAC)
• Reading 1.3: ‘How “soft skills” can boost your career’ (J. Jarvis)
• Compiled APES 110 Code of Ethics for Professional Accountants (including Independence Standards)
(APESB 2022a), accessed July 2023, https://apesb.org.au/wp-content/uploads/2023/05/Compiled_APES_
110_Dec_2022.pdf
Candidates are not expected to print the entire Compiled APES 110 Code of Ethics for Professional Accountants
(including Independence Standards), although it may be helpful to print sections that are referenced and/or
discussed in the study guide. Unless specifically noted, only the content in the study guide is examinable. You
should, however, ensure that you download a copy of APES 110 so that you can refer to it during study.

PREVIEW
The accounting profession’s role in society is to be a trusted and reliable provider of information that
supports high-quality decision making. The term profession is in common usage, but it may not always be
appreciated exactly what distinguishes a profession from other occupations and what being a professional
means in terms of both obligations and benefits.
Part A of this module describes the key attributes of a profession and provides an in-depth look at what
it means to be a professional accountant. The work of accountants has a strong influence on decisions that
affect many aspects of society, particularly the allocation of resources, and thus the profession is expected
to act with integrity and in society’s best interests.
Foremost, accountants must comply with the framework of principles established by the profession,
including acting in accordance with appropriate standards of governance, accountability and ethics.
This requires a balance between potentially competing interests. The module examines different ways
of viewing and managing competing interests. Successfully managing the balance of self-interest and
public interest maintains a ‘social contract’ between the profession and society, whereby in return for
the value that the profession creates, society allows it the benefits of economic rewards, self-regulation
and autonomy.
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 A failure to successfully balance interests results in withdrawal of some of these privileges. This module
examines how some failings in the performance of the profession have led to an increase in external
regulation to create a set of co-regulatory processes that are intended to strengthen the credibility of
the profession. In co-regulation, external regulation works alongside self-regulation of the profession,
which is based on professional and ethical standards, and the imposition of sanctions on those who breach
those standards.
While the role and activities of the accounting professional are changing in response to advances
in technologies such as artificial intelligence, the core notions of integrity, objectivity, professional
competence and due care, confidentiality and professional behaviour remain unchanged.
Part B of the module considers the various work environments, roles and activities of professional
accountants, and the relationships that are created through these roles. The roles accountants can hold
are diverse, and opportunities exist in many sectors and areas of expertise. Regardless of the specific
roles and activities undertaken by an accountant, they must continue to develop their technical skills,
knowledge and experience throughout their working life. In addition, to work effectively, particularly
as their career progresses and their responsibilities expand, accountants must add a portfolio of ‘soft
skills’ to their technical knowledge. These soft skills include communication, persuasion, negotiation and
leadership skills. As with their technical skills, accountants can develop these through experience and
formal continuing professional development activities.
All key terms used throughout the text can be found in the glossary at the end of the study guide.

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2 Ethics and Governance

PART A: ACCOUNTANTS AS MEMBERS OF
A PROFESSION
INTRODUCTION
Accountants perform roles and contribute to decisions that have a significant impact on clients, organisa-
tions and society. As such, they are expected to act in a professional and ethical manner. In this part of
the module we explore what is meant by the term ‘profession’ and what it means to be a professional. At
the core of any profession is the idea that the members of the profession will act in the best interests of
society and that society will, in return, provide a range of benefits for the profession. Thus, there is an
implied social contract between the accounting profession and society. To maintain the social contract,
accountants must conduct their work in accordance with the core principles of the profession.

1.1 PUBLIC INTEREST OR SELF-INTEREST?

Economies and societies require the free flow of accurate information to function efficiently. The efficiency
of market economies is particularly dependent upon disclosure of accurate financial and non-financial
information. The accounting profession is integral to the process of ensuring people have access to accurate
information. In analysing and presenting information, the professional accountant needs to be able to
clearly distinguish between the public interest in disclosing information and any sense of self-interest.
Ultimately, the accounting profession will only retain its integrity and authority by serving the wider public
interest. The ideals of professionalism and the essential principles of entrepreneurship are compatible when
it is understood that trust is the essential basis of business.
Accounting information is relied on heavily by people who make significant decisions about the
allocation of resources. Accountants, therefore, serve the public interest by creating and distributing
information that conveys a clear and accurate picture of an entity’s financial performance, financial position
and other relevant issues.
Professional accountants also serve the public interest by providing objective, accurate and appropriate
financial and accounting-related advice that is free from bias and based on expertise. This focus on acting
with integrity, objectivity and without bias is linked to the idea of altruism. The term ‘altruism’ describes
positive actions that bring no benefit to an individual and may even be at their own expense.
However, altruism may not be the driving motivation. Like West (2003), Larson (1977) is concerned that
monopolistic professionals are not motivated by a service ideal or the public interest. Larson considers there
is evidence to suggest that professions and professionals are about maintaining monopolies and extracting
unwarranted wealth and influence from that position. This could be more accurately described as self-
interest or enlightened self-interest, rather than altruism.

RESPONSIBLE DECISION MAKING

Accountants make decisions within a systematic framework of principles. These principles include
governance, accountability and ethics. This means that, as a member of a profession, an accountant cannot
simply make decisions according to personal preferences. The skill and knowledge of the accountant
must be exercised within the governance framework of the profession, which stipulates certain codes of
behaviour. Decision making must be within the governance framework of the entity an accountant works
within, not only in terms of the instruments and internal governance rules, but in terms of the policies and
strategies that have been formally approved by the governing body.
In addition, conducting accounting work and reaching decisions must be completed within a framework
of accountability, in terms of the requirements of regulatory authorities, and with the appropriate disclosure
to shareholders and other stakeholders.
Finally, the work of the accountant and any decisions taken must be exercised within a framework of
ethical conduct that informs all aspects of the accountant’s work, which is based on a commitment to
integrity and honesty in the pursuit of professional purposes and client interests.
When all these principles are recognised, there is the possibility of effective action and decision making
as illustrated in figure 1.1. Assignments completed by accountants within a framework of governance,
accountability and ethics will be more authoritative.
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MODULE 1 Accounting and Society 3

 FIGURE 1.1 A model of responsible decision making

Governance

Accountability Ethics

Source: CPA Australia 2023.

Accountants should strive to base their decisions firmly on the principles of governance, accountability
and ethics. The ideal position for balanced decisions is to be at the centre of this figure where governance,
accountability and ethics interconnect. This requires accountants to be rigorous and professional in their
conduct. However, this does not always happen, as is the case described in example 1.1.

EXAMPLE 1.1

A Costly Error
Three respondents (a consulting company, an accounting partnership, and an executive director and
partner) found themselves in a legal battle with a client, Neville’s Bus Service Pty Ltd (NBS), that cost
them $5.5 million following conduct that NBS alleged was fraudulent, in breach of contract, negligent and
in breach of provisions of Australian Consumer Law.
NBS used the consulting company to help it bid for a bus service tender. An error in calculations meant
that NBS had suffered financial losses, totalling in the first instance $660 000, which was the amount that
would have been added to the tender had the numbers been the subject of routine quality control checks.
NBS alleged that the partner, once the error was found, failed to notify the company. It was also alleged
that the partner actively attempted to conceal the error.
An error in a tender could create a situation where a company might run at a loss because the costs
associated with the novated leases was not included in calculating the bid that was submitted. The court
heard that the bid submitted by the company would still have succeeded if it had submitted an amended
tender bid.
The judgment for this case can be accessed here: www.judgments.fedcourt.gov.au/judgments/
Judgments/fca/single/2018/2018fca2098.
Source: Based on Federal Court of Australia 2018, Neville’s Bus Service Pty Ltd v. Pitcher Partners Consulting Pty
Ltd [2018] FCA 2098, accessed August 2023, www.judgments.fedcourt.gov.au/judgments/Judgments/fca/single/2018/
2018fca2098.

QUESTION 1.1

(a) To gain an understanding of the environment within which the accounting profession operates,
visit each of the listed websites in table 1.1 and state which section of the diagram in figure 1.1
it belongs to.
(b) Visit the IFAC and IFRS Foundation websites to determine the role of the following boards:
• International Auditing and Assurance Standards Board (IAASB)
• International Ethics Standards Board for Accountants (IESBA)
• International Public Sector Accounting Standards Board (IPSASB)
• International Sustainability Standards Board (ISSB).
(c) Begin work on a glossary of acronyms by including the acronyms in the list. Continue to update
this as the course progresses. The list of abbreviations in the back of the Financial Reporting
Council’s (FRC’s) annual report may assist with this.
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4 Ethics and Governance

 TABLE 1.1 Components of the external environment within which the accounting profession operates

Websites and web resources Description

AASB The Australian Accounting Standards Board is responsible for

www.aasb.gov.au developing, issuing and maintaining Australian Accounting Standards
and related pronouncements.

ACNC The Australian Charities and Not-for-profit Commission is the

www.acnc.gov.au regulator for the charities sector. It has oversight of the compliance
with relevant legislation by charities and not-for-profits that are
registered with the ACNC.

APESB The Accounting Professional and Ethical Standards Board is

www.apesb.org.au an independent, national body that sets the code of ethics and
professional standards with which accounting professionals who
are members of CPA Australia, CA ANZ and IPA must comply.

APRA The Australian Prudential Regulation Authority is the regulator

www.apra.gov.au that supervises institutions involved in banking, insurance and
superannuation.

ASIC The Australian Securities and Investments Commission is Australia’s

www.asic.gov.au integrated corporate, markets, financial services and consumer credit
regulator. Most of its work is carried out under the Corporations Act
2001 (Cwlth).

ASX The Australian Securities Exchange is a financial market exchange

www.asx.com.au offering listing, trading, clearing and settlement services across a
wide range of asset classes.
It also has a body called the Corporate Governance Council that
develops recommendations and principles that assist listed entities
prepare disclosures in their reports for their shareholders and other
stakeholders in the financial markets.

ATO The Australian Taxation Office is the principal revenue collection

www.ato.gov.au agency of the Australian Government.
Their aim is to achieve taxpayer confidence in the Australian tax
and superannuation systems by helping people understand their
rights and obligations, improving ease of compliance and access to
benefits, and managing non-compliance with the law.

AUASB The Auditing and Assurance Standards Board is responsible for

www.auasb.gov.au developing high-quality standards and related guidance for auditors
and providers of other assurance services.

AUSTRAC The Australian Transactions Reports and Analysis Centre is

www.austrac.gov.au responsible for the enforcement of anti-money laundering and
counter-terrorism financing laws. It does this by aiming to detect,
deter and disrupt the activities of criminals seeking to move money
around the globe.

Australian Sanctions Office
www.dfat.gov.au/international-
relations/security/sanctions/who-we-are
The Australian Sanctions Office is situated within the Department of
Foreign Affairs and Trade, and its main role is to ensure Australian
individuals and entities comply with sanctions against individuals or
countries that are engaged in repression of human rights, proliferation
of weapons of mass destruction, or international or armed conflict.

CA ANZ Chartered Accountants Australia and New Zealand is one of the

www.charteredaccountantsanz.com three largest professional accounting organisations in Australia and a
member of the International Federation of Accountants (IFAC).

Competition and Consumer Act 2010 The Competition and Consumer Act seeks to protect people by
(Cwlth) promoting competition, fair trading practices and regulation in the
www.legislation.gov.au/ area of consumer protection.
Series/C2004A00109

(continued)

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MODULE 1 Accounting and Society 5

 TABLE 1.1 (continued)

Websites and web resources Description

Corporations Act 2001 (Cwlth)
www.legislation.gov.au/Series/
C2004A00818
The Corporations Act is the main piece of legislation regulating
companies in Australia. It also regulates aspects of work done
by accounting professionals, including auditing, financial report
preparation and lodgement, and insolvency. The roles of directors
and other company officers are also covered in this legislation.

CPA Australia CPA Australia is one of Australia’s three largest professional

www.cpaaustralia.com.au accounting organisations and a member of IFAC.

CPA Australia’s 2022 Constitution
www.cpaaustralia.com.au/about-cpa-
australia/governance/constitution-and-
by-laws/constitution
The CPA Australia Constitution comprises the rules by which the
professional accounting body is run. It includes sections related to
membership, provisions related to the board of directors and how the
board operates, and a provision related to how other bodies such as
divisional councils are formed and run.

CPA Australia By-Laws CPA Australia’s By-Laws are a part of the membership rules and set
www.cpaaustralia.com.au/about-cpa- out the details of various processes such as elections, membership
australia/governance/constitution-and- rules and disciplinary processes. The By-Laws expand on areas that
by-laws/our-by-laws the Constitution covers in principle.

FRC The Financial Reporting Council is the oversight body for the
www.frc.gov.au Australian financial reporting framework. It oversees the work of
domestic accounting and auditing standard setters, and provides
advice related to the quality of audits completed by Australian
auditors pursuant to the Australian Securities and Investments
Commission Act 2001 (Cwlth). The FRC appoints members to the
AASB and AUASB, and provides broad strategic directions to each.

IFAC The International Federation of Accountants is an international body

www.ifac.org that represents 180 individual professional accounting organisations
in 135 jurisdictions, including CPA Australia.

IFEA The International Foundation for Ethics and Audit is a not-for-profit

www.ethicsandaudit.org organisation that oversees the work of the IAASB and the IESBA. The
Foundation is a US-based nonprofit organisation with three members:
the Monitoring Group, the Public Interest Oversight Board (PIOB),
and IFAC.

IFRS Foundation The IFRS Foundation is a not-for-profit, public interest organisation

www.ifrs.org established to oversee the development of a single set of high-
quality, understandable, enforceable and globally accepted
accounting standards — IFRS Standards — and to promote
and facilitate adoption of the standards. It is also responsible for
the oversight of the development of a single set of high-quality
sustainability standards.

IOSCO The International Organization of Securities Commissions is

www.iosco.org the global body for regulators of capital markets. ASIC is an
IOSCO member.

IPA The Institute of Public Accountants is one of the three largest

www.publicaccountants.org.au professional accounting organisations in Australia and a member
of IFAC.

Modern Slavery Act 2018 (Cwlth)
www.legislation.gov.au/Series/
C2018A00153
The Modern Slavery Act requires entities that have consolidated
revenue of more than $100 million to report on the risk of modern
slavery in their direct operations and supply chains, and the actions
they have taken to mitigate that risk. Reports filed by entities are
kept on a public register that is freely accessible from the Attorney-
General’s Department.

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6 Ethics and Governance

 OAIC The Office of the Australian Information Commissioner is the
www.oaic.gov.au regulatory body that administers the privacy laws in Australia. It
coordinates a complaints process that provides an opportunity for
people’s complaints to be heard.

PIOB The Public Interest Oversight Board is a body made up of prominent

www.ipiob.org individuals from across the globe that oversees the work programs
of the IAASB and the IESBA to ensure the standards have a public
interest focus. This oversight is achieved through the trustees
(including the chair) that the POIB appoints to the Foundation’s
Board. A separate Monitoring Group of international public interest
and financial institutions helps to monitor and oversee the activities of
the PIOB.

Security Legislation Amendment (Critical
Infrastructure) Act 2021 (Cwlth)
www.legislation.gov.au/Details/
C2021A00124
The Security Legislation Amendment (Critical Infrastructure) Act
sets up a regime that requires the keeping of a register relating to
critical infrastructure assets, and the reporting of cybersecurity
incidents. It further empowers the minister and secretary of the
relevant department to take steps to safeguard national security.

Security Legislation Amendment (Critical
Infrastructure Protection) Act 2022
(Cwlth)
www.legislation.gov.au/Details/
C2022C00160
The Security Legislation Amendment (Critical Infrastructure
Protection) Act imposes additional requirements on entities that have
critical infrastructure assets to ensure they have and comply with
a critical infrastructure risk management program. It also gives the
minister of the relevant department the power to declare a critical
infrastructure asset to be of national significance, for which enhanced
cybersecurity obligations might apply.

The Monitoring Group The Monitoring Group is a committee of international regulatory

www.iosco.org/about/?subsection=
monitoring_group
bodies and financial institutions that seeks to ensure that the public
interest is kept in mind where the setting of auditing standards
and audit quality are concerned. The group oversees the activities
of the PIOB. Members include the Basel Committee on Banking
Supervision, European Commission, Financial Stability Board,
International Association of Insurance Supervisors, International
Forum of Independent Audit Regulators, International Organization
of Securities Commissions and the World Bank.

TPB The Tax Practitioners Board is responsible for the registration,

www.tpb.gov.au oversight and discipline of professionals that are registered to provide
varying degrees of tax-related advice or services. The TPB also
recognises professional bodies (including CPA Australia) whose
voting members may then be assisted to register or maintain their
registration(s) with the TPB.

Treasury Laws Amendment (Enhancing
Whistleblower Protections) Act 2019
(Cwlth)
www.legislation.gov.au/Details/
C2019A00010
The Treasury Laws Amendment (Enhancing Whistleblower
Protections) Act was introduced to amend a range of laws dealing
with corporations, taxation and financial institutions so whistleblower
protections were strengthened.

Source: CPA Australia 2023.

1.2 ENLIGHTENED SELF-INTEREST

Inevitably, in a market economy, the economic self-interest of a profession will be an important driver
of behaviour. However, this should never be allowed to outweigh the primary commitment to the public
interest. The term ‘enlightened self-interest’ suggests that both purposes may be served together; that is,
it is possible to be committed to the public interest and yet possess a degree of self-interest. The phrase
sometimes employed is ‘doing well by doing good’.
But, if enlightened self-interest leads to actions that are purely self-interested with no benefit to other
parties such as clients, this is not acceptable professional behaviour. There is a careful balance to be
maintained between serving the public interest and pursuing self-interest, and it is the public interest
that is paramount. Can the public interest and self-interest really be integrated in a form of enlightened
self-interest?
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MODULE 1 Accounting and Society 7

 This concept of enlightened self-interest is described by Lee (1995) as protecting the public interest in
a self-interested way, and is explained in the following quote, which shows how enlightened self-interest
and the public interest may be integrated.
The accounting profession would account for its existence in relation to the efficiency benefits for society
as a whole, arising from the existence of an institutionally organised body of accounting knowledge … In
return for their monopoly position concerning the right to practise particular accountancy and auditing
functions, accountants would see themselves as serving the public interest (Robson & Cooper 1990,
p. 379).

We explore this concept again in module 5 in relation to a different question — why organisations make
the commitment to produce sustainability information and reports.

1.3 IDEALS OF ACCOUNTING —

ENTREPRENEURIALISM AND PROFESSIONALISM
Some argue that professions never really had a public interest or service ideal (Abbott 2014; Johnson 1972).
Others believe it may have existed in the past, but has been abandoned for a more lucrative role as ‘partner in
business’ (Saravanamuthu 2004). Carnegie and Napier (2010) identify the ideals of accounting profession-
alism as comprising ‘the four Es’ of education, ethics, expertise and entrepreneurship. According to these
authors, placing too strong an emphasis on entrepreneurship, especially where it involves a de-emphasis on
any of the other ideals, may result in a ‘de-professionalisation’ of accounting. This de-professionalisation
may occur because the pursuit of commercial opportunities moves an accountant away from integrity,
objectivity and professional behaviour in order to achieve commercial success. Entrepreneurship can lead
professional accountants to place more importance on increasing their personal wealth and influence than
on notions of public service.
Accountants are often in a position of power that can create an ‘ethics versus profits’ dilemma. Examples
of accountants pursuing self-interested outcomes at the expense of their ethical or professional standards
have been linked to the corporate collapses of the early 2000s, and the failures of organisations such as
Lehman Brothers in the Global Financial Crisis (GFC) of 2008–2009. In these cases of systemic failure, it
was clearly demonstrated in all of the official reports by the US Congress, UK parliament and others that
not only had there been governance failures within the entities, but also all of the associated professionals
and regulators had some responsibility in allowing the failures to develop into a crisis (UK HCTR 2009;
US FCIC 2011).
Members of a profession will at times face conflicts between their own self-interest, the public
interest, and their responsibilities to the profession. Examples 1.2 and 1.3 describe real-world cases of
conflicting interests.

EXAMPLE 1.2

Excessive Fees
Liquidators John Sheahan and Ian Lock were ordered by a court to pay back $1.9 million plus interest
to companies they had been involved in liquidating after a court agreed that the fees charged by the two
liquidators were excessive.
The corporate regulator, the Australian Securities and Investments Commission (ASIC), took action
against the liquidators because the fees they were charging reduced the amount that was available to pay
the various creditors of the companies concerned.
The case concerned the liquidations of three companies. It was found that Sheahan and Lock had
charged more than they should have and spent more time than necessary on the jobs.
This meant that creditors of the businesses involved would be getting reduced returns as a result of the
funds that were claimed by the liquidators as remuneration.
A media release from ASIC noted that the court slashed $1.9 million from the fees charged by the
liquidators. ‘Remuneration was fixed at $3.9 million compared to the $5.8 million sought by the liquidators,
a reduction of $1.9 million (33%),’ ASIC said.
‘To commence the process of determining the remuneration claim, His Honour stated that the charge
rates were excessive and ruled that the partner and manager rates were to be discounted by 20% and
the senior manager rates discounted by 10%. Other charge rates were not to be discounted.’

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8 Ethics and Governance

 The insolvency practice told media representatives that it would review the outcome and decide whether
to appeal.
Source: Quotes from ASIC 2019a, ‘Federal Court fixes liquidators’ remuneration for winding up three Adelaide companies
and orders them to repay $1.9m plus interest and ASIC’s costs’, accessed August 2023, https://asic.gov.au/about-asic/
news-centre/find-a-media-release/2019-releases/19-140mr-federal-court-fixes-liquidators-remuneration-for-winding-up-
three-adelaide-companies-and-orders-them-to-repay-1-9m-plus-interest-and-asic-s-costs.

EXAMPLE 1.3

In the Interests of the Client?

Gold Coast accountant Jenan Oslem Thorne will not provide financial services for three years after
Australia’s corporate regulator found she failed to prioritise client interests when giving advice.
Mrs Thorne entered into an enforceable undertaking with ASIC when the regulator reviewed advice that
she had provided during an investigation into Trent Properties Group Pty Ltd.
ASIC found that Mrs Thorne was receiving referrals from Park Trent regarding the establishment of
self-managed superannuation funds (SMSF) and that Mrs Thorne had advised some clients to establish
self-managed funds without considering their circumstances.
‘ASIC found that Mrs Thorne hadn’t properly considered her clients’ existing superannuation arrange-
ments or explored why they were interested in investing in direct residential property through an SMSF,’
an ASIC media release said. ‘When recommending SMSFs to some of her clients, she had inappropriately
scoped advice by excluding insurance and retirement planning.’
SMSF strategies were not properly stressed tested, according to the corporate regulator, and recom-
mendations were made to clients without considering whether the strategy would increase retirement
benefits to clients. Mrs Thorne also recommended clients with self-managed funds use her accounting
practice to do their annual accounts and tax returns. ASIC concluded that Mrs Thorne recommended the
use of her services to ‘create extra revenue for herself’.
ASIC said that financial advisers had a best-interests duty with which they need comply and that there
must be an analysis of whether a self-managed fund was the best option for a client reflecting on their
retirement plans.
Source: Quotes from ASIC 2019b, ‘Court enforceable undertaking prevents Gold Coast accountant from providing financial
services’, accessed August 2023, https://asic.gov.au/about-asic/news-centre/find-a-media-release/2019-releases/19-034mr-
court-enforceable-undertaking-prevents-gold-coast-accountant-from-providing-financial-services.

1.4 WHAT IS A PROFESSION?

A profession is defined in the Oxford Learner’s Dictionaries as an occupational area or vocation that ‘needs
special training or skill, especially one that needs a high level of education’.
A profession is based on a high level of competence and skills in a given area, which are learnt through
specialised training and maintained by continuing professional development. Members of professions are
expected to behave ethically and in the best interests of society. There is a difference between the concept of
a ‘profession’ as defined by the established professional associations, which carry many obligations and
attributes and the wider reference to somebody being professional, which simply means they complete
their work with dedication and skill (attributes to be highly valued in any occupation).
Professions focus on intellectual or administrative skills, rather than mechanical or physical actions.
Further characteristics defining the professions relate to the critical nature of their work and the esoteric
knowledge required to perform it to a high standard — for example, surgery, corporate litigation or audit.
However, there is an almost universal process of professionalisation occurring across occupations as
diverse as financial advisers, project managers, physiotherapists, and among service occupations and manual
trades such as builders and electricians. Many professions and occupations have established professional
bodies and codes of conduct. The efforts of these occupations to raise their standards, and to invest in training,
education and quality standards must be respected. This raises the bar for the established professions,
including accounting, which must demonstrate its high-level commitment to integrity and service.
There are key attributes that, combined as a group, provide valuable guidance in recognising the
existence of a profession (elements of these attributes were originally derived from Greenwood (1957), and
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MODULE 1 Accounting and Society 9

have since been developed further). The existence of these eight attributes tends to confirm the existence
of a profession:
1. systematic body of theory and knowledge
2. extensive education process for its members
3. ideal of service to the community
4. high degree of autonomy and independence
5. code of ethics for its members
6. distinctive ethos or culture
7. application of professional judgement
8. existence of a governing body.
Later in this module we will examine in more detail each of the attributes of a profession as they apply
to the accounting profession.
It must be noted, however, that there is no clear distinction between an occupation and a profession.
It is suggested that there is a continuum of the degree to which these attributes are displayed so that
professionals are only distinguished from non-professionals by a higher level of standards.
Another feature of a profession is that it often leads to greater status and wealth for its members. This
is often a result of the members’ specialised skills and the level of monopoly control. Monopoly control
describes the situation where members of the profession control who is allowed to work in the industry
by establishing licensing rules and regulations. This creates protection against competition. An example
of this exclusivity is the requirement under the Corporations Act 2001 (Cwlth) where a company auditor
must be a member of a professional accounting body (such as CPA Australia).
Early authors argued that professions exist primarily to serve society, and this view persists today. In
this view, often called the ‘service ideal’, it is accepted that professions should both serve society and do
so in part by ensuring they act in the public interest. Indeed one model (Brourard et al. 2017) suggests that
professions exist only as a result of an implied social contract. In exchange for promising to use their expert
knowledge and skills in the public interest or for social good, professions are afforded certain benefits
including self-regulation, autonomy, market control and economic rewards. This is shown in figure 1.2.

FIGURE 1.2 Social contract between a profession and society

Promises Benefits
Exchanges

Knowledge Privileges
Self-regulation
Skills Expertise
Associational control
Competencies
Autonomy Power
Values Norms
Exclusive rights
Behaviours
Public interest Occupational control
Control over market
Professional judgement
Reputation Social status
Activities
Economic rewards

Stereotypes Image

Context

Source: Brourard, F, Merriddee, B, Durocher, S & Burocher Neison, L 2017, ‘Professional accountants’ identity formation: An
integrative framework’, Journal of Business Ethics, vol. 142, no. 2, pp. 225–8.

However, when this social contract is broken, some of these benefits may be removed or modified. For
example, laws may change when the community, through its political representatives, believes that certain
functions need to be more tightly regulated.
Consider the change that brought auditing standards and auditing standard setting under the purview of
the FRC in 2004. The community, through its representatives elected to the Commonwealth Parliament,
decided that additional regulation of the auditing cohort of the accounting profession was necessary as a
result of the various corporate collapses in Australia and elsewhere in the early 2000s. The profession has
worked under a revised regime for setting auditing standards since that time.
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10 Ethics and Governance

 QUESTION 1.2

Refer back to examples 1.2 and 1.3. For each example, explain how the accountant breached their
professional obligations and state the consequences of their actions. Use the main concepts from
figure 1.2 in your explanation.

SELF-REGULATION
Most of the time, professions are given permission to provide services to the public through some
regulatory process. For example, in many countries only doctors of medicine are allowed, by law, to
prescribe certain drugs.
Once accorded the relevant permissions, it is common for a profession to have a substantial degree of
independence or autonomy. This means they have a greater level of authority to set their own rules and
regulations and have less detailed government regulation.
The independence, or autonomy, to self-regulate commonly extends to membership and membership
rules of a profession. Professional bodies set the education requirements, professional ethical standards and
disciplinary processes (which can be in addition to legal processes) for the members of their profession.
Autonomy allows members of a profession to be judged by their informed peers, rather than by regulators
whose knowledge is inevitably more limited and may have a bias resulting from less experience. Autonomy
also enables internal penalties, or sanctions, for matters that a legal process might ignore or not be able to
identify (e.g. ethical breaches of a professional code of conduct that are not legal breaches).
Professions have an extra-legal role in regulating their members. Extra-legal means regulations in
addition to what is prescribed in statute law or common law. It is another way individuals or groups are
regulated. Professions set certain expectations of conduct in constitutions and by-laws that are enforced
by a disciplinary process. A member found to have engaged in conduct that brings the profession into
disrepute can have a range of penalties imposed against them. The most severe of these is forfeiture of, or
expulsion from, the membership of a professional organisation. Outcomes of disciplinary action will often
include publication of the member’s name and a summary of the misconduct that occurred.
.......................................................................................................................................................................................
CONSIDER THIS
Why do you think it may be appropriate for a profession to publish the name of an accountant who has breached the
rules of a professional organisation such as CPA Australia?

FROM SELF-REGULATION TO A CO-REGULATORY PROCESS

Members provide services to society in their field of expertise and society benefits from the service
provided. Society trusts the profession to act in its best interest and values the service provided. There
is a potential negative outcome from this autonomy if the profession fails to properly demonstrate self-
control and self-regulation, and does not hold its members to account when they act inappropriately. If
members of a profession act in an unethical way, they are seen not to be acting in the best interest of
society. If this is allowed to continue through lack of self-regulation, trust in the profession will be eroded
and the value and the status of the profession will be destroyed.
Due to a large number of corporate failures and the poor conduct of some accountants, this erosion of
trust has occurred in the accounting profession. As a result, some of the authority to self-regulate has been
removed from the profession. Regulations from external sources are also in place, so the profession has
moved from a situation of self-regulation to co-regulation, with regulation shared between the profession
and external sources. Examples of co-regulation include:
• the FRC, which is an oversight body for accounting and auditing standard setters
• the Corporations Act, which gives auditing and accounting standards the force of law
• the Australian Securities and Investments Commission Act 2001 (Cwlth), which establishes the Com-
panies Auditors Disciplinary Board
• the Tax Practitioners Board (TPB), which is the registering authority for professionals providing taxation
services of varying levels of complexity
• professional bodies such as CPA Australia.
Each organisation plays a part in monitoring compliance of accounting professionals with ethical
standards and the law.
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1.5 WHAT IS A PROFESSIONAL?
The term ‘professional’ refers to the members of a profession and much of the previous discussion about
professions is directly relevant to this question. A professional is a person who has a significant level of
training and a high level of competence and skills in a specific area of knowledge. Professionals behave in
an ethical and appropriate manner, and apply their skill and judgement in areas of importance. The process
of becoming a professional is sometimes described as the development from a technician (i.e. someone
who has technical knowledge about how to perform specific tasks in a given area) to someone who uses
their knowledge and experience in that area to make judgements of importance to the public interest.
The description of a profession that has been used so far in this module is often called the traditional
or functional view of professionalism. As discussed, professions are recognised as offering important
advantages to society by undertaking complex tasks and functions on its behalf. In return, the professions
are accorded a privileged position in society.

1.6 THE ACCOUNTING PROFESSION — THE

‘TRADITIONAL’ VIEW AND THE ‘MARKET
CONTROL’ VIEW
There are two contrasting views of the accounting profession.
• The traditional view sees the accounting profession as demonstrating a range of attributes that are
focused on serving society. The professional accountant acts for the public interest, rather than self-
interest, and can demonstrate skill and judgement in their area of expertise. Important attributes of
the profession include a systematic body of knowledge, an extensive education process, a code of
ethics, an ethos or culture, and a governing body. This could be described as the ideal view of the
accounting profession.
• The market control view is more critical and suggests that professional accountants are self-interested
and less concerned with the broader public interest than with their own careers. The accounting
profession, according to this view, has acted to create a monopoly in order to ensure only certain people
(members of the profession) can work in this area. This helps generate greater financial returns as well
as building status and prestige in the community.
Not everybody believes professions are necessarily so valuable — and for some, the concept of the
service ideal has often been replaced by visible greed. One common perception is that professionals are
self-serving monopolists whose professional bodies exist principally to maintain membership exclusivity.
Denial of entry of non-members into an industry or occupation maintains the monopoly.
An extreme example of self-interest is outlined in example 1.4.

EXAMPLE 1.4

Self-Interest
Andersen (previously Arthur Andersen, one of the world’s largest professional accounting firms) was the
auditor of HIH, which was, until its failure, Australia’s largest insurance company. Its failure was rapid and
spectacular and took place at about the same time Enron failed in the US in 2001/2002. Arthur Andersen
audited Enron and WorldCom both of whom experienced major bankruptcies, despite clean audit reports.
As a result of a court case against Andersen’s role in the Enron failure, Andersen itself was put out of
business, despite the shell company winning the case on appeal. These three cases of HIH, Enron and
WorldCom were the most graphic illustrations of corporate failure in this period, and Arthur Anderson
featured in each of them (Jeter 2003; McLean & Elkind 2004; Westfield 2003).
In 2006, Allan noted in the Deakin Law Review that:

The independence of Andersen was also highly questionable. Three former partners of the firm sat on
the HIH board. One, who was the recipient of continuing benefits from Andersen, was made chairman
and was appointed to the audit committee only 17 months after his retirement. Another, who had been
the engagement partner, was made chief financial officer only the day after his resignation from the
firm. The third was appointed to the board only five months after his retirement having ‘played a
significant role in the audit of HIH for 25 years’ (Allan 2006, p. 144).

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12 Ethics and Governance

 Examples such as this have a highly negative impact on the reputation of the accounting profession.
Therefore, it is not surprising that ‘images of altruism, ethical service and self-regulation were supplanted
by a portrayal of professions as self-interested collectives’ (West 2003, p. 21).

1.7 TRUST AND PROFESSIONS

Society recognises, or perhaps more correctly demands, that professions be especially equipped to work
with complex matters of economic and social significance. Society expects great individual capability and
the application of professional ethics from professionals as they make complex judgements that affect
individuals, entire economies and societies.
Ultimately, the way the public regards a particular profession will control the rights granted to the
profession and the professionals working within it. Public trust regarding any profession is vital. If a
profession loses credibility in the eyes of the public, the consequences can be severe for the public, the
profession and the members of the profession.
After the early 2000s collapses of Enron, WorldCom and HIH Insurance, and the demise of the global
accounting firm Arthur Andersen, the accounting profession worldwide experienced the effects of a
credibility crisis. International bank failures during the GFC also caused doubt about the credibility of
accounting standards and the reliability of the professional work of accountants. Institutional failure,
business collapses and widespread doubt about the integrity of financial information hurt all levels
of society.
Similar issues of trust have arisen in various parliamentary inquiries related to the provision of financial
services advice involving incentive-based remuneration. The Hayne Royal Commission received evidence
that suggested some advisers sought to better their own positions by selling products that increased their
commissions without great benefit for their clients (Hayne 2019). That report and subsequent analysis
caused people to reflect on the nature of ethical and professional behaviour in the context of financial
services, and in the context of providing services to vulnerable people.
For more information on the Hayne report, please see reading 1.1.
.......................................................................................................................................................................................
CONSIDER THIS
What actions should a profession take to ensure it preserves its relevance, credibility and the trust of the community?

1.8 ATTRIBUTES OF A PROFESSION

In this section we demonstrate how the accounting profession meets the eight traditional attributes of a
profession that were identified earlier:
1. systematic body of theory and knowledge
2. extensive education process for its members
3. ideal of service to the community
4. high degree of autonomy and independence
5. code of ethics for its members
6. distinctive ethos or culture
7. application of professional judgement
8. existence of a governing body (Greenwood 1957).
.......................................................................................................................................................................................
CONSIDER THIS
Review Greenwood’s eight attributes of a profession. In light of the discussion so far and your professional
experiences, would you suggest adding any additional attributes?

A SYSTEMATIC BODY OF THEORY AND KNOWLEDGE

It is sometimes contended that the main difference between an occupational group that is a profession
and another occupational group not recognised as a profession lies in the element of superior skill. This
contention does not always withstand scrutiny, as many occupations require high levels of manual skill
but make no claim to professional status. Much more important than the possession of skills is the fact
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MODULE 1 Accounting and Society 13

that the entire range of skills and expertise should relate to, and be supported by, a well-founded body of
knowledge. Thus, theory construction by means of systematic research becomes an essential basis for the
development of a profession and for professional practice.
The educational process for accountants is one of lifelong learning that commences with the first study
of accounting. The International Federation of Accountants (IFAC) has issued International Education
Standards that outline the core competencies all aspiring accountants must satisfy in order to be recognised
as a member of the profession, and of a professional body.
All IFAC member bodies (including CPA Australia) must abide by the requirements in these standards
when designing the content and assessment of their education programs. The aim of the standards is to
ensure an equivalent level of competence and knowledge for all members of the accounting profession.
The standards cover technical knowledge, soft skills and professional competence, and they provide a
framework for professional bodies to assure the quality of their education programs.

QUESTION 1.3

Identify the advisory group that IFAC uses to provide feedback on the educational needs of the
accounting profession. Who is able to nominate panel members?

AN EXTENSIVE EDUCATION PROCESS

Membership of a professional body ensures, in principle, that entrants to that profession have acquired an
understanding of the theory and practice of the profession. Entrants to the profession have already acquired
knowledge and skills that are not generally obtained or understood by the general public.
Importantly, their knowledge and skills will be further enhanced by the accumulation of knowledge and
experience through mentoring, professional development and continuing education programs. Throughout
their careers, all professionals must maintain their knowledge and skills.
As part of the commitment to lifelong learning for the accounting profession, and to ensure all members
possess current knowledge and skills, IFAC has issued a standard prescribing the requirements for ongoing
professional development. All CPA Australia members must undertake ongoing professional development
throughout their careers.

AN IDEAL OF SERVICE TO THE COMMUNITY

Wilensky (1964, p. 140) referred to the importance of the service ideal, which he considered to be ‘the
pivot around which the moral claim to professional status revolves’.
How this service ideal is achieved by accountants is described by Willmott:
Accounting is perceived to present information in a reliable and comparable form by quantifying and
reporting the basic facts of economic life, thereby monitoring past performance and facilitating rational,
efficient decision making in respect of the generation and allocation of resources. In performing this role,
accounting is widely understood to serve the public interest (Willmott 1990, p. 315).

According to Buckley (1978), society grants the professions monopoly power over professional affairs
and the power to use this monopoly power as they see fit, as long as the power is used in the public interest.
Any profession that deliberately and consistently breaches this trust does so at its own risk. This trust is an
important part of the philosophical notion of a social contract. As Wilensky (1964, p. 140) observes, ‘any
profession that abandons the service ideal will very quickly lose the moral claim to professional status’.
Continued erosion of public trust by unethical behaviour may lead ultimately to extreme governmental
intervention in the profession’s affairs, with consequent reduction of autonomy, authority and reputation.
Therefore, each member of a profession has a responsibility, and an obligation, to behave in a manner that
maintains the reputation of the profession.
Compiled APES 110 Code of Ethics for Professional Accountants (including Independence Standards)
published by APESB (2022a) specifies the fundamental principles of acceptable professional conduct for
professional accountants. These are reviewed in detail in module 2.

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14 Ethics and Governance

 To better understand the service ideal, we examine it from three perspectives:
• the wellbeing of society
• the pursuit of excellence
• community service.

The Wellbeing of Society

Accountants contribute to the wellbeing of society by preparing and attesting information that ensures
the efficient and orderly functioning of business, not-for-profit and government enterprises. Additionally,
accountants provide information that facilitates better decision making for individuals, business and
government. Thus, financial information is vital for advancing the interests of parties at all levels, which
ultimately results in the betterment of society.

The Pursuit of Excellence

Here the focus is the performance of the professional. The individual accountant accepts responsibility for
maintaining and updating their knowledge and skills, and applying their skills and competence with due
professional care in the best interests of society.

Community Service
Many accountants offer their time and skills free of charge to the community. This is sometimes described
as pro bono, a Latin term meaning ‘for the good’, which indicates the provision of unpaid work for the
public good. Various kinds of pro bono work may include:
• membership of finance committees for church groups, charities and schools
• providing financial counselling and other advice to people referred by community welfare groups
• holding honorary positions on hospital and university boards.
True professionals bring the same care and skill to volunteer work as they bring to assignments they are
paid for. Note that as a member of the accounting profession, an accountant is held to the same level of
responsibility for all their work, whether it is paid or unpaid.
.......................................................................................................................................................................................
CONSIDER THIS
Consider where you could provide service to the community once you have obtained your membership of CPA
Australia. Identify what benefits this would provide to you as an accountant and to the organisation you are supporting.
Are there any specific considerations that you should have with respect to the provision of that service?

QUESTION 1.4

Discuss whether acts of public service are considered to be purely political actions designed to
maintain the profession’s status in the eyes of the community.

A HIGH DEGREE OF AUTONOMY AND INDEPENDENCE

As discussed earlier in this module, as part of the trust relationship between the community and the
professions, it is common for professions to be allowed a substantial degree of autonomy and independence
from government interaction and control. This is referred to as the self-regulatory aspect of professions
that, for the accounting profession, has now become a co-regulatory situation. The degree to which this
autonomy continues is dependent on the consistent demonstration of professional and ethical standards by
members of the profession and by the profession generally.
Many professions, including accounting, have endured numerous significant examples of unprofessional
conduct by their members. Earlier, we listed examples of corporate failures that involved some degree of
poor conduct by accounting professionals. As a result of these failures, the accounting profession is less
free to self-regulate than it used to be, and now co-regulates in combination with external authorities. An
example of this change is outlined in example 1.5, which describes how the boards that previously created
Australian Accounting Standards now report to a government body, not to the professional accounting
bodies in Australia.

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MODULE 1 Accounting and Society 15

 EXAMPLE 1.5

Co-Regulation of the Accounting Profession

In Australia, accounting standards are developed by the Australian Accounting Standards Board (AASB)
and auditing standards are developed by the Auditing and Assurance Standards Board (AUASB).
Originally, these boards were created and controlled by the professional accounting bodies in Australia.
There are three major professional accounting bodies in Australia: CPA Australia; the Chartered Accoun-
tants Australia and New Zealand (CA ANZ) (previously the Institute of Chartered Accountants (ICAA); and
the Institute of Public Accountants (IPA) (formerly known as the National Institute of Accountants).
Changes in laws at a Commonwealth level resulted in the professional accounting bodies giving up
full control over the standard setting processes that were previously managed by the profession through
the Australian Accounting Research Foundation (AARF), a body funded by CPA Australia and the then
Institute of Chartered Accountants. The AARF played an important role in the design and promulgation
of guidance for the accounting profession. Now, AASB and AUASB both report to the FRC, which is a
government body. This has been the case since the early 2000s when the audit standard setting function
was transferred to a government body. While the professional bodies have a number of their members on
the AASB and AUASB boards, they no longer have the complete regulatory control they had previously.
This has been a natural evolution of accounting standard setting, where a stronger regulatory framework
has been required. The professional accounting bodies are still very involved, but their involvement is
tempered by overarching regulation and FRC control.

Individual member autonomy is closely related to the concepts of professional judgement, adherence to
a code of professional conduct and professional independence.
The member must be allowed to use their professional judgement free from the direction or influence of
others, and detached from the risk of financial gain (or loss) as a result of the advice provided. The member
must also be free from fear of reprisals. In other words, the professional person’s judgement should be
autonomous in the literal sense of the term (i.e. governed by their own professional rules and laws and not
influenced by inappropriate outside interests). Autonomy, in this sense, implies a self-principled, ethical
and responsible approach by the member.
For a professional accountant in public practice, the specific attribute of independence becomes more
important in relation to the concepts of objectivity and integrity. At times the accountant may be torn
between meeting the requirements of the client to report in a given way and maintaining their own ethical
compass and professional obligations.
The ethics of the professional accountant can be tested in these circumstances, and maintaining
independence and autonomy from the client will help the professional accountant ensure the most
appropriate position is adopted.

Co-Regulation and Professional Discipline

As part of maintaining autonomy and independence, the profession is expected to regulate itself in
combination with external authorities. Co-regulation promotes a consistently high level of professional
practice in the public interest and is important to maintaining the profession’s esteem.
A complex set of regulatory structures and practices have been developed around the public accounting
profession. These regulatory structures and practices attempt to define the technical and ethical responsi-
bilities that accountants owe to their employers, clients, third parties and the public.
The regulatory structures of CPA Australia include a:
• system of accreditation for accounting degree programs to ensure that the relevant body of knowledge
is acquired by future members
• membership qualification process by way of examination and required practical experience
• requirement for high levels of continuing professional education
• code of ethics that must be complied with
• disciplinary process to address member misconduct.
A brief overview of the code of ethics is provided in the following commentary. Later in this module, we
discuss the role of APESB and the disciplinary procedures designed to enforce compliance with accounting
and auditing standards.

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16 Ethics and Governance

A CODE OF ETHICS FOR MEMBERS
Codes of professional ethics establish expected standards of behaviour and the need for members to act in
the public interest.
APES 110 (APESB 2022a), various other Accounting Professional and Ethical Standards (APES)
statements and the Constitution of CPA Australia provide guidance and a disciplinary framework for
members of CPA Australia. Relevant legislation, such as corporate law and accounting and audit standards
regulation, also provide a framework that members of CPA Australia must follow.
Professional ethics in its simplest form is behaviour that is consistent with the APESB Code of
Ethics, and behaviour that contravenes the Code is considered unprofessional. The Code attempts to
deter unethical behaviour or, alternatively, promote desirable behaviour by stipulating acceptable and
unacceptable conduct.
As part of working in a global market, we find that in different cultures and nations, different behaviours
are seen as acceptable or unacceptable. This raises challenges for professional accountants, in fact all
professionals, because there is a need to be true to the ethical guidelines of a profession without causing
others to feel that their behaviour is unethical. An example of this is the payment of bribes, which in some
countries is seen as unethical and corrupt, but in others is a part of business dealings that is sometimes
tolerated (albeit a part of business dealings that invariably leads to the undermining of the economies
in which it takes place, and to inefficiency and nepotism replacing business dealings based on quality,
efficiency and capability).

A DISTINCTIVE ETHOS OR CULTURE

The ethos or culture of a profession consists of its values, norms and symbols. In the first instance, values
are ideas that individuals, groups of individuals or entire communities believe are important. These ideas
can be embedded in documents such as constitutions so that they are core values or ideas that are observed
by people, and which may also be known as conventions. That observance of certain values — such
as representative democracy, for example — means that people in Australia get to vote in elections at
Commonwealth, state, territory or local government level. It is accepted that a government is elected when
the rules contained in the constitution and any other laws that govern elections have been complied with
by all involved in the conduct of the election.
The norms of a professional group comprise both formal and informal characteristics. New members
become familiar with the professional culture in a variety of ways. Creating a culture and a sense of
belonging are very important in maintaining a professional organisation that is kept vital by new and
interested membership — a key part of the ongoing value of the profession itself.
Symbols of a profession include its insignia, emblems, certification and titles (e.g. ASA, CPA or FCPA).
Culture and ethos stem from formal history, significant milestones, jargon, stereotypes and folklore. They
also include dress codes. For example, when you think of professions such as law, the immediate image
that comes to mind probably includes a gown and a wig and symbols may include scales. For medicine,
the Hippocratic Oath and the Rod of Asclepius or the Caduceus may spring to mind.
To succeed in their chosen profession, a new member needs to learn about the culture and ethos of the
profession, and to become part of the culture and ethos. A key to evolutionary growth is that new members
must contribute to the ethos and the culture of the profession to ensure change happens in ways that are
desirable for the community and the profession.
For CPA Australia members our ethos has the word ‘integrity’ as its foundation.
.......................................................................................................................................................................................
CONSIDER THIS
In light of the implied social contract under which professions exist and the accounting profession’s obligation to
serve in the public interest, what do you think CPA Australia’s vision and purpose should be? Locate the vision and
purpose on CPA Australia’s website — are they as you thought they would be?

APPLICATION OF PROFESSIONAL JUDGEMENT

Becker (1982) argues that professional judgement is the single most important attribute that differentiates
professionals from non-professionals. The acquisition of knowledge through a formal educational process,
important though that is, is not sufficient to identify a person as a professional. According to Becker, the
key is the ability to diagnose and solve complex, unstructured values-based problems of the kind that arise
in professional practice.
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MODULE 1 Accounting and Society 17

 Since many non-professional occupations insist on practical experience, and since problem solving is by
no means absent from those occupations, it is important to try to understand what distinguishes professional
judgement from decisions involving technical judgements only.
A major difference, as Schön (1983, p. 17), expresses it, is that professional people must have an
‘awareness of the uncertainty, complexity, instability, uniqueness, and value conflict’ that surround many
of the problems they tackle in practice. This reference to value conflict identifies that complex social values
can regularly apply to decisions.
Professionals must choose the outcome that professionally best meets the social ideal of professions,
rather than merely the best outcome for the client at that moment. It is certain that professionals will
make many technical judgements based on technical skills. However, it’s expected that professionals can
also judge values and make judgements regarding values (based on professional ethical wisdom) that
distinguishes the work of a professional within a profession.
To emphasise the previous point, Schön also stated that professionals are required to develop competency
in professional judgement, artistry and intuition. These competencies are required not only in applying
knowledge and skills to problem solving, but also (and Schön would argue, more importantly) to finding
and defining the right problem to be solved. The emphasis on problem setting rather than on problem
solving, in turn, requires professionals to communicate skilfully with their clients and/or employers in
order to identify and solve the right problems. The complexity of understanding the nature of problems may
not seem obvious at first, but this understanding is an essential component in gaining the wisdom required
to make values-based professional judgements. The exercise of professional judgement in the accounting
profession is important for all accountants, irrespective of their work environment or geographic location.
One area of concern for professionals is the distinction between a judgement made in error (that is, a
genuine mistake) and a negligently formed judgement.
Many interesting questions regarding the professional judgement of accountants have occurred in the
area of auditing. This is because judgement, and negligence in respect of judgement, have been tested in
the courts, proving the ongoing social impact of the judgements of auditors.
Auditing is based on judgement in almost every fundamental dimension of the process. Some of the key
judgements that auditors must make include:
• identifying those charged with governance in a reporting entity
• deciding whether reasonable assurance or limited assurance is possible
• ensuring that the budget for the audit is sufficient
• deciding on an audit plan — including details such as whether, in any area, sufficient appropriate audit
evidence has been identified and whether any required additional procedures have been undertaken
• deciding whether the evaluation of the results is appropriate, ensuring that the conclusions are soundly
based on the evidence examined and that appropriate action has been taken. It is also important to
consider whether the appropriate level of management has been informed and an appropriate opinion
expressed to the relevant authority or, where applicable, a modified audit report is required.
Accounting is a profession constantly involving the exercise of judgement. West (2003, p. 195) suggests
that without judgement, accounting becomes nothing more than a book of rules for compliance. Instead
of providing a useful and genuine service, accounting may become an occupational group that depends
upon the imposition of regulatory fiat where external regulations are created that require people to use
accounting services (e.g. requirements for external audits).

QUESTION 1.5

Discuss four situations where accountants may apply professional judgement in the course of their
work irrespective of the environment in which they work.

QUESTION 1.6

CPA Australia has been discussing the impact of artificial intelligence (AI) on the accounting
profession. Listen to the CPA Australia podcast ‘Artificial intelligence and the future of account-
ing (it’s not as scary as you think)’ (https://cpaaustraliapodcast.libsyn.com/artificial-intelligence-
and-the-future-of-accounting-its-not-as-scary-as-you-think), and discuss the extent to which AI is
predicted to affect professional judgement.
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18 Ethics and Governance

THE EXISTENCE OF A GOVERNING BODY
A profession must have a governing body that has been drawn from the membership on a fully democratic
basis. The governing body has the responsibility for ensuring that the attributes listed earlier are achieved
and maintained, and that the professional body and the profession are successful.
The governing body of a profession, therefore, has an important enabling role and should:
• speak for the profession as a whole, particularly on matters of public policy that adversely affect the
profession’s independence and autonomy
• ensure that those who enter the profession have the requisite standard of education and that those
practitioners already within the profession continue to keep themselves up to date with developments in
accounting theory and practice
• encourage the setting and monitoring of high standards of professional conduct
• apply disciplinary sanctions if standards of professional conduct are not observed. The power to
discipline requires the governing body to have the power to control its members’ activities. Any breach of
professional conduct is judged and acted on by professional peers without public interference, although
members who may have acted illegally may face public prosecution in the courts
• ensure high standards of performance and conformance by the professional body itself — including
establishing policies, strategies and appropriate codes of conduct within the organisation.
The governing body must be credible and effective in the eyes of both the members and the public. Even
though the attributes of a profession may be clearly evident, the community’s view about whether or not a
profession deserves to be regarded as a profession is shaped to a significant extent by how the profession
(and its members) actually behave. The accounting profession is governed by IFAC.

1.9 THE PROFESSION’S REGULATORY PROCESS

ACCOUNTING PROFESSIONAL AND ETHICAL
STANDARDS BOARD
APESB is an independent body that sets the professional standards for accountants. APESB was the result
of an initiative of CPA Australia and CA ANZ. The roles of APESB are discussed in detail next.

Background
Earlier we highlighted that a high degree of autonomy is an important characteristic of a profession, and
noted how this attribute has been challenged by the regulators with the removal from the profession of
the powers to set accounting and auditing standards. As we have seen, these powers now reside with the
AASB and the AUASB. These two boards in turn report to the FRC.
In regard to auditing standards, the CLERP 9 legislation (Corporate Law Economic Reform Program
(Audit Reform and Corporate Disclosure) Act 2004 (Cwlth)) reconstituted the AUASB as a body corporate
under the Australian Securities and Investments Commission Act 2001 (Cwlth). Consequently, the AUASB
reports to the FRC and not to the professional accounting bodies.
Auditing standards have the force of law under the Corporations Act, which means registered auditors
have a legal duty to comply with auditing standards issued by the AUASB. The AUASB’s power to approve
legally enforceable standards means that all references to ethical requirements in auditing standards will
attract legal status. However, the AUASB has acknowledged that, while this will result in professional
standards having the force of law, it will not reduce or limit the profession’s own disciplinary activities.
Once professional standards acquired the force of law for auditors, the profession sought a more rigorous
and transparent process for setting ethical requirements. On 4 November 2005, CPA Australia and the
ICAA announced the establishment of APESB, an independent ethical standards board to review and set
the code of ethics and professional standards. The formation of APESB effectively transferred the setting
of professional and ethical standards from the professional accounting bodies to an independent body.
CPA Australia, CA ANZ and the IPA are all members of APESB. Members of these three professional
associations are required to abide by APESB standards.
The profession acknowledges that, in order to increase public confidence, it needs to open the
professional standard-setting process to greater public scrutiny. While the standards previously released
by CPA Australia were of a high standard and enforced through appropriate due processes, the profession
has an ongoing interest in improving the public’s perception of its professional standards. Any appearance
of self-interest should be removed, and the standards should be written by an independent board.
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MODULE 1 Accounting and Society 19

 APESB comprises a technical board and a secretariat to enable it to fulfil this role. The technical board
consists of eight members, including two members from CPA Australia. It comprises representatives from
the public sector, corporate sector, audit profession, academia and the general public.
APESB fulfils its role by:
• reviewing the professional and ethical standards on a yearly cycle, and monitoring the needs of
the accounting profession and the public for areas requiring new or updated professional and
ethical standards
• reviewing the implementation of new and amended professional and ethical standards within six months
of issue
• referring matters to the secretariat for research, direction and amendment
• seeking comment on exposure drafts for proposed standards from the public, the professional bodies
and their members
• monitoring the effectiveness of professional and ethical standards.

QUESTION 1.7

Identify the precise wording of the ‘force of law’ provisions (s. 296, s. 307A) for accounting and
auditing standards in the Corporations Act (www.legislation.gov.au/Series/C2004A00818).

THE QUALITY ASSURANCE PROCESS

Every profession is concerned about the quality of its services, and the accounting profession is no
exception. The integrity of information provided by accountants to their immediate employers, clients
and other stakeholders is enhanced through the profession’s quality assurance process. To help assure
quality outputs, the profession and the regulators have developed a multi-level regulatory framework
that encompasses many of the activities of private and public sector organisations. These activities are
described next.

Standard Setting
The institutional arrangements for standard setting involve the FRC with oversight responsibility for the
AASB, which deals with accounting standard setting in the private and public sector, and the AUASB,
which deals with the setting of auditing standards.

Conformity with Standards

Issued by APESB, APES 205 Conformity with Accounting Standards (2023) and APES 210 Conformity
with Auditing and Assurance Standards (2019) are mandatory statements of responsibilities for members
involved in the preparation, presentation or audit of financial reports.

Practice Reviews
To hold a Public Practice Certificate, members must demonstrate compliance with quality control standards
by annually providing a signed assurance that the established quality control requirements are being met
and by undergoing a practice review. Practice reviews take place under CPA Australia’s Best Practice
Program, which is designed to ensure members who are subject to review have implemented adequate
processes to manage work quality and practice risks, follow professional and ethical standards, and meet
requirements set out in CPA Australia’s By-Laws for members who hold Public Practice Certificates.
Members in public practice will be subject to a practice assessment by an experienced assessor every
three, five or seven years depending on the complexity of the member’s practice. A review or assessment
takes place, and a member is provided with a support plan to help them implement any recommendations
designed to assist them in meeting best practice. New holders of a Public Practice Certificate can opt to
undertake an online peer consultation process designed to help them organise their practice so it complies
with CPA Australia’s requirements and achieve their business objectives.

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20 Ethics and Governance

Accounting Firm Regulation
Each public practice entity adopts policies and procedures to ensure that accountants practising within it
adhere to professional standards. Corporate failures and accounting scandals over the past two decades
have often prompted accounting firms to be more vigilant about their procedures of quality control and
independence. In order to facilitate this, APESB issued APES 320 Quality Management for Firms that
provide Non-Assurance Services (2022b).
APES 320 provides guidance on establishing a quality management system (QMS). The QMS should
ensure that a firm’s outputs are appropriate and also provide reasonable confidence that the practice has
complied with professional, regulatory and legal requirements. The standard applies to public practices
offering non-assurance services. Under APES 320, a system of quality management comprises policies
and procedures that address the following.
• Governance and leadership — to promote an internal culture that recognises quality is essential in
performing engagements (para. 4.1).
• Professional standards — to provide reasonable confidence that the firm and its personnel comply with
relevant ethical requirements as contained in the profession’s code of ethics (para. 4.4).
– Independence: Within the context of professional standards, firms may need to consider inde-
pendence requirements in APES 110 in circumstances where the firm is providing non-assurance
services to a client, and the practice is also engaged to provide assurance services for that same
client. Other services covered by standards requiring independence to be considered include foren-
sic accounting services (APES 215), valuation services (APES 225), financial planning services
(APES 230), compilation of financial information (APES 315) and insolvency services (APES 330)
(para. 4.8).
• Acceptance and continuance of client relationships and specific engagements — to ensure that the firm
will only undertake or continue with engagements where it has considered the integrity of the client, is
competent to perform the engagement and can comply with the ethical requirements (para. 4.10).
• Resources — to ensure the firm has sufficient human resources, technology resources, intellectual
resources and services providers to be able to perform engagements up to the standard required by
the firm’s quality management policies and procedures (paras 4.18–4.19).
• Engagement performance — to provide reasonable confidence that engagements are performed in
accordance with professional standards, and regulatory and legal requirements (para. 4.38).
• Information and communication — to ensure the firm has systems in place to ensure that there is
a constant flow of communication about the need for quality management and feedback from firm
personnel on how engagements have been conducted to enable continuous improvement (para. 4.59).
• Monitoring and remediation — to ensure ongoing evaluation of the firm’s system of quality control,
including a periodic inspection of completed engagements and documentation. Remediation involves
action taken when the findings from the monitoring process or other complaints have identified
deficiencies (para. 4.66).
The guidance contained in APES 320 has been revised in recent years in order to eliminate any
reference to auditing and assurance services. In 2021, the AUASB issued ASQM 1 Quality Management
for Firms that Perform Audits or Reviews of Financial Reports and Other Financial Information, or
Other Assurance or Related Services Engagements (effective from 15 December 2022), which deals with
quality management in firms involved with providing auditing and assurance services. Similarly, New
Zealand’s External Reporting Board issued PES 3 Quality Management for Firms that Perform Audits or
Reviews of Financial Statements, or Other Assurance or Related Services Engagements (also effective from
15 December 2022) in 2021. Both ASQM 1 and PES 3 are versions of ISQM 1, the international standards
issued by the IAASB, and represent updated versions of a previous set of standards.
Other standards that are applicable to organisations conducting professional assurance activities include
ASQM 2 Engagement Quality Reviews and ASA 220 Quality Management for an Audit of a Financial
Report and Other Historical Financial Information (see figure 1.3).
Figure 1.3 shows which of the quality management standards is likely to apply depending on the services
that a practice offers.

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MODULE 1 Accounting and Society 21

 FIGURE 1.3 Application of quality management standards by firms

Firm

Provides non-
Provides non-assurance assurance services and Only operates an
services only operates an Assurance Assurance Practice
Practice

Apply APES 320 to Apply ASQM 1,

the non-assurance ASQM 2 and
practice and ASA 220 to the
Engagements Assurance Practice

Professional Services provided by non- Professional Services provided by

assurance practices and Engagements Assurances Pratices consist of:
include, but are not limited to:

Business services (including compilations of Audit Engagements

financial information)
Taxation services Review Engagements
Valuation services Other assurance Engagements
Forensic accounting services Related services Engagements including
agreed-upon procedures Engagements1
Insolvency services
Corporate finance services
Financial planning services
Agreed-upon procedures Engagements1
1 ASQM 1 applies to a Firm that performs audits, reviews, other assurance and related services Engagements

(paragraph Aus 0.1 of ASQM 1). Appendix 3 of ASRS 4400 Agreed-Upon Procedures Engagements provides
differentiating factors between agreed-upon procedures Engagements and Assurance Engagements. If a Firm
does not provide any audits, reviews or other assurance Engagements, then for the quality management of
Engagements, the Firm is required to apply APES 320.

Source: APESB 2022b, APES 320 Quality Management for Firms that provide Non-Assurance Services, p. 26, APESB, Melbourne,
accessed August 2023, https://apesb.org.au/wp-content/uploads/2022/02/APES_320_reissued_Feb_2022.pdf.

.......................................................................................................................................................................................
CONSIDER THIS
Think about the organisations where you have worked or currently work. What documentation is used to assure and
control the quality of the organisation’s outputs?

QUESTION 1.8

A merger is being finalised between your public practice and a firm that provides bookkeeping
services. As the partner in charge of quality management, you have not quite finalised your due
diligence on the policies and procedures designed to provide reasonable confidence that the firm
and its personnel comply with relevant ethical requirements.

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22 Ethics and Governance

 You are confident that the bookkeeping firm’s policies and procedures are robust, but you have
not yet completed a review of them. You nevertheless assume that there are no issues, as the firm
being acquired only provides bookkeeping services.
A few months after the merger is completed, you receive a phone call from one of your clients.
Your client is concerned because an employee of your firm who performs bookkeeping services
has an interest in a business that is one of their major competitors.
Your client is particularly disturbed because they are in the middle of extremely confidential
business negotiations. The client wants guarantees that your employee will not have access to
any confidential information. You agree to investigate your client’s concerns (Sexton 2009).
Identify and describe the quality management and ethical issues arising from this scenario.

PROFESSIONAL DISCIPLINE
Professional and ethical standards aim to ensure that members of the accounting profession work to the
highest level of professionalism, providing a quality of service that achieves credibility among the general
public and gains their confidence. Members often face personal, financial and other pressures that threaten
their integrity and test their judgement. Unfortunately, in response to such pressures, some members
prioritise self-gain and overlook their duty to protect the interests of third parties and the trust bestowed
upon members by the public. It should be noted that no profession is totally free of unscrupulous members.
Joining CPA Australia means committing to upholding the reputation of the CPA designation by
adhering to the obligations spelt out in CPA Australia’s Constitution and By-Laws, the Code of Professional
Conduct and applicable regulations. To ensure all members uphold these standards, CPA Australia has a
formal process that enables complaints about members to be heard and evaluated and, where appropriate,
disciplinary actions to be taken.
Investigations and disciplinary processes are guided by the principles of procedural fairness (the right
for a member to put forward their case), confidentiality, independence and the right to appeal.
CPA Australia has undertaken to act in the public interest and has an obligation to ensure that complaints
about members are investigated thoroughly, in an impartial and timely manner, at all times striving to
preserve the rights of members while acknowledging the public interest concerns of complainants.
Investigation and disciplinary procedures form an essential adjunct to the Code of Professional Conduct.
CPA Australia has placed due importance on the area of co-regulation and professional discipline by
establishing an elaborate set of rules and procedures to handle disciplinary matters.

Regulation of Member Conduct

The specific procedures for regulation are identified in:
• Articles 36–40 in the Constitution of CPA Australia (effective 11 May 2022)
• Part 5 of the By-Laws of CPA Australia (effective 1 October 2023).

QUESTION 1.9

Access CPA Australia’s Constitution and By-Laws (www.cpaaustralia.com.au/about-cpa-australia/

governance/constitution-and-by-laws) and answer the following questions.
(a) Which article in the Constitution defines the term ‘adverse event’?
(b) Who or what is a ‘GMPC’?

The process for dealing with member conduct is started when a complaint is made. A complaint may be
raised by any person including members of the public, members of CPA Australia or the General Manager
Professional Conduct (GMPC) of CPA Australia.
Involvement in an adverse event (see article 76 of the Constitution as follows) may lead to disciplinary
action being taken against a member.
Adverse Event means an event in which a Member:
(a) obtained admission as a Member, or obtained admission as a member of any other professional body,
by improper means including making a false declaration on the application for membership;
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MODULE 1 Accounting and Society 23

 (b) renewed their membership of the Company by improper means including making a false declaration
on the membership renewal form;
(c) breached this Constitution (or a constitution of the Company in force from time to time before the
Amending Date), By-Laws, Code of Professional Conduct or the Applicable Regulations;
(d) engaged in:
(i) dishonourable practice in any profession or undertaking; or
(ii) conduct which is derogatory to, or not in the best interests of, the Company or its Members;
(e) failed to observe a proper standard of professional care, skill or competence;
(f) ceased to hold the necessary qualifications to be a Member or to be a member of any other professional
body recognised by the Company;
(g) became insolvent;
(h) became the subject of a final adverse finding in relation to the Member”s conduct, competence or
recognition by any Court, professional body, statutory or other regulatory authority in any jurisdiction;
(i) pleaded guilty to, or was found guilty of (either without conviction or with a final conviction), any
offence (criminal or otherwise, but excluding any offence relating to traffic infringement) before any
Court in any jurisdiction, which in the Board’s reasonable opinion, is likely to have a material adverse
effect on the Company’s standing or reputation;
(j) was found to have acted dishonestly in any civil proceedings before any Court in any jurisdiction and
such finding has not been overturned on appeal;
(k) failed to comply with any reasonable and lawful direction of the Board or its delegate concerning the
Company’s good order and administration such as non-compliance with a Determination including
relating to costs; or
(l) was Closely Associated with a Practice Entity:
(i) which has become Insolvent:
(A) at the time when it became Insolvent; or
(B) at any time during the two years prior to it becoming Insolvent; or
(ii) which has done any of the things referred to in paragraphs (a) to (k) above as may be applicable.

The complainant should first attempt to resolve the matter directly with the CPA Australia member.
Where this initial resolution attempt is unsuccessful, the complainant must lodge a written complaint
providing all necessary details, supported by documentary evidence.
All complaints are reviewed by the GMPC. The GMPC will determine whether the complaint is relevant
and, if it is, a file will be opened to address the issue. The complaint will be allocated to a Professional
Conduct Officer (PCO).
The PCO will contact the member against whom the complaint has been made and provide details of
the nature of the issue. The member will be asked to provide an explanation.
Once the PCO has completed the investigation, a report will be given to the GMPC to enable a
recommendation to the Chief Executive Officer (CEO) of CPA Australia as to whether there is a case
to answer.
The CEO must determine whether there is a case to answer based on the GMPC’s recommendation and
any relevant external advice. If the member is assessed as having a case to answer, the CEO must refer
the complaint to either the Disciplinary Tribunal or to a One Person Tribunal (OPT), depending on the
circumstances.
The member and complainant will be notified by the GMPC that there is a case to answer and the GMPC
will refer the case to an investigating case manager (ICM). The ICM will prepare written particulars of the
case and present the complaint at the hearing that will be conducted.
After the hearing of the case, a determination (decision) will be made, and the member and complainant
will be advised of the outcome.

Penalties and Appeals

The findings and decisions of the Disciplinary Committee are published on CPA Australia’s website. The
Constitution of CPA Australia (article 36(b)) specifies that the following penalties can be imposed.
(a) In regulating the conduct of a Member under Article 49(e), the Board may impose on a Member any
one or more of the penalties set out in Article 36(b) if, in the Board’s opinion a Member has committed,
participated in or been involved with an Adverse Event.
(b) The Board may impose any Professional Conduct Penalty in accordance with Article 36(a) including:
(i) forfeiture of membership on such terms and conditions as to Readmission (or non-Readmission)
as may be prescribed;

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24 Ethics and Governance

 (ii) suspension from membership for any period not exceeding five years on such Reinstatement
terms and conditions as may be prescribed;
(iii) a Fine not exceeding the Maximum Fine;
(iv) admonishment;
(v) a severe reprimand;
(vi) for such period and on such terms as may be imposed:
(A) cancellation or suspension of any certificate, privilege, right or benefit issued or granted to
the Member; and/or
(B) prohibition of the Member’s use of any designation permitted to be used by the Member;
(vii) restriction for such period and on such terms and conditions as may be imposed on the
authorisation, permission or ability of the Member, or any Practice Entity under which the
Member trades or is to trade, use, display or otherwise utilise any Intellectual Property of the
Company or its subsidiaries including any status or designation;
(viii) the lowering of the Member’s Membership Status and/or removal of any specialist designation;
(ix) a direction to undertake such additional number of hours of Continuing Professional Develop-
ment as may be prescribed;
(x) a direction to undertake such activities or actions under the Company’s Practice Review Program
as may be prescribed; and/or
(xi) such other penalty as may be deemed appropriate in the circumstances.
(c) If in the Board’s reasonable opinion a Member has committed, participated in or been involved with an
Adverse Event under:
(i) subsections (c) or (d) of the definition of “Adverse Event” and that breach is serious; or
(ii) subsections (a), (b), (g), (h), (i), (j) or (l) of the definition of “Adverse Event,” the Board may
suspend the membership of that Member with immediate effect, pending a subsequent hearing at
the Board’s discretion as to the merits and on which the Member will be given the opportunity of
being heard.
(d) The Board may require a Member to pay all or any of the costs and expenses (not exceeding the
Maximum Costs) reasonably incurred by the Company investigating a Complaint and making a
Determination in relation to any matter arising under Article 36. Except where the Determination is
subject to an appeal (pending which the time specified in this Article 36(d) does not run) or the Board
otherwise resolves, in default of such payment within 30 days, or such further period as allowed by the
Board, the membership of that Member is forfeited. No appeal is available under this Article 36(d).
(e) The Board may publish, in any manner it deems fit, the name of any Member whose conduct has been
regulated under Article 49(e), together with details of the Determination including the nature of the
charge and any penalty or costs imposed.

It should be noted that the formal complaints process does not investigate issues relating to fees. Fees
charged by members are a commercial matter between members and their clients. However, the complaints
process will consider cases where members are in breach of their professional obligations, such as those
included in APES 110 (2022a) and other APES standards. Where the client’s concern relates to the size
of the fee, the client may consider contacting an organisation that mediates commercial disputes. There is
usually a cost involved in using mediation services.

QUESTION 1.10

Locate CPA Australia’s Disciplinary Hearing Outcome reports. Is the member’s name always
published?

SUMMARY
The accounting profession is integral to the process of ensuring people have access to accurate and useful
financial information upon which to base their decisions. These decisions often relate to the allocation of
resources and have important consequences for society. To make appropriate decisions about the analysis
and presentation of information, the professional accountant needs to clearly understand what information
serves the public interest and to ensure this — rather than any sense of self-interest — guides their
professional conduct. Ultimately, the accounting profession will only retain its integrity and authority
by serving the wider public interest.
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MODULE 1 Accounting and Society 25

 A profession such as accounting has a series of features that distinguish it from other occupations.
These include a specific body of knowledge obtained through formal qualifications from tertiary education
institutions and regular continuing professional development courses conducted by accounting bodies or
commercial training providers. A profession has as a core ideal the notion of service to the community. A
profession will typically have a code of ethics (for example, APES 110), a culture in which the exercise
of professional judgement is important, and a governing body (for example, IFAC).
Professions often exhibit a high level of autonomy and self-regulation. In the case of accounting, a degree
of external regulation has been imposed in response to various failings in some parts of the profession.
This co-regulatory approach means that in addition to the self-regulation undertaken by the peak bodies
of the profession, legislation and external regulators also have a degree of power over the conduct of the
profession and its members.
As a professional accountancy organisation, CPA Australia has a constitution and disciplinary rules that
set down what the profession expects of its members. Members who are the subject of public complaints,
for example, may be subject to disciplinary action. This may result in penalties, including forfeiture of
membership, fines, additional professional development or a reprimand.
The key points covered in this part, and the learning objectives they align to, are as follows.

KEY POINTS

1.1 Describe the nature and attributes of a profession.

• Professions exist because of an implied social contract.
• A profession generally has an overarching responsibility to operate in the public interest.
• A profession has a code of ethics and other guidance that establishes acceptable norms for
professionals practising in a specific discipline.
• A profession is established and defined by a set of specific attributes.
1. A systematic body of theory and knowledge — a profession has a specialised, unique body of
knowledge, skills and competencies that members of the profession must possess.
2. An extensive education process for its members — professionals must obtain the profession’s
body of knowledge, often initially through university education, and engage in formal continuing
professional development throughout their professional lives.
3. Ideal of service to the community — an implied social contract exists between a profession and
society based on the core notion that the profession will act in the public interest.
4. High degree of autonomy and independence — society grants professions considerable
autonomy and independence in return for consistently demonstrating that they are acting in
accordance with their professional and ethical standards and in the best interests of society.
5. A code of ethics — members of a profession are required to practise in accordance with a formal
code of ethics that establishes principles for good conduct.
6. Distinctive ethos or culture — a profession adopts a set of values that are expressed in
behaviours, documents and symbols that together form and reinforce the profession’s ethos
and culture.
7. Application of professional judgement — a profession is distinguished by the regular use of
judgement, rather than mere application of rules, to make decisions on situations and problems
that involve uncertainty and competing interests.
8. Existence of a governing body — professions maintain a peak body that brings members
together, establishes professional standards of conduct, assures the quality of the profession
and disciplines its members.
1.2 Explain the co-regulatory processes of the accounting profession.
• Society grants professions a high degree of autonomy and independence in return for acting in the
best interests of the society as a whole.
• When professions fail to act in the best interests of society, society responds by imposing
external regulation.
• A series of unexpected corporate failings in the early 2000s prompted regulators to increase
external oversight of the accounting profession.
• The mix of external regulation and self-regulation is known as ‘co-regulation’.

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26 Ethics and Governance

 • External regulation of the accounting profession in Australia includes legislation such as the
Corporations Act, regulatory bodies such as ASIC and the ATO, and organisations such as the FRC,
which oversees the AASB’s and AUASB’s work on setting accounting and auditing standards,
respectively. These standards have the force of law.
• Self-regulation of the accounting profession in Australia includes the professional accounting
organisations (CPA Australia, Chartered Accountants Australia and New Zealand, and the Institute
of Public Accountants), and their set of membership rules, ethical standards, educational require-
ments and disciplinary processes.
• In a co-regulatory environment, government regulators and professional bodies interact to ensure
that professionals working in specific areas follow the relevant ethical standards and laws.

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MODULE 1 Accounting and Society 27

PART B: INTERACTION WITH SOCIETY
INTRODUCTION
As described in part A, much of what characterises a profession is the way it interacts with society.
Professions enjoy various privileges in return for acting in the public interest.
This part of the module looks in more detail at the professional relationships between accountants
and various stakeholders. In particular, the different roles accountants may fill within a variety of
work environments strongly influence the way in which accountants create value for themselves, their
organisations and society as a whole.
The core value created by accountants is their support of high-quality decisions by providing relevant
and useful information to decision-makers. It is in return for this value that society confers on accountants
professional status and the accompanying benefits. Accordingly, society scrutinises the conduct of the
profession and where it has been found to fail, increased regulation and oversight has been introduced.
To ensure professional conduct, accountants must combine their technical accounting skills with skills
across a broad range of areas — sometimes collectively referred to as soft skills’ — such as communication,
negotiation, persuasion and leadership skills. To support this, the profession requires accountants to
undertake formal continuous professional development throughout their careers.

1.10 ACCOUNTING ROLES, ACTIVITIES

AND RELATIONSHIPS
RELATIONSHIPS AND ROLES
Accountants are found in an ever-increasing number of roles and relationships in society. The key
professional relationships that accountants have are with employers, clients, regulators, employees (if
business owners or managers) and their peers. These relationships are shown in figure 1.4.

FIGURE 1.4 Accountants’ key professional relationships

Society

Employers

Employees Clients

Accountant

Peers Regulators

Professional
bodies

Source: CPA Australia 2023.

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28 Ethics and Governance

 Peers include work colleagues, accountants in professional networks and other accountants who work
for the same client in a different aspect of accounting. Maintaining good-quality professional relationships
is an essential part of being a successful professional accountant.
Many factors influence how an individual will behave in their workplace. These factors include culture,
standards and ethical evaluations. Other variables that have an impact on an accountant include:
• personal moral development
• family influences and personal relationships, including those at work
• the organisational level (business structure and relationships with superiors and subordinates, etc.)
• laws and regulations
• professional aspects (including professional expectations and professional ethics).
These all have an impact on the way problems and issues are dealt with by an individual in the workplace.
A threat to, or excessive pressure on, any of these areas has the potential to result in unprofessional conduct.

ACCOUNTING WORK ENVIRONMENTS

Examples of accounting work environments are shown in table 1.2.

TABLE 1.2 Types of accounting work environments

Work environment Examples

Public practice Big Four accounting firm

Second-tier accounting firm
Small partnerships and sole practitioners

Private or business sector Professional accountant in business

Large companies — privately held or publicly listed
Small and medium enterprises (SMEs)
Start-ups

Public sector Government departments

Public entities (e.g. hospitals)

Financial advice High wealth individuals

Business organisations
Trusts and foundations

Not-for-profit sector Charities

Sporting and cultural associations

Source: CPA Australia 2023.

CPAs must be equipped with a range of skills to function as business leaders. Further, professional
capabilities are mobile, enabling accountants to work in different geographic locations, various work
environments and online. Each of the environments listed in table 1.2 is discussed in more detail in the
following sections.

Public Practice Environment

Public practice refers to professional accountants who offer accounting services to businesses and the
public. The public practice environment can be grouped into three types of firms and practices. These are
summarised in table 1.3.

TABLE 1.3 Sub-types of the public practice environment

Sub-type Description

Big Four The ‘Big Four’, as they are known, are the four largest international professional public
accounting firms practice firms that offer services in accountancy and professional services in Australia and
the world.
These firms are PwC (PricewaterhouseCoopers), Deloitte, EY (Ernst & Young) and KPMG.
The revenues of these firms have been reported to be in the tens of billions. A significant but
decreasing service line for the four largest firms in the world is audit and assurance. These
companies audit a majority of the listed entities in Australia and overseas.

(continued)
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 TABLE 1.3 (continued)

Sub-type Description

Big Four The Big Four firms provide a broader range of services than just audit and assurance,
accounting firms including advising on corporate or entity restructures, taxation, consulting to various
entities on their operations and governance structures, and providing staff for secondments
to companies.
Evolving areas of practice in the Big Four environment include the provision of advice on
information technology, and developments in climate and sustainability disclosure.

Second-tier Mid-tier public practice firms operate on a smaller scale than the Big Four, but they offer a
accounting firms wide range of services.
They generally have a number of offices in capital cities and large regional centres, together
with some level of international engagement, generally through alliances or network
affiliations.
Examples of these firms are Findex, BDO, Grant Thornton and Pitcher Partners.

Small practices This level of public practice includes the smaller accounting practices with one
and sole professional accountant as practitioner or a team of professional accountants and
practice support staff.
operations Smaller accounting firms tend to be used by small and medium enterprises (SMEs), which
often have no statutory audit requirements. Accordingly, these practices usually undertake
compliance work that is less related to audit (e.g. tax returns, standard accounting), and
increasingly business and IT advisory work.

Source: CPA Australia 2023.

Roles in Public Practice

While Big Four firms, and to some extent mid-tier firms, offer services that include consulting and legal
divisions, the range of accounting activities for an accountant in public practice is similar, irrespective of
the size of the practice.
The types of roles within public practice work environments include those shown in table 1.4.

TABLE 1.4 Public practice roles

Area Activity

Assurance and Financial statement attestation, in which the firm examines and attests to a company’s
audit financial statements. Other assurance services including assessing procedures and
controls relating to privacy and confidentiality, performance measurements, systems
reliability, information security and outsourced process controls.

Financial Covers performance management, corporate governance, stakeholder relations, risk, as

management well as the traditional financial controls.

Taxation services Covers company and individual taxation, fringe benefits tax (FBT), goods and services tax
(GST), capital gains tax (CGT) and international tax issues.

Forensic Specialised area that involves engagement for legal issues including fraud, disputes
accounting or litigation.

Insolvency Specialised area that involves engagements in personal insolvencies (bankruptcies) and
corporate insolvencies (administrations, liquidations and receiverships).

Internal audit Systematic, disciplined approach to evaluating and enhancing risk management, control
services and governance processes.

Business advising Assisting business managers to more successfully achieve value. The tasks involved are
varied, often reflecting that businesses have internally recognised weaknesses, or have
identified that objective external evaluations and contributions can be valuable. Business
advising can also extend to advice on business re-engineering, restructuring, takeovers
and mergers.

Other advisory Assisting businesses in areas such as sustainability and accounting for climate change,
services and compliance with new legislation such as the Modern Slavery Act 2018 (Cwlth). Advice
on IT and technology-related matters.

Source: CPA Australia 2023.

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30 Ethics and Governance

Accountants as External Advisers to SMEs
It is important to note that often, in very small SMEs, no accountants will be employed internally and there
is total reliance on an external public accounting practice to perform all accounting functions. Research
commissioned by CPA Australia in 2005 found that accountants from public practice provided a wide
range of services as advisers to the SME sector. The survey reported that 97 per cent of SMEs purchase
accounting services (i.e. taxation advice and financial statement preparation) from an external accountant
(CPA Australia 2005).
Five years later, and at an international level, IFAC (2010) found the same general trend. IFAC also
clarified that it is important for external accountants (small to medium practices) to recognise the real
opportunities that exist in the greater provision of profit-oriented business advice rather than accepting the
current overwhelming dominance of compliance advice. These opportunities benefit the businesses being
advised and help to grow the accounting practice.
The following summary explains how IFAC (2010) discusses the issue.
• Researchers identified that some owner-managers want to ‘go it alone’ rather than expose their problems
to outsiders, depicting this as a ‘fortress enterprise’ mentality. Owners displaying this attitude wanted
to hide their weaknesses and typically they would justify their approach by saying that outside advice
was irrelevant or poor. As they were not using outside advice anyway — how would they know?
• Other researchers have pointed out that the ‘range and quality of advice available’ in relation to business
advising from external advisers is growing. This has been a derivative of the work of external advisers
helping SMEs to meet regulatory requirements and can be seen in the increased number of advisers and
the increasing advisory skills in relation to ‘regulatory and day-to-day and strategic challenges’.
• It is apparent that SMEs do require external advice because many smaller entities have no internal
accounting staff. Much advice has been in relation to meeting regulatory requirements, but demand is
also evident in relation to business monitoring and quality control. Importantly, IFAC states that ‘this
is not merely confined to financial compliance’. While it is clear that a compliance bias has continued,
external advice and support have been sought from accountants (as general business advisers) in relation
to ‘employment, health and safety and environmental regulations’.
Further research on the scope of work done by small and medium practices (SMPs) for small businesses
was released in 2016 by IFAC in the form of a global SMP (small-to-medium practice) survey. According
to the survey, 84 per cent of SMP respondents provided business or consulting services to clients with the
most common services being tax planning (52 per cent); corporate advisory services (45 per cent) that
encompasses transaction, due diligence and financing advice; and management accounting (41 per cent)
that includes planning and risk management (IFAC 2016a).
IFAC published a 56-page literature review on accountants and their roles in small to medium
practices in 2016. That review noted that accountants from SMPs provided a wide range of business
services. These business services include acquisition, succession, financial management, business strategy,
tax planning, cash-flow advice, financing advice and debt administration, business valuation, forensic
accounting, bankruptcy, costing and pricing, financial planning and budgeting, human resources, pensions,
remuneration schemes and payroll, environmental sustainability, IT services, secretariat, training and skill
development, and risk management (IFAC 2016b).

QUESTION 1.11

Owners of SMEs have sometimes been reluctant to seek the advice of accountants. Identify some
of the reasons why a business owner might be reluctant to seek advice from an accountant.

Private or Business Sector Environment

Professional accountants in business (PAIB) are employed by private sector businesses in varying roles.
The scale of a business’s operations will determine the professional accountants’ roles.
Notwithstanding the size of the business, the tasks undertaken by professional accountants are expanding
in response to changes in the contemporary environment in which businesses operate. Accountants are
increasingly involved in, for example, responding to sustainability and climate change challenges, and
assisting with IT-related matters and issues associated with digital transformation.

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 These changes have led to new roles requiring specific skill sets that accountants can fill, especially
within large businesses. For example, it has been observed that the traditional role of the Chief Financial
Officer (CFO) is being replaced by what is now called the Chief Value Officer (CVO). This new role
recognises that finance is only one way in which businesses create value and that a more integrated mindset
incorporating other forms of capital is needed to support decision making (see table 1.5).
PAIB Employed in Large Businesses
Many professional accountants work in large corporations, often in specialised roles in accounting and
related areas. Some of these roles are listed in table 1.5.
During their career a professional accountant may remain in a particular role or may move through
various functional roles and then on to management levels within the finance area. Often, professional
accountants move into general management roles as a result of the wide capabilities and skills they acquire
during their career. Professional accountants are also often found on the boards of companies as directors
or company secretaries. Even with changes in the roles performed and challenges faced, which generally
become more complex as more senior roles are accepted, a CPA must continue to maintain the service
ideal and continue to comply with professional ethical requirements.

TABLE 1.5 PAIB roles in large businesses

Role Responsibilities

Board member Elected to the board of directors to oversee the activities of the company
or organisation.

Chief executive officer Overall management of business operations with oversight from the board.

Finance director or chief Formulation, management and review of the financial and strategic direction of the
financial officer company or corporate group.

Chief value officer Value creation within the entity as opposed to just financial results. Ensures all aspects
of value creation (and destruction) are reported to the board.

Financial accountant Preparation of general purpose financial reports, the annual report and special
purpose financial reports as required. May supervise a team of accountants.

Treasury accountant Management of treasury functions of the organisation in order to ensure sufficient
cash flow and the effective use of financial instruments.

Risk manager Quality and risk management responsibility for the business.

Strategic management Preparation of budgets and forecasts, costing, performance measures for analysing
accountant and improving organisational performance.

Internal auditor Review of internal controls, information and business processes.

Sustainability Development of sustainability policy and processes to support sustainability

accountant strategies. Implementation of sustainability management controls and reporting on
sustainability-related matters on a voluntary basis or as required by legislation.

Human resources Remuneration and payroll-related functions.

accountant

Company secretary Reporting and regulatory compliance and ensuring, with the chair, the efficient
functioning of the board of directors.

Source: CPA Australia 2023.

PAIB Employed in SMEs

Small- and medium-size enterprises (SMEs) vary significantly in their size, number of employees, direct
ownership control and geographic dispersion of resources.
So what is an SME? IFAC defines SMEs as follows.
Entities considered to be of a small and medium size by reference to quantitative (for example assets,
turnover/employees) and/or qualitative characteristics (for example, concentration of ownership and
management on a small number of individuals). What constitutes an SME differs depending on the country
(IFAC 2010, p. 10).

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32 Ethics and Governance

 The accounting functions within an SME are broadly the same as in a large business environment.
However, an SME-employed accountant may have to complete more detailed work because there will be
fewer (if any) support staff. Also, the number of areas they need to cover may be wider but have less
complexity compared to a large business environment.
At the same time, because they will know the business and typically be very close to the ownership
(in fact, may even be an owner) and senior management, the professional accountant in an SME will also
often be involved in a range of business decision activities.
An example of the differences in the roles performed by a professional accountant in a large business
compared to an SME is as follows.
• A large business may engage a management accountant whose sole responsibility is budgeting,
forecasting and reporting actual results compared to budget for one of its areas of operation.
• An SME may engage a finance manager who is responsible for their end-to-end accounting and finance
function — with responsibility for every function from petty cash to monthly reporting to the directors.
IFAC Research
The PAIB Committee of IFAC focuses on ensuring that accountants who work in commerce, industry,
financial services, education, and the public and not-for-profit sectors meet the future needs of business
and the public sector. Studies by IFAC underscore the importance of the role played by PAIB in business
performance and the need for further training to be made available to these professionals. A report
published by IFAC in 2018, The Role of the Finance Function in Enterprise Performance Management,
highlighted the need to ensure that PAIB were treated as more than individuals who form one part of
a financial reporting chain within an entity. The report argued that the PAIB needed to be promoted
and advanced as a contributor to business performance and value creation. A way of encouraging this,
according to IFAC (2018), is to create an environment where knowledge is acquired in a series of
areas including:
• an organisation’s operating environment and business model
• strategic and operational planning, budgeting and forecasting
• lean operational management, including quality management principles, continuous process improve-
ment and optimisation (all of which can also be applied to finance as well as to operations)
• finance fundamentals including core processes, systems and technology
• integrated thinking and reporting
• organisational management including culture, change and behaviour.
We can link these areas to the roles identified earlier and the different sizes of private sector businesses.
For example, the measurement activity in a large business may be a management accountant measuring
the performance of international freight supplier contracts. In a small business, the measurement activity
may be the financial controller determining a breakeven sales figure.
There is a greater awareness of the value PAIB are able to bring to the overall workplace outside of
the compliance and storytelling function that they have traditionally fulfilled within the entities for which
they work.
.......................................................................................................................................................................................
CONSIDER THIS
What are the ways in which you add value in your workplace? What areas would you like to develop in the future that
will allow you to add more value?

QUESTION 1.12

Refer to reading 1.2. How did Roel van Veggel add value to André Rieu’s business?

Public Sector Environment

The public sector includes a wide range of government and regulatory bodies. It includes the federal
government and lower levels including state, territory and local government. Where governments provide
for-profit services, they often set up particular entities called government business enterprises (GBEs)
or state-owned enterprises (SOEs). Governments are characterised by the breadth of their powers in
comparison with the private sector, such as the ability to establish and enforce legal requirements.

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 Qualified accounting professionals can build successful careers in the public sector because governments
and their agencies require economic, financial, accounting and audit staff for their operations. Often people
are drawn to the government sector because of the potential for greater work–life balance, training and
development and career progression and because they wish to make a difference.
Over recent years there have been significant cultural changes with a shift towards a more corporate
model of best practice and ‘value for money’ approaches. As in the private sector, the public sector highly
values commercial know-how, analytical thinking and leadership and stakeholder management abilities.
Accounting roles within the public sector are quite similar to those in the private and business sector,
with the requirement for financial reporting, internal audit, risk management and strategic management
accounting of key importance.

Financial Advice Environment

Accountants are often called upon to offer financial advice to clients, who include high net worth
individuals, businesses or other entities such as trusts or foundations. As accountants are knowledgeable
and skilled about financial matters, and are able to interpret complex financial information, it is natural
that clients call upon them for investment or other financial advice beyond their normal accounting duties.
However, offering financial advice has significant risks and responsibilities that must be recognised.
Providing financial advice takes a critical step away from assessing compliance within a body of rules
and frameworks to actually taking complex decisions regarding the best means of financial performance.
Additional regulatory and educational obligations have been imposed on accounting professionals
engaged in the provision of financial advice through the imposition of education standards. One of those
additional obligations is for financial planners to sit a financial adviser exam that has been administered
by ASIC since January 2022. The exam and the development of ethical standards and other regulations
were previously administered by the Financial Adviser Standards and Ethics Authority.
The risks involved in offering financial advice are many. It is vital to remember Adam Smith’s words:
this is ‘other people’s money’. That is, any risks involved in the proposed investment strategy are borne by
the client, not the adviser. Moreover, if, as a financial adviser, the accountant becomes too close to certain
investment funds, this poses the risk of the adviser acting out of self-interest rather than the client’s interest.
The financial advice industry has been associated with these dilemmas on many occasions, which has led
to a number of government inquiries into the financial advice industry both in Australia and overseas,
including a comprehensive examination of the current cost, quality, safety and availability of financial
services, products and capital for users, in the Australian Government’s Financial System Inquiry Final
Report (The Treasury 2014) and the Royal commission that resulted in the Hayne Report, which reported
on misconduct across a range of entities in the financial services sector.
The dilemmas of self-interest conflicting with public service are most serious in the field of financial
advice. The occupation of financial adviser has expanded considerably in recent decades as more people
have accumulated wealth that they wish to invest wisely. Since accountants have extensive financial skills
and knowledge, some accountants have been drawn into providing financial advice, often at the request of
their clients.
Regrettably, internationally there has been a series of scandals involving widespread selling of inappro-
priate investment products, charging unacceptably high fees, and sometimes corrupt practices. This has
not only occurred with individual financial advisers, but with financial advisers working for the insurance
industry in the UK, and the major banks in Australia.
Clearly the role of financial adviser carries significant responsibilities and risks beyond those normally
encountered in the accounting profession. It is essential for any accountant engaging in financial advice to
be fully aware of the responsibilities and risks involved, and to maintain a sense of objectivity regarding
the best interests of the client receiving the advice.

Not-for-Profit Sector Environment

Not-for-profit entities (NFPs) are generally defined as legal or social entities formed for the purpose of
producing goods or services, and whose status does not permit them to be a source of income, profit or
financial gain for the individuals or organisations that establish, control or finance them.
NFPs can vary in size from very large charitable institutions to local sports clubs. The principal sources
of income for their operations are usually receipts from members and supporters, grants, donations and
fundraising. Some NFPs also supplement revenue with trading activities. Although generating profit
from trading is not their core purpose, NFPs require sound financial management to ensure that they
are sustainable, can demonstrate positive social impact and can continue to meet their objectives and
reporting obligations.
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34 Ethics and Governance

 The NFP sector, sometimes called the community or third sector, is diverse and growing. In Australia,
the NFP sector encompasses 600 000 organisations. A 2023 report, published by the Australian Charities
and Not-for-profits Commission (ACNC), revealed that there were 59 967 charities registered with the
charities regulator (as at 8 February 2023). Using information compiled from the 2021 annual information
statements submitted by charities, the report outlines that most charities — about 65 per cent — are small
and have revenue up to $250 000; however, the total revenue for charities was $190 million. This is not
surprising considering that several of the largest charities are universities and private health providers
(ACNC 2023).
As the complexity of tendering and accountability requirements grow in this sector, so does the need
for professionally qualified staff to enhance efficiency and effectiveness.
Keeping the organisation in good financial shape, meeting the reporting requirements of a myriad
of stakeholders, understanding the grants process, constructing and monitoring budgets, tendering for
outsourced government services, diversifying revenue streams through new models of investment and
social enterprise and meeting best practice volunteer management are all part of the daily mix for an
accounting professional working in the NFP environment.

1.11 SOCIAL IMPACT OF ACCOUNTING

It might be argued that all professions, because of their accumulation of relevant capabilities, have a duty
to use those capabilities to improve and enhance society. We can call this a positive (or active rather than
passive) social impact. Does accounting have a positive social impact? Can that impact be negative in some
circumstances? Is it possible that accounting may even change society?
One aspect of accounting is the important role of reporting to investors, owners, management and other
users. This reporting may be designed principally to inform users about events that occurred in the past, by
way of annual, half-yearly and quarterly reports, and some types of historical reports within organisations.
Some people might think that this reactive information is passive. However, as a result of this historical
accounting information (created under applicable accounting standards), investors, governments, managers
and other stakeholders make decisions with significant social consequences. Reporting, which is reactive
in respect of events, is the active foundation for a variety of outcomes — and these outcomes actively
change social circumstances and entire societies. An example of this may be the preparation of the half-
yearly results for a publicly listed company. If the results are poor, there is an obligation for the company
to announce this to the public. Investors may then choose not to go ahead with a plan to purchase shares
in the company. If financial results for a large number of companies are poor, society may interpret this as
a sign that the economy is failing.
Examples such as these show that implementing accounting systems and their constructs have a forceful
social impact and social and economic consequences, so accountants need to understand and apply
their professional capabilities to achieve appropriate reporting in each circumstance. These professional
capabilities include relevant technical knowledge, soft (sometimes called social or interpersonal) skills and
extensive experience to avoid adverse consequences due to poor or inaccurate reporting.
Beyond reporting about the past, accounting is commonly used within organisations to provide
information to support managers in decision making. Such information is future-oriented and is designed
to facilitate, support and even to cause change. For example, a strategic management accountant designing
information to support a new manufacturing plant is change-focused, as is an accounting regulator working
on new laws or new accounting standards designed to create changes.
If the reporting is right, then the social impact, arguably, will be good, as markets and decision-
makers are informed appropriately. If the reporting is wrong, then the social impact will almost certainly
be negative.
Arguably, even perceptions about accounting can create significant social impact — so communications
regarding accounting need to be professional and balanced.
Accounting is increasingly recognised internationally and nationally as creating changes to society,
affecting individuals, business entities and regulatory agencies (including governments). The professional
accountant must always be aware of their ethical obligations and the reliance society places on the
information they provide.
Accounting is often perceived as neutral — a set of black and white tasks performed in a mechanical
manner — but this understates its influence. Rather, the activities of accountants and the use of accounting
information, including the decisions that are made based on the outputs provided by accountants, have a
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MODULE 1 Accounting and Society 35

decisive impact on the social functioning of individuals, groups and entities. The impact is far wider than
at first might be apparent.
It is important for accountants to understand the possible social impacts of accounting practices and the
information they produce at the micro and the macro levels. At the macro level, these possible impacts
extend to all types of business, public organisations and social institutions, and society generally. At the
micro level, we must understand the potential impact that accounting can have on the motivation and
behaviour of managers and employees within an organisation.
The motivational effects of performance measurement are discussed in more detail in the ‘Strategic
Management Accounting’ subject of the CPA Program.
At a macro level, ASIC reviews financial statements on an annual basis and raises concerns with
companies as issues arise. Issues related to the impairment of assets appear regularly on the corporate
regulator’s accounting watchlist, one of which is outlined in example 1.6.

EXAMPLE 1.6

ASIC’s Power
ASIC conducts regular surveillance of financial statements and frequently looks at issues where the
regulator has expressed concern about the methods entities have used to produce the numbers in their
financial statements. A frequent area of concern is the impairment and useful lives of assets.
In its 2017–18 Annual Report:

ASIC raised concerns on the value of assets in Myer Limited’s financial report for the full-year ended
29 July 2017. Our concerns included the reasonableness and supportability of the cash flow forecasts
used in testing the assets for impairment.
After ASIC raised these concerns, … Myer announced its decision to write down the value of its
goodwill and brand name intangible assets by $515 million in its [half-year] financial report … Myer
has stated that this write-down in the value of its assets reflects its adoption of lower cash flow
forecasts, as well as the deterioration in trading during the first half of the 2018 financial year.
The impairment of non-financial assets remains a focus in ASIC’s surveillance of financial reports.

Source: Quotes from ASIC 2018, ‘Annual Report 2017–18’, p. 78, accessed August 2023, https://download.asic.gov.au/
media/5aqkyjpj/annual-report-2017-18-published-31-october-2018-full.pdf.

ASIC also has an Audit Inspection Program, under which it looks at a selection of audits of the financial
reports of public interest entities. Part of the 2022 report is included in example 1.7.

EXAMPLE 1.7

Audit Deficiencies
ASIC has today reported on the results from its audit firm inspections of 45 audit files across 14 firms
(which included one large unlisted entity file at each of the largest six firms) in the 12 months to 30 June
2022. The audit files were selected from a population of over 2100 companies listed on the ASX and large
unlisted entities audited by the largest six firms.
ASIC Commissioner Sean Hughes said, ‘Audit inspections are designed to promote audit quality and
high-quality financial reports. ASIC encourages audit firms to continue to focus on improving audit quality,
which will in time improve the overall level of findings. As we announced in July 2022 (see 22-172MR),
ASIC will commence routinely communicating negative findings from its reviews of audit files to directors,
to further improve the quality of financial reporting.’
‘For the first time our report includes two case studies of good practice in the areas of the audit of
revenue and the audit of asset values and impairment of non-financial assets. These are areas where we
have historically had large numbers of negative findings. We expect these case studies will help auditors
to improve their audit processes in these areas,’ said Mr Hughes.
As ASIC reviews only a small sample of audit files on a risk-assessed basis, there will always be
variations in negative audit findings from year to year. However, ASIC expects all audit firms to focus
on audit quality. They must identify and address the root cause of negative findings and develop and
implement action plans to foster an effective and sustainable audit quality system.

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36 Ethics and Governance

 While the most recent inspections have shown an overall raw increase in negative findings, this does
not mean that the financial reports audited were materially misstated. Rather, in ASIC’s view, the auditor
may not have a sufficient basis to support their opinion on the financial report. The increase in negative
findings is potentially due to ASIC’s focus on a small number of high-risk audits and higher risk key audit
areas within these audits, as well as the inclusion of audits of large unlisted entities and the impact of
COVID-19 conditions.
Source: ASIC 2022, ‘ASIC reports on audit inspection findings for 12 months to 30 June 2022’, accessed
August 2023, https://asic.gov.au/about-asic/news-centre/find-a-media-release/2022-releases/22-296mr-asic-reports-on-
audit-inspection-findings-for-12-months-to-30-june-2022.

.......................................................................................................................................................................................
CONSIDER THIS
Reflect on the role regulators play in the surveillance of financial statements and audits. Do you think that this has
an impact on the actions of accountants and auditors? Would it have an impact on your actions as an accountant
or auditor?

1.12 CREDIBILITY OF THE PROFESSION

For accounting to continue to be regarded as a profession, it is important that it is perceived to provide a
public service and contribute to effective governance of organisations, large and small, public and private.
Our technical actions and behaviours as accountants are under scrutiny. The way we act and the work we
perform have a significant impact on organisations and society. As such, when we fail to perform our work
to an adequate standard and organisations experience trouble and distress, the credibility of the profession
is called into question.

CREDIBILITY UNDER CHALLENGE

Some authors argue that the credibility of the profession has declined because of several factors including
accuracy of financial reporting, corporate failures, auditor independence and a lack of audit quality. For
example, Brewster (2003) documents the loss of trust in the accounting profession during 2001 and 2002
in How the Accounting Profession Forfeited a Public Trust and this study was updated by Carnegie and
Napier (2010) who examined the stereotypes used to portray accountants, and found a movement toward
a more negative stereotype.
Accountants and auditors who have not performed their roles effectively are seen as responsible for
the failures and inaccuracies that have led to the decline in credibility. The view is that the accounting
profession did not fulfil its service ideal role as it did not prevent these situations by giving appropriate
advice to managers and/or making appropriate disclosures.
Following the many corporate collapses of the late 1980s, the market collapse of October 1987 (Black
Monday), the corporate collapses in the early 2000s and the GFC in 2008 and 2009, many efforts were
made to make accounting standards more consistent — and these efforts continue today.

KEY ISSUES CAUSING REDUCED CREDIBILITY

Other core problems affecting the credibility of the profession are outlined next. These were highlighted
during the corporate failures of the early 2000s as well as during the GFC.

Earnings Management
Earnings management refers to the use of accounting techniques to manipulate the final profit and earnings
figures. It can be achieved via the manipulation of reserves, accounting policy changes that are not
reflective of the organisation’s position, and other changes permitted under the accounting standards, such
as the choice of valuation method.
A powerful example of the social impact of accounting is shown by looking at how assets are depreciated.
People who are not familiar with accounting may see depreciation as a technically accurate adjustment to
reflect the decline in value of non-current assets. However, in reality, there is a broad scope for choice
in depreciation methods, and these choices impact the results an entity reports to it owners, the financial
markets and the community at large.
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 The way an asset is depreciated, and the length of time over which the depreciation is spread (referred to
as the useful life of an asset), will have an impact on several key indicators that users of financial statements
focus on, including reported profits and asset balances, and, therefore, remuneration and bonus plans that
are linked to profits or return on investment. It is also important to remember that the financial results of
prominent entities are frequently reported in the media. Therefore, any choice made about depreciation
methods that does not accurately reflect a realistic decline in value of the company’s assets, and results in
an unrealistic increase in profits, may attract additional scrutiny.
Higher levels of depreciation
Higher levels of depreciation can have the following impacts.
• In the short term, higher depreciation levels will mean lower profits and lower asset levels.
• In the longer term, there will be a rise in profits with lower asset levels. This may lead to a lower
measurement base for a manager against which future performance is measured — this will show a
greater percentage improvement and is likely to lead to higher long-term bonuses. Lower asset levels
will also lead to a higher return on assets.
• Lenders may be nervous due to lower profit levels and asset values that may be used as security.
Consequently, senior accountants in companies may need to explain the financial results to financiers.
This may necessitate renegotiation of loan agreements based on financial statement figures.
• Owners with a short-term focus may be frustrated by lower profits and consider selling their investment.
This may lead to a decline in the share price.
Lower levels of depreciation
Lower levels of depreciation can have the following impacts.
• Lower depreciation levels will lead to higher profits and higher asset levels, which may be the source
of short-term rewards for managers.
• Lenders and owners may have greater confidence levels in the organisation because of higher profits
and asset values.
• Lower levels of depreciation may reduce investments in assets in the future, as assets are assumed to
have a longer lifespan than they actually do. This may hinder the organisation’s competitiveness.
• When assets reach the end of their useful life and are scrapped or sold, there may be large write-offs if
the written-down value of the asset is higher than its disposal value.
From these points, we can conclude that the choice of depreciation method and residual life of the asset
is not a value-free or technical choice, but one that may have a significant impact on different people.
Because the different outcomes may have positive or negative effects, they have a social and behavioural
impact on accountants, managers and users of financial reports, including lenders, owners and the broader
community. This may create a situation where an accountant is pressured to report an artificial result or
does so out of self-interest.

Creative Accounting
‘Creative accounting’ means using the choices available to present information in ways that do not clearly
represent reality, and which provide a distorted and often favourable view of the organisation.
Many accounting issues from the 1980s remain unresolved, including practices such as capitalisation
of interest expenditure, financial instrument valuation and risk management, formation expenditure being
treated as an asset, mining exploration expenses regularly being capitalised and related party transactions.
The words of Chambers, writing in 1973, are still current:
If due to the optional accounting rules available to them, the company managers and directors are
able to conceal the drift (in financial position), shareholders and creditors will continue to support, and
support with new money, companies that are weaker than their accounts represent them to be (Chambers
1973, p. 166).

Chambers could just as easily have been writing about corporate collapses that took place in the 1980s,
the 2000s or about the valuation of sub-prime debt and complex financial instruments from 2007 to 2009.

Poor Audit Quality

Poor audit quality refers to the perceived inability of auditors to identify a company in distress prior
to collapse.
The GFC also saw auditors become subject to increased scrutiny (Durkin & Eyers 2009; Eyers 2009).
GFC corporate failures have demonstrated valuation failures especially in relation to financial instruments
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38 Ethics and Governance

and these valuation failures have raised questions about the role and value of auditing (Sikka 2009; Sikka,
Filling & Liew 2009; Woods et al. 2009).
In view of the massive financial bailouts of many prominent corporations around the globe, Sikka
observed that:
Many financial enterprises have sought state support within a short period of time of receiving unqualified
audit opinions. This raises questions about the value of company audits, auditor independence and
quality of audit work, economic incentives for good audits and the knowledge base of auditors (Sikka
2009, p. 868).

Lack of Auditor Independence

Another issue is lack of auditor independence, where conflicted auditors do not act in the public interest.
Sikka, Filling and Liew (2009), for example, expressed a perennial view of the basic auditing model, that
is, it is ‘flawed since it makes auditors financially dependent on companies’. Consequently, according to
Sikka’s view, auditors will not give objective independent professional judgements because their incomes
depend on the survival of the audit ‘target’. Example 2.13 in module 2, ‘Arthur Andersen’, explores this
issue in detail.

Financial Accounting Distortions

Accounting has played a role in triggering financial distress, especially with mark-to-market techniques
that reduce asset values, and may lead to breach of banking covenants or even default.
It has been proposed that the GFC was at least in part caused by ineffective accounting standards for
complex financial instruments. The role of risk, along with the failure of the various decision-makers to
understand risk and the true nature of ‘complex financial instruments’, has also been a key factor. The fact
that accounting standards did not help has been a matter of professional concern for accountants.
It is worth noting that IFAC commissioned a study in 2002 to look at the loss of credibility in financial
reporting and approaches to resolving the problem.
Critical matters that were identified in the study include:
• the payment of incentives that encourage the manipulation or misstatement of information
• lack of actual or perceived auditor independence
• lack of audit effectiveness both through lack of skill or deliberate action
• too much flexibility and loopholes in reporting practices (IFAC 2003).

QUESTION 1.13

Outline reasons why the four key issues identified by IFAC (2003) (listed previously) could reduce the
profession’s credibility. What strategies may be useful for reducing or eliminating these problems
in future?

Example 1.8 details a case in which a company auditor has successfully identified fraud in an
organisation’s financial records and reported the matter to the regulators.

EXAMPLE 1.8

Armistead Convicted for Accounting Fraud and Misleading an Auditor

Victorian accountant Wayne Allan Armistead was convicted and sentenced on charges related to
accounting fraud in the financial records of Calvary Health Care ACT Ltd by the ACT Magistrate’s Court
that resulted in a company recording a fake profit.
Mr Armistead pleaded guilty to two charges of causing false entries to be recorded in the financial
records of Calvary Health Care as well as providing false information to the company auditor.
The charges, which were laid by the Australian Securities and Investments Commission, related to
28 false entries that were made in the accounts of the company that resulted in the misstatement of
revenue for the financial statements in the 2012–2013 and 2013–2014 financial years.
Mr Armistead also provided information about the company to the company auditor between 30 July
2014 and 1 August 2014 that he knew was false.
The fiddling of the company books by Mr Armistead resulted in the company reporting ‘earnings of
$1.925 million in the 30 June 2014 financial report’, a media release issued by the Australian Securities
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MODULE 1 Accounting and Society 39

 and Investments Commission said. ‘Once the entries were readjusted to reflect the true financial position,
Calvary Health Care ACT Ltd reported a loss of $9.451 million.’
Mr Armistead was sentenced to a $1000 good behaviour bond for two years and fined $3000 for the
making of false entries into the company accounts. He also copped a further good behaviour bond for
two years and was fined $2000 for lying to the company auditor about the accounts.
The corporate regulator had Mr Armistead’s behaviour brought to their attention by the company auditor
and the matter was prosecuted by the Commonwealth Department of Public Prosecutions.
Source: Quotes from ASIC 2019c, ‘Former chief financial officer convicted of causing false records and providing
false information to company auditor’, accessed August 2023, https://asic.gov.au/about-asic/news-centre/find-a-media-
release/2019-releases/19-037mr-former-chief-financial-officer-convicted-of-causing-false-records-and-providing-false-
information-to-company-auditor.

As we look at corporate failures over the last 40 years, it appears that too often the independence and
professional ethics of accountants failed. Instead, professionals left behind their standards in the hope of
becoming part of an economic revolution related to booming share market growth. Beginning with the
failures of 2001–2002 and continuing through to the recent confidentiality issues, the profession remains
under scrutiny.
The credibility of accounting as a profession of value has been very much ‘on the line’. Arguably, there
has been a diminution of public trust in the profession’s service ideal and a reduction in its former degree of
autonomy and independence. We now consider the response of the professions and government to restore
credibility to financial accounting, auditing and the accounting profession itself.

RESTORING CREDIBILITY TO ACCOUNTING

Pressure from governments, the investor community, professional accounting bodies and others have
resulted in a number of measures aimed at reducing the likelihood and severity of the corporate failures
that have occurred in recent times. Examples are given below.
• Establishment of the FRC. As detailed earlier, the AASB and the AUASB are no longer controlled only
by the professional accounting bodies. They are controlled by the FRC, a government body set up to
oversee the effectiveness of financial reporting.
• Accounting standards are backed by law. Accounting standards are externally created and enforced by
regulations, meaning non-compliance by a professional accountant can mean both disciplinary action
from their professional body and legal penalties.
• Auditors must apply the code of ethics. APES 110 also has legislative application to auditors.
• FRC responsible for auditor independence. The FRC now has direct responsibility for monitoring the
effectiveness of auditor independence. This reduction in autonomy is likely to lead to greater comfort in
the community and less opportunity for abuse by auditors. As a result, this change should help to restore
and maintain professional auditor credibility in the future.
• Enhanced regulation. Laws, regulations and guidance have also been developed globally, including the
Sarbanes–Oxley Act 2002 in the US, COSO 2004 and the extensive process leading to the CLERP 9
Act in Australia.
• Adoption of international standards. Since 2004, many countries have adopted, or are in the process of
adopting, common international standards on accounting, auditing and professional ethics.
• The reduction of the profession’s autonomy (in terms of setting its own rules and guidelines) is one
change that is leading to restored credibility, as externally enforced legislation and rules provides greater
protection and comfort to users of accounting information and society in general.
Individual accounting bodies, such as CPA Australia, have also been active with various initiatives
in support of improved financial reporting, enhanced auditing standards and more effective governance.
The Corporate Governance Council of the Australian Securities Exchange (ASX), the Organisation for
Economic Cooperation and Development (OECD) and the UK Financial Reporting Council have also
undertaken much work. These institutions and their work are covered in module 3.
To restore credibility the underlying problems must be identified, and practical measures put in place
to reduce or eliminate them. The measures described above aim to reduce the likelihood of past issues
being repeated.
If these aims are met, they will help alleviate society’s concerns and provide reassurance that these
issues will not happen again. Success will require the utmost application of all the relevant professional
capabilities that a professional accountant must possess.
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40 Ethics and Governance

1.13 CAPABILITY CONSIDERATIONS
So far, we have been discussing the broader accounting profession, what it means to be a professional
and the issues the profession has been facing. Professional accountants are expected to understand their
professional responsibilities and apply themselves diligently to achieve and maintain these standards. As
such, they have a role to play in improving the credibility of the profession, ensuring the public interest is
served, and making sure clients, employers and the broader community benefit from their skills, knowledge
and decision making.
The CPA Program is a large component of developing technical knowledge to attain professional status.
However, it is also important to develop a broader range of skills. The pathway to becoming a CPA
includes professional mentoring and achieving rigorous technical knowledge requirements, combined with
broader business knowledge and soft skills including communication and leadership. Managing oneself is
fundamental to successfully achieving professional status, and so personal effectiveness becomes another
foundation for a successful career.

BUSINESS LEADERSHIP CAPABILITIES

Professional accountants are well-placed to attain leadership roles within society. These leadership roles
may be as a partner in a professional practice, chief financial officer of a large enterprise or on the board
of a company or not-for-profit organisation.
Leaders are required to develop the strategy, drive change and align the organisation’s structure,
resources and culture with the strategy. Leadership requires vision, energy and drive from the professional
accountant, the desire to be strategic and to be a key contributor to the improvement and strategic growth
of the organisation. As business leaders, and as professionals, accountants must exercise a high degree of
competence and due care, and have a professional obligation to service ideals.
We discussed earlier that professional competence requires not only strong technical accounting skills,
knowledge and experience, but also the desire to actively enhance our professional expertise and insights
through the acquisition of diverse new skills, knowledge and experience. As the professional accountant
enhances their skills, knowledge and experience, they enhance what they can offer society, and in particular
their readiness to be leaders in society.
The skills, knowledge and experience of a professional accountant can be broken into the two key
categories of technical skills and soft skills. Both are vitally important, and it is a mistake to concentrate on
one at the expense of the other. Professional capabilities are not simply skills, knowledge nor experience
on their own. Rather, professional capabilities arise over a relatively long timeframe through the steady
accumulation of all the relevant skills, knowledge and experience. There is no clear definition of when we
become professional, but arguably an individual can be regarded as professional when that individual has
sufficient capabilities to make complex and difficult professional judgements and effectively advise others
in respect of those judgements.

TECHNICAL SKILLS, KNOWLEDGE AND EXPERIENCE

From your study and employment, you will have a good understanding of the technical skills, knowledge
and experience (TSKE) that relate to general accounting activities, including:
• financial reporting
• taxation
• finance and financial analysis
• management accounting
• relevant IT and technical communications knowledge
• an understanding of regulations, laws and company structures.
The degree of TSKE required varies according to the tasks being undertaken by the accountant. For
example, an accountant functioning as a company secretary (called ‘public officer’ in some jurisdictions)
for a publicly listed entity must have a strong awareness of financial reporting requirements and the local
stock exchange listing rules.
Some accountants will have TSKE regarding internal audit, external audit and forensic accounting.
Technical requirements will depend on the field of work and the level of detailed skills and knowledge
required.

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MODULE 1 Accounting and Society 41

SOFT SKILLS, KNOWLEDGE AND EXPERIENCE
CPAs must also possess extensive soft skills, knowledge and experience (SSKE). SSKE is primarily (some
might say is all) about people and related issues. More specifically, professional accountants need well-
developed social skills and capabilities, including the ability to:
• listen
• understand complex and difficult issues and their role in the decisions and information needs of others
• communicate effectively (both verbally and in writing)
• discuss and debate without hostility — a vital aspect of interpersonal skills
• persuade and convince based on logical and reasonable argument — another vital aspect of interpersonal
skills and an important part of leadership
• manage time
• meet deadlines
• build and improve capabilities.

TSKE AND SSKE — CAREER PERSPECTIVES

CPAs are subject to formal continuous professional development (CPD) learning requirements. CPA
Australia recognises both TSKE and SSKE activities as satisfying CPD requirements, acknowledging that
lifelong learning for both activities is vital for professional accountants.
Professional career progression, advancement and promotion within employment, along with higher
status in the profession (as a person becomes a CPA and then an FCPA), are all functions of demonstrated
improvement in TSKE and SSKE capabilities.
Staff from the University of North Carolina (Blanthorne, Bhamornsiri & Guinn 2005) reported that
TSKE are relatively more important in the early years of professional accountants’ actual careers but,
as time passes, and TSKE and SSKE improve and as some CPAs move to partnership (and/or senior
management) level, SSKE becomes relatively more important in career progression.
In fact, Blanthorne, Bhamornsiri and Guinn (2005) found that CPA firms, when selecting candidates for
early career promotions, regarded technical skills of candidates as the most important evaluation criterion
(ranked first on a list of six ranked appointment criteria). However, when seeking promotion later in their
careers (promotion to partnership level), the research found that technical skills moved to fifth place in the
six items.
Further, the ‘interpersonal’ soft skill moved from its previous third place (for early career appointments)
to first place, with leadership in second place and communication in third place for partner appointments.
This demonstrates that accountants need to have a strong foundation of technical skill, but that building
relationships, interacting with staff and clients, and leadership skills are required to further their careers.
.......................................................................................................................................................................................
CONSIDER THIS
Continuing professional development is a CPA Australia requirement. Search job advertisements for your ‘dream’
jobs or the next job you’d like to have in your career. Where and how might you acquire the soft skills required for
these jobs?

QUESTION 1.14

Reading 1.3, ‘How “soft skills” can boost your career’, was released in 2005 and is still relevant. It is
valuable in further discussing attributes of soft skills and how these can be important in successful
career development. You should study this now.

SUMMARY
Accountants operate in different sectors. They are relied upon by entities in the private, public and not-
for-profit sectors to provide advice on financial and compliance matters, but that is not the only work
accountants are either skilled at or capable of doing. IFAC has long recognised that there are different
streams to accounting. Through its Knowledge Gateway, IFAC provides extensive guidance on many topics
including audit and assurance, governance, sustainability and ethics.
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42 Ethics and Governance

 These roles place an inherent obligation on professional accountants to consider stakeholders affected
by their work. One example of this is the preparation of financial statements. There are many stakeholders
that may wish to use financial statements. For example, governments, regulators, shareholders, potential
investors, suppliers, creditors and analysts are all users of financial statements. It is important that financial
statements are prepared in accordance with acceptable standards so that they provide accurate and complete
information in an understandable format.
There are also legal obligations that require accountants to ensure that they act in the public interest rather
than self-interest. For example, there have been numerous instances of distress caused to clients when
accounting professionals acting as advisers put their financial self-interest before the future retirement
benefits being sought by a client. Accountants and other financial advisers are routinely the subject of
enforcement action as a result of regulators expressing concern about their conduct. This has the potential
to do damage to the profession as a whole. Indeed, failings in some areas of professional practice have led
to co-regulation of the accounting profession, whereby external regulation and oversight has been imposed.
During an accountant’s career, there is a clear pattern of growth in skills and knowledge. Early in careers
the focus is on technical skills and personal skills such as time management. Later in careers interpersonal
skills such as communication and negotiation need to be acquired as accountants increasingly interact with
clients and take on leadership roles.
The key points covered in this part, and the learning objectives they align to, are as follows.

KEY POINTS

1.3 Differentiate the roles, relationships and activities of accountants.

• The precise role and activities undertaken by an accountant are largely determined by their work
environment, which may be in public practice, in the private or business sector, in the public sector,
as financial advisers or in the not-for-profit sector.
• Accountants have professional relationships with employers, clients, regulators, employees and
peers. These relationships vary depending on the sector the accountant works in and the nature
of their role. For example, accountants in public companies will engage with management, boards
of directors, employees, investors and suppliers amongst others.
• In each instance, regardless of the specific roles, activities or relationships attached to an
accountant’s work, they are obliged to work in accordance with their code of ethics and other
professional and legal standards.
1.4 Evaluate the challenges faced by the accounting profession in the global context.
• Accounting is a global profession and bodies such as the International Federation of Accountants
have sought to develop and, through member organisations, promote implementation and compli-
ance with global guidance.
• There is a need to build and maintain the credibility of the profession through co-regulatory
processes.
• It is the role of IFAC to ensure that uniform guidance is developed in a range of elements of the
accounting discipline, so that the profession, across the world, has a base level of uniform guidance
on which to draw.
• Several factors, including lack of auditor independence and skill, incentives to misstate financial
information and too much flexibility in reporting practices, have resulted in a reduction of the
credibility in the accounting profession.
• Several strategies have been put forward to restore credibility. These include appointment of
auditors by an independent body and heavier penalties for non-compliance.
1.5 Explain the importance of soft and technical skills required of accountants.
• Accountants require a mix of technical, interpersonal and organisational skills.
• Early in an accountant’s career the focus is on technical skills.
• As an accountant’s career progresses, and they need to interact more with clients and may start to
manage staff, the development of interpersonal and organisational skills becomes more important.
• Interpersonal and organisational skills are often referred to as “soft skills” and cover areas such as
communication, persuasion, negotiation and leadership.
• Accountants continue to develop knowledge, skills and competencies throughout their working
lives through professional experience and continuing professional development activities.

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MODULE 1 Accounting and Society 43

REVIEW
This module explored what it means to be a professional accountant and the need to combine technical,
interpersonal and organisational skills with a commitment to the ethos and core values of the profession
in order to properly fulfil the demands and obligations of their role.
A recurring theme throughout this module has been the overarching obligation of the professional
accountant to put the public interest ahead of self-interest. This obligation guides the conduct of the
accounting profession in its work to provide useful information to support high-quality decision making.
Accountants must be capable of making professional ethical choices in complex circumstances that often
involve competing interests and degrees of uncertainty.
The accounting profession has been confronted with various challenges over the past few decades. This
module covered the responsibility that the accounting profession, in general, and professional accounting
organisations, in particular, have to respond to these challenges and ensure that society places value on and
benefits from the work of accounting professionals.
The core attributes of a profession represent and reflect both the value it creates and the way society
recognises this value. One core attribute is the privilege to self-regulate. CPA Australia has procedures
in place to ensure its members meet the required standards of professional conduct and the measures to
monitor and manage members’ conduct. Members can be subject to disciplinary action if allegations of
misconduct are proven against them and, in some cases, members may be struck off the membership
register. At present, accounting is co-regulatory, with external oversight imposed on the profession.
Professional accountants must be enquiring, innovative, measured and courageous in making ethically
sound, balanced professional judgements. To preserve the integrity of the profession and the trust of society,
acting in the public (rather than self) interest should be a fundamental goal of professional accountants.

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Westfield, M 2003, HIH: The inside story of Australia’s biggest corporate collapse, Wiley, Hoboken, New Jersey.
Wilensky, HL 1964, ‘The professionalisation of everyone?’, The American Journal of Sociology, vol. 70, no. 2, pp. 137–58.
Willmott, HC 1990, ‘Serving the public interest? A critical analysis of a professional claim’, in Cooper, DJ & Hopper, TM (eds),
Critical accounts, Macmillan, London.
Woods, M, Humphrey, C, Dowd, K & Liu, Y 2009, ‘Crunch time for bank audits? Questions of practice and the scope for
dialogue’, Managerial Auditing Journal, vol. 24, no. 2, pp. 114–34.

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MODULE 1 Accounting and Society 45

Pdf_Folio:46
MODULE 2

ETHICS
LEARNING OBJECTIVES

After completing this module, you should be able to:

2.1 explain the concept of professional and business ethics
2.2 discuss the key philosophical approaches to ethics and how these impact on the professional’s ethical
decision making
2.3 apply the Compiled APES 110 Code of Ethics for Professional Accountants (including Independence
Standards)
2.4 analyse and resolve ethical dilemmas in accounting
2.5 apply ethical decision-making models
2.6 discuss the impact of decision making and actions on society.

ASSUMED KNOWLEDGE

Candidates will have completed module 1.

LEARNING RESOURCES

• Compiled APES 110 Code of Ethics for Professional Accountants (including Independence Standards)
(APESB 2022), accessed August 2023, https://apesb.org.au/wp-content/uploads/2023/05/Compiled_APES_
110_Dec_2022.pdf
• APES 230 Financial Planning Services (APESB 2019), accessed August 2023, https://apesb.org.au/wp-
content/uploads/2021/01/APES_230_December_2019_web.pdf
• APES GN 40 Ethical Conflicts in the Workplace – Considerations for Members in Business (APESB 2020),
accessed August 2023, https://apesb.org.au/wp-content/uploads/2020/03/04032020054655_APES_GN_40
_Mar_2020.pdf
Candidates are not expected to print the entire Compiled APES 110 Code of Ethics for Professional Accountants
(including Independence Standards), although it may be helpful to print sections that are referenced and/or
discussed in the study guide. Unless specifically noted, only the content in the study guide is examinable. You
should, however, ensure that you download a copy of APES 110, APES 230 and APES GN 40 so that you can
refer to them during study.

PREVIEW
In module 1, we discussed what it means to be a professional accountant. We now extend this discussion to
examine the practical implications of professional ethics, based on the notions of the service ideal and the
public interest. Professional ethics extends beyond compliance with written codes and laws to also include
the ethical commitment of the professional person to act in the best interests of society.
Written codes and relevant rules establish the expectation and provide the principles for ethical
conduct. However, in practice many situations that involve ethical issues cannot be resolved by the simple
application of rules. Rather, the situation must be analysed from an ethics perspective to reach an ethical
decision. In this module, we discuss the notion of professional ethics and the analytical tools that guide
accountants and help them resolve ethical problems and dilemmas. These tools include a code of ethics
for professional accountants, philosophical theories of ethics and ethical decision-making frameworks.
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PART A: PROFESSIONAL ETHICS
INTRODUCTION
Ethics essentially deals with what is ‘right’ and ‘wrong’ and how people should act when faced with a
particular situation. The Chambers Dictionary defines ethics as ‘a code of behaviour considered correct’.
Professional ethics is the application of ethical principles or frameworks by professionals who have
an obligation to act in the interests of those who rely on their services as well as in the best interests
of the public. Ethical principles include integrity, objectivity, professional competence and due care,
confidentiality and professional behaviour. By acting ethically, professionals maintain the credibility of
the profession.
Any professional ethics framework adopted must be understood by members of the profession so that
it forms the basis for sound and consistent ethical behaviour. Later in this module, we will explore
Compiled APES 110 Code of Ethics for Professional Accountants (including Independence Standards)
(APES 110), the professional ethics framework issued by the Accounting Professional and Ethical
Standards Board (APESB 2022).
The ethical responsibilities of a professional accountant include:
• the exercise of reasonable skills and diligence
• adherence to a professional code of ethics and standards
• the cautious application of relevant knowledge and experience
• professional scepticism to ensure that any observed discrepancies are properly followed up and
investigated.
A professional accountant is objective, takes full responsibility for the tasks they are entrusted to do,
adopts proper planning and control procedures, and possesses the integrity to maintain a professional
approach to work.
.......................................................................................................................................................................................
CONSIDER THIS
Reflect on what you understand to be the meaning of ethics at this point of your reading in the module. Write a
note somewhere. Come back to it at the conclusion of the module to see whether you would change what you
have written.

2.1 IMPACT OF ETHICAL OR UNETHICAL DECISIONS

APES 110 (para. 200.2) outlines the role of members in business as:
Investors, creditors, employing organisations and other sectors of the business community, as well as
governments and the general public, might rely on the work of Members in Business. Members in Business
might be solely or jointly responsible for the preparation and reporting of financial and other information,
on which both their employing organisations and third parties might rely. They might also be responsible
for providing effective financial management and competent advice on a variety of business-related matters.

In many cases, the information provided will be the result of decisions that members make when
compiling or preparing the information.
The discussion of ethical issues is not a theoretical pursuit. Decisions have an effect on others and
ourselves, and can be beneficial or may cause significant harm. For example, ethical reporting of a poor
financial position may lead to the failure of an organisation. Stakeholders may lose confidence in an
organisation. Jobs may be lost. Creditors and suppliers may lose monies owed to them as a result of an
entity trading when it should have ceased plunging itself further into debt. Despite this, ethical action is
still desirable as it is likely to limit losses and lead to faster resolution of issues. It also respects the rights of
all stakeholders involved to know the true state of affairs, despite the negative outcomes for stakeholders.
Consider the role played by incentive payments for advisers encouraged to sell more financial products
to customers. Some advisers sold products they knew were unsuitable for clients or generated fraudulent
documents in order to get commissions. Customers later complained because the cost of poor adviser
behaviour was financial hardship for the customer and also the financial institution. There were, for
example, financial advisers who lost their jobs and regulatory registration because they failed to behave
ethically while trying to meet performance criteria set by their institutions. The behaviour of individual
or groups of advisers, which was outlined in detail during the royal commission into the financial
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48 Ethics and Governance

services sector, led to banks establishing remediation schemes to compensate customers for lost funds and
financial distress.
Another example of the way in which some entities behave that impacts on the broader community
is the failure of companies to report correctly in accordance with accounting standards. The Australian
Securities and Investments Commission (ASIC) conducts financial reporting surveillance and seeks
financial statement amendments from entities that failed to properly apply a particular accounting standard.
Accounting standards exist as a generally accepted set of principles for the preparation and presentation
of financial statements. Breaches of accounting standards result in a set of financial statements that a user,
irrespective of the stakeholder group to which they belong, may be misled. In circumstances where the
financial statements are relied on by an investor or other stakeholder, this can lead to incorrect judgements
being made about the governance of the entity or poor decisions about continuing investment in a business.
The regulator is empowered to request correction of the financial statements and, at times, court action can
be taken to penalise companies that have transgressed.
The impact of unethical decisions can be considered in relation to the whole profession and at the
individual level as well. The two levels are connected because the ethical failings of individual accountants
(who may suffer personal consequences as a result) also affect the overall profession, which suffers reduced
credibility and increased restrictions on its ability to act autonomously and to self-regulate.
Decisions that are not in line with accounting professional ethical standards and legal obligations can
result in loss of membership, fines and even imprisonment. Therefore, it is important for professional
accountants to carefully assess decisions when faced with ethical choices to ensure the decisions they
make are satisfactory, both to other stakeholders and to themselves. Further examples are presented at the
end of this module.
A benefit of applying the frameworks that we will be describing in this module is that it helps us focus
not only on ourselves, but also on others who will be affected by our decisions. These frameworks can
guide the professional accountant to the most ethical decision, even when the most suitable option is not
readily apparent.
It is also appropriate to highlight the dilemma faced by managers who deal with the consequences of
unethical conduct by employees, contractors and others who are connected with the business. One model of
resolution that is worth noting was promoted by the late Doctor Rushworth Kidder, an ethicist (Christensen
1996). Doctor Kidder outlined a series of approaches to deal with ethical dilemmas in different parts of
life. These involved understanding that not all decisions by employers and others in authority relate to
things that are good or bad. The most challenging ethical dilemmas that a manager may face can be related
to deciding what to do when two outcomes can be deemed right. The Kidder approach is discussed in the
following section.

2.2 ETHICS — AN OVERVIEW

So far in this subject we have looked at a variety of activities and attributes that are relevant to professional
accountants. We have identified that accounting has an impact on society and that accountants are actively
involved in creating social outcomes and social change. To be professional, the activities of accountants
need to be pursued appropriately and, where deliberate social outcomes are intended, they must also be
pursued in an appropriate manner.
By what standard is appropriate behaviour to be measured? According to whose judgements or
assessments? Every individual is different and will form their own ethical assessment in a given situation.
However, ethics is subjective, cast from personal upbringing and experience and from personal views on
philosophies of life, religion and similar concepts.
Therefore, one person’s ethical code may judge an action to be ethical, but another’s may not. To get a
more definitive understanding of ethics, we need to delve further to contemplate ‘What exactly is ethics?’
and ‘How does ethics relate to professional ethics?’
Sociologist Raymond Baumhart conducted a survey of businesspeople in the early 1970s by asking them
‘What does ethics mean to you?’ Some of the responses he obtained were as follows.
• Ethics has to do with what my feelings tell me is right or wrong.
• Ethics has to do with my religious beliefs.
• Being ethical is doing what the law requires.
• Ethics consists of the standards of behaviour our society accepts (Baumhart, cited in Mitchell 2003,
p. 8).
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MODULE 2 Ethics 49
 However, simply equating ethics with feelings, religious beliefs, laws and social behaviour fails to
identify an important aspect of ethics, and further explanation is required. A systematic ethical process
is needed to create a coherent and consistent approach to resolving issues. Undertaking actions based
on one’s feelings of right or wrong may be a good approach in certain circumstances, but the absence
of any system or structure means that acting solely on emotion or ‘gut feel’ may be unconvincing and
inconsistent. We recommend using a systematic approach to resolve ethical issues. In this module, we
introduce structured approaches to resolving ethical issues that provide an alternative to a more instinctive
approach. It is beyond the scope of this module to discuss the differences and similarities of ‘ethics’ and
‘morals’. In many circumstances, the two terms can be used interchangeably. Examples of ethical or moral
behaviour that can be observed in everyday life include being honest or loyal, and being charitable to those
needing help. Honesty, loyalty and charity might be considered good characteristics to which people should
aspire, but they could also be seen as giving right to ethical behaviour.
If we define ethics as the principles or morals we use to determine right or wrong, then business ethics
may be defined as the principles stipulating what constitutes appropriate behaviour in a business context.
For example, an organisation might decide to donate to specific charities as part of doing business, allowing
it to contribute to the community it is part of. Over an extended period, charity-giving becomes part of the
corporate culture or ethic of the organisation. An example of honesty in a business context could be a
retailer selling a product that is in a workable condition and functions as advertised. A retailer that sells
goods that do not live up to advertised claims could be the subject of a complaint by the consumer for
breaching consumer rights through the Australian Competition and Consumer Commission (ACCC). The
ACCC educates both retailers and consumers about the rights and obligations that exist under the various
consumer guarantees. The regulator may investigate the conduct of a business and take enforcement action
if a business is found to have behaved inappropriately.
In contrast to business ethics, professional ethics refers to the ethics of a particular profession. You
will already be familiar with APES 110, which sets out the fundamental principles for the accounting
profession. That standard is an example of a statement of professional ethics.
Not all accountants will participate in ethical decision making at a strategic business level, but individual
accountants should be sufficiently agile in their thinking to be able to identify ethical dilemmas, including
those that will emerge from new technologies — for example, the use of artificial intelligence (AI) and
the collection of personal data online. Accountants may be required to provide their analysis and proposed
solutions to these developments to decision makers.
There is a difference between following laws and acting ethically. Just because you are complying with
the law does not mean you are acting ethically. This is shown in example 2.1, which examines the actions
of a company dealing with its asbestos liabilities.

EXAMPLE 2.1

James Hardie Industries NV

In February 2007, ASIC commenced civil penalty proceedings against a number of former directors of
James Hardie Industries Ltd (JHIL). This was in relation to disclosures by James Hardie in respect to the
adequacy of the funding of the Medical Research and Compensation Foundation (MRCF) for victims of
asbestos-related diseases (ASIC 2007).
Prior to ASIC commencing its proceedings, the Special Commission of Inquiry into the MRCF released a
report in September 2004. Commissioner Jackson QC raised serious issues about corporate governance
and disclosure, and particular concerns about potential breaches of the Corporations Act. In the Report
of the Special Commission (Jackson 2004), Commissioner Jackson stated:

There was no legal obligation for JHIL [emphasis in original] to provide greater funding to the
Foundation, but it was aware — indeed, very aware because it had made extensive efforts to
identify and target those who might be ‘stakeholders’, or were regarded as having influence with
‘stakeholders’ — that if it were perceived as not having made adequate provision for the future
asbestos liabilities of its former subsidiaries there would be a wave of adverse public opinion which
might well result in action being taken by the Commonwealth or State governments (on whom much
of the cost of such asbestos victims would be thrown) to legislate to make other companies in the
Group liable … (para. 1.8).

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50 Ethics and Governance

 The James Hardie Group has also indicated … (including that it is under no legal obligation to do so),
that it is prepared to fund the future asbestos liabilities. In my opinion it is right that it should do so
(para. 1.23).

Source: Extract from Jackson, DF 2004, ‘Report of the Special Commission of Inquiry into Medical Research and
Compensation Foundation’, September, accessed August 2023, www.dpc.nsw.gov.au/assets/dpc-nsw-gov-au/publications/
Medical-Research-and-Compensation-Foundation-listing-442/80be743ceb/Report-Part-A-Special-Commission-of-Inquiry-
into-the-Medical-Research-and-Compensation-Foundation.pdf. © State of New South Wales.

It is useful to consider the circumstances underlying the James Hardie case in the context of the work
of the late Dr Rushworth Kidder. Dr Kidder offered a different way of looking at ethical dilemmas in
circumstances where managers, parents and others struggled to identify the best course of action. The
Kidder philosophy identified four types of ethical dilemmas.
(1) Truth versus loyalty. You are a child. Your best friend has broken a window at school and has confessed
to you in confidence. The principal asks you if you know who did it. Do you tell the truth or evade the
question and remain loyal to your friend?
(2) Individual versus group. In wartime, a downed pilot is being hidden by the residents of a village
occupied by enemy soldiers. The soldiers will shoot one village resident every hour until the pilot
is surrendered. You are the mayor. Whose life do you save?
(3) Short-term versus long-term. You are a single parent with two small children. To qualify for a much
better position at work, you need an MBA which will require at least two years of classes and study on
nights and weekends. Where do you devote your time?
(4) Justice versus mercy. Your office manager confesses to you that she has been stealing money from the
office account to buy medicine for her ailing father. Her father has died, and she offers you a check
from the insurance proceeds to pay you back. After you cash the check, do you fire her or forgive her?
(Christensen 1996)

The categories put forward by Dr Kidder test what individuals believe is important in a specific situation.
These are not easy decisions. Consider the last category referring to the concept of ‘justice versus mercy’.
Terminating the employee for her conduct could be justified because the employee had been stealing funds
from the company, but is a more merciful approach, understanding the situation the employee was facing,
more appropriate here? Would the James Hardie case fall into the fourth category of justice versus mercy?
There was no obligation on the company to pay funds into a Foundation but is it right (morally correct)
that it did so?
.......................................................................................................................................................................................
CONSIDER THIS
Consider the four categories of ethical dilemma described by Dr Kidder and identify a situation in your professional
and personal life in which you have confronted similar challenges. Reflect on how the issue was resolved and whether
you believe it was resolved in an appropriate way.

2.3 ETHICAL CHALLENGES WITHIN THE

ACCOUNTING PROFESSION
Accountants face many difficult ethical situations. It is important to understand that ethical dilemmas
can arise throughout your daily professional life; they do not necessarily involve large-scale activities but
can be simple events or decisions that at first glance do not appear unusual. As accounting work often
involves decisions about money and other resources, people will often have strong motivations to act in
their own self-interest. This can lead to pressure on the accountant and may make it difficult to act in an
objective manner.
The current environment of continuous and rapid change, combined with the complexity of accounting
work, provides many challenges for accountants. This creates many types of pressures that are compounded
by the requirement to comply with deadlines. Such pressures may create the risk that integrity or
competence will be subordinated to expedience.

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MODULE 2 Ethics 51
ETHICAL CHALLENGES FACED BY MEMBERS IN PUBLIC
PRACTICE AND IN BUSINESS
Various surveys have been published in recent years asking accountants what they believed to be the most
frequent ethical issues they have confronted through work. The International Federation of Accountants
(IFAC) published the results of a survey of Australian practitioners conducted by Dr Cristina Neesham and
Associate Professor Eva Tsahuridu. The research team involved in this study, which was funded by a CPA
Australia, surveyed 238 accounting professionals that worked in either practice or business. The most
frequent ethical issue that practitioners in business or public practice encounter is misleading reporting
with 40.88 per cent of the sample citing this as a prominent ethical concern. Fraud and tax evasion are in
second place with 13.87 per cent of the sample highlighting this issue. Misuse of funds and insider trading
are encountered less frequently with 1.46 per cent of the sample reporting occurrences of both these types
of ethical challenges. These results are shown in figure 2.1.

FIGURE 2.1 Most frequent ethical issues encountered by accountants

Issue
Misleading reporting 40.88%
Fraud/ Tax evasion 13.87%
Lack of transparency in accounting decisions 11.68%
Breach of confidentiality 8.03%
Misrepresentation of expertise/Cheating 7.30%
Overcharge of fees to client/Overservicing 6.57%
Bribery 4.38%
Favouritism or bias 2.19%
Cover-up of accounting errors 2.19%
Misuse of funds 1.46%
Insider trading 1.46%

0% 5% 10% 15% 20% 25% 30% 35% 40% 45%

Source: Neesham, C & Tsahuridu, E 2018, ‘Assessing and improving professional accountants’ ethical capability’, IFAC,
accessed August 2023, www.ifac.org/knowledge-gateway/building-trust-ethics/discussion/assessing-and-improving-professional-
accountants-ethical-capability.

The research identified three key reasons why misconduct occurred within organisations, as shown in
figure 2.2. These were: pressures from clients (21.43 per cent), conflicts of interest (18.91 per cent) and
pressure from corporate management or a board of directors (17.65 per cent).

FIGURE 2.2 Reasons for misconduct

Cause
Pressure from client 21.43%
Conflict of interests 18.91%

Pressure from management /board 17.65%

Other/Not stated 42.02%

0% 5% 10% 15% 20% 25% 30% 35% 40% 45%

Source: Neesham, C & Tsahuridu, E 2018, ‘Assessing and improving professional accountants’ ethical capability’, IFAC,
accessed August 2023, www.ifac.org/knowledge-gateway/building-trust-ethics/discussion/assessing-and-improving-professional-
accountants-ethical-capability.

The survey results detailed the most frequent responses of accountants to situations in which they
encounter ethical challenges. As shown in figure 2.3, accountants who report resisting pressure or saying
‘no’ made up 29.66 per cent of the sample surveyed. Other strategies included the seeking of advice
(16.35 per cent), educating fellow professionals (14.07 per cent) and educating clients (11.79 per cent).
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52 Ethics and Governance

 FIGURE 2.3 Accountants’ responses to ethical challenges

Action

Resisted pressure/Said ‘no’ 29.66%

Sought advice 16.35%

Educated fellow professionals 14.07%

Educated client 11.79%

Reported issue to management 11.79%

Documented events in writing 10.27%
Resigned 3.80%
Admitted mistake 1.52%
Compromised within legal limits 0.76%

0% 5% 10% 15% 20% 25% 30% 35% 40% 45%

Source: Neesham, C & Tsahuridu, E 2018, ‘Assessing and improving professional accountants’ ethical capability’, IFAC,
accessed August 2023, www.ifac.org/knowledge-gateway/building-trust-ethics/discussion/assessing-and-improving-professional-
accountants-ethical-capability.

The research provides evidence that accountants encounter ethical challenges on a daily basis and an
examination of ethical and philosophical issues is not merely an academic exercise. Professionals must
ensure that they behave in a manner that is appropriate, irrespective of the context in which they work.
.......................................................................................................................................................................................
CONSIDER THIS
Read the article in which the preceding survey results are published (www.ifac.org/global-knowledge-gateway/ethics/
discussion/assessing-and-improving-professional-accountants-ethical). Reflect on any other issues you feel are of
interest or that provoke further thought on your part.

Contemporary Ethical Challenges

New ways of doing business bring fresh circumstances in which the application of ethics must be considered.
Emerging technological advances such as artificial intelligence (AI) create a series of ethical questions for
accountants. How reliant should an individual or entity be on AI? How can you ensure that AI outputs
are accurate and free from bias, comply with relevant laws and regulations, and have not plagiarised other
sources? AI also poses new questions for auditors and the experts they use on their engagements with clients
that use AI. For example, does a staff member review, in detail, what is produced by AI? Does the information
produced with AI faithfully represent the financial performance and financial position of the client?
Ethical concerns are also becoming more prominent in relation to sustainability. Compliance with new
standards issued by the International Sustainability Standards Board will be of especial concern, as will
the quality of the disclosures provided by entities. Legally complying with a disclosure requirement is one
consideration, but there is also the question of whether the substance of a disclosure is in fact meaningful
for the users for which a report is intended. ‘Greenwashing’ is another sustainability issue that corporate
regulators such as ASIC are acting against. Greenwashing occurs when organisations make misleading or
false claims about how environmentally conscious they are in order to attract investment from individual or
institutional ethical investors. Greenwashing poses a challenge for accountants in organisations that may
make exaggerated claims of their environmental friendliness. How does a person in a reporting function
prevent a disclosure they know is misleading from being published? What, if any, mechanisms exist in
an entity to help whistleblowers make reports about inaccurate information being planned for market
release? Greenwashing is also an issue for the providers of audit and assurance services. What skills must
an engagement team have in order to be able to test management claims related to climate impacts intended
for publication? It is useful for accountants to remember that each action has a range of consequences for
people in the reporting ecosystem.
.......................................................................................................................................................................................
CONSIDER THIS
Read the IFAC publication Ethics Considerations in Sustainability Reporting (www.ifac.org/_flysystem/azure-private
/publications/files/Ethics-Considerations-in-Sustainability-Reporting-Greenwashing.pdf), and reflect on the authors’
key concerns about greenwashing.
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MODULE 2 Ethics 53
 Examples 2.2 and 2.3 illustrate various situations encountered by professional accountants that highlight
the complexity of conflicts and choices that accountants face daily in their professional lives.

QUESTION 2.1

Read examples 2.2 and 2.3 and complete the following.

(a) Briefly summarise the ethical dilemmas that Gil and Jane face.
(b) For each of these dilemmas, state which of Kidder’s four categories summarises the problem.
(c) Describe two courses of action that each accountant may take.

EXAMPLE 2.2

Keep on Trucking
An entrepreneurial spirit, Jack Davis had moved out of his parents’ home at the age of 20, and into their
garage. He had successfully lobbied the local council to have the garage re-designated as a subplot of
his parents’ house, and hence a separate address: ‘303a’. As the area had mixed zoning, Jack began to
start a number of businesses. A voracious consumer of social media and online material, he was quick to
know what businesses might become fashionable, and set about creating low-cost start-ups, gathering
the requisite rights, and then selling them on.
Having gained sufficient capital in these ventures, Jack began his own ‘bricks and mortar’ business,
a Texas BBQ restaurant that would be delivered solely via food trucks. He refitted the unzoned ‘303a’
address as a smokehouse kitchen and bought two ageing trucks. Running a comprehensive social media
promotion for the business, Jack soon attracted investment, and decided to grow the business and seek
partnerships. Gil White, a friend who had recently completed his CPA, bought one of three 20 per cent
stakes in the business and took over finance and accounting for the business.
Over the next six months the business expanded; Jack and Gil bought and refitted three more trucks
and took on several employees. At the end of this period, Jack prepared a memorandum for the partners,
recommending that they sell the business, as interest was high and they could probably net a considerable
profit. Gil was a little surprised, as the business seemed to be growing healthily. He asked Jack if it was
the best time to sell, and whether perhaps they should hang on to the business for another year or so.
Jack revealed that he’d heard rumours that there were plans to restrict the movements of food trucks,
heavily pushed by local restaurant owners who were feeling the pinch of the competition. This would likely
impact the company’s viability in its expanded state. Gil realised that Jack was probably right, and that
exiting the business was the prudent move. Jack asked Gil to prepare the projected estimates in order to
begin the process of courting buyers. Gil pointed out that the estimates would depend heavily on whether
the council restricted food truck operations. Jack asked Gil to make no mention of the council plans, as
nothing was yet official, and few people were aware of the rumours. Jack had been closely monitoring local
government planning since having the garage re-designated. Furthermore, if they projected a downturn
in revenue then they would likely make a severe loss on the sale.

EXAMPLE 2.3

Sustainable Distribution
Dwyer worked as an auditor for several companies, but one source of regular work was a timber
decking business, Sustainable Solutions, an intergenerational family business now managed by two high
school friends. Jane also worked as a personal accountant for the two managers. A married couple,
Joe and Debbie Frazer, ran the company together after Joe’s father had retired from the position, until
Debbie largely retired to raise their two children. After steadily growing the business over more than a
decade, Joe and Debbie separated due to growing marital difficulties. In the following year Joe decided
to significantly expand the business, proposing the acquisition of a second distribution centre and to
expand the company’s fleet of light trucks, and sought Jane’s assistance in signing off on the proposal.
Jane looked at Joe’s projected estimates and was not convinced. The proposal required significant
outlay on infrastructure, much of which would be borrowed against the value of the business. While
Sustainable Solutions maintained a constant client base, it was not clear that they could expand this
base proportionally to Joe’s proposed business expansion. Jane suspected that the move was intended to

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54 Ethics and Governance

 embed Sustainable Solution’s current revenue in the new venture for the foreseeable future. She suspected
that Joe probably feared that a divorce may be imminent, involving a subsequent division of assets. By
taking on this debt, Joe could probably delay any division of revenue or company assets with Debbie.
Jane felt she had a duty to Debbie as much as Joe.

SUMMARY
The decisions made by professional accountants have consequences for themselves, the profession and
society. In this part of the module, we have described professional ethics as the application of ethical
principles and frameworks by professionals to guide their own behaviours. Ethical decisions are those
that support the overall objective of serving the interests of society. Unethical decisions undermine
the credibility of the entire profession and increase the likelihood that external regulators will impose
restrictions on the profession’s ability to act autonomously and self-regulate. For individuals engaging
in unethical conduct, consequences can include fines, loss of membership of the professional accounting
body and even imprisonment.
A career in the accounting profession will inevitably involve dealing with many ethical issues. Key
sources of pressure to act contrary to professional ethics include clients, corporate management (e.g. the
board of directors) and conflicts of interest. The most frequently encountered ethical issues revolve around
misleading reporting, fraud, tax evasion, lack of transparency and breaches of confidentiality.
Mere compliance with legal requirements does not ensure ethical behaviour. The use of a set of principles
provides the accountant with a clear and coherent basis for thoughts and actions, and a decision-making
framework guides the accountant to an ethical decision, even when uncertainty and conflicting interests
are involved.
To help with this, the next section provides a detailed overview of ethical theories, which is followed by
a practical examination of APES 110.
While some of this discussion is quite theoretical, it is important for you to develop a clear philosophy
and understand your own ethical thoughts and approaches. You should consider each theory carefully and
identify which most closely aligns with your own view of what is ethical.
The key points covered in this part, and the learning objectives they align to, are as follows.

KEY POINTS

2.1 Explain the concept of professional and business ethics.

• Professional ethics is the use of principles and frameworks to guide decisions and behaviours that
accord with the interests of clients and society and reflect the expectations of the profession.
• In the professional context, ethical principles include integrity, objectivity, professional competence
and due care, confidentiality and professional behaviour.
• Business ethics is the moral principles that guide business conduct in potentially controversial
areas, including insider trading, bribery, conflicts of interest and greenwashing.
• Decisions relating to ethics are often complex, involving conflicting interests and uncertainty.
• Research suggests people have varying personal definitions of ethics. Similarly, ethicists offer
different conceptions of ethics and what constitutes an ethical dilemma.
• A set of ethical principles provides a coherent and consistent basis for decisions and actions and
thus is more useful in the professional context than reliance on personal feelings, religious beliefs
or social norms.
• CPA Australia funded research that found that accountants regularly confront serious ethical issues
but have established strategies and actions to deal with them.
• Ethical challenges facing accountants include conflicts of interest and pressure from clients
and corporate management. The most frequently encountered ethical issues involve misleading
reporting, fraud, tax evasion, transparency and confidentiality.
• Contemporary ethical issues faced by accountants include the use of AI, ensuring sustainability
disclosures and reporting are understandable by users, and greenwashing.
2.6 Discuss the impact of decision making and actions on society.
• The decisions that accountants make and those that are made by others based on information
provided by accountants often have significant consequences for stakeholders.

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MODULE 2 Ethics 55
 • Ethical financial reporting provides all stakeholders with true information relating to an entity’s
financial position and performance, enabling stakeholders to make properly informed decisions.
• Unethical financial reporting misleads some stakeholders, leading to decisions different from those
that would be made with the true information.
• Both ethical and unethical reporting can have positive and negative consequences for various
stakeholders and the entity itself.
• Ethical financial advice puts the client’s interests ahead of the adviser’s interests. Unethical financial
advice may benefit the adviser at the expense of the client’s interests.
• Decision making by professional accountants that does not accord with the profession’s ethical
standards impacts negatively on the profession as a whole and on society’s trust in the profession.
This may result in increased external regulation.
• On an individual level, accountants that breach ethical standards may face penalties and lose their
membership of their accounting body.

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56 Ethics and Governance

PART B: ETHICAL THEORIES
INTRODUCTION
Theories are models constructed by thinkers that present one way of explaining certain kinds of phe-
nomenon. Ethics comes under the general category of theories known as philosophy. Some categorise
ethics as moral philosophy.
There are differences between the ways in which ethics are considered in Western and Eastern cultures.
The Western approach to ethical theory tends to orient itself around the objective of finding the truth in a
situation. Western ethical theories are predominantly discussed in this subject, but it is important to note
that cultural traditions, customs and religious beliefs may govern how people behave.
Eisenbeiss (2012) describes the different cultural traditions that must be considered when examining the
different principles and backgrounds that constitute Western and Eastern philosophies using the example
of leadership (see figure 2.4). Eisenbeiss states that Western theories in the area of ethics and leadership
have their historical roots in the work by ancient theorists or ethicists such as Plato and Aristotle. Eastern
traditions have their historical roots in Confucianism, which has an emphasis on social order, responsibility,
reverence for a family. More modern authors in the Western traditions of ethics and leadership are Kant,
Rawls and Jonas with Tagore being a more current philosopher in the Eastern tradition.
It should also be noted that religions play a large part in the way individuals and groups engage with each
other. Religions in the Western tradition that have shaped various aspects of thought include Christianity,
Judaism and Islam. Islam is classified as a Western religion by Robinson and Rodrigues (2006; cited in
Eisenbeiss 2012) because it has its origins in the Abrahamic tradition. Each of the Abrahamic faiths has
its own traditions.

FIGURE 2.4 Religious traditions

Western tradition Eastern tradition

Moral philosophy Ancient Modern Plato, Aristotle Confucianism

Kant, Rawls, Jonas Tagore

World religions Christianity, Judaism, lslama Buddhism, Hinduism, Sikhism,

Shinto, Daoism and Jainism
a Islam
is classified as a Western religion due to its Abrahamic roots but is predominantly practised in Northern Africa and Eastern
regions of the world (Robinson and Rodrigues 2006).
Source: Eisenbeiss, SA 2012, ‘Re-thinking ethical leadership: An interdisciplinary integrative approach’, The Leadership
Quarterly, vol. 23, no. 5, pp. 791–808. http://dx.doi.org/10.1016/j.leaqua.2012.03.001.

It is important to understand that there are other sources of ethical guidance, but that this part of
module 2 focuses on sources of Western ethical thought. In Western ethics, ethical theories are attempts to
either explain human behaviour as it is, which is called descriptive ethics, or provide a framework for how
people should behave, which is called normative ethics. One way of thinking about these approaches is
that any descriptive theory of ethical behaviour explains existing behaviour without necessarily seeking to
change it while normative ethical theories set norms for behaviour. In this course, the focus is on normative
theories of ethics.

2.4 NORMATIVE THEORIES

Ethical theories are, in some respects, similar to religious traditions and their texts, as mentioned
previously. Theories establish frameworks and prescribe ways in which certain challenges can be reflected
on and resolved. They may assist individuals and organisations to resolve ethical dilemmas. Different
theories of ethics are explored next.

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MODULE 2 Ethics 57
 Normative theories of ethics propose principles that distinguish right from wrong by establishing a
norm or standard of correct behaviour that should be followed at all times. The awareness and application
of such theories provide two key functions. First, they provide a framework for judging the rightness of an
act or decision after the event has occurred, and secondly, they provide a framework for decision making to
resolve ethical problems. Applying different ethical theories involves examining the situation or dilemma
from multiple perspectives.
Normative ethics are split into two specific categories: ethics of conduct and ethics of character.

ETHICS OF CHARACTER
Ethics of character is also called virtue ethics. This is an area of ethical theory that calls upon people to
examine the various traits of individuals in order to determine whether they have behaved in a manner that
is wrong, based on that particular assessment. It has its origins in the thinking put forward by theorists
such as Aristotle. We will examine ethics of character in further detail later in this part of the module.

ETHICS OF CONDUCT
Ethics of conduct can be split into two prominent categories: teleological (or consequential) and
deontological (or non-consequential or duty-based). These two categories and the types of theories that
are classified within these categories are discussed in the following sections, but the key schools of thought
may be briefly summarised as follows.
• Teleological theories centre around the need for individuals and groups to consider the consequences
of actions. The ends justify the means. Two major theories in this category take alternative perspectives
on the object of the consequences/benefits.
– Egoism: focuses on taking actions that result in the best consequences for the individual taking the
action/making the decision.
– Utilitarianism: focuses on taking actions/making decisions that will result in the greatest good for the
greatest number of people, including possibly, but not necessarily, the person making the decision.
• Deontological theories centre round the need for individuals and groups to consider the intent of actions.
Some actions will never be justified despite potentially positive consequences and conversely some
actions may be justified despite the potentially negative consequences. Two major theories in this
category take alternative perspectives on what constitutes appropriate intentions.
– Rights: focuses on taking actions that intend to recognise the rights of the parties involved
– Justice: focuses on taking actions that intend to be fair and equitable to the parties involved.
Figure 2.5 illustrates the theories that fit into these two categories and two other key areas of moral
philosophy (ethics) — descriptive ethics and ethics of character.

FIGURE 2.5 Theories of ethics

Normative ethics Descriptive ethics

Ethics of conduct Ethics of character

Teleological Deontological
(Consequential) (Non-consequential) Virtue ethics
theories theories

Egoism Utilitarianism Rights Justice

Source: CPA Australia 2023.

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58 Ethics and Governance

2.5 TELEOLOGICAL (CONSEQUENTIAL) THEORIES
Teleological theories determine right from wrong or good from bad, based solely on the results or
consequences of the decision or action. As teleological theories evaluate the impact of decisions or actions
on outcomes, they are termed ‘consequential’. Generally, if the benefits of a proposed action outweigh the
costs, the decision or action is considered ethically correct. Conversely, if the harms outweigh the benefits,
the decision or action is considered ethically wrong. The terms ‘benefits’ and ‘costs’, used for the purpose
of weighing up consequences, include both tangible and psychological outcomes. Benefits may therefore
include pleasure, health, life, satisfaction, knowledge and happiness. Likewise, costs may include pain,
sickness, death, dissatisfaction, ignorance and unhappiness.
.......................................................................................................................................................................................
CONSIDER THIS
From whose perspective should the consequences of a decision or action be evaluated? Do you think evaluation
should be based on the consequences for the decision maker or for those who are affected by the decision?

There is no correct answer to these questions. Rather, these different approaches are represented by two
traditional teleological theories: egoism and utilitarianism. In brief, egoism evaluates the rightness of
an action from the perspective of the decision maker (self) whereas utilitarianism evaluates the rightness
of an action based on consequences for others. Because each person is a product of a number of factors
including education, culture and background, different individuals may choose to apply these approaches
differently. Remember that these theories are conceptual approaches to how we ‘ought to’ behave, not how
we do behave. When it comes to making decisions, people are likely to make a decision based on a mix of
different types of ethical approaches, and their approach may also depend on the particular situation.

EGOISM
An ethical egoist approach describes the idea that it is right for a person to pursue an action in their own
self-interest, assuming that everyone else is entitled to act in their own self-interest as well. As stated
previously, this is an ethical theory so, in reality, people are more likely to have a mix of different ethical
approaches. In this respect, ethical egoism is different from psychological egoism, which describes how
people tend to behave, without implying an ethical judgement about how they should behave.
Ethical egoists evaluate the rightness of a proposed action by choosing a course of action that maximises
the net positive benefits to themselves. An example of egoism would be a company that only releases
information or clarifies issues when it is in the company’s self-interest for the information to be released.
Such companies display ethical egoism when they support this behaviour as an appropriate general rule.
Based on the assumption that human beings tend to act in a way that brings them some form of happiness
or avoids some form of unhappiness, ethical egoism contends that this reality should be accepted as a
social norm.
The term ‘happiness’ has a number of connotations, but the characteristics of happiness generally include
a feeling of joy or delight, satisfaction or peace of mind, and the sense of achieving one’s goals or desires.
Correspondingly, unhappiness may be defined as a feeling of pain or sadness, frustration and the sense of
failure in achieving one’s goals or desires. Although this module refers to an egoist as a single person, the
term ‘egoist’ can also refer to a group of people or an organisation.
One difficulty with egoism is that acts of self-interest are commonly misunderstood as acts of selfishness.
According to this view, egoists are people who demonstrate a lack of concern for the wellbeing of
others and will justify questionable acts such as discrimination or dishonesty if they promote self-interest.
However, self-interest may also include concern for the wellbeing of others, and can sometimes contradict
selfishness. We use the term enlightened self-interest precisely to highlight situations where acting
selfishly may not be in our own self-interest. Example 2.4 illustrates one such situation.

EXAMPLE 2.4

Egoism and Providing a Professional Opinion

Consider an accountant who is asked by a client for a professional opinion. Suppose that the opinion
would be to the detriment of the client, who has threatened to seek the services of another professional
accountant if the news is not favourable.
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 According to ethical egoism, the accountant should provide full and accurate advice and allow the client
to employ the professional adviser of their choosing. It is not in the accountant’s long-term interest, nor in
the interests of those who rely on their advice, to offer less than frank or full advice. Overall, the pursuit of
self-interest will generally promote one’s wellbeing, but selfishness tends to ignore the interests of others
when they ought not to be ignored. Therefore, ethical egoism contends that the pursuit of self-interest
should not knowingly come at the expense of one’s wellbeing or that of others.

Ethical egoism also contends that the pursuit of self-interest should be constrained by the law and the
conventions of fair play. Rules and legal systems exist to resolve conflict. It is, therefore, in the interests of
all parties to obey and accept the decision of arbitration systems because, without them, chaos will result.
Thus, self-interest is not allowed to function unbridled by the law or the dictates of what is considered fair
competition. We can refer to this as restricted egoism.
Restricted egoism can be seen as an ethically more acceptable form of egoism. It sanctions corporate
self-interest and encourages competition to the extent that it leads to the maximisation of utility and is in
the interests of society as a whole.

UTILITARIANISM
According to the utilitarian (or utility) principle, determining good from bad, or right from wrong, is an
act or decision that produces the greatest benefit or pleasure for the greatest number of people. Similarly, if
harm is inevitable, the right course of action is the one that minimises harm or pain to the greatest number
of people. Under utilitarianism, pleasure and pain may be both mental and physical. As noted in the earlier
example, one of the problems that may arise is that an action that generates great benefit for many people
may also come at the cost or harm to smaller minority groups. This dilemma is often faced by governments,
but is also faced by organisations, which often need to make decisions that may benefit most employees
but may also have a negative impact on a few employees.
The utilitarian principle is attractive because it is easy to understand and provides a systematic approach
to problem resolution. Applying this principle to judgement, decision making and problem solving is a
process that relies on five basic steps.
1. Identify and articulate the ethical problem(s).
2. Identify all available courses of action that will resolve the situation.
3. Determine the foreseeable costs and benefits (short and long term) associated with each option.
4. Compare and weigh the ratio of good and bad outcomes associated with each option.
5. Select the option that will produce the greatest benefit for the greatest number of people.
While the process is conceptually simple, in certain circumstances it may lead to very complex
calculations.
A utilitarian analysis should be distinguished from a cost–benefit analysis that is normally applied in
business decisions. A cost–benefit analysis in business is generally weighed up in economic terms and
only as it relates to the decision maker and the employing organisation. This is shown in example 2.5.

EXAMPLE 2.5

Cost–Benefit Analysis by Ford

In America, in the 1970s, the Ford Motor Company reacted to safety concerns regarding its Pinto car by
conducting a cost–benefit analysis to determine whether the company should fix the apparently unsafe
placement of the petrol tank. Ford decided not to repair the cars because its cost–benefit analysis revealed
that the cost of fixing the cars was higher than that of paying damages for death and injury arising from the
design fault. This is shown in table 2.1. Needless to say, Ford was ordered by the court to pay damages
for negligent behaviour. The cost of the damages order imposed by the court far exceeded the cost of
repairing the cars.

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60 Ethics and Governance

 TABLE 2.1 Ford Pinto cost–benefit analysis

Benefits

Savings 180 burn deaths, 180 serious burn injuries, 2100 burned vehicles

Unit $200 000 per death, $67 000 per injury, $700 per vehicle

Total benefit 180 × ($200 000) + 180 × ($67 000) + 2100 × ($700) = $49.5 million

Costs

Sales 11 million cars, 1.5 million light trucks

Unit cost $11 per car, $11 per truck

Total cost 11 000 000 × ($11) + 1 500 000 × ($11) = $137 million

Source: Hoffman, WM 1982, ‘The Ford Pinto’, Business ethics: Readings and cases in corporate morality, McGraw-Hill
Book Company, New York, pp. 412–20.

The application of the utilitarian principle considers the costs and benefits for all who are affected by the
proposed decision or action (not just the decision maker), and measures outcomes both in economic and
psychological terms. If executive management at the Ford Motor Company had undertaken a utilitarian
analysis, it may well have arrived at a different decision. Rather than a short-term and narrow economic
analysis of costs, management would have given due consideration to the safety concerns of its customers
as well as the long-term market reaction to a seemingly callous decision.
Utilitarian theory has a much wider application than that of the impact on the immediate group, or a
group whose interests are immediately identifiable, which is arguably an ethical judgement based on the
theory of egoism. Most importantly, however, the application of the utilitarian principle should not be
reduced to a simple economic cost–benefit analysis measured in dollars and cents.
Although it appears simple and widely applicable, utilitarianism is subject to four main limitations.
1. Measuring and assigning a numerical value to consequences is difficult and subjective, particularly
when dealing with non-economic outcomes. How should non-economic outcomes such as pleasure,
pain, health or improved personal rights be measured?
2. Identifying all stakeholders potentially affected by a decision or action and the ability to reliably predict
future outcomes is an uncertain and difficult process. Balancing risks against benefits is a perpetual
problem for which there is no easy solution. The risks include failing to identify the impact of any
decisions on all stakeholders and whether all consequences have been identified and examined.
3. Utilitarianism focuses on the results of proposed action and not the motivation, intention or character
of the action itself. Consequently, a questionable act may be justified on utilitarian grounds because it
brings greatest happiness to the majority, even if it disregards the minority that may also be affected by
the act. Therefore, it is concerned with total happiness and may ignore the individual or the minority,
and is indifferent to the distribution of benefits.
4. In business, utilitarian arguments are often relied on to justify a board’s decision to close down a loss-
making segment of the business so the entity can continue financially. That is, the benefit of maintaining
the entire business and its stakeholders outweighs ethical reasons to maintain the loss-making segment.
In this case, a utilitarian judgement may lead to terminating the services of employees in this segment.
Critics, however, contend that actions such as this ignore other factors (e.g. community interests or the
interests of the particular employees whose employment was discontinued).
The key differences between ethical egoism and utilitarianism are highlighted in table 2.2.

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 TABLE 2.2 Differences between ethical egoism and utilitarianism

Theory Ethical egoism (including restricted egoism) Utilitarianism

Type of theory Normative theory Normative theory

Proposes how one ought to behave. Proposes how one ought to behave.

Guiding principle Maximises net positive benefits to oneself. Maximises net positive benefits to the
greatest number of people.

Stakeholders Pursuit of self-interest should not come at the
expense of others.
Pursuit of happiness is constrained by
the law and the conventions of fair play
(restricted egoism).
Produces the best overall conse-
quences for everyone concerned.
Greatest happiness rule may come at
the expense of a minority.

Source: CPA Australia 2023.

QUESTION 2.2

A candidate in the CPA program is explaining to a friend the concept of utilitarianism. In doing
so, the candidate defines utilitarianism as ‘an action that provides me with the greatest amount of
measurable monetary rewards over costs’. Identify the problem(s) with this definition.

2.6 DEONTOLOGICAL THEORIES

We now turn our attention to the main deontological theories. In contrast to teleology, a deontologist asserts
that there are more important considerations than outcomes. In fact, it is the intention behind the act itself
that is more important than the results of the act. To do justice to the complexities of professional life, it
is important to acknowledge that ethical decisions may be evaluated using a variety of criteria, and that
giving priority to consequences is only one criterion among others.
According to German philosopher Immanuel Kant (1724–1804), persons of goodwill are motivated by
a sense of duty to do the right thing. Therefore, what is important to a deontologist is the intention to do
the ‘right thing’, or the motivation to behave in an appropriate manner in accordance with a sense of duty.
Take the example of telling a lie. Some look to the consequences that are likely to flow from telling a
lie (a consequential analysis), whereas a deontologist would argue that it is always wrong to lie, whatever
the outcome(s).
Deontology advocates that the motive is far more important than the action itself or its consequences.
Self-interest or emotion, rather than a sense of duty, are not appropriate motives for an ethical act. The
overriding value that guides duties, in Kant’s view, is respect for the human dignity of all involved.
Although the good consequences that result from an act may be the same regardless of its motive, it is
the desire to do the right thing for its own sake that makes it an ethical act and distinguishes it from an act
of selfishness. Therefore, actions are right, not because of their benefits but because of the nature of the
actions or the rules from which they derive.
There are two major concepts in relation to which duties may be examined: rights and justice.

RIGHTS
An ethical theory of rights contends that a good or correct decision is one that respects the rights of others.
Conversely, a decision is considered wrong if it violates the rights of a person or organisation.
A right is an entitlement that a person may have by virtue of a particular characteristic, role or condition
that defines them. For example, it is generally recognised that each person has a right to liberty, and
therefore no one should be enslaved.
While rights are not to be confused with duties or obligations, there is a close correlation between
a person’s rights and the duty or obligation of another not to interfere with or abuse these rights. In
accounting, a client can expect to have their right to confidentiality protected by their accountant, who
has a duty not to breach this right unless the need to serve the public interest supersedes it. A decision will
be considered ethical if the resulting actions do not offend the rights of anyone affected by that decision.
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Legal and Contractual Rights
Among the many types of rights that exist, legal rights are particularly important for the accounting
profession. Legal rights, namely those rights that are defined and enforced by the legal system, prescribe
both what people are entitled to and what duties others have to protect those entitlements. Contractual rights
(also called special rights) arise out of agreements and relationships between individuals. An accountant
has a contractual duty, for example, to provide professional services that the client has a contractual right
to receive (refer back to example 1.1: ‘A Costly Error’ in module 1 for an example of this right). To do
otherwise may demonstrate a wrongful act on the part of the accountant. There is also the need to consider
contractual rights and obligations that relate to general employment. Example 2.6 illustrates this situation.

EXAMPLE 2.6

Whistleblower Committed for Trial

The case of the whistleblower, former army lawyer David McBride, illustrates the tension between an
employment agreement where staff are obliged to keep matters confidential — effectively secret — and
the publicising or leaking of sensitive military information. The McBride leak manifested itself in the form
of a television report and a series of articles on the website of national broadcaster, the ABC. McBride
was committed for trial (set for November 2023 at the time of writing).
............................................................................................................................................................................
CONSIDER THIS
Read the article by Samantha Maiden in The New Daily online entitled ‘Whistleblower at centre of ABC raid
stands by Afghan leaks’ (https://thenewdaily.com.au/news/national/2019/06/05/abc-raid-david-mcbride).
Consider in your own mind what circumstances you believe give grounds for an employee, consultant or
employer to break the terms of a contract.

Human Rights
Human rights, on the other hand, are more fundamental to society and relationships, and are the key to
maintaining social order. They are natural rights that apply to all people simply because they are human
beings. Some commonly recognised human rights are the:
• right to life
• freedom of choice
• right to the truth
• right to privacy
• freedom of speech.
One limitation of the rights principle is its inability to address conflicting rights and obligations. What
should one do when respecting one person’s rights contravenes the rights of another? Which rights should
be given preference? In Western societies, the right to free speech is often considered a fundamental human
right that should be respected. But what if allowing one person to express their views brings harm to
another? An important weakness of the rights principle is that it provides little guidance on how to prioritise
among different rights. A solution to this problem may be examining the freedoms and interests at stake
and deciding which one of all those considered is more essential to human dignity.

JUSTICE
Under principles of justice, an ethical decision is one that produces: (1) the fairest process by which any
person in a particular situation should be treated by others (procedural justice); or (2) the fairest distribution
of benefits and burdens among members of a group or community (distributive justice). Therefore, justice
theory is concerned with issues of fairness and equality.
Considering distributive justice, while it is generally unethical or unjust to have an unfair distribution
of benefits and burdens, there are different ways of deciding on what basis a fair distribution should
be conducted.
• Should each person receive an equal share? (equality principle)
• Should each person be rewarded for their individual effort or ability? (merit principle)
• Should each person receive a share based on need rather than ability? (needs principle)
Example 2.7 highlights an issue concerned with the principles of justice.
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 EXAMPLE 2.7

Equality
Ravi and Delfina perform the same job functions to the same level. Distributive justice then commands that
they should receive equal benefits. Injustice occurs when Ravi receives more benefit because of irrelevant
concerns such as gender or race. However, if Ravi is more talented and works harder, the justice principle
dictates that Ravi should receive more. Therefore, justice is a function of contributions and rewards.
This example highlights a significant justice issue that exists in relation to the gender gap, where men
often receive higher wages than women for equivalent roles.

The principle of equality can be discussed in significantly different ways. Aristotle argued that fairness
does not mean treating everyone the same but acknowledging individual differences and allocating
resources to reflect these differences. In applying his account of fairness to workers with disabilities,
for example, treating equals equally and treating those who are unequal differently or unequally requires
that special provisions should be made for disabled workers to access and enjoy the use of workplace
facilities just as others do. Another qualified approach to equality is the difference principle (Rawls 1971),
which allows for unequal distribution of resources only in circumstances where this distribution works to
everyone’s advantage, including those placed in an inferior position by the inequality that results.
Irrespective of the nuances involved, according to the principle of distributive justice, an ethical decision
is one that results in a fair and equal distribution of benefits and burdens.

2.7 VIRTUE ETHICS

The previous discussion on normative theories of ethics described what a person should do based on either
consequences (teleology) or duty (deontology). Critics have challenged the notion of what one should
do according to principles of correct behaviour and argue that there is a more important issue, namely,
what people should be. If the guiding principle of right and wrong is external to the self, as is the case
with normative theories of ethics, then it lessens individual responsibility because it shifts the burden of
having to make decisions from oneself to an external authority — be it a community, a principle or an
abstract rule.
According to Melé (2005), determining what is right according to a set of duties or by systematically
analysing the consequences of an action may not motivate appropriate behaviour. Consistent ethical
behaviour is more likely to be the result of values such as integrity and good character. According to
this view, ethical character is seen to be more important than the right action. This branch of ethics is
known as ‘virtue ethics’. Its focus is to understand and develop virtues that make us better people.
Virtues may be defined as attitudes, dispositions or traits of character that enable us to do what is
ethically desirable, and which, through consistent practice, become habitual acts. Virtues (e.g. courage,
courtesy, compassion, generosity, fairness, fidelity, friendliness, honesty, integrity, prudence and self-
control) develop dispositions that favour ethical behaviour. Virtues are not natural or inborn but rather
they are developed through learning and practice.
Students acquire virtues or ethically ‘good’ habits by behaving ethically in context, much in the same
way as athletes or musicians gain the ability to perform. Through practice, students can learn to be
courageous and compassionate. Once they have been learned, these virtues are internalised and become
a character trait. Virtuous behaviour then becomes a natural reaction — usually referred to as ‘second
nature’. In other words, once acquired, virtues predispose us to act ethically.
The concept of virtue ethics is arguably more applicable to the role of professional accountants than
are the traditional normative theories of ethics. The responsibilities and expectations of a professional
accountant and the principles of professional conduct are outlined in APES 110.
Principles of professional conduct such as integrity, objectivity and competence (as outlined in
APES 110) are not unlike the virtues described above. Doucet and Ruland (1994), for instance, identify
three virtues of particular relevance for accountants, which are necessary to enable them to fulfil their
professional responsibilities. These are expertise, courage and integrity:
In essence to have expertise means that the accountant knows what the rules and principles are … Courage
is necessary to resist client or competitive pressures … Integrity entails the disposition to do the right and
just action without regard to personal gain or advantage (Doucet & Ruland 1994).
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 A limitation of virtue ethics is that it does not always provide guidance when a person is faced with a
genuine ethical dilemma. Unlike traditional theories of ethics that emphasise a ‘right’ action, virtue ethics
emphasises the personal attributes that an ethical person should possess. However, it does not necessarily
make clear what one should do in a specific conflict situation.

MORAL AGENCY
A moral agent is a decision maker who has the ability to make moral judgements based on some notion of
right and wrong and is held accountable for these actions. Accountants are a class of professional that may
be regarded as being moral agents. They have a framework of ethics and are trained in the requirements
of their profession. They are capable of being held accountable for their actions and are less likely to be
able to claim that they lack an understanding or avoid responsibility.
Consider the various areas of guidance accountants use in everyday practice. Accountants understand
that financial statements are meant to be prepared in accordance with accounting standards. There is no
manner in which an accountant can claim to not know that accounting standards should apply. Auditors
know that auditing standards should be applied in the engagements they undertake. Accountants who are
liquidators also understand that there are legal and regulatory constraints on what they are able to do in
the circumstances of an administration or receivership. The theory of moral agency should lead a person
applying it to conclude that each practitioner in each of these areas is in a position to understand their
obligations under ethical and legal frameworks and do what is regarded as the right thing.
This theory of moral agency is applied in practice by professional accounting bodies such as CPA
Australia through the enforcement of disciplinary processes and guidelines, particularly in circumstances
where the practitioner knows or should know the technical and legal frameworks under which they are
conducting work for a client or an employer.

QUESTION 2.3

Refer back to examples 2.2 and 2.3. Jack and Jane are each acting from a particular ethical
perspective. For each, identify the ethical theory that they as moral agents could use to justify
their actions.

SUMMARY
We have now considered a broad range of ethical viewpoints, from those that focus on self-interest to those
that are linked to intention and motivation rather than outcomes.
From this discussion you should be aware that two people may come to very different answers about
what is ethical in a particular situation. You should also have a clearer understanding of your own ethical
philosophy. It is also useful to understand how other people may be making their decisions.
In the next section, we move away from the theoretical aspects of ethics to review APES 110, which
outlines the ethical principles guiding the behaviour of professional accountants.
The key points covered in this part, and the learning objective they align to, are as follows.

KEY POINTS

2.2 Discuss the key philosophical approaches to ethics and how these impact on the professional’s
ethical decision making.
• Normative theories set down principles that establish a norm for behaviour. These theories provide
a framework for judging right from wrong or good from bad.
• There are two categories of normative theories: teleological (or consequential) and deontological
(or duty based).
• Two theories in the teleological category are egoism and utilitarianism.
• Egoism has at the centre of its ethical approach that a person is right to pursue actions in their own
self-interest.

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MODULE 2 Ethics 65
 • Utilitarianism is a theory that gives primacy to actions which serve the greater good of a majority of
people, even though a minority may be adversely affected by decisions.
• Deontological theories are duty based, and a central theorist in the deontological school of thought
is Kant. Two key theories in the deontological category are rights and justice.
• Virtue ethics, another ethical theory, comes from the tradition of Aristotle and centres around how
a person should be rather than what a person should do.
• Each of these philosophical standpoints is a way of viewing problems people confront each day.
Each philosophical approach offers a different perspective about how people should deal with
dilemmas. Professional ethics are built on principles that are drawn from general ethical theories.
• Professional accountants, in their role as moral agents, may use any one of these ethical theories
when making decisions involving ethical dilemmas, and be held accountable for their decisions.

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66 Ethics and Governance

PART C: COMPILED APES 110 CODE OF
ETHICS FOR PROFESSIONAL
ACCOUNTANTS (INCLUDING
INDEPENDENCE STANDARDS)
INTRODUCTION
In this section, we discuss the Compiled APES 110 Code of Ethics for Professional Accountants (including
Independence Standards) (APESB 2022). It is referred to as the Compiled APES 110 because it includes
amendments that have been made to the standard over time. It may also be referred to as APES 110,
the APESB Code of Ethics or ‘the Code’. The most recently issued version of the APESB Code of Ethics
can be found on the APESB website (https://apesb.org.au/wp-content/uploads/2023/05/Compiled_APES_
110_Dec_2022.pdf).
Candidates are not expected to print out the entire APESB Code of Ethics, although it may be helpful
to print sections that are referenced and/or discussed in the study guide. Unless specifically noted, only
the content in the study guide is examinable. You should, however, ensure that you download a copy of
the Code of Ethics so that you can refer to it during study.
The International Ethics Standards Board for Accountants (IESBA) develops and issues the
International Code of Ethics for Professional Accountants (including International Independence
Standards). CPA Australia is a member body of IFAC and, as such, cannot apply less stringent standards
than those stated in the IESBA Code.
APESB, which issues the ethical and professional standards for CPA Australia, released the APESB
Code of Ethics, which incorporates the IESBA Code and was initially operative from 1 July 2006. The
current version of the APESB Code of Ethics was compiled in December 2022. Australian-specific ethical
requirements that have been inserted into the APESB Code of Ethics are denoted with an ‘AUST’ prefix.
It is important to be aware of the hierarchy of ethical pronouncements issued by APESB. Figure 2.6
illustrates the hierarchy, which is has at its apex the Code of Ethics that is supported by standards covering
specific topics, and guidance notes. The Code sets down the foundation principles on which other APESB
guidance is based.
Under paragraph R1.2 of the APESB Code of Ethics, ‘all Members in Australia shall comply
with APES 110 including when providing Professional Services in an honorary capacity’. Under
paragraph R1.3 of the Code, ‘all Members practising outside of Australia shall comply with
APES 110 to the extent to which they are not prevented from so doing by specific requirements of
local laws and/or regulations’. CPA Australia members must comply with the APESB Code of Ethics.
The APESB Code of Ethics expresses the distinguishing mark of the accounting profession, which
is its acceptance of the responsibility to act in the public interest. The Code highlights the fundamental
principles that apply to all aspects of a professional accountant’s work, and also provides guidance for
resolving conflicts of interest and other ethical situations that may arise from time to time.
To further clarify what it means to act in the public interest and, more explicitly, to outline the
members’ obligations that stem from this responsibility, the ‘Responding to Non-Compliance with Laws
and Regulations’ (NOCLAR) requirements were added in the APESB Code of Ethics in May 2017 and
became effective on 1 January 2018. NOCLAR allows members to report to an appropriate authority
an actual or suspected non-compliance with laws and regulations by a client or employer, when such a
disclosure is in the public interest, without breaching the duty of confidentiality. It provides proportional
requirements for members to follow depending on the professional activity or service they provide,
and clarifies that withdrawing from the engagement and professional relationship or resigning from
the employing organisation are not substitutes for the other actions that are required under NOCLAR.
Provisions related to NOCLAR are discussed further in this section.
By joining a profession, members agree to uphold its high ethical standards. The proper fulfilment of
the role of an accountant involves discharging one’s professional work responsibilities while ensuring
compliance with all the obligations included in the Code.

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MODULE 2 Ethics 67
 FIGURE 2.6 Applicability of APESB pronouncements

Due process and working procedures

Compiled APES 110: Code of Ethics for

Professional Accountants
(including Independence
Standards)

APESB Standards
Conceptual Framework Members in All Members Members
• Principles based Public Practice in Business
• Mandatory for professional accountants
APES 300 APES 400
Standards series series
• Introduces principles
• Mandatory requirements in bold-type
APES 200
• Guidance and/or explanation in regular type
Series
Guidance notes
Guidance notes
• Do not introduce new principles
• Guidance on a specific matter on which Members in All Members Members
the principles are already stated in Public Practice in Business
a Standard
• Guidance is only in regular type
APES GN 30 APES GN 40
series series

APES GN 20
Series

Source: APESB 2022, Compiled APES 110 Code of Ethics for Professional Accountants (including Independence Standards),
APESB, Melbourne, accessed August 2023, https://apesb.org.au/wp-content/uploads/2023/05/Compiled_APES_110_Dec_2022.pdf.

2.8 THE PUBLIC INTEREST — ETHICS IN PRACTICE

A distinguishing feature of a profession is its commitment to promote and preserve the public interest even
if it comes at the expense of its members’, and its own self-interest. IFAC has defined public interest as
‘the sum of the benefits that citizens receive from the services provided by the accountancy profession,
incorporating the effects of all regulatory measures designed to ensure the quality and provision of such
services’ (IFAC 2010).
IFAC defines ‘interest’ as the ‘responsibilities that professional accountants have to society’. Examples
of these responsibilities include the following.
• Providing sound financial and business reporting to stakeholders, investors, and all parties in the
marketplace directly or indirectly impacted by that reporting;
• Facilitating the comparability of financial reporting and auditing across different jurisdictions;
• Requiring that accounting professionals apply high standards of ethical behaviour and professional
judgment;
• Specifying appropriate educational requirements and qualifications for professional accountants; and
• Providing professional accountants in business with the knowledge, judgment and means to con-
tribute to sound corporate governance and performance management for the organizations they serve
(IFAC 2010).

Safeguarding the public interest is an overriding responsibility that underpins all professional duties and
obligation. Members have a duty to a number of stakeholders, including clients, employers, shareholders
and the accounting community. For example, in preparing financial reports for a client, accountants have
a responsibility to the financial institutions from which client companies obtain finance. They also have a
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68 Ethics and Governance

responsibility to the client, who provides remuneration in return for diligent and competent service, and
to shareholders, who invest their trust in the external financial reports of the client company.
In cases where the accountant has obligations to more than one stakeholder, the question arises of to
whom the accountant owes their primary loyalty. In public practice, it is tempting to assume that the
accountant–client relationship is central to the function of accounting. In this view, no one else matters but
the client. Similarly, in the accountant–employer relationship, it may be presumed that accountants owe
their primary loyalty to their employers. Both views are incorrect.
The accountant’s primary duty is not to the client or the employer, but to the public. Therefore, emphasis
on the public interest extends to interests beyond the needs of an individual client or employer. In general,
it is assumed that the accountant is obligated to advance the interests of their client or employer, so long
as this does not conflict with the obligation to safeguard the public interest.
In addition to defining their obligations under the public interest, members of the accounting profession
must also understand what it means to serve the public interest. This encompasses the pursuit of excellence
for the benefit of others and includes integrity, objectivity, independence, confidentiality, adherence to
technical and professional standards, competence and due care, and ethical behaviour.
Consequently, serving the public interest relies on professional behaviour, underpinned by adherence
to the fundamental principles of professional conduct and a conceptual framework approach to applying
those principles. As a result, the APESB Code of Ethics is relevant to all professional accountants. By
applying the Code of Ethics, professional accountants will be acting in the public interest.

2.9 THE APESB CODE OF ETHICS (APES 110)

The Code of Ethics is divided into four parts.
• Part 1 sets out the requirement for all members to comply with the code, lists the fundamental principles
that members must comply with and provides a conceptual framework that members can use to ensure
that they comply with the principles.
• Part 2 sets out how the conceptual framework applies to members in business.
• Part 3 sets out how the conceptual framework applies to members in public practice when providing
professional services.
• Part 4, which is split into two sections (4A and 4B), sets out the independence standards that apply to
members when providing assurance services.
These parts are preceded by a Guide to the Code that has the purpose of highlighting how the Code
of Ethics should be read and used. Members need to ensure they understand the rationale underlying the
Code of Ethics.

QUESTION 2.4

Imagine you are required to explain the Code to a new recruit in an office. (You may need to refer
to paragraphs 1–4 and 11–15 in the Guide to the Code at the start of APES 110.) Consider how you
would describe:
(a) the purpose and importance of the Code
(b) the members to whom the Code applies
(c) whether the Code applies to members working in not-for-profit organisations
(d) the purpose of the letters R and A throughout the Code in various paragraphs
(e) the difference in interpretation and application of clauses in the Code that contain the words
‘shall’, ‘may’ and ‘might’.

PART 1 OF THE CODE — FUNDAMENTAL PRINCIPLES AND

CONCEPTUAL FRAMEWORK
The first part of the Code introduces members to the five fundamental principles of the Code of Ethics
and the conceptual framework which sets out a framework for resolving ethical issues. The principles
deal with the fundamentals of ethical behaviour expected of members irrespective of where they practice
and the conceptual framework deals with how a member should consider resolving any ethical challenges
they confront.
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MODULE 2 Ethics 69
Fundamental Principles (ss. 110–115)
The five fundamental principles are: integrity, objectivity, professional competence and due care, con-
fidentiality and professional behaviour (see figure 2.7). The fundamental principles should be regarded
as the minimum standard of ethical behaviour for a professional accountant. They are also to be used as
ethical outcomes in the resolution of ethical and professional dilemmas.

FIGURE 2.7 The fundamental principles and where they are mentioned in the Code of Ethics

Professional competence
Integrity Objectivity
and due care
(s. 111) (s. 112)
(s. 113)

Confidentiality Professional behaviour

(s. 114) (s. 115)

Source: CPA Australia 2023.

QUESTION 2.5

Access APES 110 and use your reading of section 110 to complete this question.
Each of the fundamental principles is defined in paragraph 110.1 A1. Add the definitions to
table 2.3.

TABLE 2.3 Fundamental principles

Definition

Integrity

Objectivity

Professional competence and due care

Confidentiality

Professional behaviour

Source: Adapted from APESB 2022, Compiled APES 110 Code of Ethics for Professional Accountants (including
Independence Standards), APESB, Melbourne, accessed August 2023, https://apesb.org.au/wp-content/uploads/2023/05/
Compiled_APES_110_Dec_2022.pdf.

A more detailed discussion of each principle follows.

Integrity (s. 111)
According to Windal, ‘integrity is an element of character and is essential to the maintenance of public
trust’ (1990, p. 26). Integrity in accounting is centred on concepts such as trust, honesty, and honourable
and reliable behaviour. Integrity requires strength of character and the courage to pursue one’s convictions,
otherwise good intentions may not be sufficient.
As integrity is intrinsically linked with trust, the APESB Code of Ethics imposes an obligation on
accountants to be straightforward and honest in professional and business relationships (para. R111.1).
This means that accountants:
. . . shall not knowingly be associated with reports, returns, communications or other information where
the Member believes that the information:
(a) Contains a materially false or misleading statement;
(b) Contains statements or information provided recklessly; or
(c) Omits or obscures required information required where such omission or obscurity would be misleading
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(para. R111.2).

70 Ethics and Governance

 Example 2.8 illustrates a situation where an accountant has demonstrated integrity in the workplace.

EXAMPLE 2.8

Moral Courage
Michael Woodford, the CEO of Olympus, blew the whistle on an enormous USD1.7 billion fraud, knowing
that this would cause personal hardship to himself. Instead of being rewarded, he was sacked and ended
up fearing for his life. Despite this, Woodford insists that he would take the same action again. However,
he also suggested that, based on his experience, he understood how hard it would be for a more junior
employee with responsibilities such as a family or mortgage to take the risk of disclosing problems to an
employer (Dugdale 2012).

Objectivity (s. 112)

Objectivity refers to the state or quality of being true, outside of any individual feelings or interpretations.
Accountants may be exposed to numerous situations that may impair their objectivity in the application
of professional judgement. For example, a member in business may feel pressure from a supervisor
to overlook an accounting irregularity. Similarly, a member in public practice may feel the need to
support a client’s questionable assertions to secure ongoing fees. In such circumstances, accountants may
subordinate the interests of the public to those of the client or themselves, or compromise one client’s
interest over another’s.
Flowing from these examples are three obligations that are founded on the principle of objectivity:
accountants should be impartial, honest and free from conflicts of interest. Consequently, accountants are
required to ‘exercise professional or business judgement without being compromised by: [b]ias; [c]onflict
of interest; or [u]ndue influence of, or undue reliance on, individuals, organisations, technology or other
factors’ (para. R112.1).
There are many circumstances that have the potential to compromise a member’s objectivity, such as
acquiring a financial interest in a client, formal or informal relationships with executive management, or
receiving excessive fees from a single client.
Related party transactions can compromise objectivity because of a lack of independence. Such
transactions arise whenever an organisation, or a member within an organisation, deals with others who
cannot be seen as independent. Examples include a company awarding a contract to a supplier company
in which the finance director has a significant shareholding, or a board deciding to send offshore some
functions of a business to an entity owned by a board member.
The highest risk arising from related party transactions is that they may not be at arm’s length. An arm’s
length transaction is one in which both parties act in their own interests (e.g. to maximise returns), without
pressure or duress from the other party or a third party. To do this effectively, it is important to keep the
other party at a distance, or at arm’s length — and not engage in relationships that interfere with each
party’s independent interests. Because they may not be at arm’s length, failure to disclose or report related
party transactions may lead to distorted representations of an organisation’s financial situation and hide
dealings that benefit other parties to the detriment of the organisation.
Professional Competence and Due Care (s. 113)
Professional competence and due care involve two distinct obligations. The first obligation is to ‘Attain
and maintain professional knowledge and skill at the level required to ensure that a client or employing
organisation receives competent Professional Activities, based on current technical and professional
standards and relevant legislation’ (para. R113.1(a)). The second obligation is to ‘Act diligently and in
accordance with applicable technical and professional standards’ (para. R113.1(b)).
Having professional competence requires both acquiring and maintaining professional competence.
It is normally acquired by completing an accredited university accounting degree and a professional
development program such as the CPA Program. Once CPA status is acquired, professional competence is
normally maintained by keeping up to date with relevant technical, professional, business and technology-
related developments (para. 113.1 A2).
Diligence encompasses the responsibility to ‘act in accordance with the requirements of an assignment,
carefully, thoroughly and on a timely basis’ (para. 113.1 A3). In addition to producing credible and accurate
reports, members should not accept jobs or tasks unless they possess the requisite skill to perform the
task properly. Supervisors have a corresponding duty to ensure that those working under their authority
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MODULE 2 Ethics 71
have appropriate training and supervision (para. R113.2). Due diligence and appropriate supervision are
critical to the work of accountants, particularly during busy and stressful times. Under the strain of a heavy
workload, attention to detail may be overlooked in favour of meeting deadlines and errors can occur.
Due care also imposes a condition of compliance with relevant technical and professional requirements.
Such requirements include accounting and auditing standards and other statutory regulations such as
taxation laws.
Confidentiality (s. 114)
A professional accountant should respect the confidentiality of information acquired as a result of
professional and business relationships and should not disclose any such information to third parties
without proper and specific authority, unless there is a legal or professional right or duty to disclose it.
Clients and employers have a right to expect that accountants will not reveal anything about their
personal or business affairs. Accountants must also refrain from using confidential information to their
‘personal advantage . . . or the advantage of a third party’ (para. R114.1(e)).
Accountants should maintain confidentiality in all circumstances, including discussions with prospec-
tive clients and employers, and in social situations, particularly where long-term collaborations with
associates or related parties might result in accountants being less alert to the possibility that they may
be inadvertently indiscreet.
The duty of confidentiality extends to all members, including those within employing firms or
organisations (para. R114.1(b)), as well as prospective clients or employers (para. R114.1(c)). Further-
more, the duty of confidentiality does not end with the termination of the professional — client or
professional — employer relationship. The duty continues even after such relationships have been
terminated (paras R114.1(f), R114.2).
Generally, the duty of confidentiality is relieved only when disclosure is required by law, or there is a
professional duty or right to disclose. The following, listed in paragraph 114.1 A1, are the circumstances
when disclosure of confidential information is required or may be appropriate.
(a) Disclosure is required by law, for example:
(i) Production of documents or other provision of evidence in the course of legal proceedings; or
(ii) Disclosure to the appropriate public authorities of infringements of the law that come to light;
(b) Disclosure is permitted by law and is authorised by the client or the employing organisation; and
(c) There is a professional duty or right to disclose, when not prohibited by law:
(i) To comply with the quality review of a Professional Body;
(ii) To respond to an inquiry or investigation by a professional or regulatory body;
(iii) To protect the professional interests of a Member in legal proceedings; or
(iv) To comply with technical and professional standards, including ethics requirements.

Paragraph AUST 114.1 A1.1 states that:

The circumstances described in paragraph 114.1 A1 do not take into account Australian legal and regulatory
requirements. A Member considering disclosing confidential information about a client or employer
without their consent is advised to first obtain legal advice.

Professional Behaviour (s. 115)

A professional accountant must ‘[c]omply with relevant laws and regulations; [b]ehave in a manner
consistent with the profession’s responsibility to act in the public interest in all Professional Activities and
business relationships; and [a]void any conduct that the Member knows or should know might discredit
the profession’ (para. R115.1).
Therefore, in addition to their duty to clients, employers and the public, which comes with a commitment
to act in the public interest, accountants also have a responsibility to the accounting profession and fellow
members. They must act in a way that promotes the good reputation of the profession and their colleagues.
This includes avoiding exaggerated claims about the services offered, qualifications or experience, and
avoiding disparaging references or unsubstantiated comparisons to the work of others (para. R115.2).

QUESTION 2.6

Each statement in table 2.4 is aligned to one of the fundamental principles. Identify the principle
and add it next to the statement in the column on the right.
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72 Ethics and Governance

 TABLE 2.4 Statements aligned with principles

Statement Principle

This fundamental principle deals with implicit fair dealing and truthfulness.

Members are obliged to ensure their professional judgement is not compromised due to
undue influence by others.

A member is required to ensure they act diligently and in accordance with professional
standards that apply to their work.

A member needs to be conscious about inadvertent disclosure of client information.

A member should not associate themselves with documents where the member believes
the content is materially false

Conduct that a reasonable and informed third party would be likely to conclude adversely
affects the good reputation of the profession is conduct that is or may be defined as
conduct discrediting the profession.

Information acquired as a result of working on an engagement shall not be disclosed unless

there is a legal or professional duty to do so.

It may be a breach of a principle if a member associates themselves with statements or

information that was provided recklessly.

Members shall avoid conduct that they know may discredit the profession.

A member shall make clients or employers aware of any limitations of the services a
member is providing.

Members should not be involved with the publication of information where the presentation
of information omits or obscures the true substance of a situation.

Members shall not mislead clients or potential clients with claims that misrepresent their
actual qualifications or experience.

Proper authorisation shall be obtained before certain kinds of information are shared with
parties that are not involved in an engagement within a company or professional practice.

A member shall disassociate themselves from information that is false, provided recklessly
or omits information that might otherwise lead a reader to interpret a situation differently if a
full and clear account of a situation was presented.

Ending a relationship between a client or employing organisation does not mean that a
member is free to share information with other parties or on social media.

Disparaging references or unsubstantiated comparisons to the work of others shall not be

made by a member.

A member shall take necessary measures to ensure people working under their authority
are properly supervised and trained.

A member shall not undertake a professional engagement if there is a situation or

relationship that may unduly influence the member’s exercise of professional judgement
if they were to engage in that activity.

Information acquired as a result of professional and business relationships shall not be used
for the personal advantage of the member or the advantage of a third party.

Members have a professional duty or right to disclose information where not prohibited by
law to comply with quality reviews conducted by CPA Australia or responding to an inquiry
or investigation by CPA Australia.

Source: Adapted from APESB 2022, Compiled APES 110 Code of Ethics for Professional Accountants (including
Independence Standards), APESB, Melbourne, accessed August 2023, https://apesb.org.au/wp-content/uploads/2023/05/
Compiled_APES_110_Dec_2022.pdf.

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MODULE 2 Ethics 73
 The fundamental principles form the foundation of the Code of Ethics and are to be applied by all
members irrespective of the context in which they work. Specific guidance on how members who are
accountants in business or accountants in practice appear later in the module. Consider the issues related
to fundamental principles in the context of the Scott London case study which follows below.

EXAMPLE 2.9

Scott London, Former Senior Partner (Audit) at KPMG Los Angeles

On 11 April 2013, Scott London (London), a former senior audit partner at KPMG Los Angeles who had
worked at KPMG for nearly 30 years, was charged by the FBI with insider trading. On the same day, the US
Securities and Exchange Commission (SEC) filed civil charges against London (SEC 2013a). The director
of the SEC’s office in Los Angeles stated: ‘As a leader at a major accounting firm, London’s conduct was
an egregious violation of his ethical and professional duties’ (SEC 2013a).
As a result of his position, London had access to highly sensitive and confidential information regarding
upcoming earnings announcements about KPMG clients before that information was disclosed to the
public. For over two years, London illegally provided this confidential information to his close friend Bryan
Shaw, who made over USD1 million profit by using the information to trade securities. In exchange, Shaw
gave London thousands of dollars in cash, a Rolex watch and concert tickets (FBI 2013).
On 1 July 2013, London pleaded guilty to insider trading and admitted to disclosing confidential
information to Shaw. On 27 September 2013, London was banned by the SEC from auditing public
companies and ‘denied the privilege of appearing or practicing before the Commission as an accountant’
(SEC 2013b, p. 9).
On 24 April 2014, London was sentenced to 14 months in jail, commencing in July 2014, and ordered
to pay a $100 000 fine. After being sentenced, London said ‘I had to plead guilty. The impacts on the
profession and on KPMG could have led to even further damage if there had been a long investigation
and court case. It doesn’t take long for bad public perception about accounting firms, like what happened
to Arthur Andersen in 2002. So I want to do as much as I can to set things right. What I did was
clearly wrong, and I take full responsibility. However, this is a subject matter that unfortunately may be
very prevalent with people who have access to confidential information, but it’s difficult to catch people
doing it. Even seemingly innocuous conversations with a good friend can lead a person to be tempted
and think they won’t get caught. I hope that my story can help prevent others from crossing the line’
(O’Bannon 2014).

QUESTION 2.7

(a) Who were the stakeholders (individuals or groups who have a stake in what happens), and how
were they affected by the actions of Scott London?
(b) Did London breach any of the fundamental principles of professional conduct contained in the
Code of Ethics? If so, state those principles and explain why you think they have been breached.

The Conceptual Framework (s. 120)

The conceptual framework approach, which relies on the application of key principles for decision making,
differs from rule-based codes, which require adherence to a set of specific rules in terms of the specific
actions that should or should not be taken. The problem with a code that is entirely rules-based is that it
becomes too prescriptive and too voluminous to be of practical use. Excessive prescription causes ethical
decision making to focus too much on whether the rule permits or prohibits a particular treatment or
behaviour, rather than using ethical judgement to determine whether a fundamental principle is protected.
For a principles-based code to be effective, it is useful to take a blended approach containing a mix of
broad principles and more specific guidance that is specific to areas of an accountants’ work and certain
tasks which together show how the conceptual framework applies in specific situations.
The conceptual framework (outlined in APES 110) that members are required to consider when
determining whether there are any threats to the fundamental principles is made up of three steps.
(a) Identify threats to compliance with the fundamental principles;
(b) Evaluate the threats identified; and
(c) Address the threats by eliminating or reducing them to an Acceptable Level (para. 120.2).
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74 Ethics and Governance

 Members need to identify, evaluate and respond to any identified threat that may compromise compli-
ance with the fundamental principles. If the identified threats are significant, members must address them
by eliminating them or reduce them to an acceptable level, so that compliance is no longer compromised.
If accountants are unable to implement appropriate safeguards, they should either decline or discontinue
the specific professional service involved, or consider resigning from the client or employer. Figure 2.8
illustrates the conceptual framework approach.

FIGURE 2.8 The conceptual framework approach

Identify threats

Is the threat Yes

at an acceptable Ongoing monitoring
level?

No

Eliminate or reduce the threat

to an acceptable level by ...

... applying
... eliminating ... declining or
safeguards to reduce
circumstances that ending the specific
the threat to an
create the threat professional activity
acceptable level

Source: Adapted from Dellaportas, S et al. 2005, Ethics, governance and accountability: A professional perspective, John Wiley &
Sons, Milton, Queensland.

Members need to be aware that this is continuing process rather than a one-off task. As new information
comes to hand, or facts or circumstances change, members are obliged to re-evaluate and address existing
threats and be alert to new threats (para. R120.9). In applying the three steps of the conceptual framework,
members are encouraged to document the substance of issues, and process and outcomes (para. 110.2 A3),
and to consider consulting others to confirm information and conclusions, including:
• Others within the Firm or employing organisation.
• Those Charged with Governance.
• A professional body.
• A regulatory body.
• Legal counsel (para. 110.2 A2).

When applying the conceptual framework to ethical issues, members must ‘have an inquiring mind;
[e]xercise professional judgement; and [u]se the reasonable and informed third party test’ (para. R120.5).

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MODULE 2 Ethics 75
 QUESTION 2.8

Read paragraphs R120.5–120.5 A6 in APES 110 to answer these questions.

(a) Does the reasonable and informed third party need to be a member of a professional accoun-
ting body?
(b) Why is an inquiring mind important and what does it involve?
(c) What conditions need to be met to ensure the exercise of professional judgement results in
valid conclusions?

Identifying Threats (para. R120.6)

APES 110 sets down the obligation of a member to identify threats to fundamental principles in
paragraph R120.6. Threats to the fundamental principles may be created by a broad range of relationships
and circumstances. The first step in the conceptual framework is to identify such threats. Such a
circumstance or relationship may ‘create more than one threat, and a threat might affect compliance with
more than one fundamental principle’ (para. 120.6 A4). APES 110 defines five categories of threat: self-
interest, self-review, advocacy, familiarity and intimidation (para. 120.6 A3).

QUESTION 2.9

Read paragraph 120.6 A3 in APES 110 carefully and add the name of the threat category that
matches each definition given in table 2.5.

TABLE 2.5 Threat categories

Threat category Definition

The threat that a Member will be deterred from acting objectively because of actual
or perceived pressures, including attempts to exercise undue influence over
the Member.

The threat that a Member will promote a client’s or employing organisation’s

position to the point that the Member’s objectivity is compromised.

The threat that a Member will not appropriately evaluate the results of a previous
judgement made, or an activity performed by the Member or by another individual
within the Member’s Firm or employing organisation, on which the Member will rely
when forming a judgement as part of performing a current activity.

The threat that a financial or other interest will inappropriately influence a Member’s
judgement or behaviour.

The threat that due to a long or close relationship with a client, or employing
organisation, a Member will be too sympathetic to their interests or too accepting
of their work.

Source: APESB 2022, Compiled APES 110 Code of Ethics for Professional Accountants (including Independence
Standards), APESB, Melbourne, accessed August 2023, https://apesb.org.au/wp-content/uploads/2023/05/Compiled_
APES_110_Dec_2022.pdf.

Example 2.10 illustrates the conceptual framework approach to compliance with the fundamental
principles of professional conduct.

EXAMPLE 2.10

Intimidation — a Threat to the Fundamental Principles

An intimidation threat to the accountant’s objectivity or competence and due care may arise where the
accountant is pressured (or motivated by the possibility of personal gain) into being associated with
misleading information.
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76 Ethics and Governance

 The accountant must evaluate the significance of such a threat and, if the threat is other than clearly
insignificant, safeguards should be considered and applied as necessary to reduce the threat to an
acceptable level. One relevant safeguard includes consultation with superiors within the employing
organisation (such as the audit committee or other body responsible for governance), or with a relevant
professional body. If the threat cannot be mitigated to an acceptable level, the accountant should consider
discontinuing their service for the employer.
The specific nature of each threat will depend on the particular circumstances or relationships in which
it arises, and some may be difficult to categorise.

QUESTION 2.10

Review the threat definitions in table 2.5 and read paragraphs 200.6 A1 and 300.6 A1 of APES 110,
then determine the primary category of threat (according to the categories used in APES 110) that
each circumstance in table 2.6 might give rise to. To assist you, some of the circumstances have
already been categorised. Please review these before you attempt to categorise the others.
Remember that some circumstances might threaten compliance with more than one fundamental
principle. It is also important to consider the context in which activities have taken place — including
any relationships and interests — when deciding whether the fundamental principles have been
compromised. Only the primary threat will be listed in the solution.

TABLE 2.6 Examples of threats — accountants in business and accountants in public practice

Self-interest

Intimidation
Self-review

Familiarity
Advocacy
Circumstance

Members in Business

1. A Member holding a Financial Interest in, or receiving a loan or

guarantee from, the employing organisation.

2. An individual attempting to influence the decision making process of ✓

the Member, for example with regard to the awarding of contracts or
the application of an accounting principle.

3. A Member determining the appropriate accounting treatment for a

business combination after performing the feasibility study supporting
the purchase decision.

4. A Member having the opportunity to manipulate information in a

prospectus in order to obtain favourable financing.

5. A Member being responsible for the financial reporting of the ✓

employing organisation when an Immediate or Close Family member
employed by the organisation makes decisions that affect the financial
reporting of the organisation.

6. A Member having a long association with individuals influencing

business decisions.

7. A Member or Immediate or Close Family member facing the threat of ✓

dismissal or replacement over a disagreement about:
• The application of an accounting principle.
• The way in which financial information is to be reported.

8. A Member being offered a gift or special treatment from a supplier of ✓

the employing organisation.

(continued)

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MODULE 2 Ethics 77
 TABLE 2.6 (continued)

Self-interest

Intimidation
Self-review

Familiarity
Advocacy
Circumstance

9. A Member participating in incentive compensation arrangements

offered by the employing organisation.

10. A Member having access to corporate assets for personal use.

Members in public practice

1. A Member being threatened with dismissal from a client engagement

or the Firm because of a disagreement about a professional matter.

2. A director or officer of the client, or an employee in a position to exert

significant influence over the subject matter of the engagement, having
recently served as the Engagement Partner.

3. An Audit Team member having a long association with the Audit Client.

4. A Member quoting a low fee to obtain a new engagement and the fee
is so low that it might be difficult to perform the Professional Service
in accordance with applicable technical and professional standards for
that price.

5. A Member having prepared the original data used to generate records ✓

that are the subject matter of the Assurance Engagement.

6. A Member acting as an advocate on behalf of a client in litigation or

disputes with third parties.

7. A Member having a Close or Immediate Family member who is a

Director or Officer of the client.

8. A Member being informed that a planned promotion will not occur

unless the Member agrees with an inappropriate accounting treatment.

9. A Member having accepted a significant gift from a client and being

threatened that acceptance of this gift will be made public.

10. A Member issuing an assurance report on the effectiveness of the

operation of financial systems after implementing the systems.

11. A Member lobbying in favour of legislation on behalf of a client. ✓

12. A Member having access to confidential information that might be

used for personal gain.

13. A Member promoting the interests of, or shares in, a client.

14. A Member having a Direct Financial Interest in a client. ✓

15. A Member feeling pressured to agree with the judgement of a client ✓

because the client has more expertise on the matter in question.

16. A Member discovering a significant error when evaluating the results

of a previous Professional Service performed by a member of the
Member’s Firm.

17. A Member having a close business relationship with a client. ✓

18. An individual who is being considered to serve as an appropriate ✓

reviewer, as a safeguard to address a threat, having a close
relationship with an individual who performed the work.

Source: APESB 2022, Compiled APES 110 Code of Ethics for Professional Accountants (including Independence
Standards), APESB, Melbourne, accessed August 2023, https://apesb.org.au/wp-content/uploads/2023/05/Compiled_
APES_110_Dec_2022.pdf.

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78 Ethics and Governance

Evaluating Threats (para. R120.7)
Once a threat has been identified, members need to evaluate the threat to determine whether a threat is at an
acceptable level (para. R120.7). APES 110 states that ‘An Acceptable Level is the level at which a Member
using the reasonable and informed third party test would likely conclude that the Member complies with
the fundamental principles’ (para. 120.7 A1). In other words, the standard requires members to determine
whether the facts or the circumstances with which they are confronted compromise their ability to meet
the fundamental principles set down in the Code.
Paragraph 120.8 A1 of the Code states that qualitative as well as quantitative factors must be considered
when evaluating a threat or the combined impact of threats. This will depend on the circumstances
confronted by a member, group of members or organisation that employs members bound by the Code.
There may also be specific pieces of guidance that entities themselves produce that assist with dealing
with specific threats to fundamental principles. The forms of guidance relevant to evaluating the threat
level (para. 120.8 A2) include:
• Corporate governance requirements.
• Educational, training and experience requirements for the profession.
• Effective complaint systems which enable the Member and the general public to draw attention to
unethical behaviour.
• An explicitly stated duty to report breaches of ethics requirements.
• Professional or regulatory monitoring and disciplinary procedures.

Parts 2 and 3 of the Code contain specific considerations for accountants in business and in practice to
use when evaluating threats. These are summarised in table 2.7.

TABLE 2.7 Considerations for evaluating threats

Members in Business Members in Public Practice

• The nature and scope of the professional activity • The client and its operating environment (para. 300.7
(para. 200.7 A2). A1), including whether they are an audit client (and,
moreover, a public interest entity), an assurance
client or a non-assurance client (para. 300.7 A3).

• The work environment within the employing
organisation and its operating environment, including
whether (para. 200.7 A3):
– leadership emphasises the importance of ethical
behavior
– policies and procedures empower and encourage
employees to communicate ethics issues to senior
management–
– policies and procedures implement and monitor
employee performance
– systems of corporate or other oversight and strong
internal controls exist.
– recruitment procedures are focused on employing
high-quality personnel
– communication about policies and procedures, and
appropriate training and education on them, are
provided in a timely manner
– ethics and code of conduct policies exist.
• The firm (professional practice) and its operating
environment (para. 300.7 A1), including whether
(para. 300.7 A5):
– leadership promotes compliance with the
fundamental principles and establishes the
expectation that assurance team members will
act in the public interest
– policies or procedures establish and monitor
personnel’s compliance with the fundamental
principles
– compensation, performance appraisal and
disciplinary policies and procedures promote
compliance with the fundamental principles
– reliance on revenue received from a single client is
managed
– the engagement partner has authority within the
firm for decisions concerning compliance with the
fundamental principles, including any decisions
about accepting or providing services to a client
– educational, training and experience requirements
exist
– processes to facilitate and address internal and
external concerns or complaints exist.

(continued)

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MODULE 2 Ethics 79
 TABLE 2.7 (continued)

Members in Business Members in Public Practice

• Legal advice if the member believes unethical
behaviour has occurred, or will continue to occur,
within their employing organisation (para. 200.7 A4).
• The nature or scope of the service involved
(para. 300.7 A2).
• The client’s governance structure and cultural
tone, and whether they promote compliance with
fundamental principles by, for example
(para. 300.7 A4):
– having individuals other than management ratify or
approve the appointment of a firm to perform an
engagement
– employing competent employees with experience
and seniority to make managerial decisions
– implementing internal procedures that facilitate
objective choices in tendering non-assurance
engagements
– developing a corporate governance structure
that provides appropriate oversight and
communications regarding the firm’s services.
• New information or changes in facts and circum-
stances that could affect the level of a threat or
the member’s conclusions about safeguards
(para. 300.7 A6), such as (para. 300.7 A7):
– the scope of a professional service being
expanded
– the client becoming a listed entity or acquiring
another business unit
– the firm merging with another firm
– a dispute arising between two clients that have
jointly engaged the member
– the member’s personal or immediate family
relationships changing.

Source: APESB 2022, Compiled APES 110 Code of Ethics for Professional Accountants (including Independence Standards),
APESB, Melbourne, accessed August 2023, https://apesb.org.au/wp-content/uploads/2023/05/Compiled_APES_110_Dec_2022.pdf.

Identification and evaluation are the first two steps in the process for dealing with threats to the
fundamental principles. A threat that is evaluated as not being at an acceptable level needs to be addressed.
This is the third step in applying the conceptual framework.
Addressing Threats (para. R120.10)
Members need to consider how to address the threats that have been identified as not at an acceptable level.
The Code refers to the process of addressing threats in the context of eliminating them or reducing them
to an acceptable level (para. R120.10).
Threats should be addressed by either:
(a) Eliminating the circumstances, including interests or relationships, that are creating the threats;
(b) Applying safeguards, where available and capable of being applied, to reduce the threats to an
Acceptable Level; or
(c) Declining or ending the specific Professional Activity (para. R120.10).

It should be noted that, if members are unable to eliminate the circumstances that gave rise to the threat
or find that safeguards will not bring the threat down to an acceptable level, the only option left is to decline
to engage in or to end a particular professional activity (para. 120.10 A1).
A safeguard is defined as ‘actions, individually or in combination, that the Member takes that effectively
reduce threats to compliance with the fundamental principles to an Acceptable Level’ (para. 120.10 A2).
It should be noted that the standard tailors specific guidance for matters such as independence issues
(particularly relevant in the circumstances of audit and assurance engagements) and guidance related to
the way in which threats can be dealt with in a business or accounting practice environment.
The independence standards form Parts 4A and B of the Code while issues of specific relevance to
professional accountants in business are covered in Part 2, and public practice accountants will find
guidance in Part 3.
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80 Ethics and Governance

PARTS 2 AND 3 OF THE CODE — APPLYING THE CODE TO
MEMBERS IN BUSINESS AND PUBLIC PRACTICE
Part 1 of the Code provides a theoretical overview of the fundamental principles and the conceptual
framework. Parts 2 and 3 of the Code provide specific guidance for selected circumstances members in
business or public practice may encounter that pose threats to the fundamental principles. Part 2 of the
Code deals with seven common situations that members in business may need to deal with and Part 3 deals
with eight common situations faced by members in public practice. These situations are listed in table 2.8
and examined in more detail in the material that follows. Note that there are four topics in common and
these will be addressed together at the start of the material. Other topics will follow.

TABLE 2.8 Code of Ethics Parts 2 and 3

Part 2: Members in Business Part 3: Members in Public Practice

Section Topic Section Topic

210 Conflicts of interest 310 Conflicts of interest

220 Preparation and presentation of information 320 Professional appointments

230 Acting with sufficient expertise 321 Second opinions

240 Financial interests, compensation and 325 Objectivity of an engagement quality

incentives linked to financial reporting and reviewer and other appropriate reviewers
decision making

250 Inducements, including gifts and hospitality 330 Fees and other types of remuneration

260 Responding to non-compliance with laws 340 Inducements, including gifts and hospitality
and regulations

270 Pressure to breach the fundamental 350 Custody of client assets

principles

360 Responding to non-compliance with laws

and regulations

Source: Adapted from APESB 2022, Compiled APES 110 Code of Ethics for Professional Accountants (including Independence
Standards), APESB, Melbourne, accessed August 2023, https://apesb.org.au/wp-content/uploads/2023/05/Compiled_APES_110_
Dec_2022.pdf.

Conflicts of Interest (ss. 210, 310)

These sections cover the area of conflicts of interest in the case of both members in business and in public
practice. The Code requires individuals to not allow a conflict of interest to compromise their judgement
when involved in professional activities or engagements. The Code sets down examples of circumstances
in both cases that may give rise of conflicts of interest. These appear in table 2.9.

TABLE 2.9 Circumstances that may create a conflict of interest

Members in Business (para. 210.4 A1) Members in Public Practice (para. 310.4 A1)

• Serving in a management or governance position • Providing a transaction advisory service to a client

for two employing organisations and acquiring
confidential information from one organisation that
might be used by the Member to the advantage or
disadvantage of the other organisation.
• Undertaking a Professional Activity for each of two
parties in a partnership, where both parties are
employing the Member to assist them to dissolve
their partnership.
• Preparing financial information for certain members
of management of the Member’s employing
organisation who are seeking to undertake a
management buy-out.
seeking to acquire an Audit Client, where the Firm
has obtained confidential information during the
course of the audit that might be relevant to
the transaction.
• Providing advice to two clients at the same time
where the clients are competing to acquire the same
company and the advice might be relevant to the
parties’ competitive positions.
• Providing services to a seller and a buyer in relation
to the same transaction.
• Preparing valuations of assets for two parties who
are in an adversarial position with respect to
the assets.

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(continued)

MODULE 2 Ethics 81
 TABLE 2.9 (continued)

Members in Business (para. 210.4 A1) Members in Public Practice (para. 310.4 A1)

• Being responsible for selecting a vendor for the
employing organisation when an immediate Family
member of the Member might benefit financially from
the transaction.
• Serving in a governance capacity in an employing
organisation that is approving certain investments
for the company where one of those investments will
increase the value of the investment portfolio of the
Member or an Immediate Family Member.
• Representing two clients in the same matter who are
in a legal dispute with each other, such as
during divorce proceedings, or the dissolution of
a partnership.
• In relation to a license agreement, providing an
assurance report for a licensor on the royalties due
while advising the licensee on the amounts payable.
• Advising a client to invest in a business in which,
for example, the spouse of the Member in Public
Practice has a Financial Interest.
• Providing strategic advice to a client on its
competitive position while having a joint venture or
similar interest with a major competitor of the client.
• Advising a client on acquiring a business which the
Firm is also interested in acquiring.
• Advising a client on buying a product or service while
having a royalty or commission agreement with a
potential seller of that product or service.

Source: APESB 2022, Compiled APES 110 Code of Ethics for Professional Accountants (including Independence Standards),
APESB, Melbourne, accessed August 2023, https://apesb.org.au/wp-content/uploads/2023/05/Compiled_APES_110_Dec_2022.pdf.

The more direct the connection between the professional activity and a conflict of interest, the more
likely it is that there is no way of ensuring a risk is kept to an acceptable level. There is a need for businesses
and professional practices to ensure that they identify potential conflicts and decide on the best way to
deal with them. It is necessary in the cases of members in either business or public practice to ensure they
review all business engagements to assess them for any potential conflicts. Members in public practice,
in particular, need to ensure they evaluate the nature of interests and relationships that exist between the
various parties involved, and whether there are implications of any service offering that is being considered.
There is a need to ensure that a conflict of interest is properly dealt with by putting in place safeguards
that may assist in mitigating or reducing threats to the fundamental principles to an acceptable level.
Safeguards that may be applied in business and practice in the context of minimising or preventing conflicts
of interests are presented in table 2.10.

TABLE 2.10 Conflict of interest safeguards

Members in Business Members in Public Practice

(paras 210.7 A2–210.7 A3, 210.9 A1) (paras 310.8 A2–310.8 A3)

• Restructuring or segregating certain responsibilities
and duties.
• Obtaining appropriate oversight, for example,
acting under the supervision of an executive or non-
executive Director.
• Withdrawing from the decision making process
related to the matter giving rise to the conflict
of interest.
• Consulting with third parties, such as a professional
body, legal counsel or another Member.
In the case of confidential client information that may
be a concern when dealing with clients in similar
industries, for example, the Code suggests measures
such as the following.
• The existence of separate practice areas for specialty
functions within the Firm, which might act as a barrier
to the passing of confidential client information
between practice areas.
• Policies and procedures to limit access to client files.
• Confidentiality agreements signed by personnel and
partners of the Firm.
• Separation of confidential information physically and
electronically.
• Specific and dedicated training and communication.

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82 Ethics and Governance

 Safeguards to address conflicts of interest more
generally include the following.
• Having separate Engagement Teams who are
provided with clear policies and procedures on
maintaining confidentiality.
• Having an appropriate reviewer, who is not involved
in providing the service or otherwise affected by
the conflict, review the work performed to assess
whether the key judgements and conclusions
are appropriate.

Source: APESB 2022, Compiled APES 110 Code of Ethics for Professional Accountants (including Independence Standards),
APESB, Melbourne, accessed August 2023, https://apesb.org.au/wp-content/uploads/2023/05/Compiled_APES_110_Dec_2022.pdf.

QUESTION 2.11

Francis is a member working in a practice that specialises in the provision of financial advice.
Toby and Francis are both directors and they are both engaged in providing financial advice to
clients. Francis and Toby discussed investment strategies appropriate for a new client that involved
property investments and Toby disclosed that he has interests in a property investment firm while
Francis has no shares or ownership in such an entity.
Determine the potential conflict that exists in this situation and suggest a strategy to reduce the
threat to fundamental principles to an acceptable level.

QUESTION 2.12

Celia is a director of a company that is a local uniform manufacturer, but she is also on the
management committee of a local community group which has launched its annual fundraising
drive. Celia has mentioned the fundraising initiative to her board colleagues and suggested that
the business could benefit from being associated with a group that has an objective to help the
needy in the same area in which the company has its factory and corporate offices. Celia is an
accountant and has disclosed her interest as a member of the management committee.
The board of the uniform manufacturing company is considering the request. How should the
board deal with Celia’s suggestion?

QUESTION 2.13

You have been asked to audit Toytown Pty Ltd’s half-year financial statements.
• The company was last audited by Smith, Jones & Associates, which resigned as the auditor as a
result of the retirement of the only registered company auditor within the practice.
• For the last three years, Toytown has engaged Ace Tax Services, a firm of local CPAs, to prepare
corporate income tax returns and wishes this arrangement to continue.
Are you required by the APESB Code of Ethics to contact or obtain professional clearance from
each of the above accounting firms before accepting the appointment as auditor of the half-year
financial statements?

Remuneration, Incentives, Fees and other Forms of Payment (ss. 240, 330)
Financial considerations that are improperly managed in both business and public practice can lead to
threats to fundamental principles set down in the Code. Members in business (paras 240.1–240.3 A4) and
members in public practice (paras 330.1–330.6 A1) have specific guidance about how to deal with threats
that might arise. In both circumstances there is the possibility of a self-interest threat that can arise if
situations are not properly managed. Self-interest threats can arise in several ways if financial affairs are
compromised in some form. Table 2.11 outlines these in some detail.

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MODULE 2 Ethics 83
 TABLE 2.11 Circumstances that create a self-interest threat

Members in Business (para. 240.3 A2) Members in Public Practice

• Having motive and opportunity to manipulate price-
sensitive information for financial gain.
• Holding financial interest in the employing
organisation and being able to directly affect that
financial interest.
• Being eligible for a profit-related bonus and being
able to directly affect the value of that bonus.
• Holding deferred bonus share rights or share options
in the employing organisation and being able to
affect those rights or options.
• Participating in compensation arrangements where
incentives are linked to performance.
• Quoting fees inappropriately – for example, quoting
a fee so low that it becomes difficult to comply
with technical and professional standards while
performing the service (para. 330.3 A1–A2).
• Working for contingent fees may create a self-interest
threat in specific circumstances. Contingent fees are
prohibited in specific engagement circumstances
related to forensic accounting, valuation, insolvency,
reporting on prospective financial information, and
due diligence committee participation in connection
to a public document as detailed in various APESB
standards including APES 215, APES 225,
APES 330, APES 345 and APES 350.
(paras 330.4 A1, AUST R330.4.1).
• Paying referral fees or commissions to another
member to provide specialist services not offered
by the existing accountant, and receiving referral
fees, including:
– for referring a client to another member who
can provide a specific service not offered by the
existing accountant
– from a third party (e.g. a software company) in
connection with the sale of goods or services to a
client (para. 330.5 A1).

Source: APESB 2022, Compiled APES 110 Code of Ethics for Professional Accountants (including Independence Standards),
APESB, Melbourne, accessed August 2023, https://apesb.org.au/wp-content/uploads/2023/05/Compiled_APES_110_Dec_2022.pdf.

The Code requires members to evaluate the threats once they are identified as required by the conceptual
framework. Each member will have a slightly different way of evaluating threats. For members in public
practice, this includes consideration of (para. 330.4 A2):
• The nature of the engagement.
• The range of possible fee amounts.
• The basis for determining the fee.
• Disclosure to intended users of the work performed by the Member in Public Practice and the basis
of remuneration.
• Quality management policies and procedures.
• Whether an independent third party is to review the outcome or result of the transaction.
• Whether the level of the fee is set by an independent third party such as a regulatory body.
Members may also use different safeguards to avoid contravening the fundamental principles set down
in APES 110. These are outlined in table 2.12. While the points that appear in the first column are a part
of the evaluation of threats in a business setting, they can also be regarded as safeguards that may restrict
behaviour that is contrary to the fundamental principles.

TABLE 2.12 Safeguards to prevent self-interest threats

Members in Business (para. 240.3 A3) Members in Public Practice

• The significance of the financial interest. What
constitutes a significant financial interest will depend
on personal circumstances and the materiality of the
financial interest to the individual.
• Policies and procedures for a committee indepen-
dent of management to determine the level or form of
senior management remuneration.
• In accordance with any internal policies, disclosure to
those charged with governance of:
– all relevant interests
– any plans to exercise entitlements or trade in
relevant shares.
Level of fees (para. 330.3 A4):
• Adjusting the level of fees or the scope of the
engagement.
• Having an appropriate reviewer review the work
performed.
Contingent fees (para. 330.4 A3):
• Having an appropriate reviewer who was not involved
in performing the non-assurance service review the
work performed by the Member in Public Practice.
• Obtaining an advance written agreement with the
client on the basis of remuneration.

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84 Ethics and Governance

 • Internal and external audit procedures that are
specific to address issues that give rise to the
financial interest.
Referral fees or commissions (para. 330.5 A2):
• Obtaining an advance agreement from the client for
commission arrangements in connection with the
sale by another party of goods or services to the
client might address a self-interest threat.
• Disclosing to clients any referral fees or commission
arrangements paid to, or received from, another
Member in Public Practice or third party for
recommending services or products might address a
self-interest threat.

Source: APESB 2022, Compiled APES 110 Code of Ethics for Professional Accountants (including Independence Standards),
APESB, Melbourne, accessed August 2023, https://apesb.org.au/wp-content/uploads/2023/05/Compiled_APES_110_Dec_2022.pdf.

Commissions and Soft-Dollar Benefits

Financial advisers have an important role to play in helping clients achieve their financial objectives such
as wealth accumulation and retirement planning. To do this, advisers must provide high-quality, objective,
expert advice.
Accountants in public practice who provide financial advice must be able to recognise potential threats
created by personal and business relationships. Those who provide financial advice (which generally
includes advice on financial products such as shares, managed funds, master funds and life insurance)
must follow the provisions of APES 230 Financial Planning Services.
Receiving remuneration in the form of commissions and other financial benefits might threaten a mem-
ber’s objectivity. Commissions create potential self-interest threats to objectivity. Therefore, accountants
should adopt a fee-for-service approach, as this approach is seen as consistent with the principle of
professional independence.
At a minimum, where a member accepts commissions or other incentives, the member must fully and
clearly disclose to the client the nature and extent of such fees. In addition to commissions, soft-dollar
benefits received from third parties create conflicts that can potentially undermine independent advice.
Soft-dollar benefits include all monetary and non-monetary benefits received from a third party, such as
fund managers, for the sale or recommendation of certain products. Remuneration in the form of soft-
dollar benefits has the potential to influence an adviser’s recommendations to clients, or at least give the
impression of such influence.
CPA Australia, through APES 230, has accordingly banned a wide range of benefits, gifts or other
incentives (including soft-dollar benefits), including commissions based on sales volumes, preferential
commissions linked to in-house financial products, free or subsidised office equipment, computers or
software, and gifts over $300 in value.
.......................................................................................................................................................................................
CONSIDER THIS
Turn to paragraph 230.3 A3 in APES 110, which relates to members in business, and compare it to
paragraph 330.4 A2 presented earlier, which covers the topics of fees for members in public practice. Reflect
on why these lists are different.

Inducements, Including Gifts and Hospitality (ss. 250, 340)

Inducements are defined in paragraph 250.4 A1 as being objects, situations or actions that are used as a
means to influence another individual’s behaviour. The Code describes inducements as ranging from acts
of hospitality to acts that end in noncompliance with the legal and regulatory pronouncements that are in
force in a jurisdiction. Various forms of inducements exist, and they may take the form of gifts, hospitality,
entertainment, political or charitable donations, appeals to friendship and loyalty, employment or other
commercial opportunities, and preferential treatment, rights or privileges.
The Code points to rules and laws that operate in jurisdictions that prohibit the offer or acceptance of
inducements. These laws are typically related to bribery and corruption. Members are obliged under the
Code to understand relevant regulations and ensure compliance. The Code offers a series of examples of
different threats that may exist in the provision of inducements, even if there is no intent on the part of the
person offering hospitality, for example, to influence behaviour.
Paragraph 340.11 A3 states that there are situations where an inducement may create a threat in the
context of public practice. A self-interest threat may be created in circumstances where a member in public
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MODULE 2 Ethics 85
practice who is providing corporate finance services to a client is offered hospitality by a prospective
acquirer of the client. Familiarity threats may arise if an existing or prospective client is regularly taken to
sporting events. An intimidation threat could exist if a member in public practice accepted hospitality of a
kind that could be seen as inappropriate by the broader community if it was publicised.
Table 2.13 lists the key indicators that determine whether inducements are likely to cause a threat to
fundamental principles. That is, is the intent of the inducement (actual or perceived) to influence the
behaviour of the recipient or other individual?
Factors to consider when evaluating inducements with intent to improperly influence
TABLE 2.13 behaviour

Members in Business (para. 250.9 A3) Members in Public Practice (para. 340.9 A3)

• The nature, frequency, value and cumulative effect of • The nature, frequency, value and cumulative effect of
the Inducement. the Inducement.

• Timing of when the Inducement is offered relative to • Timing of when the Inducement is offered relative to
any action or decision that it might influence. any action or decision that it might influence.

• Whether the Inducement is a customary or cultural • Whether the Inducement is a customary or cultural
practice in the circumstances, for example, offering a practice in the circumstances, for example, offering a
gift on the occasion of a religious holiday or wedding. gift on the occasion of a religious holiday or wedding.

• Whether the Inducement is an ancillary part of • Whether the Inducement is an ancillary part of
a Professional Activity, for example, offering or a Professional Service, for example, offering or
accepting lunch in connection with a accepting lunch in connection with a
business meeting. business meeting.

• Whether the offer of the Inducement is limited to an
individual recipient or available to a broader group.
The broader group might be internal or external to
the employing organisation, such as other customers
or vendors.
• Whether the offer of the Inducement is limited to an
individual recipient or available to a broader group.
The broader group might be internal or external to
the firm, such as other suppliers to the client.

• The roles and positions of the individuals offering or • The roles and positions of the individuals at the Firm
being offered the Inducement. or the client offering or being offered the Inducement.

• Whether the Member knows, or has reason to • Whether the Member in public practice knows, or
believe, that accepting the Inducement would breach has reason to believe, that accepting the Inducement
the policies and procedures of the counterparty’s would breach the policies and procedures of
employing organisation. the client.

• The degree of transparency with which the • The degree of transparency with which the
Inducement is offered. Inducement is offered.

• Whether the Inducement was required or requested • Whether the Inducement was required or requested
by the recipient. by the recipient.

• The known previous behaviour or reputation of • The known previous behaviour or reputation of
the offeror. the offeror.

Source: APESB 2022, Compiled APES 110 Code of Ethics for Professional Accountants (including Independence Standards),
APESB, Melbourne, accessed August 2023, https://apesb.org.au/wp-content/uploads/2023/05/Compiled_APES_110_Dec_2022.pdf.

There are some safeguards that can be used to ensure that any threat to fundamental principles from
inducements irrespective of their nature is either eliminated or reduced to an acceptable level. These are
outlined in table 2.14.

TABLE 2.14 Safeguards related to inducements

Members in Business (para. 250.11 A6) Members in Public Practice (para. 340.11 A6)

• Being transparent with senior management or • Being transparent with senior management of the
Those Charged with Governance of the employing Firm or of the client about offering or accepting
organisation of the Member or of the counterparty an Inducement.
about offering or accepting an Inducement.

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86 Ethics and Governance

 • Registering the Inducement in a log maintained by • Registering the Inducement in a log monitored by
the employing organisation of the Member or senior management of the Firm or another individual
the counterparty. responsible for the Firm’s ethics compliance or
maintained by the client.

• Having an appropriate reviewer, who is not otherwise
involved in undertaking the Professional Activity,
review any work performed or decisions made by the
Member with respect to the individual or organisation
from which the Member accepted the Inducement.
• Having an appropriate reviewer, who is not otherwise
involved in providing the Professional Service, review
any work performed or decisions made by the
Member in Public Practice with respect to the client
from which the Member accepted the Inducement.

• Donating the Inducement to charity after receipt and • Donating the Inducement to charity after receipt and
appropriately disclosing the donation, for example, appropriately disclosing the donation, for example, to
to Those Charged with Governance or the individual a member of senior management of the Firm or the
who offered the Inducement. individual who offered the inducement.

• Reimbursing the cost of the Inducement, such as • Reimbursing the cost of the Inducement, such as
hospitality, received. hospitality, received.

• As soon as possible, returning the Inducement, such • As soon as possible, returning the Inducement, such
as a gift, after it was initially accepted. as a gift, after it was initially accepted.

Source: APESB 2022, Compiled APES 110 Code of Ethics for Professional Accountants (including Independence Standards),
APESB, Melbourne, accessed August 2023, https://apesb.org.au/wp-content/uploads/2023/05/Compiled_APES_110_Dec_2022.pdf.

QUESTION 2.14

Toby is working with an accounting firm providing consulting services to a manufacturing client
who repeatedly offers him hospitality at the football, tennis and the cricket. The output from his
consulting services is a report that needs to be seen as independent when it is completed and
lodged with a regulator.
Describe what Toby’s response should be to the client when a representative approaches him
with an offer of hospitality at sporting events. Name the threat and fundamental principle involved.

QUESTION 2.15

Muscle Adventures Ltd is looking for a new contractor to supply its photocopiers and associated
supplies. The company’s purchasing officer, Peter, a CPA, has a key role in organising the tender
and deciding on the successful party. He has been invited out to lunch and dinner by a company
that is considering tendering for services.
What kind of threat does this invitation pose to Peter given his role in the tendering process?

Responding to Non-Compliance with Laws and Regulations (ss. 260, 360)

Members in business and in public practice may encounter or be made aware of actual or suspected
non-compliance with laws and regulations when carrying out professional activities. Members in public
practice may find non-compliance in activities undertaken by their clients while members in business
may encounter non-compliance within their own company and in the activities of companies with which
they engage.
Non-compliance in the following areas is covered by this part of the standard.
(a) Laws and regulations generally recognised to have a direct effect on the determination of material
amounts and disclosures in the employing organisation’s/client’s Financial Statements; and
(b) Other laws and regulations that do not have a direct effect on the determination of the amounts and
disclosures in the employing organisation’s/client’s Financial Statements, but compliance with which
might be fundamental to the operating aspects of the employing organisation’s/client’s business, to its
ability to continue its business, or to avoid material penalties (paras 260.3, 360.3).

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 NOCLAR deals with how members must respond when they encounter or are made aware of non-
compliance or suspected non-compliance with laws and regulations in the course of carrying out
professional activities, to ensure that they act in the public interest.
If there are laws or regulations that specify how members should deal with non-compliance or suspected
non-compliance, members have the responsibility to be aware of and comply with them.
NOCLAR provides a framework for accountants in business so that they can fulfil their responsibility
to act in the public interest when responding to non-compliance:
(a) To comply with the fundamental principles of integrity and professional behaviour;
(b) By alerting management or, where appropriate, Those Charged with Governance of the employing
organisation/client, to seek to:
(i) Enable them to rectify, remediate or mitigate the consequences of the identified or suspected
NOCLAR; or
(ii) Deter the commission of the NOCLAR where it has not yet occurred; and
(c) To take such further action as appropriate in the public interest (paras 260.4, 360.4).

Laws and regulations that are fundamental to the operations of the employing organisation or lead to
material penalties vary for each entity and context, and generally include:
• Fraud, corruption and bribery.
• Money laundering, terrorist financing and proceeds of crime.
• Securities markets and trading.
• Banking and other financial products and services.
• Data protection.
• Tax and pension liabilities and payments.
• Environmental protection.
• Public health and safety (paras 260.5 A2, 360.5 A2).

Figure 2.9 provides an example of how the NOCLAR regime works. Notice that the graphic has on the
right-hand side a solid navy bar with the word ‘documentation’. It is critical to ensure that details of
all considerations are documented because the notes and records may be required later if litigation
becomes involved.

FIGURE 2.9 Applying the NOCLAR regime

Obtain an understanding of the matter

Documentation

Address the matter

Determine whether further action is needed

Determine whether to disclose the matter to an appropriate authority

Source: CPA Australia 2023.

NOCLAR provides a different and proportionate approach for senior accountants in business and
for accountants other than those in senior positions. Accountants in business must consider established
protocols and procedures, such as ethics and whistleblowing policies, when determining how to respond
to non-compliance with laws and regulations. There are core obligations that need to be followed by senior
accountants in business and also senior accountants in practice. These are set down in sequence.

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88 Ethics and Governance

Senior Members in Business (paras 260.11 A1–260.23 A1)
Senior members are ‘Directors, Officers or senior employees’ who are ‘able to exert significant influence
over, and make decisions regarding’ the employing organisation’s resources. Their roles, positions and
influence create the expectation that they will ‘take whatever action is appropriate in the public interest
to respond to NOCLAR or suspected NOCLAR than other Members within the employing organisation’
(para. 260.11 A1).
Senior accountants or senior members in business must (paras R260.12–R260.23):
• obtain an understanding of the matter, including its nature and circumstances, the relevant laws and
regulations, and potential consequences for the employing organisation and its stakeholders; as well as
apply knowledge, professional judgement and expertise
• address the matter:
– discuss the non-compliance or suspected non-compliance with the immediate superior, or the next
hierarchical level if the immediate superior seems to be involved in it
– communicate with those charged with governance, comply with laws and regulations, rectify,
remediate or mitigate the consequences of the non-compliance, reduce risk of reoccurrence, and
deter the non-compliance from happening, if it has not already occurred
– the member must also determine whether the non-compliance needs to be communicated with the
external auditor, if any
• determine whether further action is needed:
– assess the response from superiors and those charged with governance
– determine if further action is needed in the public interest by considering factors such as the legal and
regulatory framework, the urgency and pervasiveness of the matter, confidence in the integrity of the
superiors and those charged with governance, the possibility of recurrence, evidence of substantial
harm to stakeholders, etc.
– take into account whether a reasonable and informed third party, weighing all the specific facts
and circumstances available at the time, would be likely to conclude that the member has acted
appropriately in the public interest
• determine whether to disclose the matter to an appropriate authority:
– making a disclosure to an appropriate authority is not allowed if it is contrary to law or regulation;
in all other cases, the senior member must determine whether to disclose to an appropriate authority
by considering the actual or potential harm to stakeholders. Senior accountants may determine that
disclosure to an authority is appropriate in cases such as bribery, harmful products, tax evasion,
systemic risk to the financial markets, etc.
– determine whether an appropriate authority exists, there are adequate protections from civil, criminal
or professional liability or retaliation, and there is potential for threats to safety
• document details of the matter, judgements and decisions made, responses from management and those
charged with governance, and so on.
Accountants other than Senior Members (paras R260.24–R260.26)
Accountants in business who are not in senior positions are required to obtain an understanding of the
matter and apply knowledge, professional judgement and expertise. They are also required to inform their
immediate superior about the non-compliance or suspected non-compliance, or the next hierarchical level
if the immediate superior seems to be involved in it.
In exceptional circumstances, the member may decide to disclose the non-compliance to an appropriate
authority. If a disclosure is made to an appropriate authority in line with the requirements of section 260,
this will not be considered a breach of the duty of confidentiality.
Disclosure of non-compliance with laws and regulations to an appropriate authority may be a complex
and difficult judgement. The Code of Ethics suggests that members in business may consider consulting on
a confidential basis within the employing organisation, obtain legal advice to understand options and the
professional or legal implications of taking any particular course of action; or consult a professional body.
However, in relation to disclosure of confidential information when not required by law or regulation,
the Australian-specific guidance requires accountants to seek advice before disclosing confidential
information about a client or employer without consent.

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NOCLAR for Members in Public Practice
APES 110 has guidance that differs for audits and professional services other than audits. Public
practitioners who identify or suspect non-compliance must apply the guidance in a timely manner,
they must:
• obtain an understanding of the matter
• address the matter
• determine whether further action is needed
• document details of the matter.

QUESTION 2.16

Read the relevant parts of section 360 and complete the following.
(a) Fill in the missing items in table 2.15.
(b) What difference does the presence or possibility of an ‘imminent breach’ make to the process?

TABLE 2.15 Guidance for managing non-compliance

Steps for professional services other than

Steps for audits (paras R360.10–360.28 A1) audits (paras R360.29–360.40 A1)

1. 1. Obtain an understanding of the matter

2. Address the matter 2.

3. 3. Communicate with the entity’s external auditor

4. Document the steps and outcomes 4.

5.

Source: CPA Australia 2023.

Example 2.11 highlights a situation where an accountant has become aware of non-compliance with
laws and regulations.

EXAMPLE 2.11

DDV Accounting
DDV Accounting offers accounting services to a number of small and medium enterprises. Over the past
five years it has managed the payroll for some restaurant chains and corner stores. One of its clients was
the fast-food chain Yummy Tummy. Three years ago, Yummy Tummy was audited by the relevant regulator
and found to have been underpaying its casual employees by thousands of dollars and non-compliant
with the relevant labour and employment conditions laws. DDV Accounting was informed by the regulator
and provided with information about the legal labour rates and conditions that apply in the jurisdiction.
Kath Omany, a CPA, has been working for DDV Accounting for four years. She has been responsible
for the services provided to Yummy Tummy for three and a half years. These services include managing
the chain’s payroll for its 287 employees. Kath is aware that the amounts paid to at least half of those
employees are well below the legal requirements. She became aware of this when she started providing
services to Yummy Tummy. She has not done anything about it because she did not, and does not, think
that the decisions made by her clients are her business. She believes that she is only obligated to complete
tasks requested by the client.

QUESTION 2.17

Consider example 2.11. How would you advise Kath Omany?

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90 Ethics and Governance

 QUESTION 2.18

In your jurisdiction there is no legal requirement to keep client confidentiality under a relevant law
or regulation. However, in your professional services contract and terms of engagement there is a
confidentiality clause. Considering this, answer the following questions.
• Are you required to do anything if you identify or suspect a non-compliance with laws and
regulations?
• Are you protected if you do not comply with the confidentiality clause in your client contract and
terms of engagement?

The following sections deal with the topics that are specific to members in business.

Preparation and Presentation of Information (s. 220)

Closely related to the issue of conflicts of interest is earnings and balance sheet management. Earnings
and balance sheet management consists of actions that deliberately increase or decrease reported earnings,
assets or liabilities in order to achieve a preferred outcome. The management of a company may, for
example, favour the adoption of such practices in order to mislead shareholders and other stakeholders
about the underlying economic performance of the company or to influence contractual outcomes that
depend on the published accounting information.
Accountants in business who are involved in preparing and reporting information must ensure that they:
(a) Prepare or present the information in accordance with a relevant reporting framework, where applicable;
(b) Prepare or present the information in a manner that is intended neither to mislead, nor to influence
contractual or regulatory outcomes inappropriately;
(c) Exercise professional judgement to:
(i) Represent the facts accurately and completely in all material respects;
(ii) Describe clearly the true nature of business transactions or activities;
(iii) Classify and record information in a timely and proper manner;
(d) Not omit anything with the intention of rendering the information misleading or of influencing
contractual or regulatory outcomes inappropriately;
(e) Avoid undue influence of, or undue reliance on, individuals, organisations or technology; and
(f) Be aware of the risk of bias (para. R220.4).

Accountants in business can be pressured to prepare or report information in a misleading way or to

become associated with misleading information through the actions of others. Safeguards to address such
threats or reduce them to an acceptable level include consultation with others within the firm or employing
organisation, those charged with governance, a professional body, a regulatory body or legal counsel
(para. 110.2 A2).
A member may decide to refuse to be associated with information that is misleading if attempts to
deal with various individuals within the corporate hierarchy fail (para. R220.9). Application guidance
in paragraph 220.9 A1 states that ‘it might be appropriate for a Member to resign from the employing
organisation’ depending on the circumstances. The Code also provides guidance for accountants to
document all of the relevant issues, facts, communication with parties involved in the discussions over
reporting issues and what courses of action were considered (para. 220.10 A1).
Reporting with Integrity
Accountants have long been trusted as those who assure the community of reliable and accurate financial
information. The wider community relies heavily on the work performed by accountants. People who
use the services provided by accountants, particularly decision makers relying upon financial statements,
expect accountants to be highly competent and objective. Therefore, those who work in the field of
accounting must not only be well qualified but also must possess a high degree of integrity.
The Institute of Chartered Accountants in England and Wales (ICAEW 2007) developed a frame-
work for reporting with integrity. While integrity is often associated with the ethics of the individual,
according to this framework, reporting with integrity is a joint endeavour of individuals, organisations and
the profession.
A person with integrity will then demonstrate desirable behavioural attributes that are associated with
integrity, such as being honest and compliant with the relevant laws and regulations. Overall integrity in
reporting is underpinned by ethical values such as honesty, motives such as fairness, a commitment to users,
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and qualities such as scepticism and diligence. Reporting with integrity relies on all entities (e.g. audit
firms) to take steps to promote integrity through leadership, strategy, policies, information and culture.
Example 2.12 shows an integrity breach where an intentional act of deception occurred.

EXAMPLE 2.12

Fortex
In the early nineties, New Zealand meat processor Fortex failed owing more than $130 million to creditors
and another $30 million to farmers. The managing director was jailed for 6.5 years and the financial
controller for 4 years (although this was later reduced on appeal). Both showed a distinct lack of integrity
and were convicted of fraud for:
• classifying $20 million of loans as income
• overvaluing inventory by $25 million by reclassifying lamb flaps as French cutlets
• recording $5 million of false sales.
Source: Information from Hutching, C 2017, ‘Fortex boss spills beans about jail and return to business’, Stuff,
26 September, accessed August 2023, www.stuff.co.nz/business/97120854/fortex-boss-spills-beans-about-jail-time-and-
return-to-business.

QUESTION 2.19

Explain why integrity is an essential attribute of the profession.

Acting with Sufficient Expertise (s. 230)

The requirement to act with sufficient expertise is linked closely to the fundamental principle of profes-
sional competence and due care. A member shall ‘only undertake significant tasks for which the Member
has, or can obtain, sufficient training or experience’ (para. 230.3 A1). Furthermore, ‘A Member shall
not intentionally mislead an employing organisation as to the level of expertise or experience possessed’
(para. R230.3).
Potential threats include having insufficient time to properly perform or complete relevant duties, and
having insufficient experience, training and/or education (para. 230.3 A2). Safeguards include obtaining
additional training, ensuring that there is adequate time available for performing the relevant duties, and
obtaining assistance from someone with the necessary expertise (para. 230.3 A4).

QUESTION 2.20

James Chan is a sole practitioner specialising in audit services. James has become interested in
assurance services for the elderly. He recently attended a presentation on care services for the
elderly and believes that this new assurance service will differentiate him from other practitioners
in the area and, therefore, offers a means to attract more clients.
James has placed a series of advertisements in the local press. The advertisements state that he
can provide expert reports to assure family members that proper care is provided to elderly family
members who are no longer totally independent.
Although James has no previous experience or training in this area, he believes that he can carry
out the work using traditional audit skills.
(a) What is the threat here and which principles are threatened?
(b) Advise James on how to address this threat.

Pressure to Breach Fundamental Principles (s. 270)

Section 270 of APES 110 details the pressures that individuals may be subjected to in the workplace or
as a part of an engagement to breach one or more of the fundamental principles. The standard requires
members not to allow pressures from others to result in breaches of the fundamental principles, and not to
pressure others in a way that could result in a person breaching one or more of the fundamental principles.

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92 Ethics and Governance

 The standard identifies three key sources of potential pressure to behave inappropriately that might be
applied to an individual. These sources, which may apply explicit or implicit pressure, are:
• Within an employing organisation, for example, from a colleague or superior.
• An external individual or institution such as a vendor, customer or lender.
• Internal or external targets and expectations (para. 270.3 A1).

The last category can include key performance indicators that employees must meet in order to receive
certain bonuses or rewards. Sales targets, such as those that were the subject of questions put to banks
during the Hayne Royal Commission during 2018, are an example of this kind of internal pressure.
One issue to keep in mind when discussing pressures to breach fundamental principles is the context of
the ethical guidance to which we are referring. It must be a member who is pressuring or being pressured
in order for this to be considered a threat under APES 110.

QUESTION 2.21

Please read s. 270 of APES 110 and answer these questions.

A senior manager is pressuring you (a junior accountant) to pay invoices for expenses that she
has signed off on but that you know are not work related.
(a) What type of threat is this?
(b) What should you do?

The following sections deal with the topics that are specific to members in public practice.

Professional Appointments (s. 320)

When a member in public practice is approached by a potential client, acceptance of the client should
not be granted automatically. The member must consider a number of issues before accepting a new
client. In particular, they must consider whether acceptance would create any threats to compliance
with the fundamental principles. For example, ‘client involvement in illegal activities [such as money
laundering], dishonesty, questionable financial reporting practices or other unethical behaviour’ could
threaten a member’s compliance with integrity and professional behaviour (para. 320.3 A1). Likewise,
a member may be approached by a potential client to undertake tasks for which the member has neither
experience nor knowledge. In this circumstance, a self-interest threat to professional competence and due
care arises because the member does not possess the competencies necessary to properly carry out the
engagement (para. 320.3 A3).
The Code of Ethics outlines factors to take into account when evaluating a threat. These include:
• acquiring an appropriate understanding of the nature of the client’s business, the complexity of its
operations, the specific requirements of the engagement and the purpose, nature and scope of the work
to be performed
• knowledge of relevant industries or subject matter
• experience with relevant regulatory or reporting requirements
• assigning sufficient staff with the necessary competencies
• using experts where necessary
• agreeing on a realistic time frame for the performance of the engagement
• complying with the system of quality management designed to provide reasonable assurance that
specific engagements are accepted only when they can be performed competently (paras 320.3 A2,
320.3 A4).
Communication
It has long been considered a matter of etiquette for a proposed successor to communicate with their
predecessor before accepting a professional appointment. This communication provides the proposed
successor accountant with the opportunity to identify whether there are professional reasons why the
appointment should not be accepted. For example, reasons could include intimidation threats where the
predecessor was placed under undue pressure to act in a way that was illegal and/or unethical.

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 In the case of an audit of financial statements, paragraph R320.8 requires that a member requests:
. . . the Existing or Predecessor Accountant to provide known information regarding any facts or other
information of which, in the Existing or Predecessor Accountant’s opinion, the Member needs to be aware
before deciding whether to accept the engagement. Except for the circumstances involving NOCLAR or
suspected NOCLAR set out in paragraphs R360.21 and R360.22:
(a) If the client consents to the Existing or Predecessor Accountant disclosing any such facts or other
information, the Existing or Predecessor Accountant shall provide the information honestly and
unambiguously; and
(b) If the client fails or refuses to grant the Existing or Predecessor Accountant permission to discuss
the client’s affairs with the Member in Public Practice, the Existing or Predecessor Accountant shall
disclose this fact to the Member, who shall carefully consider such failure or refusal when determining
whether to accept the appointment.
Similarly, there may be a threat to professional competence and due care if an accountant accepts the
engagement before knowing all the facts regarding the client’s business. Thus, the matter becomes one of
competence, integrity and objectivity.
One problem inhibiting effective communication is that existing accountants are bound by the principle
of confidentiality. The extent to which the existing accountant can and should discuss the affairs of a
client with a proposed successor will ultimately depend on whether the client has granted permission
to do so, as well as the legal or ethical requirements relating to such communications and disclosure.
Circumstances where disclosure of confidential information is required or may otherwise be appropriate
are set out in an earlier section of the framework on confidentiality. Generally, a member will need to
obtain the client’s permission, preferably in writing, to communicate with the existing or predecessor
accountant (para. 320.5 A1). The existing or predecessor accountant must provide information ‘honestly
and unambiguously’ (para. R320.7) and should do so only with the client’s permission (para. R320.7 A1)
or under the circumstances set out in paragraph 114.1 A1 (para. 320.7 A2).
Referrals
Referrals occur when a client requires specialist advice in an area that is beyond the competence of their
existing accountant. In this case, the member or the client should engage another accountant with the
required expertise. A referral should not be seen as an invitation for the accountant who has received the
referred special assignment to ‘take over’ the client. The established relationship between the referring
accountant and the client is maintained.
The underlying issue with referrals is one of professional competence. Knowing the extent of one’s
own skills and when the skills of a more qualified expert are required is closely linked to the principle of
professional competence.
Second Opinions (s. 321)
Seeking a second opinion is common in many professions. In an accounting setting, problems may arise
when a client who is dissatisfied with the original opinion on an accounting transaction seeks alternative
opinions from other accountants. This practice, colloquially referred to as ‘opinion shopping’, occurs when
the client seeks alternative opinions until they succeed in obtaining an opinion favourable to their position.
When this occurs, the client may use this opinion to place pressure on the existing accountant to adopt the
alternative opinion favourable to the client or risk losing the client.
When a member is asked to provide a second opinion, the member should seek permission from the
client to contact the existing accountant and discuss the transaction in question to ensure that the member
provides a fully informed second opinion If the client refuses the member permission to communicate
with the existing accountant, the member should consider whether it is appropriate to provide a second
opinion (para. R321.4). In providing a second opinion, as safeguards, the member should clearly inform
the client about limitations surrounding any opinion and also provide the existing accountant with a copy
of the opinion (para. 321.3 A3).

Reviewing Engagements Within a Practice (s. 325)

Careful thought needs to go into the appointment of an engagement quality reviewer so that threats to
objectivity are not created. Threats might arise include (para. 325.6 A1):
• self-interest — two partners reviewing each other’s work
• self-review — reviewing an engagement for which the reviewer was the engagement partner
• familiarity — reviewing an engagement where those engaged in the engagement are immediate family
members or have a close relationship with the reviewer
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• intimidation — reviewing an engagement when the reviewer is in a direct reporting line to the
engagement partner.
These threats can be addressed by assigning a different reviewer, reassignment of reporting lines
(para. 325.8 A1) or allowing a sufficient cooling off period before a participant in an engagement can
be appointed as a reviewer (para. 325.8 A2).

Custody of Client Assets (s. 350)

Unless permitted by law, accountants should not assume custody of client monies or other assets. Where
an accountant has been entrusted with money, they should make sure this is kept separate from other assets
and should only be used for its intended purpose (para. R350.3).

QUESTION 2.22

Using your understanding of the Code as it presently stands, answer the following.
• Does the Code of Ethics require a member in business to actively look for any noncompliance
with laws and regulations in the employing organisation?
• Does it require accountants to know laws and regulations that are not related to their role
and responsibilities?

PART 4 OF THE CODE — APPLYING THE CONCEPTUAL

FRAMEWORK IN THE CONTEXT OF AUDIT, REVIEW AND
ASSURANCE ENGAGEMENTS
Audit, review and assurance engagements receive individual, special treatment in the Code because of the
need to ensure that these engagements are conducted in an environment where auditors and other assurance
professionals provide independent perspectives on a set of facts. The area of audit independence is taken
seriously by the profession and all members are expected to understand the underlying principles that drive
the need to ensure any audit, review or assurance report or opinion is seen as being done by professionals
who are independent of the client.
Independence is a fundamental component of complying with the fundamental principles of integrity
and objectivity. The conceptual framework in APES 110 requires members involved in audit, review and
assurance engagements to ensure that any threats to independence are either eliminated or reduced to an
acceptable level using safeguards as outlined in the previous section. There are circumstances in which
specific threats can only be dealt with by declining or withdrawing from a particular professional activity
or engagement.

Definition of Independence
The Code defines independence as being linked to both objectivity and integrity. It comprises:
(a) Independence of mind — the state of mind that permits the expression of a conclusion without being
affected by influences that compromise professional judgement, thereby allowing an individual to act
with integrity, and exercise objectivity and professional scepticism.
(b) Independence in appearance — the avoidance of facts and circumstances that are so significant that a
reasonable and informed third party would be likely to conclude that a Firm’s or an Audit or Assurance
Team member’s integrity, objectivity or professional scepticism has been compromised (Glossary,
APES 110).

The Code of Ethics treats independence as a significant concern for accountants and there are two
sections in the Code that deal with independence in the context of specific engagements.
Part 4A deals with independence of audit and review engagements while Part 4B deals with indepen-
dence in the context of assurance engagements other than audit and review engagements. While you are
not expected to know this section in detail for examination purposes, it is important that you understand
the underlying principles embedded within these two sections of the Code of Ethics.
Parts 4A and 4B of the Code are comprehensive in their coverage of a range of independence-related
matters. It is not a requirement to print the whole section on independence. Parts 4A and 4B cover the
topics that appear in table 2.16.
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MODULE 2 Ethics 95
 TABLE 2.16 Independence topics for public practice

Part 4B: Independence topics for assurance

Part 4A: Independence topics for audit and engagements other than audit and
review engagements review engagements

Section Topic Section Topic

410 Fees 905 Fees

411 Compensation and evaluation policies 906 Gifts and hospitality

420 Gifts and hospitality 907 Actual or threatened litigation

430 Actual or threatened litigation 910 Financial interests

510 Financial interests 911 Loans and guarantees

511 Loans and guarantees 920 Business relationships

520 Business relationships 921 Family and personal relationships

521 Family and personal relationships 922 Recent service with an assurance client

522 Recent service with an audit client 923 Serving as a director or officer of an
assurance client

523 Serving as a director or officer of an 924 Employment with an assurance client

audit client

524 Employment with an audit client 940 Long association of personnel with an
assurance client

525 Temporary personnel assignments 950 Provision of non-assurance services to

assurance clients

540 Long association of personnel (including 990 Reports that include a restriction
partner rotation) with an audit client on use and distribution (assurance
engagements other than audit and
review engagements)

600 Provision of non-assurance services to an

audit client

601 Accounting and bookkeeping services

602 Administration services

603 Valuation services

604 Tax services

605 Internal audit services

606 Information technology systems services

607 Litigation support services

608 Legal services

609 Recruiting services

610 Corporate finance services

800 Reports on special purpose financial

statements that include a restriction on
use and distribution (audit and
review engagements)

Source: Adapted from APESB 2022, Compiled APES 110 Code of Ethics for Professional Accountants (including Independence
Standards), APESB, Melbourne, accessed August 2023, https://apesb.org.au/wp-content/uploads/2023/05/Compiled_APES_110_
Dec_2022.pdf.

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96 Ethics and Governance

Special Purpose Financial Statements (ss. 800, 990)
A substantial section in the Code contains guidance applicable for members who are dealing with special
purpose financial statements. Special purpose financial statements are ‘prepared in accordance with
a financial reporting framework designed to meet the financial information needs of specified users’
(Glossary, APES 110). They may not comply with accounting standards. The provisions (ss. 800, 990)
modify the rest of the independence provisions in Parts 4A and 4B. At this point, it is sufficient to
understand that audit, review or assurance reports prepared for these special purpose financial statements
will include a restriction on use and distribution, and that the intended users of the reports need to be told
about modified independence requirements that may apply. Users must also be told and understand the
purpose and limitations of such reports, and explicitly agree to the application of any modifications to
independence requirements.

Audit and Review Engagements

Independence
Independence is especially relevant to members in public practice who provide audit and review services.
Auditor independence is critical to the credibility and reliability of an auditor’s reports and public
perceptions of the profession. In fact, financial reports audited by accountants may appear to lack integrity
if the professionals involved have failed to maintain independence.
The concept of independence is so important and ingrained that it is often regarded as the cornerstone on
which much of the ethics particular to the audit profession is built. The entire rationale for the profession of
public accounting rests on the foundation of integrity, of which independence is an important part. Cottell
and Perlin (1990) remind us that independence should be considered of utmost importance if the profession
is to maintain the confidence of the public.
Debate about [independence] … will continue if the profession is to be viable, for such a debate is an
indicator of ethical health … Perhaps the greatest danger to the profession lies in potential apathy toward
independence. If the public and its representatives were ever to perceive that independence was a sham, the
profession would likely be swept away like a sand castle before the tides (Cottell & Perlin 1990, p. 40).

In general, independence is equated with an attitude of objectivity (no bias, impartiality) and integrity
(honesty). This means adherence to the principles of integrity and objectivity is possible when indepen-
dence is achieved. According to this relationship, being independent, both in appearance and reality, will
assist in satisfying the principles of integrity and objectivity. Conversely, a breach of integrity or objectivity
may result when independence is lost.

QUESTION 2.23

Make a note of the definition of independence as it appears in APES 110 and write down the
fundamental principles with which independence is closely associated.

Being independent means that one is not only unbiased, impartial and objective but is also perceived
to be that way by third parties. Independence in appearance is the avoidance of facts and circumstances
where a reasonable and informed third party, having knowledge of all relevant information, including
any safeguards applied, would reasonably conclude that the accountant’s integrity or objectivity has
been compromised. While independence is applicable to all accounting professionals, independence is
especially important for members in public practice.
The rules pertaining to independence for members in public practice who perform audits are detailed
and technical. There are a large number of areas in which independence threats can emerge. CPA Australia
has produced a checklist (figure 2.10) to assist in determining whether the firm in which they are employed
complies with the independence rules, regulations and interpretations of CPA Australia and relevant
statutory bodies. Have another look at the list of topics in table 2.16. You will notice that the checklist
in figure 2.10 is a concise summary of the key areas that the ethical standard covers and appear in
table 2.16. The checklist is one method used to check whether employees comply with the guidance set
down in APES 110.

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MODULE 2 Ethics 97
 QUESTION 2.24

Reflect on each of the questions in the checklist in figure 2.10 and note which of the fundamental
principles you believe are breached by a member if they fail to respond in the negative to those
questions in the form.

FIGURE 2.10 Independence checklist for employees (to be used ANNUALLY in conjunction with the
employee review)

Name of employee: Office:

Completion of this form provides data for determining that the practice is complying with the independence rules,
regulations and interpretations of CPA Australia and any relevant statutory bodies.
Yes† No
❑ ❑ Do you have a direct or indirect material financial interest in a client or its subsidiaries/affiliates?
❑ ❑ Do you have a financial interest in any major competitors, investees or affiliates of a client?
❑ ❑ Do you have any outside business relationship with a client or an officer, director or principal shareholder
having the objective of financial gain?
❑ ❑ Do you owe any client any amount, except as a normal customer, or in respect of a home loan under
normal lending conditions?
❑ ❑ Do you have the authority to sign cheques for a client, or make electronic payments on their behalf?
❑ ❑ Are you connected with a client as a promoter, underwriter or voting trustee, director, officer or in any
capacity equivalent to a member of management or an employee?
❑ ❑ Do you serve as a director, trustee, officer or employee of a client?
❑ ❑ Has your spouse or minor child been employed by a client?
❑ ❑ Has anyone in your family been employed in any managerial position by a client?
❑ ❑ Are any billings delinquent for clients that are your responsibility?
❑ ❑ Have you received any benefits such as gifts or hospitality from a client, that are not commensurate with
normal courtesies of social life?
❑ ❑ Are there any other independence issues that you believe are relevant to disclose?

I have read the Independence Policy of the practice, and professional standards related to independence, and I
believe I understand them. I am in compliance except for the matters listed below.

Arrangements made to dispose of above exceptions to comply with policies:

† Note:
If you answered ‘YES’ to any of the answers above, please also complete the Independence Resolution
Memorandum.

Signature of employee: Date:

Signature of employer: Date:

Source: CPA Australia 2022, ‘Independence checklist for employees’, CPA Australia, accessed August 2023, www.
cpaaustralia.com.au/-/media/project/cpa/corporate/documents/public-practice/my-firm-my-future/supporting-your-people/
independence-checklist-for-employees.docx.

Specific Areas of Concern for Audit and Review Engagements

Part 4A of the Code sets down ways in which members in public practice are able to manage independence
threats. Table 2.17 covers the most common threats and the way in which the Code asks members in public
practice to deal with them.

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98 Ethics and Governance

 Common threats to independence and relevant safeguards — audit and
TABLE 2.17 review engagements
Circumstance
Fees — large amounts in
fees from a specific client
Compensation and
evaluation policies — selling
non-assurance services to
an audit client
Gifts and hospitality
Actual or
threatened litigation
Financial interest in client
Loans and guarantees
Close business relationships
with clients
A family and personal
relationship between a
member of the audit team
and an officer of the client
Recent service with an
audit client
Serving as a director or
officer of an audit client
Employment with an audit
client — former partner of
team member joins an
audit client
Pdf_Folio:99
Section Threat(s) Safeguard(s)
410 Self-interest or Reduce fee dependence on specific
intimidation clients by growing the client base.
411 Self-interest Revise the compensation plan for the
audit team member that has a
selling obligation.
Remove the individuals from the
audit team.
420 Self-interest, familiarity Reject gifts and hospitality offered to
or intimidation audit team members unless they are
trivial and inconsequential.
430 Self-interest and Remove any audit team member that
intimidation may be involved in the litigation.
Have work reviewed by an
appropriate individual.
510 Self-interest Depending on the role of the person
holding the financial interest, the
materiality and type of
financial interest:
• remove the audit team member, or
remove the audit team member from
significant decision making
• have an appropriate reviewer review
the work
• dispose of the financial interest.
511 Self-interest Do not make or guarantee loans to
audit clients.
Reject loans or guarantees of a loan
from banks or institutions that are audit
clients unless they are made under
normal lending procedures, terms
and conditions.
Have work reviewed by an appropriate
reviewer who is not working for the firm
or network firm that is the beneficiary of
the loan.
520 Self-interest and In circumstances where the interest
intimidation is material or the relationship is not
insignificant, no safeguard can reduce
the threat to an acceptable level.
521 Self-interest, familiarity A wide spectrum of safeguards is
and intimidation available in this section.
522 Self-interest, familiarity Have work reviewed by an
and intimidation appropriate reviewer.
523 Self-review and The Code prohibits involvement on
self-interest company boards or the appointment as
a company secretary.
524 Self-interest, familiarity Modify the audit plan.
or intimidation Appoint audit team members who
have a similar level of experience to
the former audit team member.
Have a suitable individual review the
former audit team member’s work.
(continued)
MODULE 2 Ethics 99
 TABLE 2.17 (continued)

Circumstance Section Threat(s) Safeguard(s)

Temporary personnel 525 Self-review, advocacy Conduct an additional review of

assignments — secondment
or loaning of audit personnel
or familiarity the work performed by the
loaned personnel.
Exclude the loaned personnel from the
audit team.
Do not give the loaned personnel audit
responsibility for any function or activity
that the personnel performed during
the loaned personnel assignment.

Long association of
personnel (including partner
rotation) with an audit client
540 Familiarity or self-interest Change the role of the individual on the
audit team or the nature and extent of
the tasks the individual performs.
Have an appropriate reviewer who was
not an audit team member review the
work of the individual.
Perform regular independent internal
or external quality reviews of
the engagement.

Source: CPA Australia 2023.

Provision of Non-Assurance Services to an Audit Client (ss. 600–610)

The provision of non-assurance services (which include all services that do not constitute assurance or
audit services) to audit clients is an activity that often provides additional value for an audit client. Audit
clients benefit from the non-assurance services provided by their audit firms, which have an intimate
understanding of the client’s business.
However, the provision of non-assurance services to an audit client may also create real or perceived
threats to independence They can also create self-review, self-interest and advocacy threats. For example,
when a client asks its audit firm to prepare the original books of entry, a self-review threat is created
because the audit team is placed in a position where it will audit its own work. In this situation, the auditor
theoretically can alleviate this self-review threat by making arrangements so that the personnel providing
accounting services do not participate in the assurance engagement.
In all circumstances, before accepting an engagement to provide a non-assurance service to an
audit client, paragraph R600.4 of the Code requires the firm to determine whether there is a threat to
independence posed by the proposed service offering.

QUESTION 2.25

Based on your reading so far, reflect on why you think the accounting professional believes certain
non-audit services create a threat to independence.

Assurance Engagements
Assurance services are related to services provided by members that provide users of specific reports or
information with confidence that the information is accurate. There is a similar framework in place for
dealing with threats to the fundamental principles in the Code. Firms conducting assurance engagements
are required to be independent and they are required to apply the conceptual framework set out in
section 120 of the Code. Firms must identify, evaluate and address or treat independence threats in
a similar fashion to other threats described in the Code. Table 2.18 outlines some of the common threats
and safeguards.

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100 Ethics and Governance

 TABLE 2.18 Threats to independence and safeguards — assurance engagements

Circumstance Section Threat(s) Safeguard(s)

Fees 905 Self-interest Reduce the extent of services other than assurance
and possibly services provided to the client.
intimidation Increase the client base of the partner to reduce
dependence on the assurance client.
Have an appropriate reviewer who was not an
assurance team member review the work.

Gifts and hospitality 906 Self-interest, Reject gifts and hospitality from an assurance client
familiarity or unless the value is trivial and inconsequential.
intimidation

Actual or 907 Self-interest or Consider materiality of litigation and whether the

threatened litigation intimidation litigation relates to prior assurance engagements.
Remove the team member involved in the litigation
from the assurance team.

Financial interests 910 Self-interest Various safeguards and measures are outlined in the
Code for different kinds of financial interests.

Loans and guarantees 911 Self-interest Unless immaterial to both the firm and team
members, do not make or guarantee a loan for an
assurance client.
Do not accept loans or guarantees from a bank
assurance client unless they are made under normal
lending procedures, terms and conditions.

Business relationships 920 Self-interest or Close business relationships are not acceptable
intimidation unless the financial interest is immaterial or the
relationship is insignificant to both parties.
Eliminate or reduce the size of the transaction
involving the assurance team member.
Remove the individual from the assurance team.

Family and 921 Self-interest, Restructure activities so that an assurance team

personal relationships intimidation or member is not dealing with issues that are the
familiarity responsibility of the person with whom an assurance
team member has a close relationship.
Remove the individual from the assurance team.

Recent service with 922 Self-interest, Exclude someone who was employed as a director or
an assurance client self-review or officer of the client from the assurance team.
familiarity Have an appropriate reviewer review the work
performed by an assurance team member.

Serving as a director 923 Self-review and The Code prohibits serving as a director or officer.
or officer of an self-interest Guidance is also provided in the Code regarding
assurance client serving as a company secretary.

Employment with an 924 Self-interest, Various provisions apply depending on the previous
assurance client familiarity or role held and the new role within the assurance
intimidation client’s organisation. Refer to the Code for
more information.

Long association of 940 Familiarity or Change the role of the individual on the assurance
personnel with an self-interest team or the nature and extent of the tasks the
assurance client individual performs.
Have an appropriate reviewer who was not an
assurance team member review the work of
the individual.
Perform regular independent internal or external
quality reviews of the engagement.

(continued)

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MODULE 2 Ethics 101

 TABLE 2.18 (continued)

Circumstance Section Threat(s) Safeguard(s)

Provision of non- 950 Various The Code provides guidance to members that relate
assurance services to to the provision of non-assurance services to clients.
assurance clients Refer to the Code for more information.

Source: CPA Australia 2023.

It is essential to read section 950 in its entirety so that you fully understand the ramifications of the
provision of certain non-assurance services where a practice is providing assurance services to a client.
Example 2.13 shows the problems relating to providing non-audit services to audit clients and a
preoccupation with profit.

EXAMPLE 2.13

Arthur Andersen
Throughout the 1990s, accounting firms, including Arthur Andersen, offered consulting services along
with traditional auditing services, and discovered that consulting work was often more profitable. Critics
argue that the two services are incompatible as auditors verify and communicate to users the accuracy of
company reports, but, as the auditors were providing consulting services, they would be checking their
own work. Auditors must be independent of their clients, and consulting enmeshes them in their clients’
business in ways that compromise independence (Aronson 2002).
During the 1990s the firm separated into two units, Arthur Andersen and Andersen Consulting (known as
Andersen Worldwide). In 1996, Steve Samek ‘became the firm’s world-wide head of auditing, with indirect
responsibility for 40 000 people’. In the spring of 1998, he headed Arthur Andersen’s US operations, which
accounted for about half of the firm’s revenue. Mr Samek gave rousing speeches designed to inspire the
auditors to sell to their clients everything from tax services to consulting work (Brown & Dugan 2002).
Meanwhile, Andersen Consulting more than doubled its revenue to USD3.1 billion, ‘bringing in 58% of
the overall firm’s revenues, and subsidizing the accountants to the tune of about $150 million a year’. In
1997, Andersen Consulting partners ‘voted unanimously to split off entirely’ (Brown & Dugan 2002) and
changed its name to Accenture.
Arthur Andersen and Enron
According to reports, Enron paid Arthur Andersen USD52 million in 2000. More than 50 per cent
(USD27 million) came from consulting services. Consequently, traditional auditing services, compared
to consulting, became less and less profitable and, unfortunately, seemingly less and less important to
the firm.
Embroiled in the multi-billion-dollar bankruptcy of Enron, Arthur Andersen shared with its client the
accusation of not fully disclosing Enron’s financial position to investors. In the lead-up to pending
enquiries, Arthur Andersen destroyed (by shredding) a significant number of documents relating to the
Enron audit.
On 15 June 2002, Arthur Andersen was convicted of obstruction of justice for shredding documents
related to its audit of Enron. The firm ultimately lost its right to practice.
Arthur Andersen’s greatest foe was not the courts, but market forces and public perceptions (Simpson
2002). This included the termination of merger talks between Arthur Andersen and another major
accounting firm. Clients terminated their relationship with Arthur Andersen and many employees resigned.
The market and public imposed the ultimate penalty on Arthur Andersen, hastening its implosion in 2001
(Simpson 2002). On 31 May 2005, the Supreme Court of the United States unanimously overturned Arthur
Andersen’s conviction, due to flaws in the jury instructions. By this time it was too late for Arthur Andersen.

QUESTION 2.26

Consider example 2.13.

(a) Describe Arthur Andersen’s organisational culture and explain how the firm’s culture may have
contributed to its downfall.
(b) Explain why the provision of non-auditing services to an audit client may compromise the
auditor’s independence. In your answer, list two threats to the audit and explain why they
are threats.
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102 Ethics and Governance

 (c) List the safeguards that Arthur Andersen might have employed to reduce the threat to an
acceptable level.
(d) Explain how Arthur Andersen failed to act according to the public interest principle.

2.10 EXAMPLES OF ETHICAL FAILURES

BY ACCOUNTANTS
This section highlights examples of accountants in business and public practice who have failed to comply
with the fundamental principles of the Code. Examples 2.14, 2.15 and 2.16 illustrate the actions of
CPA Australia’s Disciplinary Tribunal in response to member breaches of the fundamental principles.

EXAMPLE 2.14

Sonya Denise Causer (August 2010)

Member in Business (Integrity, Professional behaviour)
On 19 August 2010, Sonya Denise Causer, aged 39 years, was sentenced in the Supreme Court of Victoria
after pleading guilty to stealing $19 million from her previous employer, Clive Peeters Ltd. Causer was
sentenced to eight years’ jail with a non-parole period of five years (i.e. she must serve a minimum five
years). Approximately $16 million of the funds stolen have been recovered. The fraud was detected by a
routine audit.
In March 2006, Causer commenced employment as a Senior Financial Accountant with Clive Peeters,
a publicly listed whitegoods and electrical retailer. Between July 2007 and July 2009, Causer deceptively
recorded in the company’s electronic accounts 125 individual payments totalling $19 million, with the
funds paid to eight bank accounts controlled by Causer. Causer would alter the payee details for a
particular transaction, substituting the number of a bank account she controlled in place of the genuine
bank account. To conceal the thefts, Causer manipulated the online banking records, general ledger and
management reporting.
On 14 September 2011 the CPA Australia Disciplinary Tribunal imposed the following penalties and
costs against Causer:
• forfeiture of Accountantship
• non-eligibility for readmission for 30 years
• a fine of $100 000
• costs of $464.
Source: Adapted from R v. Causer (2010) VSC 341, Supreme Court of Victoria, 19 August; Butler, B 2010, ‘ITL revises
hire policy after fake CV’, The Age, 14 August; CPA Australia 2011, ‘Sonya D Causer’, 14 September, accessed August
2023, www.cpaaustralia.com.au/about-cpa-australia/governance/member-conduct-and-discipline/outcomes-of-disciplinary-
hearings/2011/sonya-d-causer.

EXAMPLE 2.15

Trevor Neil Thomson (May 2010)

Member in Public Practice (Integrity, Objectivity, Professional Behaviour)
On 13 May 2010, Trevor Neil Thomson, a Perth accountant, was sentenced in the Supreme Court of
Western Australia after pleading guilty to having conspired with others to evade paying approximately
$27 million in tax. Thomson was sentenced to 13 months’ jail. Judge McKechnie said, ‘The Australian
Income Tax Assessment scheme depends upon the honesty of all involved. It particularly depends on the
honesty of thousands of tax agents who assist their clients to meet their lawful obligations. Your actions
are a blight on thousands of honest accountants. You were an accountant trusted not only by your clients
but also by the tax office to be scrupulous in your dealings at all times’.
The Executive Director of the Australian Crime Commission, Michael Outram, said, ‘Through the use of
false documents, Mr Thomson deliberately attempted to hide profits generated by his clients’ businesses
and knowingly misled the Australian Government, to ensure his clients did not pay their required tax’.
Source: Adapted from R v. Thomson (2010) QCA 191, Sentencing remarks of McKechnie, J 2010, Supreme Court of Western
Australia, 13 May (WASC INS 172 of 2009); ABC News 2010, ‘Jail for $30 M fraud’, 13 May, accessed August 2023,
www.abc.net.au/news/2010-05-13/jail-for-30m-fraud/434568.

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MODULE 2 Ethics 103

 EXAMPLE 2.16

Warren Sinnott (June 2014)

Member in Public Practice (Objectivity, Professional Competence and Due Care,
Professional Behaviour)
Warren Sinnott, a member of CPA Australia, was the lead auditor responsible for the audits of companies
in the Banksia group of companies (Banksia) for the accounting periods between 31 December 2008 and
30 June 2012. Sinnott signed unqualified audit opinions in respect of Banksia.
Banksia was based in regional Victoria and was involved in raising money from the public by issuing
debentures and lending the funds raised to third-party borrowers for property investment and development
purposes. Banksia was able to raise approximately $663 million from 15 000 investors by 25 October
2012. On that date Banksia was placed into receivership following concerns that it was insolvent or likely
to become insolvent.
ASIC found that Sinnott did not conduct the audits in accordance with the Australian Auditing Standards.
In relation to each audit ASIC formed the view that Sinnott failed, among other things, to:
• perform sufficient audit procedures in relation to loan receivables and obtain sufficient appropriate
audit evidence to reduce the risk of material misstatement of loan receivables to an acceptably
low level
• display an appropriate level of professional scepticism when auditing the valuation of, and
provision for, impairment of loans receivable, and adequately document his conclusion about the
reasonableness of the provision for impairment
• remain alert through the audits that the risk of the potential impairment of loan receivables may
cast doubt over Banksia’s ability to continue as a going concern
• take responsibility for the overall quality of the audit and provide an appropriate level of supervision
and review
• appropriately conclude that he had obtained reasonable assurance to form an appropriate opinion
on the financial report.

On 11 June 2014, ASIC accepted an undertaking from Warren Sinnott, a registered company auditor,
that he would not practise as an auditor for five years.
Source: Adapted from ASIC 2014, ‘ASIC suspends former Banksia auditor for five years’, media release, accessed
August 2023, https://asic.gov.au/about-asic/news-centre/find-a-media-release/2014-releases/14-127mr-asic-suspends-
former-banksia-auditor-for-five-years.

SUMMARY
The Compiled APES 110 Code of Ethics for Professional Accountants (including Independence Standards)
is the ethical framework for members of the accounting profession. The Code of Ethics:
• outlines fundamental principles of ethical professional behaviour
• lists the key threats to fundamental principles
• provides instances of guidance for specific common circumstances
• includes a conceptual framework that sets down a process by which members should deal with ethical
dilemmas that emerge throughout their professional and personal lives.
The inclusion of a conceptual framework avoids the need for volumes of rules to try to accommodate
every possible ethical issue that may arise.
Independence, which is defined as being both independence of mind and independence in appearance, is
handled in Parts 4A and 4B of the Code as it impacts on audit and review engagements and other assurance
engagements respectively. This guidance is provided to ensure that members in public practice are able
to resolve possible threats to the fundamental principles of integrity and objectivity. An independent
perspective on a set of financial statements, or a specific set of facts in the case of an assurance project, is
what the member in practice is being paid to provide. Breaches of the fundamental principles can lead to
the work done by members in public being perceived to be compromised.
The key points covered in this part, and the learning objective they align to, are as follows.

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104 Ethics and Governance

 KEY POINTS

2.3 Apply the Compiled APES 110 Code of Ethics for Professional Accountants (including
Independence Standards).
• APES 110 is the ethical standard for accounting professionals in Australia.
• APES 110 is based on the international equivalent code that is issued by IFAC.
• By applying the Code of Ethics to their decisions and actions, professional accountants will be
acting in the public interest.
• The Guide at the beginning of APES 110 instructs the professional accountant on how the Code
should be read and used.
• Part 1 of APES 110 reflects the profession’s recognition of its public interest responsibility, setting
out five fundamental principles for ethical conduct: integrity; objectivity; professional competence
and due care; confidentiality; and professional behaviour.
• Part 1 of APES 110 also includes a conceptual framework that provides a process for making ethical
decisions in any situation. The conceptual framework is made up of three steps: identifying threats,
evaluating threats, and addressing threats.
• Parts 2 and 3 of APES 110 set out ethical requirements for members in business and members in
public practice respectively, including guidance and safeguards to apply to specific circumstances
that members may commonly face.
• Part 2 of APES 110 provides guidance on ethical issues facing members in business related to:
conflicts of interest; preparation and presentation of information; acting with sufficient expertise;
financial interests, compensation and incentives linked to financial reporting and decision making;
inducements; responding to NOCLAR; and pressure to breach the fundamental principles.
• Part 3 of APES 110 provides guidance on ethical issues facing members in public practice
related to: conflicts of interest; professional appointments; second opinions; fees and other types
of remuneration; inducements; quality reviewers; custody of client assets; and responding to
NOCLAR.
• Parts 4A and 4B of APES 110 deal with the requirement for independence in audit, review and other
assurance engagements where a client is seeking an independent perspective.
• Special purpose reports may be subject to modified independence requirements. Users of the
reports must be told about, understand and agree to those modifications.

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MODULE 2 Ethics 105

PART D: ETHICAL DECISION MAKING
INTRODUCTION
Ethical frameworks and ethical standards do not exist in a vacuum. They are intended to be applied or
used as guidance for those seeking a way to make decisions in complex or challenging circumstances.
Figure 2.11 highlights the various factors that influence decision making. Most decisions are influenced
predominantly by an individual’s cognitive processes (the reasoning used in making a decision). How-
ever, other factors also have an influence. Additional individual variables such as situational variables
(e.g. societal, professional and organisational) interact with the cognitive component to determine how an
individual is likely to behave in response to an ethical dilemma.
We can see from figure 2.11 that, although we attempt to take a disciplined and rational approach to
decision making, it is strongly affected by many things. The more we are aware of these influences, the
more we consider them as part of the decision-making process, to make sure they do not have a negative
effect. In the centre we have our individual influences, which will include our character and past experience,
and these will then be strongly influenced by the organisation we are working within.
In general, the intensity with which these variables affect decision making is directly related to their
proximity to the individual, as appears in figure 2.11. For example, organisational values exert a more
intense influence on decision making than do professional values. Understanding these influences will
help professional accountants identify factors that may impact their ethical decision making.

FIGURE 2.11 Influences on an individual’s decision

SOCIETAL

PROFESSIONAL

ORGANISATIONAL

INDIVIDUAL
PROBLEM

DECISION
Corporate

Cognitive
Culture
culture
Stress
Law

development
Moral development
Ethical courage

Codes
Significant others
Policies

Code of ethics

Source: CPA Australia 2023.

Decision making is the thought process necessary to select a course of action to achieve a desired result
from among two or more options. Put more simply, it involves making a purposeful choice from a set of
alternatives. Decision making with ethical implications is simply another form of problem solving. The
chief difference between decision making and ethical decision making is the consideration of ethical values
and implications in the selection of an appropriate alternative.
Therefore, ethical decision making is defined as reaching a responsible decision after taking into
consideration the general ethical beliefs of the individual, the ethical implications of a course of action,
and the norms and rules pertaining to the circumstances of the situation.
Example 2.17 highlights the issues involved in making an ethical decision. The rest of this module
examines the inputs to ethical decision making in greater detail and then examines several ethical decision-
making models.
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 EXAMPLE 2.17

Whistleblowing
When accountants believe or suspect that unethical or illegal behaviour is occurring, they may be put
in a difficult position. Whistleblowing describes the action of bringing these concerns to the attention of
appropriate people. Whistleblowing should be seen as beneficial to the organisation as it helps identify
fraud and inappropriate behaviours and actions. However, it seems that in many organisations, managers
view whistleblowing ‘as a risk generator rather than an element of the risk management infrastructure’
(Tsahuridu 2011, p. 56). Rather than being a faithful servant, the whistleblower is perceived to be ‘against
the organisation’ and disloyal.
The Code of Ethics and its NOCLAR sections deal with how members should respond to non-
compliance with laws and regulations so that they act in the public interest.
............................................................................................................................................................................
CONSIDER THIS
Reflect on what role a member of CPA Australia may have in helping another professional deal with the question
of disclosing unethical or illegal behaviour.

2.11 FACTORS INFLUENCING DECISION MAKING

Decision making is a function of individual characteristics and the environment in which the decision
maker works and lives. Rational decision making is, therefore, constrained by a number of organisational,
psychological and environmental factors.
Undertaking an analysis of the factors affecting decision making provides a better understanding of
how and why decisions are made. If such factors are recognised and understood, the decision maker may
take particular care when making decisions with ethical implications, and also appreciate the impact any
decision will have on the decision maker and other stakeholders.
The factors that influence ethical decision making can be classified into four broad categories (see
figure 2.11) that are introduced in order of their likely influence on decision making. Despite some
interrelated dependencies between the categories, these factors may be characterised as individual,
organisational, professional and societal.

INDIVIDUAL FACTORS
Arguably, the factor having most influence on a person’s decision making is their cognitive ability to judge
the ethical rightness of a situation. People have different levels of moral development. Some people are
selfish and may only act in the right way out of fear of punishment, rather than because it is the right thing to
do. Others (who are self-interested) may act appropriately in order to gain additional benefits from others.
Others may act in a particular way to gain approval from other people they see as significant to them.
Obeying the law and the rules also motivates many people, without much thought as to whether those
laws and rules are appropriate. Meanwhile, others may focus on acting based on intentions to do the right
thing — regardless of external factors such as peer approval or legal rules (Kohlberg 1981).
From this, we can summarise that people at different levels of moral development have varying capacities
to judge what is ethically right and so may react differently to a similar situation. Therefore, the higher a
person’s moral development, the less dependent that person is on outside influences and, hence, the more
that person is likely to behave autonomously and ethically.
Another factor influencing a person’s decision making is their development of ethical courage. Ethical
courage is the level of courage a person demonstrates in order to make difficult decisions and act upon these
decisions. Acting with courage means being straightforward and honest in all professional and business
relationships. Accountants face difficult situations and often have to make decisions, requiring them to
choose between the competing interests of clients, employers and the public.
A junior or recently qualified accountant may not be in a position to act with courage when faced with an
ethical situation due to a fear of superiors or the possible loss of employment. However, a more experienced
accountant may not hold such fears and will not be intimidated by demands from other people. The ability
to act with courage can be developed over time.

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 The Code of Ethics covers the responsibilities of an experienced member in a business, particularly in
areas where the member has the ability to impact decisions where honesty and transparency in a company’s
dealings with the broader marketplace.

ORGANISATIONAL FACTORS
Corporate culture is defined as patterns and rules that govern the behaviour of an organisation and its
employees. Corporate culture defines acceptable behaviour within an organisation. The culture of an
organisation may be formally expressed in the form of written policies and codes of ethics or may be
informally expressed through the words and actions of significant others.
A culture that lacks written policies and codes of ethics and accepts dishonesty and unethical conduct
may have a strong influence on a person’s ethical decision making. They may feel compelled to go along
with what is being done for fear of being excluded from the group.
In the 1960s the social psychology experiments of Solomon Ash, Stanley Milgram and Philip Zimbardo,
which investigated the effects of conformity, obedience to authority, assigned roles and situational
environments on our behaviour, showed how much our actions are influenced by the people, the authority
structures and the environment surrounding us. Similarly, organisational research finds that even honest
employees will behave in deviant ways if their environment, or management, encourages it. Pressure
to conform, excessive performance demands and unfair treatment have all been found to contribute to
organisational misconduct (Litsky, Eddlestone & Kidder 2006).
Unsupportive management styles and organisational cultures as well as hierarchical structures that are
not open to upwards communication can also lead to employee silence on issues such as supervisor
and colleague competence, dysfunctional organisational processes and working conditions. Fear of poor
treatment, negative labelling and distrust by colleagues as well as feelings of futility can prevent employees
notifying management of these problems, resulting in inefficiency, employee apathy and high turnover,
at considerable costs to the organisation (Milliken, Morrison & Hewlin 2003). This can be offset by
ensuring rules and procedures are perceived as fair and by managers establishing trusting relationships with
employees, including them in decision-making processes, setting measurable and attainable goals, offering
consistent performance evaluation, leading by example and creating ethical climates (Litsky, Eddlestone
& Kidder 2006).
Top-tier management is considered the most influential factor in setting organisational values, which
in turn determines the culture that influences accountants’ behaviour. The actions and decisions of
management have a significant contribution to the culture and ethical approach of an organisation. Schein
(2004) identifies six areas in which such actions and decisions are most relevant.
• What leaders pay attention to, measure, and control on a regular basis.
• How leaders react to critical incidents and organizational crises.
• How leaders allocate resources.
• Deliberate role modelling, teaching, and coaching.
• How leaders allocate rewards and status.
• How leaders recruit, select, promote, and excommunicate.

There is a direct and positive relationship between the strength of the organisation’s culture and the
extent of that culture’s influence on ethical behaviour. A strong culture is likely to have more influence
on people’s daily decisions than a weak one. If the culture is strong and supports high ethical standards, it
should have a powerful and positive influence on employees’ behaviour. Conversely, a weak ethical culture
tends to have a negative influence on employees’ behaviour.
.......................................................................................................................................................................................
CONSIDER THIS
Commissioner Kenneth Hayne referred to a culture of greed causing problems in the financial services sector. His
observations related to behaviours that were related to bankers, financial planners, brokers and other intermediaries
adopting a ‘whatever it takes’ approach to getting commissions or bonuses for selling financial products to customers.
Reflect on the issues you believe Commissioner Hayne’s observation raises from an ethical standpoint?

Ethical climates, or cultures, have been found to affect various organisational outcomes (Simha &
Cullen 2012).
• Instrumental climates where egoistic, opportunistic behaviour predominates, have been associated with
low job satisfaction for employees and managers, low employee commitment and high turnover, low
moral reasoning, unethical behaviour, organisational misconduct and bullying.
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• Principal-based climates where rules and regulations are faithfully adhered to.
• Benevolent climates where decisions are made mindful of the interests and needs of all affected
organisational accountants, perform considerably better on these measures.
Benevolent climates generally perform the best.
Generally, the more ethical the culture of an organisation, the more ethical employee behaviour is likely
to be. While the ethical culture of an organisation might be formally expressed in the form of written
policies and a code of ethics, its effectiveness is subject to the actions of management.
If top management aims to develop an ethical culture based on the principles of the organisation’s code of
ethics, there must be consistency between the words and behaviour of top management and the behavioural
expectations of the code. In this way, the code of ethics and the ethical culture are congruent.
The major limitation in achieving acceptance of the code by employees is the belief that the code is
merely rhetoric and serves as a public relations document. To this end, codes are only as good as the
commitment made by management.
In addition to the benefits that are derived from ethical behaviour, an ethical culture may also enhance
a company’s productivity. In a survey on business ethics administered to over 15 000 professionals,
80 per cent of respondents said they would work harder for an ethically run company and 75 per cent
said that they would leave the company if it was violating their core ethical principles (Dent 2009).
Examples 2.18 and 2.19 illustrate the linkages between management behaviours, culture and ethics.

EXAMPLE 2.18

Poor Ethical Cultures Cause Significant Trouble

The link between leadership and culture has been examined by Sims (2000), Sims and Brinkmann
(2002, 2003) and Dellaportas, Cooper and Braica (2007). These authors demonstrate how mismanaging
organisational culture can have devastating effects.
Sims and Brinkmann (2002) examined the case of Salomon Brothers and the role played by John
Gutfreund, the CEO of the investment banking division at Salomon Inc., at the time of its bond trading
scandal in 1991. The authors link Gutfreund’s irresponsible leadership style to a win-at-all-costs culture
at the bank, which led to the unethical and illegal behaviour of its accountants. Sims (2000) describes
how Warren Buffett, after displacing John Gutfreund as the CEO, successfully changed the culture at
Salomon Brothers following the bond fiasco. However, Gutfreund’s style was so ingrained in the culture
of Salomon that simply removing Gutfreund was not enough.
Further steps were necessary to turn the culture away from a short-term win-at-all-costs attitude to that
of responsible corporate citizenship. Changes to the firm’s compensation system proved to be the most
difficult for Buffett to manipulate. Salomon lost many of its best performing accountants and the remaining
employees had to be assured that their positions were safe.
Sims and Brinkmann (2003) conducted a similar analysis on the Enron failure and the results were
comparable to those of the Salomon Brothers case. The authors had no reservations in blaming the top
executives for the unethical behaviour that took place within the company, which eventually brought down
one of the world’s largest and seemingly most successful organisations. The authors conclude that ‘in
retrospect, the leadership of Enron almost certainly dictated the company’s outcome through their own
actions by providing perfect conditions for unethical behaviour’ (Sims & Brinkmann 2003, p. 250).
Dellaportas et al. (2007) considered the case of the National Australia Bank, in which four rogue
traders incurred and concealed losses of AUD360 million (one of Australia’s largest banking losses due
to deception). The bank recruited traders who had a reputation for creating outstanding profits and
encouraged risk-taking beyond prescribed limits, suggesting a profit-driven culture. However, it was
management’s abrogation of responsibilities that contributed to the problem. Issues, when they arose,
were ignored or deferred by management and, in so doing, management neglected its responsibility for
rectifying the identified problems. It was this leadership style that reduced the likelihood of detecting and
dealing with rogue behaviour.

.......................................................................................................................................................................................
CONSIDER THIS
Make a list of rules and regulations that exist in your place of employment, or an organisation you are familiar with,
and classify each item as explicit or implicit. Explicit rules are formal rules, such as those found in company policy or
codes of ethics, and implicit rules are those recognised and accepted by a large majority of your colleagues but not
formally expressed in company documents. Then consider how each item affects your behaviour.

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 EXAMPLE 2.19

Omega Finance
Omega Finance is a prominent accounting, auditing and financial advice company, frequently advertising
on television, social media and radio, emphasising their ability to offer solutions, ‘whatever the problem,
big or small’. Upon successfully gaining employment there shortly after gaining his CPA certification,
Jerry Black was surprised to find that for such a high-profile company, the number of employees was
small. After a few months working on individual and small business tax problems, he was reassigned to
their ‘consultation and referrals’ department. It was explained to him that, due to the varied nature of the
clients that came to them, it was frequently necessary to refer them to a more specialised firm, in order to
ensure compliance with the Code of Ethics.
When jobs came in that were beyond the expertise of Omega’s own accountants, they were sent to the
referrals department with a synopsis of the relevant details and the kind of expertise required, and it was
the job of referrals to recommend an appropriate specialist and forward the account to them. Jerry was
surprised at the volume of referrals that came across his desk — it was clearly a substantial proportion of
the clients processed by the company. Furthermore, being new to the field, it was difficult to recommend
appropriate specialists for the referrals. Jerry had been reassured that his supervisor could help in this
regard, and so he frequently sought advice on appropriate referrals.
After a while, he noticed that the same names frequently came up in his supervisor’s recommendations,
though there were alternative companies that may have been better suited. He pointed this out, but
his supervisor simply told him that they had good working relationships with these companies, and
that it streamlined the process both for Omega and for their clients. Omega was transparent about the
referral commissions, or fees, received from the specialists to whom it referred these cases, and it was a
standardised rate, yet the sheer volume of referrals must have made the total commissions or fees received
from these companies sizeable. Jerry noticed also that following his query his caseload increased,
explained by management as due to an overall growth in client numbers, but Jerry had heard similar
stories from other employees. It was suspected that this was an informal punitive measure to discourage
employees from questioning managerial decisions and to restrict both their discretion and autonomy. One
consequence of this increase was a further reduction in the ability to examine alternative specialist options,
and the necessity to increase referrals to those companies already receiving considerable business
from Omega.

QUESTION 2.27

What is the effect of the culture at Omega Finance on the individual ethical decisions of the
employees such as Jerry? Can you think of any possible violations of the Code of Ethics these
decisions may present?

QUESTION 2.28

What reasons or factors can you think of that may cause an employee to compromise their personal
ethics in a corporate environment?

Speaking up on Ethical Issues

What is the best way for an accountant to grapple with ethical issues in the workplace when they may
not be in a position of power or influence? Creative thinking about how to resolve an ethical dilemma in
the workplace may be required. For example, a junior accountant may not feel comfortable raising issues
with senior management. However, issues can be raised without leading to confrontation. Mary Gentile
(2010), author of Giving voice to values: How to speak your mind when you know what’s right, provides
the following ideas as to how accountants might approach the resolution of ethical dilemmas.
• Frame questions in a way that invites people to reflect on decisions they intend to make or have made,
rather than confronting them in a manner that may be counterproductive to getting the right thing done.
This may involve questions or prompts that lead the person to look at issues from a different perspective
or timeframe, or in light of the business’s core values.
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• Have a conversation with somebody who is in a better position to raise concerns about an issue. A more
senior colleague may be recognised as having greater authority in the entity, and therefore better able
to persuade others in the organisation not to undertake an action or actions.
• Find an ethically acceptable way to complete tasks and achieve the desired outcome.
Will everyone share the core values that an accountant brings to the table when seeking to do business
in an ethical way? CPA Australia member and governance expert Sharon Ditchburn (2022) — who has
represented CPA Australia on the IFAC Professional Accountants in Business Advisory Group — notes
that not everyone working within an organisation will be a member of a professional accounting body. They
might be members of another professional association that has a code of ethics, or they may not belong
to any professional body. However, working in an environment that is challenging because of colleagues’
differing backgrounds does not alter the accountant’s obligation to attempt to influence decision making.
This may not always be effective if an accountant is the sole voice raising matters of concern in the
organisation. Ditchburn suggests that an accountant may find support from colleagues in compliance or
internal audit roles, and that those individuals might be able to assist with finding a solution to a problem
or dilemma identified by the accountant in the first place.

PROFESSIONAL FACTORS
In addition to individual and organisational factors influencing ethical decision making, accountants are
also influenced by their accountantship of a profession. We have already described the Code of Ethics in
detail and how accountants must follow the Code, which unites accountants by having a common set of
values and standards of behaviour.
The extent of the influence on decision making is dependent on the effectiveness of the Code. According
to the Code, accountants in business may hold a senior position.
The more senior the position of a Member, the greater will be the ability and opportunity to access
information, and to influence policies, decisions made and actions taken by others involved with the
employing organisation . . . Members are expected to encourage and promote an ethics-based culture in
the organisation [with the more senior having a greater responsibility] (para. 200.5 A3).

QUESTION 2.29

Why should accountants in business be accountable to a higher authority such as the professional
accounting bodies?

SOCIETAL FACTORS
Societal factors that influence decision making generally relate to the world we live in. These include the
laws that govern our behaviour and culture, which reflect the attitudes and values of the community.
Laws and Regulations
Laws and regulations are rules, established by the community through the legislature, that prohibit certain
actions. Laws are generally a reflection of societal attitudes, so for most people they will have minimal
impact on ethical behaviour other than maintaining order and resolving disputes when they arise.

QUESTION 2.30

Discuss whether decisions that are compliant with the law will always result in ethical decisions.

Culture
Understanding the culture of the community in which an organisation is operating is an essential first step
in identifying the effects that the attitudes and values of the community may have on how decisions are
made. Cultural values play an important role in the way business is conducted and in determining people’s
perceptions about what is important and what is not.
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 In ethics, cultural values have a major influence in determining what is considered proper and ethical
in a particular society. Ethical relativism holds that ethical behaviour is relative to the norms of one’s
culture. That is, whether an action is right or wrong depends on the ethical norms of the society in which
it is practised. If ethical relativism is accepted, the rightness or wrongness of an act depends on a society’s
norms and any act inconsistent with those norms is ethically wrong. Alternatively, an ethical act is one that
is consistent with the norms of society. Therefore, a person with good ethical intentions will be influenced
to act in accordance with society’s norms. A common saying describing the practice of relativism is ‘When
in Rome, do as the Romans do’.
Relativism is premised on the belief that there is no single ethical standard. While this is the major
premise of relativism, it is also the cause of its major criticism: there is no universal standard of right and
wrong that can be applied to all people at all times. In this sense, no guidance on accepted behaviour is
provided when there are divergent opinions within society or across societies. The same action may be
ethical in one society but unethical in another.
This is particularly important in multicultural societies and multinational companies where cultural
practices can directly or indirectly influence respective business behaviour, giving rise to possible conflicts
of opinion and ethical values. For the ethical relativist, there is no universal standard of right or wrong but
only the standard of a particular society. Therefore, unlike normative theories of ethics, there is no common
framework for resolving ethical dilemmas across different societies.
.......................................................................................................................................................................................
CONSIDER THIS
Identify an issue you have seen reported in the media that relates to differing cultural values as they relate to
the conduct or freedom of individuals. What, if any, are the risks in taking a relativist approach to an ethical or
philosophical debate?

QUESTION 2.31

You are an employee of a company operating in a culture where bribery is commonplace. You have
been offered a gift, but no favours have been sought. Returning the gift will offend the donor. What
should you do?

However, we can recognise that different people, and different cultures, hold different values, and that
many of these are valid, without accepting that any value is equally valid to other values. Related to the
notion of cultural relativism is cultural diversity — observations of the different values embraced by
different cultures.
One of the most widely cited studies of cultural differences was by Geert Hofstede (1980), who
measured differences in values held by employees in IBM offices around the world to study the
way organisational culture varied from country to country. Sorting these differences along five
dimensions — masculinity/femininity, individualism/collectivism, high/low uncertainty avoidance,
high/low power distance and short-/long-term perspective — this research has been a significant resource
for organisational studies, as many items have clear relevance for organisational decision making.
A company culture that is high in power distance, for instance, will likely employ a hierarchical structure
and top-down decision-making process, and the questioning or feedback of subordinates is less likely
to be encouraged than in a company culture that is low in power distance. An organisational culture
that has low uncertainty avoidance is likely to tolerate higher levels of risk and seek fewer assurances
than one that is high in uncertainty avoidance. Since Hofstede, other studies, such as the World Values
Survey and the Global Leadership and Organizational Behaviour Effectiveness (GLOBE) study, have
measured differences in values between countries both among their general populations and within
business organisations.
.......................................................................................................................................................................................
CONSIDER THIS
At this stage in your career, how are you going to build a network to assist you when you are faced with an ethical
dilemma? What are some of the strategies you might use to ‘give voice’ to your values?

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2.12 ETHICAL DECISION-MAKING MODELS
Probably the most widely employed approach to decision making in practice is to rely on personal
insight, intuition, judgement and experience. Rather than rationally searching for the best alternative,
decision makers often select alternatives that are merely satisfactory or adequate. Because of this tendency,
people will seek easily understood decision-making rules rather than attempting to find the best or
optimal outcome.
This can lead to simplistic approaches to decision making that are often called heuristic approaches. The
term heuristics is used to describe a set of decision-making rules or approaches based on past experience,
intuition or mental short-cuts. Decision rules are a convenient way of reducing the number of alternatives
that must be evaluated. However, the problem with this approach is that it is limited to the individual’s
background, previous experience, memory, knowledge and perceptions.
.......................................................................................................................................................................................
CONSIDER THIS
While decisions based on past experience could lead to consistency, what dangers can you identify in this approach
for individuals, groups, companies or firms?

Often, the decision maker may not have a sufficient knowledge base to make proper decisions,
particularly when faced with new and difficult situations. Although decision making that relies on the
application of decision rules may be justified on practical grounds, it might not be adequate from an ethical
point of view. Some situations may require a more systematic approach to problem resolution.
A more systematic approach is to use structured methods of decision making that help reduce the
potential for inappropriate and inconsistent decision-making processes and outcomes. These models are
often based on normative ethical theories and ask probing questions to help identify the underlying ethical
issues, as well as the outcomes that various choices will have on different stakeholders. This helps avoid the
problem of forgetting to consider the ramifications of a particular course of action or ignoring a minority
interest group.
We have already outlined the conceptual framework in the Code of Ethics. In this section we outline:
• the decision-making model that can be applied to the conceptual framework
• two additional models:
– the philosophical model
– the American Accounting Association model.
Each of these models is designed to help accountants make well-reasoned ethical decisions. A detailed
discussion of all ethical decision-making models is beyond the scope of this module.
The decision-making models will not guarantee the correct or ethical decision, but they reduce the
possibility of an incorrect or inappropriate decision being made. A decision-making model is likely to
lead to a more systematic analysis and comprehensible judgement, clearer reasons and a justifiable and
more defensible decision than would have otherwise been the case.
Decision-making models also assist accountants in exercising proper judgement when faced with
difficult or complex situations. This strengthens the ability of accountants to act in the public interest,
since our decision-making process is carried out with integrity and objectivity.
There is no perfect or correct model to use. It is not unusual to use one or more ethical decision-
making models when assessing ethical situations so as to gain different perspectives on the same situation.
Ultimately, it is up to the accountant to assess the suitability of the various frameworks. We recommend
referring to a range of models and selecting one or more that are most useful in the circumstances.

APES GN 40 ETHICAL CONFLICTS IN THE WORKPLACE –

CONSIDERATIONS FOR MEMBERS IN BUSINESS
In March 2020, APESB issued a revised edition of APES GN 40, which gives members in business
guidance on:
• fundamental responsibilities of the Member in Business when dealing with ethical conflicts in the
workplace;
• the application of the conceptual framework in the Code to identify, evaluate and address ethical issues;

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 • specific circumstances such as dealing with conflicts of interest, reporting of information, acting with
sufficient expertise, financial interests, Inducements, responding to non-compliance with laws and
regulations and pressure to breach the fundamental principles; and
• the disclosure of confidential information of an Employer to a third party and whistleblowing (para. 1.1).

Paragraph 4.2 of the guidance note outlines a structured approach to ethical decision making that mirrors
the conceptual framework in the Code of Ethics. The steps in the approach are:
(a) Gather the facts and identify the problem or threat;
(b) Identify the fundamental principles involved;
(c) Identify the affected parties;
(d) Determine whether established organisational procedures and conflict resolution resources exist to
address the threat to compliance with the fundamental principles;
(e) Identify the relevant parties who should be involved in the conflict resolution process;
(f) Discuss the ethical issue and the conflict with the relevant parties, and in accordance with the prescribed
procedures evaluate the significance of the threats identified and actions available to address these
threats;
(g) Consider courses of action and associated consequences;
(h) Consider whether to consult confidentially with external advisers such as an independent adviser, legal
advisor and/or the Professional Body to which the Member belongs;
(i) Consider whether to consult Those Charged with Governance;
(j) Decide on an appropriate course of action;
(k) Document all enquiries and conclusions reached; and
(l) Implement the appropriate course of action. In the event that the Member believes that the threat to
compliance with the fundamental principles has not been satisfactorily resolved, the Member should
determine whether it is appropriate to resign.

The guidance note includes a flowchart that illustrates the steps. There are several things to notice about
this process as it is set down in the guidance note. It looks at the way in which a member investigating a
complaint or a potential breach of standards ought to undertake the fact finding process to determine what
had occurred and what the appropriate way may be to address the issue. It is another illustration of a way
in which ethical issues can be dealt with.
APES GN 40 also includes 21 case studies incorporating examples from commercial, public and not-
for-profit sectors where professional accountants in business encounter ethical conflicts in their workplace
that require application of the fundamental principles of the Code of Ethics.

QUESTION 2.32

Download a copy of APES GN 40 from the APESB website and complete the following.
(a) Read section 4.2.
(b) Select two of the 21 case studies that appear in section 14 of APES GN 40.
(c) Apply the structured approach to the case study.
A solution is not provided for this question, so please self-assess your answer to (c) by comparing
your analysis of the case study to that given in APES GN 40.

PHILOSOPHICAL MODEL OF ETHICAL DECISION MAKING

The second model to be discussed is the Philosophical model of decision making. By applying a
philosophical model of ethical decision making, ethical theories are no longer abstract concepts but
questions of ethical analysis.
The philosophical ethical decision-making model presents a combination of the normative ethical
principles derived from the theories of egoism, utilitarianism, and rights and justice in the form of specific
questions rather than abstract principles. For each alternative course of action, answers to the following
questions should be established.
1. Do the benefits outweigh the harms to oneself?
2. Do the benefits outweigh the harms to others?
3. Are the rights of individual stakeholders considered and respected?
4. Are the benefits and burdens justly distributed?
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 For example, consider a situation where a private business has a small number of significant external
investors and a large level of debt funding. The business has experienced some difficulty and the accountant
in the business has been asked to ‘produce’ the right figures (in effect, manipulate them, to create the
appearance of better results). These results are to be distributed to the external lenders and investors. The
accountant is advised that a bonus is on offer for achieving strong results, but that ‘there will be significant
trouble if we fail to satisfy these stakeholders’.
The accountant can evaluate the situation by considering potential courses of action, which include
complying with the request or refusing to comply.
For Question 1, we see that the immediate financial benefits of complying with the unethical request
will be greater than refusing. Harm to oneself may come from doing the right thing, although there would
also be long-term harm in terms of loss of integrity by complying with the request.
Considering Question 2, we see that the benefits of honest reporting would be linked to the external
investors and lenders who receive accurate information and may be able to protect their investments,
whereas harm will probably come to the owners of the company as the financial results may lead to action
being taken against them.
In relation to Questions 3 and 4, deceiving the external funding providers is disrespectful of their rights,
and leads to an unfair distribution of benefits and burdens. All of these factors can then be weighed as the
accountant makes the decision.
The overall objective of the philosophical approach is to provide a framework within which ethical
issues can be identified, analysed and resolved. The strength of this approach lies in the application of
multiple theories to an ethical dilemma, rather than a single theory. Each normative theory of ethics is
subject to inherent limitations. Therefore, adopting multiple ethical theories will overcome the limitations
of individual theories. In this model, the ideal course of action is one that satisfies all four principles:
one that is just, balances the benefits and harms to oneself and to others, and respects the rights of others
and maximises both the net benefit to self, and the net benefit to stakeholders. Striving to satisfy all four
principles will be difficult, but attempting to do so is more likely to result in the best decision overall.

QUESTION 2.33

Alpha Ltd, a clothing manufacturer in Australia, has decided to outsource its clothing production
to a supplier in Bangladesh to take advantage of the relative strength of the Australian dollar and
lower operating costs.
The company identified a supplier, called Delta Ltd, which was capable of providing this work.
Delta Ltd had offered to do the work at a lower price than other competitors, and a review of the
work quality indicated that it was at a comparable and suitable level.
During a visit to the production factory, the Australian management team observed the working
arrangements, how the factory was set up, and discussed working conditions with local employees.
They noticed and were advised of potential work safety problems in relation to noise, fire and
ventilation. However, the managers of Delta Ltd explained that the factory was a typical example in
Bangladesh and that it was compliant with all relevant laws.
Using the philosophical model of ethical decision making, recommend whether Alpha Ltd should
work with Delta Ltd.

AMERICAN ACCOUNTING ASSOCIATION MODEL

The third model to be examined is the American Accounting Association model. Langenderfer and
Rockness (1990) developed a seven-step ethical decision-making model based on the process of con-
ventional decision making. The model was adopted by the American Accounting Association (AAA) in a
publication designed to provide instructors with a comprehensive resource for teaching ethics in accounting
and is commonly known as the AAA model.
The purpose of the seven-step model is to develop a systematic approach to making decisions that can be
used in any situation with ethical implications. The advantage of the AAA model is the ethical awareness
it creates by giving particular attention to stakeholders and ethical issues.
The seven steps of the model are as follows.
1. What are the facts of the case? Pertinent information must be determined in order to identify the
problem.
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2. What are the ethical issues in the case? This question involves a two-part process. Firstly, the primary
stakeholders are identified and, secondly, the ethical issues are clearly defined. Identifying and labelling
ethical conflicts and the competing interests of those affected by the dilemma are important stages in
the resolution process.
3. What are the norms, principles and values related to the case? The norms, principles and values
relating to all stakeholders at all levels, including corporations, individuals and accountants, should be
identified. Generally, norms, principles and values are standards, rules and beliefs that guide acceptable
and ethically ‘good’ conduct. Examples of principles include integrity and respect for individuals.
4. What are the alternative courses of action? The major alternative courses of action that will resolve the
problem should be identified, including alternatives that may involve compromise.
5. What is the best course of action that is consistent with the norms, principles and values identified
in Step 3? At this point, all alternatives are considered in light of the norms, principles and values
identified in Step 3. One purpose of this process is to determine whether any norm, principle or value
(or a combination of them) is so persuasive that resolution is obvious. For example, protecting the
environment is important to avoid permanent damage and to respect the rights of the communities who
rely on the environment for survival.
6. What are the consequences of each possible course of action? Each course of action should be evaluated
with respect to its norms, principles and values, from both short- and long-term perspectives, and for
its positive and negative consequences.
7. What is the decision? The consequences should be balanced against the primary norms, principles and
values, and an appropriate option should be selected.
A comparison of the AAA model with the Code of Ethics framework shows that they are consistent
with each other. However, the Code attributes greater emphasis to the fundamental principles, threats and
safeguards. The AAA model is a model of ethical decision making applicable to all settings and not specific
to accounting.
Example 2.20 illustrates the AAA ethical decision-making model.

EXAMPLE 2.20

An Asset by any other Name

Until recently, Booker Manufacturing Company had been a family business. Booker manufactured small
machines and household equipment as its primary product line. Recently, the company was bought by
a large equipment firm that wished to expand its product line into household equipment. The financial
director of Booker, Paul Davis, CPA, had been asked to stay on in his position. In the future, however, Paul
Davis would report to both the CEO of the Booker subsidiary and the CEO of the parent company. Paul
had a close relationship with the Booker CEO, but he realised that he would have to prove himself to the
CEO of the parent company.
In preparation for the acquisition, Davis was asked to supply the parent company with a list of Booker’s
fixed assets, their date of acquisition, the original cost and the accumulated depreciation, all on an
individual asset basis. In general, the fixed assets were relatively old and, therefore, the book values
were substantially lower than the original costs. Davis assumed that the parent company needed this
information to determine the fair market values of these assets in order to arrive at an estimated purchase
price for Booker. Eventually, the fair market values assigned to the fixed (i.e. non-current) assets would
be used in the consolidated financial statements. These values would be used to determine the portion
of the purchase price that should be allocated to goodwill.
When Davis was shown the consolidated balance sheet, as at the date of acquisition on 13 April 2019
he noted that Booker’s tangible fixed assets were assigned a fair market value. Davis agreed with that
value. The excess purchase price above the fair market value of the assets was included as goodwill. This
amounted to $450 000. During late May and early June of 2019 the parent company’s auditors spent time
at Booker. Their purpose was to become familiar with the operations and to conduct a full scale audit.
They would publish their opinion on the consolidated financial statement for the financial year ending
30 June 2019.
Shortly after the audit was completed, Davis received a copy of the consolidated financial statements
and was surprised to note that the goodwill amount of $450 000 was not shown as such but had been
used to raise the asset values. Most of these assets were quite old and not as efficient as the new
machines because current technology had improved considerably since the assets had been acquired.
To add to his concern, Davis noted that the auditors had given an unqualified opinion on the financial
year-end statements.

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116 Ethics and Governance

 Davis is aware that the company policy was to amortise goodwill over 20 years. However, assets are
depreciated over five to 10 years. He was aware that the company’s contract with its labour unions was
soon to be renegotiated and he wondered if the higher asset values, with a much faster write-off than over
20 years, were a relevant factor in preparing the figures for the negotiation. He learned that the company
might sell some of its assets owing to an expansion of product lines. A higher book value would most
likely result in a recognised loss at the time of sale.
The more Davis thought about the treatment of the Booker company assets, the more upset he became.
He felt that the parent company deliberately ‘cooked the books’ (misrepresented the accounts) and that
the auditors were either a party to it or did not do a sufficiently careful audit of the Booker company assets.
Source: Langenderfer, HQ & Rockness, JW 1990, Ethics in the accounting curriculum: Cases and readings, American
Accounting Association, Sarasota, Florida.

QUESTION 2.34

What are the ethical issues in example 2.20? What should Davis do? Use the AAA model to analyse
the case.

Example 2.21 is an example scenario where an accountant faces an ethical dilemma.

EXAMPLE 2.21

Chain of Command
Jenna worked as an in-house accountant for a superannuation fund, Millennial Funds, and was part of a
team preparing estimated dividends over the coming financial year as part of the company’s prospectus.
While estimating the revenue to be raised via its investments, she noticed considerable investment in a
proposed coal mine in Queensland, the Deep Vein mine. She found this odd, as she knew Millennial had a
policy of diversified investment, and particular in limiting fossil fuel investment. Jenna knew that the coal
prices factored into the projected profitability of the proposed mine could not be guaranteed. Millennial’s
CFO had publicly stated that it planned to move to an investment distribution that capped investment in
fossil fuels at 20 per cent of its portfolio. This new mine investment would place its investment in coal
alone above that 20 per cent threshold.
Jenna revised the projected estimate in line with a more conservative ongoing value of coal. When
she submitted her revisions, the document was returned to her by her manager, pointing out what they
considered to be an error — her revised estimate of the mine’s projected revenues. She forwarded her
workings on the topic but was sent a curt reply to use the value initially supplied by Deep Vein. The
superannuation market was competitive, and Millennial couldn’t afford to lose accounts to their rivals.
Furthermore, Jenna’s performance review would be coming at the end of the year, and it would not help
that process if she’d been found to be unhelpful in these essential matters.

QUESTION 2.35

Apply the AAA model to the scenario in example 2.21. What action would you recommend in
this situation?

SUMMARY
Ethical theories and principles provide useful tools to resolve dilemmas that arise in practice or in
workplaces. It is important to recognise, however, that decision making occurs in the context of numerous
individual, organisational, professional and societal influences. Generally, individual and organisational
factors can have a more intense influence on decision making than professional factors. The better a
professional understands these influences, the better they can take into consideration their potential effects
on decision making and ensure their decisions reflect the ethical standards of the profession. Professionals
should also ensure that they have the skills to raise ethical issues in a constructive manner and have a
support network in place to consult on such issues.
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 Ethical frameworks and decision-making models are useful tools for individuals and groups to analyse
situations that involve ethical dilemmas and to make decisions that successfully deal with the tensions
between competing interests.
APESB’s APES 110 includes a conceptual framework that provides a structured approach to dealing
with ethical issues that arise in the work of the professional accountant. APESB has also issued a guidance
note known as APES GN 40 that reflects the approach in the conceptual framework. APES GN 40 provides
a method to enable a member to methodically analyse and deal with ethical conflicts in the workplace. A
series of case studies in the guidance note provide further assistance to members in business.
A philosophical model of ethical decision making brings together multiple ethical theories and thus
provides a way to identify, analyse and resolve ethical issues in a way that is just, balances the benefits
and harms to oneself and others, and respects the rights of each stakeholder.
The American Accounting Association issued a decision-making model for use in any ethical situation.
It is consistent with the conceptual framework in APES 110 but is also applicable beyond the professional
accounting context.
The key points covered in this part, and the learning objectives they align to, are as follows.

KEY POINTS

2.4 Analyse and resolve ethical dilemmas in accounting.

• Professional accountants routinely confront ethical dilemmas in their work, including where they
detect non-compliance with laws and regulations, receive or are approached with inducements, or
observe wilful misleading and deceptive statements being made by management or a client.
• People commonly rely on personal insight, intuition, judgement and experience to make decisions,
but this approach is limited and may result in decisions that are less than optimal.
• A systematic approach to decision making, based on decision-making models that incorporate
structured processes, is more likely to result in ethical decisions that properly consider all
relevant factors.
• Resolution of ethics issues will sometimes mean finding ways to influence more senior members
in an organisation. Encouraging reflection from different perspectives and timelines and in light of
core values may be helpful.
• Support networks may be able to offer support in raising ethical issues; these should be built in
anticipation of ethical dilemmas.
2.5 Apply ethical decision-making models.
• APES 110 includes a conceptual framework that provides a decision-making model. This approach
is mirrored in APES GN 40, which provides members with a framework to be used when ethical
conflicts arise.
• The philosophical model of decision making combines various ethical perspectives. The philosoph-
ical model requires the professional accountant to specifically consider the benefits and harms
to oneself; the benefits and harms to others; the rights of individual stakeholders; and the just
distribution of benefits and burdens.
• The American Accounting Association provides its own model of decision making. It is a seven-step
model that focuses on stakeholders and ethical issues and is broadly applicable to ethical issues,
not only the accounting context.
• The American Accounting Association model and the Code of Ethics framework are consistent with
one another, but the Code is more specific to the professional accounting context and emphasises
fundamental principles, threats and safeguards.

REVIEW
Professional ethics requires the application of a set of principles or a framework to make decisions and
take actions that are in the best interests of the public, in accordance with the professional ideal to serve
society. The Compiled APES 110 Code of Ethics for Professional Accountants (including Independence
Standards) sets out five fundamental principles for the ethical conduct of professional accountants:
integrity; objectivity; professional competence and due care; confidentiality; and professional behaviour.
APES 110 also includes a conceptual framework that provides a structured decision-making approach
to deal with any ethical dilemma that may confront an accountant in their professional life. In addition,
specific guidance to identify and safeguard against threats is included for members in business and
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118 Ethics and Governance

members in public practice. Finally, independence requirements are set out for accountants who engage
in audit, review and other assurance engagements.
The professional accountant needs to be aware of influences at a personal, organisational, professional
and societal level that may impact their decision-making process. They also need to have the skills to
effectively raise ethical issues with more senior members of an organisation. It can be helpful to use a
variety of ethical theories and perspectives to identify and resolve ethical issues. This module introduced
the different orientations of teleology, deontology and virtue ethics.
Key sources of ethical dilemmas facing accountants are conflicts of interest; professional appointments;
preparation and presentation of information; acting with sufficient expertise; second opinions; financial
interests, compensation and incentives linked to financial reporting and decision making; fees and
remuneration; inducements; custody of client assets; responding to NOCLAR; and pressure to breach
the fundamental principles.
Ethical frameworks and principles help accountants to address such dilemmas in a coherent and
consistent way, reducing the risk of choosing sub-optimal outcomes.

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Dellaportas, S, Alagiah, R, Gibson, K, Leung, P, Hutchinson, M & Van Homrigh, D 2005, Ethics, governance and accountability:
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ICAEW (Institute of Chartered Accountants in England and Wales) 2007, ‘Information for better markets: Reporting with
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ETHICS WEBSITES
USEFUL WEBSITES ON PROFESSIONAL AND BUSINESS ETHICS
• Accounting Professional & Ethical Standards Board, accessed August 2023, https://apesb.org.au
• The Ethics Centre, accessed August 2023, https://ethics.org.au

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MODULE 3

GOVERNANCE
CONCEPTS
LEARNING OBJECTIVES

After completing this module, you should be able to:

3.1 describe corporate governance and explain why it is important
3.2 evaluate the importance of the key elements of the corporate governance framework
3.3 describe the nature of corporations and the division of corporate powers
3.4 discuss agency theory and how it is used to understand corporate behaviour
3.5 discuss the key features of corporate structure
3.6 examine the characteristics and duties of directors and other officers
3.7 explain the various international approaches to corporate governance
3.8 analyse how robust governance is relevant to public sector and non-corporate entities
3.9 interpret and apply codes and principles of corporate governance.

ASSUMED KNOWLEDGE

No specialised knowledge is assumed for this module.

LEARNING RESOURCES

• Corporate Governance Principles and Recommendations, 4th edition (ASX CGC 2019), accessed October
2023, www.asx.com.au/documents/regulation/cgc-principles-and-recommendations-fourth-edn.pdf
• The UK Corporate Governance Code (UK FRC 2018), accessed October 2023, www.frc.org.uk/getattachme
nt/88bd8c45-50ea-4841-95b0-d2f4f48069a2/2018-UK-Corporate-Governance-Code-FINAL.pdf
• G20/OECD Principles of Corporate Governance (OECD 2023a), accessed October 2023, www.oecd.org/cor
porate/revised-g20-oecd-principles-corporate-governance.htm
• OECD Corporate Governance Factbook (OECD 2023c), accessed October 2023, https://www.oecd-ilibrary.
org/finance-and-investment/oecd-corporate-governance-factbook-2023_6d912314-en
• Corporations Act 2001 (Cwlth), accessed October 2023, www.legislation.gov.au/Series/C2004A00818

PREVIEW
Governance is the system that is put in place to operate and control an organisation. With the advent of
the corporate structure, the resulting agency relationship between the company (or its owners) and those
who act on its behalf, and a spate of reasonably recent corporate failures, a form of governance known as
‘corporate governance’ has evolved.
Part A of this module examines the nature and structure of corporations, the characteristics and duties
of directors and other officers, the division of power between owners and directors within a company and
what, theoretically, this division of power means for the governance of an organisation.

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 Part B of this module defines and discusses the importance of corporate governance and looks at the
key elements of a corporate governance framework that are common to most organisations.
Part C looks at the history of and differing international perspectives on corporate governance.
Part D examines the content and application of various corporate governance codes and principles.
Finally, part E examines governance in the small- and medium-sized enterprises (SME), and the not-
for-profit (NFP) and public sectors.

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PART A: CORPORATIONS
INTRODUCTION
As organisations have grown, their activities have become more complex and the demand for capital has
increased, new forms of business structures have arisen. One of these structures is the corporation. A
corporation is separate from its owners; it is a distinct legal entity with most of the same legal rights as an
individual. In Australia, there are various forms of corporation, generally distinguished by size, liability,
and how they can raise capital.
By its very nature, in a corporation the owners of the capital are not the ones managing the day-to-day
operations of the business. This has the potential to lead to a misalignment of goals. In response, legislation
imposes various duties on those charged with the governance of the corporation.
This part of the module examines the key features of proprietary and public companies, the division of
power between owners and directors, the duties required of directors and a number of theories that help
explain and understand corporate governance.

3.1 KEY FEATURES OF CORPORATIONS

There are many legal forms for business associations. The public corporation is the legal form we are most
familiar with, as it is the legal form adopted by many of the largest business organisations.
Corporations are frequently at the heart of debate and discussion about corporate governance. As
‘fictional entities’ brought into existence through legal means (e.g. being registered under the Corporations
Act 2001 (Cwlth) (Corporations Act)), they give rise to a number of distinct advantages over other forms
of business organisation (such as sole traders or partnerships), including the following.
• Separate legal entity distinct from its owner. This results in the ability to hold and own property in the
name of the corporation, to sue and be sued, and to enter into contracts.
• Limited liability. This provides that the liability of the owners of a corporation is limited to the original
capital invested by owners. Other rules may be defined, such as ‘no liability’, where unpaid capital is
not at risk, and ‘unlimited liability’, where some corporations leave owners exposed beyond the amount
of invested capital.
• Perpetual succession. As an artifice of law, corporations do not have a finite life. Individuals (as a
biological fact) and trusts (as a legal requirement) have finite lives and a partnership legally terminates
and re-forms whenever a partner leaves or enters a partnership. Ownership by, and operations of,
corporations can theoretically last forever. A corporation ceases to exist only through formal legal
procedures that result in the corporation ‘winding up’.
In the 1960s, noted economist Milton Friedman argued that the primary responsibility of a corporation
is to maximise the wealth of its shareholders (Friedman 1962). However, increasingly this view has been
challenged by people who believe that an organisation should also consider the interests of a wider group of
stakeholders such as employees, customers, suppliers and the community. This point of view is discussed
further in module 5.
Corporations vary enormously in size, capitalisation, structure, the nature of their activities, number of
employees and other factors. They may be for-profit or NFP, private or public, with no liability, limited
liability or unlimited liability, and listed or unlisted. Section 112 of the Corporations Act lists the types of
company that can be registered in Australia.
In 2017, the Corporations Act was amended to allow some companies to offer shares through
equity-based crowd-sourced funding (CSF) (Corporations Amendment (Crowd-sourced Funding) Act
2017 (Cwlth)). According to the Australian Securities and Investments Commission (ASIC), CSF is a
financial service where start-ups and small businesses raise funds, generally from a large number of
investors who invest small amounts of money (ASIC 2020). In summary, the CSF regime was designed
to reduce the regulatory requirements for public fundraising while maintaining appropriate investor
protection measures.

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 Table 3.1 provides examples of different types of corporations in Australia and other countries.

TABLE 3.1 Types of corporations

Ownership Liability Naming

Private/Proprietary Limited by shares Pty Ltd Proprietary Limited (Australia)

(unlisted) Pvt Ltd Private Limited (India)
Ltd Limited (UK)
Sdn Bhd Sendirian Berhad (Malaysia)
Corp/Inc. Incorporated (US)
PT Perseroan Terbatas (Indonesia)
YK Yugen-Kaisha (Japan)

Unlimited with share capital Pty Proprietary (Australia)

ULC Unlimited Liability (Canada/UK)

Public (listed Limited by shares/guarantee Ltd Limited (UK, Australia, India)

or unlisted) PLC Public Limited Company (UK)
Bhd Berhad (Malaysia)
Corp/Inc. Incorporated (US)
PT Tbk Perseroan Terbuka (Indonesia)
KK Kabushiki-Kaisha (Japan)

Unlimited with share capital ULC Unlimited Liability (Australia/Canada/UK)

No liability company NL No Liability (Australia)

Source: CPA Australia 2023.

PROPRIETARY COMPANIES
Proprietary companies are the most commonly registered company type in Australia. Shares are held
privately by no more than 50 non-employee members. A proprietary company is not allowed to do
anything that would require disclosure to investors, including, offering securities for issue or sale to the
public. Proprietary companies may however issue shares to existing shareholders, employees or subsidiary
companies. They may also issue shares or corporate bonds to sophisticated or professional investors, and
as small-scale issues of not more than $2 million in any 12-month period to no more than 20 people.
Should a proprietary company fail to follow any of these rules, ASIC may force it to change to a public
company. Proprietary companies are further subdivided into large and small proprietary companies. The
financial reporting obligations for large proprietary companies are different to those of small proprietary
companies.

QUESTION 3.1

Refer to s. 45A of the Corporations Act and s. 1.0.0.2B of the Corporations Regulations 2001 (Cwlth)
(www.legislation.gov.au/Details/F2023C00677). List the rules used to differentiate between large
and small proprietary companies.

PUBLIC COMPANIES
Public companies are defined as companies that are not proprietary companies. It will have more than
50 members and may issue securities to the public. Public companies may apply to list on the Australian
Securities Exchange (ASX).

PROPRIETARY V. PUBLIC COMPANIES

Compliance requirements for companies come from a variety of sources including:
• the Corporations Act
• ASX listing requirements, www.asx.com.au/listings/how-to-list/listing-requirements.html
• ASX Listing Rules, www.asx.com.au/about/regulation/rules-guidance-notes-and-waivers/asx-listing-
rules-guidance-notes-and-waivers.html
These requirements are summarised in table 3.2. Note that there are specific requirements for companies
limited by guarantee that are not covered in this table.
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124 Ethics and Governance

 Pdf_Folio:125
TABLE 3.2 Compliance requirements (unless specified otherwise, section references are to the Corporations Act)
Aspect of compliance
Minimum number of directors
(resident in Australia)
Company secretary
Auditor/Audit report
Financial records
Ongoing disclosure
Reporting requirements
ASIC notification of changes to
members, issuance or transfer
of shares
MODULE 3 Governance Concepts 125
Source: CPA Australia 2023.
Small proprietary company
One (one) (s. 201A(1)–(1A))
Optional (Part 2D.4)
Only in certain circumstances
(s. 301(2))
Yes, electronic or convertible to
hard copy, kept for 7 years and
either in English or a translation
to be made available upon
request (Part 2M.2)
No
Annual financial report and
directors report only in some
circumstances (ss. 292(2), 293,
294, 298(3))
Note that these do not need
to comply with accounting
standards (s. 296(1A))
Yes (Part 2C.2)
Large proprietary
company
One (one) (s. 201A(1)–(1A))
Optional (Part 2D.4)
Yes, but ASIC may provide
relief in appropriate cases
(ss. 301, 342(2)–(3),
Part 2M.4)
Yes, electronic or
convertible to hard copy,
kept for 7 years and either
in English or a translation
to be made available upon
request (Part 2M.2)
No
Annual financial report
(s. 295) and directors report
(ss. 298, 299, 300(1)–(9))
Yes (Part 2C.2)
Public company
Three (two) (s. 201A(2))
At least one who resides in
Australia (Part 2D.4)
Yes, including independence
requirements
(ss. 301, 307, 308, Part 2M.4)
Yes, electronic or convertible
to hard copy, kept for 7
years and either in English
or a translation to be made
available upon request
(Part 2M.2)
No
Annual financial report (s. 295)
and directors report (ss. 298,
299, 300(1)–(13))
Financial report, auditor’s
report and directors’ report to
be presented at AGM (ss. 315,
317, 250N)
No
Listed public company (disclosing entity)
Three (two) (s. 201A(2))
At least one who resides in Australia (Part 2D.4)
Yes, including independence and rotation
requirements (ss. 301, 307, 308, 309, Part 2M.4)
Yes, electronic or convertible to hard copy, kept for
7 years and either in English or a translation to be
made available upon request (Part 2M.2)
Yes (Chapter 6CA)
ASX Listing Rules — Chapter 3
Annual and half-year financial report (ss. 295,
302–306) and directors report (ss. 298, 299, 299A,
300(1)–(13), 300A)
Financial report, auditor’s report and directors’ report
to be presented at AGM (ss. 315, 317, 250N)
Submit annual and half yearly financial, directors and
audit reports to ASIC (s. 319)
ASX Listing requirements — Chapter 4 and
Chapter 5 which include submission of quarterly
returns to ASX for some companies (mining, oil and
gas, and those without a record of revenue or profit)
Appendix 4G (ASX Listing Rule 4.7.3)
No
 The three components to an annual financial report are the financial statements, the notes to financial
statements, and the directors’ declaration.
Listed public companies must also comply with the ASX Corporate Governance Council’s Corporate
Governance Principles and Recommendations, which will be discussed in part D.
Figure 3.1 illustrates how the level of regulation, reporting and disclosure vary depending on the type
of corporate structure.

FIGURE 3.1 Level of company regulation

Listed
company

Public
company
Structure

Large private
company

Small private
company
Low High

Regulation
Source: CPA Australia 2023.

3.2 DIRECTORS AND OTHER OFFICERS

The Corporations Act sets out the eligibility criteria for directors and their duties. It also sets out the
requirements for company secretaries.

QUESTION 3.2

Find and list the eligibility criteria for directors in the Corporations Act. Use ASIC’s list of eligibil-
ity criteria at https://asic.gov.au/for-business/running-a-company/company-officeholder-duties/
your-company-and-the-law/#can-anyone-be-an-officeholder to confirm your list.

DIRECTOR IDENTIFICATION NUMBERS

From November 2021, ASIC introduced Director Identification (Director ID) Numbers. The Director ID
system is managed by the Australian Business Registry Services (ABRS), a new entity of the Australian
Taxation Office (ATO). Director IDs are designed to prevent the use of false or fraudulent director
identities (ASIC 2023).

DIRECTORS AND THEIR DUTIES

As noted in the previous discussion on corporations, incorporation brings specific corporate attributes,
including the benefits of limited liability, separate legal personality and perpetual succession. As corpo-
rations grow in size, there is also a separation of ownership and management. Over time, the legal duties
and responsibilities of directors have evolved to protect the interests of the owners, who are not able to
observe closely the daily management activities within a corporation.
In most jurisdictions, there is a core group of directors’ duties and responsibilities that have arisen from
either statute or case law. The key duties are to:
• avoid conflicts of interest and where these exist, ensure they are appropriately declared and, as required
by law, otherwise managed correctly
• act in good faith in the best interests of the corporation
• exercise powers for proper purposes
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126 Ethics and Governance

• retain discretionary powers and avoid delegating the director’s responsibility
• act with care and diligence
• remain informed about the corporation’s operations
• prevent insolvent trading.
Additionally, directors must not use information they gain in the course of their duties improperly nor
use their position as a director improperly. It is also important that directors ensure they apply professional
scepticism as they deal with issues arising during their term as a director.

Duty to Avoid Conflict of Interest

Conflict of interest is an issue that often arises with respect to all types of agency. An agency relationship
exists when one person acts on behalf of another, for example directors act on behalf of shareholders. The
ever-present opportunities that would benefit the agent due to their position provide significant temptation.
Potential conflicts may be at the expense of the corporation, or may even be beneficial to the corporation.
That is, it is not necessary that there be fraud, dishonesty or loss to the corporation, as the corporation does
not have to suffer a detriment for the director to be in breach of their duty. An example of this is when
a contract is awarded to a supplier that is owned by one of the directors. It may still provide a benefit to
the organisation in terms of the best price and appropriate quality, but this does not remove the conflict of
interest for the particular director involved.
All agents, including directors, need to be aware of conflicts of interest and must manage them correctly.
As a fundamental of good corporate governance compliance, directors need to fully understand that the
law requires that directors of larger corporations (including all public and listed corporations) must not be
involved in decisions where any actual or potential conflicts of interest are identified.
They can bypass this rule if they clearly advise the board of the conflict and also gain approval from
the remaining directors or from the shareholders or from corporate regulators. Failure to disclose to the
board or seek necessary shareholder approvals can result in civil liabilities, full obligations to compensate
persons (natural and corporate) who are harmed and even criminal prosecutions, including possible jail
and fines.
There are a number of examples of possible conflicts of interest to be aware of, including:
• relationships or circumstances that create conflicts of interest where no relevant gains to a director
may ever arise, but where the ability of the director to be regarded as independent is compromised by
relationships such as competing shareholdings, the interests of relatives or friends, and so on
• bribes, secret commissions and undisclosed benefits (e.g. in the awarding of a tender)
• misuse of corporation funds (e.g. for personal expenses)
• taking up corporate opportunities (e.g. purchasing land to on-sell to the corporation at a profit)
• using confidential information (e.g. to trade in the corporation’s shares)
• competing with the corporation (e.g. tendering for the same project)
• using a position in the corporation improperly (e.g. to secure a personal discount to the detriment of
the corporation).
It should be noted that accepting or being involved in secret commissions (which are often in the form
of bribes) is an offence in Australia under relevant criminal codes such as the Crimes Act 1958 (Cwlth).
This legal concept has legislative equivalents in most countries. Legislation for such actions often has a
wide reach, with citizens of a country being liable for prosecution for actions committed outside their
home country.

Duty to Act in Good Faith in the Corporation’s Best Interests

The duty to avoid conflicts of interest is matched with the corresponding demand to act in the best interests
of the corporation. Actions should be made in good faith, honestly and without fraud or collusion.
In many jurisdictions, the test for this is whether directors themselves believed their actions to be in the
best interests of the corporation. Directors who use good business judgement and behave honestly in a way
that a reasonable person in their position would act will satisfy the duty.

Duty to Exercise Powers for Proper Purpose

In addition to the need to act in the best interests of the corporation and avoid conflicts of interest, it is
essential for directors to act within their designated powers. The two main areas that must be satisfied are
that directors:
• act within their power
• do not abuse their powers.
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MODULE 3 Governance Concepts 127

 It is important to note that action that is perceived to be in the best interests of the corporation is still
unacceptable if it goes beyond the authority given to a director. This duty to exercise powers for proper
purposes is usually linked to legislation, and the constitution of the corporation or its equivalent, which
outlines the authority of directors.
Possible breaches of this duty include making anti-competitive agreements that benefit the corporation
but are illegal (e.g. price-fixing). There are a number of situations where the issue of improper purpose
may arise, including defensive actions during hostile takeovers (that are focused on protecting the current
management team rather than getting the best deal for shareholders) and actions to destroy majority voting
power (where a small minority gains control of a corporation at the expense of the majority).
Nominee Directors
A difficult situation arises when powerful interest groups appoint nominee directors to a board. These
directors are appointed to represent third-party interests, such as a major shareholder, a class of share-
holders or a holding corporation. However, this may put the nominee in a position where their loyalties
are divided between the conflicting interests of the nominator and the corporation. The nominee director
must always act in the best interests of the corporation and use their powers only for proper purposes when
making a decision as a director of a board.

Duty to Retain Discretionary Powers

Directors generally have powers granted to them in legislation or a corporation’s constitution to delegate a
range of their functions. These include the power to manage the corporation, which is generally delegated
to executive directors and other senior officers. However, situations can occur where a director delegates
to another a power that the director should themselves have exercised. If the delegate’s action, or inaction,
subsequently causes the corporation to suffer loss, the director may be liable.
The board must not, without express authority from the corporation’s constitution or from statute,
delegate their discretion to act as directors to others. While the directors can engage employees and agents
to perform the ordinary business of the corporation, the directors must not let someone who is not a
director carry out their duties. In addition, as directors owe a fiduciary duty to the corporation to give
proper consideration when exercising their right to vote or act — they cannot simply accept the direction
of others as to how they will vote at board meetings.
Where a director has delegated powers to anybody (usually managers), the director (or the whole board
jointly and severally) remains responsible for the exercise of the power by the delegate, as if the director
had exercised the power themselves.
However, corporate legislation in various jurisdictions usually allows directors to escape this total
liability for every action by a manager to whom power is delegated. Delegates (i.e. managers) need to be
properly appointed by boards (of directors) using professionally acceptable procedures (as to competence,
qualifications, etc. of the manager).
Additionally, the board must carry out correct and ongoing oversight. Note, however, that the board
does not undertake day-to-day operational management, so a balanced approach is required. If these
two obligations are met, then boards can be comfortable that they will not be exposed to a vast array
of management-induced personal liabilities.
A word of caution is required however. From both the Centro case and the James Hardie case, to be
discussed shortly, a residual matter arising in discussion relates to the fact that some director’s duties and
tasks are simply ‘non-delegable’. This means that any attempt to delegate these ‘non-delegable’ functions
(to managers or to other fellow directors) will comprise inappropriate action by a director and will not deem
the director immune from liability. The obligation to report correctly to shareholders on major matters
affecting the finances of the corporation, which directors should do or be aware of, appear from the Centro
and James Hardie decisions to be ‘non-delegable’. These two cases are discussed later in the module in
example 3.3 and example 3.4 respectively.

Duty to Act with Care and Diligence

A director is expected to exercise risk in a sensible and prudent manner. The appropriate standard or test
‘is basically an objective one in the sense that the question is what an ordinary person, with the knowledge
and experience of the [director], might be expected to have done in the circumstances if he was acting on
his own behalf’ (ASC v. Gallagher (1993) ASCR 43).
There are two interesting situations where the standard of care may differ even between directors of the
same corporation.
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128 Ethics and Governance

• A director who also has professional qualifications (e.g. a CPA) and uses them in an executive capacity
(e.g. as a chief financial officer (CFO)) may be subject to a higher level of responsibility. In this sense,
these directors may have a higher standard of care than unqualified directors because of their higher
level of skills and the specific role they fulfil and for which they receive executive remuneration.
• Non-executive directors who are not involved in the business on a day-to-day basis are still required
to demonstrate a duty of care. However, the care, skill and diligence that a non-executive direc-
tor may be expected to exercise may not equate to that of an executive director who also holds
professional qualifications.
Business Judgment Rule (s. 180(2))
As a protection for directors the Corporations Act contains the business judgment rule. Effectively a
director can be said to have met their duty to act with care and diligence in respect of decisions that they
have made if they:
(a) make the judgment in good faith for a proper purpose; and
(b) do not have a material personal interest in the subject matter of the judgment; and
(c) inform themselves about the subject matter of the judgment to the extent they reasonably believe to be
appropriate; and
(d) rationally believe that the judgment is in the best interests of the corporation.

Duty to Remain Informed about Company Operations

To fulfil their duties, directors need to know what is happening within the company and in the environment
within which the company operates. Reading board papers is a crucial facet of this duty. Applying
professional scepticism and asking appropriate questions of company officers and auditors enable directors
to get the information that they require, make informed judgements and act accordingly.
Continuous Disclosure Regimes
A further responsibility of directors related to remaining informed about the operations of a listed company
is the regime of continuous disclosure that now applies to companies listed on major exchanges including
the ASX. This is to ensure that shareholders and other stakeholders are provided with high-quality
disclosures on the financial and operating results of the company. This includes any aspect of operations
that might impact upon the share price of the company or the market perception of the company. This also
involves matters such as governance, performance, investment and other issues relating to the company.
Shareholders and others can then make informed assessments concerning the progress of the company and
informed decisions regarding further investment.
Continuous disclosure does not only apply to significant financial or operating performance develop-
ments, but also to any development in the company that may affect the market for the company’s shares
(e.g. the possibility of a merger or takeover, a new product launch, entering an important new market).
In recent years, penalties imposed upon companies that have failed to disclose material issues have
increased and included significant fines and banning of directors.
Most of the corporate governance regimes around the world commit companies to disclosure as a vital
basis for the effective operation of all other mechanisms of governance and investment.
Chapter 3 of the ASX Listing Rules (ASX 2014a) gives the following examples of information that
could be market sensitive:
• a transaction that will lead to a significant change in the nature or scale of the entity’s activities;
• a material mineral or hydrocarbon discovery;
• a material acquisition or disposal;
• the granting or withdrawal of a material licence;
• the entry into, variation or termination of a material agreement;
• becoming a plaintiff or defendant in a material law suit;
• the fact that the entity’s earnings will be materially different from market expectations;
• the appointment of a liquidator, administrator or receiver;
• the commission of an event of default under, or other event entitling a financier to terminate, a material
financing facility;
• under-subscriptions or over-subscriptions to an issue of securities (a proposed issue of securities is
separately notifiable to ASX under Listing Rule 3.10.3);
• giving or receiving a notice of intention to make a takeover; and
• any rating applied by a rating agency to an entity or its securities and any change to such a rating.
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MODULE 3 Governance Concepts 129

 While understanding the broad principles and necessity of continuous disclosure, boards and directors
are often challenged on exactly when disclosure is required. The ASX (2014a) advises:
Once an entity is or becomes aware of any information concerning it that a reasonable person would expect
to have a material effect on the price or value of the entity’s securities the entity must immediately tell ASX
that information (Listing Rule 3.1 (p. 301)).
A listed entity should have a written policy directed to ensuring that it complies with this obligation so
that all investors have equal and timely access to material information concerning the entity – including its
financial position, performance, ownership and governance.
In designing its disclosure policy, a listed entity should have regard to ASX Listing Rules Guidance
Note 8 Continuous Disclosure: Listing Rules 3.1 – 3.1B and to the 10 principles set out in ASIC Regulatory
Guide 62 Better disclosure for investors (Corporate Governance Recommendation 5.1 (p. 21)).
Further advice offered by the ASX (2014b) regarding the immediacy of the need for disclosure includes
when and where the information originated (rumours abound and need to be countered carefully); the
forewarning the entity had of the information and the need to verify the bona fides of the information; and
the need for an announcement to be drawn up that is accurate, complete and not misleading.
Example 3.1 describes a case in which directors breached their continuous disclosure obligations.

EXAMPLE 3.1

GetSwift Ltd
In February 2023, the Federal Court of Australia issued the largest ever penalty against a company for
breaching continuous disclosure laws and engaging in misleading and deceptive conduct. GetSwift Ltd,
a tech start-up, was issued an AUD15 million penalty. Notably, two of GetSwift’s former directors were
penalised for corporate misconduct, including financial penalties and disqualification from managing
corporations for 12–15 years.
Source: Adapted from Federal Court of Australia 2021, Australian Securities and Investments Commission v. GetSwift
Limited (penalty hearing) [2023] FCA 100, accessed August 2023, https://download.asic.gov.au/media/rhedt5ly/23-029mr-
asic-v-getswift-limited-penalty-hearing-2023.pdf; ASIC 2021, ‘ASIC successful in Federal Court against GetSwift and
its directors Bane Hunter, Joel Macdonald and Brett Eagle’, accessed August 2023, https://asic.gov.au/about-asic/news
-centre/find-a-media-release/2021-releases/21-298mr-asic-successful-in-federal-court-against-getswift-and-its-directors-
bane-hunter-joel-macdonald-and-brett-eagle.

Duty to Prevent Insolvent Trading

The Global Financial Crisis (GFC) of 2007 resulted in numerous publicised corporate insolvencies and
liquidations. This economic environment focused attention on directors’ duties where a corporation is
experiencing financial difficulties or, in a worst-case scenario, has become insolvent.
While the laws relating to corporate insolvency and liquidations can be complex and contain important
technical differences across countries, the following summary covers the key issues under the Corporations
Act, from the point of view of directors.
A basic duty of directors under the Corporations Act is to ensure that a company can pay its debts. This
means that the directors must, at the time a debt is incurred, have reasonable grounds to believe that the
company will be able to pay its debts when they are due for payment. An insolvent company is one that
is unable to pay all its debts when they fall due. If a company becomes insolvent, the directors must not
allow it to incur further debts.
Serious penalties can be imposed on directors if they allow a company to trade while insolvent. It is
therefore very important that the directors are constantly aware of the company’s financial position — not
just at the end of the financial year when they sign off the company’s financial statements. Directors need
to pay careful attention to the declaration where they confirm whether or not, at the date of the declaration,
there are reasonable grounds to consider that the company will be able pay its debts as and when they fall
due and payable. In situations where the company is experiencing financial difficulty, it may be prudent
for directors to seek independent advice on their responsibilities.
In an effort to protect directors in their attempt to trade out of insolvency, the Corporations Act includes
a safe harbour provision (s. 588GA). Under this provision, directors who incur debts while insolvent are
protected if:
(a) at a particular time after the person starts to suspect the company may become or be insolvent, the
person starts developing one or more courses of action that are reasonably likely to lead to a better
Pdf_Folio:130
outcome for the company; and

130 Ethics and Governance

 (b) the debt is incurred directly or indirectly in connection with any such course of action during the period
starting at that time, and ending at the earliest of any of the following times:
(i) if the person fails to take any such course of action within a reasonable period after that time —
the end of that reasonable period;
(ii) when the person ceases to take any such course of action;
(iii) when any such course of action ceases to be reasonably likely to lead to a better outcome for the
company;
(iv) the appointment of an administrator, or liquidator, of the company.
This provision also states that should a director rely on this defence, the burden of proof rests with
the director.
Unless the company can obtain sufficient finance or trade its way out of financial difficulty, the options
available to directors are to appoint a voluntary administrator or a liquidator. In a voluntary administration,
an independent and suitably qualified person will assume full control of the company to try to work out
a way to save either the company or the company’s business. If it isn’t possible to save the company or
its business, the aim is to administer the affairs of the company in a way that results in a better return to
creditors than they would have received if the company had instead been placed straight into liquidation.
The purpose of liquidation of an insolvent company is to have an independent and suitably qualified
person (the liquidator) take control of the company so that its affairs can be wound up in an orderly and
fair way for the benefit of its creditors. There are also circumstances under which directors may find
themselves liable for insolvent trading and have judgements awarded against them. Example 3.2 presents
one such set of circumstances.

EXAMPLE 3.2

Mainzeal
A notable case in New Zealand is the Mainzeal case. In February 2019, a court decided that directors were
liable for trading while insolvent and that the directors were to pay a penalty of NZD36 million. Mainzeal
was a construction company that was placed in the hands of liquidators in 2013 after it had built up
NZD110 million in debt to creditors. The company directors, including former New Zealand Prime Minister
Dame Jenny Shipley, were told they were to pay an amount capped at NZD6 million individually.
The directors subsequently challenged the decision, and the Court of Appeal upheld the lower court’s
ruling that the directors traded the company recklessly. However, the directors were successful in
overturning the NZD36 million in penalties, arguing that while they exposed Mainzeal’s creditors to the
risk of a serious loss, that risk did not materialise.
In March 2022, the case reached the Supreme Court of New Zealand. Former directors and the Chief
Executive of Mainzeal were seeking to overturn the Court of Appeal’s decision to send the case back to
the High Court. In July 2023, submissions were still being made to the Supreme Court.
The case illustrates the need for directors to obtain proper legal advice, and to not use an auditor’s
opinion that views the entity as a going concern as the sole basis for their assessment for whether the
entity is able to pay its debts as they fall due.
Source: Adapted from Dolor, S 2019, ‘Mainzeal judgment highlights need for good corporate governance’, March,
New Zealand Lawyer, accessed August 2023, www.thelawyermag.com/nz/news/general/mainzeal-judgment-highlights-
need-for-good-corporate-governance/206565; Radio New Zealand 2021, ‘Mainzeal former directors’ penalties overturned,
but not ruling’, 31 March, viewed August 2023, www.rnz.co.nz/news/business/439565/mainzeal-former-directors-penalties
-overturned-but-not-ruling.

.......................................................................................................................................................................................
CONSIDER THIS
What are the issues that you would consider important if you were a director contemplating whether your entity was
a going concern?

EXAMPLES OF THE EXERCISE OF DIRECTORS’ DUTIES

Examples 3.3 and 3.4 illustrate important principles concerning the duty of care and diligence expected
of directors when they approve financial statements, and how problems may occur. Both cases reveal that
company directors cannot rely solely on the view of company executives and auditors but must exercise
their own judgement. While the courts may look to those with significant professional expertise such as
CFOs or CEOs for a more detailed understanding of corporate dilemmas, it is the duty of every company
director to have an understanding of the main issues in annual reports and corporate communications, and
these duties are not delegable to others.
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MODULE 3 Governance Concepts 131

 EXAMPLE 3.3

Centro Case
The Centro case (ASIC v. Healey & Ors (2011) FCA 717) involved actions brought by the Australian
corporate regulator, ASIC, against certain executives and non-executive directors of the Centro group
of entities. The principal activities of the Centro group, the parent of which is listed on the ASX, involves
the ownership, management and development of shopping centres throughout Australia, New Zealand
and the United States, and the management of unlisted funds.
ASIC alleged that the defendants had contravened their statutory duties of care and diligence under the
Corporations Act in relation to their approval of the consolidated financial statements of the Centro group
for the year ended 30 June 2007. In particular, it was alleged that the consolidated financial statements
were incorrect as they incorrectly classified $1.5 billion of debt as non-current liabilities when in fact they
should have been classified as current liabilities.
Furthermore, it was alleged that the defendants had failed to disclose USD1.75 billion of guarantees
as a material post balance date event in the financial statements of Centro. Centro’s auditor, Pricewater-
houseCoopers, did not identify any such errors in the financial statements of Centro.
In June 2011, Justice Middleton of the Federal Court of Australia (FCA) held that each of the directors
had breached their duty of care and diligence in relation to the Centro group of entities and had
failed to take all reasonable steps to ensure compliance with the financial reporting obligations of the
Corporations Act.
The directors were also found to have approved the financial statements of Centro without receiving a
CEO/CFO declaration that complied with section 295A of the Corporations Act. The court held that each
director knew or should have known of the extent of the relevant entities’ borrowings and maturity profiles
as well as the post balance date guarantees.
Key lessons for directors arising out of the Centro case include the following matters.
Duty of Care
The Centro case emphasises the duty of care expected of public company directors when they approve
financial statements. The directors should apply their minds to the proposed financial statements,
including a careful review of how the financial analysis is presented and the clarity of the accompanying
directors’ report.
The directors should determine whether the information contained in these documents is consistent
with their knowledge of the company’s affairs and that they do not omit material matters known, or that
should have been known, to the directors.
The directors should know enough about basic accounting concepts to enable them to carry out their
responsibilities adequately. Furthermore, they should make appropriate inquiries if they are uncertain.
Reliance on Others
The Centro directors argued that the Corporations Act permits reasonable reliance on others in the
discharge of their duties, and that they reasonably relied on Centro’s management and the external auditor
to ensure that the financial statements complied with relevant accounting standards.
The court found that the directors may rely on others, including management and external advisors,
who prepare financial statements and advise on accounting standards. Such reliance can exclude
independently verifying the information on which the advice is based, provided that there is no cause
for suspicion or circumstances demanding critical attention.
However, directors cannot substitute reliance on advice for their own attention and examination of
important matters within the board’s responsibilities (i.e. the directors must approach their tasks with
an enquiring mind). Therefore, the directors’ failure is not excused even if others on whom they relied fell
into error.
Delegation
The obligation of directors to approve the financial statements, and to express an opinion as to their
compliance with accounting standards and that they give a true and fair view, rests with the directors and
is not able to be delegated to others. The court referred to the ‘core, irreducible requirement of directors
to be involved in the management of the Company’.
Information Flow
Directors have a duty to take into account information they receive from all sources when reviewing the
financial statements, including information about loan maturities provided in board papers. Having to deal
with complex and voluminous material is no excuse for failure to take sufficient care and responsibility.
The board can control the information it receives, so it can take steps to prevent information overload.
Over time, it is expected that directors will or should accumulate sufficient knowledge of what is contained
in regular board reports. Information provided to directors by management is assumed to be given to them
for a reason.

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132 Ethics and Governance

 Financial Competence
Directors are required to have the financial literacy to understand basic accounting conventions and to
exercise proper diligence in reading the financial statements. Note that this does not mean that the director
should have a working knowledge of all the accounting standards.
While there are many matters a director must focus on, the financial statements are regarded as
one of the most important matters. For instance, directors should understand that financial statements
classify assets and liabilities as current and non-current, and directors should understand what these
concepts mean.
............................................................................................................................................................................
CONSIDER THIS
Do you agree with the idea that different directors within the same organisation may be held to have a different
standard of care based on their qualifications?

Example 3.4 further illustrates the importance of directors not relying on others to avoid their duty to
use care, skill and diligence in their dealings with and on behalf of the corporation.

EXAMPLE 3.4

James Hardie Case

The James Hardie Group is an industrial building-materials company with operations in Australia, the US,
New Zealand and the Philippines. Two subsidiaries of the James Hardie Group were exposed to major
liabilities associated with asbestos-related claims.
The group restructured itself to separate those subsidiaries from the group and established a foundation
to compensate the victims of asbestos-related diseases who had claims against the two subsidiaries.
February 2001
The board of James Hardie Industries Limited (the parent in the James Hardie Group) announced to the
ASX that the foundation had sufficient funds to meet all anticipated compensation claims. In fact, the
announcement was misleading because the foundation was underfunded by $1.5 billion.
2007
ASIC brought proceedings against the directors of James Hardie Industries Limited and certain officers
for failing to exercise due care and diligence in approving and releasing the ASX announcement.
May 2012
The High Court of Australia (ASIC v. Hellicar (2012) HCA 17) found that the directors of James Hardie
Industries Limited had breached their duties to act with due care and skill by approving the release of a
misleading announcement to the ASX concerning the funding arrangements for the asbestos liabilities.
It was held that none of the directors were entitled to abdicate responsibility (in relation to the misleading
ASX announcement) by delegating their duty to a fellow director or by pleading reliance on management
or expert advisers for the task of approving a draft of the ASX announcement.

Following the Centro and James Hardie cases, detailed in examples 3.3 and 3.4, there are some non-
delegable duties, and these apply to business judgment decisions. While the area is unclear, it can be stated
with reasonable certainty that if matters are considered carefully by a director and on an informed basis,
it would seem that directors can delegate to others.
This would include the concept that non-executive directors delegate to appropriately qualified executive
directors with the expectation that personal liability is also ‘delegated’. If the matter is of major importance,
delegation may not be effective — just as it would not be if the delegate is, on an ongoing basis, objectively
considered not to be reliable and appropriate as a delegate.
From a regulatory perspective, several types of officers or agents deserve special mention. Other than
directors, a number of agents in a corporation play important roles in its governance. (Note that many of
these may also have the office of director, meaning that they hold two ‘offices’ — one as a director and
another as a skilled executive as shown in figure 3.2.) These ‘other officers’ include positions that are
simply defined as offices and other positions where responsibilities may have a significant impact on the
corporation. Officers under either approach include:
• CEO
• CFO
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MODULE 3 Governance Concepts 133

• company secretary
• legal counsel
• internal auditor.
Without a highly competent CEO who is committed to good governance, it would be difficult for good
governance practices to be effectively implemented. To enhance governance, some corporations are also
appointing chief operating officers, compliance officers, ethics officers and risk managers. The titles are
often somewhat meaningless on their own — the crucial issue on every occasion is for the board (and each
director) to establish the responsibilities and capabilities of these officers and to ensure that all delegations
to the officers are understood and properly documented.
The board needs to understand and take appropriate responsibility for the formal approval of all signif-
icant delegations and their documentation. Correct board policies and knowledge relating to systems and
procedures involving significant delegations is an important foundation of good corporate governance.

DIRECTOR INDEPENDENCE
It is crucial to appreciate the importance of independence in the role of directors. All independent directors
must be non-executive directors, but not all non-executive directors are independent. Sometimes people
confuse these two terms or use them interchangeably, but they are different.
The ASX Corporate Governance Council’s Corporate Governance Principles and Recommendations
(ASX Principles), which are now in their fourth edition, provide the following commentary on indepen-
dence and directors.
To describe a director as ‘independent’ carries with it a particular connotation that the director is not aligned
with the interests of management or a substantial holder and can and will bring an independent judgement
to bear on issues before the board.
It is an appellation that gives great comfort to security holders and not one that should be applied lightly.
A director of a listed entity should only be characterised and described as an independent director if he
or she is free of any interest, position or relationship that might influence, or reasonably be perceived to
influence, in a material respect their capacity to bring an independent judgement to bear on issues before
the board and to act in the best interests of the entity as a whole rather than in the interests of an individual
security holder or other party (ASX CGC 2019, p. 13).

There are ultimately three director categories, as illustrated in figure 3.2: executive directors (ED),
who work for the company and are, therefore, not independent; non-independent non-executive directors
(NINED), who do not work in the organisation but are also not independent due to the nature of a particular
relationship; and independent non-executive directors (INED), who are in a position where they are free
from influence or bias, meaning they can truly exhibit the characteristics needed for independence.

FIGURE 3.2 Director categories

Executive
directors (ED)
Non-independent
Directors non-executive
directors (NINED)
Non-executive
directors (NED)
Independent
Company
Officers non-executive
secretary
directors (INED)

Other officers

Source: CPA Australia 2023.

The UK Corporate Governance Code (produced by the UK Financial Reporting Council (FRC) and
known as the UK FRC Code) provides the following items to help guide consideration of whether a director
is independent, by asking if the director:
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134 Ethics and Governance

 • is or has been an employee of the company or group within the last five years;
• has, or has had within the last three years, a material business relationship with the company, either
directly or as a partner, shareholder, director or senior employee of a body that has such a relationship
with the company;
• has received or receives additional remuneration from the company apart from a director’s fee,
participates in the company’s share option or a performance-related pay scheme, or is a member of
the company’s pension scheme
• has close family ties with any of the company’s advisers, directors or senior employees;
• holds cross-directorships or has significant links with other directors through involvement in other
companies or bodies;
• represents a significant shareholder; or
• has served on the board for more than nine years from the date of their first appointment (UK FRC 2018,
pp. 6–7).

Even if a director is not independent, it is important to appreciate the concept and to ensure decisions
are made as impartially (i.e. as independently) as possible. This obligation is actually required by law in
most jurisdictions.
The identification of non-executive and independent directors is important. In Australia, for example,
Recommendation 2.3 of the ASX Principles states that ‘a listed entity should disclose the names of the
directors considered by the board to be independent directors’ (ASX CGC 2019). It also provides a
checklist of factors to consider when assessing a director’s independence. There are similarities between
these factors and those from the UK FRC Code discussed earlier.
In addition to this, certain committees should only have independent or at least non-executive members
on them, this will be discussed in part D. The ASX Principles also deal with the need to periodically
review the tenure of directors to ensure that they maintain independence. The recommendations suggest
that the relationships, experience and tenure of directors should be reviewed periodically to ensure that
directors that are classified as being independent are able to continue to be classified as independent. The
commentary on Recommendation 2.3 describes in some detail what the Corporate Governance Council
expects of directors.

QUESTION 3.3

(a) Download the two sets of governance guidance from the ASX Corporate Governance Council
and the UK FRC as per the links below.
– www.asx.com.au/documents/regulation/cgc-principles-and-recommendations-fourth-
edn.pdf
– www.frc.org.uk/getattachment/88bd8c45-50ea-4841-95b0-d2f4f48069a2/2018-UK-
Corporate-Governance-Code-FINAL.PDF
(b) Take notes on similarities and differences between Box 2.3 of the ASX Principles and
Provision 10 of the UK FRC Code.
(c) What does the Corporate Governance Council state that a board should do in relation to
directors whose tenure is more than 10 years?

COMPANY SECRETARIES AND THEIR DUTIES

Company secretaries are individuals who fulfil a critical compliance role. A company secretary has the
responsibility for ensuring a company maintains all its compliance obligations with the corporate regulator.
This will include ensuring required documents are filed on time, fees for registration paid and changes to a
company register are made as required under the Corporations Act. These changes include new directors,
changes to addresses for serving notices as well as changes to shareholdings where relevant. A company
secretary must be at least 18 years of age and reside in Australia. Companies may have more than one
company secretary but at least one of the company secretaries must be resident in Australia.

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MODULE 3 Governance Concepts 135

 QUESTION 3.4

The Small Business Guide in the Corporations Act (Volume 1, Chapter 1, Part 1.5, paragraph 5)
describes the responsibilities of a company secretary. Find the responsibilities as described in the
guide and ensure you note them.

3.3 NATURE OF CORPORATIONS AND DIVISION OF

CORPORATE POWERS
In a corporate structure the shareholders, board of directors, and the CEO share power. The powers of the
board and shareholders are detailed in the Corporations Act and, if it has one, a company’s constitution.
This includes the right of the board to delegate some of their powers to the CEO. The relationship between
these three ‘actors’ is known as an agency relationship. An agency relationship is created when one party
(the agent) assumes or is given responsibility for looking after the rights or interests of another party (the
principal). In a corporate structure, two such agency relationships exist; one between the shareholders (as
principals) and the board (as agents of the shareholders), and another between the board (as principals)
and the CEO (as an agent of the board). The roles of each of these three actors and their powers and/or
responsibilities are described next.

SHAREHOLDER POWERS
Shareholders (or members, as they are referred to in the Corporations Act) are given powers under the
Corporations Act. Generally, these powers include the power to appoint, remunerate and remove directors,
call meetings, call for and vote on resolutions, and seek redress from the courts.

Appointment of Directors
The Corporations Act states that directors can be appointed in two ways (ss. 201G, 201H):
• by resolution passed in a general meeting;
• by the directors of a company which is subject to confirmation by:
– a proprietary company via resolution within two months of the appointment; and
– a public company via resolution at the company’s next annual general meeting (AGM).

Once appointed (unless otherwise restricted), they can exercise all the powers conferred upon them by
the Corporations Act.

Remuneration
In public companies, shareholders generally approve the overall upper limit of (or increases to) director
remuneration. For listed companies, members at annual general meetings have the opportunity via
s. 250R(2) to adopt a company’s remuneration report; however, ‘this is advisory only and does not bind
the directors or the company’ (s. 250R(3)). Two successive ‘strikes’ (a ‘no’ vote of 25 per cent or more
to the adoption of the remuneration report) gives members the opportunity to vote on a spill resolution.
If the resolution is passed by at least 50 per cent of votes, all directors are forced to put themselves up
for re-election at a ‘spill meeting’, which must be held within 90 days of the spill resolution being passed
(ss. 250U, 250V, 250W).

QUESTION 3.5

Find the sections from the Corporations Act listed in table 3.3 and fill in the other powers reserved
for shareholders.

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136 Ethics and Governance

 TABLE 3.3 Shareholder powers

Section Shareholder power

136

162

173(2)

201P

203D

208

234

246B

249D(1)

249N

251B

314 and 316A

327B and 329

Source: CPA Australia 2023.

BOARD POWERS
The Corporations Act (s. 198A) states that ‘the business of a company is to be managed by or under the
direction of the directors’. The board of directors (the board) is the body that oversees the activities of
an organisation.
It is preferable that the roles and responsibilities of the board be explicitly set out in a written charter
or constitution. A significant court case in Australia regarding what boards should do has received
international recognition in the Anglo-American corporate world. In AWA Ltd v. Daniels (1992) 10
ACLC 933, Rogers CJ concluded that the role of the board in modern companies is to set policy and
organisational objectives (performance) and then ensure adequate controls and review procedures are in
place (conformance) to ensure effective implementation by management (performance).
However, Rogers CJ observed that the board is not in place to actually run the business itself. That
part of the governance process is delegated to the CEO, although the board must remain informed and is
responsible for taking timely action where fundamental CEO failures arise. Rogers CJ stated:
The board of a large public corporation cannot manage the corporation’s day-to-day business. That function
must by business necessity be left to the corporation’s executives. If the director of a large public corporation
were to be immersed in the details of day-to-day operations, the director would be incapable of taking more
abstract, important decisions at board level (AWA Ltd v. Daniels (1992) 10 ACLC 933, p. 1013).

Therefore, directors are entitled to rely on management to manage the daily operational activities of
the corporation. The board need not be informed of these details and will expect the paid managers to
run the corporation according to strategies and policies set by the board. However, the board cannot leave
everything to the managers, as the board also has an ongoing oversight responsibility.
The board must ensure appropriate procedures are in place for risk management and internal controls,
and it must also ensure that it is informed of anything untoward or inappropriate in the operation of those
procedures. Any major operational issues will also be brought to the attention of the board for appropriate
consideration and decision.
Despite these expectations, in many high-profile corporate collapses, it is apparent that the board was not
informed about key business decisions or simply chose to comply with management. For example, in the
case of a former prominent Australian company, HIH Insurance, it was apparent that the major takeover of
another company, FAI Insurance, was undertaken without rigorous debate at board level or due diligence
being carried out before the transaction was finalised.
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 The role of the board has become more onerous, making support mechanisms more important. These
include induction for new directors, relevant education and training for all directors and board evaluations.
Furthermore, to enable directors to properly carry out their legal and ethical duties, it is necessary for them
to be provided with expert advice (including legal and financial advice). Such advice should be objective
and as independent as possible. Professional accountants, along with other professional groups and other
experts, are important contributors to meeting these needs of boards.
The board is elected by shareholders and functions as their agent. Boards are expected to act for, on
behalf of or in the best interests of shareholders. Under Anglo-American law (which has been developed in
many Western countries), companies developed with the concept that shareholders are part of the company,
being the owners. Therefore, the primary duty of boards is to shareholders, with the duty to all other
stakeholders deriving from the directors’ duty to ‘act in good faith in the best interests of the company’
(Corporations Act, s. 181). Obviously, it is not possible to make all shareholders happy at all times, but if
the directors genuinely make decisions intended to be good for the general body of shareholders, then this
is satisfactory.

Alternative Board Structures and Relationships

Board structure and stakeholder representation may vary, especially in different countries. For example,
two-tier board structures are commonly required for large companies in some northern European countries.
The top tier comprises the supervisory board and the second tier is the management board, which may
have strong employee representation. In Japan, it is common for banks and finance providers to have
a relationship with boards that is much stronger and more influential than elsewhere. Traditionally this
provided a stable source of investment capital for Japanese companies, though the equity markets are now
growing in influence. As professional accountants, we must recognise and understand these differences.

CEO POWERS
The CEO is responsible for the ongoing operations of the organisation. The CEO is usually a director of
the board as well, and because of this, may also be called the managing director or MD. In this capacity, the
CEO is easily identified as an agent of the board, with carefully defined responsibilities to make a range
of operational decisions as delegated by the board.
The CEO effectively has two roles, board member and CEO, and potentially two identifiable agency
relationships arise — one with shareholders and another with the board. This duality results in a series of
governance rules and laws designed to control problems that can arise.
The CEO, in conjunction with the management team, is responsible for constructing the strategies and
the significant policies of the company. However, this will be the result of boardroom deliberations in
which the CEO, as a director, will participate. When the process is completed to the satisfaction of the
board, the board will formally approve these corporate strategies and policies. The task of implementing
corporate strategies and policies rests with the CEO and the management team.
The CEO must keep the board informed on key issues relating to the management of the company — for
example, through monthly management reports to the board. These reports should include information on
performance and key risks, and also exceptional/significant events (such as the loss of a key customer). The
CEO also works with the board (primarily the chair) and the company secretary to prepare the agenda for
board meetings and to ensure that appropriate background information accompanies the agenda to enable
the board to make the right decisions.

3.4 THEORIES OF CORPORATE GOVERNANCE

There are a number of theories that attempt to explain how a corporation will or should operate.
A theory of corporate governance provides an understanding of how different people or groups are likely
to behave in the corporate environment. From this understanding, we can then design governance systems
to ensure the best outcomes. For example, if our underlying belief is that people or corporations are selfish
or egoists, we need to ensure there are appropriate rules and regulations in place to stop them from abusing
their position to maximise their own wealth and status.
The first two theories discussed in this section (stewardship theory and agency theory) take a narrower
internal view of corporate governance, and focus on the behaviour of managers and staff in relation to the
owners of the corporation.

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138 Ethics and Governance

 The two additional theories presented (stakeholder theory and corporate social responsibility theory)
take a broader external perspective of corporate governance. These theories are discussed briefly at the
end of this section.

STEWARDSHIP THEORY
Stewardship theory suggests that people in power (the agents or stewards) will act for the benefit of
those who have engaged them. Stewardship theory sees appointed directors as ‘stewards’ who carefully
look after the resources they have been trusted with. Rather than directors and managers as agents who act
in their own self-interest, these stewards are expected to naturally act favourably on behalf of the owners
(Donaldson & Davis 1991). Executive self-interest is not expected to interrupt corporate goals and genuine
stakeholder outcomes. In this situation, financial reports provide a formal means for the directors to declare
their stewardship obligations to the owners.
While stewardship theory accepts that directors must also consider the interests of groups other than
shareholders (i.e. stakeholders such as employees, suppliers, customers), the primary duty of directors is
for the interests of shareholders. The boundaries of corporate governance under stewardship theory are
therefore defined by the relationship between directors and shareholders.
The interests of other stakeholders are assumed to be addressed by relevant laws outside the boundaries
of corporate governance, such as consumer protection or competition laws. A strength of stewardship
theory is that it perceives directors as professionals able to demonstrate their commitment to the company
and its shareholders in a virtuous and capable way without constant oversight. One criticism of this theory
is the assumptions that good stewards do exist and that these stewards will maintain their virtues over
extended periods of time.

AGENCY THEORY
Agency theory takes the alternative view and assumes people have a self-interested egoist
approach. Agency theory views corporate governance through the relationship between agents and
principals. At its broadest level, agency consists of giving power to individuals or groups to act on
behalf of others. Agents are permitted to act in place of, and to make decisions for and on behalf of, the
principals and to comply with the terms of the agency and the rules applying to them.
While agents are expected to act on behalf of the principal, agency theory differs from stewardship theory
because it suggests the agent may not naturally act in the best interests of the principal. The underlying
assumption of agency theory is that all parties are rational utility maximisers, which means agents may
pursue different goals from those of the principals. Therefore, potential for conflict arises and mechanisms
such as corporate governance must be in place to ensure the agent acts appropriately.
Agents must therefore be aware of the concepts and principles of good governance, and to comply with
the terms of the agency and the rules applying to them. Jensen and Meckling define agency and comment
on its central problem.
We define an agency relationship as a contract under which one or more persons (the principal(s)) engage
another person (the agent) to perform some service on their behalf, which involves delegating some decision
making authority to the agent. If both parties to the relationship are utility maximizers, there is good reason
to believe that the agent will not always act in the best interests of the principal (Jensen & Meckling 1976,
p. 308).

Two key assumptions underlie agency theory.

1. All individuals will act in their own self-interest. Therefore, where a potential conflict of interest exists
between principals and agents, agents will tend to act first in ways that will maximise their own personal
circumstances.
2. Agents are in a position of power as they have better access to, and control of, information (information
asymmetry) and the ability to make decisions. This allows them to further their own interests.
The key question to be resolved in any agency is: How do you align the interests of the principals and
agents, thereby modifying any self-serving and ill-informed behaviour of the agents in order to minimise
agency costs? Interest alignment, also called ‘goal congruence’, is a critically important aspect of good
governance. The costs of not achieving interest alignment can sometimes be catastrophic.
Specific examples of governance that address this issue that are discussed in this module include a
remuneration committee that sets management performance targets and rewards, and an audit committee
that focuses on ensuring financial information and internal controls are in order.
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 Most of the discussion in this module is directed at large corporations whose shares are sold on public
stock exchanges. The shareholders or owners are the principals, and the managers of the corporation are
the agents. The concept of agency is particularly pertinent here due to the usually wide separation between
the owners and the board and other management. Nevertheless, the concept of agency is common in all
entities; small or large, public or private.

AGENCY ISSUES AND COSTS

Many corporate governance rules, regulations and principles are based on agency theory. For example,
directors have legal duties with which they must comply, such as a duty to act in the best interests of a
corporation. We therefore need to explore the agency issues and costs that arise when an agent acts in
a self-interested manner. This will help with understanding the intent of the rules, codes, principles and
guidance that we discuss later in this module.
Within corporations, shareholders are the principals and boards are their agents. Similarly, another
principal or agent relationship arises when the board engages the CEO and other senior managers, and
delegates specific management powers. In this case, the board is the principal, and the CEO and managers
are the agents.
It is common practice for boards to delegate day-to-day operational powers to the CEO, but not extensive,
strategic decision-making powers. Boards need to carefully consider all delegations. Sir Adrian Cadbury
(CFACG 1992) has stated that there must be a ‘series of checks and balances’, and the freedom to delegate
broadly is implicitly limited by the system of checks and balances. A director cannot delegate and then
deny all responsibility. In module 1, we observed the importance of ‘professional judgement’. It is clear
that boards must understand good judgement, exercise sound judgement and act accordingly.

QUESTION 3.6

What is one major issue that arises from an agency relationship, where powers of control
are delegated?

Agency theory identifies three types of agency costs: monitoring costs, bonding costs and costs relating
to residual loss. These costs can arise as a result of:
• information asymmetry (where the agent has more information than the principal)
• poor communication
• poor understanding
• innocent and unintended self-interested behaviour by agents
• deliberate legal self-interested behaviour
• illegal self-interested behaviour by agents (e.g. fraud).

Monitoring Costs
Monitoring costs are incurred by principals because an agency relationship exists. Some monitoring costs
are compulsory, such as costs relating to annual reporting and external auditing. Other monitoring costs
are discretionary, such as the work required to construct and analyse activities according to a strategic or
balanced scorecard.

Bonding Costs
Bonding costs are costs incurred by the agent to demonstrate to the principal that they are goal
congruent. This may include voluntary restrictions on the agent’s behaviour or benefits to demonstrate
goal congruence, and are part of the explanation for the development of executive stock options and other
benefits that have significantly increased executive rewards in recent decades. An example of bonding
costs is provided later in example 3.5.

Residual Loss
Residual loss is a cost incurred by the principal. Residual loss arises because, no matter how good the
monitoring and bonding efforts, the agent will inevitably make decisions that are not consistent with
the principal’s interests. Any loss, cost or underperformance arising from these decisions or actions
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140 Ethics and Governance

by the agent represents a residual loss of value to the principals. Some examples of residual loss are
described next.
Excessive Non-financial Benefits
The over-consumption of perquisites (perks) relates to obtaining an excessive level of incidental benefits
in addition to income. Many directors and managers highly value these often-prestigious benefits. In
contemporary business, this may include a company car, club membership, low-interest loans, prestigious
offices and furnishings. Such perks, paid for by the corporation, reduce both profitability and cash flow
available for distribution to shareholders.
Empire Building
Empire building refers to acts by management to increase their power and influence within a company for
reasons associated with personal satisfaction. Such personal aggrandisement or excess may have little or
no congruence with company profitability or success.
An example would be the recommendation to the board by a CEO that it should purchase a subsidiary.
Having a desire for growth, as is common in many corporations, the board may agree to the acquisition
without sufficient consideration. In fact, the board may not know that the real motivation driving the CEO
was the opportunity to enhance their own power and authority, and the prospect of additional financial
rewards in relation to additional responsibilities. Importantly, increased shareholder value was not a
key goal.
Risk Avoidance
Depending on how managers are remunerated, there may be little incentive for them to engage in risky
investments. The higher returns associated with risk might be actively sought by some shareholders who
have the ability to diversify their own risk through their portfolio of investments.
If managers are remunerated with fixed salary packages and do not participate in the higher returns, the
only rational approach for them is to minimise the downside risk (losses) that may affect their continued
employment. The organisation may therefore underachieve, with higher returns forgone, representing a
loss of value to the shareholders.
While risk avoidance can be a result of a lazy, self-seeking agent (the board or manager, depending on
the agency under consideration), it is a requirement that principals must properly instruct agents so that
the risk appetite of the corporation is structured according to the wishes of the owners. Agency is highly
dependent on communication, and failed communication may damage agency as much as, or more than,
self-seeking agents.
Differing Time Horizons
Managers often only have an interest in the firm for the duration of their employment. If managers are
to be rewarded on current-year profits alone, then those managers may only consider the current year as
being the relevant time frame. If managers anticipate leaving the firm or are approaching retirement, they
may seek to maximise gains based on those time frames.
The time frame is an important consideration when designing remuneration schemes. A well-designed
scheme will provide management performance rewards that correlate the timing of management perfor-
mance with the timing of shareholder performance expectations.
Example 3.5 provides an example of all three types of agency cost. Many costs may be conceptual rather
than dollar costs, and this is especially so for bonding costs.

EXAMPLE 3.5

Agency Costs
Robert was the CEO of a large listed corporation. He had been in the position for many years. During his
tenure, a branch had opened near a popular seaside resort in Thailand. It was not profitable, but Robert
argued it was important and visited it several times each year. He would commonly take a holiday at the
same time at a nearby resort. The corporation would pay his hotel bills and travel costs.
Robert later retired and his position was advertised. Susan was interviewed by the board for the
position. Susan had sought extensive information about the corporation and had learned about Robert’s
regular travel and holidays. At the interview, without inappropriately referring to Robert, Susan advised the
board that:
• she would only travel with permission from the corporation chair

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 • if urgent travel was required without permission from the chair, she would provide a written report to
the board following the travel
• if the report was not accepted immediately, she would pay the travel costs personally without further
request to the corporation
• she would undertake a review of the efficiency of all overseas branches with a view to closing those
that were not profitable.

In example 3.5, Robert’s expenses are an example of residual loss. Susan’s behaviour demonstrates
voluntary restrictions accepted by Susan in order to show that she is bonded to the corporation. Restrictions
on freedoms are bonding costs borne by agents. In example 3.5, Susan will also bear a dollar cost if the
board does not approve the travel. Her willingness to undertake the overseas branch review is possibly
another bonding cost. Also, note that Susan has suggested extra duties to the chair. If performed, these
extra duties are a monitoring activity, the cost of which is borne by the principal.
Aside from self-interest, ineffective communication between principal and agent will result in residual
loss, as agents will not know or understand the principal’s goals — meaning that good goal congruence
will be highly unlikely.
When we consider remuneration issues, we might find that an agent who is highly bonded should be
remunerated more abundantly. The diminished residual loss and the reduced need to monitor a highly
bonded agent would seem to imply that the extra value available to the principal might, at least in part, be
made available as an extra reward to the good agent.

QUESTION 3.7

Describe key aspects of the principal and agent problems that exist within corporations and that
can result in loss of value for the shareholders.

OTHER GOVERNANCE THEORIES

According to additional theories of corporate governance, a corporation doesn’t operate in a vacuum and
should take the wider community in which it is allowed to operate into consideration.

Stakeholder Theory
Stakeholder theory focuses on how managers in an entity, irrespective of its type, seek to manage their
relationships with all of their internal and external stakeholders. Internal stakeholders include the owners
of an entity, which can vary depending on entity structure or sector in which the entity operates, employees
and management. Each internal stakeholder group will require different responses from the entity in order
to fulfil their demands. It should be noted that shareholders may, at times, be seen as external stakeholders
even though they are owners of part of an entity.
External stakeholders are much broader. External stakeholders include customers, suppliers, creditors,
regulators, government, community, the planet and future generations. Each of these stakeholders should
be considered and negative impacts on them mitigated.
It is worth noting that each stakeholder group does not have a relationship with the entity in isolation.
Often the entity must simultaneously manage competing interests while also being held accountable in the
public domain.
.......................................................................................................................................................................................
CONSIDER THIS
What tensions do you believe exist when an entity in the financial services sector considers its obligations to
shareholders and also customers?

Corporate Social Responsibility Theory

Corporate social responsibility (CSR) theory deals with the concept that an entity and those employed by
it should engage in activities and promote causes and initiatives that are seen as providing a social benefit
to the community. It is said that the individuals working within the entity are then engaged, not just on the
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142 Ethics and Governance

 work they do within the entity, but also with the broader community. It is also a way in which an entity
emphasises its support of various community-based causes.
.......................................................................................................................................................................................
CONSIDER THIS
Identify an entity and a charitable or social cause it has supported. What are the possible advantages or disadvantages
to the entity?

SUMMARY
Corporate law encompasses the body of law that regulates the operation of companies. In Australia, the
Corporations Act provides the framework of regulation for companies.
Corporate law defines company directors’ duties and sets out the rights of shareholders. Essential char-
acteristics of corporate law include the consideration of the corporation as having the legal capacity and
powers of both an individual and a body corporate. This enables the corporation to act as an autonomous
entity. Limited liability means the shareholders’ liability is limited to the value of their shares in the
corporation, and direction of the company is delegated to a board of directors. Within the different types
of corporate structure permitted by corporate law, there is the freedom of directors to govern by pursuing
the best interests of the corporation. A range of duties are imposed on directors and other officers to act
on behalf of the company to ensure their duties are carried out in accordance with the best interests of the
company. The Corporations Act also includes two protective provisions for directors (business judgment,
safe harbour).
Shareholders are unable to directly intervene in management decisions but have power to appoint and
remove directors and determine their remuneration.
A range of theories offer different perspectives on corporate behaviour. A common theme among these
theories is a focus on the interaction of different actors in a corporation and the importance of different
groups in the chain of decision making. These theories are a useful way of reflecting on a company’s
obligations to various groups and individuals and hence can be used as problem-solving tools in business.
They should not be thought of as only academic undertakings.
The key points covered in this part, and the learning objectives they align to, are as follows.

KEY POINTS

3.3 Describe the nature of corporations and the division of corporate powers.
• Corporations are artificial persons that have most of the rights and obligations of real people.
• Companies are a separate legal entity from their owners.
• Most companies have limited liability, meaning their owners cannot be held responsible for the
company’s debts.
• There is a perpetuality of life in the case of companies.
• There are proprietary (or private) companies and public companies.
• Public companies may be unlisted or listed.
• Public companies are commonly limited by shares or limited by guarantee and there is also a
category of no liability company.
• Companies have directors who are responsible for the oversight of the business.
• Shareholders have a range of powers to appoint the board and vote on a range of motions at annual
general meetings, but cannot directly intervene in management.
• Boards have specific powers under law.
3.4 Discuss agency theory and how it is used to understand corporate behaviour.
• Agency theory views corporate governance through the relationship between principals (generally
the shareholders) and agents (those that the shareholders appoint to act on their behalf).
• Agency consists of giving power to individuals or groups to act on behalf of others. Agents are
permitted to act in place of, and to make decisions for and on behalf of, the principals and to
comply with the terms of the agency and the rules applying to them.
• While agents are expected to act on behalf of the principal, agency theory suggests the agent may
not naturally act in the best interests of the principal. The underlying assumption of agency theory
is that all parties are rational utility maximisers, which means agents may pursue different goals
from those of the principals.

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 • Therefore, potential for conflict arises and mechanisms such as corporate governance must be in
place to ensure the agent acts appropriately. This is why auditors, for example, are engaged to
ensure that managers are presenting information that is truthful and fair when financial statements
are finalised.
• The costs of an agency relationship include monitoring, bonding and residual loss.
3.5 Discuss the key features of corporate structure.
• In a corporate structure the shareholders, board of directors and the CEO share power.
• The powers of the board and shareholders are detailed in the Corporations Act and a company’s
constitution.
• These powers include the right of the board to delegate some of their powers to the CEO.
• The relationships between shareholders and the board, and between the board and the CEO, are
known as agency relationships.
• In a corporate structure, two agency relationships exist: one between the shareholders (as
principals) and the board (as agents of the shareholders) and another between the board (as
principals) and the CEO (as an agent of the board).
3.6 Examine the characteristics and duties of directors and other officers.
• Directors need to ensure that they:
– avoid conflicts of interest and where these exist, ensure they are appropriately declared and, as
required by law, otherwise managed correctly
– act in good faith in the best interests of the corporation
– exercise powers for proper purposes
– retain discretionary powers and avoid delegating the director’s responsibility
– act with care and diligence
– remain informed about the corporation’s operations
– prevent insolvent trading
– do not use their position as a director or the information they gain in that capacity for improper
purposes.
• Company secretaries handle the compliance work for a company, and this includes lodging
regulatory paperwork.
• Two protections are available for directors: safe harbour in relation to the duty to prevent insolvent
trading and business judgment in relation to the duty to act with care and diligence.

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144 Ethics and Governance

PART B: CORPORATE GOVERNANCE
INTRODUCTION
The governance of enterprises has become a key concern in recent decades. Governance is the system
by which companies are directed and controlled, and accountability and transparency are assured.
While the concept is usually associated with corporate governance, that is the governance of large
listed corporations, similar governance principles should apply to all enterprises. Governance relates to
the responsibilities of the board of directors towards investors and other stakeholders, and involves setting
the objectives and direction of the company. Governance is distinct from management of the enterprise on
a daily basis, which is the job of full-time executives.
The governance of enterprises is broadly structured by the law, not just corporate law (or trust or other
relevant law) but also employment law, environmental law and so forth. It is the first duty of directors
to ensure that the enterprise operates within the law. However, beyond requiring a board of directors to
exercise certain duties such as the duty of care and diligence, corporations law gives considerable scope for
directors to make decisions in the best interests of the company. It is here where the skills of governance
become critical. Most important is the capacity to understand and interpret the strengths and weaknesses of
the enterprise, and how to direct the enterprise towards business success while maintaining accountability
and good relationships with all stakeholders. Good governance is a hallmark of enterprises that achieve
improving and sustainable performance even in changing and unpredictable environments.
The first section of this part of the module explains the need for good governance in some detail.
The need for governance arises when an individual, group or entity has responsibility to look after
the rights or interests of other individuals, groups or entities. As stated in part A, those assuming such
responsibilities are called agents and those whose rights or interests are being looked after are the
principals. In an agency relationship, principals are represented by agents, and the principals give or
delegate to their agents the freedom or authority to make decisions on their behalf. Shareholders entrust
company directors to pursue the success of the company, citizens elect representatives to pursue their
democratic interests in government and, in voluntary associations, members elect a board to represent
their interests. To ensure this role is performed in a systematic way, we use a framework of corporate
governance, defined as follows.
Corporate governance is the system by which business corporations are directed and controlled (CFACG
1992, para. 2.5).

The second section of this part of the module examines the key elements of a corporate governance
framework, but we will briefly explain the basic principles here. ‘Direction’ refers to steering the
organisation towards its performance goals. ‘Control’ relates, at least in part, to ensuring compliance
with rules. We use the word ‘corporate’ to indicate that we are focusing on the governance of corporate
or business organisations. This may be a formal corporate structure (e.g. company) or a non-corporate
entity such as an NFP organisation (e.g. charity or government entity) or an incorporated association
(e.g. sporting club). Note that the term ‘corporate governance’ is, in practice, also used by non-corporate
entities. The important thing to grasp is that all entities acting on behalf of the rights or interests of others
need to respect basic principles of governance if they are to act with integrity, authority and accountability.
It is important not to focus solely on the compliance and regulatory aspects of governance, which must
always be balanced with a focus on pursuing an effective strategy and successfully achieving organisational
goals and objectives. As such, corporate governance extends to both conformance with all the necessary
rules for the proper conduct of the organisation, including compliance with external regulations and internal
organisational policies, and performance, with a focus on economic success. If an organisation is an NFP
entity, then its performance will relate to the economy, efficiency and effectiveness of its activities.
A large amount of discussion and effort in the governance area has focused on compliance rather than
performance. As a result, some people have argued that the term ‘corporate governance’ is limited and
solely focused on compliance, and that a different name, ‘enterprise governance’, is needed to describe
the broader focus on both conformance and performance. In this subject we take the perspective that this
is not necessary, and corporate governance is a broad enough term to capture both approaches.
Organisations need to demonstrate compliance and accountability to offer assurance to investors and
other stakeholders, and they need strategies to achieve higher performance if they are to offer the returns
and benefits that investors and stakeholders expect. Indeed, it is when accountability and strategy are well
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integrated that organisations perform most effectively. In the public and NFP sectors, similar standards of
accountability and performance are required even though the mission is to provide high quality public and
social services, and while there may not be shareholders to satisfy, there are many stakeholders who must
be considered.
We can therefore state the following important relationship.

Governance = conformance + performance

A more detailed explanation of corporate governance is provided by the Organisation for Economic
Co-operation and Development (OECD).
Corporate governance involves a set of relationships between a company’s management, its board, its
shareholders and other stakeholders. Corporate governance also provides the structure through which the
objectives of the company are set, and the means of attaining those objectives and monitoring performance
are determined (OECD 2023a).

The Ethics and Governance subject emphasises the conformance aspect of governance. Both perfor-
mance and conformance are equally important, and performance aspects are covered in other subjects
of the CPA Program. However, it is important to appreciate the close relationship between strategy
and accountability: strategy without accountability may lead to recklessness, and accountability without
strategy may lead to paralysis (Clarke 2016).

3.5 IMPORTANCE OF GOVERNANCE

Good governance aims to ensure that organisations are properly run in the best interests of their
stakeholders, including the optimal performance of national and international economies. The ASX has
acknowledged in the fourth edition of the principles issued by its Corporate Governance Council that good
corporate governance promotes investor confidence, ‘which is crucial to the ability of entities listed on the
ASX to compete for capital’. The same point is made in the OECD’s Legal Instruments Recommendation
of the Council on Principles of Corporate Governance, which goes on to make an additional two points
about the importance of corporate governance.
The principles of corporate governance are intended to help policy makers evaluate and improve the legal,
regulatory, and institutional framework for corporate governance, with a view to supporting economic
efficiency, sustainable growth and financial stability. Well-designed corporate governance policies can
play an important role in contributing to the achievement of broader economic objectives and three major
public policy benefits. First, they help companies to access financing, particularly from capital markets. …
Second, well-designed corporate governance policies provide a framework to protect investors, which
include households with invested savings. … Third, well-designed corporate governance policies also
support the sustainability and resilience of corporations and in turn may contribute to the sustainability
and resilience of the broader economy (OECD 2023a).

.......................................................................................................................................................................................
CONSIDER THIS
Identify areas in the accounting discipline where authoritative guidance emanates from a global organisation. What
are your views on global consistency in guidance? Under what circumstances could divergence from global guidance
be appropriate?

At an organisational level, the behavioural styles and business management practices of managers (and
other employees) or directors can result in outcomes that are not in the best interests of shareholders
and other stakeholders. These situations can range from relatively minor technical breaches of policies or
practices to more serious cases where excessive risk taking or poor controls place the ongoing survival of
the organisation at risk.
In extreme cases, public organisations may be run more as personal fiefdoms where personal greed is
put ahead of the interests of shareholders and other stakeholders. To reduce undesirable consequences
for shareholders and other stakeholders and to ensure personal accountability, organisations need an
appropriate system of checks and balances in the form of a corporate governance framework. This
framework emphasises both conformance and performance as vital elements of the way that companies
are run.
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146 Ethics and Governance

 An organisation with good governance can instil confidence in its shareholders and other stakeholders.
For example, transparent disclosure policies are crucial for ensuring shareholders and lenders continue to
supply the finance required by organisations. The performance of individual organisations also contributes
to the enhanced performance of national economies, not just through their individual contributions, but also
through their role in fostering positive relationships with other organisations in the economy. Corporate
governance is also one of the criteria that foreign investors increasingly rely on when deciding in which
companies to invest.
It should be noted that while good governance can bring benefits to companies, it can also temper
growth. For example, strict governance policies and practices can lengthen the time to undertake mergers
and acquisitions due to the requirement to follow extensive due-diligence procedures. However, growth is
more valuable when it is durable through being built on solid foundations, rather than hastily pursued as
opportunities arise.
The ability of management to make quick decisions may be constrained by the need to observe proper
governance policies and practices. These risk-mitigation requirements contained within compliance-
oriented rules need to be understood. As was seen in the GFC, excessive risk-taking and ‘management
enthusiasm’ (often based on personal motivations) can result in devastating consequences for shareholders
and other stakeholders. In many ways, good governance is a balancing act between the two extremes of
unfettered excessive risk taking and overly restrictive decision making.

GOVERNANCE AND PERFORMANCE

With the emphasis on accountability embedded in popular definitions of governance, it is often forgotten
that good governance is also the route to enhanced performance. Governance allocates clear roles to the
board and to management, and a well-constituted and high-performance-oriented board can motivate and
encourage management to achieve greater corporate performance.
As Robert Tricker (1984) highlights, the management role is to run the business efficiently and
effectively, while the governance role is to give strategic direction to the enterprise, as well as ensuring
accountability. ‘If management is about running the business; governance is about seeing that it is run
properly’ (Tricker 1984, p. 7). This is a very critical distinction in governance. If the board is performing
its role effectively, it will ensure that management is held to account. However, this does not mean that
the board intervenes in the management of the enterprise. The board must work with and through the chief
executive officer (CEO) and other executive directors and senior executives of the company. It is the senior
executives’ role to run the company, but within the policy and strategic parameters that have been set by
the board.
The multi-faceted elements of governance are clearly revealed in Tricker’s (2015) framework for
analysing board activities (figure 3.4). The framework illustrates the accountability activities of the board:
monitoring and supervising management by reviewing business results and budgetary controls. Externally,
the board provides accountability through reporting to shareholders and ensuring regulatory compliance.
The board also has a role in performance through policy making and approving budgets. By creating a
corporate culture, a framework for performance improvement is put in place, which is focused through
strategic analysis and reviewing competitiveness.

ACCOUNTANTS AND EFFECTIVE GOVERNANCE

Accounting, as part of the overall governance process, involves improving decision making and achieving
goals and objectives while maintaining and strengthening controls. One risk is that accountants spend too
much time on conformance and compliance-based work, and too little on enhancing business performance.
It is important that, as accountants, our focus combines both value creation and value protection.
The International Federation of Accountants (IFAC) recognises that performance as part of governance
is specifically related to value creation and resource allocation. The skills, knowledge and judgement
of accountants in this area of decision making will be crucial and the role of professional judgement is
fundamental to achieving performance success. ‘The focus is on helping the board to: make strategic
decisions; understand its appetite for risk and its key drivers of performance, and; identify its key points
of decision-making’ (IFAC 2004 p. 4).

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3.6 CORPORATE GOVERNANCE FRAMEWORK
This section provides an overview of the key components of governance that commonly exist in large listed
corporations and, to a lesser extent, smaller corporations. As previously noted, the professional accountant
plays an important role in corporate governance and, combined with the ethical duties expected of them,
accountants can add significantly to the success of corporations.
Obviously, there will be differing governance approaches across organisations, with the actual compo-
nents also varying from one organisation to another. Appreciating the following most basic component
parts of governance is a first step on the path to full understanding.
Figure 3.3 offers a process view of the components of governance, with the external framework of
governance established through the legal and regulatory activity of governments, the requirements of
investors, and the standards set by industry and professional bodies. The internal governance of the
company is established by the board, who are appointed by the shareholders, and who in turn appoint
the chief executive officer. Finally, the external auditor assures the financial reporting of the company
(Kiel et al. 2012).

FIGURE 3.3 Corporate governance framework

Stakeholders that make up the external governance environment

Business
Government
partners and Shareholders Employees Consumers Community
and regulators
lenders

Reports and is accountable to Appoints/confirms Reports and is accountable to

Appoints
Management Board of External
led by the CEO directors Recommends/appoints auditor
Reports and is
accountable to

Works through
Works with

Sustainability Nominations Remuneration Audit

Risk committee
committee committee committee committee

Source: CPA Australia 2023.

.......................................................................................................................................................................................
CONSIDER THIS
Identify the components of the framework from figure 3.3 that have been covered in this module so far.

Although shareholders and boards have been examined in terms of their relative powers, this section
examines them in more detail followed by the other components of the corporate governance framework.

SHAREHOLDERS
Shareholders are the persons or entities who own a company and have an important part to play in corporate
governance. Shareholders elect directors to operate the business on their behalf and, therefore, should hold
them accountable for its success or failure. One needs to recognise that shareholders have delegated much
authority to the directors. This is the classic principal/agent relationship.
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148 Ethics and Governance

 There are different kinds of shareholders that are involved in dealing with companies. These shareholders
are typically defined as:
• individual shareholders, or
• institutional shareholders.
These types are discussed in more detail next, but it should be noted that all shareholders do not have
the same need or opportunity to participate in the governance of the company. In fact, as the company is
a separate legal entity, the powers of shareholders are often clearly defined in law and limited to certain
decisions including, as detailed previously:
• changes in a company’s constitution
• the appointment and removal of directors and auditors
• the approval of directors’ remuneration.
The issues that concern each group of shareholders will vary and depend, for example, on the number
of shares they hold, the length of time their shares will be held, and the level of interest demonstrated by
the shareholders. Despite varying levels of need and opportunity, shareholders in general do have similar
rights and obligations.
Shareholders who hold a significant stake in a company are often able to use their voting power to gain
places for themselves or their nominees on the board. In principle, these nominee directors are supposed to
act in the interests of the company, not the interests of the major shareholders. However, in practice, there is
a risk of decisions being made that favour major shareholders at the expense of the minority shareholders.
If any shareholder has a controlling shareholding, then it may be possible for them to use their voting power
to create a board that is unbalanced. Boards should be balanced and demonstrate substantial independence
in their composition.

Individual Shareholders
The increase in the number of individuals holding shares is having far-reaching effects on companies. A
substantial number of these shareholders may be retired and have time to devote to the task of keeping
themselves informed. This has been facilitated by greater access to technology such as the internet. In
addition, there are organisations that represent the collective interests of smaller shareholders, such as the
Australian Shareholders’ Association (ASA), which has been active in striving for improvements in the
corporate governance of Australian companies (see example 3.6).
Individual shareholders want companies to be run efficiently and profitably, and for the companies to be
adequately supervised by the board. They also want honesty from directors and managers. To achieve these
objectives, shareholders are prepared to be more vocal. The media and the internet have provided vehicles
for shareholders to more publicly express their concerns regarding poor corporate governance practices.

EXAMPLE 3.6

Institutional Shareholder Power

ASA to Vote Against the AMP Remuneration Report
ASA will vote against the remuneration report of AMP at its upcoming AGM on Thursday 2 May 2019, but
will vote for the election of David Murray AO as a director.
Last year ASA voted against AMP’s remuneration report, which received a first strike of 62%. While
the Board of AMP slashed bonuses in 2018 and is adopting a new remuneration model in line with ASA’s
guidelines, it has not been finalised. There is therefore insufficient detail about the 2019 KPIs, targets or
vesting to deliver confidence to shareholders. This is compounded by an excessive sign-on benefit for
the new CEO, with the sole vesting condition being continuous employment.
ASA remains concerned about governance and culture at AMP, as the incentives revealed to date are
weighted in favour of driving the share price up. The failure to seek shareholder approval of the sale of the
life business also provided little comfort.
However, ASA will vote in favour of Mr Murray’s election and appointment as Chairman. His considerable
regulatory and banking experience will be required in light of the magnitude of the task ahead for the
AMP Board. His appointment has no doubt helped attract the experienced non-executive directors the
company needs. The changes to Board structure and remuneration also reflect his involvement and
commitment to change for the organisation.
Source: ASA 2019, ‘ASA to vote against the AMP Remuneration Report’, accessed August 2023, www.australian
shareholders.com.au/common/Uploaded%20files/MEDIA%20RELEASES/MR_20190424_ASA_votes_against_AMP_
rem_report.pdf.

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Institutional Shareholders
The terms ‘institutional shareholders’ or ‘institutional investors’ include insurance companies, superan-
nuation funds, investment trusts and professional investment fund managers. This class of shareholder is
becoming more important in corporate governance, due to the substantial retirement savings they manage,
of which a significant proportion is invested in shares.
Because of the size of their shareholding and the nature of their business, institutional investors can be
seen to have a greater responsibility and ability to hold management to account. In many cases they have
in-house analysts who monitor the companies that they invest in. In other cases, they use the services of
proxy advisors. Increasingly the ‘clients’ of institutional investors are looking for more transparency and
accountability. In response, institutional investors and proxy advisors are publishing or becoming signatory
to stewardship guidelines or publishing voting guidelines.
.......................................................................................................................................................................................
CONSIDER THIS
Most Australians have superannuation funds that are mainly managed by large superannuation funds.
(a) A superannuation fund is reacting to calls for it to be more accountable and transparent in its stewardship by
looking to become a signatory to a stewardship code. Which of the following codes would you want your fund
to use?
– Australian Asset Owner Stewardship Code, https://acsi.org.au/wp-content/uploads/2021/10/ASSET-
OWNER-CODE-stewardship.pdf
– ICGN Global Stewardship Principles, www.icgn.org/sites/default/files/2021-06/ICGN%20Global%20Steward
ship%20Principles%202020_1.pdf
(b) The superannuation fund that manages your superannuation funds does have its own in-house analysts but
sometimes also relies on proxy advisors to provide information to determine how they will vote. If you had to
choose a proxy advisor for the fund, which one of these three would you choose?
– Glass Lewis 2022 Policy Guidelines, www.glasslewis.com/wp-content/uploads/2022/07/Voting-Guidelines-
Australia-GL-2022.pdf
– Ownership Matters, Voting Guidelines, www.ownershipmatters.com.au/voting-guidelines (an email address
needs to be submitted to access the document)
– ISS Australia Proxy Voting Guidelines, www.issgovernance.com/file/policy/active/asiapacific/Australia-Voting-
Guidelines.pdf

Information Asymmetry
Investor knowledge comes from individual research, shareholder activists and proxy advisers. Access to
knowledge may be limited to information that the company publishes or information that shareholders
or their representatives can encourage companies to share. In a perfect world, everyone would have
equal access to all information. However, there is often significant information asymmetry within the
company structure.

QUESTION 3.8

(a) Define the terms ‘information asymmetry’ and ‘moral hazard’.

(b) Explain how the terms are related and their consequences.

An example of information asymmetry that may have led to a moral hazard can be seen in the 2019
Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry. An
excerpt from the final report is provided in example 3.7.

EXAMPLE 3.7

Information Asymmetry and Moral Hazard

3.1 Flex Commissions
I discussed the use of flex commissions in the Interim Report. As I recorded there, under that kind of
arrangement, the lender fixed a base rate of interest that would be charged under the loan agreement.
If the dealer could persuade the borrower to agree to pay a higher rate the dealer received a large part of
the interest payable over and above the base rate. In more recent times, lenders provided that the agreed
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150 Ethics and Governance

 rate must not exceed a rate fixed by the lender but, below that cap, the dealer was free to offer a loan on
behalf of the lender at a rate greater than the base rate fixed by the lender.
Many borrowers knew nothing of these arrangements. Lenders did not publicise them and dealers did
not reveal them. The dealer’s interest in securing the highest rate possible is obvious. It was the consumer
who bore the cost. To the borrower, the dealer might have appeared to be acting for the borrower by
submitting a loan proposal on behalf of the borrower. The borrower was given no indication that in fact
the dealer was looking after its own interests rather than acting as a mere conduit between lender and
borrower. For all the borrower knew, the interest rate the dealer quoted had been fixed by the lender. But,
whenever the dealer quoted a rate larger than the base rate, the dealer was acting in its own interests.
Since 1 November 2018, flex commissions have been banned. But, because at least one large lender,
Westpac, was continuing to offer flex commission arrangements to car dealers when the Commission
looked at these matters in March 2018. There were many car loan contracts where the interest rate being
charged was above whatever rate the lender fixed at the time as its base rate.
Until 1 November 2018, the conduct was not unlawful. It was conduct that Westpac accepted could
create unfairness in individual transactions. But despite recognising this, Westpac considered that it could
not stop the practice because doing that ‘would simply leave the market to others who did not’.
Flex commissions stand as one of the starker examples of changes to practices in the financial services
industry — even changes seen by important industry participants as desired and desirable — foundering
on the rock of first-mover disadvantage. There are times, and this was one, where regulatory intervention
was necessary to achieve change.
Source: Australian Government 2019, Royal commission into misconduct in the banking, superannuation and financial
services industry (Final report), accessed August 2023, www.royalcommission.gov.au/system/files/2020-09/fsrc-volume-1-
final-report.docx, pp. 85–86.

THE BOARD
Boards and directors are the most significant components of corporate governance. It is essential to develop
a clear understanding of what a director is and what a board of directors is. The following description of a
company and the directors is useful in considering the role that directors play in an organisation.
A company may in many ways be likened to a human being. It has a brain and a nerve centre which controls
what it does. It also has hands which hold the tools and acts in accordance with directions from the centre.
Some of the people in the company are mere servants … who are nothing more than hands to do the work
and cannot be said to represent the mind or will. Others are directors and managers who represent the
directing mind and will of the company, and control what it does. The state of mind of these people is
the state of mind of the company and is treated by the law as such (L J HL Bolton Engineering Co. Ltd v.
TJ Graham & Sons Ltd [1957] 1 QB 159 at 179).

In this section we provide a considerable discussion about various aspects of this area, including the
main functions of the board of directors (see figure 3.4 and table 3.4) and various board committees.
.......................................................................................................................................................................................
CONSIDER THIS
As an exercise to assess your own financial reporting knowledge in preparation for advising a board or becoming a
board member, access and complete the ASIC quiz at https://asic.gov.au/regulatory-resources/financial-reporting-
and-audit/directors-and-financial-reporting/financial-reporting-quiz-for-directors.

Boards of directors are composed of a chair, executive directors (usually including the CEO) and non-
executive directors, some or all of whom may be independent.
Board Chair
Each board must have a chair. The role of the chair is to lead the board of directors, including determining
the board’s agenda, obtaining contributions from other board members as part of the board’s deliberations,
and monitoring and assessing the performance of the directors. This role is crucial in ensuring that the
board works effectively.
In some countries, it is important that the chair be independent (i.e. without any direct link to the
company), while in other countries this is not seen as critical. For example, in the United Kingdom (UK),
the largest listed companies are expected to have a chair who is independent at the time of appointment.
In contrast to this, many companies in the United States (US) allow a person to fulfil both the role of CEO
and chair of the board at the same time. However, an increasing number of US companies are separating
the roles of CEO and chair; and, where the roles are combined, it is the usual practice to have a senior
independent director who can express an independent view.
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Summary of Board Functions and Responsibilities
Boards and directors perform a wide range of vital functions for the company. According to the Tricker
model (figure 3.4) and as detailed by Henry Bosch, one of the foremost Australian authorities on corporate
governance, the board’s responsibilities and functions, include those listed in table 3.4.

FIGURE 3.4 The primary functions of the board

Outward
looking

Providing Strategy
accountability formulation

Approve and work with

and through the CEO

Monitoring and Policy

supervising making

Inward
looking

Past and present focused Future focused

Source: Tricker, RI 2015, Corporate governance: Principles, policies and practices, 3rd edn, Oxford University Press, Oxford.
.......................................................................................................................................................................................
CONSIDER THIS
Choose two separate listed companies and find their board charters on their website. What are the features you
notice? How do they align with Tricker’s analysis of what boards should be doing as people in charge of governance?

Each item in the list of important board functions in table 3.4 has either a performance or confor-
mance focus.

TABLE 3.4 Board responsibilities

Function Responsibilities

Monitoring and • Taking steps designed to protect the company’s financial position and its ability
supervising to meet its debts and other obligations as they fall due.
• Adopting an annual budget for the financial performance of the company and
monitoring results on a regular basis.
• Ensuring systems are in place that facilitate the effective monitoring and
management of the principal risks to which the company is exposed.

Providing accountability • Determining that the company has instituted adequate reporting systems and
internal controls (both operational and financial) together with appropriate
monitoring of compliance activities.
• Determining that the company accounts conform with Australian Accounting
Standards and are true and fair.
• Determining that satisfactory arrangements are in place for auditing the
company’s financial affairs and that the scope of the external audit is adequate.
• Selecting and recommending auditors to shareholders at general meetings.
• Ensuring that the company has in place a policy that enables it to communicate
effectively with shareholders, other stakeholders and the public generally.
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152 Ethics and Governance

 Strategy formulation • Determining the company’s vision and mission.*
• Reviewing opportunities and threats to the company in the external environment,
and strengths and weaknesses within the company.*
• Considering and assessing strategic options for the company.*
• Adopting a strategic plan for the company, including general and specific goals,
and comparing actual results with the plan.

Policy making • Establishing and monitoring policies directed at ensuring that the company
complies with the law and conforms to the highest standards of financial and
ethical behaviour.
• Selecting and, if necessary, replacing the CEO, setting an appropriate
remuneration package for the CEO, ensuring adequate succession plans are in
place for the CEO, and giving guidance on the appointment and remuneration of
other senior management positions.
• Adopting formal processes for the selection of new directors and recommending
them for the consideration of shareholders at general meetings, with adequate
information to allow shareholders to make informed decisions.
• Reviewing the board’s own processes and effectiveness, and the balance of
competence on the board.
• Approving and working with and through the CEO.
• Adopting clearly defined delegations of authority from the board to the chief
executive officer (CEO) or a statement of matters reserved for decision by
the board.
• Agreeing on performance indicators with management.

*Bullet points identified by an asterisk are not from the Bosch Report but are added by the author of this text.
Source: Bosch, H 1995, Corporate practices and conduct, 3rd edn, Pitman, Melbourne, p. 9. Reproduced with permission.

QUESTION 3.9

Classify each of the board responsibilities listed in table3.4 as having either a performance focus
or a conformance focus.

Committees of the Board

The effectiveness of the board, and particularly of non-executive directors, is likely to be enhanced by
the establishment of appropriate board subcommittees, usually simply referred to as ‘committees’. These
committees enable the distribution of workload to allow a more detailed consideration to be given to
important matters, such as executive remuneration and external financial reporting.
Furthermore, in relation to issues that involve conflicts of interest (e.g. related party transactions, finan-
cial reporting and setting executive remuneration), subcommittees are important for creating environments
where independent directors’ views can take priority in order to achieve independent decisions.
The chairs of committees are singled out for attention in some corporate governance requirements or
guidance. In particular, the importance of independent directors as chairs can be observed. This role is
discussed later in part D with regard to specific codes and guidance on corporate governance.
However, these committees do not reduce the responsibility of the board as a whole, and care needs
to be taken to ensure that all those concerned understand their functions. It is important to note that the
board of directors is still responsible for decisions made by the committees. The delegation of duties from
the board to the committees enables examination of issues in greater detail and discussion of issues in the
absence of executive directors — and in some cases, with only independent directors present.
Carefully written terms of reference for each committee are required along with defined procedures for
reporting to the full board. Modern corporate governance principles allow that some matters may be dele-
gated fully (e.g. executive remuneration delegated to a remuneration committee). The recommendations of
such a committee will be accepted by the board without further consideration by the whole board. Where
this occurs, very careful attention to procedures and protocols is required so that board delegations are
fully understood and properly carried out.
Important committees that may exist are discussed next. The four committees that are normally required
by various corporate governance codes/recommendations are the:
• nomination committee
• remuneration committee
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MODULE 3 Governance Concepts 153

• audit committee
• risk committee.
Boards are also free to choose to have any additional committees that may assist in creating a better
governance structure for running the corporation. With the advent of the International Sustainability
Standards Board’s S1 and S2 standards in 2023, boards are increasingly adding a sustainability committee
to complement the work of their risk and audit committees.

Nomination Committee
This committee is primarily responsible for recommending the succession procedures within an organi-
sation. Succession is the concept of identifying and selecting people who will replace senior staff when
they leave.
This committee, because of the skills each member acquires in this role, is valuable in assessing the
overall performance of the board and, sometimes, the performance of key executives. An important aspect
of succession responsibilities is recommending candidates for shareholders to vote on to the board as
directors. Given that boards comprise a balance of directors, including executives, it is appropriate for the
nomination committee to include executive directors.

Remuneration Committee
This committee deals with remuneration, especially for senior executives. Important aspects of remunera-
tion include what and how directors and executives are paid. It is apparent that this area is particularly
complex. One of the main causes of the GFC was the setting of inappropriate remuneration policies
that focused almost entirely on short-term revenue generation and marginalised the concern for risk
management. The sensitivity of setting a remuneration policy can be reduced if executives are not involved
in the committees that decide their remuneration. Furthermore, in order to ensure independence, it is
necessary that executives do not set the remuneration of independent directors.

Audit Committee
The audit committee is, in many ways, the most important in relation to the conformance aspects of
corporate governance. It is often considered the appropriate conduit between the company and the external
auditor, ensuring that the work of the external auditor maintains the utmost integrity and independence.
While this committee is recommended for all listed companies (and will be valuable in many others),
it can also be mandatory to have an audit committee. Listed entities in the S&P All Ordinaries Index
at the beginning of their financial year are required, under the listing rules, to have an audit committee
for that whole financial year. There are some tighter requirements for those listed entities that are on the
ASX 300 Index, which also includes that they must comply with the structure and disclosure requirements
of the audit committee recommendation.
To ensure the independence of the audit committee, it is recommended that the audit committee comprise
only non-executive members, with a majority being independent. An audit committee with no executives
means that communications with the external auditor at a formal level will take place without the CFO.
This is an important aspect of good governance at the auditing/reporting phase.
Under the US Sarbanes–Oxley Act (US Congress 2002), all US-listed companies must have an
audit committee. The committee must comprise only independent directors and must be the principal
communication conduit between the company and the external auditor. The Sarbanes–Oxley Act also
provides that the audit committee has the responsibility to ‘hire and fire’ auditors.
The audit committee has many responsibilities, and its role should include reviewing the adequacy of
operational and internal controls (including the internal audit function) and reviewing half-year and full-
year financial statements prior to board approval (Percy 1995). Percy identifies that the audit committee’s
review should place particular focus on changes in accounting policies, areas requiring the use of
judgement and estimates, audit adjustments, and compliance with accounting, legal and stock exchange
requirements. A detailed list of audit committee responsibilities is provided in Appendix 3.1, which reviews
relevant extracts from the UK FRC Code (UK FRC 2018) and will be discussed later in this module.
It is also preferable that, in order to avoid misunderstandings, the role and responsibilities of the audit
committee be explicitly set out in a written charter.

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154 Ethics and Governance

Benefits of Audit Committees
An audit committee undertaking good practice will provide benefits to the board and the entity by:
• strengthening the internal control structure and helping to ensure the maintenance of appropriate
accounting records
• supporting the independence of external auditors and assisting in creating improved ‘independence
regimes’ for internal auditors (despite the fact that, as employees, internal auditors will not achieve
full independence)
• facilitating appropriate communication channels between management, the board, external auditors and
internal auditors
• improving the quality of financial disclosures and the effectiveness of the audit function by providing
an independent review of these functions
• acting as a forum for the resolution of disagreements between management and external auditors and
also assisting with such issues involving internal auditors
• improving the effectiveness of external and internal auditors by providing a coordinated approach to
audit planning
• keeping the board fully informed about relevant accounting and auditing issues
• advising the board of directors on independence issues and, where appropriate, analysing whether
members of the board have exercised due care in fulfilling their responsibilities
• highlighting relevant important matters that require the board’s attention
• ensuring that an effective whistleblower system is in place within the corporation.

Limitations of Audit Committees

Audit committees have limitations with regard to improving corporate governance standards. It is important
to be aware of these limitations so that, as professional accountants, it is possible to put in place mechanisms
to remedy the following possible weaknesses.
• The audit committee may not have the power to enforce its recommendations.
• Financial report users may have unrealistic expectations of audit committees.
• The establishment of an audit committee may cause dissent within the board, particularly between
executive and non-executive directors. Many CFOs believe they, more than anybody else, should be
on the audit committee but, in reality, the CFO is the most important person to exclude from the audit
committee in order to ensure auditor independence.
• The audit committee may be ineffective due to a lack of competent, financially skilled members.
• Committee members may be selected because of their association with the CEO or chair, thus reducing
their real independence.
• The presence of management may inhibit open discussion and affect committee independence.
• The responsibilities of the audit committee may impinge on those of management, creating an
atmosphere of conflict and distrust.
• The maintenance of an audit committee is time-consuming and costly.
• Ambiguous terms of reference may create misunderstandings and undermine the committee’s authority.
• The terms of reference of the committee may be so broad as to require the participation of all members
of the board.
Audit committees may also be formed as a means of giving the appearance of good corporate governance
without achieving any useful purpose for the organisation and with little commitment to attempting to
improve the monitoring of the organisation. However, with the major corporate failures linked to audit
failure, and the increasing emphasis of regulation including Sarbanes–Oxley Act in the US, and the
Corporate Law Economic Reform Program (CLERP) in Australia, companies are invariably taking the
work of their audit committees more seriously.
One situation in which audit committees are formed without regard for quality or effectiveness of their
work, is fear of litigation. Although it could be argued that the mere fact that a firm has an audit committee
is evidence that the directors take due care in performing their duties, if this is the only reason for the audit
committee being formed, then potentially the whole board is derelict in its duty. An effective board will
always ensure the audit committee is performing its role with diligence and competence.
The effectiveness of audit committees is considered in example 3.8, in relation to Enron Corporation.
Read this and then answer question 3.10.

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 EXAMPLE 3.8

The Enron Audit Committee

Enron’s audit committee seemed to fulfil all of the requirements of best practice. It consisted of seven
well-known and highly qualified board members who were all non-executive directors of the company.
But, like many things at Enron, the reality was quite different.
One member of this committee, John Wakeham, had in place a USD72 000 per year consulting
contract with Enron. Two other committee members had been employees of universities that had received
significant charitable contributions from Enron or its chairman, Kenneth Lay (Lavelle 2002, p. 28).
Specifically, one of these members, Jon Mendelsohn, was also president of the MD Andersen Cancer
Centre at the University of Texas. Lavelle (2002, p. 29), reported that this centre had received USD332 150
from Enron and Lay since 1999. Under disclosure rules at the time, it was not necessary to disclose this
relationship to Enron’s shareholders and there was no voluntary public disclosure of these arrangements.
Another committee member, Wendy Gramm, was an employee at the Mercatus Centre at George Mason
University. According to the university’s records, USD50 000 was collectively paid by Enron and Lay to this
centre from 1997. Moreover, Wendy Gramm’s spouse, Senator Phil Gramm (Republican, Texas), received
USD80 000 in political campaign donations from Enron and its employees from 1993, when she became
a director of Enron (Lavelle 2002).
It should also be noted that the chair of Enron’s audit committee, Robert Jaedicke, was aged 72 years
at the time of Enron’s collapse. While he was eminently qualified for the role — he had worked at Stanford
University as an accounting professor until his retirement some 10 years earlier — his advanced age and
the complexity of Enron’s finances and operations called into question his competence for this high-level
role (Lavelle 2002).
There were also concerns about the lack of action taken by the audit committee against questionable
accounting practices by management. The minutes of an audit committee meeting held in February 1999
indicated that the senior audit partner had told the committee that accounting work relating to several
areas, including ‘highly structured transactions’, was considered ‘high risk’.
The accounting firm’s (Arthur Andersen) legal counsel later testified that this risk rating was designed to
convey to the audit committee that the company was ‘using accounting practices that, due to their novel
design, application in areas without established precedent or significant reliance on subjective judgements
by management personnel, invited scrutiny and presented a high degree of risk of non-compliance with
generally accepted accounting principles’ (COGA 2002, pp. 15–16). The audit committee seemingly chose
to ignore these warnings.

The Enron case demonstrates that good governance is about far more than establishing board commit-
tees. The members of each committee need to demonstrate independence and be prepared to stand up
to management in the event of questionable practices. Moreover, they need to adopt a sceptical view of
management submissions and be prepared to delve deeper when they do not receive the answers they want
or they suspect something is not quite right. Clearly, the individual members of an audit committee are
required to be competent, experienced and even courageous in adequately performing such a key role.

QUESTION 3.10

Examine the Enron audit committee role and independence in light of the earlier discussion on the
benefits and limitations of audit committees. Evaluate the effectiveness of the committee and list
steps you would recommend to improve the Enron audit committee in this situation.

Risk Committee
Risk management is important to ensure that risk is assessed, understood and appropriately managed. This
is important both for conformance and performance. It is essential that strategic planning and management
decisions are made appropriately in the context of the risk appetite of the corporation and its various
stakeholders, especially its shareholders. If a company does not have a good understanding of risk, the
likelihood of conformance and performance failure is high.
A good understanding of risk is assisted by a clear understanding of strategy. The Professional
Accountants in Business (PAIB) Committee of IFAC recommends that companies should establish
a strategy committee that reviews strategy in all its dimensions including risk (IFAC 2004, p. 6).
In fact, many organisations do have a risk committee that oversees the systems and processes for
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156 Ethics and Governance

managing risks (including currency, interest rate risk, operational risk, and climate risks such as transition
and physical risks). It is also common for risk committees to assess the risks attached to corporate
strategy — in which case IFAC’s recommendation is also satisfied. In a more recent publication,
IFAC (2015) has highlighted the need to move away from a bolt-on review of risk as if this were a
marginal aspect of doing business, and accept that risk must be managed as an integral part of overall
enterprise management.

Sustainability Committee
The sustainability committee assists the board by providing advice and guidance in relation to environ-
mental, social and governance (ESG) and sustainability issues. This may include the company’s strategy,
business model, policies, plans and actions in areas such as climate change, decarbonisation, emissions
targets and metrics, modern slavery and cybersecurity. This links to the work of the risk committee, who
will identify and manage the risks associated with these areas, and the audit committee, who are responsible
for working with the auditor to assure sustainability disclosures and reporting.

AUDITORS
Most large organisations have an internal audit department, which generally reports directly to the audit
committee. Internal auditors undertake a variety of tasks that contribute to good corporate governance. In
general, the internal auditor plays an important role in ensuring that internal financial controls, compliance
controls, operational controls and risk management systems are operating effectively.
The external audit is also a vital part of the corporate governance process. Investors rely heavily
on information provided in financial reports. It is essential that these reports are accurate and free
from material misstatement. Accordingly, the capacity of external auditors to conduct a thorough and
independent review of the financial statements is the cornerstone of the corporate governance process.
‘Audit failure’ is the term used when an audit is deficient due to negligence, incompetence or lack of
independence by the auditor. While the vast majority of audits are conducted in a satisfactory manner,
regrettably, there are exceptions.
The external auditor, as an independent party with a detailed knowledge of the entity’s financial affairs,
is able to provide substantial advice to the audit committee. The external auditor may also assist the audit
committee by informing it of any developments such as legislative changes or new accounting standards.
It is also important that the external auditor should attend the full board meeting when the financial
statements are approved, to enable all directors to ask any questions they may have regarding the financial
statements or the audit process.

REGULATORS
Objective of Regulation
The business environment is increasingly competitive, with companies constantly trying to improve
performance. There are often strong incentives to achieve these objectives and, sometimes, questionable
methods may be used.
Effective regulation and enforcement are essential to ensure that companies can compete against each
other in a fair and reasonable manner. Failure to create such an environment can lead to poorer outcomes
for all stakeholders. ASIC states that the following are traits of a sound regulatory system, which are also
relevant internationally.
• Companies can get on with doing business confident that the same rules are applied to everybody. They
can seek capital in Australian markets at rates that are broadly competitive with leading world markets
and without paying a significant market risk premium.
• Financial products and services businesses can operate profitably and efficiently, while treating cus-
tomers honestly and fairly. Being in a well-regulated market helps them do business across borders.
• Financial markets are well respected and attractive internationally, and clean, fair and reliable.
• Everybody can find and understand their obligations.
• Investors and consumers participate confidently in our financial system, using reliable and trustworthy
information to make decisions, with ready access to suitable remedies if things go wrong.
• The community is confident that markets, corporations and businesses involved in them operate
efficiently and honestly and contribute to improving Australia’s economic performance. Firm action
is taken against fraud, dishonesty or misconduct. The regulatory system is respected (ASIC 2006, p. 4).
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 From this regulatory perspective, the purpose of regulation is to support free and open markets. Yet many
businesses and some economists argue that imposing restrictions on corporations’ activities, and the way
they are governed, stifles incentive, creativity and entrepreneurship. They believe that wealth creation is
maximised by allowing markets to be free of restrictions. Nobel prize–winning economist Milton Friedman
is of the view that ‘there is one and only one social responsibility of business — to use its resources and
engage in activities designed to increase its profits so long as it engages in open and free competition
without deception or fraud’ (Friedman 1970). However, critics ask: at the expense of whom?
Others argue that corporations do not exist in a vacuum. Instead, they are an integral part of society, and
the focus should be much broader than just increasing profits and returns to shareholders.
Self-interest often appears to be the guiding philosophy of certain groups, even if they do appear to
be ideologically based. Business groups and trade associations that promote free markets and limited
regulation often are led by the vested interests, which can sometimes be inconsistent with the advocacy of
free markets. They may strongly favour government intervention, such as subsidies or tariffs, when it assists
that particular industry, while opposing government intervention elsewhere in the economy. Governments
may also advocate free trade while continuing to protect certain domestic industries for political purposes.

Alternative Approaches to Regulation

While there is no single best model of corporate governance, many countries, governments and other
authorities have attempted to address corporate governance issues through two broad models of regulation.
A principles-based approach is where broad principles or recommendations on corporate governance
are specified. Organisations are expected to operate within these general guidelines, but with some
flexibility to choose how they do this. Under this approach, corporations will normally be expected to
follow the principles or recommendations — as to do otherwise is essentially to ‘break the rules’ of
accepted good corporate governance. Later in this module, we will outline the OECD Principles, the ASX
Principles and the UK FRC Code, which all reflect a principles-based approach.
This approach provides more flexibility in implementing specific corporate governance practices in view
of the potential diversity of corporations. Under the UK and Australian approach (also seen in Singapore,
for example), the board of a corporation may decide not to follow the local principles or recommendations,
which may be allowed, but it must then disclose that it is not following them and explain why. Sometimes,
some principles or recommendations must be followed fully, and the board is not allowed a choice.
By contrast, a rules-based approach is more detailed and prescriptive, as reflected in the approach
adopted in the US Sarbanes–Oxley Act (US Congress 2002), and in the Dodd–Frank Wall Street Reform
and Consumer Protection Act 2010 (US Congress 2010), which was introduced following the GFC.
Specific and detailed regulations are provided and must be complied with. There is no flexibility in deciding
whether to comply or not.
Further to the above, regulators are increasingly turning to risk-based regulation in order to manage risks.
Risk-based regulation involves focusing resources on the highest non-compliance risks (Breen 2023). This
approach is informed by data, evidence and intelligence (Department of Finance 2023). According to the
OECD (2021), a risk-based approach helps achieve public outcomes while minimising unintended side-
effects of regulation and rules.
To help appreciate the difference between these approaches to forming an audit committee, consider
example 3.9.

EXAMPLE 3.9

Approaches to Audit Committee Formation

Principles-Based Approach
The regulations may state that it is important to have an audit committee, and it should have members
who are suitable to the role. If there is no audit committee, an explanation must be provided.
Rules-Based Approach
The regulations may state that there must be an audit committee. It must have at least four members.
These members must all be independent directors. These members must all have financial qualifications.
Risk-Based Approach
It is unclear what the adoption of a risk-based approach to regulation might mean for corporate
governance in general and, for example, the formation and role of an audit committee. Nonetheless, the
activities of any such committee under this approach would be focused on the application of risk scoring
or a risk matrix, with attention given to the areas deemed to pose the greatest risk.
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158 Ethics and Governance

 From this example, it is clear that the principles approach creates a broad guideline, which it is then
up to the company to apply in the most appropriate way. The rules-based approach gives very specific
instructions and must be complied with.

STAKEHOLDERS
The term ‘stakeholder’ is used in a very broad sense, meaning anyone who is affected by the operations
of an entity. These stakeholders include not just shareholders (for corporate entities) but other parties,
such as employees, competitors, customers and suppliers, lenders, society generally and, indeed, even
the environment.

Stakeholder Concept
The Anglo-American corporation law approach is that directors must act in the best interests of the
corporation as a whole. This means corporations are run according to corporate law duties in relation
to shareholders. However, this approach does not mean that a corporation should be run for the exclusive
benefit of its shareholders. Any director or senior manager who believes that acting according to this
approach will lead to long-term success and satisfactory corporate governance is mistaken. The success
of an organisation depends on the successful management of all the relationships an organisation has
with its stakeholders. The principal focus of our discussion in this module is on the Anglo-American
derivative duties approach to stakeholders. Stakeholder theory is considered further in module 5 as part of
the discussion of sustainability and social responsibility concerns.

Stakeholder Map
Stakeholders differ across organisations. Figure 3.5 provides a diagram of potential stakeholders that
may be of concern to an organisation and table 3.5 expands on a corporation’s stakeholder relationships.
In any situation, some stakeholders will be more important than others to a particular corporation at a
particular time and, inevitably, this stakeholder map may omit relevant stakeholders. You should observe
that stakeholders are not only people or corporate entities — even the environment is a stakeholder (as a
corporation’s operations may have an effect on it). Notice also that competitors are treated as stakeholders
because there must be a commitment to open and fair competition in the marketplace, and if a competitor
undermines this, both producers and consumers suffer. Those affected by a particular corporation are
stakeholders of that corporation. Where a stakeholder’s interest is significant, corporations must manage
the relationship carefully.

FIGURE 3.5 Stakeholders

Environment

Community
Agents

Government Owners

Regulators Organisation Suppliers /

Lenders

Employees
Consumers

Auditors Competitors

Source: CPA Australia 2023.

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MODULE 3 Governance Concepts 159

 Pdf_Folio:160
TABLE 3.5 Nature of the corporation and some stakeholder relationships
Stakeholder Relationship Type and source of power
Shareholders Owners who are a source Legal power through the
of finance in the form Corporations Act
of equity Political power through institutional
investors
160 Ethics and Governance
Voting power at general meetings
Customers Purchasers of goods Political power through word of mouth,
or services media and social media
Economic power by spending
elsewhere
Legal power through the Competition
and Consumer Act and the ACCC
Suppliers Supply goods/services Economic power by restricting supply
Legal power through the Competition
and Consumer Act and the ACCC
Lenders Supply funds Voting power by having a director on
the board
Economic power by the lending terms
and conditions of the lending contract
Employees Provide labour Political power by withdrawal of labour
Legal power through the Fair Work,
Disability and Discrimination and Work
Health and Safety Acts
Interest and influence
Return on investment
Satisfaction from ownership interest
Investors can withdraw finance if they
are dissatisfied with the company’s
processes
Satisfaction with value from purchase
Dissatisfaction can lead to customers
not wanting to buy services and it may
lead to negative publicity by word of
mouth or social media
Revenue from sales
Business relationship
Poor experiences with a company may
lead to a refusal by a supplier to deal
with the company
Revenues from interest
Lenders may choose not to lend
depending on the credit rating of
an entity
Salaries and wages
Job security
Important life activity
Employees can withdraw labour if
conditions at a workplace get worse
Risk
Underperformance may mean
withdrawal of investment or investor
pressure to remove directors
Reputation risk management will be
needed if customers receive poor
service or faulty products
Directors may need to source other
products from other suppliers if the
company fails to pay the supplier for
goods or services
Faulty goods or services received
from a supplier may also lead to the
company’s reputation being damaged
Finance may be unobtainable if
the company cannot pay back the
principal plus interest
Poor management of employees can
lead the board to see evidence of
employee turnover
Misconduct by employees may lead
the organisation to suffer reputational
damage
 Pdf_Folio:161
Government Receive taxes
Impose regulations
Provide general
infrastructure
Society Consume goods/services
Provide standard operating
practices (legal and social
permissions)
Source: CPA Australia 2023.
MODULE 3 Governance Concepts 161
Legal and political power through Acts
of parliament
Economic power through the
taxation system
Political power by influencing
politicians and social media
Economic power through
spending elsewhere
Source of revenue Boards may find an increase in
Society’s interest regulatory risks that arise from new
laws and regulation
Economy
Threat of regulatory enforcement
Legal compliance
directed at boards where they or
Government may choose to impose responsible staff fail to comply
greater regulation on a sector if
specific companies are perceived to
be misbehaving
Good corporate citizen Directors may bear the consequences
Positive impact on society for poor decisions made in relation to
services offered, goods sold and the
Poor behaviour from a company can
company’s attitude towards corporate
lead to an industry being ostracised by
social responsibility
the community
Lobbying may exist to shut down or
prevent an industry from starting up
or expanding
 In addition to the problem of identifying significant stakeholders, other issues arise from stakeholder
theory, including the following.
• How should managers allocate (prioritise) limited time, energy and other resources among
stakeholders — and according to what time frame? Balancing the interests of stakeholders is obviously
an important aspect of corporate success, and the best boards and managers do this well and will enjoy
success accordingly.
• Some argue that stakeholder theory places too much discretion with management. They contend that
stakeholder theory is too vague. For example, management could claim to be balancing the interests of
various stakeholders while in fact acting to further their own interests. Generally, self-interest is not a
bad motivator, but it must not be at the expense of stakeholders. In module 5, the concept of enlightened
self-interest is discussed further. In this module, we have discussed remuneration approaches under
agency theory and have seen that self-interest is a key factor in seeking to ensure that agents perform
their duties to a high standard.
• Critics of stakeholder theory decry the infringement of property rights of the owners of the corporation.
For example, free market supporters have taken the approach of Milton Friedman and argued that
stakeholders other than shareholders should not form part of management thinking.
• Some consider that under ‘stakeholder management’, there is the potential for stakeholders to be co-
opted, captured and controlled. Stakeholder management approaches are considered in module 5.

Employees
These are important stakeholders in any corporate environment, which is why they are included in
figure 3.5. In increasingly knowledge-based businesses, it is the knowledge and skill of the employees
(including managers) that will be critical to the success of the company. In this sense, the employees
become the greatest asset (e.g. in professional service firms) and without this asset the company cannot
compete. In some jurisdictions, where dual board structures exist (e.g. Germany), employees may have
a more formal role on boards — especially on the lower-tier board. It is not uncommon for very senior
managers also to be on boards. For example, the CFO may well join the CEO on the board and will therefore
also possess the joint characteristic of being an executive and a director — and have the complex mix of
two sets of duties.
Importantly, in all jurisdictions, managers and employees alike are owed duties by corporations and,
in turn, owe duties to the corporation. For example, employees are entitled to safe working conditions
and holiday periods, while employers are entitled to expect diligent service and protections such as
confidentiality about commercially sensitive information.

Suppliers and Lenders

We have previously emphasised the importance of all stakeholders and addressed issues relating to
various stakeholders. The significance of customers in the value chain is obvious and much emphasis has
been given to the economy, to competitors and to consumers/customers. Suppliers and lenders, although
‘upstream’ in business relationships, are also very important stakeholders.
Developing and maintaining good relationships with suppliers and lenders will improve performance
(e.g. ensuring legal compliance and correct ethical relationships). On the performance side, good relation-
ships add value by avoiding disruptions, and reducing transaction costs and the cost of borrowing (through
lower interest rates if lenders better understand a borrower). In fact, often businesses are more immediately
dependent on the goodwill of their suppliers and lenders for their continuing success on a day-to-day basis
than on their shareholders with whom they may have a more distant relationship that only becomes focused
more sharply at the time of reporting the annual results.
It is important to appreciate that, just as a business will wish to have dealings with ethical lenders and
suppliers based on well-understood relationships, lenders and suppliers will have the same expectations in
return. Good ethical relationships will make it easier to conduct business and will reduce overall costs.
Table 3.6 provides a basic list of important matters to consider in regard to suppliers and lenders as
stakeholders of a corporation.

Consumers (Customers)
Consumers or customers are very important stakeholders. Corporations recognise that the long-term
support from consumers for their outputs will be important for value generation and corporate performance.
However, many managers and corporations succumb to the temptation to seek quick profits without proper
care for consumers and their long-term needs. Sometimes, there are even deliberate attempts to target
vulnerable consumers by deception and dishonesty. Consumer law is discussed in module 4.
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162 Ethics and Governance

 TABLE 3.6 Considering suppliers and lenders as stakeholders

Stakeholder Areas for consideration

Suppliers • Reliability and ‘on time’ performance

• Quality at delivery
• Terms for payment, including timing and discounts
• Financial security and alternative suppliers
• Refund and warranty policies for goods acquired
• Willingness to work in partnership — within the law
• Compatibility of ethical standards and codes of conduct

Lenders • Security required

• Significant debt covenants involved
• Interest rate applicable — fixed/variable
• Up-front fees, rollover fees and ongoing charges
• Principal and interest repayment timing and costs
• Special purpose financial reports or information

Source: CPA Australia 2023.

For many businesses, the relationship with customers is changing. Rather than the customer being the
passive purchaser of a good or service, the customer’s views and ideas are actively canvassed as a means of
product and performance improvement. This can serve to deepen the relationship with customers and, in
some instances, customers become more active collaborators in the design of products and services. This
form of active customer intelligence and involvement is what is required in rapidly changing markets with
constant innovation.

MANAGEMENT
As has been emphasised in this module, in formal corporate governance principles, managers are the agents
of the board, responsible for pursuing the vision of the company as developed by the board, and fulfilling
the strategic direction determined by the board. The CEO in most companies is also a director and a member
of the board (and there are often other executive directors such as the CFO of the company). These executive
directors have a full role working with the board to advance strategic direction and establish the policy and
values of the company. Once these are decided, it is the manager’s duty to actively pursue these, and the
board’s role is to monitor the results for the business.
Of course, in reality the interface of governance and management is more complex. Often boards and
managers respect and understand the different roles and have a commitment to make the relationship
work. However, sometimes tensions do emerge, for example, in the choice of strategy. Because of rapidly
changing markets and technology, boards often have to be continuously engaged in strategic decisions. At
times, managers may feel that the board is becoming too involved in the implementation of strategy when
it is the management team who have the operational experience required to guide strategies to success.
On other occasions, the board may feel that managers are making significant strategic decisions without
properly securing the approval of the board.
Skeet (2015) examines this issue from the perspective of both the board of directors and the management
team. When CEOs are asked what issues contribute to the board and management being at cross purposes,
they point to two main factors: directors acting ‘out of position’ and attempting to play a management
role; or a conflict of interest where, even if disclosed, directors are not able to place the interests of the
organisation above their own or those of the group they are representing.
Often what boards interpret as arrogance of the CEO and the management team can be, in reality, a
lack of experience, strategic direction differences or deceit. These can all lead to the management team
withholding information from the board. Board members should consider what information they do not
currently have and request this additional information if they feel the CEO or management team may be
concealing something. This is a legal right of the board, and the management team is not permitted to
suppress this information, once requested. The board is able to draw on multiple points of view when
making decisions, which is a strength of shared governance (Skeet 2015).
This tension occurred some years ago at BHP Billiton when a newly appointed CEO began negotiating
for major acquisitions without fully consulting the board. The board became concerned about the serious
risk implications of the CEO’s actions, and the contract of the CEO was terminated. With the appointment
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MODULE 3 Governance Concepts 163

 of another new CEO, the BHP board was careful to agree on a series of protocols regarding the scope
for independent decision making by the CEO on financial and other matters, and the issues that always
needed to be brought to the board for consideration. These protocols appear to have worked well and, in
other large corporations, similar, clear understandings exist between board and executive management on
their respective roles and powers.
.......................................................................................................................................................................................
CONSIDER THIS
Choose a listed company and locate its board charter on its website. Read the charter and note the references to
stakeholders. Are stakeholders adequately covered?

Operational Management
Management is at the sharp end of delivering the aspirations of the board for the company. Boards of
directors are often highly skilled at financial analysis, strategic thinking and policy development, but it
is the managers who have to implement all of these, which requires considerable intellectual, operational
and technical skills. It is management who must inspire employees with the goals of the enterprise, delight
customers with the quality of the product or service, convince suppliers and distributors that the company
deserves their full support, and keep stakeholders onside.
Ensuring that there is the energetic commitment of managers to their task of realising the vision of the
board and making a success of the company is ultimately the role of the CEO, who is the essential link
between the governance mechanisms and the operational mechanisms of the company.

SUMMARY
Governance is the means by which entities — in the case of corporate governance, corporations —
are directed and controlled, and accountability is assured. Governance relates to the responsibilities of
the board of directors towards investors and other stakeholders, and involves setting the objectives and
direction of the company. Governance is distinct from the day-to-day management of the enterprise, which
is the responsibility of executives.
Good corporate governance involves ensuring the corporation operates in the best interests of its
stakeholders. Good corporate governance is also linked to the ability to achieve the strategic goals of
the organisation. Accountants play an important role in good corporate governance by providing useful
information for decision making that ultimately results in value creation while maintaining controls that
ensure compliance.
The precise components of the system of corporate governance vary based on the nature of the
organisation, but there are several common key elements that make up a corporate governance framework.
These include external elements (governments, stakeholders, and industry/professional bodies), internal
elements (owners/members, boards, and management, led by a CEO) and the audit function.
The key points covered in this part, and the learning objectives they align to, are as follows.

KEY POINTS

3.1 Describe corporate governance and explain why it is important.

• Corporate governance is the system by which companies are directed and controlled, and
accountability and transparency are assured.
• Good corporate governance helps the corporation to act in the best interests of its stakeholders,
achieve its strategic goals, including by accessing capital and complying with regulations.
• Corporate governance relates to the responsibilities of the board of directors towards investors and
other stakeholders, and involves setting the objectives and direction of the company. The board’s
role is distinct from day-to-day management.
• Boards of directors and managers of companies need to engage with all stakeholders in a manner
that is appropriate for each group.
3.2 Evaluate the importance of the key elements of the corporate governance framework.
• The external framework of governance is established through the legal and regulatory activity of
governments, the requirements of investors and the standards set by industry and professional
bodies.
• The internal governance of the company is established by the board, who are appointed by the
shareholders, and who in turn appoint the chief executive officer.
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164 Ethics and Governance

 • The external auditor reviews the financial reporting of the company and thus helps ensure the
information provided by directors to stakeholders, particularly capital providers, is free from material
misstatement.
• Directors (and the board that they constitute) are the most important components of the corporate
governance framework as they direct and control the overall actions of the corporation and are
accountable for those actions.
• Shareholders delegate authority to the directors but maintain some influence through the appoint-
ment and removal of directors and setting director remuneration. Institutional shareholders tend to
have most power, but individual shareholders have become more active in recent years.
• Regulators create a system of rules within which businesses are required to operate, thus ensuring
they act in a manner that is acceptable and beneficial to the society that hosts them.

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MODULE 3 Governance Concepts 165

PART C: INTERNATIONAL PERSPECTIVES
ON CORPORATE GOVERNANCE
INTRODUCTION
As described in part B, corporate governance involves a set of relationships between a company’s
management, board and stakeholders and establishes a structure by which objectives are set, pursued
and monitored. Within this overall scope of corporate governance, various approaches exist based on
different perspectives of how the overall aim of good corporate governance is best achieved. This part of the
module explores some of these alternative approaches, the factors that drive changes to aspects of corporate
governance frameworks and significant developments in corporate governance that have occurred in
recent decades.
In particular, any examination of the history of regulation in any country shows that major corporate
collapses or share market calamities are followed by regulatory changes designed to improve corporate
governance, in particular the market behaviour of corporations. Some reforms take the shape of laws,
while others involve the introduction or revision of codes of conduct or best practice guidelines.

3.7 GLOBAL PUSH FOR IMPROVED GOVERNANCE

Large global corporations have a significant impact on economies around the world. These entities are
subject to intense competition and require investor and customer confidence to underpin their activities.
Poor governance adversely affects customers and investors, and makes corporations uncompetitive. This
can also affect entire economies. In the context of the GFC, the collapse of the US investment bank Lehman
Brothers demonstrates that corporate failure can hurt economies globally. The failure of Lehman Brothers
to properly manage and understand risk is a clear example of the failure of good governance.
The modern corporate governance world has become very complex, and accountants must be aware
of this. As an internationally mobile profession, working with and within international corporations,
accountants must be equipped to deal with this complexity and be prepared to provide leadership on
corporate governance.
Key factors driving the need for better corporate governance internationally include the following.
• Corporations are being exposed to more competition as a direct result of globalisation. This has placed
additional pressure on corporations as they strive to improve on their historic levels of performance.
• Capital markets have been ‘freed up’ as a result of advances in technology and globalisation allowing
rapid flows of debt and equity capital, each requiring optimal returns. The long process of deregulation
in international capital markets was interrupted by the GFC. However, as we have seen in the post-GFC
world, only the best organisations will attract low-cost capital. Therefore, corporations exhibiting high
levels of good governance will receive the lowest cost debt and equity finance.
• Company performance and other related measures are more readily available to the public as a result of
technological advances and the consequential rapid growth of timely and easily accessible information.
Investors have also become more sophisticated due to an improved understanding of economic systems.
This has further heightened the demand for information and performance.
• Shareholder activism has grown for two key reasons.
1. The global ageing population is demanding adequate financing of retirement. This has led to
significant growth in superannuation funds and pension plans and, with that growth, the need for
superior financial performance of those plans. The California Public Employees’ Retirement System
(CalPERS), which managed pension and health benefits for more than 1.6 million Californian public
employees, retirees and their families, is one example of an active (institutional investor) pension
fund. The investment power of pension funds is becoming a globally significant factor.
2. The significant growth in small shareholder ownership of major corporations internationally has
meant there are more interested stakeholders demanding accountability. The growth in Australia
of self-managed superannuation funds has also contributed to a high level of small shareholder
ownership.
• Awareness that global warming continues to have a growing impact on climate and the sustainability
of the planet has increased. The G20/OECD Principles of Corporate Governance were revised in 2023
with the overarching goal of promoting ‘corporate governance policies that support the sustainability
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166 Ethics and Governance

 and resilience of corporations which, in turn, can contribute to the sustainability and resilience of the
broader economy’ (OECD 2023b).
• The UK Corporate Governance Code was published in July 2018. The Code, accompanied by a
supporting guidance, is designed to assist companies address specific aspects of governance and
accountability. In 2023, the UK FRC launched a public consultation on proposed revisions to the
Code. This follows the UK government’s response to the white paper Restoring Trust in Audit and
Corporate Governance, which identified areas of reform related to directors’ responsibilities for internal
control, risk, audit and corporate reporting (UK FRC 2023).
The professional accountant has an important role in corporate governance. Areas of involvement
include the internal audit function, providing external audits, and being a key partner in providing
management with information relevant to decision making and planning. Furthermore, by ensuring that
professional ethical standards applicable to accountants are complied with fully, the accountant can make
an important contribution to enhancing the business ethics of the corporation.
Before we explore international frameworks more closely, it is necessary that we look at the events
that cause countries to reflect on whether their legal and extra-legal frameworks need change. Corporate
collapses and financial scandals have created the need for changes to law to tighten rules. These are
summarised in table 3.7. Note that there is a lag between events and responses with some events yet to be
responded to.

TABLE 3.7 Corporate governance events and responses

Events Responses

1980s US US
• Savings and loan crisis (1986–1995) • Financial Institutions Reform, Recovery and
• Texaco bankruptcy (1987) Enforcement Act (1989)
• Stock market crash (1987)
Australia
• Ariadne collapse (1988)
• Rothwells Merchant Bank collapse (1989)
• Qintex collapse (1989)

1990s International International

• Swedish banking crisis (1991–1992)
• Asian financial crisis (1997)
UK
• Polly Peck collapse (1990)
• Bank of Credit and Commerce International
fraud scandal (1991)
• Barings Bank collapse (1995)
US
• Long-Term Capital Management
collapse (1998)
• Sunbeam accounting fraud (1998)
• Waste Management fraud scandal (1998)
Australia
• Bond Corporation (1991)
• National Safety Council (Victorian
Division) (1991)
• State Bank of South Australia (1991)
• OECD Principles of Corporate
Governance (1999)
UK
• Cadbury Report and Code of Best Practice (1992)
• Greenbury Report (1995)
• Hampel Report (1998)
• Turnbull Report (1999)
US
• NACD Blue Ribbon Commission on Director
Professionalism (1996)
Australia
• Corporations Law (1991)
• Hilmer Report (1993)

2000s International International

• Parmalat financial scandal (2003)
• Global financial crisis (2008–2009)
• Satyam accounting scandal (2009)
UK
• Marconi collapse (2002)
• MG Rover Group collapse (2005)
• Northern Rock collapse (2008)
• Royal Bank of Scotland collapse (2008)
• BAE Systems corruption scandal (2009)
• OECD Revised Principles of Corporate
Governance (2004)
• ICGN Global Governance Principles (2009)
UK
• Myners Review (2001)
• Higgs Review (2003)
• Combined Code of Practice (2003)
• Companies Act of 2006

(continued)
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MODULE 3 Governance Concepts 167

 TABLE 3.7 (continued)
Events
2000s US
• Cendant accounting fraud (2000)
• Enron collapse (2001)
• WorldCom bankruptcy (2002)
• Lehman Brothers collapse (2008)
Australia
• HIH Insurance (2001)
• One.Tel (2001)
• NAB forex scandal (2004)
• AWB oil-for-wheat scandal (2005)
• James Hardie asbestos scandal (2005)
2010s International
• Volkswagen emissions scandal (2015)
• Toshiba accounting scandal (2015)
• Kobe Steel falsified data scandal (2016)
• Paris Agreement signed at COP21 (2015
UK
• GlaxoSmithKline bribery scandal (2014)
• Tesco accounting scandal (2014)
• Carillion collapse (2018)
• British Steel collapse (2019)
US
• Dynegy bankruptcy (2012)
• Valeant Pharmaceuticals scandal (2015)
• Wells Fargo fake account scandal (2016)
• Goldman Sachs 1MDB Malaysian sovereign
wealth fund scandal (2015–2019)
• Boeing 737 Max scandal (2019)
Australia
• ANZ bank bill swap scandal (2016)
• Dick Smith collapse (2016)
• APRA Inquiry into CBA (2017)
• Banking Royal Commission (2017–2018)
2020s International
• Silicon Valley Bank collapse (2023)
• Credit Suisse failure (2023)
Source: CPA Australia 2023.
SPECIFIC AUSTRALIAN CHANGES SINCE 2001
Ramsay Report
Ian Ramsay chaired a committee that produced the Ramsay Report (Ramsay 2001). That report examined
the adequacy of Australian legislative and professional requirements regarding the independence of
external auditors and made recommendations for changes. Some parts of the report were concerned
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168 Ethics and Governance
Responses
US
• NACD Blue Ribbon Commission Role of the
Board in Corporate Strategy (2000)
• Business Roundtable Principles of Corporate
Governance (2002)
• Sarbanes–Oxley Act (2002)
Australia
• Corporations Act 2001
• ASX Principles (2003) (Revised 2007)
• Standards Australia (AS 8000-2003) (2003)
• CLERP 9 (2004)
International
• G20/OECD Principles of Corporate
Governance (2023)
• ICGN Global Governance Principles (2016)
UK
• UK Corporate Governance Code (2010; 2012;
2014; 2016; 2018)
• FRC Guidance on Board Effectiveness (2018)
• UK Stewardship Code (2012; 2020)
US
• Dodd–Frank Act (2010)
• Report of the NSE Commission on Corporate
Governance (2010)
• Commonsense Principles of Corporate
Governance (2016)
• ISG Corporate Governance Principles for US
Listed Companies (2017)
Australia
• ASX Principles (2010; 2014; 2019)
• Corporations Amendment (Executive
Remuneration) Act 2011
• ACNC Governance Standards (2013; 2019)
• Banking Executive Accountability Regime
(BEAR) (2018)
• AICD NFP Principles (2019)
• Treasury Laws Amendment (Enhancing
Whistleblower Protections) Act 2019
International
• G20/OECD Principles of Corporate Governance
(revised 2023)
• International Sustainability Standards Board
(ISSB) issued two IFRS® Sustainability Disclosure
Standards, IFRS S1 General Requirements for
Disclosure of Sustainability-related Financial
Information and IFRS S2 Climate-related
Disclosures (June 2023)
directly with audit independence (employment relationships, financial relationships and the provision of
non-audit services) and others were designed generally to enhance audit independence (e.g. establishing
audit committees and a board to oversee audit independence issues).
One of the key recommendations was that auditors would not be seen to be independent if their
employment relationships with the audit client created a conflict of interest. For example, holding financial
investments in the client, owing debts to the client, or if members of the team had a business relationship
with the client can all create a conflict of interest. Ramsay (2001) did not recommend a ban on the
provision of non-audit services to audit clients. Instead, he recommended that the disclosure requirements
be enhanced.

ASX Corporate Governance Council’s Corporate Governance Principles

and Recommendations
In 2002, the Australian Stock Exchange (since renamed the Australian Securities Exchange) responded
to calls for it to play a greater role in corporate governance through the establishment of the Corporate
Governance Council. The council, comprising representatives from business, investment and shareholder
groups, aimed to develop a principles-based framework for corporate governance that would be applicable
to listed companies. The council released the first edition of its Principles of Good Corporate Governance
and Best Practice Recommendations (ASX CGC 2003) in 2003 — providing 10 recommendations. These
were revised in 2007 and titled Corporate Governance Principles and Recommendations. The 2007
revision was amended in 2010. The third edition was released in 2014 and a fourth in 2019. The 2019
iteration of the principles is discussed later in the module.

Corporate Law Economic Reform Program (CLERP) Act 2004 (Cwlth)

The Australian Government released a discussion paper in the aftermath of the collapses of, among others,
Enron in the US and HIH Insurance in Australia. This paper outlined proposals for audit and financial
reporting reform, as well as other legislative proposals, to improve corporate governance practices in
Australian companies. The discussion paper was part of the government’s ongoing reform program.
The CLERP discussion paper (CLERP 2004, referred to as CLERP 9, as it resulted from the ninth set of
deliberations in this scheme of legislative amendments) took into consideration the initiatives introduced
by the Sarbanes–Oxley Act, as well as the recommendations of the Ramsay Report. After a period of
consultation, the Corporate Law Economic Reform Program (Audit Reform and Corporate Disclosure)
Act 2004 (Cwlth) was passed by the Australian Government, coming into effect on 1 July 2004. Some of
the key changes are described below.
Audit Reform
• Oversight of auditors was strengthened.
• The Auditing and Assurance Standards Board (AUASB) became a Commonwealth statutory body
(rather than remaining controlled by the major accounting bodies in Australia).
• The auditing standards made by the AUASB were given legal authority (under the Corporations Act).
• Independence requirements for auditors were introduced.
Financial Reporting
• Requirements for the CEO and CFO to make a written declaration stating whether the financial records
have been properly maintained, and whether the financial statements and notes comply with accounting
standards and give a true and fair view.
• Expansion of the requirements for the disclosure of the remuneration of directors and executives of
listed companies.

3.8 ALTERNATIVE INTERNATIONAL APPROACHES

TO GOVERNANCE
While corporate governance rules and guidelines largely originated from developed markets such as the US
and UK, the importance of good governance is now recognised in both developed markets and emerging
markets in South-East Asia, Eastern Europe and Latin America. This global awareness is due to:
• a general trend in society towards openness, transparency and disclosure
• a gradual realisation of the growing significance of the scale and activity of corporations in determining
the prosperity and wellbeing of economies
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• the growth of international capital markets resulting in companies globally needing to comply with
acceptable corporate governance practices in order to tap the funding available in these markets
• the increasing amounts of individual wealth held in equities through the huge growth of investment
institutions, including pension funds and insurance companies
• the growing acceptance by many people, including senior business and government officials, that good
corporate governance can be a matter of national interest.
The different systems of corporate governance found globally are classified as either market-based or
relationship-based systems. Each of these systems has inherent strengths and weaknesses that have been
demonstrated in recent times. Note that there are several terms that are used interchangeably to describe
each type of governance system.
Terms used to describe the market-based systems include the outsider system, the Anglo-Saxon system
and the shareholder system. Terms used to describe the relationship-based systems include the insider
system and the stakeholder system. Examples of each type of system are shown in table 3.8.

TABLE 3.8 Governance systems

Market-based systems Relationship-based systems

United States Continental Europe (e.g. Germany, France)

United Kingdom Asia (e.g. Japan)

Australia

New Zealand

Source: CPA Australia 2023.

MARKET-BASED SYSTEMS
The market-based systems of corporate governance in the US and the UK are the most established and
have had the greatest influence on the rest of the world. This is because of the historical strength of the
US and UK capital markets, and the growth of their investment institutions that have become increasingly
active internationally. This is the model that has been adopted in many other countries, including Australia
and New Zealand. The central characteristics of the market-based system are as follows:
• widespread equity ownership among individuals and institutional investors, with institutions often
having large shareholdings
• shareholder interests as the primary focus of company law
• an emphasis on minority shareholder protection in securities law and regulation
• stringent disclosure requirements.
In these countries, a growing amount of the national wealth is held by institutions, including:
• insurance companies
• pension funds
• mutual funds.
There has been considerable growth in the financial assets of institutional shareholders relative to GDP
over the last decade. Institutional shareholders have been the dominant owners of equity in the UK for some
time now, and they are achieving this position in the US as well. They are charged with the responsibility
of securing the maximum return on their investments for their beneficiaries, balancing risk and return over
time, and in accordance with their investment mandates.
In the past, institutional shareholders demonstrated little interest in influencing the companies they
invested in, employing strategies of portfolio diversification and indexation. However, more recently, there
has been evidence of institutional shareholders becoming more actively engaged.
The market-based system of corporate governance has been characterised as disclosure based, as the
numerous investors depend on access to a reliable and adequate flow of information to make informed
investment decisions. Regulation is intended to ensure all investors remain fully informed, and to prevent
privileged groups of shareholders sharing information only among themselves.
The role of the banks is less central in a market-based system of corporate governance. Normally, bank
finance is short term, and usually banks operate at arm’s length in their dealings with corporations. Equity
finance is seen as more important as a means of developing companies (Nestor & Thompson 2000, p. 7).
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 Under a market-based system, shareholders have the right to use their voting power to select the
board and decide on certain issues facing the company, such as the appointment of an external auditor.
However, in practice, fragmented investors rarely exercise this control when faced with an informed and
determined management.
In the past, investors who were dissatisfied with how a company was being managed and directed tended
to sell their shares in the company. When this happens in sufficient numbers, it can depress the share price
to the point where a company becomes a target for hostile takeover.
Moreover, many institutional shareholders have become so large that they need to invest in a large
number of companies to spread their risk. Some investors, such as pension funds and insurance companies,
being typical institutional investors, also need to take a longer-term view of their investments.
These factors, together with pressure from regulators and beneficiaries, are forcing more institutional
shareholders to practise ‘responsible investing’ and to become more engaged with companies they are
investing in. This means that, rather than just selling their shares when they are unhappy with the
management or board, they are using a range of strategies — such as private meetings, voting against
resolutions, and applying public pressure using the media.

QUESTION 3.11

Why is disclosure important for the integrity of equity markets? In your answer, you should address
what occurs when information is monopolised by privileged groups.

The US is the world’s major capital market. It operates a market-based system that has some distinct
characteristics. In the US, the board of directors is entrusted with an important responsibility — to monitor
the company on behalf of shareholders. However, in the US, boards of directors are often dominated by
the company management.
As a consequence, there have been efforts to achieve greater accountability by requiring that boards
have a majority of independent non-executive directors. This is now required under the listing rules of
the two major stock markets in that country: the New York Stock Exchange (NYSE) and the NASDAQ.
(When NASDAQ was originally conceived in the 1970s, the acronym stood for the National Association
of Securities Dealers Automated Quotations. Since then it has been known for its listing of growth
companies.) Moreover, in the US, it is common for the chair of the board and the CEO to be the same
person. This practice differs from many other countries where these roles are expected to be separate.
To enhance the oversight function of boards and limit the powers of CEOs, committees were established
in the 1980s in US corporations to undertake critical tasks. These tasks included the remuneration of
executive directors, nomination of new board members and key decisions in respect of auditing. As a
result, most CEOs of large companies in the US could no longer decide their own pay, select their own
board and audit their own financial performance. However, in many companies, CEOs continued to wield
considerable power in the boardroom, partly because they also retained the role of chair.
Notwithstanding these developments, controversy still exists in relation to issues such as executive
remuneration. The GFC has placed the pay and performance of senior bank executives at the forefront
of public debate again. Many US banks that received government bailout monies continued to pay large
amounts to their key executives, despite their recent mediocre performance and seemingly excessive risk-
taking behaviours. The result was that the US Government announced that caps on executive pay and
bonuses would be placed on the salaries of CEOs of banks subject to taxpayer-funded bailouts.
Other checks on management include the more active role being played by institutional shareholders
and rules such as Sarbanes–Oxley. As previously noted, many of these large investors, such as CalPERS,
closely monitor the corporate governance practices of companies in which they invest. However, in
practice, shareholders in the US possess limited power to appoint or remove directors. This is because,
in a public company with widely dispersed share ownership, it is difficult and expensive for shareholders
to take all of the actions and achieve the necessary coordination to remove directors. There are also other
administrative hurdles.

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 QUESTION 3.12

Is interest in corporate governance regulation and legislation inevitably associated with recession,
market failure and corporate collapse, or is it possible to maintain attention on improving standards
of corporate governance at times of market expansion and business growth?

QUESTION 3.13

Identify the strengths and weaknesses of the market-based system of corporate governance as
practised in countries such as the US, UK and Australia.

RELATIONSHIP-BASED SYSTEMS —
EUROPEAN APPROACHES
European countries exhibit diversity in corporate governance practices and structures, and have participants
that reflect differences in histories, cultures, financial traditions, ownership patterns and legal systems.
The main difference between corporate governance systems in the US and the UK and those of European
countries is that the Europeans emphasise cooperative relationships and consensus, whereas the Anglo-
Saxon tradition emphasises competition and market processes (Nestor & Thompson 2000).
With the move towards equity financing and broader share ownership in Europe in the 1990s, it seemed
at times that the market-based system was gaining favour. However, important elements of the European
tradition have proved resilient and enduring.
The European relationship-based or insider system relies on the representation of interests on the board
of directors. More diverse groups of stakeholders are actively recognised, including:
• workers
• customers
• banks
• other companies with close ties
• local communities
• national governments.
Stable investment and cross-shareholdings mean that the discipline of management by the securities
market is not strong; and the market for corporate control is weak, with hostile takeovers rarely occurring.
In other words, long-term large shareholders give a company a degree of protection from both the stock
market and the threat of takeover. The continental European system is characterised by a supervisory
board for the oversight of management, where banks play an active role, inter-corporate shareholdings are
widespread and, often, companies have close ties to political elites.
In most European countries (and indeed most countries in the world), ownership and control are held by
cohesive groups of insiders who have long-term stable relationships with the company (La Porta, Lopez-
de-Silanes & Schleifer 1999). Groups of insiders tend to know each other well and have some connection
with the company in addition to their investment (e.g. through family interests, allied industrial concerns,
banks and holding companies). Insider groups monitor management that often acts under their control. The
agency problem of the market-based system is much less of a problem in the relationship-based system
(Nestor & Thompson 2000, p. 9).
Corporate finance in such countries is highly dependent upon banks, with companies having high debt-
to-equity ratios. Banks often have complex and longstanding relationships with corporations, rather than
the arm’s length relations of equity markets. As a result, rather than the emphasis on public disclosure
as in the market-based system, the insider system is based on a deeper but more selective exchange of
information among insiders.

Different Political, Legal and Regulatory Structures

A number of important distinctions remain among European countries that also distinguish the Euro-
pean approach from other models of corporate governance, policy and practice (Weil, Gotshal &
Manges 2002, pp. 3–5).
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• Company law. Many European countries have a distinctive tradition of company law influenced by
prescriptive Roman law. In France, regulations on incorporation were inspired by the Napoleonic Code.
In Germany, regulation insisted upon a board of supervision separate from the company’s board of
directors to represent and protect shareholders’ interests. Company law is embedded in different and
often unique political, cultural and social traditions.
• Employee representation. Employee representation is embedded in law in Austria, Denmark, Germany,
Luxembourg and Sweden. Employees of companies of a certain size have the right to elect some
members of the supervisory board. In Finland and France, company articles may provide this right.
In other European countries, it is the shareholders who elect the members of the supervisory board.
• Stakeholder issues. Different European countries articulate the purpose of corporate governance in
different ways. Some place emphasis on a broader range of stakeholder interests, while others strongly
emphasise the ownership rights of shareholders.
• Shareholder rights and participation mechanics. Laws and regulations relating to the equitable treatment
of shareholders, including minority rights in takeovers and other transactions, vary significantly among
countries. Limits on shareholder participation rights pose barriers to cross‐border investment.
• Board structure, roles and responsibilities. Two main corporate board structures exist. First, the unitary
board (single tier) structure that is used in most common-law countries, and second, the two-tier
structure, which characterises the German governance system. In France, the legal system allows firms
to choose between a one-tier or two-tier board structure. There are similarities in practices between one-
and two-tier boards. For example, both recognise a supervisory function and a management function,
although the distinction between them is more formally recognised in a two-tier board. It is valuable to
note that the two-tier board structure can also be found commonly in Japan and in China — but not in
South Korea.
• Supervisory body independence and leadership. The purpose of the supervisory board is to ensure
accountability and provide strategic guidance, leaving management with the capacity to make
decisions — management normally will have significant input to the ‘management board’ where a
two-tier structure exists.
• Disclosure. Variations in disclosure requirements and the resulting differences in information provided
to investors are a potential impediment to a single European equity market. Nevertheless, the amount
of disclosure is increasing, and there is more agreement about the type of information that needs to be
disclosed. In part, this is due to the promotion of International Financial Reporting Standards (IFRS).

Germany
The German business sector is typified by the following characteristics:
• a relatively strong concentration of ownership of individual enterprises
• the importance of small and medium-sized unincorporated companies
• a close correspondence between owners and managers
• the limited role played by the stock market.
The central characteristic of the corporate governance of German enterprises is their relationship-
based nature in which all interested stakeholders are able to monitor corporate performance. The German
Corporate Governance Code was first published in 2002 and has since been amended several times,
including in 2015. It stresses the need for transparency and clarifies shareholder rights in order to promote
the trust of investors and capital market development. It also seeks to enhance investors’ understanding
of the complex civil law–based corporate governance framework by setting out key principles in the one
document (Government Commission 2015). Moreover, the Code’s ‘comply or explain principle’ seeks to
foster transparency by requiring an explanation from those corporations not complying with the provisions
of the Code (Enriques & Volpin 2007).

France
France and Italy are the European countries with the smallest ownership of company shares by financial
institutions. The majority of shares have traditionally been owned by non-financial enterprises, which
reflects an elaborate structure of cross and circular ownership. That is, companies own one another’s shares
in a circular relationship. No external party can readily gain entry to the network, or seize control of any
entity in the network, and all of the member companies support one another against outsiders.
Another distinguishing feature of France is the concentration of ownership, which is higher than in any
other Group of Seven (G7) industrialised country, with the exception of Italy. In France, half the firms
are controlled by one single investor who owns the absolute majority of capital. On boards, the role of
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non-executive directors is muted, as business tends to be dominated by the president directeur général
(PDG) who combines the functions of chair and CEO. The independence of the PDG is reinforced by
the legal notion that enterprises should pursue the intérêt social de l’entreprise (the social interest of the
company). This law is interpreted in two ways:
1. that management has to act in the interests of shareholders
2. that management has to act in the interest of the enterprise (e.g. to ensure its survival) (OECD
1997, p. 113).

QUESTION 3.14

Identify the advantages and disadvantages of the European relationship-based insider system of
corporate governance.

RELATIONSHIP-BASED SYSTEMS — ASIAN APPROACHES

Differing Corporate Governance Models
Countries in Asia also have a rich cultural diversity with different political and legal structures, and social
traditions. This leads to differences in corporate governance policy and practice. Many countries in Asia
are also still engaged in a process of institutional development. Many countries in the region have corporate
governance systems that are essentially based on close relationships (usually involving family control) and
further ongoing close relationships with creditors, suppliers and major customers. In some systems, this is
reinforced by close relationships with regulators and state officials.
In certain Asian countries, there are still many government-controlled organisations carrying out roles
that are typically performed by the private sector in Western countries. This situation reflects the history
of countries where, during the mid-20th century, governments created and owned all significant business
entities, before later reforming state-owned enterprises, with many SMEs being privatised.
Nevertheless, there are still many government-controlled entities in existence today. They are typically
controlled by local governments and the central government. Given their public charter, they are expected
to perform roles that are consistent with the broad social aims of the government. Consequently, their
governance structure and processes reflect heavy government influence and control.
In Singapore, many of the largest listed companies have the state as the largest shareholder although,
in terms of number, there are more listed companies that have either families or founder-managers as the
largest shareholders.
The relationship-based form of conducting business contrasts with the rules-based systems that predom-
inate in Western industrial countries, where a combination of internal and external controls is exerted on
companies. Internally, company directors are responsible for exercising a duty of care and diligence that
includes ensuring financial controls are effective. This financial discipline is reinforced by the requirement
to audit the annual company accounts. Externally, the company operates within a framework of company
law that is enforced by regulatory authorities. Finally, there is the enveloping discipline of the capital
market, the effect of which is to exercise a commercial discipline on companies.
A common problem is that Asian economies have a considerable concentration of ownership of com-
panies. Most companies in Asia either have a majority shareholder or a cohesive group of minority
shareholders who act together to control the company. Often, the company is part of an extensive corporate
network, which in turn has majority shareholders, which allows influential shareholders to control not just
individual companies but entire networks of companies, often concealing the true extent of their influence.
The most prevalent company form in East Asia is the diversified conglomerate that is controlled and
managed by a single extended family. Companies with widely dispersed ownership are rare in Asia. In
this context, it is difficult to protect the rights of minority shareholders. Though there are usually laws and
penalties against insider-trading and related party transactions, as well as on the conduct of substantial
transactions and takeovers, it is open to question how often and how rigorously these are enforced (Prowse
1998). An example of change can be seen in Japan, which, in very recent years, has taken a number
of steps to improve corporate governance, including new rules designed to improve independence in
the boardroom.
The following overviews of corporate governance in Japan and India illustrate how their different
cultures and histories have shaped the development of their corporate governance models.
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Japan
The formal legal features of the Japanese corporate governance system resemble those in most other
advanced industrial countries. Corporate law in Japan was modelled, starting in 1899, on the German
system, with the establishment of limited liability corporations, typically with a two-tier board structure.
As in most OECD countries, the majority of enterprises are organised as public limited companies, though
in Japan, a significant number of medium-sized firms are private limited corporations.
The functioning of major institutions and mechanisms of corporate governance, including shareholders,
banks and boards of directors, is different in Japan. For example, in the West, the board of directors is
largely appointed from outside the company and serves to monitor management. However, in Japan, the
main board of directors plays a more strategic and decision‐making role, and is more fully drawn from
the ranks of management who are employed by the company. Putting it simply, in the West, the board
members are outsiders representing the shareholders while, in Japan, the board members are insiders
leading management (Yasui 1999, p. 4).
A problem with this approach is that, over time, there is a tendency for boards to grow in size as more
managers need to be rewarded. The average board size in Japan is much larger than in the West, often with
around 20 directors, with some boards reaching as many as 40 members. As a result, most companies
form a board committee whereby some senior board members make all of the essential management
decisions, which are later ratified by the main board as a formality. Thus, the role of Japanese boards
may be considered superficial in supervising the executive management. In terms of responsibility for the
company, the Japanese main board’s role is limited. However, there is no doubt regarding the executive
management’s commitment to and responsibility for the company, which is often more intense than
anything experienced in the West.
The ownership structure of Japanese companies is also different from those in Western countries. Many
large companies are formed into what are termed keiretsus, which are essentially sets of companies with
interlocking business relationships and shareholdings. The major keiretsus are centred on one bank, which
lends money to the keiretsus member companies and holds equity positions in the companies.
Each bank has significant control over the companies in the keiretsus and acts as a monitoring entity and
as an emergency bail-out entity. Prominent keiretsus are Mitsubishi and Toyota. One effect of this structure
is to minimise the incidence of hostile takeovers. This concentrated pattern of shareholding has created
considerable stability, but at the potential expense of the market, due to corporate control being restricted.
Traditionally, keiretsus have put more emphasis on expanding their business rather than on seeking short-
term returns.
Though Japanese companies may be moving in the direction of the Anglo-Saxon model, this movement
is one of degree. The distinctive interrelated elements of the Japanese economic and social systems,
together with legal, regulatory, financial market and employment systems, will continue to have a powerful
effect. Though reforms are under way in the Japanese system of corporate governance, the progress
has at times been at only a gradual pace. The Japanese highly value their culture and institutions, and
are not eager to change them without fully understanding or accepting the reasons for change (Seki &
Clarke 2014).

India
Despite a legal system substantially similar to that of Britain and therefore a corporate governance approach
that follows the Anglo-American model, India has still found it difficult to develop a fully functional
corporate governance system. It requires a system that balances international approaches with its unique
culture, including extensive family control of even the largest corporations and, in recent years, the
phenomenal rate of growth achieved, locally and internationally, by Indian corporations.
An example of corporate governance failings involved one of India’s largest corporate frauds —
resulting in substantial international damage. In 2009, the internationally-significant listed Indian computer
corporation Satyam Computer Services was the subject of a major fraud involving, among other things,
extensive overstatement of profits. Its founder, B Ramalinga Raju, resigned after admitting that the
company had fraudulently misrepresented its profits. In addition to criminal prosecutions in India, there
have been international ramifications — including regulatory legal action in the US. In April 2011, Satyam
Computer Services and its former auditor, PW India (an affiliate of PricewaterhouseCoopers), accepted
fines totalling USD17.5 million in the US in relation to the fraud and the negative impact it had on trading
on Satyam shares on the New York Stock Exchange (The Hindu 2011).

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 It seems that at least some of the corporate governance problems in India arise from the fact that British
corporate governance approaches, which have formed the basis of Indian corporate governance, do not
easily fit into the Indian environment.
India’s most significant governance issue is likely to be ensuring that a dominant shareholder does
not abuse their power, and protecting minority shareholders. This is different from the Western focus
on the separation of owners (principals) and control (agents) and the need to align the two. This may
limit the ability to transfer external models of corporate governance directly into the Indian commercial
environment. In addition to this, India has trouble with weak enforcement of corporate governance
regulations (Pande & Kaushik 2011, p. 2).
We can deduce from these observations that corporate governance in India is still in development, but
that India is prepared to take major steps to achieve successful corporate governance. The fact that rapid
changes in direction in the past have not solved problems shows that achieving better corporate governance
is a slow and painstaking process that requires constant effort and an acceptance that perceptions and
approaches matter more than rules.
If we accept that Australia and the UK, for example, have more-effective corporate governance, it must
be remembered that, in each of those locations, the development of better corporate governance has been
constant in direction and effort for decades. Even so, we still find examples of failure in both — so it is
hardly surprising if things are difficult in a society as socially complex as India. Progress may be slower
than wished in India, but long-term improvements are taking place and will continue to do so.

QUESTION 3.15

Download a copy of the OECD Corporate Governance Factbook 2023 (https://www.oecd-ilibrary.

org/finance-and-investment/oecd-corporate-governance-factbook-2023_6d912314-en) and use
the information from Table 2.2 and Figure 4.1 to fill in table 3.9. What are the similarities and
differences in the corporate governance of these countries?

TABLE 3.9 Governance codes

Element of regulatory framework (Table 2.2)

Disclosure Maximum term of

in annual office for board
Basis for company members before
Country framework Approach report Surveillance re-election (Figure 4.1)

Australia

India

Japan

Germany

Source: Adapted from OECD 2023c, OECD corporate governance factbook 2023, Table 2.2 and Figure 4.1, accessed October
2023, https://www.oecd-ilibrary.org/finance-and-investment/oecd-corporate-governance-factbook-2023_6d912314-en.

SUMMARY
Corporate governance practices change over time. In particular corporate collapses and financial crises tend
to trigger changes in rules and regulations that apply to the governance of corporations. Such changes in
recent decades have included legislative measures to tighten regulation of directors and other company
officers. One example of this is the Sarbanes–Oxley Act that was introduced in the US to improve
governance practices following the collapse of Enron and the implosion of major accounting firm Arthur
Andersen. Individually the UK and Australia developed guidance to ensure their regulatory literature had
some parity or similarity with the work done in the US.
The US, UK, Australia and New Zealand have market-based systems of corporate governance in which
shareholder interests have primacy. Various European and Asian countries have relationship-based systems
of corporate governance reflecting each country’s own cultures and financial traditions.
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 The European model of corporate governance tends to emphasise cooperation and consensus, in
contrast with the market-based system that emphasises competition. The European model places greater
importance on recognising the interests of a wider range of stakeholders, including communities, workers
and customers. Investment tends to be relatively stable compared to the market-based systems and thus
companies are generally less subject to the consequences of share market movements.
The key points covered in this part, and the learning objective they align to, are as follows.

KEY POINTS

3.7 Explain the various international approaches to corporate governance.

• Market-based systems of corporate governance have shareholder interests as the primary focus
of company law. They are characterised by widespread equity ownership among individuals
and institutional investors, an emphasis on minority shareholder protection in securities law and
regulation and stringent disclosure requirements.
• Market-based systems exist in the USA, UK, Australia and New Zealand.
• Relationship-based systems of corporate governance recognise a wider range of stakeholder
interests, including those of workers, customers, banks, other companies, communities and
governments.
• The European relationship-based model emphasises cooperation over competition and investment
in companies tends to be more stable than in market-based systems.

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PART D: CODES AND GUIDANCE
INTRODUCTION
Earlier in the module, we discussed a framework for corporate governance, what constitutes good corporate
governance, recent changes in corporate governance, including associated regulation and guidance, and
different international approaches to corporate governance.
In this part of the module, we will firstly consider the international best practice principles of corporate
governance issued by the OECD. Then we will look at two of the corporate governance codes that have
been developed from these principles, namely the UK FRC Code for the UK and the ASX Principles
for Australia.
It is important to understand and be able to apply the central principles underlying these codes, but it is
not necessary to memorise every clause.

3.9 G20/OECD PRINCIPLES OF

CORPORATE GOVERNANCE
The OECD, with members and funding sources from countries with major market-orientated economies,
has developed international best practice principles of governance. The OECD Principles of Corporate
Governance (OECD Principles) were first published in 1999 and were updated in 2004 with a new first
principle giving a broad view of governance including performance. A review of these principles started
in 2014 and, following extensive consultation, the updated principles were released in September 2015,
entitled G20/OECD Principles of Corporate Governance. The principles were then further revised in 2023
(OECD 2023a).
The OECD Principles are general or principles based. The OECD Principles are ‘good practice
guidelines’ and are not written for companies or directors. They are written so that governments writing
detailed laws relevant to individual nations will have a framework that provides sound guidance. They
are also valuable for ensuring that corporate governance guidelines developed by various agencies are
consistent with the OECD Principles. The OECD Principles can also be used as a guidance framework for
profit-seeking businesses and NFP organisations.
The OECD Principles specify six principles relating to:
I. ensuring the basis for an effective corporate governance framework
II. the rights and equitable treatment of shareholders and key ownership functions
III. institutional investors, stock markets, and other intermediaries
IV. disclosure and transparency
V. the responsibilities of the board
VI. sustainability and resilience (OECD 2023a).

In the discussion that follows we introduce each principle with its sub-principles.

PRINCIPLE I. ENSURING THE BASIS FOR AN EFFECTIVE

CORPORATE GOVERNANCE FRAMEWORK
The corporate governance framework should promote transparent and fair markets, and the efficient
allocation of resources. It should be consistent with the rule of law and support effective supervision and
enforcement.
…
I.A. The corporate governance framework should be developed with a view to its impact on overall
economic performance, market integrity and the incentives it creates for market participants and the
promotion of transparent and well-functioning markets.
…
I.B. The legal and regulatory requirements that affect corporate governance practices should be consistent
with the rule of law, transparent and enforceable. Corporate governance codes may offer a comple-
mentary mechanism to support the development and evolution of companies’ best practices, provided
that their status is duly defined.
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178 Ethics and Governance

 …
I.C. The division of responsibilities among different authorities and self-regulatory bodies should be
clearly articulated and designed to serve the public interest.
…
I.D. Stock market regulation should support effective corporate governance.
…
I.E. Supervisory, regulatory and enforcement authorities should have the authority, integrity and resources
to fulfil their duties in a professional and objective manner. Moreover, their rulings should be timely,
transparent and fully explained.
…
I.F. Digital technologies can enhance the supervision and implementation of corporate governance
requirements, but supervisory and regulatory authorities should give due attention to the management
of associated risks.
…
I.G. Cross-border co-operation should be enhanced, including through bilateral and multilateral arrange-
ments for exchange of information.
…
I.H. Clear regulatory frameworks should ensure the effective oversight of publicly traded companies within
company groups. (OECD 2023a, pp. 9–13)

As the OECD advises governments on corporate governance, its focus here is on macro performance at
the market level. This acknowledges that the appropriate mix of legislation, regulation, self-regulation and
voluntary standards will vary across jurisdictions.

PRINCIPLE II. THE RIGHTS AND EQUITABLE TREATMENT OF

SHAREHOLDERS AND KEY OWNERSHIP FUNCTIONS
The corporate governance framework should protect and facilitate the exercise of shareholders’ rights and
ensure the equitable treatment of all shareholders, including minority and foreign shareholders.
All shareholders should have the opportunity to obtain effective redress for violation of their rights at a
reasonable cost and without excessive delay.
…
II.A. Basic shareholder rights should include the right to: 1) secure methods of ownership registration;
2) convey or transfer shares; 3) obtain relevant and material information on the corporation on a
timely and regular basis; 4) participate and vote in general shareholder meetings; 5) elect and remove
members of the board; 6) share in the profits of the corporation; and 7) elect, appoint or approve the
external auditor.
II.B. Shareholders should be sufficiently informed about, and have the right to approve or participate
in decisions concerning fundamental corporate changes such as: 1) amendments to the statutes, or
articles of incorporation or similar governing documents of the company; 2) the authorisation of
additional shares; and 3) extraordinary transactions, including the transfer of corporate assets that in
effect result in the sale of the company.
…
II.C. Shareholders should have the opportunity to participate effectively and vote in general shareholder
meetings, and should be informed of the rules, including voting procedures, that govern general
shareholder meetings.
II.C.1. Shareholders should be furnished with sufficient and timely information concerning the
date, format, location and agenda of general meetings, as well as fully detailed and timely
information regarding the issues to be decided at the meeting.
II.C.2. Processes, format and procedures for general shareholder meetings should allow for
equitable treatment of all shareholders. Company procedures should not make it unduly
difficult or expensive to cast votes.
…
II.C.3. General shareholder meetings allowing for remote shareholder participation should be
permitted by jurisdictions as a means to facilitate and reduce the costs to shareholders of
participation and engagement. Such meetings should be conducted in a manner that ensures
equal access to information and opportunities for participation of all shareholders.
…

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 II.C.4. Shareholders should have the opportunity to ask questions to the board, including on the
annual external audit, to place items on the agenda of general meetings, and to propose
resolutions, subject to reasonable limitations.
…
II.C.5. Effective shareholder participation in key corporate governance decisions, such as the
nomination and election of board members, should be facilitated. Shareholders should be
able to make their views known, including through votes at shareholder meetings, on the
remuneration of board members and/or key executives, as applicable. The equity compo-
nent of compensation schemes for board members and employees should be subject to
shareholder approval.
…
II.C.6. Shareholders should be able to vote in person or in absentia, and equal effect should be given
to votes whether cast in person or in absentia.
…
II.C.7. Impediments to cross-border voting should be eliminated.
…
II.D. Shareholders, including institutional shareholders, should be allowed to consult with each other on
issues concerning their basic shareholder rights as defined in the Principles, subject to exceptions to
prevent abuse.
…
II.E. All shareholders of the same series of a class should be treated equally. All investors should be able to
obtain information about the rights attached to all series and classes of shares before they purchase.
Any changes in economic or voting rights should be subject to approval by those classes of shares
which are negatively affected.
…
II.F. Related party transactions should be approved and conducted in a manner that ensures proper
management of conflicts of interest and protects the interests of the company and its shareholders.
II.F.1. Conflicts of interest inherent in related party transactions should be addressed.
…
II.F.2. Members of the board and key executives should be required to disclose to the board whether
they, directly, indirectly or on behalf of third parties, have a material interest in any transaction
or matter directly affecting the corporation.
…
II.G. Minority shareholders should be protected from abusive actions by, or in the interest of, controlling
shareholders acting either directly or indirectly, and should have effective means of redress. Abusive
self-dealing should be prohibited.
…
II.H. Markets for corporate control should be allowed to function in an efficient and transparent manner.
II.H.1. The rules and procedures governing the acquisition of corporate control in the capital markets,
extraordinary transactions such as mergers, and sales of substantial portions of corporate
assets, should be clearly articulated and disclosed so that investors understand their rights
and recourse. Transactions should occur at transparent prices and under fair conditions that
protect the rights of all shareholders according to their class.
II.H.2. Anti-takeover devices should not be used to shield management and the board from account-
ability. (OECD 2023a, pp. 13–20)

Within companies, shareholders are considered to be important stakeholders. Principle II concerns the
protection of shareholders’ rights and the ability of shareholders to influence the behaviour of corporations.
It lists some basic rights including obtaining relevant information, sharing in residual profits, participating
in key decisions (including via remote participation), fair and transparent treatment during changes of
control and the fair operation of voting rights. Shareholders, as the legal owners of corporations, should
expect to be able to enjoy these rights in all jurisdictions.
This principle emphasises that all shareholders, including minority and foreign shareholders, should
be treated equitably by controlling shareholders, boards and management. Transparency is required with
respect to distribution of voting rights and the way that voting rights are exercised. There should be
appropriate disclosure of all related party transactions, and conflicts of interest should be addressed.
Redress should be available for violations of shareholder rights in a timely manner at reasonable cost.

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PRINCIPLE III. INSTITUTIONAL INVESTORS, STOCK
MARKETS, AND OTHER INTERMEDIARIES
The corporate governance framework should provide sound incentives throughout the investment chain and
provide for stock markets to function in a way that contributes to good corporate governance.
…
III.A. The corporate governance framework should facilitate and support institutional investors’ engage-
ment with their investee companies. Institutional investors acting in a fiduciary capacity should
disclose their policies for corporate governance and voting with respect to their investments,
including the procedures that they have in place for deciding on the use of their voting rights.
Stewardship codes may offer a complementary mechanism to encourage such engagement.
…
III.B. Votes should be cast by custodians or nominees in line with the directions of the beneficial owner of
the shares.
…
III.C. Institutional investors acting in a fiduciary capacity should disclose how they manage material
conflicts of interest that may affect the exercise of key ownership rights regarding their investments.
…
III.D. The corporate governance framework should require that entities and professionals that provide
analysis or advice relevant to decisions by investors, such as proxy advisors, analysts, brokers, ESG
rating and data providers, credit rating agencies and index providers, where regulated, disclose and
minimise conflicts of interest that might compromise the integrity of their analysis or advice. The
methodologies used by ESG rating and data providers, credit rating agencies, index providers and
proxy advisors should be transparent and publicly available.
…
III.E. Insider trading and market manipulation should be prohibited and the applicable rules enforced.
…
III.F. For companies who are listed in a jurisdiction other than their jurisdiction of incorporation, the
applicable corporate governance laws and regulations should be clearly disclosed. In the case of
cross-listings, the criteria and procedure for recognising the listing requirements of the primary
listing should be transparent and documented.
…
III.G. Stock markets should provide fair and efficient price discovery as a means to help promote effective
corporate governance. (OECD 2023a, pp. 20–23)

In many jurisdictions, the reality of corporate governance and ownership is no longer characterised by a
direct relationship between the performance of the company and the income of the ultimate beneficiaries.
In reality, the investment chain is often complex, with numerous intermediaries, including institutional
investors, between the company and the ultimate beneficiary. Principle III recommends that institutional
investors disclose their corporate governance and voting policies, and should manage conflicts of interest.
Insider trading and market manipulation are prohibited. The methodologies of rating agencies and proxy
advisors should be available to all. Shareholder engagement is also noted to take various forms from voting
at shareholder meetings to direct contact and dialogue with the board and management.

PRINCIPLE IV. DISCLOSURE AND TRANSPARENCY

The corporate governance framework should ensure that timely and accurate disclosure is made on all
material matters regarding the corporation, including the financial situation, performance, sustainability,
ownership, and governance of the company.
…
IV.A. Disclosure should include, but not be limited to, material information on:
IV.A.1. The financial and operating results of the company
…
IV.A.2. Company objectives and sustainability-related information
…
IV.A.3. Capital structures, group structures and their control arrangements
…

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MODULE 3 Governance Concepts 181

 IV.A.4. Major share ownership, including beneficial owners, and voting rights
…
IV.A.5. Information about the composition of the board and its members, including their qualifica-
tions, the selection process, other company directorships and whether they are regarded as
independent by the board
…
IV.A.6. Remuneration of members of the board and key executives
…
IV.A.7. Related party transactions
…
IV.A.8. Foreseeable risk factors
…
IV.A.9. Governance structures and policies, including the extent of compliance with national
corporate governance codes or policies and the process by which they are implemented
…
IV.A.10. Debt contracts, including the risk of non-compliance with covenants.
…
IV.B. Information should be prepared and disclosed in accordance with internationally recognised account-
ing and disclosure standards.
…
IV.C. An annual external audit should be conducted by an independent, competent and qualified auditor in
accordance with internationally recognised auditing, ethical and independence standards in order to
provide reasonable assurance to the board and shareholders on whether the financial statements are
prepared, in all material respects, in accordance with an applicable financial reporting framework.
…
IV.D. External auditors should be accountable to the shareholders and owe a duty to the company to
exercise due professional care in the conduct of the audit in the public interest.
…
IV.E. Channels for disseminating information should provide for equal, timely and cost-efficient access to
relevant information by users. (OECD 2023a, pp. 24–29)

The OECD views disclosure of material information as an important tool in influencing the behaviour of
corporations, protecting investors and maintaining confidence in markets. The types of information to be
disclosed include the traditional financial and operating results, and the more contemporary environmental
and social metrics. Board and executive remuneration, board skills and future risks also need to be
disclosed. Disclosures are to be assured and available to relevant users.

PRINCIPLE V. THE RESPONSIBILITIES OF THE BOARD

The corporate governance framework should ensure the strategic guidance of the company, the effec-
tive monitoring of management by the board, and the board’s accountability to the company and the
shareholders.
…
V.A. Board members should act on a fully informed basis, in good faith, with due diligence and care, and in
the best interest of the company and the shareholders, taking into account the interests of stakeholders.
…
V.A.1. Board members should be protected against litigation if a decision was made in good faith
with due diligence.
…
V.B. Where board decisions may affect different shareholder groups differently, the board should treat all
shareholders fairly.
…
V.C. The board should apply high ethical standards.
…
V.D. The board should fulfil certain key functions, including:
V.D.1. Reviewing and guiding corporate strategy, major plans of action, annual budgets and business
plans; setting performance objectives; monitoring implementation and corporate perfor-
mance; and overseeing major capital expenditures, acquisitions and divestitures.
…

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182 Ethics and Governance

 V.D.2. Reviewing and assessing risk management policies and procedures.
…
V.D.3. Monitoring the effectiveness of the company’s governance practices and making changes
as needed.
…
V.D.4. Selecting, overseeing and monitoring the performance of key executives, and, when necessary,
replacing them and overseeing succession planning.
…
V.D.5. Aligning key executive and board remuneration with the longer term interests of the company
and its shareholders.
…
V.D.6. Ensuring a formal and transparent board nomination and election process.
…
V.D.7. Monitoring and managing potential conflicts of interest of management, board members and
shareholders, including misuse of corporate assets and abuse in related party transactions.
…
V.D.8. Ensuring the integrity of the corporation’s accounting and reporting systems for disclosure,
including the independent external audit, and that appropriate control systems are in place, in
compliance with the law and relevant standards.
…
V.D.9. Overseeing the process of disclosure and communications.
V.E. The board should be able to exercise objective independent judgement on corporate affairs.
…
V.E.1. Boards should consider assigning a sufficient number of independent board members capable
of exercising independent judgement to tasks where there is a potential for conflicts of
interest. Examples of such key responsibilities are ensuring the integrity of financial and other
corporate reporting, the review of related party transactions, and nomination and remuneration
of board members and key executives.
…
V.E.2. Boards should consider setting up specialised committees to support the full board in
performing its functions, in particular the audit committee — or equivalent body — for
overseeing disclosure, internal controls and audit-related matters. Other committees, such as
remuneration, nomination or risk management, may provide support to the board depending
upon the company’s size, structure, complexity and risk profile. Their mandate, composition
and working procedures should be well defined and disclosed by the board which retains full
responsibility for the decisions taken.
…
V.E.3. Board members should be able to commit themselves effectively to their responsibilities.
…
V.E.4. Boards should regularly carry out evaluations to appraise their performance and assess whether
they possess the right mix of background and competences, including with respect to gender
and other forms of diversity.
…
V.F. In order to fulfil their responsibilities, board members should have access to accurate, relevant and
timely information.
…
V.G. When employee representation on the board is mandated, mechanisms should be developed to
facilitate access to information and training for employee representatives, so that this representation
is exercised effectively and best contributes to the enhancement of board skills, information and
independence. (OECD 2023a, pp. 30–38)

This principle states the OECD’s basic view on the board and its responsibilities. As a document for
global consumption, it states a series of general requirements but does not provide a detailed analysis.
However, it is very easy to see them reflected in the provisions of the Corporations Act and the ASX
Principles.

PRINCIPLE VI. SUSTAINABILITY AND RESILIENCE

The corporate governance framework should provide incentives for companies and their investors to make
decisions and manage their risks, in a way that contributes to the sustainability and resilience of the
corporation.
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MODULE 3 Governance Concepts 183

 VI.A. Sustainability-related disclosure should be consistent, comparable and reliable, and include
retrospective and forward-looking material information that a reasonable investor would consider
important in making an investment or voting decision.
…
VI.A.1. Sustainability-related information could be considered material if it can reasonably be
expected to influence an investor’s assessment of a company’s value, investment or
voting decisions.
…
VI.A.2. Sustainability-related disclosure frameworks should be consistent with high quality, under-
standable, enforceable and internationally recognised standards that facilitate the compara-
bility of sustainability-related disclosure across companies and markets.
…
VI.A.3. Disclosure of sustainability matters, financial reporting and other corporate information
should be connected.
…
VI.A.4. If a company publicly sets a sustainability-related goal or target, the disclosure framework
should provide that reliable metrics are regularly disclosed in an easily accessible form to
allow investors to assess the credibility and progress towards meeting the announced goal
or target.
…
VI.A.5. Phasing in of requirements should be considered for annual assurance attestations by an
independent, competent and qualified attestation service provider in accordance with high
quality internationally recognised assurance standards in order to provide an external and
objective assessment of a company’s sustainability-related disclosure.
…
VI.B. Corporate governance frameworks should allow for dialogue between a company, its shareholders
and stakeholders to exchange views on sustainability matters as relevant for the company’s business
strategy and its assessment of what matters ought to be considered material.
…
VI.B.1. When corporate governance frameworks allow for existing companies to adopt corporate
forms that incorporate both for-profit and public benefit objectives, such frameworks should
provide for due consideration of dissenting shareholder rights.
…
VI.C. The corporate governance framework should ensure that boards adequately consider material
sustainability risks and opportunities when fulfilling their key functions in reviewing, monitoring and
guiding governance practices, disclosure, strategy, risk management and internal control systems,
including with respect to climate-related physical and transition risks.
…
VI.C.1. Boards should ensure that companies’ lobbying activities are coherent with their
sustainability-related goals and targets.
…
VI.C.2. Boards should assess whether the company’s capital structure is compatible with its
strategic goals and its associated risk appetite to ensure it is resilient to different scenarios.
…
VI.D. The corporate governance framework should consider the rights, roles and interests of stakeholders
and encourage active co-operation between companies, shareholders and stakeholders in creating
value, quality jobs, and sustainable and resilient companies.
…
VI.D.1. The rights of stakeholders that are established by law or through mutual agreements are to
be respected.
…
VI.D.2. Where stakeholder interests are protected by law, stakeholders should have the opportunity
to obtain effective redress for violation of their rights at a reasonable cost and without
excessive delay.
…
VI.D.3. Mechanisms for employee participation should be permitted to develop.
…
VI.D.4. Where stakeholders participate in the corporate governance process, they should have
access to relevant, sufficient and reliable information on a timely and regular basis.
…

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184 Ethics and Governance

 VI.D.5. Stakeholders, including individual workers and their representative bodies, should be able
to freely communicate their concerns about illegal or unethical practices to the board and/or
to the competent public authorities, and their rights should not be compromised for doing
this.
…
VI.D.6. The exercise of the rights of bondholders of publicly traded companies should be facilitated.
…
VI.D.7. The corporate governance framework should be complemented by an effective and efficient
insolvency framework and by effective enforcement of creditor rights. (OECD 2023a,
pp. 38–45)

This final principle is a new focus for the OECD in terms of corporate governance. It encourages a
holistic, data-based, transparent and integrated approach to corporate sustainability and resilience. Both
extant and emergent risks and opportunities should be managed, and publicly stated targets need to be
substantiated. Interestingly, the principle allows for the possibility of public benefit objectives, although
dissenting voices must be considered.

QUESTION 3.16

Refer back to Principle II and discuss the potential for conflict between sub-principles II.A.4
and II.G.

QUESTION 3.17

Evaluate the following case study using the OECD Principles.

Sweet Dreams Ltd is a technology company that is developing natural organic sleeping pills for
people who have trouble sleeping. The company has been listed for one year and has:
• established a board of directors made up of executive and non-executive directors. The two
non-executive directors include a major potential customer who works closely with the company,
and a major shareholder who has asked for a board position to monitor their investment closely
• required shareholders who purchased shares in the initial public offering to purchase and hold
shares for at least two years — the explanation for this requirement is that the company wants
to ensure a stable position on the stock market while it establishes itself in the marketplace
• stated in their prospectus that they expected to be carbon neutral by 2030 but in their first year,
to save costs, will not be providing a sustainability report.
Outline three actions in the case study that create issues in relation to the OECD Principles.

3.10 THE UK CORPORATE GOVERNANCE CODE

The UK Corporate Governance Code, which was amended in 2018, demonstrates the way that governance
has developed in most jurisdictions using the Anglo-American model. Under this model, company law
developed in conjunction with common law principles. The first modern joint stock companies (i.e. with
shares) were formed in the 1860s under the very simple Companies Acts. Inevitable gaps in the law were
filled by the courts as litigation on particular issues arose.
The principles in the UK FRC Code follow in the tradition of guidance that is not legislated but its
authority is persuasive because they are generally accepted as the guidance companies should follow when
considering board appointments, structure of committees, risk management and remuneration matters
amongst others.
The Code has a series of changes that were introduced in 2018 and these include the following.
• Workforce and stakeholders. There is a new provision to enable greater board engagement with the
workforce to understand their views. The Code asks boards to describe how they have considered the
interests of stakeholders when performing their duty under Section 172 of the 2006 Companies Act.
• Culture. Boards are asked to create a culture that aligns company values with strategy and to assess how
they preserve value over the long-term.

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MODULE 3 Governance Concepts 185

• Succession and diversity. To ensure that the boards have the right mix of skills and experience,
constructive challenge and promote diversity, the new Code emphasises the need to refresh boards
and undertake succession planning. Boards should consider the length of term that chairs remain in
post beyond nine years. The new Code strengthens the role of the nomination committee on succession
planning and establishing a diverse board. It identifies the importance of external board evaluation for
all companies. Nomination committee reports should include details of the contact the external board
evaluator has had with the board and individual directors.
• Remuneration. To address public concern over executive remuneration, the new Code emphasises that
remuneration committees should take into account workforce remuneration and related policies when
setting director remuneration. Importantly formulaic calculations of performance-related pay should be
rejected. Remuneration committees should apply discretion when the resulting outcome is not justified.
The changes were added to reflect more-contemporary perspectives on issues such as diversity on boards
and other issues. Example 3.10 is a letter from the UK FRC chairman, outlining the changes made with
the introduction of the 2018 version of The UK Corporate Governance Code.

EXAMPLE 3.10

Letter to Company Chairs

Letter to Company Chairmen from Sir Winfried Bischoff, the UK FRC Chairman
July 2018
Dear Company Chair
The FRC has published the new 2018 UK Corporate Governance Code. This is a result of a substantial
outreach and consultation and we thank respondents for their contributions.
Over 26 years the Code has improved standards of practice and reporting on governance. The UK has
a strong reputation in this field of which we should be proud. But this reputation is tarnished when we
see corporate collapses accompanied by poor governance and conduct. Such events harm public trust
in business and deter investment.
The 2018 Code has substantially evolved and builds on the progress we have made to improve the
quality of governance in the UK. There are significant changes to its structure and content. It is shorter
and sharper, there is a renewed emphasis on the Principles and there are fewer Provisions. The new Code
takes a broader view of governance and emphasises the importance of a healthy corporate culture and
constructive relations with a wider range of stakeholders in delivering long-term sustainable success.
By reporting on the application of the Principles in a manner that can be evaluated, companies should
demonstrate how the governance of the company contributes to its long-term sustainable success and
achieves wider objectives. This statement should cover the application of the Principles in the context
of the particular circumstances of the company, how the board has set the company’s purpose and
strategy, met objectives and achieved outcomes through its decisions. High-quality reporting will include
signposting and cross-referencing to other relevant parts of the annual report.
The effective application of the Principles should be supported by high-quality reporting on the more
detailed Provisions. Companies should avoid a tick-box approach. An alternative to complying with
a Provision may be justified in particular circumstances. Explanations are a positive opportunity to
communicate, not onerous obligation. These should set out the background and provide a clear rationale
for the action the company is taking.
We are writing to other parties involved in making the Code a success. Before it comes into force, we
will be working with stakeholders to embed the Code and enable the improvements in governance we
all wish to see. After the introduction of the 2018 Code we intend to escalate our monitoring of practice
and reporting.
The FRC’s mission is to promote transparency and integrity in business. We look forward to continuing to
work with you so that we can ensure a strong flow of investment into successful UK companies, delivering
long-term growth which supports a prosperous economy and society.
Source: Bischoff, W 2018, ‘Open letter to company chairs from Sir Winfried Bischoff’, UK FRC, July 2018, accessed
August 2023, www.frc.org.uk/getattachment/d067c1e6-6890-4a67-8160-4de53fa2dfda/Open-letter-from-Sir-Win-to-
company-chairs-about-2018-Code-July-2018.pdf.
............................................................................................................................................................................
CONSIDER THIS
Read the letter above and identify the approach that the UK FRC chairman says companies must avoid when
drafting disclosures meant for users of their annual reports and other statements.

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186 Ethics and Governance

 Study the components from the UK FRC Code outlined in Appendix 3.1 and answer questions 3.18
and 3.19.

QUESTION 3.18

Under The UK Corporate Governance Code:

(a) who is responsible for reviewing a company’s internal controls?
(b) how often should a board undertake a formal evaluation of its own performance?
(c) outline whether a chief executive may also be the chair. Suggest reasons why the UK FRC Code
has taken this view.

QUESTION 3.19

Review the following scenario.

A large listed company has a board of directors with seven members.
• The chair is a non-executive director who holds a 25 per cent shareholding in the company.
• Four of the members are executive directors including the CEO and the CFO.
• The board has one subcommittee — an audit committee with three members. This includes the
chair, an independent director and the CFO, who is able to provide specific information about
the company.
Outline areas where this structure does not comply with components of the UK FRC Code that
are outlined in Appendix 3.1.

3.11 ASX CORPORATE GOVERNANCE COUNCIL’S

CORPORATE GOVERNANCE PRINCIPLES AND
RECOMMENDATIONS
The fourth edition of the ASX Principles is effective from 1 January 2020 (ASX CGC 2019). One important
change in the more recent versions of these recommendations relates to gender balance on the board
of directors. Another change in later versions compared to the earlier versions relates to membership
recommendations for the remuneration committee — and these are linked to mandatory requirements of
new ASX Listing Rules, which apply to certain larger companies.
There are eight broad principles, which are supported by 35 main recommendations and three additional
recommendations. The eight principles are:
1. Lay solid foundations for management and oversight: A listed entity should clearly delineate the respec-
tive roles and responsibilities of its board and management and regularly review their performance.
2. Structure the board to be effective and add value: The board of a listed entity should be of an appropriate
size and collectively have the skills, commitment and knowledge of the entity and the industry in which
it operates, to enable it to discharge its duties effectively and to add value.
3. Instil a culture of acting lawfully, ethically and responsibly: A listed entity should instil and continually
reinforce a culture across the organisation of acting lawfully, ethically and responsibly.
4. Safeguard the integrity of corporate reports: A listed entity should have appropriate processes to verify
the integrity of its corporate reports.
5. Make timely and balanced disclosure: A listed entity should make timely and balanced disclosure of
all matters concerning it that a reasonable person would expect to have a material effect on the price or
value of its securities.
6. Respect the rights of security holders: A listed entity should provide its security holders with appropriate
information and facilities to allow them to exercise their rights as security holders effectively.
7. Recognise and manage risk: A listed entity should establish a sound risk management framework and
periodically review the effectiveness of that framework.
8. Remunerate fairly and responsibly: A listed entity should pay director remuneration sufficient to attract
and retain high quality directors and design its executive remuneration to attract, retain and motivate
high quality senior executives and to align their interests with the creation of value for security holders
and with the entity’s values and risk appetite (ASX CGC 2019).
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MODULE 3 Governance Concepts 187

 These specific principles often need to be applied to particular sets of case facts, so a thorough
understanding of them is required. These principles are recommended for implementation in specific
ways — just as was the case in the UK — although the Australian principles are a little different as are
the Australian implementation recommendations. Further discussion of each of the core principles and
recommendations of the ASX Principles follows.

UNDERSTANDING THE ASX PRINCIPLES

A literal approach to applying the recommendations of the ASX Principles is not appropriate. Even where
detailed guidance is given, the spirit of the ASX Principles remains vital. This means that compliance with
a detailed guidance item is meaningless if it is accompanied by other actions that ignore the spirit of good
governance. This framework approach is consistent with the OECD approach and the thrust of the UK
FRC Code as applied both in its UK context and its international context.
In fact, all ASX Principles apply on the ‘if not, why not’ approach. This concept is similar to the ‘comply
or explain’ approach in the UK FRC Code. It operates so that non-compliance is generally permitted as
long as this non-compliance is identified and explained in the company’s corporate governance statement,
which is disclosed in its annual report or on its website.

QUESTION 3.20

Choose a company that is listed on the ASX and review its disclosures on corporate governance
as you read through the principles and recommendations. Track the company’s disclosures in their
corporate governance statement and note where it complies with the corporate governance rules
and where you believe they fall short. The purpose of this exercise is to observe how a listed
company implements the principles and recommendations.

THE ASX PRINCIPLES AND RECOMMENDATIONS

Principle 1 — Lay Solid Foundations for Management and Oversight
(ASX CGC 2019, pp. 6–11)
A listed entity should clearly delineate the respective roles and responsibilities of its board and management
and regularly review their performance
Recommendation 1.1
A listed entity should have and disclose a board charter setting out:
(a) the respective roles and responsibilities of its board and management; and
(b) those matters expressly reserved to the board and those delegated to management.
…
Recommendation 1.2
A listed entity should:
(a) undertake appropriate checks before appointing a director or senior executive or putting someone
forward for election as a director; and
(b) provide security holders with all material information in its possession relevant to a decision on whether
or not to elect or re-elect a director.
…
Recommendation 1.3
A listed entity should have a written agreement with each director and senior executive setting out the terms
of their appointment.
…
Recommendation 1.4
The company secretary of a listed entity should be accountable directly to the board, through the chair, on
all matters to do with the proper functioning of the board.
…
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188 Ethics and Governance

 Recommendation 1.5
A listed entity should:
(a) have and disclose a diversity policy;
(b) through its board or a committee of the board set measurable objectives for achieving gender diversity
in the composition of its board, senior executives and workforce generally; and
(c) disclose in relation to each reporting period:
(1) the measurable objectives set for that period to achieve gender diversity;
(2) the entity’s progress towards achieving those objectives; and
(3) either:
(A) the respective proportions of men and women on the board, in senior executive positions and
across the whole workforce (including how the entity has defined “senior executive” for these
purposes); or
(B) if the entity is a “relevant employer” under the Workplace Gender Equality Act, the entity’s
most recent “Gender Equality Indicators”, as defined in and published under that Act.
If the entity was in the S&P/ASX 300 Index at the commencement of the reporting period, the measurable
objective for achieving gender diversity in the composition of its board should be to have not less than 30%
of its directors of each gender within a specified period.
…
Recommendation 1.6
A listed entity should:
(a) have and disclose a process for periodically evaluating the performance of the board, its committees
and individual directors; and
(b) disclose for each reporting period whether a performance evaluation has been undertaken in accordance
with that process during or in respect of that period.
…
Recommendation 1.7
A listed entity should:
(a) have and disclose a process for evaluating the performance of its senior executives at least once every
reporting period; and
(b) disclose for each reporting period whether a performance evaluation has been undertaken in accordance
with that process during or in respect of that period.

In relation to Recommendation 1.6, the Governance Institute of Australia has published a Good Gov-
ernance Guide: Issues to consider in board evaluations. This is available at: www.asx.com.au/documents/
asx-compliance/issues-to-consider-in-board-evaluations.pdf.

Principle 2 — Structure the Board to be Effective and Add Value

(ASX CGC 2019, pp. 12–15)
A listed entity should have a board of an appropriate size, composition, skills and commitment to enable it
to discharge its duties effectively.
Recommendation 2.1
The board of a listed entity should:
(a) have a nomination committee which:
(1) has at least three members, a majority of whom are independent directors; and
(2) is chaired by an independent director, and disclose:
(3) the charter of the committee;
(4) the members of the committee; and
(5) as at the end of each reporting period, the number of times the committee met throughout the period
and the individual attendances of the members at those meetings; or
(b) if it does not have a nomination committee, disclose that fact and the processes it employs to address
board succession issues and to ensure that the board has the appropriate balance of skills, knowl-
edge, experience, independence and diversity to enable it to discharge its duties and responsibilities
effectively.
…
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MODULE 3 Governance Concepts 189

 Recommendation 2.2
A listed entity should have and disclose a board skills matrix setting out the mix of skills that the board
currently has or is looking to achieve in its membership.
…
Recommendation 2.3
A listed entity should disclose:
(a) the names of the directors considered by the board to be independent directors;
(b) if a director has an interest, position or relationship of the type described in Box 2.3 but the board is
of the opinion that it does not compromise the independence of the director, the nature of the interest,
position or relationship in question and an explanation of why the board is of that opinion; and
(c) the length of service of each director.
…
Recommendation 2.4
A majority of the board of a listed entity should be independent directors.
…
Recommendation 2.5
The chair of the board of a listed entity should be an independent director and, in particular, should not be
the same person as the CEO of the entity.
…
Recommendation 2.6
A listed entity should have a program for inducting new directors and for periodically reviewing whether
there is a need for existing directors to undertake professional development to maintain the skills and
knowledge needed to perform their role as directors effectively.

In relation to Recommendation 2.2, the Governance Institute of Australia has published a Good
Governance Guide: Creating and disclosing a board skills matrix. This is available at: www.asx.com.au/
documents/asx-compliance/creating-disclosing-board-skills-matrix.pdf.
The recommendations of the ASX Corporate Governance Council are expanded on and supplemented
by materials published by other organisations. These organisations include:
• Governance Council of Australia, www.governanceinstitute.com.au
• Australian Institute of Company Directors (AICD), www.aicd.com.au
Boxes highlighting specific issues are also provided among the recommendations and principles.
For example, figure 3.6 shows Box 2.3, which was referred to in an earlier question and is linked to
Recommendation 2.3.

FIGURE 3.6 Box 2.3: Factors relevant to assessing the independence of a director

Examples of interests, positions, associations and relationships that might cause doubts about the
independence of a director include if the director:
• is, or has been, employed in an executive capacity by the entity or any of its child entities and there has
not been a period of at least three years between ceasing such employment and serving on the board;
• is, or has within the last three years been, a partner, director or senior employee of a provider of material
professional services to the entity or any of its child entities;
• is, or has been within the last three years, in a material business relationship (e.g. as a supplier or
customer) with the entity or any of its child entities, or an officer of, or otherwise associated with,
someone with such a relationship;
• is a substantial security holder of the entity or an officer of, or otherwise associated with, a substantial
security holder of the entity;
• has a material contractual relationship with the entity or its child entities other than as a director;
• has close family ties with any person who falls within any of the categories described above; or
• has been a director of the entity for such a period that his or her independence may have been
compromised.

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190 Ethics and Governance

 In each case, the materiality of the interest, position, association or relationship needs to be assessed to
determine whether it might interfere, or might reasonably be seen to interfere, with the director’s capacity
to bring an independent judgement to bear on issues before the board and to act in the best interests of
the entity and its security holders generally.
Source: ASX CGC 2019, Corporate governance principles and recommendations, 4th edn, p. 14, accessed August 2023,
www.asx.com.au/documents/asx-compliance/cgc-principles-and-recommendations-fourth-edn.pdf. © Copyright 2019 ASX
Corporate Governance Council.

One way to enhance company behaviour is to create formal codes of conduct. If these are carefully
considered and well-constructed, they will provide a far stronger basis for the implementation of good
business ethics. From that point of view, it will be necessary to ensure all staff are trained appropriately
in the ethical code of business conduct and then to ensure that the code is maintained and developed as
necessary according to business and environment changes.

Principle 3 — Instil a Culture of Acting Lawfully, Ethically and Responsibly

(ASX CGC 2019, pp. 16–18)
A listed entity should instil and continually reinforce a culture across the organisation of acting lawfully,
ethically and responsibly.
Recommendation 3.1
A listed entity should articulate and disclose its values.
…
Recommendation 3.2
A listed entity should:
(a) have and disclose a code of conduct for its directors, senior executives and employees; and
(b) ensure that the board or a committee of the board is informed of any material breaches of that code.
…
Recommendation 3.3
A listed entity should:
(a) have and disclose a whistleblower policy; and
(b) ensure that the board or a committee of the board is informed of any material incidents reported under
that policy.
…
Recommendation 3.4
A listed entity should:
(a) have and disclose an anti-bribery and corruption policy; and
(b) ensure that the board or a committee of the board is informed of any material breaches of that policy.

.......................................................................................................................................................................................
CONSIDER THIS
Refer to the ASX Principles (www.asx.com.au/documents/regulation/cgc-principles-and-recommendations-fourth
-edn.pdf). If the organisation that you work for is a listed company, compare your company’s whistleblower policy
with the ASX’s suggestions in Box 3.3.

Principle 4 — Safeguard the Integrity of Corporate Reports

(ASX CGC 2019, pp. 19–20)
A listed entity should have formal and rigorous processes that independently verify and safeguard the
integrity of its corporate reporting.
Recommendation 4.1
The board of a listed entity should:
(a) have an audit committee which:
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MODULE 3 Governance Concepts 191

 (1) has at least three members, all of whom are nonexecutive directors and a majority of whom are
independent directors; and
(2) is chaired by an independent director, who is not the chair of the board, and disclose:
(3) the charter of the committee;
(4) the relevant qualifications and experience of the members of the committee; and
(5) in relation to each reporting period, the number of times the committee met throughout the period
and the individual attendances of the members at those meetings; or
(b) if it does not have an audit committee, disclose that fact and the processes it employs that independently
verify and safeguard the integrity of its corporate reporting, including the processes for the appointment
and removal of the external auditor and the rotation of the audit engagement partner.
…
Recommendation 4.2
The board of a listed entity should, before it approves the entity’s financial statements for a financial
period, receive from its CEO and CFO a declaration that, in their opinion, the financial records of the entity
have been properly maintained and that the financial statements comply with the appropriate accounting
standards and give a true and fair view of the financial position and performance of the entity and that the
opinion has been formed on the basis of a sound system of risk management and internal control which is
operating effectively.
…
Recommendation 4.3
A listed entity should disclose its process to verify the integrity of any periodic corporate report it releases
to the market that is not audited or reviewed by an external auditor. A periodic corporate report includes
an entity’s annual directors’ report, annual and half yearly financial statements, quarterly activity report,
quarterly cash flow report, integrated report, sustainability report, or similar periodic report prepared for
the benefit of investors.

Under the ASX Listing Rules, audit committees are compulsory for all companies listed in the top 500
(Standard & Poor’s listing of the ASX) according to market capitalisation (i.e. total market value of the
shares). The Sarbanes–Oxley Act and the UK FRC Code both require at least one financial person on the
board. The ASX’s Recommendation 4.1 states:
The audit committee should be of sufficient size and independence, and its members between them should
have the accounting and financial expertise and a sufficient understanding of the industry in which the
entity operates, to be able to discharge the committee’s mandate effectively.

Arguably, it would be a poor board structure that did not select people with appropriate skills. One of
the greatest failures a true professional can make is to accept duties that are not within their capabilities.
It is strongly arguable that a director who, without appropriate skills, takes a place on an audit committee
would be making a negligent business judgment. Negligent business judgments can result in significant
legal difficulties for a director (and perhaps for the entire board) who act in this way.
Another feature of the Sarbanes–Oxley requirements that contrasts with the ASX Principles is that all
members of the audit committee must be independent at all times according to strict criteria. Furthermore,
Sarbanes–Oxley mandates that the primary external auditor relationship must be with the audit committee.
Note that these specific legislative requirements are not part of the framework in Australia or the UK.

Principle 5 — Make Timely and Balanced Disclosure

(ASX CGC 2019, pp. 21–22)
A listed entity should make timely and balanced disclosure of all matters concerning it that a reasonable
person would expect to have a material effect on the price or value of its securities.
Recommendation 5.1
A listed entity should have and disclose a written policy for complying with its continuous disclosure
obligations under listing rule 3.1.
…

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192 Ethics and Governance

 Recommendation 5.2
A listed entity should ensure that its board receives copies of all material market announcements promptly
after they have been made.
…
Recommendation 5.3
A listed entity that gives a new and substantive investor or analyst presentation should release a copy of the
presentation materials on the ASX Market Announcements Platform ahead of the presentation.

Principle 6 — Respect the Rights of Security Holders

(ASX CGC 2019, pp. 23–25)
A listed entity should provide its security holders with appropriate information and facilities to allow them
to exercise their rights as security holders effectively.
Recommendation 6.1
A listed entity should provide information about itself and its governance to investors via its website.
…
Recommendation 6.2
A listed entity should have an investor relations program that facilitates effective two-way communication
with investors.
…
Recommendation 6.3
A listed entity should disclose how it facilitates and encourages participation at meetings of security holders.
…
Recommendation 6.4
A listed entity should ensure that all substantive resolutions at a meeting of security holders are decided by
a poll rather than by a show of hands.
…
Recommendation 6.5
A listed entity should give security holders the option to receive communications from, and send
communications to, the entity and its security registry electronically.

Principle 7 — Recognise and Manage Risk (ASX CGC 2019, pp. 26–28)
A listed entity should establish a sound risk management framework and periodically review the effective-
ness of that framework.
Recommendation 7.1
The board of a listed entity should:
(a) have a committee or committees to oversee risk, each of which:
(1) has at least three members, a majority of whom are independent directors; and
(2) is chaired by an independent director, and disclose:
(3) the charter of the committee;
(4) the members of the committee; and
(5) as at the end of each reporting period, the number of times the committee met throughout the period
and the individual attendances of the members at those meetings; or
(b) if it does not have a risk committee or committees that satisfy (a) above, disclose that fact and the
processes it employs for overseeing the entity’s risk management framework.
…

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MODULE 3 Governance Concepts 193

 Recommendation 7.2
The board or a committee of the board should:
(a) review the entity’s risk management framework at least annually to satisfy itself that it continues to be
sound and that the entity is operating with due regard to the risk appetite set by the board; and
(b) disclose, in relation to each reporting period, whether such a review has taken place.
…
Recommendation 7.3
A listed entity should disclose:
(a) if it has an internal audit function, how the function is structured and what role it performs; or
(b) if it does not have an internal audit function, that fact and the processes it employs for evaluating
and continually improving the effectiveness of its governance, risk management and internal control
processes.
…
Recommendation 7.4
A listed entity should disclose whether it has any material exposure to environmental or social risks and, if
it does, how it manages or intends to manage those risks.

Principle 8 — Remunerate Fairly and Responsibly

(ASX CGC 2019, pp. 29–30)
A listed entity should pay director remuneration sufficient to attract and retain high quality directors and
design its executive remuneration to attract, retain and motivate high quality senior executives and to align
their interests with the creation of value for security holders and with the entity’s values and risk appetite.
Recommendation 8.1
The board of a listed entity should:
(a) have a remuneration committee which:
(1) has at least three members, a majority of whom are independent directors; and
(2) is chaired by an independent director, and disclose:
(3) the charter of the committee;
(4) the members of the committee; and
(5) as at the end of each reporting period, the number of times the committee met throughout the period
and the individual attendances of the members at those meetings; or
(b) if it does not have a remuneration committee, disclose that fact and the processes it employs for setting
the level and composition of remuneration for directors and senior executives and ensuring that such
remuneration is appropriate and not excessive.
…
Recommendation 8.2
A listed entity should separately disclose its policies and practices regarding the remuneration of non-
executive directors and the remuneration of executive directors and other senior executives.
…
Recommendation 8.3
A listed entity which has an equity-based remuneration scheme should:
(a) have a policy on whether participants are permitted to enter into transactions (whether through the use
of derivatives or otherwise) which limit the economic risk of participating in the scheme; and
(b) disclose that policy or a summary of it.

Additional Recommendations
In addition to the recommendations associated with Principles 1–8, there are a number of additional
recommendations that apply only in certain cases (ASX CGC 2019, p. 32).

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194 Ethics and Governance

 Recommendation 9.1
A listed entity with a director who does not speak the language in which board or security holder meetings
are held or key corporate documents are written should disclose the processes it has in place to ensure
the director understands and can contribute to the discussions at those meetings and understands and can
discharge their obligations in relation to those documents.
…
Recommendation 9.2
A listed entity established outside Australia should ensure that meetings of security holders are held at a
reasonable place and time.
…
Recommendation 9.3
A listed entity established outside Australia, and an externally managed listed entity that has an AGM,
should ensure that its external auditor attends its AGM and is available to answer questions from security
holders relevant to the audit.
.......................................................................................................................................................................................
CONSIDER THIS
Consider what you have noted throughout the financial statements in the company that you chose to examine in
question 3.20. What would you ask them to expand, remove or change as a result of your assessment of the quality
of their disclosure?

SUMMARY
Over time, corporate governance guidance has been refined. Specifically, the OECD Principles have been
used as the basis for codes of corporate governance developed in the UK and Australia.
These codes and the disclosures they recommend serve as benchmarks and information sources for
stakeholders seeking to evaluate the robustness of a company’s corporate governance standards.
The European and ASX codes are principles-based rather than rules-based. They require entities to
provide an explanation if particular provisions of best practice governance guidance are not followed.
The key points covered in this part, and the learning objective they align to, are as follows.

KEY POINTS

3.9 Interpret and apply codes and principles of corporate governance.

• The OECD has developed a set of principles that governments and other regulators may use as
the basis of development for their own corporate governance codes. The OECD Principles are
considered best practice.
• Various jurisdictions develop their own best practice documents that provide corporate governance
guidance to companies and their office bearers.
• The UK has a governance code issued by its FRC. This code is also regarded as international
best practice.
• The ASX Principles provide guidance to Australian companies.
• All codes and guidance on corporate governance can be used by external stakeholders as
a benchmark by which to measure a company’s performance against corporate governance
best practice.

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MODULE 3 Governance Concepts 195

PART E: NON-CORPORATES
AND GOVERNANCE
INTRODUCTION
This module began with an introduction to the corporate form and has presented a discussion of corporate
governance mainly applicable to large publicly listed corporations. Such corporations are often among
the most influential economic entities in any country, but considerable economic and other activity is
conducted by other forms of business, including family-owned businesses, SMEs, and organisations in the
NFP and public sectors. It is important to note that the same general concepts of governance apply to these
other types of organisations, including privately held corporations and public sector entities. There are,
however, a number of special considerations.
In this final part of the module, we will consider governance in:
• family-owned businesses, and
• NFP organisations
• the public sector.

3.12 FAMILY-OWNED BUSINESSES, AND SMALL-

AND MEDIUM-SIZED ENTERPRISES
So far, corporate governance as a mechanism for reducing agency costs has been discussed. However,
this point needs some clarification with regard to SMEs. The agency problem essentially arises from the
separation of management and the owners of an organisation. However, in many small companies with
an owner/manager or with family or minor shareholding, this separation does not exist. Therefore, it is
necessary to examine what corporate governance issues there are for these companies and the extent to
which improvements in corporate governance are useful.
SMEs are often family-owned. Corporate governance for family-owned firms has been the focus of the
paper by Sir Adrian Cadbury, author of the Cadbury Report, which was the forerunner for the Combined
Code on Corporate Governance. The paper, ‘Family firms and their governance: Creating tomorrow’s
company from today’s’ (Cadbury 2000), states that family-owned firms comprise 75 per cent of registered
companies in the UK and 95 per cent of companies in some economies.
Distinctive features of family firms were identified by Cadbury (2000). These included a longer-term
perspective with a focus on building the firm to be passed onto future generations, often combined with a
culture based on the unique values of a founder. Conflict between family members poses significant risk,
as does the problem of successful growth. While this might seem unusual, a major issue occurs when the
business grows successfully, beyond the ability of family members to manage it effectively. This often
leads to the need for external professional support and this transition can be very difficult. Moving to more
formal methods of decision making and control can be troublesome, and many companies do not make the
transition successfully.
To combat these issues, Cadbury recommended that a family council be used to structure family
engagement and that a board of directors should be established. The inclusion of outside directors
would benefit the company through the introduction of new ideas and a broad range of experience. The
establishment of a board would reorient the firm from being based on family relationships to being based on
business relationships.
There are several concerns for small companies, and a key issue is the level and cost of compliance.
The need to conform to the recommended audit committee, which requires a minimum number of three
directors, one of whom is to have financial expertise, may be impractical for a small, closely held company.
However, the involvement of the company’s external accountants can overcome some of the resource
limitations in ensuring good corporate governance, particularly with regard to risk management, the
introduction and management of internal controls, and the adequacy of financial reporting.
.......................................................................................................................................................................................
CONSIDER THIS
Read the article on the IFAC website (www.ifac.org/global-knowledge-gateway/governance/discussion/governance-
all-including-smes) and take note of the four benefits the author says are derived by good governance in small
businesses.
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196 Ethics and Governance

3.13 NOT-FOR-PROFIT ORGANISATIONS
Good corporate governance is equally essential for entities that do not have a profit motive as their
main objective.
NFP organisations fall within two categories:
• charities
• other NFP organisations that are not charities — for example, most sporting and recreational clubs,
community service organisations, professional and business associations and social organisations.
Depending on the type of NFP organisation, different tax concessions are available. If an organisation
has deductible gift recipient (DGR) status, donors to that organisation can claim a tax deduction.
NFPs often focus on social issues and aim to achieve a great deal with very few resources, and, therefore,
these resources must be utilised even more carefully than in a commercial organisation.
NFPs may be organised in a number of different forms, including foundations, trusts, associations and
special types of companies (e.g. in Australia, a public company limited by guarantee). Furthermore, they
can represent such diverse sectors of the community as:
• the provision of social services (e.g. Red Cross)
• arts and entertainment sectors (e.g. Sydney Symphony Orchestra)
• sports and leisure sectors (e.g. International Olympic Committee).
Unlike profit-oriented entities, NFPs are accountable principally to stakeholders rather than
shareholders. These stakeholders can include the founder of the organisation, its clients, employees,
volunteers and sponsoring partners, including individuals, corporations and government.
Despite the different corporate governance goals between profit-oriented and NFPs, there are many
similarities in their objectives and principles. For example:
• Similar responsibilities exist to maintain solvency within their available funding.
• A similar focus is required on strategy, performance, accountability and stewardship.
• Larger NFPs will have committee structures similar to their for-profit counterparts.
• Although the directors may act in an honorary (unpaid) capacity or receive minimal director compen-
sation, the same director’s liability may exist as that expected in a for-profit company.
In addition to this, an NFP organisation that is structured as a company limited by guarantee (or other)
must comply with appropriate provisions of the Corporations Act.
Guidance for NFPs is available from a variety of sources, including:
• ACNC, www.acnc.gov.au
• AICD, www.aicd.com.au/tools-and-resources/nfp-resource-centre.html
• ASIC, https://asic.gov.au/for-business/running-a-company/charities-registered-with-the-acnc
• Australian Indigenous Governance Institute, www.aigi.com.au
• Not for Profit Law, www.nfplaw.org.au
• Department of Education and Training (Victoria), www2.education.vic.gov.au/pal/school-council-
training/policy.
The first two of these will be addressed in this module.

ACNC GUIDANCE
ACNC guidance is specifically for charities and includes two sets of standards: one for charities operating
in Australian and one for charities operating overseas.
An organisation must meet the ACNC Governance Standards in order to be registered as a charity with
the ACNC. Once an organisation is registered as a charity, it must continue to comply with the standards
in order to retain its registration. The Governance Standards do not apply to ‘basic religious charities’.
(ACNC 2018a).

ACNC Governance Standards

The governance standards that apply to the Australian operations of a charity are as follows (ACNC 2018a).
Standard 1: Purposes and not-for-profit nature
A charity must be not-for-profit and work towards their charitable purpose. They must be able to
demonstrate this and provide information about their purposes to the public.

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 Standard 2: Accountability to members
A charity that has members must take reasonable steps to be accountable to its members and provide them
with adequate opportunity to raise concerns about how the charity is governed.
Standard 3: Compliance with Australian laws
A charity must not commit a serious offence (such as fraud) under any Australian law or breach a law that
may result in a penalty of 60 penalty units or more.
Standard 4: Suitability of Responsible People
A charity must take reasonable steps to:
• be satisfied that its Responsible People (such as board or committee members or trustees) are not
disqualified from managing a corporation under the Corporations Act 2001 (Cwlth) or disqualified from
being a Responsible Person of a registered charity by the ACNC Commissioner, and
• remove any Responsible Person who does not meet these requirements.
Standard 5: Duties of Responsible People
A charity must take reasonable steps to make sure that its Responsible People are subject to, understand,
and carry out the duties set out in Governance Standard 5. These duties include:
• to act with reasonable care and diligence
• to act honestly and fairly in the best interests of the charity and for its charitable purposes
• not to misuse their position or information they gain as a Responsible Person
• to disclose conflicts of interest
• to ensure that the financial affairs of the charity are managed responsibly, and
• not to allow the charity to operate while it is insolvent.
Standard 6: Maintaining and enhancing public trust and confidence in the Australian not-for-profit sector
A charity must take reasonable steps to become a participating non-government institution of the National
Redress Scheme if the charity is, or is likely to be, identified as being involved in the abuse of a person
either:
• in an application for redress made under section 19 of the National Redress Scheme for Institutional
Child Sexual Abuse Act 2018 (Cwlth) (Redress Act), or
• in information given in response to a request from the National Redress Scheme Operator (the Secretary
of the Department of Social Services) under section 24 or 25 of the Redress Act.

While many NFPs are effective in achieving their goals and facilitating positive social change, there have
been instances of poor governance. For example, in 2018, RSL Queensland was reported for governance
failures and an inability to meet record-keeping obligations, including not being able to account for how
$400 000 in charitable funds were spent (Hyam 2018).
It is critical that NFPs abide by governance standards, particularly as they are often recipients of
donations by individuals and are directly involved in communities.
.......................................................................................................................................................................................
CONSIDER THIS
Compare the list of duties in Standard 5 to the list of director duties earlier in the module.

External Conduct Standards

The international operations of charities are governed by the ACNC’s External Conduct standards, which
are summarised in the following extract (ACNC 2018b).
External Conduct Standard 1: Activities and control of resources
This standard covers the way a charity manages its activities overseas, how it is required to control the
finances and other resources it uses overseas and the requirement to comply with Australian laws.
External Conduct Standard 2: Annual review of overseas activities and record-keeping
This standard covers the requirements for a charity to obtain and keep sufficient records for its overseas
activities on a country-by-country basis.

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198 Ethics and Governance

 External Conduct Standard 3: Anti-fraud and anti-corruption
This standard covers the requirements for a charity to have processes and procedures that work to combat
fraud and corruption and identify and document any actual, potential or perceived conflicts of interests in
its overseas operations.
External Conduct Standard 4: Protection of vulnerable individuals
This standard covers the requirement for a charity to protect the vulnerable people that it works with when
conducting its overseas operations.

NFPs have different structures and the decision-making committee or board may have different names.
The notion of a responsible person, which is embedded in the ACNC’s standards and other materials, is
designed to capture all individuals that are responsible for the running of the entity subject to the ACNC’s
oversight. The term is similar to a phrase that occurs in auditing standards related to those in charge of
governance. It simply means the people who run the organisation.

AICD GUIDANCE
The AICD also provides governance principles for NFP entities. The most recent (January 2019) edition
contains 10 principles, and supporting practices and guidance for each principle. This is available at
www.aicd.com.au/content/dam/aicd/pdf/tools-resources/nfp-governance-principles/06911-4-ADV-NFP-
Governance-Principles-Report-A4-v11.pdf.
.......................................................................................................................................................................................
CONSIDER THIS
Compare the ASX Principles to the snapshot of the AICD’s Not-for-Profit Governance Principles (www.aicd.com.
au/content/dam/aicd/pdf/tools-resources/nfp-governance-principles/06911-5-ADV-NFP-Governance-Principles-
Summary-Report-A4-WEB.pdf), and consider whether there is anything in the latter that might be a useful addition
to the former.

Good corporate governance in NFP organisations, therefore, has many similarities to profit-orientated
entities and, as a result, many NFP organisations are voluntarily complying with the corporate governance
guidelines applicable to for-profit entities.

DIVERSITY IN THE NOT-FOR-PROFIT SECTOR

The extent of the diversity of the NFP sector is considerable as the sector covers many forms of social,
health, cultural, sporting and leisure pursuits. Within the sector are diverse organisations including
cooperatives, community businesses, credit unions, trading charities, housing associations and sports
clubs. These enterprises may take many different legal forms and can be registered as companies
limited by guarantee, charities or unincorporated non-profit organisations. The critical difference between
these enterprises and commercial enterprises is that the surpluses are reinvested for the purpose of the
organisations and not for the benefit of the employees or owners.
NFPs are usually autonomous organisations with independent governance and ownership structures, run
by and for the stakeholders of the organisation. They are accountable to the stakeholders and the wider
community and are dedicated to the provision of goods or services to this community.
As with commercial organisations, NFPs face governance dilemmas. The first is securing people with
the appropriate skills and experience to contribute to making the board an effective body for governing the
organisation. In this sector, board members are invariably volunteers, and few may possess professional
experience. Resources are usually in extremely short supply and the funds of the NFP have to be carefully
managed. The loss or misallocation of the funds of NFPs is a serious issue that can damage the work and
reputation of the organisation. However, many NFPs are exceptionally cost conscious and do a remarkable
job of conserving resources and applying them to best effect.
One particular governance problem experienced by NFPs is that if a paid manager is employed, they are
rarely given much freedom to manage since they are surrounded by committed volunteers who feel they
have a right to be involved in decision making. This calls for special qualities of consultation, deliberation
and engagement, which the NFPs are very experienced in. The great strength of NFPs is the vitality and
commitment of their members; however, this can also lead to instability in these organisations. Often, there
are not clear lines of succession, so if the original founders move on the future of the NFP sometimes
becomes doubtful. However, this process of continuous regeneration in relatively short life cycles is
common in NFPs as it is in other small businesses.
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MODULE 3 Governance Concepts 199

 Example 3.11 examines some of these issues in relation to the governance of a community childcare
centre.

EXAMPLE 3.11

Governance of a Childcare Centre

A group of young parents with pre-school children were tired of being unable to find adequate and
affordable childcare in their community, and set about establishing their own childcare centre. At first,
they attempted to do this informally, but realised that they required more formal structures to ensure the
safety of the children and the viability of the operation. They found suitable premises and hired a qualified
childcare worker and an assistant. Initially they met monthly, but realised they would require more formal
governance processes to sustain an effective operation.
They called for elections to the board and at the first meeting of the board, a chair was elected. Then they
discovered they had no-one on the board with financial skills and had to nominate someone to the board
to become the treasurer. They realised it would be advantageous to form a company limited by guarantee
for their dealings with the bank, other suppliers and their employees. After seeking legal advice, they
succeeded in registering their company, and as the popularity of the childcare centre grew, they realised
there was a future for the centre.
However, in the second year of operation some members of the board wanted to extend the hours of the
centre, and to introduce new facilities. The full-time manager of the centre was cautious about this initiative
and was concerned the centre might not be able to meet its obligations. Relations became strained and
the manager moved on to a larger childcare centre. After recruiting a replacement, the board realised they
would have to work more cooperatively with the manager of the centre, and that they could not simply
impose their will. Over time, the increasing experience and professionalisation of the board membership
and procedures meant it was easier for the manager to bring concerns to the board, confident that the
board would listen and contribute to resolving issues in a productive way. The maturing of the governance
of the childcare centre was allowing the provision of a more efficient and effective service.

3.14 PUBLIC SECTOR ENTERPRISES

In the past two decades, the extent of commercialisation and corporatisation of government businesses has
focused attention on corporate governance in the public sector. In the public sector, corporate governance
is also about how the government, boards and parliament relate to one another in stewardship matters.
Whereas companies focus mainly on shareholder returns, the public sector’s role is to implement
programs cost-effectively in accordance with government legislation and policies. There are also review
processes normally imposed by governments and their committees. The international association of
auditors-general (i.e. government auditors) is the International Organization of Supreme Audit Institutions
(INTOSAI). INTOSAI identifies the three Es — economy, efficiency and effectiveness — as the heart of
public sector governance.
Government agencies must satisfy a complex range of political, economic and social objectives, and
operate according to a different set of external constraints and influences compared to private or public
businesses. In addition, they are subject to the expectations of, and forms of accountability to, their various
stakeholders, who are more diverse and likely to be more contradictory in their demands than those of a
private sector company. Nevertheless, private sector approaches can be adapted to reflect the different
nature of public sector agencies, in particular their different statutory and managerial frameworks and
their wider and more complex accountabilities.
The fact that the public sector collects and redirects public monies for the greater social good is in itself
a reason to require good corporate governance. It could be said that failure to ensure that objectives and
accountabilities are met will be reflected in the electoral process, but with election time frames of three or
four years in most cases, that process is not timely in ensuring ongoing good governance.
According to Harris (1997), a former auditor-general of New South Wales in Australia, there are
important guiding principles that achieve more effective governance by boards in the public sector. In
addition to having clear and separate roles of ministers and boards, Harris also strongly recommends the
use of legislation to set out the roles, powers and responsibilities of the board and provide the board with
enough authority to perform its role.

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200 Ethics and Governance

 Uhrig (2003) noted a lack of effective governance for several statutory authorities due to a range
of factors, including unclear boundaries in their delegation, a lack of clarity in their relationships with
ministers and portfolio departments, and a lack of accountability in the exercise of their power (Uhrig 2003,
p. 5). To address these issues, he recommended several best practice approaches that are very similar to
recommended best practice for publicly listed companies. These included the use of committees to enhance
effectiveness, annual board reviews, appropriate experienced directors, and set terms to ensure a rotation
of directors. In addition to these items, he also suggested that representational appointments (e.g. specific
appointments to a board by a government minister) be limited.

QUESTION 3.21

How can the broad public service mission of public sector enterprises be focused and delivered
through better governance?

THE UNIQUENESS OF THE PUBLIC SECTOR

In earlier decades, the public sector gained a reputation for being poorly governed. Often public bodies
were subjected to the changing fortunes of governments and sometimes to the whims of their government
ministers. Lacking autonomy in centralised government systems, the senior management of public
organisations often simply looked to their political masters for guidance, and sometimes ignored the
interests of their clients — the general public — who were rendered relatively powerless compared to
market-based business systems.
However, a process of reform has taken place in the public sector just as dramatic and far reaching as in
the private sector, and often inspired by the transformation of private sector governance. For example, the
Uhrig Report on public sector governance argued:
There are benefits in looking to developments and lessons learnt in the private sector when considering
appropriate governance frameworks for the public sector. The environment in which the private sector
operates creates significant challenges for companies. The consequences of failure and threat of takeover
provide incentives for the private sector to constantly strive to improve governance practices. In dealing
with the challenges of the market, the private sector has gained considerable experience in applying the
core elements of governance (Uhrig 2003, p. 26).

As a result of the widespread reform movement in the public sector in Australia and in other countries,
public organisations now have much more responsive governance, including autonomous boards with
independent directors responsible for strategies to meet clients’ needs, and with authority to distribute
resources appropriately (within agreed parameters).
Yet the public sector remains different in values, objectives and methods compared to the private sector:
• The public sector produces ‘public values’, promotes equity, and protects the collective interests
(e.g. about the environment and international relations) as well as market ones.
• The public sector operates in a complex decision-making environment, usually manages many and
diverse stakeholder interests and often considers short, medium, and long range effects of decisions
(inter-generational equity is one example).
• The public sector’s effectiveness often relies on the co-operative, as opposed to the competitive,
participation of others. Competition has a dysfunctional effect if applied inappropriately in the public
sector: examples include service duplication, loss of scale economies, the dismantling of collaborative
institutional arrangements, and the focusing on marketing at the expense of service delivery.
• The public sector uses diverse resources to achieve its policy ends, involving not only public money but,
significantly, public power as well (Halligan & Horrigan 2005, p. 16).

In the previous analysis, whatever delegated powers the board of a public organisation are given, there
is an obligation to work broadly within the framework of government policy, and to engage with other
public agencies in the achievement of policy goals, rather than pursuing separate institutional policies. Yet
‘the conventional spectrum of bureaucratisation, commercialisation, corporatisation and privatisation of
government entities still leaves much room for a multiplicity of governance arrangements at both sectoral
and organisational levels’ (Edwards et al. 2012, p. 175).
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 Example 3.12 illustrates the governance dilemmas frequently encountered in the public sector: pursuing
a much wider and more vital public purpose; enjoying a degree of autonomy, which must be exercised
with extreme care; and being subject to the ultimate sanction of the government, even if this is rarely, if
ever, exercised.

EXAMPLE 3.12

Governance in the Public Sector

The Reserve Bank of Australia (RBA) is a body corporate charged by the Australian Government to ensure
‘that the monetary and banking policy of the Bank is directed to the greatest advantage of the people
of Australia’, and that its powers are directed towards contributing to ‘the stability of the currency of
Australia’ and the ‘maintenance of full employment’ and ‘the economic prosperity and welfare of the
people of Australia’ (s. 10(2), Reserve Bank Act 1959 (Cwlth)).
Clearly these are more substantive and demanding objectives than commercial banks face. The RBA
has two boards: the RBA board, which is responsible for monetary and banking responsibility, and the
Payment Systems Board, which is responsible for payment systems. Successive Australian governments
have emphasised the RBAs independence, yet the bank is connected to the government in a number
of ways. The board must keep the government informed of its monetary and banking policy, and if the
RBA and the federal Treasurer disagree on how well the policy is serving the Australian people, they must
strive to reach agreement. If they cannot reach agreement, the government has formal mechanisms at its
disposal to ensure its view prevails, but governments are very reluctant to ever exercise this power as not
only would it undermine the independence of the RBA, but it would also damage the government, and
possibly the Australian economy (Edwards et al. 2012, p. 187).

GUIDANCE FOR PUBLIC SECTOR GOVERNANCE

There are various sources available for public sector organisations. In 2015, the OECD published its
Guidelines on Corporate Governance of State-Owned Enterprises. This document is to be read in
conjunction with the OECD’s Corporate Governance Principles and is designed as:
recommendations to governments on how to ensure that SOEs [state-owned enterprises] operate efficiently,
transparently and in an accountable manner. They are the internationally agreed standard for how
governments should exercise the state ownership function to avoid the pitfalls of both passive ownership
and excessive state intervention (OECD 2015).

In 2019, the OECD released further guidance to support the state in fighting corruption and promoting
integrity in SOEs. The preface in the OECD’s Guidelines on Anti-Corruption and Integrity in State-Owned
Enterprises (2019) encapsulates the rationale for the guidance, the unique nature of the risks and the
reputational damage caused should corruption occur in the sector.
Research by the OECD and others shows that certain SOEs may be particularly exposed to corruption risk.
State ownership is concentrated in high-risk sectors, such as the extractive industries and infrastructure,
where public and private sectors intersect via valuable concessions and large public procurement projects.
Strong and responsible state ownership is essential to effectively mitigate these corruption risks. At the
same time, SOEs in many economies also continue to provide essential public services. The cost to the
public purse and the perverse effects of misallocated resources by corruption in SOEs can dangerously
undermine citizens’ trust in public institutions (OECD 2019, p. 3).

The guidance goes on to discuss many items that will be familiar in the private sector governance
context, including:
• hiring and remuneration that is transparent and based on merit, equity, aptitude and integrity
• avoiding conflicts of interest
• handling sensitive information to prevent insider trading
• procedures for reporting concerns about illegal or irregular practices
• a risk management system
• independent external audit based on internationally recognised standards
• independent board members.
It also contains guidance that is specific to the public sector context, including:
• public officials not becoming involved in the corporate governance of private sector companies
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202 Ethics and Governance

 • policies and procedures that prohibit use of SOEs as vehicles for financing political activities and for
making political campaign contributions
• expectations that SOEs adhere to laws related to lobbying — for example, declaring a meeting in the
appropriate registry.
.......................................................................................................................................................................................
CONSIDER THIS
Access the Implementation Guide: OECD Guidelines on Anti-Corruption and Integrity in State-Owned Enterprises
(www.oecd.org/corporate/ca/Implementation-Guide-ACI-Guidelines.pdf) and compare the infographic on page 8
(The pillars of the ‘ACI guidelines’) to figure 3.3.

Australian domestic corporate governance codes or frameworks that specify the kind of behaviour
that is expected of individuals involved in the public sector exist across all jurisdictions. Some of these
requirements are stipulated by the Australia Public Sector Commission (APSC) in a range of publications
on the commission’s website, but there are various publications issued by Commonwealth, state and
territory government departments that articulate what constitutes acceptable conduct when reflecting on
governance of public sector entities.
The APSC published a guide in 2007 called Building Better Governance that outlined a series of
governance principles. These principles are consistent with those you may find in other governance
contexts but are tailored for the government sector. It defines public sector governance as being ‘the
set of responsibilities and practices, policies and procedures, exercised by an agency’s executive, to
provide strategic direction, ensure objectives are achieved, manage risks and use resources responsibly
and with accountability’. The guide also lays down two key components of good governance in the public
sector. These components as stated in Building Better Governance, which were also reflected in guidance
produced by the Australian National Audit Office in 2003, are:
• performance — how an agency uses governance arrangements to contribute to its overall performance
and the delivery of goods, services or programmes, and
• conformance — how an agency uses governance arrangements to ensure it meets the requirements of
the law, regulations, published standards and community expectations of probity, accountability and
openness (APSC 2007, p. 1).

In other words, performance means how well agencies performance as measured against their various
programme or service requirements and conformance covers how a government agency fulfils the role of
the public sector equivalent of the good corporate citizen.
There are six principles articulated in the 2007 guidance document that set down the core values for
public sector employees. These are:
• accountability — being answerable for decisions and having meaningful mechanisms in place to ensure
the agency adheres to all applicable standards
• transparency/openness — having clear roles and responsibilities and clear procedures for making
decisions and exercising power
• integrity — acting impartially, ethically and in the interests of the agency, and not misusing information
acquired through a position of trust
• stewardship — using every opportunity to enhance the value of the public assets and institutions that
have been entrusted to care
• efficiency — ensuring the best use of resources to further the aims of the organisation, with a commitment
to evidence-based strategies for improvement
• leadership — achieving an agency-wide commitment to good governance through leadership from the
top (APSC 2007, p. 2).

These principles are included in corporate governance frameworks issued by state and territory
government departments. One example is the Department of Education and Training in Queensland. It
published these principles as a focus for its employees within the department. Other states also have specific
guidelines. The Victorian Public Sector Commission (VPSC) has developed a framework that illustrates
the accountability of various groups of public servants. The framework is shown in figure 3.7.
The VPSC states that there are a series of stakeholders involved in the running of any individual public
entity. The list of key parties involved, according to the Victorian authority is:
• a minister (and parliament) and those who support the minister directly
• a department (and departmental secretary)
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MODULE 3 Governance Concepts 203

• a public entity board and non-executive (and executive) board directors
• a board chair
• board committees (and chairs of the committees), including audit and risk committees that could include
specialist independent members who are not themselves directors of the public entity
• a board secretary
• a chief executive officer
• a chief finance and accounting officer (or CFO)
• public entity managers and other employees
• other stakeholders.
This list largely reflects internal public sector stakeholders except for the final category, which will
include those members of the community — individuals and groups — that use the services or may be
regulated by a specific government or public sector entity.

FIGURE 3.7 Victorian public sector accountability framework

Stakeholders Parliament
• Customers and clients
• Victorian community
• Ministers and
departments Minister
responsible for
functions affected
by the operations of
the public entity Directions, delegations
• Public sector and advice
organisations that
cooperate with the
public entity
• Business partners
such as companies
Portfolio Department Directions, priorities,
and NGOs
Secretary, advice and reports
• Local government
managers and staff
• Regulators

Monitoring
and advice

Integrity bodies
• IBAC Portfolio Entities
• Ombudsman Board Chief Executive Officer
• Auditor-general Chief Finance and Accounting Officer
Manager and staff

Source: Victorian Public Sector Commission 2015, ‘Governance structure’, accessed August 2023, https://vpsc.vic.gov.au/wp-
content/uploads/2015/03/Governance-Structure.png.

3.15 SIGNIFICANCE OF THE

NON-CORPORATE SECTOR
As noted previously, there are many forms of business association, and large corporations are only one
form of association. Because of the scale and impact of the economic activity of large listed corporations,
the governance literature has concentrated very much on these, both in Australia and around the world.
The SME sector is of great significance in every economy and community, providing substantial
economic activity and employment. The SME sector represents the corner shop and the local business
without which communities could not function properly, and they are vital to the provision of many
goods and services. While the governance of small enterprises is necessarily simple, it is nonetheless
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204 Ethics and Governance

important that these enterprises are accountable to assure those that they do business with will not encounter
unexpected losses.
Consider the Australian Small Business and Family Enterprise Ombudsman (ASBFEO 2023) statistics
presented in table 3.10. The ASBFEO report categorises businesses as small, medium or large. A significant
proportion of the 4533 large businesses are probably listed on the ASX. In comparison, the report states
that there are more than 2.5 million small businesses.

TABLE 3.10 Business size measured by employment in June 2022

Number of employees Number of businesses % of total businesses

Small business (0–19 employees) 2 506 012 97.5

Medium business (20–199 employees) 59 355 2.3

Large business (200+ employees) 4 533 0.2

Total 2 569 900 100.0

Source: ASBFEO 2023, ‘Contribution to Australian business numbers’, accessed August 2023, www.asbfeo.gov.au/sites/
default/files/2023-06/Contribution%20to%20Aust%20Business%20Numbers_June%202023_0.pdf.

In addition, there is the public sector, which continues to have a substantial impact even after the episodes
of privatisation in recent decades. For example, there are government business enterprises, which remain
part of federal and state governments, and maintain governance accountability to the elected government,
such as the Australian Postal Corporation and the NBN Co Limited.
A further dimension of economic activity (which begins to merge with social, cultural and sporting
activity) is the work of NFP organisations. These are organisations that cannot distribute their earnings to
those who exercise control in the organisation, but are dedicated to a wider purpose (Hansmann 1980).
The ACNC’s Australian Charities Report 9th edition (2023) stated that, as at 8 February 2023, there
were 59 967 charities in Australia. The report also revealed the following from charities’ 2021 Annual
Information Statements.
• Total revenue generated by charities was $190 billion.
• Government grants as a revenue source totalled $97 billion.
• Donations and bequests as a revenue source totalled $13 billion.
• There were 3.2 million volunteers and 1.42 million employees across Australia’s charities.
• Most registered charities (33 per cent) are ‘extra small’, a subset of small.
• Twenty-one point five per cent of charities reported their main activity as religious and faith-based
spirituality.
• Six per cent of charities operate overseas.
It is clear from these statistics that the charitable and NFP sectors are large and a major part of the
economy. There is a need to ensure that governance processes of a similar stringency operate in the case
of government bodies, NFP organisations and charities because listed companies and private entities are
not the only entities that deal with the allocation of scarce resources on behalf of stakeholders.

SUMMARY
Non-corporate entities have governance principles that generally align with those applying to corpo-
rate entities, but the context in which non-corporate entities operate is different and some special
considerations apply.
Family-owned businesses and many SMEs do not exhibit the separation of ownership and management
that occurs in large corporations. The owners and managers are often the same people. To overcome poten-
tial conflicts and ensure the business can cope with growth and increasing complexity, it is recommended
that formal management structures and processes are put in place to ensure good governance.
Guidance for non-corporate entities that are charities is available from the ACNC, which, as the regulator
of the charities sector, requires entities to have appropriate governance systems in place. The Australian
Institute of Company Directors and a number of other sources provide guidance for other types of
NFP organisations.

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 Commonwealth, state and territory governments have public sector authorities (known as commissions)
that set the behavioural norms for public sector entity boards. There are values that are embedded in
government guidance that entities are encouraged to follow and implement to ensure they perform in
accordance with their operating charters as well as maintain a level of accountability.
The key points covered in this part, and the learning objective they align to, are as follows.

KEY POINTS

3.8 Analyse how robust governance is relevant to public sector and non-corporate entities.
• Governance standards for non-corporate bodies are generally aligned with corporate standards
although the context differs.
• The public sector has established hierarchies that require a chain of accountability within public
sector entities.
• The chain of accountability in public sector entities extends to the ministerial level and to the
parliament.
• In Australia, key documents are issued by each state and territory government that embed common
public sector values derived from Commonwealth publications.
• Private sector NFPs are accountable to their stakeholders and thus must demonstrate robust
governance, regardless of whether they are structured as a corporation. NFPs’ goals are often
different in nature to those of for-profit entities, but they must still demonstrate effective use of
resources in pursuing those goals.
• Family businesses and SMEs often lack the separation of ownership and management that
characterises large corporations. In order to deal with potential conflicts and adapt to changing
circumstances, such organisations should adopt a governance framework.

REVIEW
Governance refers to the system used to operate and control an organisation. This module explored the
importance of having clear principles in place for guiding organisations to achieve their objectives while
conforming to expected business behaviour and rules and respecting the right of stakeholders.
The module explained how various stakeholders perform their governance roles. Directors, with their
relevant duties and obligations, have the greatest role in governance, and also the power to have the
most impact on the organisation. Shareholders, auditors and regulators all have roles to play in the
corporate governance framework to ensure that problems are quickly identified and rectified, and to help
organisations pursue their goals and objectives appropriately and successfully.
After considering the development of corporate governance best practice over the past 30 years, the
module focused specifically on best practice principles as outlined in the OECD Principles, the UK
FRC Code and the ASX Principles. This included a detailed review of specific items that have been
recommended as helpful or essential for ensuring good governance in both corporate and non-corporate
sectors. It is recognised that there are alternatives approaches to corporate governance in different national
cultures, with the main ones being marked-based and relationship-based.
Finally, the non-corporate sector (including family-owned businesses and SMEs, NFP organisations
and the public sector) has various special characteristics. While certain specific considerations apply
to the governance of these organisations, generally the principles underlying corporate governance are
broadly applicable.

APPENDIX 3.1
UNDERSTANDING THE UK FRC CORPORATE GOVERNANCE CODE
The 2018 version of The UK Corporate Governance Code (UK FRC Code) is an important mechanism
designed to improve corporate governance from the conformance and performance perspectives. Although
it only formally applies in the UK, it has international importance. You will find it valuable to download
and review this document. Only the parts of the UK FRC Code that are reproduced in the study guide
(including this appendix) are examinable.
The UK FRC Code (2018) is available online at: www.frc.org.uk/getattachment/88bd8c45-50ea-4841-
95b0-d2f4f48069a2/2018-UK-Corporate-Governance-Code-FINAL.pdf.
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206 Ethics and Governance

 You should download a copy of the Code for your own reference so that you see the following elements
of the UK FRC Code in their full context. We are only examining relevant extracts from the UK FRC Code.
Governance and the UK FRC Code
The UK FRC Code applies in a similar fashion to the recommendations issued by the ASX Corporate
Governance Council. The UK FRC advises entities reporting under the Code that they must ‘report
meaningfully when discussing the application of the principles and to avoid boilerplate reporting’. In other
words, the entities should report in a manner that tells the story of the entity rather than produce template
disclosures that could be applied in differing circumstances.
The ‘comply or explain’ approach is outlined on page 2 of the UK FRC Code and relevant sections are
reproduced below (UK FRC 2018, p. 2).
1. The effective application of the Principles should be supported by high-quality reporting on the
Provisions. These operate on a ‘comply or explain’ basis and companies should avoid a ‘tick-box
approach’. An alternative to complying with a Provision may be justified in particular circumstances
based on a range of factors, including the size, complexity, history and ownership structure of a company.
Explanations should set out the background, provide a clear rationale for the action the company is
taking, and explain the impact that the action has had. Where a departure from a Provision is intended
to be limited in time, the explanation should indicate when the company expects to conform to the
Provision. Explanations are a positive opportunity to communicate, not an onerous obligation.
2. In line with their responsibilities under the UK Stewardship Code, investors should engage construc-
tively and discuss with the company any departures from recommended practice. In their consideration
of explanations, investors and their advisors should pay due regard to a company’s individual circum-
stances. While they have every right to challenge explanations if they are unconvincing, these must not
be evaluated in a mechanistic way. Investors and their advisors should also give companies sufficient
time to respond to enquiries about corporate governance.

The Principles in the Code and their Application

There are five different categories of principles within the UK FRC Code. These categories each
have a series of principles attached to them. There is also guidance to assist in the interpretation and
implementation of the principles. The areas covered by the principles are:
1. Board Leadership and Company Purpose
2. Division of Responsibilities
3. Composition, Succession and Evaluation
4. Audit, Risk and Internal Control
5. Remuneration (UK FRC 2018, p. 3)

The Code as revised in 2018 by the UK FRC applied to all companies that have a premium listing
irrespective of whether they are incorporated within the UK or in another country. This means that an
Australian company, for example, that might be listed or considering getting a listing in the UK will need
to factor these guidelines into their regulatory risk management. The revised Code applies to accounting
periods or financial reporting periods beginning on or after 1 January 2019.
There are some specific provisions set down for the application of the Code to certain kinds of entities.
For parent companies with a premium listing, the board should ensure that there is adequate co-operation
within the group to enable it to discharge its governance responsibilities under the Code effectively. This
includes the communication of the parent company’s purpose, values and strategy.
Externally managed investment companies (which typically have a different board and company
structure that may affect the relevance of particular Principles) may wish to use the Association of
Investment Companies’ Corporate Governance Code to meet their obligations under the Code. In addition,
the Association of Financial Mutuals produces an annotated version of the Code for mutual insurers to use
(UK FRC 2018, p. 3).
.......................................................................................................................................................................................
CONSIDER THIS
Reflect on whether the UK FRC Code is a document that covers all of the essential issues related to the governance
of an entity as you read through the principles.

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The Format of the Principles
The principles are grouped together in their category and the relevant application guidance is published
immediately below the principles to which it applies. The key principles and applicable guidance appear
below (UK FRC 2018, pp. 7–18).
Category 1 Board Leadership and Company Purpose
Principles
A. A successful company is led by an effective and entrepreneurial board, whose role is to promote the
long-term sustainable success of the company, generating value for shareholders and contributing to
wider society.
B. The board should establish the company’s purpose, values and strategy, and satisfy itself that these
and its culture are aligned. All directors must act with integrity, lead by example and promote the
desired culture.
C. The board should ensure that the necessary resources are in place for the company to meet its objectives
and measure performance against them. The board should also establish a framework of prudent and
effective controls, which enable risk to be assessed and managed.
D. In order for the company to meet its responsibilities to shareholders and stakeholders, the board should
ensure effective engagement with, and encourage participation from, these parties.
E. The board should ensure that workforce policies and practices are consistent with the company’s values
and support its long-term sustainable success. The workforce should be able to raise any matters
of concern.
Provisions
1. The board should assess the basis on which the company generates and preserves value over the long-
term. It should describe in the annual report how opportunities and risks to the future success of the
business have been considered and addressed, the sustainability of the company’s business model and
how its governance contributes to the delivery of its strategy.
2. The board should assess and monitor culture. Where it is not satisfied that policy, practices or behaviour
throughout the business are aligned with the company’s purpose, values and strategy, it should seek
assurance that management has taken corrective action. The annual report should explain the board’s
activities and any action taken. In addition, it should include an explanation of the company’s approach
to investing in and rewarding its workforce.
3. In addition to formal general meetings, the chair should seek regular engagement with major sharehold-
ers in order to understand their views on governance and performance against the strategy. Committee
chairs should seek engagement with shareholders on significant matters related to their areas of
responsibility. The chair should ensure that the board as a whole has a clear understanding of the views
of shareholders.
4. When 20% or more of votes have been cast against the board recommendation for a resolution, the
company should explain, when announcing voting results, what actions it intends to take to consult
shareholders in order to understand the reasons behind the result. An update on the views received
from shareholders and actions taken should be published no later than six months after the shareholder
meeting. The board should then provide a final summary in the annual report and, if applicable, in the
explanatory notes to resolutions at the next shareholder meeting, on what impact the feedback has had
on the decisions the board has taken and any actions or resolutions now proposed.1
5. The board should understand the views of the company’s other key stakeholders and describe in the
annual report how their interests and the matters set out in section 172 of the Companies Act 2006
have been considered in board discussions and decision-making.2 The board should keep engagement
mechanisms under review so that they remain effective. For engagement with the workforce,3 one or a
combination of the following methods should be used:
• a director appointed from the workforce;
• a formal workforce advisory panel;
• a designated non-executive director.
If the board has not chosen one or more of these methods, it should explain what alternative
arrangements are in place and why it considers that they are effective.

1 Details of significant votes against and related company updates are available on the Public Register maintained by The Investment
Association — www.theinvestmentassociation.org/publicregister.html.
2 The Companies (Miscellaneous Reporting) Regulations 2018 require directors to explain how they have had regard to various
matters in performing their duty to promote the success of the company in section 172 of the Companies Act 2006. The Financial
Reporting Council’s Guidance on the Strategic Report supports reporting on the legislative requirement.
3 See the Guidance on Board Effectiveness Section 1 for a description of ‘workforce’ in this context.
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208 Ethics and Governance

 6. There should be a means for the workforce to raise concerns in confidence and — if they wish —
anonymously. The board should routinely review this and the reports arising from its operation. It should
ensure that arrangements are in place for the proportionate and independent investigation of such matters
and for follow-up action.
7. The board should take action to identify and manage conflicts of interest, including those resulting from
significant shareholdings, and ensure that the influence of third parties does not compromise or override
independent judgement.
8. Where directors have concerns about the operation of the board or the management of the company
that cannot be resolved, their concerns should be recorded in the board minutes. On resignation, a non-
executive director should provide a written statement to the chair, for circulation to the board, if they
have any such concerns.
Category 2 Division of Responsibilities
Principles
F. The chair leads the board and is responsible for its overall effectiveness in directing the company. They
should demonstrate objective judgement throughout their tenure and promote a culture of openness and
debate. In addition, the chair facilitates constructive board relations and the effective contribution of all
non-executive directors, and ensures that directors receive accurate, timely and clear information.
G. The board should include an appropriate combination of executive and non-executive (and, in particular,
independent non-executive) directors, such that no one individual or small group of individuals
dominates the board’s decision making. There should be a clear division of responsibilities between
the leadership of the board and the executive leadership of the company’s business.
H. Non-executive directors should have sufficient time to meet their board responsibilities. They should
provide constructive challenge, strategic guidance, offer specialist advice and hold management to
account.
I. The board, supported by the company secretary, should ensure that it has the policies, processes,
information, time and resources it needs in order to function effectively and efficiently.
Provisions
9. The chair should be independent on appointment when assessed against the circumstances set out in
Provision 10. The roles of chair and chief executive should not be exercised by the same individual.
A chief executive should not become chair of the same company. If, exceptionally, this is proposed
by the board, major shareholders should be consulted ahead of appointment. The board should set
out its reasons to all shareholders at the time of the appointment and also publish these on the
company website.
10. The board should identify in the annual report each non-executive director it considers to be indepen-
dent. Circumstances which are likely to impair, or could appear to impair, a non-executive director’s
independence include, but are not limited to, whether a director:
• is or has been an employee of the company or group within the last five years;
• has, or has had within the last three years, a material business relationship with the company, either
directly or as a partner, shareholder, director or senior employee of a body that has such a relationship
with the company;
• has received or receives additional remuneration from the company apart from a director’s fee,
participates in the company’s share option or a performance-related pay scheme, or is a member of
the company’s pension scheme;
• has close family ties with any of the company’s advisers, directors or senior employees;
• holds cross-directorships or has significant links with other directors through involvement in other
companies or bodies;
• represents a significant shareholder; or
• has served on the board for more than nine years from the date of their first appointment. Where
any of these or other relevant circumstances apply, and the board nonetheless considers that the
non-executive director is independent, a clear explanation should be provided.
11. At least half the board, excluding the chair, should be non-executive directors whom the board considers
to be independent.
12. The board should appoint one of the independent non-executive directors to be the senior independent
director to provide a sounding board for the chair and serve as an intermediary for the other directors
and shareholders. Led by the senior independent director, the non-executive directors should meet
without the chair present at least annually to appraise the chair’s performance, and on other occasions
as necessary.

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 13. Non-executive directors have a prime role in appointing and removing executive directors. Non-
executive directors should scrutinise and hold to account the performance of management and
individual executive directors against agreed performance objectives. The chair should hold meetings
with the non-executive directors without the executive directors present.
14. The responsibilities of the chair, chief executive, senior independent director, board and committees
should be clear, set out in writing, agreed by the board and made publicly available. The annual report
should set out the number of meetings of the board and its committees, and the individual attendance
by directors.
15. When making new appointments, the board should take into account other demands on directors’ time.
Prior to appointment, significant commitments should be disclosed with an indication of the time
involved. Additional external appointments should not be undertaken without prior approval of the
board, with the reasons for permitting significant appointments explained in the annual report. Full-
time executive directors should not take on more than one non-executive directorship in a FTSE 100
company or other significant appointment.
16. All directors should have access to the advice of the company secretary, who is responsible for advising
the board on all governance matters. Both the appointment and removal of the company secretary
should be a matter for the whole board.
Category 3 Composition, Succession and Evaluation
Principles
J. Appointments to the board should be subject to a formal, rigorous and transparent procedure, and an
effective succession plan should be maintained for board and senior management.4 Both appointments
and succession plans should be based on merit and objective criteria5 and, within this context, should
promote diversity of gender, social and ethnic backgrounds, cognitive and personal strengths.
K. The board and its committees should have a combination of skills, experience and knowledge.
Consideration should be given to the length of service of the board as a whole and membership
regularly refreshed.
L. Annual evaluation of the board should consider its composition, diversity and how effectively members
work together to achieve objectives. Individual evaluation should demonstrate whether each director
continues to contribute effectively.
Provisions
17. The board should establish a nomination committee to lead the process for appointments, ensure plans
are in place for orderly succession to both the board and senior management positions, and oversee the
development of a diverse pipeline for succession. A majority of members of the committee should be
independent non-executive directors. The chair of the board should not chair the committee when it is
dealing with the appointment of their successor.
18. All directors should be subject to annual re-election. The board should set out in the papers accompa-
nying the resolutions to elect each director the specific reasons why their contribution is, and continues
to be, important to the company’s long-term sustainable success.
19. The chair should not remain in post beyond nine years from the date of their first appointment to the
board. To facilitate effective succession planning and the development of a diverse board, this period
can be extended for a limited time, particularly in those cases where the chair was an existing non-
executive director on appointment. A clear explanation should be provided.
20. Open advertising and/or an external search consultancy should generally be used for the appointment
of the chair and non-executive directors. If an external search consultancy is engaged it should be
identified in the annual report alongside a statement about any other connection it has with the company
or individual directors.
21. There should be a formal and rigorous annual evaluation of the performance of the board, its
committees, the chair and individual directors. The chair should consider having a regular externally
facilitated board evaluation. In FTSE 350 companies this should happen at least every three years.
The external evaluator should be identified in the annual report and a statement made about any other
connection it has with the company or individual directors.
22. The chair should act on the results of the evaluation by recognising the strengths and addressing any
weaknesses of the board. Each director should engage with the process and take appropriate action
when development needs have been identified.

4 The definition of ‘senior management’ for this purpose should be the executive committee or the first layer of management below
board level, including the company secretary.
5 Which protect against discrimination for those with protected characteristics within the meaning of the Equalities Act 2010.
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210 Ethics and Governance

 23. The annual report should describe the work of the nomination committee, including:
• the process used in relation to appointments, its approach to succession planning and how both
support developing a diverse pipeline;
• how the board evaluation has been conducted, the nature and extent of an external evaluator’s contact
with the board and individual directors, the outcomes and actions taken, and how it has or will
influence board composition;
• the policy on diversity and inclusion, its objectives and linkage to company strategy, how it has been
implemented and progress on achieving the objectives; and
• the gender balance of those in the senior management6 and their direct reports.
Category 4 Audit, Risk and Internal Control
Principles
M. The board should establish formal and transparent policies and procedures to ensure the independence
and effectiveness of internal and external audit functions and satisfy itself on the integrity of financial
and narrative statements.7
N. The board should present a fair, balanced and understandable assessment of the company’s position
and prospects.
O. The board should establish procedures to manage risk, oversee the internal control framework, and
determine the nature and extent of the principal risks the company is willing to take in order to achieve
its long-term strategic objectives.
Provisions
24. The board should establish an audit committee of independent non-executive directors, with a minimum
membership of three, or in the case of smaller companies, two.8 The chair of the board should not be a
member. The board should satisfy itself that at least one member has recent and relevant financial
experience. The committee as a whole shall have competence relevant to the sector in which the
company operates.
25. The main roles and responsibilities of the audit committee should include:
• monitoring the integrity of the financial statements of the company and any formal announcements
relating to the company’s financial performance, and reviewing significant financial reporting
judgements contained in them;
• providing advice (where requested by the board) on whether the annual report and accounts,
taken as a whole, is fair, balanced and understandable, and provides the information necessary for
shareholders to assess the company’s position and performance, business model and strategy;
• reviewing the company’s internal financial controls and internal control and risk management
systems, unless expressly addressed by a separate board risk committee composed of independent
non-executive directors, or by the board itself;
• monitoring and reviewing the effectiveness of the company’s internal audit function or, where there
is not one, considering annually whether there is a need for one and making a recommendation to
the board;
• conducting the tender process and making recommendations to the board, about the appointment,
reappointment and removal of the external auditor, and approving the remuneration and terms of
engagement of the external auditor;
• reviewing and monitoring the external auditor’s independence and objectivity;
• reviewing the effectiveness of the external audit process, taking into consideration relevant UK
professional and regulatory requirements;
• developing and implementing policy on the engagement of the external auditor to supply non-audit
services, ensuring there is prior approval of non-audit services, considering the impact this may have
on independence, taking into account the relevant regulations and ethical guidance in this regard,
and reporting to the board on any improvement or action required; and
• reporting to the board on how it has discharged its responsibilities.
26. The annual report should describe the work of the audit committee, including:
• the significant issues that the audit committee considered relating to the financial statements, and
how these issues were addressed;

6 See footnote 4.
7 The board’s responsibility to present a fair, balanced and understandable assessment extends to interim and other price-sensitive
public records and reports to regulators, as well as to information required to be presented by statutory instruments.
8 A smaller company is one that is below the FTSE 350 throughout the year immediately prior to the reporting year.
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MODULE 3 Governance Concepts 211

 • an explanation of how it has assessed the independence and effectiveness of the external audit
process and the approach taken to the appointment or reappointment of the external auditor,
information on the length of tenure of the current audit firm, when a tender was last conducted
and advance notice of any retendering plans;
• in the case of a board not accepting the audit committee’s recommendation on the external auditor
appointment, reappointment or removal, a statement from the audit committee explaining its
recommendation and the reasons why the board has taken a different position (this should also
be supplied in any papers recommending appointment or reappointment);
• where there is no internal audit function, an explanation for the absence, how internal assurance is
achieved, and how this affects the work of external audit; and
• an explanation of how auditor independence and objectivity are safeguarded, if the external auditor
provides non-audit services.
27. The directors should explain in the annual report their responsibility for preparing the annual report
and accounts, and state that they consider the annual report and accounts, taken as a whole, is fair,
balanced and understandable, and provides the information necessary for shareholders to assess the
company’s position, performance, business model and strategy.
28. The board should carry out a robust assessment of the company’s emerging and principal risks.9 The
board should confirm in the annual report that it has completed this assessment, including a description
of its principal risks, what procedures are in place to identify emerging risks, and an explanation of
how these are being managed or mitigated.
29. The board should monitor the company’s risk management and internal control systems and, at least
annually, carry out a review of their effectiveness and report on that review in the annual report.
The monitoring and review should cover all material controls, including financial, operational and
compliance controls.
30. In annual and half-yearly financial statements, the board should state whether it considers it appropriate
to adopt the going concern basis of accounting in preparing them, and identify any material uncertain-
ties to the company’s ability to continue to do so over a period of at least twelve months from the date
of approval of the financial statements.
31. Taking account of the company’s current position and principal risks, the board should explain in the
annual report how it has assessed the prospects of the company, over what period it has done so and why
it considers that period to be appropriate. The board should state whether it has a reasonable expectation
that the company will be able to continue in operation and meet its liabilities as they fall due over the
period of their assessment, drawing attention to any qualifications or assumptions as necessary.
Category 5 Remuneration
Principles
P. Remuneration policies and practices should be designed to support strategy and promote long-term
sustainable success. Executive remuneration should be aligned to company purpose and values, and be
clearly linked to the successful delivery of the company’s long-term strategy.
Q. A formal and transparent procedure for developing policy on executive remuneration and determining
director and senior management10 remuneration should be established. No director should be involved
in deciding their own remuneration outcome.
R. Directors should exercise independent judgement and discretion when authorising remuneration out-
comes, taking account of company and individual performance, and wider circumstances.
Provisions
32. The board should establish a remuneration committee of independent non-executive directors, with a
minimum membership of three, or in the case of smaller companies, two.11 In addition, the chair of the
board can only be a member if they were independent on appointment and cannot chair the committee.
Before appointment as chair of the remuneration committee, the appointee should have served on a
remuneration committee for at least 12 months.

9 Principal risks should include, but are not necessarily limited to, those that could result in events or circumstances that might
threaten the company’s business model, future performance, solvency or liquidity and reputation. In deciding which risks are
principal risks companies should consider the potential impact and probability of the related events or circumstances, and the
timescale over which they may occur.
10 See footnote 4.
11 See footnote 8.
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212 Ethics and Governance

 33. The remuneration committee should have delegated responsibility for determining the policy for
executive director remuneration and setting remuneration for the chair, executive directors and senior
management.12 It should review workforce13 remuneration and related policies and the alignment of
incentives and rewards with culture, taking these into account when setting the policy for executive
director remuneration.
34. The remuneration of non-executive directors should be determined in accordance with the Articles of
Association or, alternatively, by the board. Levels of remuneration for the chair and all non-executive
directors should reflect the time commitment and responsibilities of the role. Remuneration for all
non-executive directors should not include share options or other performance-related elements.
35. Where a remuneration consultant is appointed, this should be the responsibility of the remuneration
committee. The consultant should be identified in the annual report alongside a statement about any
other connection it has with the company or individual directors. Independent judgement should be
exercised when evaluating the advice of external third parties and when receiving views from executive
directors and senior management.14
36. Remuneration schemes should promote long-term shareholdings by executive directors that support
alignment with long-term shareholder interests. Share awards granted for this purpose should be
released for sale on a phased basis and be subject to a total vesting and holding period of five years or
more. The remuneration committee should develop a formal policy for post-employment shareholding
requirements encompassing both unvested and vested shares.
37. Remuneration schemes and policies should enable the use of discretion to override formulaic outcomes.
They should also include provisions that would enable the company to recover and/or withhold sums
or share awards and specify the circumstances in which it would be appropriate to do so.
38. Only basic salary should be pensionable. The pension contribution rates for executive directors, or
payments in lieu, should be aligned with those available to the workforce. The pension consequences
and associated costs of basic salary increases and any other changes in pensionable remuneration, or
contribution rates, particularly for directors close to retirement, should be carefully considered when
compared with workforce arrangements.
39. Notice or contract periods should be one year or less. If it is necessary to offer longer periods to new
directors recruited from outside the company, such periods should reduce to one year or less after the
initial period. The remuneration committee should ensure compensation commitments in directors’
terms of appointment do not reward poor performance. They should be robust in reducing compensation
to reflect departing directors’ obligations to mitigate loss.
40. When determining executive director remuneration policy and practices, the remuneration committee
should address the following:
• clarity — remuneration arrangements should be transparent and promote effective engagement with
shareholders and the workforce;
• simplicity — remuneration structures should avoid complexity and their rationale and operation
should be easy to understand;
• risk — remuneration arrangements should ensure reputational and other risks from excessive
rewards, and behavioural risks that can arise from target-based incentive plans, are identified and
mitigated;
• predictability — the range of possible values of rewards to individual directors and any other limits
or discretions should be identified and explained at the time of approving the policy;
• proportionality — the link between individual awards, the delivery of strategy and the long-term
performance of the company should be clear. Outcomes should not reward poor performance;
and alignment to culture — incentive schemes should drive behaviours consistent with company
purpose, values and strategy.
41. There should be a description of the work of the remuneration committee in the annual report,
including:
• an explanation of the strategic rationale for executive directors’ remuneration policies, structures
and any performance metrics;
• reasons why the remuneration is appropriate using internal and external measures, including pay
ratios and pay gaps;
• a description, with examples, of how the remuneration committee has addressed the factors in
Provision 40;
• whether the remuneration policy operated as intended in terms of company performance and
quantum, and, if not, what changes are necessary;

12 See footnote 4.
13 See the Guidance on Board Effectiveness Section 5 for a description of ‘workforce’ in this context.
14 See footnote 4.
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MODULE 3 Governance Concepts 213

 • what engagement has taken place with shareholders and the impact this has had on remuneration
policy and outcomes;
• what engagement with the workforce has taken place to explain how executive remuneration aligns
with wider company pay policy; and
• to what extent discretion has been applied to remuneration outcomes and the reasons why.

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216 Ethics and Governance

MODULE 4

GOVERNANCE IN
PRACTICE
LEARNING OBJECTIVES

After completing this module, you should be able to:

4.1 evaluate the implications of board diversity and executive remuneration in relation to corporate governance
including corporate performance
4.2 identify a range of operational responsibilities which affect some significant stakeholders and that are
important for good governance
4.3 identify aspects of corporate governance that arise in relation to audit responsibilities and regulatory
compliance
4.4 evaluate the importance of good corporate governance as a factor in mitigating the risks of financial failures
4.5 understand and apply policy laws and regulations that exist for the protection of markets and services,
and relevant stakeholders including consumers
4.6 identify some important rules that exist for the protection of financial markets and the value of corporations.

ASSUMED KNOWLEDGE

Knowledge from modules 1–3 of this study guide is assumed.

LEARNING RESOURCES

• Treasury Laws Amendment (Enhancing Whistleblower Protections) Act 2019 (Whistleblower Act), accessed
October 2023, www.legislation.gov.au/Details/C2019A00010
• Corporations Act 2001 (Cwlth), accessed October 2023, www.legislation.gov.au/Series/C2004A00818
• Reading 4.1: Open letter endorsing Commonsense Corporate Governance Principles (available on My
Online Learning)

PREVIEW
In module 3 we looked at the theory of corporate governance along with the key elements of a corporate
governance framework and guidelines for international best practice. In this module we will explore the
practical aspects of corporate governance. This relates to specific actions those charged with governance
can take to demonstrate accountability and achieve good corporate governance.
Corporate governance is a complex area both in theory and in practice, but it is central to achieving the
organisation’s objectives and being accountable to stakeholders. Corporations that have good corporate
governance are more likely to succeed in achieving their long-term goals.
This module explores the application of corporate governance principles. In particular, in this module
we will examine:
• the role of corporate governance in the prevention of corporate financial failure
• a board’s operational responsibilities including legislation in relation to stakeholders
• mechanisms for the protection of financial markets and the value of corporations.

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PART A: CORPORATE GOVERNANCE
SUCCESS FACTORS
INTRODUCTION
One practical outcome of poor corporate governance is the financial failure of the corporation. Boards are
charged with preventing this through adherence to good corporate governance practices. The following
areas all contribute to reducing the risk of financial failure:
• board selection, operation, evaluation and departures
• diversity
• executive remuneration and performance appraisal
• compliance with the Corporations Act 2001 (Cwlth)
• auditing the financial statements.
This part of the module will examine each of these areas in turn. We will begin with a discussion of the
make-up of the board of directors itself. Most of what corporate boards should be doing structurally is
contained within the Australian Securities Exchange (ASX) Corporate Governance Council’s Corporate
Governance Principles and Recommendations (ASX Principles) (ASX CGC 2019). Implementation of
the principles is another matter and is dependent on the quality of the board and making sure that there
is a match between what is required to govern the organisation and the attributes of directors. The ASX
Principles are referenced where relevant in the following discussion.

4.1 MITIGATING THE RISK OF FINANCIAL FAILURE

Corporate failure can have many causes and it is rare that a company fails for a single or unexpected reason.
Following a spate of corporate collapses, including Enron, former KPMG chairman David Crawford stated
that there ‘ain’t no new way of going broke’ (cited in Gettler 2002). Crawford said that businesses that fail
often ignore the fundamentals, and research conducted by various academics and institutions has supported
that conclusion. Altman and Hotchkiss (2006) note that management inadequacies are often at the core.
This can be reflected in management not being able to read the market and not understanding the effect
external factors can have on the organisation’s operations.

COMMON CAUSES OF CORPORATE FAILURE

Following an in-depth examination of a number of high-profile corporate failures — including Enron,
Barings Bank, WorldCom, Tyco and Parmalat — Hamilton and Micklethwait (2006) believe that the main
causes of failure can be grouped into six categories, a number of which stem from governance failure:
(1) Poor strategic decisions. Management fails to understand the relevant business drivers when they
expand into new products or markets, leading to poor strategic decisions.
(2) Greed and the desire for power. High-achieving executives can be ambitious, eager for more power and
may attempt to grow the company in a way that is not sustainable.
(3) Overexpansion and ill-judged acquisitions. Integration costs often far exceed anticipated benefits.
Cultural differences and lack of management capacity can also be problems.
(4) Dominant CEOs. Boards can sometimes become complacent and not adequately scrutinise the CEO.
(5) Failure of internal controls. Internal control deficiencies may relate to complex and unclear organ-
isational structures and failure to identify and manage operational risks. This can lead to gaps in
information flow, control and risk management systems.
(6) Ineffective boards. While directors are expected to provide an independent view, occasionally they
can become financially obligated to management, which can impede their judgment (Hamilton &
Micklethwait 2006).

Lamers (2009) also highlights the importance of cash flow in ensuring the ongoing viability of a
business. Dun & Bradstreet Chief Executive Officer (CEO) Christine Christian notes that businesses are
more likely to fail because of poor cash flow than poor sales, with this being more prevalent in times of
economic recession or downturn (Heaney 2011). National Credit Insurance (Brokers) Pty Ltd, which offers
insurance to protect companies in the event of bad debts in their debtors’ lists, reported a significant rise in
the number of claims against bad debtors following the global financial crisis (GFC), indicating businesses
were not prepared for the slowdown in the economy, resulting in a strain on cash flows (Lamers 2009).
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218 Ethics and Governance

 Corporate culture has also been identified as a significant factor in corporate failure. The following
extract from Cruver (2002) about the collapse of Enron demonstrates the culture in that company during
the 1990s.
Fear among competitors, suppliers, customers, and even Enron’s own employees … Greed among those
who dreamed of colossal bonuses, millions in stock options, and generous campaign contributions. Fear
and greed … were radically and permanently entrenched — throughout the culture, the people, and the
industries Enron touched (Cruver 2002, p. xv).

This highlights the importance of understanding agency theory and the related issues and costs.
According to Monks and Minow (2008), there has been significant abuse, not just by the directors, but
by all involved in the corporate governance process. This includes incompetence and negligence as well
as corruption by managers and directors as well as other peripheral players including securities analysts
and lawyers, accountants and financiers, and even shareholders.
The GFC provided a number of lessons for governance. The OECD identified that corporate governance
weaknesses in remuneration, risk management, board practices and the exercise of shareholder rights had
played an important role in the development of the financial crisis and that such weaknesses extended to
companies more generally (OECD 2010a, p. 3). These issues are explored further in the following extract
from an article that considers the corporate governance lessons from the GFC.
The financial crisis can be to an important extent attributed to failures and weaknesses in corporate
governance arrangements. When they were put to a test, corporate governance routines did not serve their
purpose to safeguard against excessive risk taking in a number of financial services companies.
A number of weaknesses have been apparent. The risk management systems have failed in many cases
due to corporate governance procedures rather than the inadequacy of computer models alone: information
about exposures in a number of cases did not reach the board and even senior levels of management, while
risk management was often activity rather than enterprise based.
These are board responsibilities. In other cases, boards had approved strategy but then did not establish
suitable metrics to monitor its implementation. Company disclosures about foreseeable risk factors and
about the systems in place for monitoring and managing risk have also left a lot to be desired even though
this is a key element of the Principles.
Accounting standards and regulatory requirements have also proved insufficient in some areas leading
the relevant standard setters to undertake a review.
Last but not least, remuneration systems have in a number of cases not been closely related to the strategy
and risk appetite of the company and its longer-term interests.
The Article also suggests that the importance of qualified board oversight, and robust risk management
including reference to widely accepted standards is not limited to financial institutions. It is also an essential,
but often neglected, governance aspect in large, complex non-financial companies.
Potential weaknesses in board composition and competence have been apparent for some time and
widely debated. The remuneration of boards and senior management also remains a highly controversial
issue in many OECD countries (Kirkpatrick 2009).

A KPMG guide to corporate collapses (KPMG 2016) also provides some insight into the key drivers
of certain corporate misadventures by analysing a series of case studies. The global firm summarises the
following factors as being principal causes of corporate failure:
1. Greed or sense of making magic happen
2. Over-ambitious corporate expansions leading to complex structures
3. Excessive debt to fund expansions or personal expenses
4. Incentives to management increase the motivation to commit fraud
5. Pressure to achieve market expectations
6. Corporate governance failures as a result of incompetent or ineffective boards and board committees
7. Sense of entitlement by senior management
8. Failure and override of internal controls
9. Manipulation of financial records and/or fraudulent financial reporting to disguise the true nature of
underlying problems (KPMG 2016).

Other issues that have been linked to governance failures include remuneration, wilful blindness and
poor risk management — especially in relation to managing complex financial products. These are
discussed next.

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Remuneration
Two major issues arise in relation to the remuneration that senior executives receive.
First, there are concerns about the extent to which high executive earnings are linked to performance.
Remuneration methods may fail to achieve alignment or congruency between the agent and principal. They
may actually encourage the agent to behave in ways that the principal does not desire at all. This may be the
result of linking too much remuneration to excessive risk-taking, or to focusing remuneration too closely
on short-term performance while ignoring long-term sustainable and reliable growth and profits. Yeoh
(2016) emphasised the point in a paper on corporate governance failure that ‘executive compensation
schemes induced extreme risk-taking without punishing failures while focusing on short-term interests
without aligning with the long view of risk’.
Second, there is frequently shareholder concern regarding the total amount that executives receive,
which is often regarded as excessive and involves a residual loss agency cost. This cost is borne by the
shareholders whose returns are reduced by the payments received by senior executives. Despite constant
attempts by organisations and corporate governance advisory bodies, most attempts to manage and control
remuneration levels have not been successful.
A further problem that was emphasised throughout debates on misconduct in the financial services
sector were the incentives paid to financial services professionals for selling products. These featured
prominently in discussions related to the Hayne Royal Commission and were cited as a primary reason
why various acts of misconduct were committed. Incentives may lead to a skewing of decision making in an
inappropriate manner.

Wilful Blindness
‘Wilful blindness’ (or ‘wilful ignorance’) is a term that is sometimes used to refer to types of cases
involving serious corporate governance failure. Although it is not a formal legal term under, for example,
Australian or UK law, it is a term referred to in US legislation such as the US Foreign and Corrupt Practices
Act (1977) and the US Bankruptcy Code.
In essence, wilful blindness refers to situations where individuals seek to avoid their legal liability for
a wrongful act by deliberately putting themselves in a position where they are unaware of facts that will
make them liable. In US cases where defendants have sought to escape legal liability on this basis, the
courts have frequently rendered defendants liable on the basis that they could and should have known of
facts that, had they been acted upon, would have prevented the wrongful act.
The concept of wilful blindness was referred to in the case involving Enron CEOs Kenneth Lay and
Jeffrey Skilling. The Sarbanes–Oxley regulations aim to prevent this type of approach by requiring the
CEO and Chief Financial Officer (CFO) to sign off on the financial accounts and certify the appropriateness
of internal controls.
From a corporate governance perspective, allegations of wilful blindness can have serious reputational
consequences for the individuals and organisations concerned, and potentially serious legal consequences.
This highlights that it is important for directors and others to uphold ethics and follow good corporate
governance practices in order to prevent such incidents in the first place.

Poor Risk Management

Poor risk management is a common theme in relation to corporate governance failures. A major implication
in relation to the GFC is a lack of expertise of some boards of directors in understanding and effectively
managing the risks involved with trading in complex financial instruments. It is clear that some bank boards
were not aware of the substantial risks that the trading of these instruments had brought to their bank.
Such a finding mirrors earlier lessons learned from banking disasters such as the collapse of Baring
Brothers in the mid-1990s. In that case, a rogue trader built up significant exposures to falls in some market
prices, seemingly without the board being aware until it was too late. More recently, a much larger scandal
erupted concerning the fixing of the rates with the London Interbank Offered Rate (LIBOR), which is the
primary benchmark for short-term interest rates around the world. It was discovered that traders at a large
number of international banks were manipulating these rates, leading to excessive interest payments by
customers. The banks involved were heavily fined, though the boards of the banks and senior executives
insisted they were not aware of the systemic manipulation of rates that was taking place.
These examples demonstrate where a range of companies had failed. The following sections explore
what companies are able to do to improve the quality of governance in order to reduce the likelihood of
poor performance and ultimate closure.
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220 Ethics and Governance

SELECTION, MONITORING, EVALUATION AND CESSATION OF
BOARD APPOINTMENTS
Companies are like a wristwatch. Each part of the watch needs to function in order for the watch to tell the
time properly and consistently. Anyone not monitoring the watch and checking that it is working correctly
may notice that it is right at least on two occasions each day. A watch needs to be wound up or have a
battery replaced to ensure that it is fit for purpose. A company is the same. All of the parts, elements or
departments within a corporation need to be considered when analysing whether things work or there are
problems. For example, the kickbacks that AWB Ltd (formerly the Australian Wheat Board) paid to Iraq’s
former government and the News Corporation phone hacking scandal that erupted in the UK in 2011 show
what can happen in the absence of good governance and adherence to ethical norms or practice.
This module builds on the discussion of corporate governance in module 3 through the consideration of
additional issues and international trends (including new regulation) in relation to boards and management.
Important factors relate to how directors are appointed and the diversity of board candidates and managers.
We also look at the role of shareholders in voting for the appointment of directors, and how directors cease
to be on the board. This voting power is gaining new significance because of the vexed issue of executive
remuneration and corporate performance as a key part of good corporate governance.

Appointment of Directors
Capable directors, properly appointed, are vital to the effective oversight of modern corporations. In
Australia, in common with most countries, only a natural person (i.e. a human being, in contrast to merely
a legal person) of at least 18 years of age can be formally appointed as a director. A person currently
disqualified ‘from managing a corporation’ cannot be appointed a director (and also cannot be appointed
as a senior executive).
Notwithstanding the various corporate governance recommendations discussed in module 3, in Australia
and some other jurisdictions, the law does not specify that directors must hold any particular qualifications
or capabilities. In contrast, the majority of executives who are also directors will be required to have
qualifications relevant to their appointed executive position. Further, while it is expected that those
recommending board appointments to shareholders (e.g. the nomination committee) will properly assess
each candidate before appointment (and reappointment in the case of incumbent directors), it is noteworthy
that some appointments seem to add little value to the corporation.
The appointment of directors is traditionally strongly influenced by the board, even though the
shareholders legally appoint directors. In most jurisdictions, the annual general meeting of shareholders
will vote in favour of candidates recommended by the board (or by the nomination committee). Indeed,
endorsed directors of ASX 200 companies have averaged about 95 per cent of the vote in favour since
2000. Where a ‘casual vacancy’ arises, it is common for the board to use its powers to appoint a director
immediately (for later ratification by shareholders’ vote at the next AGM). Rarely are shareholders
presented with a range of candidates from which to choose.

Election of Directors
There have been two approaches that have emerged for the election of directors. One of these approaches
is a ‘staggered’ approach to election of directors. The staggered approach is one that places a greater
emphasis on ensuring that there is some preservation of corporate memory and consistency of decision
making over time.
For a nine-member board over a three-year period, a staggered approach would look like the following.
• 2023: Board members 1, 2 and 3 are required to retire from their position and, if they want to re-join
the board, must be subject to a shareholder vote of approval.
• 2024: Board members 4, 5 and 6 are required to retire, and these directors also require a shareholder
vote of approval to re-join the board.
• 2025: Board members 7, 8 and 9 are required to retire and also require a shareholder vote of approval
to re-join the board.
The standard period of director appointment has tended to be around the three years in most countries —
with just a few directors being re-elected by shareholders each year under staggered voting. A three-year
staggered vote cycle for directors means that every year, one-third of the directors are required to resign
and then typically all, or most, of these individuals will stand for re-election.

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 The other approach that has grown in use is referred to as ‘destaggering’. This approach refers to placing
all directors up for election each year rather than using a staggered approach. The destaggered approach
is gaining acceptance as it is set to enhance director accountability and shareholder power.
Australian investors have been exposed to this direction change (e.g. at the 2012 AGMs of Rio Tinto,
BHP and News Corp). In the United States (US), annual voting for all directors is now very common,
which is a major step forward from past practices where US shareholders could not actually vote ‘against’
a director, but instead simply ‘withheld’ a vote in favour.
A process by which all directors are appointed in an annual basis would look like this:
• 2023: All board member appointments expire, and reappointment is subject to shareholder vote and
approval.
• 2024: All board member appointments expire again, and reappointment is once again required.
In Australia, an election exemption exists for the managing director, under ASX Listing Rule 14.4.
The managing director is usually the CEO of the organisation. Many managing directors will employ this
exemption and may never face a shareholder election.
An annual cycle still leaves the possibility of ‘continuing appointment’ of directors who have been on
the board for some time. Boards need renewal, as weary or tired directors are unlikely to bring new ideas
to the boardroom and may often be resistant to change.
Further, the relationships that arise within boards mean that independent directors will gradually lose
their independence as board and corporate familiarity grow over time.
Both the UK and Australia have specified maximum periods for directors to be considered independent,
although boards often conclude that independence persists despite the fact that directors have moved
beyond the recommended time limits (e.g. 10 years). This is less than satisfactory, because deciding that
independence is likely to cease after a designated period can encourage board renewal and help create a
clear majority of independent directors.
While holding annual elections of the whole board is regarded by some as a way of improving corporate
governance, an appropriate degree of board continuity (i.e. all directors not being replaced at the same time)
is also important to ensure the orderly oversight of corporations by directors with ‘corporate knowledge’.
As in all matters of good corporate governance, a balance of skills and judgement is vital in ensuring sound
board composition. On this, Kiel and colleagues offer the following advice.
Since it takes a year for a director to experience the full board cycle, anything less than two (and possibly
three) years is likely to underutilise the skills of the individuals involved. Similarly, by presenting an upper
limit of around five years before a director has to stand for re-election, the board guards against directors
becoming entrenched (Kiel et al. 2012, p. 215).

Evaluation of Board Performance

A key to properly governing any entity is to ensure that a board reviews its own performance at least
annually to ensure that it is performing at the optimal level. A range of areas need to be examined in the
review of board performance. The OECD (2018, pp. 7–8) recommends the following.
The performance and effectiveness of the board can be measured by the following ‘four dimensions’:
1. Quality of the monitoring and risk-management role.
2. Quality of strategic and other business-related advice.
3. Board dynamics and board members’ pro-active participation.
4. Board composition and diversity.

These four dimensions, and accompanying attributes, are presented in figure 4.1.
Corporate governance codes recommend that the performance of boards be evaluated as follows.
• Recommendation 1.6 of the ASX Principles issued in February 2019 suggests that listed companies
have periodic reviews of board performance and that companies disclose whether an evaluation has
taken place in a given reporting period.
• Sub Principle V.E.4. of the G20/OECD Principles of Corporate Governance (2023) (OECD Principles)
states that ‘[b]oards should regularly carry out evaluations to appraise their performance and assess
whether they possess the right mix of background and competences, including with respect to gender
and other forms of diversity’.

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222 Ethics and Governance

 FIGURE 4.1 The ‘four dimensions’ of board evaluation

Compliance Innovation
Law & regulations Growth

St
Corporate governance Value creation

ra
em &
t
Whistleblower approach Window to market

te
en
ag ng

gy
Related party transactions Network

an ri

&
m ito
Conflicts Connections

bu
k- on

si
ris M

nes
s
s s
se ic
C &d

es am
om iv

oc n
Gender Committed

po ers

pr dy
si ity
Expertise Engaged

& rd
tio

a
n

Bo
Skills Prepared
Knowledge Information
Integrity Agenda
Independent Chair

Source: OECD 2018, Board evaluation: Overview of international practices, OECD, p. 8, accessed August 2023, www.oecd.org/
daf/ca/Evaluating-Boards-of-Directors-2018.pdf.

Departures
Directors may resign from their position during the current term or, alternatively, choose not to stand for
re-election at the end of their current board term. The resignation or death of a director will result in
a board vacancy that allows the board, if it chooses, to make a temporary appointment, subject to later
shareholder vote.
While a director’s resignation does not have the same negative connotations as a formal ‘removal’ or a
legal ‘disqualification’, it is important for shareholders to be informed of the reasons behind any particular
resignation. In Australia, shareholders and other stakeholders will normally be informed through ASX
disclosure processes or by the Australian Prudential Regulation Authority (APRA). Similar agencies exist
in many jurisdictions.
The problem is that the real reasons for resignation are not usually known. Even if there is good reason
to believe that something is seriously wrong, resignation statements generally indicate such reasons as
‘health’ or to ‘pursue other interests’. Corporate governance can be greatly enhanced if directors who
resign on a point of principle follow the Bosch Committee recommendation and make their concerns
known either to shareholders or to the relevant regulator (Bosch 1995).

Removal
As with appointments of directors, in most jurisdictions a vote by shareholders at a general meeting can
also remove a director from office. Furthermore, in some countries, it may be possible for the remaining
directors to pass a resolution to remove a director, although there usually needs to be just cause to do so.
Removal of a director of a public company in Australia before their term has expired can only be by
a shareholders’ vote at a general meeting. Under Australian law, shareholders have three ways to force a
motion to remove individual directors by way of an ordinary resolution requiring support of 50 per cent of
the votes cast.
Firstly, any individual or group of shareholders holding 5 per cent of the votes can require the board to
call an extraordinary general meeting, and the meeting is held at the company’s expense.
Secondly, any individual or group of shareholders holding 5 per cent of the votes are also able to call a
general meeting at their own expense, which is unlikely due to the substantial costs involved.
Thirdly, where a company has already called a general meeting, shareholders holding 5 per cent of the
votes — or 100 members entitled to vote — can seek to give the company notice of a proposed resolution
to be put to the meeting, including removal of directors.
These processes can be difficult and costly exercises and should not be undertaken lightly. It is also
significant in a legal sense and local corporate regulators will usually require an explanation of the removal
of a director before their term expires. Such a vote commonly will require the support of larger institutional
shareholders if it is to be successful.

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MODULE 4 Governance in Practice 223

How Voting is Carried out
For listed companies, the general rule is that at least 28 days’ notice must be given for general meetings. A
shorter period can be specified if members with at least 95 per cent of the votes agree beforehand. Notice
shorter than 21 days is not allowed for a meeting at which a resolution will be moved to remove a director
(Corporations Act, s. 249H).
In a resolution to remove directors, show of hand (i.e. each member has one vote; Corporations Act,
s. 250E) is the default method for voting. However, a poll (i.e. each member has one vote for each share
they hold; Corporations Act, s. 250E) may be demanded by:
(a) at least 5 members entitled to vote on the resolutions; or
(b) members with at least 5% of the votes that may be cast on the resolution on a poll; or
(c) the chair (Corporations Act, s. 250L).

Members can request to vote by polling:

(a) before a vote is taken; or
(b) before the voting results on a show of hands are declared; or
(c) immediately after the voting results on a show of hands are declared (Corporations Act, s. 250L).

The default requirements outlined in the Corporations Act regarding removal of directors also serve
as replaceable rules applicable to private companies. These rules act as a statutory framework providing
guidelines for private companies that have either not adopted their own constitution or have a constitution
that does not comprehensively address this particular issue.
Two-Strikes Rule — Shareholders Spill the Whole Board of Listed Company
In 2011, the Corporations Act was amended to provide for ‘two strikes and re-election’ of all board
members of listed companies. The rule, which was recommended in a report Executive Remuneration
in Australia (Productivity Commission 2009), relates specifically to rising dissatisfaction among share-
holders and in the general community about the generosity of remuneration policies within corporations,
especially for senior executives.
The two-strikes rule is accompanied by a range of measures designed to provide better information to
shareholders. Other accompanying measures also control who may vote and the way that ‘remuneration
consultants’ can be used by boards and management. Remuneration is now a matter to be considered by
the board’s remuneration committee, which must have a majority of independent members.
The two-strikes rule provides that the entire board can be removed after a shareholder vote ‘to spill the
board’. However, this spill vote can only occur after the eligible shareholders have voted twice against the
remuneration report. When voting on remuneration policies, not all shareholders are permitted or eligible
to vote. Those shareholders who hold key management positions or are conflicted in some other way are
not eligible to vote. When there is a large number of ineligible shareholders (e.g. when the managers own a
large proportion of the shares), this gives the other shareholders significant power to reject the remuneration
report and potentially cause a spill of the whole board.
The first strike occurs where 25 per cent or more of the eligible shareholders vote ‘No’ on the mandatory
resolution by the board that shareholders accept the corporation’s remuneration report presented in the
annual report.
Following the first strike, the company’s subsequent remuneration report (i.e. in the next annual report)
must explain the board’s action in response to the negative vote or, if no action was taken, the board’s
reason for inaction. The subsequent remuneration report must also disclose all relevant information for
the (second) year, just ended. The second strike occurs where, once again, 25 per cent or more of eligible
votes are ‘No’ in respect of the second year’s board resolution to shareholders that the remuneration report
be accepted.
Following the second strike, and at the same annual general meeting at which it occurs, a resolution to
‘spill’ (i.e. remove the whole board) must be put to shareholders. Other than the managing director, all
directors who were on the board when it resolved for the second time to put the remuneration report to
shareholders must be subject to the spill vote.
The spill resolution is successful if a simple majority (i.e. 50 per cent or more) of ‘eligible votes’ is in
favour of the spill at that time. This concept is extremely important, as no key management personnel
(KMP) (or any of their related parties) are eligible to vote on either the remuneration reports or the
spill motion. Importantly, this generally gives independent shareholders larger voting power proportions
than usual, because the large numbers of shares often held by directors and executives (and their related
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224 Ethics and Governance

parties) are not permitted to vote. Note that the Corporations Act specifically uses the KMP definition from
AASB 124 Related Party Disclosures:
Key management personnel are those persons having authority and responsibility for planning, directing
and controlling the activities of the entity, directly or indirectly, including any director (whether executive
or otherwise) of that entity (AASB 124, para. 9).

The shareholders’ meeting to elect a new board must take place within 90 days. At this meeting, all
shareholders are permitted to vote, as the board represents all shareholders including KMP. The 90-day
period allows for new persons to nominate for appointment to the board by shareholders’ vote. Notably,
the law provides that at least two of the old directors (other than the managing director) are required to
continue in order to ensure continuity of the board.
This is an important new direction but, with this new power being given to shareholders in the search
for improved corporate governance, we must fully understand how the measures operate and how they
may be used. The newspaper report (Wen 2013) in example 4.1 describes the first board spill under the
two-strikes rules.

EXAMPLE 4.1

Reaction to Shareholder Spills

Penrice Duo Pass Two-Strike Spill
The directors of Penrice Soda have called for the ‘two-strikes’ policy to be revoked, after avoiding going
down in history as the first board dumped under the contentious rule.
Chairman David Trebeck and deputy Andrew Fletcher were both re-elected after receiving 78% of the
vote at an extraordinary general meeting in Adelaide on Friday.
Both men had already created a bit of unwanted Australian corporate history, with the small Adelaide-
based chemicals manufacturer that has a market capitalisation of $10 million thrust into the spotlight for
being the first board to be spilled and forced to fight for re-election.
Shareholders rejected the company’s remuneration report for the second year in a row in October.
The ‘two-strikes’ rule was designed to deliver shareholders a greater say in the executive remuner-
ation policies of large corporates, particularly as pay packets bulged, often at odds with diminishing
shareholder returns.
But after the meeting on Friday, Mr Trebeck said the negative vote against the remuneration report ‘had
more to do with general shareholder disaffection’ — the company’s poor performance, a declining share
price and the absence of dividends — than it did with excessive executive pay.
‘Ideally, the two-strikes policy should be terminated,’ he said, adding that before the two-strikes rule,
shareholders who were disgruntled with the performance of the board could still muster enough support
to request an extraordinary general meeting and move against some or all directors.
Shareholder advocacy groups and large institutional funds have largely delivered positive feedback
on the ‘two-strikes’ regime, and the fact that company directors were now more open to share-
holder feedback.
Influential fund manager AMP Capital said earlier this month that it had experienced a ‘dramatic
increase’ in companies engaging with it, when previously concerns ‘fell on deaf ears’.
Source: Wen, P 2013, ‘Penrice duo pass two-strike spill’, The Age, 26 January, accessed August 2023, www.theage.com.au
/business/penrice-duo-pass-two-strike-spill-20130125-2dca3.html.

QUESTION 4.1

Explain the significance of the shareholder vote in the ‘two-strikes’ rule and the fact that, at different
points, it includes 25 per cent and 50 per cent of ‘eligible votes’, and finally the participation of all
shareholders as a simple majority.

Disqualification
Disqualification from managing corporations in any circumstances, either as a director or as an officer,
depends on the existence of some element of legally defined commercially unacceptable behaviour or
legal wrongdoing. Specific ‘wrongs’ that may lead to disqualification include:
• responsibility for certain civil wrongs (which are specified in legislation)
• financial market misconduct
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• responsibility for multiple insolvencies
• significant dishonest actions and corporate crimes
• civil and criminal wrongs in relation to anti-competitive conduct in markets for goods and services.
Disqualification may be ‘automatic’. In this case, circumstances surrounding a director may mean that,
without any formal declaration of disqualification occurring, a person is disqualified — typically for a
period of five years.
For example, a person who is declared bankrupt is automatically disqualified from continuing their
company directorships. Similarly, criminal offences involving breaches of laws governing corporations
will typically involve automatic disqualification. While the rules vary slightly across jurisdictions, the
underlying principles demonstrate great consistency internationally. In most jurisdictions, automatic
disqualification applies only where criminal breaches have been proven.
Disqualification may also occur because of an order of the court, where the misbehaviour of a director
or other senior officer is of a type that the courts are empowered to impose disqualification — with periods
of disqualification that could be as long as 20 years. The types of misbehaviour leading to court-ordered
disqualification involve various legislatively defined ‘civil wrongs’ including legislatively defined breaches
that lead to civil penalties.
In some circumstances, disqualification can be prescribed by regulatory agencies (such as the Australian
Securities and Investments Commission (ASIC) or APRA in Australia — and even gaming authorities can
disqualify) where directors and other senior officers have been involved in multiple insolvencies or have
breached relevant probity provisions.
Ethics of Disqualification
Offences relating to dishonesty will usually automatically disqualify a person from serving as a director
of a corporation. Disqualification aims to act as a deterrent to would-be offenders and helps protect
the public from exposure to persons who may reoffend. It also gives reassurance to markets and
individual investors.
It is useful to note that the rules regarding disqualification relate to managing a corporation as a director
and also managing a corporation as a senior executive (or other ‘officer’), whether a director or not. Simply
being a poorly performing director, who is not in breach of a relevant law, and where the companies they
manage have not been placed into insolvency as described below, will not result in disqualification — so
the appointing capable people who can do the job is very important, as the removal of poor appointees
may simply not occur.
When looking at the reasons for disqualification, it is possible that a person who has exercised poor
judgement on a number of occasions, leading to the insolvent failure of the corporation of which they
are a director, may be disqualified because of that poor judgement. In doing so, it is arguable that the
disqualification of the person from managing the corporation is not to act as a deterrent to others or
to punish unethical behaviour — rather it is to remove that person from the commercial arena and,
therefore, prevent further harm. Inherent in the word ‘failure’ is the financial harm caused to creditors
of the corporation. To some extent, there does appear to be measurable overlap between the law and
underlying ethical precepts. Arguably, a person who allows multiple insolvencies to occur really is not
behaving properly in a corporate context.

QUESTION 4.2

From the perspective of the disqualified person, what is the effect of being disqualified and what
is the key difference between disqualification that is ordered by the courts (or by ASIC) and a
disqualification that is automatic?

DIVERSITY
Diversity includes an individual’s race, ethnicity, gender, sexual orientation, age, physical abilities,
educational background, socioeconomic status, and religious, political or other beliefs. One key area
where the subject of diversity arises is in relation to discrimination in employment. This relates to fairness.
Diversity is also an important factor in performance. These two issues are described next.

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 Under Australian state, territory and federal legislation, it is unlawful for an employer to discriminate
against employees on certain prohibited grounds of discrimination such as race, gender, sexual orientation
and religion. For example, the Equal Opportunity for Women in the Workplace Act 1999 (Cwlth) has done
much to advance gender diversity by requiring organisations with 100 or more employees to establish a
workplace program to remove the barriers to women entering and advancing in their organisation.
In recognition of a lack of gender diversity in Australian boardrooms and at the request of the Australian
Government, the Corporations and Markets Advisory Committee (CAMAC 2009) reported on Diversity on
Boards of Directors. Following the CAMAC report, the ASX Principles were amended in 2010 to promote
greater diversity, particularly gender diversity, among the employees and boards of ASX-listed companies
(ASX CGC 2010). The recommendations on diversity in the ASX Principles aim to address the major
challenge of balancing gender on boards, since there are currently far fewer women than men who can
progress to board level in the upper levels or echelons of organisations.
The Australian Workplace Gender Equality Agency (WGEA) reported that even though women make
up half of the employees in their 2021–22 dataset, women comprise only 19.4 per cent of CEOs,
32.5 per cent of key management positions, 33 per cent of boards and 18 per cent of board chairs
(WGEA 2023). A considerable effort has been made to increase the participation of women in leadership
by the ASX, the Australian Institute of Company Directors (AICD) and other bodies since the Workplace
Gender Equality Act 2012 (Cwlth) was passed. By comparison, the EU has set a mandatory quota for large
European corporations to ensure 40 per cent of the positions on boards are held by women by mid-2026
(Huet 2022).
The recommendations in the ASX Principles were amended again in 2019. Recommendation 1.5 was
revised by the Corporate Governance Council to embed a 30 per cent target for senior executives and the
general workforce to be of each gender within a specified timeframe, as well as 30 per cent of each gender
on boards of directors.
The approach in Australia is similar to that of the United Kingdom (UK), where the FRC Code
includes, among other things, a recommendation that companies apply a formal, rigorous and transparent
procedure when appointing new directors to the board, with due regard to the benefits of diversity, including
gender. Indeed, many countries are now including recommendations that boards establish policies on the
board’s approach to achieving diversity (UK FRC 2018, Principle J). For example, the Malaysian Code on
Corporate Governance (Securities Commission Malaysia 2012) suggests that boards should disclose their
gender diversity policies and targets in their annual reports.
Since corporations look to corporate governance codes to benchmark their performance, the inclusion
of diversity in such codes is an important way to reinforce the concept that a diverse board can be a source
of new skill sets and innovation and can ultimately add value to the corporation. However, countries such
as Norway, France and Spain have gone further and have introduced mandatory quotas to increase gender
diversity on boards. These quotas have proven successful in addressing the gender imbalance on boards
(Credit Suisse 2012), and other countries have announced that they will introduce or are considering
introducing similar quotas. An alternative to the quota approach is that of the 30% Club, which was
established in the UK in 2010. At the time of writing, it had chapters in 18 countries including Australia.
‘The 30% Club is a global campaign led by Chairs and CEOs taking action to increase gender diversity at
board and executive committee levels’ (30% Club 2021).
In Australia, leading corporations are voluntarily committing to achieving significantly greater participa-
tion of women on boards and backing this up with commitments to also increase the participation of women
in senior executive ranks. Creating greater gender balance in management is a sign of the preparedness on
the part of companies to utilise all of their potential talent (Klettner, Clarke & Boersma 2015).
The importance of improving the gender balance of boards is backed by research. For example,
research by Credit Suisse found that over a six-year period, ‘companies with at least some female board
representation outperformed those with no women on the board in terms of share price performance’
(Credit Suisse 2012). Other published research in the area of diversity (Ali, Ng & Kulik 2014) has indicated
that there are great benefits in getting a diverse board in place with a range of academics finding that diverse
boards that feature members of different genders, ages and backgrounds are able to provide differing
perspectives. Researchers have commented on the fact that there were sound economic reasons to aim
for diversity as well as there being a social justice rationale for ensuring boards that were diverse in
their constituency.
The social justice rationale, which is evidenced by regimes that actively promote the appointment of
women to boards, is one where the objective is to achieve an environment where men and women would
experience equality at every level in society. Ali and colleagues note that ‘push initiatives’ designed to
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elevate the importance of achieving gender equality on boards would take some years to bear significant
fruit. The researchers note that there are studies that point to the fact that diverse boards can have some
positive impacts.
• Diverse boards may make the organisation an employer of choice for people with different backgrounds
because the board is seen as championing diversity.
• Diverse boards may also provide a broad range of networks that could include potential customers
and suppliers.
• Broad range of ages on a board may mean that different levels of education and perspectives are available
to the board.
Ali and colleagues note that diverse boards ‘may help improve strategic directions, expand networks,
and engage talent, which may help organisations to become productive and financially successful’. Ntim
(2015) found that market valuation of companies does take account of board diversity, which includes both
gender and ethnicity, but that ethnic diversity was valued more highly in the context of this specific study
than gender diversity.

Adopting Diversity
Adopting diversity is not just a matter of rules and targets. It is necessary to create an environment where
diversity becomes part of the culture of good corporate governance generally. This can result in long-term
high performance of the organisation and a contribution to the capabilities of the entire community.
The National Australia Bank (NAB) is an example of an early adopter of diversity in the boardroom and
at management levels (consistent with the ASX Principles). As stated on its website, ‘NAB believes that
investing in its employees is crucial to building a sustainable business’ (AICD 2010).
Diversity improvements take time to effect actual changes. As at August 2015, NAB’s board of
10 directors included two female members and the bank’s senior executive group also included three
female executives of the total of 10. The impact of adopted diversity policies may be slow, but progress
is being made in many organisations. As at August 2023, the NAB board had 11 directors, five of whom
were female and the senior executive group had 13 executives, four of whom were female (NAB 2023).
NAB’s formal adoption and implementation of relevant policies improved board gender diversity from
33 per cent in 2019 to 45 per cent in 2023 (as at August 2023). However, there has been a decline
in female representation at the senior executive level, moving from 36 per cent in September 2019 to
31 per cent at August 2023 (NAB 2022, 2023).
One of the more vital campaigns is that of the previously mentioned 30% Club, which is an industry-
led body looking for a rapid increase in the UK, Australia and other countries to 30 per cent female
participation on boards. As we saw above, this requirement has been met by the NAB board.
An AICD report (AICD 2010) quotes the set of detailed diversity approaches being implemented at
NAB. These approaches provide a valuable platform for considering at least some of the issues of making
diversity an effective part of good corporate governance within the organisation. They also will equip a
more diverse array of people to contribute as part of society generally, as a large corporation such as NAB
would expect many employees to move to other corporations in their working lives.
The key points of NAB’s diversity approach identified by the AICD are:
• career development and mentoring programs specifically designed to support women progress their
careers
• an initiative to prevent parental leave disconnection, which keeps employees in touch while on parental
leave
• recruitment practices that ensures a mix of males and females are short-listed for each role, and that
both males and females make hiring decisions together
• positive recruitment targeting women looking to join the financial services industry
• remuneration fairness
• age, disability and other diversity initiatives such as addressing employment opportunities for
Indigenous Australians, job sharing, telecommuting and supporting mature age workers.
Subsequently, in a path-breaking report, the Business Council of Australia (the lead body for large
Australian corporations) committed to a policy to increase the number of women in senior executive
positions to 50 per cent within 10 years (BCA 2013). To assist member companies in achieving this goal,
the BCA commissioned a report on best practices for recruitment, selection and retention.

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 However, a report from Chief Executive Women (CEW) published in February 2023 found that women
are still under-represented in most senior leadership roles. For example, only 27 per cent of executive
leadership roles are held by women in the ASX 300 and the number of companies who have no women in
their executive leadership teams has increased from 44 to 46 since 2021 (CEW 2023).
In considering diversity and its implementation, it is important to reiterate that policies are actually set
by boards working in conjunction with managers. Good policies are always crucial for good corporate
governance. Ensuring the right people are contributing within an organisation and that the right people are
chosen as managers and directors is crucial for good corporate governance.

EXECUTIVE REMUNERATION AND PERFORMANCE

In recent years, the remuneration of senior executives including CEOs and executive directors (and
sometimes, non-executive directors) has been the focus of considerable attention. Debate inevitably
focuses on the absolute levels of remuneration paid (i.e. the total size of all components of remuneration
packages including termination payments) in comparison with the pay of average wage and salary earners,
and increasingly on the extent to which payments are made regardless of past performance success.
Furthermore, as a result of the GFC, attention is now being paid to the apparent willingness of directors
and senior executives to take risks to create profits, leading to the appearance of solid financial performance
by their organisations. Some boards and executives took higher risks when their remuneration was based
upon short-term financial performance, effectively acting for personal gain.
Debate has now turned to whether payments effectively achieve future performance, and how they relate
to incentive and motivation. The pressure to link performance and pay has seen some jurisdictions mandate
the disclosure of executive remuneration to shareholders and the wider community, described as ‘having a
say on pay’ in countries such as Australia, the UK and the US. More recently, recommendations for boards
to institute ‘clawback’ and ‘malus’ policies to recoup excessive performance-based remuneration have
featured in best-practice guidance.
.......................................................................................................................................................................................
CONSIDER THIS
Research the definitions of ‘clawback’ and ‘malus’ as they apply to remuneration plans. If you were an executive
manager subject to a remuneration plan containing these types of clauses, which one would you be most wary of?
If you were a shareholder, which would you be most supportive of?

As this discussion shows, the debate on executive remuneration is complex; this is further demonstrated
by the subject occupying almost 500 pages in the Productivity Commission’s 2009 report on executive
remuneration in Australia, which has influenced legislative changes in Australia. A speech delivered in
2012 by Jan du Plessis, chairman of Rio Tinto, revealed that corporations are beginning to recognise the
need to curb remuneration excess. He stated that the ‘spiral’ in executive pay in the past two decades
‘simply cannot continue … Many businesses sometimes appear to have lost all touch with reality’
(du Plessis 2012).
Example 4.2 further illustrates that the perceptions of shareholders, employees and the community with
respect to excessive executive remuneration are having an effect.

EXAMPLE 4.2

Remuneration — Headline Illustration

Narev Signals End to CBA’s Pay Freeze
Commonwealth Bank of Australia will lift a freeze on executive salaries in the wake of its record annual
profit, paving the way for pay increases for its senior managers.
CBA, which reported a $7.8 billion profit last week, had the freeze on salary increases in place throughout
the 2013 financial year, but will not continue it into 2014.
Despite ending the salary pause, CBA chief Ian Narev has sought to play down expectations of big
pay increases.
‘The specific freeze, we haven’t said that we are going to roll that over, but we have said to everybody
starting with me that we are going to be very, very moderate in the way that we think about any
remuneration. And those decisions for this year are just starting to be made now,’ Mr Narev said.
‘We are keeping a very strong look on year-on-year remuneration increases, that has always got to start
with me and my executive team.

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 ‘We are not saying anything publicly about exactly what the numbers on remuneration increases are but
we are keeping them very much in tune with the environment.’
CBA’s pay freeze applied to the bank’s top 400 managers, including Mr Narev and his senior
executive team.
However, it only covered fixed salaries and not performance-based incentive bonuses, which are linked
to meeting targets for profits, share price performance, customer satisfaction and other factors.
CBA’s shares are trading at near-record highs following its bumper profit result last week, while it is
ranked number one for customer satisfaction among the big four banks for both retail and business
customers.
The bank will disclose the pay of senior executives for 2013 — including bonuses — in its annual report
this week.
‘In an environment where customer satisfaction is good, shareholders are happy, people engagement
is good and we have managed risk well, the executives tend to do pretty well, that’s what short-term
incentives are all about. But again, overall in terms of remuneration, we have to make sure we cut our
cloth to suit the times,’ Mr Narev said.
Source: Liondis, G 2013, ‘Narev signals end to CBA’s pay freeze’, The Australian Financial Review, 19 August, accessed
August 2023, www.afr.com.

International Debates about Remuneration Levels and Fairness

An important factor in the debate about executive remuneration (even before we consider the relationship
between remuneration and performance) is that excessive remuneration is an issue of international concern.
In 2018, the average salaries of chief executives in the United States was 265 times the pay of an average
worker. Elsewhere, as shown in table 4.1, the gap is lower.

TABLE 4.1 Wage gap between CEOs and average work pay (multiples) in 2018

Location Multiple

United States 265

India 229

United Kingdom 201

Canada 149

Germany 136

China 127

Source: Adapted from Statista 2023, ‘Ratio between CEO and average worker pay in 2018, by country’, accessed August 2023,
www.statista.com/statistics/424159/pay-gap-between-ceos-and-average-workers-in-world-by-country.

In Australia, apart from an outlier year in 2021, the pay gap between the average CEO pay for ASX 100
companies (as shown in figure 4.2) appears to be trending downwards slightly while for ASX 101–200
companies the trend is slightly upwards (also shown in figure 4.2).
The pay gap between executive pay and average workers’ wages continue to be the subject of strong
social and political commentary in the US and elsewhere, with the city of San Francisco introducing The
Overpaid Executive Tax (also referred to as the Overpaid Executive Gross Receipts Tax) in 3 November
2020 (effective 1 January 2022). Generally, this tax imposes an additional gross receipts tax on taxable
gross receipts from businesses in which the highest-paid managerial employee, within or outside of
San Francisco, earns more than 100 times the median compensation of employees based in San Francisco.
In its first year of operation, the tax is expected to bring in USD125 million and has proved more resilient
than other local revenue sources. This type of tax generally creates an incentive to both rein in executive
pay and lift up worker wages, all while generating significant new capital for vital public investments
(IPS 2023).
The question, only very slowly being answered, is how far corporations can increase salaries without
creating community reactions that hurt themselves and shareholder wealth. The surge in procedures
designed to empower shareholders to control executive salaries and specific responses by governments
indicate that there is a limit — albeit a limit that is hard to state with any precision.

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230 Ethics and Governance

 FIGURE 4.2 Pay gap between the average CEO pay for ASX 100 and ASX 101–200 companies

Graph 1: Average ASX 100 & ASX 101–200 realised CEO pay
relative to average adult earnings FY14–FY22*
$10 000 000 120
$9 000 000
100
$8 000 000
$7 000 000
80
$6 000 000
$5 000 000 60
$4 000 000
40
$3 000 000
$2 000 000
20
$1 000 000
$0 0
FY14 FY15 FY16 FY17 FY18 FY19 FY20 FY21 FY22

ASX 100 average realised pay ASX 101–200 average realised pay
ASX 100 multiple of adult average ASX 101–200 multiple of adult average
total earnings (RHS) total earnings (RHS)
*Average earnings is average weekly full time adult total earnings as at May of each year, from ABS 6302.
Source: ACSI (Australian Council of Superannuation Investors) 2023, CEO pay in ASX200 companies: July 2023, Australian
Council of Superannuation Investors, accessed August 2023, https://acsi.org.au/wp-content/uploads/2023/07/CEO-Pay-in-ASX200-
companies-ACSI-Research-July-2023.pdf.

Payments for Past and Future Performance — and Motivation

As noted in module 3, according to the UK FRC Code and the ASX Principles, remuneration approaches for
executive directors and non-executive directors should be very different. To communicate this information,
Recommendation 8.2 of the ASX Principles states that ‘a listed entity should separately disclose its policies
and practices regarding the remuneration of nonexecutive directors and the remuneration of executive
directors and other senior executives’ (ASX CGC 2019, p. 30).
Non-Executive Directors
Good practice guidance, such as the ASX Principles, recommend that non-executive directors should not
be remunerated according to performance achieved or to be achieved, except to the extent that they hold
shares in the company and benefit from a rising share price. Their remuneration should be based primarily
on a reasonable return for time dedicated to the corporation’s business. They should not receive incentive-
based payments and should receive only basic additional payments (such as superannuation at reasonable
levels and out-of-pocket expenses).
The payment of non-executive directors is best undertaken by deliberation of the entire board. Their
overall remuneration packages should be fully known and understood by shareholders so that they
understand how non-executive directors are remunerated and also so that any shareholder approvals are
fully informed. While current Australian law gives shareholders limited influence over the amount of cash
paid to executives or employees, the overall pool of cash paid to the non-executive directors as a whole
requires specific shareholder approval.
The reason for the different pay arrangements for non-executive directors and executives is simple —
performance-based remuneration is not consistent with an independent approach to decision making and
it is necessary that all non-executive directors (even those otherwise not independent) are not subject to
remuneration types that lessen or deny independence.
Executive Directors and Other Senior Executives
Modern corporate governance approaches assume that the remuneration of executive directors (and some
senior executives who are not directors) is the key focus of those directors who comprise the remuneration
committee. Following the GFC of 2007–08, new regulations came into place to ensure that remuneration
committees have far greater independence to ensure better practices with respect to remuneration of
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executives and executive directors. Such rules include the fact that the UK FRC Code (Provision 32)
requires that only independent directors should be on the remuneration committee. In Australia, the ASX
Principles permit executives to be on the remuneration committee, but the Principle 8 commentary states
that ‘no individual director or senior executive should be involved in deciding his or her own remuneration’
(ASX CGC 2019, p. 30).
Performance-Based Remuneration
Payments to economic agents (in this case, executive directors and other managers — sometimes
also including other ‘incentivised’ employees) typically consist of ‘fixed’ and ‘at-risk’ remuneration
components. The fixed portion represents a base payment that is constant regardless of individual
and/or corporation performance, such as flat annual salaries and superannuation (i.e. retirement fund
contributions). The at-risk portion (i.e. failure to perform means that the recipient will suffer reduced or
non-payment) is based on the agent and/or entity reaching certain goals and performance benchmarks (both
short- and long-term). These benchmarks are often called key performance indicators (KPIs). In Australia,
short-term incentive payments tend to be paid annually and they are more likely to be cash based, whereas
long-term incentives are based over three to four years of performance and have a greater focus on shares
or options.
Remuneration of executives is often referred to as packaged (which can be very complex, partly for
tax reasons). The performance-related components of these packages can be especially complicated and
may consist of bonuses, shares and share options, other financial benefits, and even some types of private
expense reimbursements, such as allowances for a second home.
Performance payments should not just be a reward for past superior performance but should be designed
to motivate future performance. This motivation needs careful consideration because, recognising the
nature of agency theory, it is vital that the remuneration structure appropriately builds on the self-interest
of the manager(s). A good remuneration system will promote goal congruence between the managers, the
board and the shareholders, and will help avoid the worst aspects of agency costs.
Ideally, KPIs should not refer only to past performance but also to motivate and enhance future
performance. For example, share-based awards may be granted to certain executives for good past
performance but may also include future performance conditions (including service conditions) that must
be satisfied before the executive becomes unconditionally entitled to the share-based award.
An area of recent strong attention relates to payments made upon early resignation from executive
responsibilities. Boards and their remuneration committees need to take great care to ensure that payments
made when executive directors and other senior executives retire or resign are in fact relevant to
performance, and that the concerns of shareholders and society generally are understood and addressed.
The concept of repayment of undeserved remuneration is another important control measure, sometimes
referred to as a ‘clawback’. This concept is consistent with a rule in the US Sarbanes–Oxley Act 2002
and Provision 37 in the UK FRC Code. It is also seen in the current ASX Principles, in the commentary
to Recommendation 8.2, which states that the report should ‘include a summary of the entity’s policies
and practices regarding the deferral of performance-based remuneration and the reduction, cancellation or
clawback of performance-based remuneration in the event of serious misconduct or a material misstatement
in the entity’s financial statements’ (ASX CGC 2019, p. 30).
Australia’s prudential regulator, APRA, released a draft set of prudential requirements for remuneration
that reflected concerns expressed during the royal commission into misconduct in the financial services
sector chaired by Commissioner Kenneth Hayne. Commissioner Hayne’s concerns related to performance-
based incentive payments being tied to financial success while being perceived to downplay the need for
advisers, bankers and other participants in the financial services sector to look after the welfare of the
consumer (APRA 2019a).
The four objectives of the revised regime announced by APRA as a part of consultation were to:
• strengthen governance of remuneration frameworks and outcomes, in particular through an expanded
Board role, where the Board needs to be active and have direct oversight;
• set overarching remuneration objectives that inform design of all remuneration arrangements and
influence remuneration outcomes;
• limit the use of financial performance metrics (share price and profit-based); and
• set minimum deferral periods (up to seven years) for senior executives to provide more ‘skin-in-the-
game’ through better alignment to the time horizon of risk and performance outcomes (APRA 2019a).

The point suggesting that remuneration metrics ought to have a limited focus on share price and company
profits is seeking to directly address the concern raised in the interim and final reports of the Hayne
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Royal Commission. Conversely, media reports have periodically suggested that approaches that do not
tie remuneration to financial success are disapproved of by shareholders and shareholder advocates.
Disclosure, Transparency and Remuneration
Increased reporting in relation to remuneration, especially to shareholders and others who are the intended
users of annual reports, is a growing trend internationally.
Best practice corporate governance requires that there should be transparency in setting directors’
remuneration. A key governance principle is that no individual should be involved in setting or determining
their own remuneration levels. This can become difficult when setting the chairman’s fee, although at
least Australian shareholders must approve the overall fee cap available to the non-executive directors.
To enhance the transparency of the remuneration-setting process, as we have already discussed, inter-
nationally, laws now require a remuneration report to be included within the annual directors’ report
to shareholders.
The Productivity Commission’s 2009 report on executive remuneration provides valuable discussion of
some international approaches to remuneration disclosure (some of which are undergoing further changes
to improve performance linkage and shareholder understandings and control). For example, the report
notes that in Germany, public limited corporations must provide a breakdown of total earnings of each
member of the management board. Corporations can opt out where three-quarters of shareholders vote to
do so and only for a maximum of five consecutive years (Productivity Commission 2009, p. 245). This is
part of an international trend towards requiring disclosure of executive remuneration (Right2Info n.d.).
In the US, the Securities and Exchange Commission (SEC) amended its rules in December 2006. It
required that executive remuneration be accompanied by a detailed explanation of the rationale for that
remuneration, to strengthen the communication with shareholders on remuneration issues. The Dodd–
Frank Act (US), effective from January 2011, has given shareholders a non-binding vote on top executive
compensation. To better inform the public of executive remuneration, the SEC adopted a final rule that
requires firms to disclose the ratio between CEO compensation and median employee compensation, as
directed by section 953(b) of the Dodd–Frank Wall Street Reform and Consumer Protection Act 2010
(Dodd–Frank Act). Companies were first required to provide such disclosures for their first full fiscal year
beginning on or after 1 January 2017.
In the UK too, investors are better informed about how much directors have been and will be paid, along
with how pay relates to corporate performance. As a result, shareholders of the approximately 900 Main
Market companies (i.e. larger, more established corporations listed on the London Stock Exchange) will
be better prepared to hold companies to account, using clearer information on pay to exercise their new
legally binding vote on executive pay (BIS 2013).
Not everyone agrees with the strong emphasis on disclosure and reporting, as wide disclosure may not
always lead to the expected benefits. Some commentators argue that an increase in remuneration disclosure
has led to higher and, indeed, excessive levels of remuneration being paid to executives and some directors.
The argument is based on the premise that remuneration committees do not wish to be seen to be paying
less-than-average market remuneration. Therefore, as corporations seek to set their remuneration levels
slightly above the average, this leads to higher payments across the market incrementally over time. If
we accept these concerns as real, then it becomes apparent that the growing strength of direct shareholder
voting (as in the Australian two-strikes rule) is an important factor in controlling possible reporting-induced
salary growth.
Tightening Rules Regarding Remuneration — Australian Illustrations
As noted above, the two-strikes rule in Australia, along with its related reporting changes, is a direct
result of the 2009 Productivity Commission report on executive remuneration and is consistent with
general changes in other jurisdictions internationally. The changes include greater clarity in reporting
remuneration, including the true nature of current, past and future remuneration available to executives.
Shareholders should more easily be able to understand the real nature of remuneration and whether there
is a direct relationship with performance. If, contrary to recommendations, performance-related at-risk
remuneration is being paid to any non-executive directors, the clearer reporting regime will also identify
this undesirable corporate behaviour.
One legislative response to excessive remuneration that has proved successful is the noticeably reduced
size of so-called ‘golden handshakes’. In 2009, the law was changed so that any termination payment
exceeding 100 per cent of the executive’s 12-month fixed pay would need shareholder approval. Previously,
the limit was seven times the average total pay of an executive over their final three years of employment.
This earlier ‘seven times’ rule allowed Oz Minerals to correctly pay its departing CEO $8.35 million
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in 2008. It is interesting to note that an earlier proposal to pay the CEO $10.7 million at his departure had
been voted down by shareholders (Leyden 2008). This larger amount was subject to a shareholder vote as
it exceeded the payment that could, at that time, be made without shareholder approval.
A broad-ranging report into executive remuneration in Australia was completed by the Australian
Government Corporations and Markets Advisory Committee (CAMAC 2011). This inquired into aligning
executive remuneration with company performance, and examined how the incentive components of
executive pay arrangements could be simplified in order to improve transparency and strengthen the
correlation between the interests of the company’s executives and the interests of shareholders.
Remuneration, Risk and the GFC
An issue of great prominence since the GFC is that performance payments should relate to genuinely
superior performance and proper understandings of risk. Complex financial products that were not well
understood appeared to create very large positive financial outcomes (i.e. profits). Many corporations,
rewarding executives for achieving these large profits, paid enormous bonuses and profits-based rewards.
These reward mechanisms encouraged executives to take higher risks to gain higher bonuses related to
the rising profits. However, not only were the risks associated with the complex financial products not
understood, but frequently the expected profits eventually proved, in the long term, to be non-existent or
far smaller than previously measured. However, by then the bonuses had been paid.
This matter has also been addressed in the banking and finance sector internationally by the Financial
Stability Board (FSB), which was established under the auspices of the G20 nations. The FSB publishes
a range of documents, including internationally recommended implementation standards that relate to
its ‘Principles for sound compensation practices’ (FSB 2009). In US terminology, ‘compensation’ is the
equivalent of ‘remuneration’. These standards reflect the types of approaches we are considering at present
but with a significant addition — the concept that, within financial sector institutions, it is important for
boards and management to identify persons who are material risk-takers and to enact special procedures
in relation to remuneration for these people.
Reward structures should be designed so that self-seeking executives cannot damage corporations by
seeking early reward with high-risk deals that have dubious long-term consequences.
Public Examples
A criticism of many organisations is that, despite poor performance during and after the GFC, remuneration
levels for executives were often unaffected. Bonuses paid to executives of organisations who were per-
forming very poorly led to public anger and frustration. Many executives who experienced a remuneration
decline were even able to renegotiate their contracts to ensure they did not suffer as badly. Headlines at
the time were scathing and highly personal.
It is hardly surprising that, internationally, there was a flurry of regulatory changes. Examples 4.3
and 4.4 provide further insight in this area. BHP (formerly BHP Billiton) is an example of a corporation
that arguably is fully in touch with modern regulatory good corporate governance. Note its emphasis on
clearly defined KPIs (including non-financial KPIs) that link to shareholder value. Also, note the fact that
it clearly defines that severance payments should not result in unjustified payments.

EXAMPLE 4.3

America’s Most Overpaid CEOs

1. John Chambers
Company: Cisco Systems
Total compensation: USD18 871 875
Change in stock price: –31.4% (FYE: 7/30/2011)
Cisco (NASDAQ: CSCO) was once considered the most well-run large company in Silicon Valley. That
has changed in the last year as it has become clear that Chambers, a dean of Valley CEOs, diversified
that company too far beyond its core router business. Margins in the new set-top box, WiFi, and video
conference businesses do not match those of routers. Chambers has begun a retreat from his M&A
[Mergers & Acquisitions] strategy, trying to refocus the company. He has had only limited success so
far. Cisco has also announced that its rapid growth will slow considerably in the next two years.
Source: McIntyre, DA 2011, ‘America’s most overpaid CEOs’, 24/7 Wall Street, 20 October, accessed August 2023, https://
247wallst.com/investing/2011/10/20/americas-most-overpaid-ceos.

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234 Ethics and Governance

 Example 4.3 identifies the CEO of Cisco as the most overpaid CEO in terms of remuneration (compared
with stock performance). Cisco agreed to pay USD5 billion for controversial News Corp subsidiary NDS
in early 2012 and its market capitalisation recovered to above USD100 billion in August 2012.
There are many examples in the press illustrating the nature of the problem. Commonly, the reports
are accompanied by highly emotive language that illustrates the feelings held by many where corporate
excesses are represented. These excesses are most commonly represented by excessive remuneration and
that is where the most attention arises. Interestingly, other issues can be of concern too — including
the extent to which some executives and directors seem to seek power and/or self-publicity — although
controls on these additional excesses are as yet few.
In contrast to the previous discussion about perceived excessive remuneration, consider BHP (formerly
BHP Billiton).

EXAMPLE 4.4

BHP
In August 2012, the BHP CEO unveiled a USD2.7 billion write-down and promptly declared he would
neither receive nor accept any short-term bonus for the 2011/12 financial year. This large multinational
corporation has the following key principles in its Remuneration Committee’s policy on remuneration.

In determining the policy, the Committee will take into account all factors which it deems necessary.
The objectives of the policy will be to:
• support the execution of the Group’s business strategy in accordance with a risk framework that
is appropriate for the organisation;
• provide competitive rewards to attract, motivate and retain highly skilled executives willing to work
around the world;
• apply demanding key performance indicators including financial and non-financial measures of
performance;
• link a large component of pay … to the creation of value for the Group’s shareholders …;
• ensure remuneration arrangements are equitable and facilitate the deployment of human resources
around the Group; and
• limit severance payments on termination to pre-established contractual arrangements that do not
commit the Group to making unjustified payments in the event of non-performance.

Source: BHP 2019, ‘Remuneration committee terms of reference’, p. 2, accessed August 2023, www.bhp.com/-/media/
documents/ourapproach/governance/190812_remunerationcommitteetermsofreference.pdf?la=en.

QUESTION 4.3

A publicly listed corporation’s remuneration committee is interested in the forms of remuneration

that can be offered to management to motivate them to maximise value for the shareholders.
(a) In the context of remuneration (and related agency issues), what are the benefits to be obtained
by the appointment of independent directors?
(b) To which performance measures could different forms of remuneration be linked?
(c) How can shareholders be confident that managers are paid appropriately?

COMPLIANCE WITH THE CORPORATIONS ACT

Directors must comply with their obligations under the Corporations Act and, of particular relevance
to members, this includes the requirements to comply with reporting obligations to their stakeholders.
Part 2M.3 in Volume 2, Chapter 2M of the Corporations Act deals with the financial reporting and auditing
obligations and relevant divisions cover:
• annual financial reports and directors’ reports (Division 1)
• half-year financial reports and directors’ reports (Division 2)
• annual financial reporting to members (Division 4)
• lodging reports with ASIC (Division 5).

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MODULE 4 Governance in Practice 235

 There are a series of provisions in the Corporations Act that tie directly into what members of an
accounting body required to comply with ethical pronouncements issued by the APESB must adhere to
as professional obligations. Members are required to ensure they comply with accounting standards as
issued by the relevant standard setter. This is also a requirement of a person who assumes the role of a
director of a company under s. 296 of the Corporations Act. Compliance with the accounting standards
is paramount as is compliance with s. 297, which requires any company preparing financial statements to
ensure those statements represent a true and fair view of the company’s or consolidated entity’s overall
financial performance and financial position.
Directors are obliged to provide additional information in the notes to financial statements if compliance
with accounting standards will not give a true and fair view. It should be noted that the additional
information a company may provide can only be provided in the notes to the financial statements and
that the main financial statements must be compliant with accounting standards. Failure to comply with
accounting standards may make it difficult for users to compare financial statements and it also makes a
reader more uncertain about the basis on which the financial statements were prepared.
Boards must also be careful that they do not engage in earnings management, which is sometimes
known as ‘window dressing’ financial statements so that they look more favourable to stakeholders than
they otherwise might if the company had accounted for transactions appropriately. Earnings management
may include trying to find ways of deferring income to a later financial period and bringing income
forward so the business engineers a more positive financial result. Deferring or bringing forward income
or expenditure is a way of seeking to present company results in a misleading way, which is contrary to
director obligations under the Corporations Act.
.......................................................................................................................................................................................
CONSIDER THIS
Read sections 296 and 297 and take a note of the reason why the law would only permit information provided by a
company in the notes to financial statements in circumstances where directors feel truth and fairness is compromised
by complying with accounting standards.
.......................................................................................................................................................................................
CONSIDER THIS
Consider the issue of earnings management and take note of which of the fundamental principles of Compiled
APES 110 Code of Ethics for Professional Accountants (including Independence Standards) engaging in earnings
management may breach.

AUDITING THE FINANCIAL STATEMENTS

Boards must understand the role of the independent external auditor and the regulations that surround audit,
including the role of International Standards on Auditing (ISAs) and International Financial Reporting
Standards (IFRS). These bodies of international standards are imported into the Australian reporting
framework with the necessary additions to ensure they are able to be applied under Australian law. There
are also guidance statements that are issued that deal with the application of auditing standards in specific
circumstances. Auditing requirements and the role of the external auditor is set down in Division 3 of
Part 2M.3 of the Corporations Act:
• Section 307: Audit
• Section 307A: Audit to be conducted in accordance with auditing standards
• Section 307B: Audit working papers to be retained for 7 years
• Section 307C: Auditor’s independence declaration
• Section 308: Auditor’s report on annual financial report
• Section 309: Auditor’s report on half-year financial report
• Section 310: Auditor’s power to obtain information
• Section 311: Reporting to ASIC
• Section 312: Assisting auditor
• Section 313: Special provisions on audit of debenture issuers and guarantors.
The sections of the Corporations Act referred to above must be read by members engaged in audits in
conjunction with obligations outlined in auditing standards and codes of ethics.
.......................................................................................................................................................................................
CONSIDER THIS
Access the Corporations Act (www.legislation.gov.au/Series/C2004A00818) and read Division 3 of Part 2M.3 in its
entirety. Take detailed notes on the key elements of the provisions covered in this section of the law.
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236 Ethics and Governance

.......................................................................................................................................................................................
CONSIDER THIS
Review s. 540 of Compiled APES 110 and briefly summarise the significance of the section as it relates to the conduct
of audit.

The auditing and accounting standards and their related rules, which are contained in laws, regulations
or supplementary guidance developed by standard setters, have become very important in recent years,
with a new focus on audit and audit committees, especially as part of international corporate governance
reforms. These reforms have been under development for a long time. The major impact of the GFC, and
the consequent turmoil in the banking sector internationally, prompted further emphasis on the need for
changes, which are ongoing. Boards and management in all corporations must understand the existing
rules at any time and also the changes as they occur.
Internal auditors are also important, but they are very different and are not discussed further in this
module as they do not have, and cannot have, the same recognised actual independence. This lack
of independence comes from working as employees within the company and under the authority of
senior management. Boards must realise that this lack of independence exists and be aware of the
potential pressures faced by internal auditors from other employees and management that may affect their
independence. Boards should therefore consider the measures that can be taken to give the internal audit
function some degree of independence from management.
Note that various audits, including internal audit, are covered in detail in the Advanced Audit and
Assurance subject.
The international auditing standards state that the external auditor (referred to as the practitioner in the
auditing standards) of general purpose financial statements (annual and other reports) is required to express
an opinion, resulting from a professionally formed judgement, whether the reports and related information
are drawn up in accordance with an identified financial reporting framework. The reports themselves are
prepared by the responsible party (the board and senior management) based on proper operations within
the corporation, including the correct operation of the entire accounting system.
The auditor’s report is most importantly addressed to the ‘intended users’ — including the shareholders
and other users who, in the auditor’s professional judgement, objectively are relevant. The preparation of
the reports and the auditing of the reports are both required to comply with a relevant framework — most
commonly IFRS. The company prepares its systems and accounts so that the information is compliant with
the accounting standards.
The auditor then checks the systems and the information that results to ensure that the accounting
standards compliance required has been achieved. Professional scepticism is required by auditors to detect
instances of earnings management. ASIC (2022a) in INFO 222 states that:
Exercising professional scepticism is a critical part of conducting quality audits. The auditor must critically
assess, with a questioning mind, the validity of the audit evidence obtained and management’s judgements
on accounting estimates and treatments.

Once checks have been completed, the auditor will give a statement of their professional-judgement–
based opinion, upon which intended users are entitled to rely. The auditor is obliged to obtain sufficient
appropriate evidence to support their opinion and a failure to do so can leave the auditor liable for not
identifying a risk of misstatement in the reports. This is why auditors can be liable where materially
misleading information results in, for example, loss to shareholders. Even so, the fundamental liability
for materially incorrect information being in the reports is that of the board and management.
Beyond this, the board must understand the importance of auditor independence. For example, when the
Enron failure occurred, one of the biggest issues related to the fact that the corporation’s auditor, Arthur
Andersen, counted Enron among its largest clients, billing Enron USD52 million for audit (USD25 million)
and non-audit services (USD27 million) in 2000 (Permanent Subcommittee 2002). The auditing standards
now impose obligations on auditors to identify a threat to independence where fees from one client are
unduly large. If a board (or management) seeks to control or influence auditors in a material way (in the
auditor’s judgement), this must be reported — including in the auditor’s statement in the annual report.
Some jurisdictions also require notification to local corporate regulators.
The auditing standards require that auditors identify those charged with governance within the organisa-
tion. This group should comprise those with whom the auditor communicates on matters relating to audit
and reporting. Ideally, the group would comprise a correctly structured audit committee that includes
only non-executive directors. In some jurisdictions, the non-executive directors must fully satisfy the
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MODULE 4 Governance in Practice 237

independence rules, while in other jurisdictions, a majority should be independent and the remainder,
while still non-executive, may be non-independent.
Since the auditor is auditing executives, such as the CFO and the CEO, the auditor should not report to
these people. To do so would be contrary to the required independence. The board (and senior management
generally) must be aware of these general rules and that the rules will be enforced by local legislation.
Commonly, the accounting standards and the auditing standards are enforced as part of the local laws.
The Centro case (Harper 2012), discussed in module 3, is revisited in example 4.5 to emphasise the
importance of basic good corporate governance including the need for clear understandings and good
policies regarding disclosure, auditing and related regulations.

EXAMPLE 4.5

Centro and PwC Auditor Liability

PwC, Centro Pitch in for Investor Losses
Global accountancy group PricewaterhouseCoopers will pay almost $70 million to investors who lost
money in the collapse of the Centro property group. Centro Retail Australia revealed yesterday it would
pay $85 million of the $200 million settlement bill — the biggest in Australian class-action history.
PricewaterhouseCoopers, Centro’s auditor, will pay $67 million. Centro Retail released details of the
settlement carve-up yesterday, while confirming it had agreed to settle shareholder class actions. It came
as trading resumed in Centro Retail shares, which closed 2.3% higher yesterday at $1.89. Centro Retail
had requested a trading halt on Tuesday ahead of the settlement announcement.
About 5000 investors, represented by Maurice Blackburn and Slater & Gordon, had joined a class action
case against Centro for failing to disclose in 2007 it had $3 billion of debt due to be rolled over within a
year. The property group, made up of Centro Properties and the business it managed, Centro Retail, has
since restructured itself as Centro Retail Australia.
Centro Retail Australia chairman Dr Bob Edgar said the settlement was a commercial decision taken
to allow the company to ‘put this matter behind it’ without the distraction and expense of a trial
or appeals. The former Centro Properties Group will pay $10 million of the settlement balance, with
$38 million available through insurance proceeds.
Source: Harper, J 2012, ‘PwC, Centro pitch in for investor losses’, Herald Sun, 11 May, accessed August 2023, www.herald
sun.com.au.

REVIEWS OF AUDIT QUALITY AND AUDIT REGULATION

The work done by auditors is reviewed on a frequent basis by ASIC in its capacity as a regulator of audit
services and that review is in the form of an audit firm inspection program. This program involves the
regulator inspecting the way in which firms regulate auditing processes within their own organisations
and whether compliance with auditing standards, professional standards and relevant laws is achieved in
the way they deal with audit over time. ASIC information sheet INFO 222 provides insight as to what the
corporate regulator looks for inside an audit firm when it inspects audit working papers and the professional
culture within a practice.
The information sheet states that:
Audit quality refers to matters that contribute to the likelihood that the auditor will:
• achieve the fundamental objective of obtaining reasonable assurance that the financial report as a whole
is free of material misstatement, and
• ensure material deficiencies detected are addressed or communicated through the audit report
(ASIC 2022a).

The corporate regulator further states that:

Auditors should deliver professional, high-quality audits through:
• a strong internal culture focused on quality audits and professional scepticism
• applying appropriate resources, experience and expertise to audits
• effective internal supervision and review
• robust accountability mechanisms
• identifying and addressing audit risks and issues on a timely basis
• accepting and addressing findings from audit inspections, including findings on asset values and revenue
recognition (ASIC 2022a).
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238 Ethics and Governance

 ASIC reviews a sample of audit files from the firms that audit the largest number of listed companies
in Australia and issues a report reflecting the results of the inspection. Report 607 — Audit Inspection
Program report for 2017–18 was issued in January 2019 (ASIC 2019) and found that, while there was
some improvement in audit quality evident through the sample, weaknesses in audit processes continued
to be evident. The review considered 98 files that were reviewed from 20 firms in total, with the six largest
firms being the source of 78 audit files that were reviewed by the regulator. ASIC recommended that audit
firms still needed to pay attention to the valuations of assets that appeared in financial statements and
also the way in which revenue was accounted for by entities. The top six audit firms in Australia were
also found to have conflicts with independence rules. ASIC found three instances where an audit firm’s
provision of other services to an external audit client resulted in a perception of a loss of independence.
‘In one case, the firm provided co-sourced internal audit work and, after consultation with the firm’s
independence experts, risk advisory services. In another case, the fees for non-audit services were double
the audit fee and there was no consultation with the firm’s independence experts,’ the ASIC inspection
report noted. ‘In the third case, the firm provided actuarial services to the company (not including final
valuation figures) and that work was also used as audit evidence.’ The ASIC inspection report emphasised
the need for accounting firms to ensure they evaluated the appropriateness of selling or providing non-audit
services to clients for which they are engaged to audit.
In its 2021–22 audit inspection report, ASIC noted that negative findings were returned for 27 of the
45 audit files reviewed. ASIC also noted that the ‘largest number of negative key audit area findings
continued to relate to the audit of revenue and the audit of asset values and impairment of non-financial
assets’ (ASIC 2022b, p. 3). With this in mind, ASIC included in the report ‘case studies of good practice
in these key audit areas’ and, as these areas continue to be a problem, ASIC also ‘reviewed the largest six
firms’ approaches to root cause analysis of negative findings’ (ASIC 2022b, p. 3).
.......................................................................................................................................................................................
CONSIDER THIS
In 2022, ASIC published Report 739 Root cause analysis: Audit firm thematic review. In this report, ASIC reviewed
12 root-cause analyses that audit firms conducted in response to negative quality reviews from ASIC in 2021–22.
Access the report (https://download.asic.gov.au/media/hwcekux3/rep739-published-19-october-2022.pdf) and
read Figure 2: Primary root causes identified by the firms. Identify the APES 110 fundamental principle(s) that may
not have been complied with.

The Parliamentary Joint Committee on Corporations and Financial Services began the process of
launching an inquiry into audit regulation following concerns raised by the parliamentarians that there
had been a decline in audit quality and that there was a dispute between the UK FRC and ASIC about
what constituted audit quality. The parliamentary committee issued its terms of reference and received
community submissions on the following topics:
1. the relationship between auditing and consulting services and potential conflicts of interests;
2. other potential conflicts of interests;
3. the level and effectiveness of competition in audit and related consulting services;
4. audit quality, including valuations of intangible assets;
5. matters arising from Australian and international reviews of auditing;
6. changes in the role of audit and the scope of audit products;
7. the role and effectiveness of audit in detecting and reporting fraud and misconduct;
8. the effectiveness and appropriateness of legislation, regulation and licensing;
9. the extent of regulatory relief provided by the Australian Securities and Investments Commission
through instruments and waivers;
10. the adequacy and performance of regulatory, standards, disciplinary and other bodies;
11. the effectiveness of enforcement by regulators; and
12. any related matter (APH 2019).

The committee published an interim report, Regulation of Auditing in Australia: Interim Report, in
February 2020, which contained 10 recommendations (APH 2020a). A final report, Regulation of Auditing
in Australia: Final Report, issued in November 2020, endorsed these recommendations, albeit with some
important caveats (APH 2020b).

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MODULE 4 Governance in Practice 239

.......................................................................................................................................................................................
CONSIDER THIS
Access the interim report (https://parlinfo.aph.gov.au/parlInfo/download/committees/reportjnt/024330/toc_pdf/
RegulationofAuditinginAustralia.pdf;fileType=application%2Fpdf) and read the 10 recommendations. If the recom-
mendations were implemented, what would the implications be for boards and companies?

QUESTION 4.4

What are some measures the board can undertake to enhance the likelihood of auditor
independence?
(Note that the auditor has a responsibility to make a statement of independence to those charged
with governance for inclusion in the corporation’s reports. Essentially, this question pertains to
the types of measures that can, and should, occur within the corporation to enhance auditor
independence rather than just relying on the auditor’s statement.)

4.2 IMPROVING CORPORATE GOVERNANCE

The module has discussed several ways to mitigate the risk of financial failure. In most cases this involved
aspects of corporate governance.
Now, in this section we identify two important additional recommendations for improving corporate
governance. The first is a more rigorous approach to risk management. The second involves focusing
more strongly on ensuring an independent chair.

RISK MANAGEMENT
Risk management enables a company to maximise opportunities and minimise losses (of all types) by
assessing the different types of risk and improving safety, quality and business performance.
Often, the result of risk assessment can enable the board to determine appropriate insurance cover, but
there will be occasions when no amount of insurance will protect the company. The successful management
of risk and the laying down of guidelines on how risk is to be assessed can have additional positive benefits.
The analysis of the data collected to enable the risks to be evaluated can lead to regular monitoring by
the board and management, thus raising their awareness of the issues involved for the company.
Risk management has been defined as ‘the culture, processes and structures which come together to
optimise the management of potential opportunities and adverse effects’ (Standards Australia 2004).
Within each organisation, the board must determine the framework it considers appropriate for the
company’s needs. Risk management is a process designed to serve a number of goals including to identify,
analyse, evaluate, treat, monitor and communicate the information gathered for the benefit of the company.
The nature of the data collected will depend very much on the activities undertaken by the company.
Risks may be associated with any activity, function or process of the company. For example, one type of
risk might stem from legal liability arising from the company’s conduct (e.g. the liability for environmental
damage in the 1984 Union Carbide gas disaster at Bhopal, India, or the BP oil spill in the Gulf of Mexico
in 2010).
Identifying, evaluating and addressing risk are essential features of modern management techniques.
The role of the board in understanding and dealing with enterprise risks has been well articulated in
many of the recommendations made by various committees over the years. The International Federation
of Accountants (IFAC) Professional Accountants in Business committee (PAIB) (IFAC 2004) identified
risk as being important for both performance and conformance aspects of governance.
The OECD (2010a) specifically identified the failure to properly identify and manage risk as being
central to the GFC. The need for improvement is apparent from the large number of corporate and
government failures seen in the GFC period. Good risk control should give superior performance, but
bad risk understanding and practices have resulted in financial disasters. In Australia, APRA has instituted
a rigorous policy of risk management in major financial institutions, which comprises:
systems for identifying, measuring, evaluating, monitoring, reporting, and controlling or mitigating
material risks that may affect its ability, or the ability of the group it heads, to meet its obligations to
depositors and/or policyholders. These systems, together with the structures, policies, processes and people
supporting them, comprise an institution’s risk management framework (APRA 2019b).
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240 Ethics and Governance

Internal Control and Risk Management
ISA 315 (Revised 2019) Identifying and Assessing the Risks of Material Misstatement (IAASB 2019)
defines a system of internal control as:
The system designed, implemented and maintained by those charged with governance, management and
other personnel, to provide reasonable assurance about the achievement of an entity’s objectives with
regard to reliability of financial reporting, effectiveness and efficiency of operations, and compliance with
applicable laws and regulations. For the purposes of the ISAs, the system of internal control consists of
five inter-related components:
(i) Control environment;
(ii) The entity’s risk assessment process;
(iii) The entity’s process to monitor the system of internal control;
(iv) The information system and communication; and
(v) Control activities (para. 12(m)).

Auditors must obtain an understanding of the internal control structure and gather related evidence to
support their assessment. Effectiveness and efficiency are performance-related matters. Weaknesses in
internal control can result in material losses (under-performance). Weaknesses in internal control can also
impact on compliance with legal and regulatory requirements, including resulting in misstatements in the
financial reports.
External auditors are required to report material weaknesses to the board on a timely basis and internal
auditors are expected to assist in this process using as much independent judgement as possible.
Over the past two decades, organisations have invested heavily in improving the quality of their internal
control systems because:
1. good internal control is good business — it helps organisations ensure that operating, financial and
compliance objectives are met
2. more organisations are required to report on the quality of internal control over financial reporting,
compelling them to develop specific support for their certifications and assertions
3. internal control assists in providing reasonable assurance that the entity is complying with applicable
laws and regulations.
One of the factors observed by Mardjono (2005) as being significant in corporate failures is that there are
companies that have had systems in place, but they have been poorly implemented. Mardjono considered
the cases studies of both HIH and Enron and found that principles of good governance were violated
because of the ‘inappropriate implementation of such a framework according to their own version of
financial benefits’.
Similar themes emerged throughout the various inquiries conducted into the Australian financial services
sector over more than a decade. In most instances, there were internal policies that required good
governance and quality control checks, but egregious misconduct still took place because there were
financial incentives that promoted this behaviour.
The Sarbanes–Oxley Act in the US has received much attention about the necessity of documenting
the internal controls that affect the financial information communicated to the investing public. In
particular, s. 404 of this Act specifies that annual reports lodged with the SEC must state management’s
responsibility for establishing and maintaining an adequate internal control structure and procedures for
financial reporting. Furthermore, the annual report must contain an assessment of the effectiveness of the
company’s internal control structure and procedures for financial reporting, as at the end of the most recent
financial year.
Another example of this link between corporate governance and risk management is found in ASX
Principle 7, which states that a listed entity should establish a sound risk management framework and
periodically review the effectiveness of that framework (ASX CGC 2019).
Internal Control and Risk Systems — Including Accounting, Risk Control and Internal Audit
Good accounting systems are vital for information — for shareholders and other stakeholders in terms
of external reporting and also for the immediate information needs of managers. The internal auditor can
assist in ensuring ongoing compliance, fraud control and system integrity and may assist in making the
work of the external auditor less costly and complex. Risk control systems are important for ensuring that
board policies regarding risk are effectively managed, so management decisions are undertaken safely and
unknown risks are minimised.

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INDEPENDENCE OF THE CHAIR OF THE BOARD
The OECD (2010a) has provided the following discussion in relation to the independence of the chair of
the board.
6.1 An important role for the chair of the board
46. The Key Findings (Box 3) note that there is an emerging consensus that the separation of CEO and
Chair of the board is a good practice but not one that should be mandated … ‘[I]n a number of countries
with single tier board systems, the objectivity of the board and its independence from management may
be strengthened by the separation of the role of the chief executive and chairman, or, if these roles are
combined, by designating a lead non-executive director to convene or chair sessions of the outside
directors. Separation of the two posts may be regarded as good practice, as it can help to achieve an
appropriate balance of power, increase accountability and improve the board’s capacity for decision
making independent of management’. The annotations [to the OECD Principles] also cover the case
of two tier boards noting that it is not good practice for the CEO to move to the chair’s post of the
supervisory board on retirement. Much the same can be said of single tier boards. A new chair that is
the retired CEO may still be too close to management and hence may not be sufficiently detached and
objective. There may also be confusion as to who is leader of the company.
…
49. … When the roles of CEO and the Chair are not separated, it is important in larger, complex companies
to explain the measures that have been taken to avoid conflicts of interest and to ensure the integrity
of the chairman function.

There is no imperative statement by the OECD that the chair should not also be the CEO. The fact that,
in many US corporations, ‘presidents’ are the chair and the CEO at the same time is perhaps an influencing
factor in the OECD conclusions. However, it seems that this policy of role separation is slowly achieving
traction even in the US. As noted earlier, there is a gradual trend in S&P 500 companies in the US towards
separating the roles of chair and CEO. Nonetheless, the importance of independence, or independence
protocols, is clearly identified in the US in Sarbanes–Oxley and in other governance systems principles.
Provision 9 in the UK FRC Code states that the roles of the chair and CEO should not be exercised by
the same individual. In Australia, Recommendation 2.5 in the ASX CGC’s document states that the chair
of the board of a listed entity should be an independent director and, in particular, should not be the same
person as the CEO of the entity.

4.3 CONTINUED EVOLUTION OF

CORPORATE GOVERNANCE
The improvement of corporate governance is an ever-evolving process rather than a static, finalised state.
This section briefly discusses some current factors that are expected to drive ongoing and significant
changes in corporate governance, including the emergence of artificial intelligence (AI) technologies,
cybersecurity and the post-pandemic inflationary environment. This is followed by a discussion on
the use of technology in corporate governance, updates to corporate governance codes and principles,
and sustainability reporting. The section concludes by exploring what these developments may mean
for boards.
The emergence of AI technologies is reshaping industries, business models and decision-making
processes. Corporate governance practices will need to adapt to address the ethical and accountability
considerations associated with AI adoption, such as data privacy, algorithmic transparency and the
responsible use of AI in decision making.
.......................................................................................................................................................................................
CONSIDER THIS
In March 2023, amid growing concerns about AI, a group of prominent technologists and corporations published an
open letter calling ‘on all AI labs to immediately pause for at least 6 months the training of AI systems more powerful
than GPT-4’ (Future of Life Institute 2023). In 2023, the Human Technology Institute at the University of Technology
Sydney published a report titled The state of AI governance in Australia (Solomon & Davis 2023).
Read the letter (https://futureoflife.org/open-letter/pause-giant-ai-experiments) and the Executive Summary,
Figure 2 and Figure 7 of the report (www.uts.edu.au/sites/default/files/2023-05/HTI%20The%20State%20of%20AI
%20Governance%20in%20Australia%20-%2031%20May%202023.pdf). If you were a director, would you support
the intent of the letter or other similar initiatives?
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242 Ethics and Governance

 Cybersecurity threats also pose increasingly complex risks to companies. Corporate governance must
place greater emphasis on identifying, assessing and managing these risks effectively (Rothrock, Kaplan
& Der Oord 2018). Specifically, boards should assume a more proactive role in overseeing cybersecurity
strategies and ensuring the implementation of robust risk management measures. To navigate the evolving
threat landscape, boards will also require enhanced cybersecurity expertise.
Lastly, the post-pandemic era has brought about rising inflation, and companies are facing increased
costs such as higher input prices and wages. In response, corporate governance must prioritise effective
cost management and financial planning to mitigate the impact of inflation on profitability and maintain
financial stability (McKinsey & Company 2022).

UPDATES TO CORPORATE GOVERNANCE CODES

AND PRINCIPLES
Given the evolving nature of corporate governance, governance bodies continually revise corporate
governance principles to mitigate the potential for corporate failure and foster robust corporate governance
practices. A notable instance of this is the recent update by the International Corporate Governance
Network (ICGN) to its Global Governance Principles (GGP) (ICGN 2021). The GGP are a set of principles
and guidelines developed to promote and guide effective corporate governance practices on a global
scale. These principles address critical areas, including shareholder rights and responsibilities, board
composition and accountability, audit and risk management, remuneration and incentives, stakeholder
engagement, ethics and corporate culture, and long-term value creation. In its 2021 revision, the GGP
have been updated to address considerable systemic changes impacting companies and investors. These
changes include the disruptive effects of the COVID-19 pandemic on economic activity, growing social
inequalities, technological and digital transformation, and the impact of climate change on the world’s
ecology. Similarly, as we saw in module 3, the OECD revised their Principles of Corporate Gover-
nance in 2023 to reflect ‘significant developments relevant to corporate governance, including, among
others, concerning sustainability, ownership concentration, institutional investors, and digitalization’
(OECD 2023).

THE IMPACT OF TECHNOLOGY ON CORPORATE

GOVERNANCE
The advent of technology offers corporations novel tools to enhance their corporate governance practices.
Notably, in the realm of risk management, the use of big data facilitates the collection and analysis of
vast datasets, enabling companies to identify potential risks and prevent potential crises. The integration
of AI and machine learning also empowers companies to identify patterns and trends that were previously
undetectable, thereby contributing to more effective risk management strategies. In relation to shareholder
engagement, digital platforms offer an avenue for more efficient communication about company perfor-
mance and initiatives with shareholders. The adoption of digital platforms can also benefit board process
and board effectiveness, enabling board members to share documents and information in real time, making
it easier for them to work together and make informed decisions. In relation to cybersecurity, the use
of blockchain technology ensures the verifiable and immutable storage of data, removing the need for
intermediaries in establishing trust between the company and its shareholders. Collectively, technology
can have a positive effect on corporate governance across four major domains.
1. It increases transparency, information dissemination and accountability.
2. It increases public participation.
3. It facilitates delivery of public goods and services with greater efficiency.
4. It heightens security measures to combat cyber risks.
.......................................................................................................................................................................................
CONSIDER THIS
Search the web for ‘corporate governance software’ to find out what features are available to assist boards in doing
their work, and to see what companies are using these portals. Boardable, Nasdaq BoardVantage and BoardEffect
may be listed in your search results.

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MODULE 4 Governance in Practice 243

SUSTAINABILITY REPORTING
Sustainability reporting is an essential element of corporate governance because it relates to how a company
manages risks and opportunities related to sustainability and environmental, social and governance (ESG).
Specifically, the board of directors plays a vital role here by including sustainability as a regular board
agenda item. Having directors with expertise in sustainability matters further enables the board to provide
strategic oversight and set sustainability goals.
To create a culture of transparency about the impact of companies on society and the environment,
regulators worldwide have developed standards and guidelines on sustainability reporting. For instance,
the International Sustainability Standards Board (ISSB) is developing a suite of standards that will result
in a high-quality, comprehensive global baseline of sustainability disclosures focused on the needs of
investors and the financial markets. The first of these standards, IFRS S1 General Requirements for
Disclosure of Sustainability-related Financial Information (IFRS 2023a) and IFRS S2 Climate-related
Disclosures (IFRS 2023b), were released in June 2023 with effect for reporting periods starting 1 January
2024. The European Union’s Corporate Sustainability Reporting Directive (CSRD), in effect since January
2023, mandates large companies and listed SMEs to report on sustainability matters. This new directive
empowers investors and other stakeholders with access to information to assess investment risks arising
from climate change and other sustainability issues (EUR-Lex 2022; European Commission 2023).
Similarly, in the United States, the SEC has proposed ESG disclosure rules that would require listed
companies to disclose their greenhouse gas emissions and other climate change risks (SEC 2022).
These emerging issues and trends in corporate governance have resulted in an expansion of the
responsibilities of boards and auditors, particularly for sustainability reporting. There are new risks
to manage (including transition risks and physical risks in the sustainability reporting space, data
privacy risks in the AI space, and data security risks in the cybersecurity space), strategies and business
models to review, compliance obligations to meet and potentially increased legal liability. To fulfill these
responsibilities, boards will need to carefully examine their skill sets and fill any gaps with new members,
education or contracted external expertise.
.......................................................................................................................................................................................
CONSIDER THIS
Refer back to figure 3.3 in module 3, and evaluate whether there is any portion of the corporate governance frame-
work that will not be affected by the topics covered in this section.

4.4 GOVERNANCE ISSUES IN THE

NON-CORPORATE SECTOR
GOVERNMENT BODIES
The ideal of service in government bodies is normally associated with higher standards of ethics in the
service of the general public. In a less competitive and profit-driven environment, the culture of the public
sector emphasises professional commitment in the delivery of government policy. There have been many
efforts to reform the governance of the public sector and to learn the lessons from the earlier reforms
introduced in the private sector.
However, there are many pressures exerted on the public sector, with changes in policy and practice
occurring with changes in government. Also, encountering almost unlimited demand for services (e.g. in
healthcare), the resourcing of the public sector is often stretched to the limits. The public sector is complex
and often challenging to management and employees.
The public sector also experiences governance and fraud problems as in the private sector. The boards of
directors of public agencies have to be as informed and vigilant as boards in the private sector. In Australia,
the Australian Institute of Criminology (AIC) regularly reports on fraud against the Commonwealth.
The AIC provided the following findings in relation to the ‘Fraud against the Commonwealth 2021–22’
census results.
• Seventeen per cent (13 464) of fraud allegations received or detected were from internal sources.
• Thirty-five per cent (1998) of fraud investigations were from internal sources. This was an increase of
42 per cent from the previous year.
• Fifty-six per cent (888) of internal fraud cases were detected by automatic processes (e.g. software
flags or alerts), 22 per cent (355) by a staff member and 8 per cent (132) by tip-offs from inside the
organisation.
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244 Ethics and Governance

• The number of internal fraud investigations that were finalised was 1591, and 903 were substantiated.
• Twenty-six per cent (237) of substantiated investigations resulted in termination of employment,
26 per cent (235) in disciplinary action and 16 per cent (143) in administrative sanction (e.g. suspension,
reassignment of duties, etc.).
• Three per cent (31) of investigations were referred to police or another authority.
• The amount of money lost to internal fraud during the year was AUD2 795 284, with AUD3 632 023
recovered (this recovered amount can include monies recovered from previous financial years due to
investigations that extend across financial years) (AIC 2023).
The public sector, as with most organisations, is becoming more proactive in preventing and detecting
fraud. In Australia, the Commonwealth Fraud Prevention Centre (2023) within the Attorney-General’s
Department was established in July 2019 to strengthen the counter-fraud capability of Australian Govern-
ment entities. The centre produces a number of tools to assist organisations to prevent and detect fraud
and, at the time of writing, is working with the UK to co-author a fraud prevention standard.
To foster best practice and effective governance, regulations and legislation are developed by the
government. While specific requirements can vary depending on the type and scope of the government
body, some key legislation relevant to best practice in Australia includes the following.
• Public Governance, Performance and Accountability Act 2013 (Cwlth). This Act establishes the gover-
nance and accountability framework for Commonwealth entities. It sets out principles and requirements
for governance, performance, risk management and fraud control within the public sector.
• Public Interest Disclosure Act 2013 (Cwlth). This Act provides protection to whistleblowers who
disclose information about wrongdoing, including fraud and corruption, within the public sector. It
establishes procedures for making protected disclosures and protects whistleblowers from reprisals.
• Australian National Audit Office Act 1997 (Cwlth). This Act establishes the Australian National Audit
Office (ANAO) and sets out its responsibilities for auditing and reporting on the financial management
and performance of Commonwealth entities. It promotes accountability and transparency in the
public sector.

CHARITIES AND NOT-FOR-PROFIT SECTOR

The Charities Act 2013 (Cwlth) (the Charities Act) sets out the legal meaning of a charity. To be recognised
as a charity, an organisation must:
• be not-for-profit
• have only charitable purposes that are for the public benefit
• not have a disqualifying purpose
• not be an individual, a political party or a government entity.
In addition to having these characteristics, an organisation also needs to meet the requirements
for registration set by the Australian Charities and Not-for-profits Commission (ACNC) in order
to be considered a charity. Once registered, the charitable organisation is required to adhere to
ongoing obligations to maintain its eligibility for registration, including the provision of annual
information statements.
In Australia, charities are often companies limited by guarantee (CLG), which is a type of organisational
legal structure that requires the organisation to reinvest any surplus towards the organisation’s purpose.
CLG are registered as companies with ASIC.
The charities and not-for-profit sector is widely respected for doing good with scant resources. To a
considerable degree this is true because the charities and not-for-profits working in health, education,
social and public welfare commonly face the governance problem of responding to a growing demand
with limited funds. Many surveys highlight the growing strengths of the governance of a sector that is
large both in size and in the revenue that individual not-for-profits receive and administer on behalf of
beneficiaries or members (Grant Thornton 2014).
Although the sector is known for robust and effective governance, this is not always the case. In 2015,
the ACNC issued a notice to the effect that 4000 charities listed on the register had failed to lodge financial
reports, and a further 5500 had their charity status revoked after failing to complete their reporting for two
consecutive years. As Ferguson reported in the Australian Financial Review:
Over the past 20 years there have been numerous inquiries into the charities sector. All agreed the sector was
complex, lacked transparency and accountability and needed a dedicated regulator. In 1995, the Industry
Commission (now the Productivity Commission) found there was ‘a lack of consistent data, a lack of access
to public information and a lack of standardised financial reporting’. It made a series of recommendations,
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including the introduction of an accounting standards for the sector and better public access to information.

MODULE 4 Governance in Practice 245

 There still isn’t a standardised financial reporting that charities must comply with. This means there is
no way to detect how efficient a charity is in the delivery of service because there is no accounting standard
to benchmark charities. There have also been attempts to investigate whether the tax arrangements are
appropriate (Ferguson 2015).

As one of the regulators for the charities sector ACNC regularly produces a summary of its compliance
activities. Their 2018 Charity Compliance Report (2019) includes an analysis of the concerns assessed
by the compliance team by risk type. Further analysis shows the risk category of potential breaches in
concerns assessed by the compliance team. These are both shown in figure 4.3. Note that a total of
85.5 per cent of the total potential breaches are related to the ACNC’s governance standards (ACNC 2019).
An earlier ACNC report (2014) offers three case studies illustrating problems of fraud, governance and
private benefit in charities, indicating that there can be multiple causes of concern. These are reproduced
in examples 4.6, 4.7 and 4.8.

EXAMPLE 4.6

Fraud
An employee of a charity contacted the ACNC, concerned that a senior member of staff was using the
charity’s credit card to make private purchases, unrelated to the work of the charity.
The ACNC contacted the charity’s board about the allegations, and commenced working with the charity
as part of its investigation. As an initial step, the board removed the individual alleged to have made the
purchases, the purchases were admitted and the individual repaid some of the debts.
However, the ACNC investigation found that the theft of funds was more extensive and significant than
initially identified. The charity worked with the ACNC throughout the investigation, committed to dealing
with the matter and continuing their charitable endeavours. With the support of the ACNC, they worked
through the issues of governance that had allowed the theft to occur, and sought to implement changes
to address the identified vulnerabilities. At the ACNC’s behest the charity filed a report to the police so
that the alleged fraud could be investigated by the appropriate authority.
Source: ACNC 2014, An overview of the first year of compliance activity, 28 January, accessed August 2023, www.acnc.
gov.au. © Commonwealth of Australia 2014.

EXAMPLE 4.7

Governance and Fraud

A former director of a charity contacted the ACNC to report a number of allegations of serious
mismanagement and fraud against a husband and wife, who were directors on the charity’s board. The
couple took over the charity, initially with the support of the members and existing board; however many
members cancelled their membership following the couple’s increasing abuse of their position within
the charity.
The complainant alleged that the couple illegally changed the charity’s constitution, redirected funds
for their own personal gain, and initiated the sale of the charity’s assets, without the knowledge or the
authority of its members. They also transferred large amounts of cash from the charity’s bank accounts
to personal accounts offshore.
The ACNC’s investigation into this charity suggests serious problems with the charity’s governance,
including failure to invite members to meetings, failure to hold discussions or votes regarding changes
to the charity’s constitution and selling the charity’s assets. It also found that records of meetings were
incomplete or inaccurate.
The charity is no longer operating on a day-to-day basis and the individuals who are the subject of the
complaint have left Australia; they have no intention of returning. The ACNC is liaising with the relevant
authorities overseas, as well as working to ensure control of the charity is returned to its members and
the assets protected.
Source: ACNC 2014, An overview of the first year of compliance activity, 28 January, accessed August 2023, www.acnc.
gov.au. © Commonwealth of Australia 2014.
............................................................................................................................................................................
CONSIDER THIS
Reflect on what steps ought to be taken by a board to avoid conflicts or perceived conflicts. How should a
board deal with issues related to fraud as described in example 4.7?

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246 Ethics and Governance

 FIGURE 4.3 Concerns assessed by compliance team by risk type and risk category

0.3%
Risk type
0.4% 0.3%
Private benefit
2%
2% Poor governance
Other
3% Criminal or improper purposes
4%
26% Mismanagement
5%
Harm to beneficiaries
6% Conficts of interest
Disqualifying political purposes
7%
Risk that assets will be lost
Not entitled to charity subtype
10% 22%
Reporting issues
Terrorism
13%
Record-keeping
Disqualified persons

Risk category
Governance standard 1: Purposes and
not-for-profit nature of a registered charity — this
includes concerns such as private benefit or
failing to comply with its charitable purposes.
Governance standard 2: Accountability to
members — this includes concerns such as failing
to hold annual general meeting or not providing
sufficient information to its members.
2.4%
Governance standard 3: Compliance with
2.7% 4.7% Australian laws — this includes concerns such
4.6%
as fraudulent or other criminal activity.
Governance standard 4: Suitability of
responsible persons — this includes concerns
such as disqualified persons being responsible
persons for charities.
41.2%
Governance standard 5: Duties of responsible
persons — this includes concerns such as financial
31.8% mismanagment, managing conflicts of interest.
Entitlement to registration: this includes
concerns such as sham charities, disqualifying
purposes or private benefit.
Non-compliance with record keeping
11.9% obligations: this includes concerns such
as a failure to keep adeguate financial or
0.3% operational records.
0.3% Non-compliance with reporting obligations:
this includes concerns such as a failure to
notify of changes to charity details, failure to
lodge annual information statement and errors
in financial reporting.
Concerns outside of the ACNC’s jurisdiction.

Source: ACNC 2019, Charity compliance report 2018, accessed August 2023, www.acnc.gov.au/sites/default/files/documents/
2021-07/charity_compliance_report_2018_0.pdf.

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MODULE 4 Governance in Practice 247

 EXAMPLE 4.8

Governance, Private Benefit, Conflict of Interest

The ACNC received a referral from another government agency in relation to a concern that members
of a charity were using charitable funds for personal gain and not providing the services they claimed.
The ACNC investigated the issue and found that the charity is providing charitable services. However,
the charity’s founders were benefiting financially through arrangements they had put in place. These
arrangements included purchasing a property in their own name for the charity’s use and then leasing
the property back to the charity — the charity in effect was paying the mortgage of the individuals, with
no provision for the assets to be retained by the charity. The charity also provided a significant contract
to a company that was owned by a member of the board.
The ACNC is working with the charity’s board to ensure their governing documents protect the charity,
and to assist the charity in dealing with the conflicts of interest arising. We are also making sure that they
develop legal agreements to guarantee long-term protection of the charity’s assets.
Source: ACNC 2014, An overview of the first year of compliance activity, 28 January, accessed August 2023, www.acnc.
gov.au. © Commonwealth of Australia 2014.

These cases clearly illustrate that governance and fraud problems do occur in the charity and not-
for-profit sectors and that rigorous governance standards, financial reporting and accountability are as
imperative here as in corporations working in the market economy.
To this end ACNC has developed a self-evaluation tool which can be downloaded and completed.
Although not assessable in this subject, if you are involved with the governance or audit of a charity,
it may be a useful resource. It is available at: www.acnc.gov.au/for-charities/manage-your-charity/
governance-hub/governance-standards/self-evaluation-charities.

SUMMARY
Part A has examined the role of corporate governance and in particular a number of specific corporate
governance practices that are crucial to the corporation’s success. We began with a discussion of common
causes of and contributors to corporate failure. These include poor strategic decisions, greed, the pursuit
of power, overexpansion, overly dominant CEOs, the failure of internal controls and ineffective boards.
The selection and evaluation of the board is therefore a key factor in ensuring good corporate governance.
It is increasingly recognised that diversity in the members of the board of directors contributes to corporate
success. In addition, ensuring compliance with the Corporations Act and having financial statements
audited by an independent party help ensure good governance.
Each element of governance needs to be working properly to ensure that a company is run according
to best practice and that conduct within an entity is ethical. Failure at any level of a company’s internal
controls and other governance mechanisms could leave gaps for corporate misconduct to take place.
The key points covered in this part, and the learning objectives they align to, are as follows.

KEY POINTS

4.1 Evaluate the implications of board diversity and executive remuneration in relation to corporate
governance including corporate performance.
• Company boards are composed of individuals elected by shareholders or members.
• It is beneficial for boards to maintain a degree of continuity to ensure corporate knowledge is not
lost, but it is also important to have some turnover of members so that fresh perspectives are
brought in.
• Diversity in the membership of a board is linked with good corporate governance.
• Diversity refers to factors such as gender, age and race, as well diversity of expertise, experience
and qualifications. A diverse board composition allows for a broad range of ideas and input to
be considered.
• There is an increasing realisation that ensuring gender balance is one way to ensure a broad range
of perspectives can be taken into account.
• Increasingly, risk management and compliance requirements, particularly for cybersecurity, AI and
sustainability reporting, mean that board and audit expertise is expanding.
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248 Ethics and Governance

 • Remuneration of non-executive directors is designed to be a reasonable compensation for their time
and effort. It may also be linked to overall corporate success (such as indicated by the company
share price), but direct performance-related compensation is not used for non-executive directors
as it could compromise their independence.
• Executive directors and other employed management personnel often have part of their remuner-
ation linked to corporate performance (in general terms and in relation to more specific targets).
Performance-based remuneration is a crucial tool for aligning the actions of employees with the
goals of the company.
4.3 Identify aspects of corporate governance that arise in relation to audit responsibilities and
regulatory compliance.
• Companies in Australia are required to comply with the Corporations Act, which regulates many
aspects of companies, including aspects of financial statements and audit compliance.
• The board of directors is responsible for the company’s financial report, which includes the financial
statements and commentary on financial performance and financial position.
• External auditors are charged with the task of auditing financial statements to provide assur-
ance that they comply with the requirements set down in accounting standards, relevant laws
and regulations.
• With the advent of mandatory sustainability reporting, audit responsibility will expand.
• ASIC reviews the auditing of financial statements and often identifies weaknesses, includ-
ing the failure to gather sufficient appropriate evidence and the existence of concerns about
auditor independence.
4.4 Evaluate the importance of good corporate governance as a factor in mitigating the risks of
financial failures.
• Key causes of corporate failure are poor strategic decisions, greed, the pursuit of power, over-
expansion, overly dominant CEOs, the failure of internal controls, failure of risk management and
ineffective boards.
• Good corporate governance includes the creation and maintenance of a corporate culture and a
set of internal controls that combat the factors that contribute to corporate failures.
• Performance-based remuneration policies need to effectively align employees and managers
with company objectives while not encouraging unethical behaviour or actions detrimental to
the company.
• In order to preserve independence, non-executive directors should not have remuneration directly
linked to specific performance factors.

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MODULE 4 Governance in Practice 249

PART B: OPERATIONAL OBLIGATIONS
AND OVERSIGHT
INTRODUCTION
In addition to the Corporations Act, ASIC, APRA and ACNC, various other bodies and pieces of legislation
are relevant to governance. In general, these relate to the stakeholders for which boards have an overarching
operational responsibility. Some of this legislation and the relevant stakeholders are listed in table 4.2.

TABLE 4.2 Legislation and bodies relevant to operational responsibilities

Legislation Oversight body Stakeholder

Safe Work Australia Act 2008 (Cwlth) Safe Work Australia Employees
Work Health and Safety Act 2011 (Cwlth)
Work Health and Safety Regulations 2011 (Cwlth)

Fair Work Act 2009 (Cwlth) Fair Work Commission Employees

Disability and Discrimination Act 1992 (Cwlth) AHRC (Australian Human Customers
Rights Commissioner) Employees (existing
and potential)

Privacy Act 1988 (Cwlth) OAIC (Office of the Australian Customers

Privacy Amendment (Notifiable Data Breaches) Information Commissioner)
Act 2017 (Cwlth)
Freedom of Information Act 1982 (Cwlth)
Australian Information Commissioner Act 2010 (Cwlth)

Workplace Gender Equality Act 2012 (Cwlth) WGEA (Workplace Gender Employees (existing
Equality Agency) and potential)

Source: CPA Australia 2023.

Before looking at these, this part of the module will provide a general overview of the Australian legal
system. The module will also look at the protections for consumers and the goods and services market
as a whole. These are given force by the Competition and Consumer Act 2010 (Cwlth) and the ACCC
(Australian Competition and Consumer Commission).

4.5 THE LEGAL SYSTEM

Understanding the overall legal system is highly significant for good corporate governance. From previous
learning, including in this subject, you will be aware that, of the many laws relevant in society, a great
number of them affect corporate life. In civil law countries, detailed legislative prescriptions seek to
clarify almost every aspect of law in society. In common law countries (typically those that use the Anglo-
American company law approach), many laws originated through the court system and became legislation
over time. However, not all laws in common law jurisdictions have court-based origins. Governments often
initiate laws, especially where creation of complex innovative legal forms such as corporations are the goal.
Our discussion of laws primarily will refer to Anglo-American type common law and corporate
systems as seen in common law jurisdictions (e.g. South Africa, Singapore, US, UK, Bermuda, Australia,
New Zealand and India). In each of these places, modern complex laws are the result of extensive
parliamentary deliberation leading to fairly precise legislative form.
In these common law countries, the courts review these precise legislative forms and make interpretive
decisions that give additional, and sometimes new, meaning to the legislation. In these countries, if
legislation does not cover a matter, the courts may also make appropriate law relevant to the circumstances
of the particular matter being litigated.
If a matter is not litigated, the relevant law will not be interpreted. Sometimes, court interpretations are
considered very good sound and may be left untouched by the government — or the legislature will write
laws restating court decisions in formal laws to be passed by the parliament. Sometimes the government
will not agree with the courts’ approach and will write laws to overturn the principles made by the courts’
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250 Ethics and Governance

decision. In either case, parliament may pass more laws so that the laws are more clearly stated in the
legislation and therefore lead to more predictable court (and community) interpretations. Good laws should
achieve good outcomes and should do so reliably. Very importantly, laws should give predictable outcomes.
Under the Anglo-American system, some of the most important laws that underlie corporate life include
general community-wide laws on:
• the rights of individuals such as employees
• contracts
• negligence
• property
• ownership rights
• arrangement of these rights when a company is insolvent.
These laws all began, at least to some extent, through the common law decisions of the courts and have
become highly refined as they are subject to additional legislative responses.

THE ECONOMY AND THE LEGAL SYSTEM

The economy as a whole is heavily dependent on corporate activity. Corporations operate within the
economy. This mutual importance underlies a great deal of our discussion regarding corporate governance.
The economy and society as a whole must be regarded as crucial stakeholders. If economies are not
nurtured, then corporations cannot succeed. So, we find a number of laws that are designed to protect
the economy and important aspects of the economy such as fair competition, open financial markets and
the rights of individuals including consumers. Similarly, if the legal system is not designed, at least in part,
to encourage the success of corporations, then economies based on capital models will not succeed. There
are many laws that must be understood by boards and other management so that the balances required by
society are recognised in decision making within the corporation.
It is not possible within this module to provide any detailed analysis of laws in general. We must
note, however, that good corporate governance and the effective operation of business need these laws
to be reliable, predictable and commonly understood. Furthermore, for any commercial framework to be
fundamentally successful in the long term, it is vital that all participants within the framework can protect
their rights and seek redress for any wrongs. Therefore, a strong and reliable court system is a vital part of
the overall corporate governance framework. One important example of laws that are part of the corporate
governance framework are the legislative and court protections in place for whistleblowers, which will be
discussed later in the module in part C.
Corporations must respect the law, understand it and ‘play within the rules’. The legal system is
enormously important as it enables the very existence of corporations and provides the rules and
regulations under which corporations will succeed. Understanding these rules and ensuring that boards
and management have the appropriate awareness and access to detailed knowledge are key requirements
in building good corporate governance practices. As always, boards must ensure that appropriate policies
are in place to deal with every issue that is, or may be, material to the interests of the corporation.
We begin our discussion by looking at the way that laws can be regarded as criminal or civil in nature
and the types of consequences that may arise. We look at how those who are ‘in the wrong’ may be made
liable to compensate those who have been hurt, and also at how measures may be designed to punish or
prevent continuing unacceptable conduct. These are matters that boards and management must understand,
and where caution must be exercised. If matters are not dealt with correctly, the costs to corporations
can be very high — and in some cases, the individuals involved can be imprisoned or face harsh
financial penalties.

Proof, Penalties and Redress — Criminal and Civil

Civil law and criminal law are two distinct areas of the legal system with different purposes, procedures
and consequences. Civil law deals with disputes between individuals or organisations (e.g. breaches of
civil rights, breaches of contract), while criminal law focuses on offenses against society as a whole
(e.g. murder, drug supply and corporate crime). The key difference between civil and criminal law in
Australia is that criminal law has a higher onus of proof than civil law. In criminal cases, the onus of
proof is on the prosecution, who must prove its case against the accused to a high standard of beyond
reasonable doubt in court. In contrast, in civil cases, the plaintiff must establish their case on a balance
of probabilities.
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MODULE 4 Governance in Practice 251

 In countries using the common law system, no court would normally contemplate conducting a trial that
involves both civil and criminal matters at the same time. The cases would be totally separate and would be
carried out in different ways. If, as is common, one piece of legislation has operative provisions that may
be used in respect of criminal liability or civil liability, then this is merely a convenient (but potentially
confusing) way of stating that the issues addressed by the legislation may be subject to two very different
courtroom approaches in two different courts at two different times. Breaches of the Corporations Act,
depending on the section or sections breached, can result in either criminal or civil court cases.

Laws Leading to Criminal Penalties

A criminal is a person who has been found guilty after being charged with a crime (also called a ‘criminal
offence’ or just an ‘offence’). The concept of crime has been in existence for centuries. Crimes such as
murder and theft have always carried common law crime status. Criminal cases are always carried out by
agencies of the state and never by individuals or corporations.
Traditionally, in common law countries (which almost always includes those Anglo-American company
law traditions), crimes require the person charged to be subject to a court trial in which the prosecutor has
the duty to establish facts proving beyond reasonable doubt that the crime was committed. This includes
establishing that the person accused of the crime had the necessary criminal intent. If all of this cannot
be proved beyond reasonable doubt, the person will go free. While systems in countries that do not have
a common law tradition vary, the essential nature of crime is the same, with the outcomes of fines and jail
after prosecution being standard.
In recent decades, there has been a tendency to introduce new crimes in various pieces of legislation.
Laws made this way can reflect whatever the parliament making the law may wish (e.g. it may lessen the
need to prove criminal intent).
Criminal sanctions can take many forms but, most commonly will be in the form of fines and/or jail
sentences. In the US, competition laws are usually described as anti-trust laws, and breaches of these
laws may be punished by jail sentences of up to 10 years along with fines. Similarly, in Australia, there
are now criminal penalties for cartel conduct. Australia also provides penalties of up to 15 years jail for
individuals (including officers of corporations) and, under complex rules about fines, maximum penalties
for corporations of up to $10 million or as much as 10 per cent of group turnover.
It is also common in legislation for other outcomes to be relevant so that criminal actions result in
compensation or damages being payable to those who have been adversely affected by the crimes. This
occurs when the prosecutor requests consideration be given by the court to those who have been harmed.
An interesting aspect of some legislative schemes is where a criminal prosecution would be hard to start
(e.g. if proof beyond reasonable doubt is very hard to establish) or, once started, it fails. In these instances,
it is possible either to bring a civil action instead, or to do so after the criminal action has failed. A civil
action cannot be commenced after a successful criminal action. This is because the successful case would
have already been proved beyond reasonable doubt and the level of proof for civil cases is lower, meaning
that the outcome of the civil trial would be already known, therefore wasting the resources of the courts
and all potential parties to such a case.

Laws with Civil Outcomes and Penalties

In common law jurisdictions, the fundamental characteristic of a civil case is that any aggrieved party can
bring an action. While civil penalties previously did not exist under common law (but do now under
some legislation), civil cases have been in existence for centuries. If X has a contract with Y and Y
breaches the contract, then X can take Y to court seeking a court decision and a court-enforceable outcome
(e.g. damages and/or an injunction — a court order compelling a party to undertake or refrain from
undertaking a specific act).
In a civil case, the court requires each party to argue its case as strongly as possible and the person with
the case that is determined to be stronger relation to the relevant law will win. The standard applied is
‘proof based on the balance of probabilities’ rather than ‘proof beyond reasonable doubt’ as in criminal
cases. Neither party will be punished by jail or fines in a civil case, as these penalties apply only in criminal
cases. The court may award damages to the injured party, apply injunctions or make other orders such as
rescission (revoking or annulling) of contracts, many of which may apply at the cost of the losing party.
There are many and varied orders that have developed over the centuries and to which relevant legislation
has been added.

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 In recent decades, some legislation has been written so that civil wrongdoers are punished. This is an
important development. The concept of civil penalty means that a penalty has been prescribed within the
relevant legislation. Importantly, this will be a penalty in relation to conduct that requires proof according
to the ‘balance of probabilities’ and not ‘beyond reasonable doubt’. Penalties that apply will be pecuniary
penalties payable to the state. The term ‘pecuniary penalty’ is applied in place of the term ‘fine’, as fines
are criminal penalties. However, public statements made by the press and even statutory authorities often
refer to these pecuniary penalties as being fines. Therefore, careful reading is required in order to determine
whether, for example, a corporate officer is in fact guilty of a crime or is a wrongdoer in a civil case.
For instance, when a former Telstra director accepted that he had acted improperly in civil proceedings
brought by ASIC about his share dealings, the corporate regulator made a possibly confusing announce-
ment that headlined a civil penalty as being a fine, although the text of the announcement correctly stated
that it was a pecuniary penalty (see example 4.9).

EXAMPLE 4.9

Vizard Case
Steve Vizard Banned for 10 Years and Fined $390,000
Mr Jeremy Cooper, Acting Chairman of the Australian Securities and Investments Commission (ASIC),
today announced that Mr Stephen William Vizard has been banned from managing any corporation for
10 years and ordered to pay pecuniary penalties of $390,000.
Justice Finkelstein of the Federal Court of Australia found that Mr Vizard had breached his duties
as a director of Telstra Corporation Limited (Telstra) on three occasions when he used confidential
Telstra information to trade in the shares of three listed public companies, Sausage Software Limited,
Computershare Limited and Keycorp Limited between March and July 2000.
‘ASIC welcomes the length of the banning, which sets a new benchmark for future civil penalty cases
that ASIC brings’, said Mr Cooper.
‘This means that Mr Vizard is disqualified from managing any corporation in Australia until July 2015.
‘It was a pre-meditated and cynical exploitation of a privileged position held by Mr Vizard and showed
a complete disdain for the confidentiality of the boardroom’, he said.
Source: ASIC 2005, ‘Steve Vizard banned for 10 years and fined $390,000’, accessed August 2023, https://jade.io/article/
111020. © Australian Securities & Investments Commission. Reproduced with permission.

Mr Vizard was not subject to any criminal charges. He also was not subject to an action for insider
trading — on either a criminal or a civil basis. He was taken to court only in respect of civilly breaching
his duties as a director.
Traditionally, laws dealing with civil matters sought only to create civil outcomes and did not lead to
penalties. Almost always, laws that deal with civil issues will provide for compensation and redress for
victims of civil wrongs. This is pursued further in the following discussion.
.......................................................................................................................................................................................
CONSIDER THIS
Access the Corporations Act (www.legislation.gov.au/Series/C2004A00818) and read section 588G(2). Is this section
subject to civil penalties?

Redress Compared with Penalties

The potential victims of wrongdoings by corporations include a variety of stakeholders who deal with
corporations, including shareholders, lenders, suppliers, customers and final consumers, and indeed
the whole economy. An illustration may be seen in the Centro case (considered previously), where
shareholders were harmed by Centro’s failure to identify its current liabilities with sufficient accuracy.
The correct disclosure, when it occurred on 17 December 2007, led to a significant decline in the value
of Centro shares. Arguably, the Centro group would have struggled to cope with existing large levels of
debt at the time of the GFC. However, shareholders could have expected better information when the
2006/07 results were released more than four months earlier, in August 2007. The Centro case redress
was by way of agreed damages under a court-approved settlement between the parties rather than a
court decision.
The deliberately non-legal term ‘redress’ is used here to describe generally the ways in which
wrongdoers can be required to correct the harm they have caused. Under modern complex legislation, the
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redress of wrongs is covered by provisions that provide for compensation, injunctions and other actions
that are designed to ensure that victim’s rights are addressed and that any losses or costs are recovered
or repaid. Some victims would also regard an order disqualifying a person from managing a corporation
as a form of redress as the victim will feel better, although others might regard it as a penalty. However,
the principal concern here is to regard redress not as a penalty but rather as part of the process of putting
corporate governance matters right and of keeping these matters in good order for the future.
Damages or compensation involves having the offender make payments (i.e. pay damages) to the injured
party to compensate for the harm or loss caused. Injunctions are hearings where courts try to act quickly
to prevent wrongs from continuing or becoming worse by getting a corporation, for example, to stop its
anti-competitive conduct. Injunctions can be sought by any relevant party. Other types of remedy include
adverse publicity orders, which require the corporation to advertise to society at large the wrongs in which
it has been involved. Individuals may also be prohibited from managing a corporation, or from holding
important officer or director roles.
Penalties are different from remedies as they are meant to punish a wrongdoer. Punishment obviously
goes beyond simply redressing wrongs — as well as working in conjunction with redress. The penalties
may have been specifically designed to stop breaches (by acting as a deterrent) and courts may decide to
compensate those who have been harmed by the breaches as well as impose penalties on the wrongdoers.

FINES AND PENALTY UNITS

In Australia, a penalty unit is a standardised monetary amount used to determine the fines in both criminal
and civil proceedings. Fines are calculated by multiplying the value of one penalty unit by the number of
units that the offence or contravention carries. The value of a penalty unit is prescribed by the Crimes Act
1914 (Cwlth) and is currently $313 (up from $275) for offences committed on or after 1 July 2023. The
value of a penalty unit is indexed to inflation and updated over time to ensure fines remain proportionate.
The next indexation will be on 1 July 2026 and then every three years. The historic penalty unit rates can
be found on the ASIC website. Table 4.3 sets out common criminal penalties that businesses operating in
Australia ought to be aware of to ensure their practices are compliant with the laws.

TABLE 4.3 Common criminal offences and penalties

Act Provision/offence Maximum penalty

Corporations Directors and other officers of the Individuals: the greater of 5000 penalty units
Act 2001 (Cwlth) company failing to act with care (AUD1 565 000), or three times the benefit
and diligence (s. 180(1)) obtained and detriment avoided

Directors and other officers of

the company failing to act in the
best interests of the company as a
whole (s. 180(1))

Improper use of an executive

position (s. 182)

Improper use of company

information by directors, other
officers, and employees (s. 183)

Fair Work Serious contraventions (s. 557A) Corporations: 3000 penalty units or
Act 2009 (Cwlth) AUD939 000
Individuals: 600 penalty units or AUD187 800

Privacy Act 1988 (Cwlth) Various breaches of credit 2000 penalty units or AUD626 000
reporting restrictions
(ss. 20C–21G)

Competition and Offences against section 45AF or Corporations: the greater of AUD50 million or
Consumer 45AG (s. 79) three times the value of benefits if it can be
Act 2010 (Cwlth) determined. If it cannot be determined, 30% of
the corporation’s adjusted turnover during the
breach period
Individuals: 2000 penalty units or AUD626 000
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 Criminal Code Money-laundering offences Where money or property value is more than
Act 1995 (Cwlth) (s. 400.2B(2), (3), (5), (6), (8) and (9)) AUD10 million in a single transaction or in total
across multiple transactions and:
• the person believes the money or property is
proceeds of crime, imprisonment for life
• the person is reckless as to the fact that the
money or property is proceeds of crime,
imprisonment for 15 years or 900 penalty
units or both
• the person is negligent as to the fact that
the money or property is proceeds of crime,
imprisonment for 6 years, 360 penalty units
or both.

Anti-Money Laundering Failure of a designated service Corporations: 100 000 penalty units or
and Counter- provider to enrol on the Reporting AUD31.3 million
Terrorism Financing Entities Roll (s. 51B) Individuals: 20 000 penalty units or
Act 2006 (Cwlth)
AUD6.26 million

Providing false or misleading 10 000 penalty units or AUD3.13 million

information (documents)
(ss. 136–7)

Source: CPA Australia 2023.

DIRECTOR PENALTY NOTICES

Another aspect of the legal system in Australia is director penalty notices (DPNs). The Australian Taxation
Office (ATO) has the power to issue directors with DPNs to recover unreported and/or unpaid company
tax debts, including amounts relating to pay-as-you-go (PAYG) tax, goods and services tax (GST) and the
superannuation guarantee charge. To recover debts, the ATO can pursue either the company and/or the
directors. Amounts can be recovered by issuing a garnishee notice, offsetting tax credits or through legal
recovery proceedings (ATO 2023).

LEGAL COMPLIANCE AND GOVERNANCE

Corporations, their directors, managers, employees and other agents unfortunately sometimes take quick
and easy pathways to achieve their individual and/or corporate goals. Sometimes this entails engaging in
unethical or illegal behaviour (some of which we have already discussed). With competition and consumer
protection laws and other laws gaining greater exposure and involving significantly greater penalties, it
pays to consider the ethical and legal ramifications and do the right thing from the outset. In addition to
criminal and civil sanctions, there are always other real costs (many of which are intangible and difficult
to quantify) associated with publicised wrongdoings. Some of these include:
• the human resource costs of finding and producing relevant information for regulators, trials and so on
• the cost of legal advice and briefing advisers
• the impact of negative publicity on employee morale, share prices and profits
• the diversion of resources and management effort away from core value-building activities
• managers and other employees undergoing considerable stress, leading them to take time off work, or
even resigning
• knowledge gaps and the replacement costs if employees leave.
It is wise for boards to understand the benefit of careful planning and the need to develop and implement
appropriate ‘due diligence’ policies and approaches. This is particularly important for legal compliance,
and the development of a compliance program has been the subject of particular attention in the area
of competition law in Australia. It is also a part of effective risk management and is of great interest to
insurance companies. Insurance premiums payable by an organisation are a direct function of the risks in
existence and ‘due diligence’ compliance programs — including legal compliance — are a major factor
in achieving reduced corporate risk.

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Why Have a Compliance Program? … As Identified by Professor Fels
A former chairman of the ACCC, Professor Alan Fels (Fels 1999), gave a speech that was especially strong
in identifying the need for a relevant competition and consumer law compliance program. As we consider
his views, it is apparent that his comments are not only valuable but have universal application to legal
compliance by boards and management generally. The core principles Fels identified can be applied to
reduce the risk of poor compliance with all regulatory and legal requirements. They can even be extended
to compliance with internal ethics codes and with managing risk generally. Compliance programs are
beneficial for corporations, shareholders, boards, management, employees and for all other stakeholders —
including consumers, financial markets and society at large.
Professor Fels observed that a compliance program is a system designed to assess and reduce an
organisation’s risk of breaking the law. It also promotes a culture of compliance and encourages ‘good
corporate citizenship’. A compliance program should never be seen as just an education or training exercise
and must become part of an integrated business system. Procedures need to be put in place to ensure
compliance with the law (a management support system), and these procedures must be audited and
reviewed regularly.
Having an effective compliance program offers a number of benefits identified by Professor Fels.
Compliance programs are increasingly important, and it is not only regulators that are promoting their use.
Corporations acknowledge their value, and, in some instances, courts have had favourable regard to the
programs’ existence when considering the legal outcomes affecting corporations in relevant cases. Legal
compliance is becoming a top priority and compliance programs help to reduce corporate risk. However,
fewer corporations believe or understand how a good compliance program may help them to compete more
effectively. Professor Fels summarised his views as follows (Fels 1999).
Why have a compliance program?
Two main benefits of compliance programs are that they help a corporation to:
• avoid breaking the law and, consequently, save time and money; and
• enhance its business operations by focusing on positive business purposes (rather than reactive risk
management).
Avoiding harm
Effective compliance programs should be cost-effective and should lead to reduced risks of incurring
penalties and help limit liability for damages. They may also help avoid other financial and non-financial
costs associated with investigations, prosecutions and their aftermath.
A recent option for a person who thinks that they may have breached the Australian Consumer Law is
to offer the regulator an enforceable undertaking. This undertaking would include that they will not breach
the law again and will improve their compliance regime.
The positive business case for compliance
Possible significant benefits for compliance programs include:
• improved safety and quality of products and services;
• improved innovation;
• fostering customer goodwill;
• problems are identified systematically and may be minimised or avoided;
• encouraging identification and mitigation of risks;
• improved communication and reporting;
• increased ethical behaviour; and
• enhanced saleability of the business.
Who else can benefit from a good compliance program?
Corporation activities affect a wide variety of stakeholders. A compliance program that focuses not just
on trade practices but overall legal compliance, with all the laws that affect the corporation, may lead to
benefits for all major stakeholders, including:
• customers (through consumer protection laws);
• competitors (through competition laws);
• employees (through occupational health and safety (OHS) and industrial relations laws);
• shareholders (through corporations and securities laws); and
• the general community and the environment (e.g. through pollution laws).

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256 Ethics and Governance

4.6 OBLIGATIONS TO EMPLOYEES
A board is responsible for ensuring that appropriate policies are set for its activities. It is the responsibility
of management to implement these policies on behalf of the board and the shareholders and, as observed in
module 3, management will assist in developing policies that are approved by the board. It is not possible
to look at every one of the operational areas where policies are important. Here, we consider some matters
not dealt with at length in this, or other, subjects — beginning with a general comment on employees.
We then briefly discuss occupational health and safety, pay and working conditions, and family and
leave entitlements.
Another important area of development in recent years affecting employees (and others) has been
whistleblower protection whereby laws have been enacted in an attempt to mitigate retaliatory responses
against those who expose corporate misconduct. Whistleblower provisions will be discussed in part C of
this module in the wider context of financial market protection.
Employees are central stakeholders in any organisation. For good governance, it is crucial that policies
are in place to ensure that appropriate relationships exist between the corporation as employer and every
employee. We should not forget that executives are also employees.
The crucial understanding that we must appreciate is that boards cannot simply leave all the responsi-
bility to management. Boards have a duty to be aware of the issues and to be sure that these issues are
being appropriately addressed within the organisation, according to policies that are set at board level and
are consistent with legal obligations and community standards.
For example, laws recognising the importance of employees as stakeholders (e.g. in the EU and
Australia) make it even more important for corporations advertising employment positions to get it right.
It is significant that the protections effectively apply to the whole community, as they apply not only to
existing employees but to every potential employee. The Australian Consumer Law (s. 31, Schedule 2
of the Competition and Consumer Act) creates the Australian version of this new type of ‘employee’
protection.
Directors and managers of corporations need to comply with (or exceed) the requirements of the law in
the way they treat the whole pool of potential employees — and contractors’ employees. If they do not,
they will damage both the corporation’s value and the shareholders’ interests. Example 4.10 describes
an instance where a business was found to have failed to comply with legal requirements in relation
to recruitment.

EXAMPLE 4.10

Smith v. Redflex
Job applicant Jessica Smith received a finding in her favour that included a recommendation she receive
$2500 in compensation after the Australian Human Rights Commission (AHRC) determined a potential
employer discriminated against her in the application process.
Smith had a criminal record with two offences — assault occasioning actual bodily harm and possession
of a prohibited drug — and it was confirmed that it was her criminal record and not any other factor such
as an inappropriate skill set that ruled her out of contention for a position with Redflex Traffic Systems
Pty Ltd.
The AHRC found that Redflex had discriminated against Smith given that it had failed to communicate
with her about her National Police Check that was done after they had given her an indication that she
had done well in the application process. Smith had contacted the company on several occasions and
went to the AHRC to resolve the impasse.
Amongst the issues that AHRC President Rosalind Croucher addressed in the decision on the Smith
matter was the fact that the offences that were in her criminal record could have been examined further
by the company before refusing to take Smith on as an employee.
‘The offence of “assault occasioning actual bodily harm” can cover a range of conduct, from the infliction
of temporary bruises and scratches, to more permanent injury. In November 2004, a conviction for “assault
occasioning actual bodily harm” was punishable by up to five years imprisonment,’ Croucher said. ‘That
Ms Smith was sentenced to community service, and not a custodial sentence, suggests that her offence
was considered to fall at the lower end of the scale of objective seriousness. Similarly, her second offence
of possession of marijuana was disposed of by the Local Court by way of a fine.’
Croucher noted that the two offences did not themselves constitute a reason in their own right for the
nonappointment of Smith to a role with the company.

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 ‘In my view, without more, the existence of a nearly 12 year old conviction for the offence of “assault
occasioning actual bodily harm” and a 9 year old offence for minor drug possession did not necessarily
mean that Ms Smith was untrustworthy or of bad character in 2016,’ Croucher said. ‘I am not satisfied
that, simply because Ms Smith committed these two offences, it inevitably followed that she could not
meet high standards of character and trustworthiness many years later.’
Source: Australian Human Rights Commission 2018, Ms Jessica Smith v. Redflex Traffic Systems Pty Ltd [2018] Aus
HRC 125, accessed August 2023, www.humanrights.gov.au/our-work/legal/publications/ms-jessica-smith-v-redflex-traffic-
systems-pty-ltd-2018.

OCCUPATIONAL HEALTH AND SAFETY

Workplaces often create situations that can cause significant risks to employees. Laws in this area are
diverse and, even within countries, there are significant differences between regions. In some jurisdictions,
there may be virtually no protections or compensation available to workers, while in other jurisdictions
both civil and criminal laws and relevant remedies are very strong.
From a corporate governance perspective, a common national approach makes it easier for boards to set
appropriate policies and for management to implement policies.
It is to be expected that large corporations, wherever they operate, should pay attention to employees
as stakeholders.
Workplace injuries can severely affect a business by lowering productivity, losing sales, damaging
employee morale and diminishing public respect. Under state law in Australia, if a worker is injured in the
course of their employment, they are entitled to make a workers’ compensation claim. Because of better
health and safety at work regulation, and the efforts of employers to guard against the possibility of serious
accidents to workers, in recent decades the number of employees involved in serious injury in Australia
has reduced significantly. In 2021, a total of 169 fatalities were recorded in Australian workplaces (Safe
Work Australia 2022). This figure reflects a 35 per cent decrease over the last decade and a 57 per cent
decline from the peak in 2007.
Example 4.11 describes a court finding and the penalties imposed after a business owner had failed to
comply with OHS laws.

EXAMPLE 4.11

OHS Breach
A 72-year-old owner of a scrap metal business was sentenced to six months jail and ordered to pay a
$10 000 fine for exposing people to risks on the site of her scrap metal enterprise.
The LaTrobe Valley Magistrate’s Court heard the matter concerning scrap metal entrepreneur Maria
Jackson on 19 December 2018. Jackson pleaded guilty to two charges under Victorian occupational
health and safety laws. These charges related to a failure to comply with her duty as a self-employed
person to not expose other people to risks from the work she does, which is covered by section 24 of the
Occupational Health and Safety Act 2004. The second charge related to an offence of recklessly engaging
in conduct that places or may place another person who is at a workplace in danger of serious injury, which
is in section 32 of that same piece of legislation.
Jackson was at the centre of an incident in February 2017 while driving a forklift. An individual died as a
result of falling from the forklift’s tynes that were about three metres from the ground. Both the deceased
person and a metal bin fell from the tynes. The bin struck the individual concerned.
The scrap metal business owner failed to check that the bin was properly secured before doing anything
with the bin.
The court also ordered Jackson to pay court costs as well as the previously mentioned $10 000 fine.
Source: Adapted from Zuchetti, A 2019, ‘Jail sentence for employer over workplace death’, January, accessed August 2023,
www.donesafe.com/blog/health-safety/jail-sentence-for-employer-over-workplace-death.

FAIR PAY AND WORKING CONDITIONS

There is an argument that buoyant economies will have a high demand for labour, which in turn will ensure
fair pay and working conditions as labour will be able to set a high price. Though this argument may hold
in theory (under a limited set of assumptions), the reality can be quite different. Employees are not always
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in a strong bargaining position, so their pay and working conditions can be at the mercy of their employer.
It is for these reasons that many countries have laws and regulations covering minimum wages and
working conditions.
Both boards and managers must ensure that employees are paid appropriately, which will engender
efficiency and loyalty to the business. It may be wise to identify some additional reward payments relative
to superior performance. As with executive payments, performance-based payments need to be carefully
considered and have an emphasis on motivation rather than just reward for past performance.
This aspect, as part of the performance component of corporate governance, is also looked at in some
detail in the subject Strategic Management Accounting.
In many jurisdictions, it is common for employers to contribute to employee pension funds. In Australia,
such contributions are called superannuation guarantee contributions, which are required by law and
are designed to ensure that employees are adequately funded into retirement. Superannuation guarantee
contribution rates have been increasing by 0.5 per cent each financial year since 1 July 2021. As of July
2023, the rate stands at 11 per cent and will progressively increase to 12 per cent by July 2025.
Penalties are often applied to businesses that fail to meet their obligations in relation to pay and
entitlements. Examples 4.12 and 4.13 describe two cases.

EXAMPLE 4.12

Fashion Box Pty Ltd

A fashion start-up was hit with a total of $329 000 in penalties by the Federal Circuit Court when it was
found that fashion entrepreneur, Kathleen Enyd Purkis, had underpaid three workers.
Purkis ran a business called Fashion Box Pty Ltd and both she and the company were given penalties
by the court for failing to properly pay three individuals with one of those three being taken on for
what was described as an unpaid internship. That individual was deemed to be a part time employee
by the court.
‘The Court found three employees aged in their mid-20s were underpaid a total of $40 543 for their
entitlements including minimum hourly rates, overtime, public holiday pay and annual leave between
2013 and 2015,’ a media release issued by the Fair Work Ombudsman said. ‘One of the employees,
a graphic designer who had completed a university degree, worked two-days per week for almost
six months without pay under a purported “unpaid internship” before receiving a one-off payment of
just $1000. She was underpaid $6913.’
Ombudsman Sandra Parker said that complaints were received from the workers and inspectors were
placed on the case to determine precisely what had happened.
Fair Work Ombudsman Sandra Parker said inspectors investigated after receiving underpayment
complaints from the young workers.
‘Business operators cannot avoid paying lawful entitlements to their employees simply by labelling them
as interns. Australia’s workplace laws are clear — if people are performing productive work for a company,
they are legally entitled to be paid minimum award rates,’ Parker observed.
Judge Nicholas Manousaridis said contraventions of the law in this case were ‘serious and sustained
contraventions of important provisions of the Fair Work Act’. He said that Purkis knew she (the company)
was not paying workers proper amounts.
‘The penalty should be set at a level that, having regard to the other circumstances of the case, should
signal to employers who might be tempted not to inquire into their legal obligations as employers or not
to comply with their legal obligations, particularly in relation to inexperienced workers, that there is a
significant risk of being exposed to the imposition of a pecuniary penalty if they are to succumb to such
temptation,’ the Judge noted.
Source: Australian Fair Work Ombudsman 2019a, ‘Fashion start-up penalised over unpaid internship’, 1 March,
media release, accessed August 2023, www.fairwork.gov.au/newsroom/media-releases/2019-media-releases/march-2019/
20190301-her-fashion-box-penalty-media-release.

EXAMPLE 4.13

Safecorp Security
The operator of two defunct security companies was hit with a $39 090 penalty for underpaying security
guards, according to a 3 July 2019 media statement issued by the Fair Work Ombudsman.

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 Sydney man John Lohr, who formerly operated Brookvale-based companies Safecorp Security Pty Ltd
and Safecorp Security Group Pty Ltd, was given the penalties by the Federal Circuit Court. The companies
are no longer operating.
There were 45 security guards employed on a casual basis at various sites and these guards were owed
a total of $35 540.84.
The guards were being paid flat hourly rates between $20 and $25 and these rates did not cover casual
loading, weekend, overtime and other circumstances in which a greater payment ought to have been
made. The penalty imposed on the former security business owner was to be used to pay all affected
individuals.
Source: Information from Australian Fair Work Ombudsman 2019b, ‘Penalty for underpayment of Sydney security guards’,
3 July, media release, accessed August 2023, www.fairwork.gov.au/newsroom/media-releases/2019-media-releases/july-
2019/20190703-safecorp-security-penalty-media-release.

FAMILY AND LEAVE ENTITLEMENTS

Entitlements in many countries commonly include annual leave, parental (maternity/paternity) leave and
other types of entitlements. It is common for legislation to prescribe specific leave requirements. These
entitlements are sometimes voluntarily accepted by organisations, but more commonly are the subject
of legislative prescription. Legislated leave or holidays commonly include regular public holidays and
annual leave.
Different jurisdictions prescribe different amounts of leave. In the US, two weeks of annual leave is
common (but is not a legal requirement). In Australia and the UK, four weeks of leave is the standard legal
minimum. In Singapore, however, leave entitlement is on a sliding scale, with the maximum 14 days’ leave
applying only after eight years’ service. Additionally, in most jurisdictions, employees receive an amount
of legislated public leave. Full-time employees are paid at normal rates of pay for prescribed leave.
In Australia, the National Employment Standards (NES) set the minimum leave entitlements for
employees. While other leave entitlements can be provided in an award, registered agreement or employment
contract, these cannot be less than what is set out in the NES (Australian Fair Work Ombudsman n.d.).
Some business owners resent such impositions, but it is important to be aware that corporate governance
standards express society’s wishes and expectations, and these cannot be ignored because society at large
is a crucial stakeholder to which corporations must pay appropriate attention.
Example 4.14 illustrates strongly that employees need protection that Australia’s Fair Work Ombudsman
provides — in this case a 487 skilled visa holder.

EXAMPLE 4.14

First Paid Parental Leave Legal Action

In another first, we took legal action against an employer who failed to transfer the Australian Government’s
Paid Parental Leave funds to an employee. The affected employee was on a 487 skilled visa. After she
had a child, the Department of Human Services (DHS) transferred her paid parental leave to her employer,
Noorpreet Pty Ltd, to transfer to her. After many unsuccessful attempts by the employee to retrieve her
payment, DHS referred her to us to resolve the matter. During the investigation, Noorpreet’s director
provided a FWO Inspector with a false document that claimed the company had already paid the parental
leave payment to the employee’s husband, in cash. The court found the company and the director had
engaged in ‘deliberate deception’. Stating that deterrence against the employer’s conduct guided his
decision, the Judge issued penalties of nearly $120 000 to the company and the director (who were also
found to have engaged in several record-keeping and pay slip contraventions).
Source: Australian Fair Work Ombudsman 2018, ‘The Fair Work Ombudsman and Registered Organisations Commission
Entity Annual Report 2017–18’, p. 22, accessed August 2023, https://www.fairwork.gov.au/sites/default/files/migration/
1439/fworoce-annual-report-2017-18-final.pdf.

ETHICAL OBLIGATIONS — EMPLOYEE GOVERNANCE

Ethics were considered in module 2, and we must also be aware that there is a strong linkage with
corporate social responsibility (see module 5). Business ethics and their relationship with employees must
be understood in relation to society and the environment, and to the way in which the business interacts
with all stakeholders.
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260 Ethics and Governance

 We should also note that, just as employers have ethical obligations to employees, so do employees
towards employers. Employees have the obligation of loyalty that carries with it such concepts as regular
attendance, confidentiality of employers’ secrets and intangible property, care of employers’ tangible
property, and respect of fellow workers and their rights. As indicated earlier, it is also apparent that
employers must be aware of how their contractors treat their employees.
A well-designed code of conduct, being a corporate policy that gives full and proper attention to
employees, is an important corporate governance component. It should state the rights of employees and
what is expected of employees. Modern codes of conduct also state requirements imposed on contractors
so that contractors treat their employees correctly. As with all policies, the code of conduct needs to be
carefully prepared, communicated fully to those it is designed to affect and carefully updated as times and
expectations change.

Case Example of Failure in Relation to Employees

Employers who do not meet the needs of employees appropriately, and who bypass or ignore fundamental
principles and laws, have been seen to suffer serious adverse consequences through bad publicity and the
loss of reputation. This is demonstrated in example 4.15. Example 4.15 demonstrates a poor standard of
behaviour visible in boards of even apparently reputable corporations operating in countries reputedly with
the best legal systems. Clearly, there is never room for inattention.

EXAMPLE 4.15

Pike River Coal Mine

In late 2010, 29 miners died when they were trapped 1.5 kilometres underground by a methane explosion
inside a coal mine in Pike River, New Zealand.
A report into the incident stated:

The lessons from the Pike River tragedy must not be forgotten … That would be the best way to
show respect for the 29 men who never returned home on 19 November 2010, and for their loved
ones who continue to suffer …
Protecting the health and safety of workers is not a peripheral business activity. It is part and parcel
of an organisation’s functions and should be embedded in an organisation’s strategies, policies and
operations.
This requires effective corporate governance. Governance failures have contributed to many
tragedies, including Pike River …
The board and directors are best placed to ensure that a company effectively manages health and
safety. They should provide the necessary leadership and are responsible for the major decisions
that most influence health and safety: the strategic direction, securing and allocating resources and
ensuring the company has appropriate people, systems and equipment.

Source: Royal Commission on the Pike River Coal Mine Tragedy 2012, ‘Report of the Royal Commission on the Pike River
Coal Mine Tragedy’, accessed August 2023, http://pikeriver.royalcommission.govt.nz/Final-Report.

Clearly, one of the major effects of poor employee relations is loss of the corporation’s reputation and,
with an increasingly vigilant media, loss of brand value, share value and the threat of greater attention from
regulators. You will also observe the ability of the law to ‘strike at the agents’ — and this is appropriate
because, as observed in module 3 and using Lord Denning’s words, they are the ‘directing mind and will’
of the corporation.

Trade and Labour Unions

A trade union, also known as a labour union (or just a ‘union’), is a term for a group of workers who
have banded together to achieve collective representation of their interests. Unions are typically large and
powerful and commonly seek to achieve outcomes through collective bargaining with employers. If the
collective bargaining process fails, then industrial action may occur. This can take the form of go-slows
(deliberately working slowly), work to rule (workers performing their duties with over-attention to strict
detail compared to normal workplace practice, causing deliberate difficulties for employers), or strikes
(refusing to work).

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 Employees are important stakeholders, as are formalised industrial unions of employees. Good corporate
governance demands that unions are understood by both boards and management, and are dealt with
appropriately for ethical reasons and also out of self-interest (as unions can be powerful). Because they
project the great combined power of employees as stakeholders, unions remain highly prominent in
many countries.

4.7 PROTECTING THE GOODS AND

SERVICES MARKET
The term ‘competition policy’ refers to the measures that governments take to suppress or deter anti-
competitive practices, promote the efficient and competitive operation of markets and bring about
economic growth. One vital component of competition policy is an effective competition law that prohibits
or otherwise deals with specific anti-competitive practices, such as cartels and monopolies.
A competitive market is one where enough corporations exist, at arm’s length from each other, for
consumers to have freedom of choice, with a wide range of alternative products and efficiency-based
pricing. By contrast, a monopolistic (i.e. tending towards entirely uncompetitive) market structure is
one where a few powerful corporations, or perhaps even only one corporation, dominate. Monopolist
corporations are able to reduce supply below the competitive level in order to maximise profits, including
through artificially high prices.
It is generally agreed that competitive markets will have greater ability than other non-competitive
options to efficiently produce goods and services at prices that provide value to customers — reflecting
the fact that customers demand choice and quality as part of that value. As a relatively small and
isolated country, Australia has developed highly concentrated markets over the years in industries such
as grocery retailing, newspapers, shopping centres, banking, insurance, gaming, telecommunications,
building products, aviation, construction and liquor. Australia also does not have the forced divestiture
powers of countries like the US and the UK, where companies may be compelled to sell off parts of
their business.

WORKABLE COMPETITION
While perfect competition is difficult to achieve, the concept sought by most modern economies (including
through sometimes complex government regulation) is workable or effective competition within an
economy. The requirements of workable or effective competition include the following.
• There should be a sufficient number of buyers and suppliers so that there are real alternatives.
• No individual trader should have the power to dictate to its rivals or be free of competitive pressure.
• New traders should be able to enter the market without facing artificial barriers.
• There should be no collusion on prices, customers or trading policy.
• Customers should be able to choose their supplier.
• No trader should have an advantage because of legal or political considerations.
Note that all of these concepts are dependent on identifying a relevant market — a combination of the
product market and the geographic market that is not always easy to identify. While economists debate
what comprises a market, we find that the decision is a matter to be decided in courts of law. In a relevant
case, the court will consider the arguments of two protagonists in the courtroom and make a rational,
balanced judgment (often including consideration of the views of experts). That judgment will be based
on the balance of probabilities according to the court, based on the facts given in evidence. For those who
are not experts or judges, we can make rational, balanced judgements about what comprises a market —
especially if we use the guidance that is available from previous court decisions (precedents).
In the case of Outboard Marine Australia Pty Ltd v. Hecar Investments No. 6 Pty Ltd (1982) 66 FLR
120, the head note to the judgment of CJ Bowen, J Fisher and J Fitzgerald states that ‘the correct approach
to determine the state of competition in a market is to undertake a detailed analysis of the market, the state
of competition therein, and the likely effect of the conduct upon competition in the market’. Being aware
that this is how market competition is determined in respect of any situation or any dispute is valuable
knowledge. There are many cases in various international jurisdictions that demonstrate the approach
described in the Hecar case.

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262 Ethics and Governance

COMPETITION AND STAKEHOLDERS
It is commonly recognised that all organisations seek to achieve competitive advantage in the sale of their
goods and services. The logical purpose of seeking competitive advantage is to develop an overwhelming
competitive advantage and eventually achieve a monopoly. In theory the greatest efficiencies can be
achieved by the largest scale of activity, which logic indicates would be a monopoly. This is contrary
to the protection of competition in markets for goods and services. Further, it may be a self-defeating
endeavour, as a lack of competition and the innovative pressures that competition creates may make the
monopolist lazy, inefficient and an easy target for new entrants to the market.
Consumers are generally hurt by lack of competition because prices are not competitive, outdated
technologies and inefficiencies can prevail, and the product range and availability are directed by the
monopolist. The reduction in business opportunities and efficiencies, combined with potential diminution
of overall activity, damages the entire economy.
Internationally, laws designed to protect competition universally seek to prevent monopolies. But
sometimes, as with the developing National Broadband Network (NBN) in Australia, governments will
take deliberate short- to medium-term initiatives, including the creation of monopolies, in order to achieve
specific long-term outcomes. Any such move will be subject to great debate as the real merits and long-
term benefits of approaches are likely to be considered by many to be improper in a competitive sense.
For example, many suggest that the Australian NBN, by adopting a monopolistic approach in respect of a
single technology, may fail in key respects as market-based newer alternative technologies will be ignored.
(Though the NBN might respond that its brief is to serve the whole Australian market with an efficient
service, while other technologies and providers are aimed at selected profitable niches in the market.) The
NBN debate demonstrates that competition issues can become very complex.
The Australian Government’s concept of actively creating the NBN monopoly has also been the subject
of international commentary. These commentaries show that many, not simply opposition members of
parliament, believe the deliberate ‘legislated monopoly’ approach of the Australian Government is not
appropriate in an age of market freedom — quite aside from the long-term possibility of a series of
economically and technically inappropriate decisions and outcomes. The OECD stated very clearly that:
While establishing a monopoly in this way would protect the viability of the government’s investment
project, it may not be optimal for cost efficiency and innovation. Empirical studies have stressed the value of
competition between technological platforms for the dissemination of broadband services (OECD 2010b).

Regardless of government monopolies, the challenge for corporations internationally is to improve

productivity and become more efficient, innovative and flexible but not to misuse market power or act
in anti-competitive ways. Competition pushes corporations to improve, adapt and respond to the changing
environment. This usually leads to better prices and choices for consumers. The broader economy will also
benefit due to greater efficiency, economic growth and more employment opportunities.
Most commonly, corporations will rely on the law as the arbitrator or provider of very clear rules that
establish competition policies within the corporation. Notwithstanding the need to act ethically within
the corporation, relying on the law as it is developed and refined is both inevitable and wise, as the
law creates common standards that apply equally to all corporations within any jurisdiction. Fortunately,
while many detailed rules differ, internationally there are broad similarities in the way countries approach
competition policy.
Even so, correct balances can be hard to achieve and the laws in individual countries will change from
time to time. Further, the fact that even a government (as with the Australian NBN) is willing to protect its
own investments through creating a new, artificial monopoly is an indicator that self-interest is difficult to
overcome if entities are permitted (or feel free) to use their market power, or their ability to breach other
competition rules, to their own advantage.
Full awareness of competition policy, laws and regulations is a crucial part of corporate governance
framework. It is necessary to define and understand unacceptable anti-competitive behaviour so that this
can be avoided on all occasions — even though this is difficult where governments, who otherwise enforce
competition rules, seek to bypass the principles on occasion. The governance balance is difficult, but it must
be understood and incorporated into appropriate board-approved policies as well as into a meaningful
compliance program for competition law and other legal and regulatory risks.
Table 4.4 provides examples of international competition legislation and regulators. As noted, legislation
is very similar across different jurisdictions. This is inevitable as markets and competition have become
global, so international competition rules and regulations need to operate consistently.
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 TABLE 4.4 International competition legislation and regulators

Jurisdiction Legislation Regulator

Australia Competition and Consumer Act 2010 ACCC

Canada Competition Act (R. S. 1985) Competition Bureau Canada

Consumer Packaging and Labelling Act (R. S. 1985)

United Kingdom Competition Act 1998 Competition Commission

Office of Fair Trading

European Union Competition rules of the Community Treaties European Commission —

including Articles 101 and 102 of the Treaty on the Directorate General for Competition
functioning of the EU

Indonesia Law No. 5/1999 (Anti-Monopoly Practice and Unfair Commission for the Supervision of
Business Competition) Business Competition

Source: CPA Australia 2023.

REGULATING ANTI-COMPETITIVE BEHAVIOUR

As shown in table 4.4, internationally there are laws and regulations that seek to create a common
competition basis for all corporations. We now consider the following conduct and the rules that exist
to regulate:
• abuse of market power
• mergers and acquisitions
• agreements between competitors (cartel conduct)
• unilateral restrictions on supply (exclusive dealing)
• resale price maintenance (vertical price controls).
Abuse of Market Power
To ensure that some level of competition is maintained in a marketplace, the abuse of market power is
prohibited. For example, in Australia the law governing this area is ss. 46 and 46A of the Competition and
Consumer Act. Section 46A states the following.
(2) A corporation that has a substantial degree of market power in a trans‐Tasman market must not take
advantage of that power for the purpose of:
(a) eliminating or substantially damaging a competitor of the corporation, or of a body corporate that
is related to the corporation, in an impact market; or
(b) preventing the entry of a person into an impact market; or
(c) deterring or preventing a person from engaging in competitive conduct in an impact market.

The prohibition on misuse of market power is aimed at preventing powerful entities from taking
advantage of that market power for the purpose of disadvantaging weaker organisations.
Strategies to increase profits and market share may include lower prices, better products or greater
levels of service. These strategies generate competition and are good for the consumer. However, some
corporations are able to obtain significant market power, for example, through their size, technology or
branding. It is not in the best interests of consumers to allow these corporations to compete so vigorously
that they use their market power to destroy, eliminate or harm competitors. Therefore, in many jurisdictions,
the use of market power for these purposes is not permitted.
As another example of regulation in this area, Article 102 (formerly Article 82) of the ‘Treaty on the
functioning of the European Union’ (EUR-Lex 2012), prohibits anti-competitive business practices that
threaten the internal market of the EU, harm consumers and small and medium-sized enterprises, and
reduce business efficiency. The relevant EU provisions are operationally almost identical to the provisions
in Australia and the US, and the treaty has strong universal application. Article 102 provides as follows.
Any abuse by one or more undertakings [organisations] of a dominant position within the internal market
or in a substantial part of it shall be prohibited as incompatible with the internal market insofar as it may
affect trade between Member States.
Such abuse may, in particular, consist of:
(a) directly or indirectly imposing unfair purchase or selling prices or other unfair trading conditions;
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(b) limiting production, markets or technical development to the prejudice of consumers;

264 Ethics and Governance

 (c) applying dissimilar conditions to equivalent transactions with other trading parties, thereby placing
them at a competitive disadvantage;
(d) making the conclusion of contracts subject to acceptance by the other parties of supplementary
obligations which, by their nature or according to commercial usage, have no connection with the
subject of such contracts (EUR-Lex 2012).

As is apparent from the EU legislative approach, the main principle for establishing abuse of market
power focuses on whether a corporation that has market power has used that power to eliminate a
competitor or to prevent a competitor from entering or properly competing in a market for goods
or services.
A specific example of abuse of market power is known as predatory pricing. Predatory pricing is the
supply of goods or services below cost price over a period of time. While this looks beneficial to consumers,
it is an example of misuse of market power and is covered by specific provisions in many jurisdictions.
Predatory pricing is a prohibited activity because the likely real ambition is for powerful corporations to
eliminate less powerful competitors who cannot sustain the ongoing losses of competing at artificially low
prices. This eventually allows the powerful corporation to become dominant and then to set higher prices
and exploit customers through artificially high prices based on monopolistic market positioning.
In Australia, the principal regulator in this area is the ACCC. The ACCC, even more broadly than similar
bodies such as the Hong Kong Competition Commission, undertakes a number of functions involving
regulation, legislation development, competition law education, prosecution and administrative decision
making (through its functionally separate tribunal). In this administrative role, the ACCC secured a record
penalty against Cabcharge, as discussed in example 4.16.

EXAMPLE 4.16

Cabcharge — $14 million Penalty for Breach

The ACCC pursued Cabcharge for abusing its market power (ACCC v. Cabcharge Australia Ltd [2010]
FCA 1261). Cabcharge supplies an electronic and voucher payment system to the Australian taxi industry.
It is dominant in the market and is reported to be the supplier of 96 per cent of Australian taxis’ payment
systems. The ACCC initiated proceedings against Cabcharge in 2009 alleging that it had misused its
market power by:
• refusing to deal with competing suppliers of electronic payment systems
• refusing to allow Cabcharge payments to be processed through electronic terminals operated by rival
payment networks
• supplying taxi meters and fare schedule updates below cost or free of charge.
It was argued by the ACCC that this low-cost supply was because taxis with an integrated Cabcharge
payment system and taxi meter would be significantly less likely to deal with Cabcharge’s competitors.
The matter settled on 23 September 2010 and Cabcharge paid a substantial penalty of $14 million
and was ordered also to pay costs of about $1 million. Other parties adversely affected by Cabcharge’s
behaviour, if sufficiently concerned, could also consider bringing actions for damages under the
Competition and Consumer Act. The case was widely reported, resulting in substantial adverse publicity
for Cabcharge, and its share price was reported as being down by 20 per cent after the case. The share
price fall may have been related to adverse publicity, but it was more likely a market response to its strong
market presence potentially being reduced as other competitors gain easier market entry.
Source: Information from ACC v. Cabcharge Australia Ltd [2010] FCA 1261, Australian Competition Law, accessed August
2023, http://australiancompetitionlaw.org/cases/cabcharge2010.html.

There appears to be a renewed international focus on this type of behaviour. We previously observed
some aspects of this in the EU law. Example 4.17 is based on the EU legislation.

EXAMPLE 4.17

Intel Fined EUR1.06 billion

In May 2009, the European Commission fined Intel Corporation EUR1.06 billion for anti-competitive
practices. Intel, with over 80 per cent market share for PC microprocessors, was found to have been

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 paying manufacturers and a retailer to favour its computer chips in preference to those of its main
competitor, AMD. The payments were disguised as hidden rebates and occurred over a six-year period.
The manufacturers involved often delayed or cancelled the release of products containing the competitor’s
products (BBC 2009).

Examples 4.18 and 4.19 examine ACCC actions in relation to price fixing and market dominance.

EXAMPLE 4.18

Flight Centre and Price-fixing

In April 2018 the Full Federal Court of Australia ordered Flight Centre to pay penalties totalling
$12.5 million for attempting to induce three international airlines to enter into price-fixing arrangements
between 2005 and 2009. Under the arrangement, each airline would agree not to offer airfares on its
own website that were lower than those offered by Flight Centre. In March 2014 the trial judge imposed
a penalty of $11 million against Flight Centre. Flight Centre appealed the liability finding and the ACCC
appealed the $11 million penalty orders because it considered that the penalty would not send a strong
deterrence message to Flight Centre and other businesses. In May 2014 the Full Federal Court found
that Flight Centre’s conduct did not breach the CCA. The ACCC sought special leave to appeal and in
December 2016 the High Court allowed the ACCC’s appeal. The matter was remitted to the Full Federal
Court. In April 2018 the Full Federal Court ordered an increase in penalties to $12.5 million. Flight Centre
is Australia’s largest travel agency, with $2.6 billion in annual revenue. The ACCC will continue to argue for
stronger penalties which it considers better reflect the size of the company, as well as the economic impact
and seriousness of the conduct. Significant penalties act also as a general deterrent to other businesses
that may be considering such conduct.
Source: Information from ACCC 2018a, ‘Flight Centre ordered to pay $12.5 million in penalties’, media release, 4 April,
accessed August 2023, www.accc.gov.au/media-release/flight-centre-ordered-to-pay-125-million-in-penalties.

EXAMPLE 4.19

Pfizer and Market Dominance

Market dominance and market control in the pharmaceutical industry has been of concern to the
competition regulator and it took on Pfizer Australia Pty Ltd over what it alleged was Pfizer’s attempt
to abuse its market position by deterring people seeking to produce generic medications.
The ACCC first took Pfizer to court in 2014, alleging that the company ‘misused its market power ...
to prevent or deter competition from other suppliers selling generic atorvastatin products to pharmacies’
and engaged in ‘exclusive dealing conduct for the purpose of substantially lessening competition in the
market for atorvastatin’, the ACCC media release said. The ACCC lost its application in the courts in 2015.
The court found that the company has taken advantage of market power by engaging in the conduct
concerning the competition regulator. It was noted by the court that Pfizer’s dominance was not that great
at the time it made offers to community pharmacies. The ACCC sought to challenge that decision by
appeal, but that appeal was rebuffed by the Full Federal Court with the result that the ACCC has flagged
it would apply to the High Court of appeal the matter further.
Source: Information from ACCC 2018b, ‘High Court refuses the ACCC special leave to appeal Pfizer decision’, media
release, 19 October, accessed August 2023, www.accc.gov.au/media-release/high-court-refuses-the-accc-special-leave-to-
appeal-pfizer-decision.

QUESTION 4.5

Markets work well when fair-dealing businesses are in open, vigorous competition with each other.
With reference to examples 4.16 and 4.17, complete the following.
(a) What are the corporate governance implications of these examples for a board?
(b) Do competition laws stifle a corporation’s ability to be competitive?
(c) In what ways can respect for competition law drive competitive advantage for individual
corporations?

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266 Ethics and Governance

Mergers and Acquisitions
A significant underlying reason for many mergers and acquisitions is to reduce the number of competitors
in a market for goods and services. Therefore, in many jurisdictions, regulations are in place that prohibit or
limit mergers and acquisitions unless they are formally approved. With larger multinational corporations,
these approvals need to be obtained for each country in which the organisation plans to operate, and may
lead to specific requirements, such as the divestment of businesses where the merged entity would have
too much market power.
As discussed previously, and illustrated by example 4.20, approval for a merger or acquisition may rest
on a court’s decision in identifying the ‘relevant market’.

EXAMPLE 4.20

ACCC v. Metcash Trading Ltd [2011] FCAFC 151

Metcash is Australia’s largest independent grocery, fresh produce and liquor wholesaler and distributor. It
supplies IGA and other independent retailers. In July 2010, Metcash sought informal clearance from the
ACCC for its proposed acquisition of Franklins’ supermarkets and grocery distribution business in NSW
and the ACT. The ACCC opposed the acquisition, arguing that the relevant market was the wholesale
supply of groceries to independent supermarkets in NSW and ACT, in which the major supermarkets do
not participate, and that the acquisition would substantially lessen competition in this market.
At trial, the ACCC’s argument was rejected. The court found that in addition to being a wholesaler,
Metcash was involved in retail activities through IGA stores. The acquisition would not substantially
lessen competition but would strengthen the capacity of independent retailers operating as IGA stores
to compete vigorously with the major supermarket chains.
Source: Information from Australian Competition and Consumer Commission v. Metcash Trading Limited [2011]
FCAFC 151 (30 November 2011), accessed August 2023, www8.austlii.edu.au/cgi-bin/viewdoc/au/cases/cth/FCAFC/
2011/151.html.

.......................................................................................................................................................................................
CONSIDER THIS
In August 2023, the ACCC decided not to grant authorisation to ANZ for the proposed acquisition of Suncorp Bank
(ACCC 2023). The ACCC outlined the key reasons for their decision in the following report: https://www.accc.gov.
au/system/files/public-registers/documents/Summary%20of%20reasons%20for%20Determination%20-%2004.
08.23%20-%20PR%20-%20MA1000023%20ANZ%20Suncorp_0.pdf. Do you agree with the decision?

Agreements Between Competitors — Cartel Conduct

Cartel conduct involves the existence of a cartel provision in a contract, arrangement or understanding
between competitors. Such collusion is effectively a form of conspiracy, and conspiracies to cause harm
are usually considered particularly harshly by societies and legislatures. Therefore, it has been the subject
of the largest penalties in many jurisdictions. As part of good governance, boards and management must
understand the nature of collusion from a competition perspective.
Collusive behaviour is generally defined as any horizontal agreement or even a mere understanding
between competitors in a market that affects competition (i.e. a market test applies) or that is otherwise
defined by the law as simply not permitted (in which case it is simply not allowed — or is ‘per se illegal’).
It is the agreement between competitors who should be actively competing rather than conspiring that
makes collusion highly inappropriate.
It has been common internationally for cartel conduct, like most other anti-competitive conduct, to be
dealt with on a civil basis (in which case compensation and often very large civil pecuniary penalties occur,
based on the balance of probabilities standard of proof). However, in recent years, following the example of
the US, jurisdictions such as Australia have made cartel conduct also subject to criminal sanctions (based
on the beyond reasonable doubt standard of proof). The law still provides for compensation but also for
very large criminal fines and even jail sentences. Note that civil actions, with the lesser standard of proof,
are also available.
Attempts by competitors to gain advantage through collusion are heavily controlled (once again by
similar rules in most jurisdictions). The Hong Kong competition law contains specific provisions to stop
collusion. Each jurisdiction mentioned in table 4.4 also has relevant laws, as does the US. In the Eurozone,
EU Article 102, covers competition law.

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 Cartel behaviour can be categorised into four different types of conduct, which are individually
addressed in the Australian Competition and Consumer Act:
• output restrictions
• allocating customers, suppliers or territories
• bid-rigging
• price-fixing.
The main questions or tests we can ask to assess whether these prohibited behaviours have occurred are
as follows.
• Has there been a contract, agreement or understanding (i.e. an arrangement)?
• Has this occurred between competitors?
• Is the outcome of a type that is simply prohibited or alternatively is the outcome one that has a significant
impact on competition in the market?
Behaviour or conduct that meets these tests will be in breach of the law.
As an example, Visy Industries Holdings Pty Ltd received a $36 million fine in November 2007
for market sharing and price-fixing. Visy and its competitor, Amcor Ltd, coordinated price rises and
swapped information when negotiating quotes for larger customers to ensure that each would retain specific
customers, thereby maintaining static market shares in the corrugated fibre packaging (cardboard) industry.
On occasions when the collusion was unsuccessful and a customer elected to swap supplier, another
customer contract of around the same value would be exchanged by the two parties. The regulator granted
Amcor immunity from prosecution in return for blowing the whistle on the cartel under the ACCC Immunity
Policy for Cartel Conduct (ACCC 2009).
Boards must have a strong understanding of the nature of the four types of cartel conduct and,
if necessary, gain professional advice regarding the exact details of legislation that may affect their
corporation in any jurisdiction within which it is active. Boards must also understand the basic character
of the issues involved in order to establish and oversee appropriate policies.

Output Restrictions
Output restrictions refer to conduct where competitors agree to apply restrictions on output that will
cause shortages in markets and thus result in price rises. Such price rises will advantage suppliers and
are the reverse of a competitive situation where competitors help push prices down. An example of this
behaviour is the attempt to restrict the supply of oil to help maintain prices by the Organization of the
Petroleum Exporting Countries (OPEC) cartel. The benefit to the cartel and the cost to consumers are both
immediately apparent.

Allocating Customers, Suppliers or Territories

Dividing up markets, customers or regions between competitors is another way of limiting competition.
Also known as market sharing, this activity creates artificial monopolies in respect of segments of
the market. Customers in such an environment therefore do not receive the same level of choice or
price competition.

Bid-Rigging
Competitive tenders and quoting are used by customers to let suppliers compete vigorously against each
other to win work. Bid-rigging is where competitors collude when asked to tender or bid for work. To
ensure that prices are maintained, all competitors may agree to submit similar pricing, or allow one of the
competitors to win the work by having the rest of the cartel artificially inflate prices.

Price-Fixing
Price-fixing is where competitors collude to create common prices. An example of price-fixing could
be two competitors agreeing to supply goods to customers at the same price. An understanding between
competitors to stop discounting on a certain day might be less obvious, but it would also be price-fixing.
It does not matter if there is an unwritten agreement or a written agreement.
Effective competition should see consumers receiving lower prices and better-quality goods and
services. By fixing prices, competitors are able to maintain profits and have less incentive to improve
their efforts. This has a significant effect on competition and the penalties may be severe (see
example 4.21).

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268 Ethics and Governance

 When determining if price-fixing has taken place, we need to focus on identifying an agreement between
suppliers. This is important because there is one price-setting activity that may look unlawful but is actually
permitted. This is so-called parallel conduct and price-following. An example of this occurring is evident
in parallel pricing, where Company Y sets its selling price at the same level and at the same time as
Company X without collusion. This may seem improbable but can in fact be common. Corporate databases
are now very sophisticated, and they will have the price of all competitors’ products in all markets and will
employ this data independently in setting their own prices.

EXAMPLE 4.21

Midland Brick Case

The Federal Court of Australia (in Australian Competition and Consumer Commission v. Midland Brick Co
Pty Ltd [2004] FCA 693 (31 May 2004) — see especially paras 26 and 42 regarding penalties) ordered
Metro Brick, a subsidiary of listed building products company Boral, to pay a pecuniary (civil) penalty of
$1 million dollars for its part in price-fixing arrangements with Midland Brick Company Pty Ltd (Midland
Brick). A senior manager of Metro Brick was also ordered to pay $25 000 in civil penalties. Legal costs of
$190 000 were also awarded against Midland Brick.
It was found that in the last quarter of November 2001, Metro Brick and Midland Brick had agreed to
apply price rises for clay-brick products on specified dates. It was also established that the two companies
had made an agreement on fixed minimum pricing in relation to tendering for contracts.
Source: Information from Australian Competition and Consumer Commission v. Midland Brick Co Pty Ltd [2004] FCA 693,
accessed August 2023, https://jade.io/article/108941.

The Midland Brick case is an example of how the competitive rush by managers can see things go
wrong. It demonstrates how the law applies and it shows how rapid returns to good ethics, including
providing swift assistance to regulators, can reduce harm. By fixing prices, competitors are able to
maintain profits and have less incentive to provide genuine customer value. This has a strong negative
effect on competition generally. Market disruption penalties are very severe, to discourage this behaviour
and to recognise the strong self-interest that may motivate corporations. Penalties include large fines,
disqualification from managing companies and jail.
It provides a strong message that professional accountants’ role in eliminating problems can be
significant if we are aware of relevant laws and apply them with strong professional ethics. To emphasise
the international character of this type of situation, consider example 4.22.

EXAMPLE 4.22

International Airline Pricing Cartel

A global price-fixing cartel involving at least 15 airlines received significant penalties for fixing the prices
in the air cargo industry. Hundreds of millions of US dollars in fines have been levied against the airlines
whose illegal conduct included price-fixing and attempts to eliminate competition by fixing rates. The
airlines involved included:
• Nippon Cargo Airlines (Japan)
• Cargolux Airlines International SA (Luxembourg)
• Asiana Airlines Inc. (Korea)
• LAN Cargo SA (Chile)
• Aerolinhas Brasileiras SA (Brazil)
• El al Airlines (Israel)
• British Airways PLC (UK)
• Qantas Airways Ltd (Australia)
• Air France (France)
• KLM Royal Dutch Airlines (Netherlands)
• Cathay Pacific Airways (Hong Kong) (Weber 2009).
In June 2012, the ACCC published a report (see next) on the continuing significance of this cartel, which
has also been extensively dealt with under laws in other jurisdictions.

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 Malaysia Airlines Cargo Sdn Bhd Penalised $6 million for Price Fixing Cartel
The Federal Court in Sydney has penalised Malaysia Airlines Cargo Sdn Bhd $6 million for price fixing as
part of a cartel following action by the ACCC.
‘This penalty sees the total penalties ordered against this international cartel increase to a record
$58 million. These penalties are the highest generated by a single ACCC Investigation,’ ACCC Chairman
Rod Sims said.
The ACCC has been pursuing a number of international airlines for cartel conduct relating to the carriage
of air freight. Malaysia Airlines Cargo Sdn Bhd is the ninth airline to settle proceedings against it.
‘The ACCC’s focus on stopping cartel conduct has sent a strong message. It is crucial for the proper
functioning of business in Australia that the ACCC continues to tackle cartel conduct with the full force
of the law. Cartel conduct is damaging and unlawful because it harms competition and usually inflates
prices for consumers,’ Mr Sims said.
The ACCC instituted proceedings against Malaysia Airlines Cargo Sdn Bhd on 9 April 2010, alleging
that it reached and gave effect to understandings with other international airlines regarding the level of
particular surcharges and fees relating to air freight carriage from Indonesia. Malaysia Airlines Cargo Sdn
Bhd has admitted that it did so in relation to:
• fuel surcharges between April 2002 and September 2005
• security surcharges between October 2001 and October 2005, and
• customs fees between May 2004 and October 2005.
Justice Emmett also made orders restraining Malaysia Airlines Cargo Sdn Bhd from engaging in similar
conduct for a period of five years and to pay $500 000 towards the ACCC’s costs.
Source: ACCC 2012a, ‘Malaysia Airlines Cargo Sdn Bhd penalised $6 million for price fixing cartel’, media release,
14 June, accessed August 2023, www.accc.gov.au/media-release/malaysia-airlines-cargo-sdn-bhd-penalised-6-million-for
-price-fixing-cartel. © Commonwealth of Australia.

Unilateral Restrictions on Supply (Exclusive Dealing)

Exclusive dealing is when a single corporation decides, in the absence of agreements or understandings
with competitors (which would amount to collusion and therefore cartel conduct), to deal only with certain
customers or geographic regions. This type of conduct is generally permitted, but prohibitions may exist
if it is shown to lessen competition substantially. This type of potentially anti-competitive conduct is civil
only in most jurisdictions (i.e. there is no criminal behaviour and no criminal outcomes).
There are three core characteristics that apply to regulating exclusive dealing.
1. It is not cartel conduct. This means that the organisation in question decides to do something unilaterally
(i.e. by itself), rather than in collusion with other competitors.
2. The unilateral refusal to deal will be unlawful if, on the balance of probabilities, there is found to be a
‘substantial lessening of competition in a market’.
3. ‘Third-line forcing’, which is a specific type of exclusive dealing, is perceived to be anti-competitive
and harmful to competition. An example is where a supplier forces a customer to also purchase another
item from a third party. The most significant early case in Australia on this issue was the case of
Re Ku-ring-gai Co-operative Building Society (No. 12) Ltd [1978] FCA 50. The High Court found
in that case that an attempt by a building society to force a would-be borrower to take out mortgage
insurance with a nominated insurer was in breach of the law.
Third-line forcing is not illegal ‘per se’. This means that, unlike price agreements between competitors
and resale price maintenance, which are simply not permitted, it is market tested to see if competition in a
market is substantially lessened; if it isn’t then it may be permitted.
Franchises, which are very commonly found internationally, need special treatment regarding third-line
forcing. This is because third-line forcing exists in most franchise agreements. Example 4.23 provides
a hypothetical example of third-line forcing in a franchise arrangement.

EXAMPLE 4.23

Hypothetical — Tummy Fill

Assume that the hypothetical franchisor Tummy Fill Ltd is about to sign on Jerry’s Foods Pty Ltd as a new
franchisee. As part of the franchise agreement, Jerry’s Foods (like all franchisees within the Tummy Fill
franchise) is required to buy cakes from Yumm Cakes Ltd. This arrangement will be regarded as third-line
forcing, as Jerry’s Foods is being forced to buy a product line from a third party.

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 As a result, special rules exist in most jurisdictions so that such third-line forcing can be approved
easily — otherwise franchising would be almost impossible under standard anti-competition laws. The
basis for such approvals lies in the fact that effective franchises create business opportunities that can,
on balance, be regarded as opening new markets rather than tightening existing markets.

As with all matters involving complex business arrangements, good governance and the law, it is
important to have good knowledge and understanding so that appropriate balanced professional judgements
can be formed. If boards and management cannot do this alone, then informed professionals must be
available to assist them. Informed professionals, such as CPAs, have an important part to play — but care
must be taken even by CPAs to ensure that they do not try to become legal advisers. Legal understandings
must be provided by professionally qualified legal advisers with relevant knowledge and experience.

Resale Price Maintenance

Resale price maintenance occurs when a supplier stipulates that the goods it provides must only be resold
at or above a certain minimum price. As this leads to maintaining prices, it is regarded as anti-competitive.
A supplier cannot dictate, suggest or encourage a minimum selling price by any means whatsoever
(i.e. they cannot maintain a high resale price). To do so by means of incentives, discounts, instructions
or withholding supply is not permitted. While ‘recommended retail/resale prices’ may be provided for
products and/or services, crucially such prices must be termed ‘recommended’ and no attempts can be
made to cause any reseller to adhere to those prices. Resale price maintenance is an example of vertical
power being used in a market.
A very powerful corporation might abuse its market power and engage in either vertical or horizontal
anti-competitive behaviour. Competition laws, as they are designed to stop misconduct, are deliberately
drafted broadly.
Two questions may be asked to determine if resale price maintenance has occurred.
1. Has the supplier specified a minimum price?
2. Has the supplier taken action or attempted to enforce this minimum price?
For example, in court-enforceable undertakings provided to the ACCC in 2012, Chemical Formulators
Pty Ltd (an Australian manufacturer and supplier of commercial cleaning products) admitted that it had
engaged in resale price maintenance and undertook that, among other things, it would not engage in resale
price maintenance conduct in the future. Chemform had entered into agreements with distributors of its
products that prevented those distributors from discounting the price of those products below a price
Chemform specified, as well as withholding supply from distributors who were likely to sell its products
at a price less than the price it specified (ACCC 2012b).
A case in this area requires the complainant — who may be an affected party or the regulator (in
Australia, the ACCC) — to prove on the balance of probabilities that the behaviour has occurred. This
needs to be proved only on the balance of probabilities as the matter will be civil. There is no need to
prove that there was an effect on competition as the behaviour, once proven, is automatically in breach of
the law because resale price maintenance is typically ‘per se illegal’. A hypothetical is provided in the first
part of example 4.24.
One exception in this area relates to the concept of loss leading. A loss leader is a product that is sold
below cost price to entice resellers/customers into a selling outlet. Loss leading most-commonly occurs at
the retail level. In the simplest loss leading situation, the supplier (a manufacturer or wholesaler) supplies
to their customer (a retailer) and the retailer in turn sells to their customer (commonly the final consumer).
Retailers may decide to discount greatly some products to entice customers into their retail outlet. Where
the selling price of these products is discounted below cost price, they clearly sell at a loss, hence the
term ‘loss leaders’. Loss leaders are intended by the retailer to lead customers into the store, not only to
buy that product but also to buy other products. These other products are sold at normal profit margins.
The problem for the manufacturer or wholesaler of the loss leader product is that the loss-leading activity
damages their product, not least because other retailers will not want to sell that product as they cannot
competitively do so except by selling it at a loss.
The competition law recognises that loss leading may cause harm to the supplier (i.e. the manufacturer
or wholesaler) where it is a continually ongoing activity. Therefore, to counteract unlawful loss leading, a
supplier is permitted to withhold supply in order to prevent the reseller from loss leading with the supplier’s
products and, therefore, damaging the supplier.
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 However, if the retailer, or another entity that is loss leading with their supplier’s products, is selling
below cost price as part of a genuine sale, then their supplier cannot act against the retailer (i.e. their
customer) and cannot withhold supply. If they do so, the supplier is in breach of competition law. In the
absence of unlawful loss leading, such withholding of supply is ‘per se illegal’. A genuine sale where
loss leading is permitted would include activities such as short-term discounts to sell excess stock or other
genuine discount sales campaigns such as end of year sales.
Approvals Procedures
As discussed, in many jurisdictions, some anti-competitive behaviour is automatically illegal (‘per se
illegal’), while other behaviour is only illegal if it is shown to have a substantial effect on competition
in the market. As a result, there may be times when behaviour that is good for competition is automatically
illegal when it should be permitted. On other occasions, we might see conduct that appears to lessen
competition in a market — but which on another view can be regarded as pro competition. We observed
an example of this in the special treatment that may be required for franchising.
An example of where ‘per se illegal’ horizontal price-fixing between competitors might be useful for
consumers is setting the price for taxi fares. Instead of having to negotiate a fare each time you enter a taxi,
there is an established pricing structure in place (which in many jurisdictions is part of industry agreements
or regulations). The taxi structure of fixed prices will have been given regulatory approval through a formal
process of authorisation designed to stabilise the industry and give value to consumers.
As mentioned, franchisors often require franchisees to accept contractual terms that dictate, for example,
suppliers and products. While third-line forcing is regarded as lessening competition, the existence of many
businesses operating as franchises in fact adds greatly to overall competition in the economy.
To allow for necessary exceptions and orderly commerce, competition regulations usually provide the
opportunity for companies to apply for permission (called authorisations and notification in Australia) to
perform otherwise potentially unlawful activities without breaching the law.
Any such exception-approvals will be formally given by the local competition regulatory agency.
For example, the ACCC in Australia is specifically empowered to approve otherwise anti-competitive
arrangements on the basis of the public interest. (The ACCC will regard the creation of viable
and/or competitive markets as a public interest matter.) An example is provided in the second part of
example 4.24.
Most jurisdictions also provide other exceptions to cartel regulations. These include exceptions related
to the activities of joint ventures, agreements between related bodies corporate and other collective
acquisitions of goods and services. These become very complex and require detailed legal advice.

EXAMPLE 4.24

Competition Law — Breaches and Exemptions

Consider the following hypothetical example about a breach of competition law and real-world example
about the ACCC’s process for allowing exemptions for certain types of cooperation between competitors.
The purchasing managers of Shark Ltd (Shark) and Loose Ltd (Loose) arranged to set a fixed price
for similar products they both sold to a customer called Goods Ltd (Goods). They did this without the
knowledge of other officers in their respective organisations. If Goods attempted to negotiate lower prices
with either Shark or Loose, both managers had further agreed that they would not reduce their selling
prices to Goods. Having discovered that the arrangement was in place, Goods was unhappy with the
conduct of Shark and Loose and complained to the government regulator.
There are times when the ACCC provides authorisation to larger or better-known companies to offer
a sales point or platform to their competitors. In December 2017, the ACCC gave permission to Taylors
Wines Pty Ltd to be able to invite fellow wine suppliers — effectively competitors — to participate with it
in a range of marketing and promotional opportunities on the Deliveroo Australia platform.
‘Taylors applied to the ACCC for authorisation to invite other wine producers to supply wine products
to Deliveroo Australia’s customers by way of Deliveroo’s website and/or social media platforms,’ the
ACCC said. ‘The ACCC aims to assess applications for authorisation on a timely basis. Where conduct is
straightforward and the issues raised are not complex, the ACCC may be able to issue a final determination
well within the statutory six-month period. The CCA requires consultation only after a draft determination.’
The regulator has a practice to request feedback from the community when new applications come
through to it but what it did in this instance was fast track the process by releasing a draft determination,
which meant that the Taylors Wines application was able to be approved within two months of the
company coming to the regulator for a decision.

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 ‘We will consider using this approach again in the future where it appears that the proposed conduct
which is the subject of an application for authorisation is unlikely to raise concerns,’ the regulator said.
Source: ACCC 2018c, ‘ACCC & AER annual report 2017–18’, accessed August 2019, p. 54, www.accc.gov.au/system/
files/ACCC-%26-AER-Annual-Report-2017-18_0.pdf.

QUESTION 4.6

With reference to the first part of example 4.24, complete the following.
(a) Identify each individual or entity that may be in breach of the law.
(b) Identify the potential penalties that could apply.
(c) What would be the situation if Shark and Loose had never spoken to each other but, acting
alone, neither company would agree to reduce prices, so Goods stopped buying (and therefore
selling) the relevant product?

OBLIGATIONS TO CONSUMERS AND CUSTOMERS

Consumers are commonly thought of as ordinary people who buy products and services (including
financial services) under contracts of various forms. Domestic consumers use the goods and services they
buy at home or in domestic environments and consumer protection laws typically set out to protect them
as the first priority. In recent years, business consumers have also been afforded protection. Business
consumers buy goods or services as part of their business (this may include trading stock). If they are
relatively small businesses (the definition will vary from one jurisdiction to another), they will be afforded
business consumer protections.
Corporations (as suppliers) recognise that long-term support from consumers of their outputs will be
important for long-term corporate performance. However, many managers and corporations succumb to the
temptation to seek quick profits without care for consumers and their long-term needs. Sometimes, there
are even deliberate attempts to target vulnerable customers and consumers by deception and dishonesty.
Consumer protection is designed to work for consumers and the economy as a whole, even where
there is no direct contractual relationship with suppliers and manufacturers. For example, under product
standard protections such as safety standards, products must meet specified minimum legal standards.
Manufacturers and also retailers may be liable, regardless of direct contractual relationships, if they do not
comply with these stated minimum requirements. Consumer laws also seek to protect consumers in relation
to particular contracts where there are direct relationships. We will consider some aspects of consumer
protections shortly.
Caveat Emptor to Consumer Protection
Caveat emptor is a Latin term that means ‘let the buyer beware’. Until recent decades, protection for
consumers and customers has been quite limited — and remains so in some places. If customers purchased
or used an item that was not fit for use or was dangerous, they often had little chance of redress. Without
protection, consumers were expected to protect themselves, or put up with the consequences. Limited
emphasis was placed on requiring corporations to behave appropriately by providing honest information
and suitable products. Some long-lived corporations have always tried to behave appropriately, while other
corporations have not. Either way, older laws did not substantially address these failures or adequately
protect consumers.
Today, large corporations’ codes of conduct include the importance of good relationships with domestic
consumers (where there are direct contacts) and will nearly always also focus on building long-term
sustainable relationships with business consumers. They will also be strongly aware of domestic consumers
as final product users. To many, this awareness of customers and consumers is the very essence of customer
value required to achieve performance, a key component of good corporate governance.
Regulation and Consumer Protection
By now, most countries have constructed modern laws designed to create and enhance consumers’
rights. Table 4.5 briefly describes some examples. Issues such as properly informing and not misleading
consumers have been regulated. Rules have been developed to ensure goods are safe and meet certain
standards. In particular, goods must be fit for purpose and sold with warranties that include rights to
exchange and repair them.
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 The legislation providing these protections is not just focused on consumer protection — it is also an
attempt by governments to ensure good business practices that will lead to business success and order in
society. There are good macro-economic efficiency reasons for ensuring good products and good standards
of warranty, as well as the fact that each business is more likely to succeed with good products. When
consumers are fearful about quality, warranties and fitness for use, they are less likely to purchase a product.
Diminished consumption will harm individual businesses and their profitability, and will hinder the growth
and development of an economy.
This area of law continues to evolve, and legislation of this type now exists in most jurisdictions. Some
of the relevant legislation is referred to in the next section. At this point, we are focusing on the concept
that consumers should not be deceived by conduct or statements that are false or are intended to mislead.

TABLE 4.5 Important common approaches to consumer protection

Law Description

Malaysia: ‘No person shall engage in conduct that-

Consumer Protection Act 1999
(s. 9)
(a) in relation to goods, is misleading or deceptive, or is likely to mislead or
deceive, the public as to the nature, manufacturing process,
characteristics, suitability for a purpose, or quantity, of the goods; or
(b) in relation to services, is misleading or deceptive, or is likely to mislead
or deceive, the public as to the nature, characteristics, suitability for a
purpose, or quantity, of the services.’

Japan: In conjunction with other legislation, the Basic Act of 1968 makes illegal
The Consumer Protection misleading information and representation. Other consumer protection
Basic Act 1968 legislation deals with matters such as false labelling and false dealings
in relation to contracts (discussed later in this module under the heading
‘Unconscionable conduct’).

Australia:
The Australian Consumer Law
(Schedule 2 in the Competition
and Consumer Act)
(s. 18)
Provides that ‘A person must not, in trade or commerce, engage in conduct
that is misleading or deceptive or is likely to mislead or deceive’. This
prohibition is not limited to the supply of goods or services. It, in common
with all the laws in this table, establishes an economy-wide requirement
which corporate policies must recognise — and which will best be included
in appropriate corporate policies, set by boards.

Source: CPA Australia 2023.

Misleading Conduct and Representations

As observed in table 4.5, one concern of consumer protection law is establishing whether corporate
behaviour or conduct, including advertising, is misleading or deceptive. It is not enough, for example,
to ask: ‘Is what is said the truth?’ The truth can be misleading. It is necessary to ask questions such as:
• Has a truthful impression been conveyed?
• Would a group of less-informed people be misled or deceived?
• Is the approach I am taking one that is fair, or would some people find it deceitful?
For example, to advertise or represent that a product has been laboratory tested would not be false if
such a test has been conducted. However, the advertisement would mislead consumers if it omitted to say
that the product had failed the test. The deliberate use of half-truths or the omission of relevant information
limits the accuracy of what is being communicated and is, therefore, not acceptable.
Similarly, the retail business HBIC advertised that an opera singer named Joan Sutherland was to
sing outside its premises on a Saturday morning. However, its competitor (SBIC) complained that the
advertisement was misleading and deceptive or, as the performance had not yet taken place, was likely to
mislead consumers. The reason for the complaint was that a small-time opera singer had changed her name
legally to Joan Sutherland. She was not the real, internationally renowned, Joan Sutherland. In Hornsby
Building Information Centre Pty Ltd v. Sydney Building Information Centre Ltd (1978) 140 CLR 216,
the High Court of Australia found in favour of SBIC, and HBIC was issued with an injunction ordering
that the advertising cease, for breaching what is now s. 18 of the Australian Consumer Law (Schedule 2,
Competition and Consumer Act (2010)).
You will notice that action does not need to come from a consumer. It may come from a regulator or even
a competitor. In this situation, the self-interest of SBIC in not having its potential customers going to HBIC
because of its misleading conduct has the fortunate result that the legislation, by protecting consumers, also
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has pro-competitive outcomes. This is an interesting feature of consumer protection, as often the interests
of competitors promote actions at no cost to consumers or the regulator.
The corporate governance perspective that boards and management must understand is that corporations
that pursue their proper rights at law will look after the interests of consumers as important stakeholders.
This will benefit society at large and help to ensure that value builds for shareholders.
In example 4.25, it seems that Apple management in Australia simply followed the same international
marketing campaign for the 4G iPad as instructed by overseas management. In fact, Apple’s 4G network
connectivity is not compatible with Australia’s 4G network. Following legal action by the ACCC, in
addition to the fine discussed next, Apple was ordered to email customers with appropriate advice, and
also to allow full refunds to anyone wishing a refund. It was further ordered to ensure appropriate signage
stating the correct nature of the product.

EXAMPLE 4.25

Apple and ‘4G iPads’

Apple Pty Ltd Penalised $2.25 million for Misleading ‘iPad with WiFi + 4G’ Claims
Following action taken by the Australian Competition and Consumer Commission, the Federal Court has
ordered Apple Pty Ltd (Apple) to pay $2.25 million in civil pecuniary penalties for misleading advertising
in relation to the promotion of its ‘iPad with WiFi + 4G’, which had been found to have contravened the
Australian Consumer Law.
Apple promoted the ‘iPad with WiFi + 4G’ in Australia from 8 March to 12 May 2012 on its website, its
online store and in its retail store. Apple resellers also promoted the ‘iPad with WiFi + 4G’ online and in
their stores using promotional materials supplied by Apple.
However, the ‘iPad with WiFi + 4G’ could not connect to any networks which have been promoted in
Australia as 4G networks, in particular Telstra’s LTE network.
‘The $2.25 million penalty reflects the seriousness of a company the size of Apple refusing to change its
advertising when it has been put on notice that it is likely to be misleading consumers,’ ACCC Chairman
Rod Sims said.
‘The Federal Court has again recognized the need to protect consumers from misleading advertising
in the telecommunications and related sectors. This decision should act as a renewed warning that
the ACCC will continue to take action against traders who take risks in their advertising, regardless of
their size.’
In his reasons for judgment, Justice Bromberg considered that Apple’s conduct was ‘serious and
unacceptable’ and stated that ‘The most concerning aspect of Apple’s contravention … is the deliberate
nature of its conduct’.
Justice Bromberg noted that the facts of the case suggest that ‘global uniformity was given a greater
priority than the need to ensure compliance with the ACL’. His Honour warned that ‘Those who design
global campaigns, and those in Australia who adopt them, need to be attuned to the understandings and
perceptions of Australian consumers’.
The Court declared that Apple’s conduct was liable to mislead the public as to the characteristics of the
device in contravention of section 33 of the Australian Consumer Law. Apple agreed to the declaration
and consented to the penalties and other orders sought from the Court.
This judgment follows an undertaking given by Apple to the Court on 28 March 2012 in response to the
ACCC’s decision to institute proceedings.
Apple was also ordered to pay a contribution to the ACCC costs in the amount of $300 000.
Source: ACCC 2012c, ‘Apple Pty Ltd penalised $2.25 million for misleading “iPad with WiFi + 4G” claims’, 21 June,
accessed August 2023, www.accc.gov.au/media-release/apple-pty-ltd-penalised-225-million-for-misleading-‘‘ipad-with-
wifi-4g’’-claims. © Commonwealth of Australia.

QUESTION 4.7

A large beverage manufacturer prepares a point-of-sale poster promoting its brand as ‘the country’s
highest carbohydrate sports drink’ with the claim this will stimulate endurance, and the statement
that this is based on an independent scientific analysis. While the brand in question did have a
higher carbohydrate content than all other brands analysed, the researchers responsible for the
analysis stated in their report that, in terms of improving stamina, any differences between brands
were statistically insignificant.
Has the advertiser engaged in misleading advertising? Also, would you consider an advertise-
ment such as this to be misleading conduct or a misleading statement (or likely to mislead or
deceive), and what impact will this have on the potential outcomes?
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Puffery
Extreme exaggeration has been found not to be misleading in advertising, especially where the exaggera-
tion does not relate to objective facts. Such extreme subjective exaggeration is sometimes called puffery.
Puffery is acceptable because, if statements or representations really are puffery, the courts assume that
consumers could not possibly treat the exaggerations as serious, let alone be misled.
However, the line between obvious exaggeration and deceitful communication is not always clear. One
illustration where puffery was not allowed was a case where a car-rental company claimed to be the biggest
in luxury car rental. In fact, it was not, and being biggest is not subjective — it is an objective fact as to
whether a company is the biggest in an area of business.
In Australia, the long-held view of puffery is that:
The law does not prohibit imaginative advertising or the use of humour, cartoons, slogans etc. Regardless
of how the message is communicated the message itself should not be ‘misleading or deceptive’ or ‘likely
to mislead or deceive’ … Superlatives and comparatives that are self-evident exaggeration or puffing
are unlikely to mislead anyone … However, representations and claims that take on a factual character,
particularly in quality and price terms, may amount to a breach unless they are capable of substantiation
(Trade Practices Commission 1991, p. 16).
Note: The Trade Practices Commission was the predecessor of the ACCC.
Unconscionable Conduct
The area of unconscionable conduct is an important area of consumer protection that comprises laws
designed to stop consumers from being harmed by unfair or unfairly imposed or created contracts. These
contracts and the obligations arising from them will not be allowed where the circumstances make the
contracts or the consequences harsh or unfair and involve a more powerful party taking advantage of
another weaker party. In many jurisdictions, contracts that display these features can be set aside.
Specific laws address this matter and understanding how the concept of unconscionable conduct
originated will assist in understanding what modern legislation seeks to achieve.
Stated simply, a written and signed contract traditionally said everything about the agreement between
the parties to the contract. Courts would look beyond the written contract only to review missing concepts
or ideas. It was unthinkable that a concept written clearly in the contract might be intended to have
another meaning.
It was not until 1983 (in the case of Commercial Bank of Australia v. Amadio (1983) 151 CLR 447) that
the Australian High Court applied an important new legal concept of unconscionable conduct, which had
begun to be recognised in various ways internationally. It is a common law development, and legislatures
in many jurisdictions internationally have similar legislation.
Stakeholders who are provided protection by this concept include customers (individuals and business
consumers), suppliers, lenders and borrowers.
A summary of the 1983 High Court decision in example 4.26 is valuable as it tells us the reasons for
the decision and flags the character of the legislation that was later created. It also indicates the types of
concerns that exist in judicial concepts internationally, such as unconscionable bargains in the UK.

EXAMPLE 4.26

Amadio Case
Legal Case Summary — Commercial Bank of Australia Ltd v. Amadio (1983) 151 CLR 447
Mr and Mrs Amadio guaranteed their son’s business loan from the Commercial Bank of Australia. To
provide the guarantee, they effectively provided the bank with promises to repay and a mortgage over
their home, which meant that if their son did not repay the loan as required, they would become fully
liable. The son did not repay the loan and the bank sought full payment from Mr and Mrs Amadio. The
case went to court and, on final appeal, Mr and Mrs Amadio became involved in an action in the High
Court of Australia. The High Court was very interested in the facts and in a majority decision (3:1) found
in favour of Mr and Mrs Amadio. In so doing, it created the modern concept of unconscionable conduct
in relation to contracts (especially written and signed contracts).
Facts that the High Court found indicative of unconscionable conduct included the following.
• Mr and Mrs Amadio spoke and understood little English (inability to understand the contract).
• Mr and Mrs Amadio did not seek independent advice and no such advice was suggested by the bank
(taking advantage of power).

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 • The bank was aware that the son’s business was in a difficult financial position at the time he sought the
guarantee and was also aware that Mr and Mrs Amadio did not know this (misuse of power relationship
and withholding relevant information).
• The bank did not advise Mr and Mrs Amadio of the true extent of the guarantee and that their liability
was unlimited. Mr and Mrs Amadio believed the liability was limited to AUD50 000 (misuse of power
relationship and withholding relevant information).
Mason J (a majority judgment) at p. 462 stated:

Relief on the ground of unconscionable conduct will be granted when unconscientious advantage
is taken of an innocent party whose will is overborne so that it is not independent and voluntary,
just as it will also be granted when such advantage is taken of an innocent party who though not
deprived of an independent and voluntary will, is unable to make a worthwhile judgment as to what
is in his best interests.

Source: Information from Commercial Bank of Australia Ltd. v. Amadio (1983) 151 CLR 447, accessed August 2023,
https://jade.io/article/67047.

This type of conduct is not limited to transactions with end consumers. It can also occur in business-to-
business transactions. In fact, a significant number of complaints relating to unconscionable conduct have
arisen out of contracts for services and goods including:
• commercial tenancy arrangements
• relationships between building contractors and sub-contractors
• franchising
• financial services contracts, including loan guarantees, small business loans and financial institutions
dealing with small business.
The tests for unconscionable conduct in the case of an ordinary domestic agreement include the
following.
• What was the relative strength of the bargaining power of the corporation and the consumer?
• Were the conditions imposed on the consumer reasonably necessary to protect the legitimate interests
of the corporation?
• Was the consumer able to understand the documents used?
• Was any undue influence or pressure exerted on, or were any unfair tactics used against, the consumer?
• Was the amount paid for the goods or services higher, or were the circumstances under which they could
be acquired more onerous, when compared to the terms offered by other suppliers?
There is a fine line between aggressive bargaining and conduct that leads to one-sided, harsh or onerous
terms being imposed on a party. One possible solution for businesses (and ordinary consumers) to protect
themselves is to ensure that they obtain independent advice. For example, it has become common practice
for banks and other lenders to ensure that guarantors obtain a certificate from a solicitor certifying that the
nature and effect of the guarantee has been explained to the guarantors. In other words, it is important that
the other party has a proper understanding of the transaction and that appropriate balances exist within the
overall contract.
Importantly, this will be a civil matter only — so an afflicted consumer will only need to establish on the
balance of probabilities that the stronger corporation has acted unconscionably. There is no requirement
that all, or even most, of the tests need to have been breached — it is just how it appears on balance in the
court room based on the arguments of the parties involved.
In addition to the tests listed previously, in determining a contravention involving domestic circum-
stances, the court may consider some or all of the following additional rules. These will become additional
parts of the expected fair conduct where a business consumer has a complaint:
• whether the supplier’s conduct towards the business consumer was similar to that of other suppliers
• applicable industry codes
• any intended conduct of the supplier
• the extent to which the supplier was willing to negotiate terms and conditions
• the conduct of the supplier and business consumer in complying with the terms and conditions
• whether the supplier had the right to unilaterally vary the contract
• whether the supplier and business consumer acted in good faith.
There are many more matters in relation to consumer protection. They all need careful attention by
boards and management, in correctly structured organisational policies. Any failure can result in substantial
harm to the consumer, the corporation and many stakeholders across society — including shareholders.
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Such corporate governance failures are unnecessary and disappointing. Individuals within corporations
need to realise that breaches can also create personal costs, as penalties that corporations incur can also
be replicated at the personal level. Some types of breaches (e.g. consumer safety regulations) can result in
individual managers and directors being sent to jail for criminal breaches.

Data Privacy
Businesses need to be aware that there are obligations and restrictions around the collection, storage, usage
and disposal of personal information data. This includes employee and customer data. Data breaches or
mishandling incidents can result in customer attrition and significant business losses. Protecting customers’
data helps businesses retain existing customers and foster loyalty. In Australia, The Privacy Act 1988
(Cwlth) regulates the handling of personal information by entities to safeguard individuals’ privacy, and
governs the collection, use, disclosure and management of their personal information.
In response to growing concerns about data security and privacy, the Australian Government introduced
the Notifiable Data Breaches (NDB) scheme as an amendment to the Privacy Act. The scheme, effective
since 22 February 2018, mandates entities to notify affected individuals and the OAIC of data breaches
that may cause serious harm. Notifications must also include recommendations for individuals on how to
respond to the breach.
Following two of Australia’s largest data breaches in 2022, changes to the Privacy Act have also been
proposed in the Privacy Act Review Report released in February 2023. The key proposed changes are to:
• broaden the application of the Privacy Act, such as expanding the definitions of personal information
and removing the small business exemption
• increase entities’ obligations in relation to the handling of personal information
• expand the rights of individuals with respect to their privacy, and increase the enforcement powers under
the Privacy Act.
As of August 2023, small businesses (i.e. businesses with less than $3 million in annual turnover) are
not covered by the Privacy Act. However, there are exceptions to this, including where a business collects
individuals’ Tax File Numbers (TFNs). This exception is contained in s. 5.(3) of the Privacy (Tax File
Number) Rule 2015. This may have implications for public practitioners and some small companies.

SUMMARY
Part B of the module focused on legal and regulatory obligations imposed on those charged with
the governance of a corporation. We began with a broad description of how the legal system applies
to companies and then examined specific areas of legal obligation to various stakeholders, beyond
shareholders, who are affected by corporate actions.
These include laws related to occupational health and safety, fair pay and work conditions, and family
and leave entitlements.
Another important aspect of the law as it applies to corporations is regulation of the market. This is
designed to promote effective and fair competition between businesses in order to contribute to an efficient
market for goods and services.
There is also a range of laws that relate to consumer protection to ensure businesses do not take advantage
of or ignore the rights of customers and consumers.
Boards and directors have a responsibility to be aware of their legislative obligations and ensure that
their company complies with them fully.
The key points covered in this part, and the learning objectives they align to, are as follows.

KEY POINTS

4.2 Identify a range of operational responsibilities which affect some significant stakeholders and
that are important for good governance.
• Companies are subject to a series of laws and regulations that may be statute or common law.
• Statute law refers to law that has been codified in Acts of Parliament while common law is set down
in precedents of courts over a period of time.
• Companies and those charged with their governance may be subjected to criminal and civil
proceedings for failing to comply with laws and regulations.

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278 Ethics and Governance

 • Laws that impact on companies from an operational perspective include workplace relations laws.
• Those charged with corporate governance have various legal responsibilities to employees,
including providing a safe work environment and providing appropriate pay and other entitlements.
4.5 Understand and apply policy laws and regulations that exist for the protection of markets and
services, and relevant stakeholders including consumers.
• Companies are obliged to act within a framework of fair competition designed to ensure the
market for goods and services operates efficiently. These laws regulate their conduct in relation
to competitors, suppliers and other stakeholders in the market.
• The ACCC is Australia’s competition regulator, and it is responsible for regulating the market.
• While price fixing and collusion are not generally permitted, the ACCC is able to consider
applications for co-operation between entities when they constitute an arrangement that may be
considered not to be anti-competitive.
• Companies must also comply with a range of consumer protection laws that prohibit conduct
harmful to consumers, including data privacy breaches, misleading conduct and unconscion-
able conduct.
• Consumers are able to take action against vendors (businesses that sell them poor products or
provide poor services).
• Unconscionable conduct is an area of law that relates to contracts that contain unfair and onerous
conditions on one of the parties.
• Courts will look at the contractual terms in determining whether a contract is unconscionable.
Courts will also consider a series of factors in the relationship between the parties to a contract in
order to determine whether a remedy ought to be awarded to the affected company or individual.

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PART C: PROTECTING FINANCIAL
MARKETS AND VALUE IN CORPORATIONS
INTRODUCTION
Boards are responsible for the governance of individual companies and protecting the value of the
corporation. An important part of this is how the corporation acts in the financial markets. In this part of the
module, we look at the regulation of the financial market. Financial market protections must be understood
both from the corporate governance perspective as well as an individual responsibility perspective. This is
because those who manage and direct corporations have a duty to make sure that they attend carefully to
the corporation and its information insofar as these are important parts of any financial market. Further, as
persons who are likely to know things that are market sensitive, they must not, as individuals, do anything
with that information or their position that may harm the financial market (such as deliberately making a
personal gain from the information).
Many financial services exist within financial markets and there are overlapping financial market rules
and financial services rules. Regardless of the way the rules apply and who they may protect, the existence
of modern corporations depends on effective financial markets.
To ensure the financial markets work effectively, they are subject to various pieces of legislation and
several bodies are empowered to regulate the financial markets as a whole. These include:
• the ASX, which maintains a set of rules for the companies listed on its exchange
• ASIC, which has oversight of the ASX and many aspects of corporate behaviour, mainly via the
Corporations Act
• APRA, which regulates banks, superannuation funds and other financial market participants
• AUSTRAC, which conducts anti-money laundering and counter-terrorism financing activities
• the RBA, which is responsible for clearing and settlement of transactions between financial markets
participants.
An overarching non-statutory, co-ordination body, made up of ASIC, APRA, the RBA and Treasury,
known as the Council of Financial Regulators (CFR), exists ‘to promote stability of the Australian
financial system and support effective and efficient regulation by Australia’s financial regulatory agencies’
(CFR n.d.).
This part of the module beings with a discussion of the role of markets, including the role of information
in the operation of markets and also measures to protect financial markets and their participants from
various types of manipulation and corruption.
We will also look at measures to ensure smaller shareholders are represented in the decisions of the
corporation, including measures to protect minor shareholders’ rights.
Finally, we will look at some evidence that the importance of ethics is expanding into more areas of
corporate governance and corporate behaviour generally, and finally we will examine legal protections in
place for whistleblowers who report suspicions of illegal or unethical conduct.

4.8 ROLE OF MARKETS

Financial markets are most clearly identified as the places where ownership rights in corporations are
traded. Terms such as ‘stock market’ and ‘securities market’ are used to describe them. Commonly, we
hear terms such as the ‘Hang Seng’, ‘Dow’, ‘FTSE’ and ‘Shanghai composite’ in relation to stock exchange
activity, in particular share market movements as recognised by relevant indexes.
So important are international stock exchanges that most financially literate people know that these
terms relate respectively to key trading indexes of Hong Kong, New York, London and Shanghai. Note
that, within any exchange, there are always many other less-publicised indexes, as well as many indexes
in other stock exchanges around the world.
Financial markets are complex, people-driven structures and perhaps one of their greatest strengths is
that nobody understands them fully — so it is hard to take advantage of markets when acting ethically.
The fact that many financial markets are increasingly based on electronic platforms and driven largely
by algorithms adds further to their complexity and makes the ultimate human agency underlying digital
markets more difficult to ascertain. We will not attempt a detailed analysis of financial markets here but
will discuss general aspects that apply internationally.
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 Two basic corporate governance observations are important for managers of corporations that are listed
on the stock market.
1. Shareholders require a satisfactory return on their investment (this is arguably at the centre of the
director’s duty to act in good faith in the interests of the corporation).
2. Managers need to ensure that corporations perform well. If they do not, then sales of shares by
shareholders will exceed demand for purchases of shares and the stock price will fall. In extreme
circumstances, prices will eventually fall to a point where other potential owners in the market believe
the assets can be employed more productively under new ownership and the corporation will be subject
to a takeover, which often results in the old managers being replaced by new and better managers.
We must appreciate that the market is susceptible to rumour, manipulation, fake information, secret
information, misuse of secret information, self-serving motivations, fraud, theft and unethical conduct
of almost limitless potential. Accordingly, there are many rules and regulations in this area. A dynamic
and complex regulatory framework exists, with variations between countries regarding the nature and
effectiveness of regulation and the quality of surveillance.
While the themes are fairly similar, local detailed rules will vary and must be understood by profes-
sional accountants — especially those working in an international environment. Even in the EU, where
harmonisation is being sought, we find that detailed rules and approaches vary from one country to another.

THE ROLE OF MARKET REGULATORS

Regulators exist to ensure that the companies and others who work within the marketplace comply with
the rules governing the conduct of business. Several regulators play a role in policing the financial market
(see table 4.6).

TABLE 4.6 Australian regulators and their functions

Regulator Function Website

AUSTRAC AUSTRAC is the agency that gathers information and market www.austrac.gov.au
intelligence from a range of sources in order to prevent money
laundering and the funding of terrorist activities.

APRA APRA is responsible for regulating the banks and similar institutions. www.apra.gov.au

ASX ASX is the trading market where shares and other debt or equity www.asx.com.au
instruments in entities are bought and sold. It administers listing
rules and monitors behaviour of market participants.

ASIC ASIC is responsible for the oversight of trading markets in Australia. www.asic.gov.au

CFR CFR coordinates the activities of RBA, ASIC, APRA and Treasury. www.cfr.gov.au

RBA The RBA sets interest rates and deals with ‘big picture’ www.rba.gov.au
monetary policy.

Source: CPA Australia 2023.

Each of these regulators plays a critical role in the market and there are tasks that each regulator performs
that are complementary.
.......................................................................................................................................................................................
CONSIDER THIS
The ASX has published a two-page summary of the matters regulated by the ASX and those areas for which ASIC
has responsibility (www.asx.com.au/documents/about/corporations-act-vs-listing-rules-matters.pdf). Read through
the comparison. Why is it important that both the ASX and ASIC play a role in regulating continuous disclosure and
market sensitive information by companies to the market?

THE ROLE OF INFORMATION AND THE MEDIA

Information, properly or improperly used, influences the way in which participants and the market itself
behaves, as any market is the sum of those who comprise its constituent elements. There is a wide range
of information-creating intermediaries in financial markets such as: investment banks, analysts, rating
agencies, consultants, advisers and auditors. All influence the market and corporate governance practices,
within corporations and as exercised by the executives of corporations.
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 Crucially, the media is a powerful force in relation to financial markets. The media transmits information
from other intermediaries and also creates information (and even rumours) itself on occasion. The effect
of media reports on share prices can be remarkable. The concept of financial market manipulation
as a topic in its own right is discussed shortly. However, the 2012 David Jones event, described in
example 4.27, shows how the media is a market force that the market and boards must better appreciate.

EXAMPLE 4.27

David Jones — a Market Manipulation Event?

David Jones Ltd (DJs) is an Australian retailer that operates a large number of department stores. It is one of
several large Australian retailers and has an excellent reputation developed over many years of successful
operation. Like many retailers, in recent years, its profits (and share prices) have been challenged by
difficult operating conditions caused by general economic conditions and also by the growth of internet
shopping. DJs owns some very high value real estate — which might be of interest to investors.
In 2012, a rumoured takeover was reported on an obscure UK blog site and as a consequence, the
company received requests from the media for further information about this possible takeover. DJs issued
a statement to the ASX. Although this statement did no more than note the existence of the already known
internet news, a rapid surge in DJs’ share price followed after the takeover suggestions.
The DJs board was in a very difficult situation. As observed, to do and say nothing would have allowed
the UK blog site to continue to make market-related statements without challenge or comment by the DJs
board. On the other hand, if the DJs board made a statement, it could perhaps be perceived as in some
way legitimising the takeover suggestions stated on the blog site. The DJs board clearly thought that it
was better to make a statement — and one that merely noted the unknown status of the proposals in order
not to encourage share market speculation. The fact that some speculation based on the ASX statement
might occur, driving up share prices, was surely a lesser risk than allowing the market to take information
from an unknown blog. Clearly, the board of DJs would have considered the matter carefully and acted
carefully and correctly in the circumstances as known at the time. Even so, following the disclosure by the
board, Smith in the Australian Financial Review commented:

Conspiracy theories have ranged from shell companies to a hedge fund stunt. The Australian
Securities and Investments Commission is understood to be looking into the matter. David Jones
admits it has no details of the … financial capacity [of the party making the approach] or its
management and has made clear the circumstances surrounding the approach. It will have to do
some fast talking if the approach turns out to be a fake (Smith 2012).

There are difficulties in the suggestion that, rather than disclose fully, the DJs board should have simply
said it had not received any serious approach from a credible buyer. The continuous disclosure obligations
requirements of the local stock exchange rules do require disclosure. This disclosure is especially important
where the share price may be affected — and takeovers nearly always drive changes in share prices. Failure
to disclose would potentially be an offence and shareholders have successfully sued for damages against
corporations that have not fully satisfied the continuous disclosure requirement. Given the circumstances,
it is understandable that DJs’ board acted by cautiously disclosing what, with the benefit of full hindsight,
we now can see was apparently a fake takeover bid.
In short, we see in example 4.27 that it seems highly likely that the DJs board did the correct thing.
Even so, the public debate is good for all boards to consider when constructing responses to circumstances
that may challenge good governance. The DJs case provides an interesting illustration of the way that the
internet can add to the work of boards and the difficulties of maintaining good corporate governance in
all circumstances.
Many examples demonstrate that media publicity can have profound effects on markets and prices.
It can sometimes impose pressure on corporations to improve their corporate governance. Boards and
managements of corporations are often fearful of criticism in the press. When asked which forces have the
greatest effect on governance and governance improvements, managers typically respond that the media
has the greatest immediate effect and that market responses from institutional shareholders are impossible
to ignore.
Another illustration of the role of media and publicity in relation to improving markets is perhaps far
more important — even today. More than 10 years ago, the Enron and WorldCom scandals raised questions
about the role of external auditors as reliable participants in markets and governance generally. As observed
earlier in this module, the response from the accounting profession, governments, regulators and auditors
has led to building new approaches and rebuilding reputations.
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 Public disclosure, public commentary and free debate are all very important to good corporate
governance. Much earlier in this module we observed this in respect of remuneration issues. We see now
that financial markets, which exist for the good of society at large and are populated by shareholders of all
types and many other interested parties, also benefit from transparent public debate and commentary. This
is relevant to the discussion so far, and it also applies to the role of ratings agencies and other concepts
that follow.

THE ROLE OF RATINGS AGENCIES

Intriguingly, the spectacular problems of the GFC have raised doubts, not yet fully resolved, about the role
of the key market-rating agencies which include Fitch, Standard and Poor’s, and Moody’s as well as other
significant consultants and advisers, especially those dealing with risk assessment and remuneration.
A United Press International (UPI) report (2012) links the credit problems within the EU, the potential
downgrade of entire economies within the EU and the power of the ratings agencies.
To date, legislative attempts in the EU and USA to more heavily regulate the activities of ratings agencies
have been largely ineffective — mainly because the agencies deal in knowledge rather than securities and
thus are not directly within the scope of securities laws.

4.9 PROTECTING FINANCIAL MARKETS

There are many rules designed to protect financial markets. We will not look at all these rules — or indeed
at all aspects of financial markets.
There is one focus regarding laws that are specifically designed to protect financial markets. Unlike, for
example, laws that apply only to directors or to directors and other officers, the rules designed to protect
financial markets apply to everyone. In other words, to break the rules, you do not need to be a director,
an employee or an accountant — merely a person who breaks a relevant market protection rule.
Directors and other officers (especially senior managers) of corporations have legal responsibilities
under the rules that apply to those positions and capacities. For example, a director must act in good
faith in the best interests of the corporation. A director or other officer must also act so that the power held
as a result of the position is always used for objectively assessed proper purposes.
Consider a director who makes use of secret company information and buys shares on the market using
that information. The director has breached two different types of rules and has broken two laws, so
potentially faces two sets of punishment. In respect of the first type of breach, the director has traded
using inside information, and has breached a market protection rule that exists in many jurisdictions. The
second type of breach relates to being a director. The director has breached the director’s duties of acting in
good faith and for proper purpose, and, by improperly using the position and information, has not complied
with the duty to avoid conflicts of interest.
This example shows that it may well be easier to break a market rule if you are involved with a company
in some way. Through the corporation, you are more closely involved with the market or have more market-
sensitive information. It is important that managers and directors understand their duties in full, including
those that require understanding of the market. We must also protect the market as being central to the
existence of every large corporation. In every respect, the market is an important stakeholder and must be
treated as such.
Most market protection rules are designed to provide strong responses to breaches along with the
potential for cases to be resolved expeditiously where required. Accordingly, many legislative provisions
may provide for court cases that may be civil or criminal. Criminal cases may result in jail, fines and/or
automatic disqualification from managing a corporation. Such laws are generally crafted so that, whether
a civil or a criminal case occurs, compensation will be paid to parties that have been harmed. One of the
most important market protection rules is the prohibition against insider trading.

INSIDER TRADING
As discussed in module 3, a key feature of public corporations is their separation of management and
ownership. Despite the requirements for continuous disclosure of relevant information, commercially
sensitive, proprietary or confidential information will not be made available to the market until the
appropriate time. This inevitably leads to an information gap between those with inside knowledge and
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the public. People with inside knowledge (i.e. market-sensitive information that is not generally available
to the market) include:
• share brokers
• underwriters
• managers
• directors
• bankers
• advisers from law or accounting partnerships
• anybody who gains inside knowledge by any means, including by communications with any of the
above people.
The potential problems can be seen, for example, during the preparation phase of a corporate takeover,
when a large amount of information obviously must not be publicly disclosed or the planned event will
never come to fruition. All of the people involved in the planning and preparation have access to potentially
highly valuable information. There is nothing wrong with having such information, but large firms who
have staff working for both the target and the acquirer will need to establish special internal information
restriction protocols (so-called ‘Chinese walls’) to stop information flows that breach confidences.
Huge gains can be made from insider trading, so the rules are very strict and are intended to have a
wide operation.
The key tests in determining insider trading are based on the following criteria.
• Identifying the information, which can be very broad (e.g. rumours about events or likely events).
• Identifying whether the information has been disclosed in such a way that it is available to investors
in relevant markets (i.e. it has become public knowledge — with enough time for the information to
become known to the market).
• Identifying whether a person who understands markets would buy or sell a security were they to know
that information — in which case the secret information is considered to have a material impact on the
price of a security.
If these criteria are met, the information is called inside information. A person who possesses inside
information must not use it or disclose it. The onus is on the discloser to know the status of the recipient
of the information. Examples of insider trading include:
• purchasing or selling securities based on inside information
• having a related party purchase or sell securities on behalf of the person, based on the inside information
• communicating the inside information to any person (often called tipping) when the discloser knows or
ought to know that such disclosure is not permitted.

QUESTION 4.8

Paroo is a director of Oorap Ltd, a listed corporation. In this capacity, she learned that Oorap was
about to be subject to a takeover bid. Paroo immediately started buying shares in Oorap so as to
be well placed when the market learned of the bid. She is now being investigated by the regulator.
Discuss the key problems faced by Paroo.

Understanding the rules is important, as financial markets operate under two governing theories:
efficiency of markets and investor confidence.
Efficiency is measured by the speed with which information provided to market participants is reflected
in the share price. Investor confidence revolves around the concept of a level playing field where everyone
has an equal opportunity to compete in the market.
It can be argued that when people with non-public, price-sensitive information use that information to
trade in securities in a market, such non-transparent conduct promotes short-term efficiency in the market
as market prices very quickly adjust to reflect the value of the security. This efficiency is at a high cost to
ethical investors, given those engaging in this form of market misconduct enter and then exit the markets
at prices that give them unfair gains based on their special knowledge. Any justification of insider trading
based on market efficiency is a fundamentally absurd proposition that is totally at odds with principles
applicable to professional accountants and ethical conduct.
Insider trading will also inevitably reduce investor confidence in the market. In fact, markets in which
investors have little confidence are likely to have a variety of defects. Internationally, insider trading
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284 Ethics and Governance

legislation imposes rules designed to ensure both investor confidence and market efficiency, and to allow
the development of good corporate planning involving appropriate use of confidential information.
Every country with a significant market for securities has rules and procedures designed to prevent
insider trading, and significant penalties apply where the rules are found to be broken. These rules and
procedures have a range of common features and ambitions, including:
• fairness in the market price, by giving all market participants equal access to timely information about
shares and other securities
• preventing insider trading from damaging market integrity — that is, bringing the reputation of the
market into disrepute because of unethical conduct
• preventing financial disadvantage to entities that issue securities, and their key stakeholders, including
existing and potential shareholders, and bondholders.
Example 4.28 details an insider trading case initiated by an ASIC investigation after it noticed
suspicious trading.

EXAMPLE 4.28

Calvin Zhu — Insider Trading or More?

ASIC’s Focus on Insider Trading Pays off in Hanlong Case
A greater focus on market manipulation and insider trading by the corporate regulator is paying off, as
a former investment banker was yesterday exposed as a serial insider trader whose illegal trades netted
more than $1.3 million.
The Sydney-based Bo Shi Zhu, also known as Calvin Zhu, most recently a former vice-president
Investments at Hanlong Mining Investment, pleaded guilty yesterday to three charges of insider trading
when he appeared at the NSW Downing Centre local court. He will be sentenced in September.
The Australian Securities & Investments Commission began investigating the 30-year-old Zhu and
several of his colleagues after noticing suspicious trading just over a year ago. What they did not realise at
the time was that Zhu was a repeat offender, who had used inside information back in 2006 while working
at Caliburn Partnership.
Zhu had two friends buy contracts for difference [CFDs] in Veda securities while knowing that private
equity company Pacific Equity Partners was considering a takeover bid for the company.
Zhu later worked at Credit Suisse, and in August 2008 he learned Archer Capital was considering a
takeover of Funtastic Limited. Again Zhu enlisted the help of a friend who sold Funtastic CFDs. A year
later, Zhu admitted … he also had the same woman buy shares in another company that he knew was the
target of a takeover.
The latest charge relates to Zhu’s time at Hanlong Mining, which last year was considering a takeover of
Bannerman Resources. This time Zhu also enlisted his mother-in-law, as well as a friend, and a company,
Wingatta, to help carry out a series of trades. A later proposed takeover of Sundance Resources by
Hanlong also led to further insider trading.
More than $1.3 million was made by Zhu, who collected $370 000 for his efforts.
The court documents reveal that the Bannerman takeover was nothing more than a ploy to push up its
share price.
Further, a complicated set-up was revealed, including Hong Kong companies and bank accounts in the
British Virgin Islands.
Source: Moran, S 2012, ‘ASIC’s focus on insider trading pays off in Hanlong case’, The Australian, 1 August, accessed
August 2023, www.theaustralian.com.au/business/markets/asics-focus-on-insider-trading-pays-off-in-hanlong-case/news-
story/3d64900a9ca5e886af266ec8e494dc05.

MARKET MANIPULATION
We looked briefly at the 2012 David Jones market events in example 4.27 as an example of market
manipulation. You will note that example 4.28 was discussed in the media as a type of market manipulation.
As Zhu was principally involved in insider trading, we can say that he was an inside trader. However,
given that Zhu misused information to make personal gains, it is understandable that even insider trading
is sometimes considered to be market manipulation.
For our purposes, it is better to consider insider trading as a separate wrong. So, excluding insider trading,
it is important to understand the nature of market manipulation and at least some of the ways in which it
may occur.
Market manipulation, like insider trading, may take place from inside a corporation or by those outside
the corporation. Either way, it is generally unlawful and, as it can have a major impact on any corporation,
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boards must understand it fully as another key corporate governance responsibility. To emphasise this
point, note that in the DJs case, we saw the difficulties that confronted the board in dealing with forces
from overseas apparently seeking to manipulate DJs’ share market prices through rumours on a blog. We
now will look at some principles that apply in respect of market manipulation.

Principles Relating to Market Manipulation

Market manipulation needs to be controlled in order to achieve reasonably appropriate and fair distribution
of benefits and the correct and orderly conduct of markets. Failure to do so will result in many withdrawing
from any market that does not provide appropriate rewards. Eventually, markets that are not trusted
will fail.
It is not only directors of a corporation who are capable of market misconduct, including manipulation.
Directors and senior managers often have more opportunity to manipulate the market. There may be times
where it is in a director’s interests to, for example, create a false impression of trading in securities in the
corporation to enhance the perceived value of the shares in the market. Alternatively, in some instances, a
depression of the price of shares may be in the interests of a director who is seeking to set the bar low at the
start of a performance measurement period. Similarly, executives who are receiving options to buy shares
(which will involve buying at the market price prevailing at some future time) prefer the future buying
price to be as low as possible. Quite frequently, market manipulation is accompanied by insider trading,
as a director, having manipulated secretly, then uses that secret information. In fact, this is not confined to
directors — anybody who knows something about their own or others’ secret manipulation activity and
then uses or discloses it will be both manipulating markets and carrying out insider trading.
Market manipulation can arise in many forms and the range of various schemes or approaches is
seemingly endless. Some general forms (for which most jurisdictions have controlling legislation) include
where manipulators set in place mechanisms that are designed to achieve, or do achieve:
• artificial prices or perceptions of artificial prices
• artificial trading volumes or perceptions of these volumes
• the provision of false or misleading information including through disclosure that is incomplete, or
• false transactions including through persuading others to buy or sell as a result of misinformation.
We can see that market manipulation may be defined as existing where there are actions and/or
information (including a series of such actions and/or information) that are created with the intention
of influencing, or in fact do influence, the market in relation to shares (and related securities) — including
in relation to price or activity.
Where directors (or sometimes major shareholders) of a corporation are involved in manipulating the
market, the intention may be to artificially inflate the market price of shares in the corporation. This may
be for a number of reasons related to the corporation including preventing takeovers and relieving pressure
exerted by shareholders selling shares. If, for example, a corporation has a major loan that is repayable if
its share price collapses (as was a common feature during the GFC), then the board may fall into the trap of
unlawfully seeking to maintain the share price through market manipulation. Where a corporation seeks
to achieve this artificial price inflation, the directors may secretly cause shares in the corporation to be
purchased by a third-party entity associated with the corporation, without this association being common
knowledge. The secrecy and the manipulation are easily seen — and this leads to both market manipulation
and insider trading being highly likely as legal breaches.
Note that such manipulation may also simply be for personal reasons, as any significant shareholder
may seek to use any resources and power available to them to inflate prices to maintain their own market-
based wealth.

Types of Market Manipulation Activities

The market has given commonly used names to some frequently seen and usually prohibited market
manipulation activity, as discussed in the following sections.
Churning
Churning involves the placing of buy or sell orders for shares with the object of artificially increasing
the market turnover. This increased activity will stimulate market interest and often will be successful
in creating activity-driven price surges. For example, consider a market participant who uses strategies
of selling and then repurchasing the same securities in a similar quantity, with the intention of creating
a false and misleading appearance of active trading. Another possibility is that, as stockbrokers are paid
commissions based on activity, they may have an interest in creating rumours designed to boost activity.
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Pools
Pools are organised groups of investors who agree to buy the shares of particular corporations and, as
prices rise due to growing market interest, to sell at a time before the market price collapses. Given that the
prices were induced upwards by the pool, large profits may be derived at the expense of the other buyers
in the market. To make the pool effective, it is common for the pool to appoint a single manager to trade
as instructed on behalf of the entire pool. Note that a single very wealthy person could achieve the same
outcome acting alone. Either way, the manipulation will be unlawful — but perhaps more easily identified
if it is a conspiratorial pool.
Runs
Runs involve groups of market participants who work together with the intention of creating market effects
by either buying shares or disseminating rumours in order to attract new buyers into the market. Sharp
increases in the share price can be a direct result.
Internet discussion boards are often used to generate interest in a stock. As people watch the rapid rise,
they move quickly to buy the shares, only to discover later that they have been deceived. Directors are
sometimes tempted to do this by issuing media releases indicating significant events. Once the share price
rises, directors may sell shares at the higher price before indicating to the market that the events were not
as significant as previously thought.
In the 1980s, a well-known example involved the Guinness beer company. A group of investors
deliberately set about inflating the share price so that Guinness would be regarded by the market as having
the financial strength necessary to take over the major corporation Distillers Ltd. This is a fascinating
example as it demonstrates the various complex motivations that may exist. It also demonstrates that such
activity can involve billions of dollars — as in the Guinness case, which has been called the best-known
stock market scandal in Britain. The Guinness case had a number of complexities and was finally discussed
in the European Court of Human Rights (2000).
Misuse of Fundraising Documents
When raising new debt or equity funds, the use of fundraising documents is required unless special
arrangements are in place for sophisticated investors, existing shareholders, or private placements. The
document involved is often referred to as a prospectus. (In Australia, interested candidates can access the
prospectus rules at s. 710 of the Corporations Act.)
A prospectus is a document issued by a corporation to establish the terms of an equity issue (or a
debt raising). It provides background to the company, the finance requirements and the financial and
management status of the company so that investors can make an informed decision about whether to
invest. In Australia, in order to be valid and to avoid potential criminal offences, a prospectus must be
lodged with ASIC and the ASX.
The temptation is for directors to overstate the benefits of the investment outlined in the fundraising
document. However, false or misleading information, including the omission of significant issues and
matters that become incorrect during the life of the prospectus, are treated harshly by regulators, with
possible criminal outcomes and major personal liability for anybody mentioned in a prospectus.
The role of a prospectus is important. In addition to the actual losses suffered by investors due to the
actions of those who abuse the prospectus rules, the broader damage to market confidence and destruction
of market efficiency is completely unacceptable. If investors are fearful that they will be abused, raising
new funds becomes increasingly difficult and expensive.
Example 4.29, taken from a newspaper report, provides fascinating insight into market manipulation
and its links with insider trading, and the observations in courtrooms about greed and its connection with
unwarranted levels of remuneration.

EXAMPLE 4.29

John Hartman — Manipulation — Insider Trades and Greed

Stock Dealer Jailed for Insider Trading
Former equities dealer John Joseph Hartman has been jailed for at least three years for insider trading
that netted him in excess of $1.9 million.
The 25-year-old was led away from his tearful family at Sydney’s Supreme Court on Thursday, having
pleaded guilty to 25 offences under the Corporations Act — most of them commonly known as insider
trading, as well as six offences known as ‘tipping’.
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 In sentencing, Justice Peter McClellan said Hartman’s offences began in 2006 while he was employed
by Orion Asset Management.
‘In the course of buying and selling in significant volumes, the offender came to appreciate that large-
volume trading could have the effect of raising or lowering the price of a stock within a short timeframe,’
Justice McClellan said.
Using his knowledge of Orion’s upcoming acquisitions and sales, Hartman would use a mobile phone
to text message a good friend and co-accused, advising of the purchase or disposal of shares.
Hartman’s charges related to the trading of stocks in companies including Henderson Group, Alumina,
Riversdale Mining, CSR, AMP, Caltex, Transpacific Industries and Suncorp-Metway.
In multiple audits by Orion, Hartman told his employer he had conducted no personal trading. But his
employment was terminated in January 2009.
A day later, Hartman went to the Australian Securities and Investments Commission (ASIC), where he
was interviewed and agreed to cooperate with inquiries into his conduct.
In a statement to ASIC, Hartman said: ‘If I saw that Orion needed to trade in a stock and that may have
a material impact on the price of the stock, then I would trade for myself personally and then wade out of
the position when I thought it was appropriate for my personal best interests.’
Hartman admitted passing the information to a close personal friend, against whom he has agreed to
give evidence in upcoming court proceedings.
‘It must be remembered that his crimes were not victimless,’ Justice McClellan said of Hartman.
‘Each illegal transaction was likely to have a cost to someone who either traded or held their position
without the benefit of the knowledge available to the offender.
‘The offender set about systematically trading in breach of the law for the sole purpose of his personal
wealth at the expense of others.’
Justice McClellan said Hartman, who has a history of gambling addiction resulting in losses to
bookmakers and casinos, had shown remorse for his crimes and suffered depression since being charged,
at one stage requiring hospitalisation.
He attributed the offences in part to Hartman’s ‘immaturity’ and lack of values as a young man living a
‘high life’.
‘Paying $350 000 to a recent graduate of 21 years of age carrying out a task of modest responsibility
underlines the extent to which the values which underpin our society can be compromised,’ Justice
McClellan said.
The court was told that Hartman had repaid $1.59 million of the more than $1.9 million he netted from
his trading activity, in accordance with the Proceeds of Crimes Act.
The offender’s father, obstetrician Keith Hartman, cried as his son was sentenced and led from the court
to serve time in a ‘special management section’ of prison.
He was sentenced to a maximum of four and a half years’ jail and [was] eligible to apply for parole in
December 2013.
Source: Drummond, A 2010, ‘Stocks dealer jailed for insider trading’, Sydney Morning Herald, 2 December, accessed August
2023, http://news.smh.com.au/breaking-news-national/stocks-dealer-jailed-for-insider-trading-20101202-18hf7.html.

QUESTION 4.9

In example 4.29, the judge noted that John Hartman was highly remunerated as an employee.
Discuss this factor and its potential relationship to the market manipulation involved. Why is
insider trading a relevant factor in this case?

Bribery and Corruption

Corruption is a problem that all countries have to confront. Solutions, however, can only be home grown.

World Bank President James D Wolfensohn (1996)

There are many ways in which bribery, internationally one of the most significant forms of corruption,
may originate and be structured. Generally it involves the payment of money or the provision of benefits,
undertaken with a degree of secrecy, and intended to obtain benefits of some kind. Importantly, those
receiving the benefit use their position or knowledge to make a personal gain, by acting in the interests of the
person making the payment instead of acting according to their duty under their contract of employment.
To put it another way, the party paying the bribe seeks a benefit by paying the recipient of the bribe, so
that the recipient will act in the payer’s interests rather than acting correctly in respect of a third party.
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 An example would be where a supplier of flat screen television panels provides benefits to the purchasing
officer of a television manufacturer in order to induce the purchasing officer to buy flat panels — perhaps
at an inflated price — on behalf of their employer. The purchasing officer accepts a personal gain from the
flat panel supplier and, in return, negotiates purchasing terms that are detrimental to the employer.
Unfortunately, bribery creates effects that are worse than a single economic event. To start with, the
person accepting a bribe becomes part of a conspiracy that creates further likelihood of bribery. For
example, the flat panel supplier might threaten the purchasing officer with disclosure unless the activity
is repeated. Obviously, the effects of bribery can grow and enmesh many people. In some countries, it
has become an unfortunate common feature of business and commercial relationships across the whole
society. It can then extend internationally — eventually leading to the situation where corrupt business
transactions are almost expected.
Obviously, bribery and corruption can detrimentally affect corporate and personal reputations, and can
even affect the trading and business reputations of entire countries. Most countries have enacted specific
legislation making bribery criminal in nature, as it is a form of corruption, usually involving conspiracy. It
can attract substantial penalties including jail, large fines and obligations to compensate those harmed by
this criminal behaviour.
Bribery and corruption can occur in all forms of organisations and wherever there is economic activity
of any kind. Not-for-profit organisations also experience these problems; in 2013 the Washington Post
reported that from 2008 to 2012 more than 1000 not-for-profit organisations disclosed hundreds of millions
in losses attributed to theft, fraud, embezzlements and other unauthorised uses of funds and organisational
assets. A study cited by the Post stated that religious organisations and not-for-profits suffered one-sixth
of all major embezzlements, second only to the financial services industry (cited in Venable 2013).
International Experience of Bribery and Corruption
One common form of bribery that has long been tolerated, to some extent, relates to facilitation payments.
These payments occur where a person charged with the duty to carry out a function (often, but not always,
a government official) will agree to do so more efficiently or faster after receiving a personal payment.
Internationally, new approaches to bribery control are being introduced, with stronger controls on all
forms of bribery — including facilitation payments. The OECD Working Group on Bribery in International
Business Transactions and the UN Convention Against Corruption both demonstrate increased global
awareness of the enforcement and investigation of bribery. This is especially relevant for bribery by
corporations in foreign jurisdictions. Under the UK Bribery Act 2010, all corporations based in the UK
are in breach of UK law if they pay any bribe, including facilitation payments, anywhere in the world.
Even large corporations, with household names and brands that rely on reputational value, can
become involved in highly publicised bribery and corruptions, sometimes as the result of decisions by
individual managers or contractors acting as agents. The Australian Reserve Bank became enmeshed in
an internationally reported bribery scandal in relation to contracts to print currency notes for overseas
economies, as reported, for example, in Business Insider (Richter 2012).
Example 4.30 provides part of an article from The Lawyer (Griffiths 2011) explaining a widely reported
bribery event that affected Shell Oil internationally. We discuss some of the approaches implemented by
Shell, which were designed to prevent further bribery and corruption events.

EXAMPLE 4.30

Royal Dutch Shell — Bribery Allegations

In October 2010 Royal Dutch Shell paid out $10 million (£6.3 million) in fines to the Nigerian government,
following allegations of bribes paid on its behalf by freight forwarding company Panalpina Welttransport
Holding to Nigerian government officials. The fines were part of the settlement of Foreign Corrupt Practices
Act (FCPA) charges with the US Department of Justice (DoJ) and Securities and Exchange Commission
following an investigation launched in early 2007 that involved up to a dozen energy companies that were
customers of Panalpina.
Three of Panalpina’s customers, Tidewater Marine International, Transocean and the Nigerian subsidiary
of Royal Dutch Shell admitted to approving or condoning Panalpina’s payments on their behalf.
Shell entered into a deferred prosecution agreement with the DoJ, agreeing to pay a $30 million criminal
penalty and submit an annual report on its compliance regime on behalf of its Nigerian subsidiary.
Source: Griffiths, C 2011, ‘Bribery/Anti-corruption: Shell’, The Lawyer, 18 March, accessed August 2023, www.
thelawyer.com.

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 In 2015 the Australian Senate began an inquiry into overseas bribery allegations regarding Australian
corporations. This included interviewing executives from Leighton Holdings and BHP, with the view that
the legislative frameworks for enforcement of an anti-foreign bribery regime were more effective in the
US and UK (McKenzie & Baker 2015).
The fight against corruption is difficult, especially where offshore, possibly self-interested, contractors
act on behalf of international corporations. Boards need to understand the issues involved in establishing
and ensuring sound corporate governance, including corruption compliance, otherwise the impact on
reputation and performance can be very high. With reference to example 4.30, note that, as early as
1999, Shell had in place a group-wide, well-written policy titled Dealing with Bribery and Corruption: A
Management Primer (Shell 2003). It includes a large amount of advice and numerous statements of Shell
policy, including recognition of the benefits of not being involved in any form of bribery. If the document
had been properly used and understood by its contractors, Shell would have confronted no problems.
The fact that a contractor perhaps was not aware of or ignored Shell policies created the problem faced
by Shell.
There are strong international laws — for example in the UK where all bribes payable by British
corporations anywhere in the world are banned. Not even minor facilitation payments are allowed.

Rogue Trading
Rogue trading is discussed only briefly as it is a complex field. It is perhaps of more concern to financial
institutions than to boards in general — although it could happen in relation to a corporation’s finance risk
control (including hedges and options) or trades by or in a corporation’s own shares. Therefore, boards
should understand the issue as a matter of corporate governance generally, especially relating to finance
functions. This area is considered in some detail in the Financial Risk Management subject.
A rogue trader is normally an employee (or other authorised person) who engages in unauthorised
trading. The motivation may be personal gain or simply hubris — that is, excessive pride. Whatever the
motivation, rogue traders can sometimes create mayhem in financial markets generally.
One of the highest profile rogue trading events of all time related to the collapse of the centuries-old
Barings Bank. There, a single rogue trading employee, Nick Leeson in the Singapore office, was able
to run his own deals without any effective oversight from London. His losses on the bank’s behalf were
huge — totalling over USD1.3 billion. It seems that Leeson was not forestalled in his actions in any timely
way. The main Barings Bank board was in London, far from the scene of Leeson’s trades; they were too
impressed by his apparent trading success, not knowledgeable enough about the trades he was making,
and too willing to accept his assurances. As a result, Barings Bank, one of the oldest banks in the world,
was bankrupted by the losses Leeson generated.
However, the assumption that rogue traders have acted alone, without the knowledge or acquiescence of
senior executives, is sometimes misleading. When failures occur, both financial institutions and the courts
often attach fault to particular individuals rather than the systems and culture of the institution itself.
The attempt to do this by the UK Financial Conduct Authority and JP Morgan Chase in the London
Whale case revealed how difficult those systems and culture are to resist. Action was dropped in August
2015 against the trader Bruno Iksil, whose bets on complex derivative contracts cost JP Morgan Chase
USD6.2 billion in losses. Iksil acquired his oceanic nickname due to his trades that swamped the markets.
In the backwash, JP Morgan Chase agreed to pay USD920 million to resolve litigation in New York and
London that they had misstated financial information, and due to a lack of internal controls prevented
traders from ‘fraudulently overvaluing investments’ (Stewart 2015).
Iksil was not convicted because, while he had engaged in high-risk trading, he did not conceal his
positions and had repeatedly discussed strategy with higher ranking executives. He had grown increasingly
uncomfortable with the favourable valuations the bank was reaching, and was recorded by the bank
referring to his boss stating ‘I can’t keep this going. I don’t know where he wants to stop, but it’s getting
idiotic. Now it’s worse than before. There’s nothing that can be done, absolutely nothing that can be done.
There’s no hope. The book continues to grow, more and more monstrous’ (Stewart 2015).

Ponzi Schemes
Ponzi schemes are named after Charles Ponzi who was involved in a very high-profile and widespread
fraud using a mechanism that had earlier origins. At their simplest, Ponzi schemes involve earlier investors
being given a return by simply diverting the capital contributions of later investors to the earlier investors.
In the early stages of a Ponzi scheme, amidst the excitement of receiving returns that are surprisingly high,
earlier investors are very happy and later investors join in by investing their money so they can also obtain
these large returns.
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 In fact, so happy are earlier investors that they often invest further sums or reinvest the actual returns
received. There comes a point where new investors are too few to sustain the returns. At this point, investors
commonly start seeking payments of their capital. The fraud becomes evident as there is no remaining
capital and the accounts underpinning performance are proven to have been fraudulent. At this time, it
usually becomes apparent that the creator of the scheme and key associates (who typically are the only
people aware of what was really happening) have taken steps to enrich themselves by further frauds —
including the personal use of large amounts of cash from the scheme. Example 4.31 describes a Ponzi
scheme that operated for decades and involved tens of billions of dollars.
The fact that these schemes occur somewhere every few years shows the impact of greed and gullibility
on investing communities. The reality of Ponzi schemes and the fact that they can harm individuals,
corporations, markets and have economy-wide impact, must be understood by directors and boards as
part of overall corporate governance knowledge.

EXAMPLE 4.31

Ponzi Scheme
The largest Ponzi scheme ever conducted was created by the American investor Bernie Madoff. In March
2009, in Manhattan, Madoff pleaded guilty to 11 federal felonies and admitted that he had turned his
wealth-management business into a huge Ponzi scheme. He defrauded thousands of investors of billions
of dollars in a scheme he said he’d been operating since the early 1990s. Federal investigators said the
fraud had more likely commenced in the mid-1980s and possibly even as far back as the 1970s.
According to those charged with recovering the victims’ money, Madoff’s investment operation was
probably never legitimate. Almost USD65 billion was missing from client accounts, including fabricated
gains. Actual losses to investors were estimated by the trustee to be approximately USD20 billion.
Madoff’s business began deteriorating after the global financial crisis when clients requested a total of
USD7 billion back in returns — and he only had USD200 to USD300 million left to give back to them.
One reason Madoff managed to remain undetected for so long — even though several people had filed
reports to the SEC expressing their fear that he may be operating a Ponzi scheme — was due to his
wide reputation and respected position in the financial industry. He had founded his own market-maker
firm in 1960 and assisted in the launching of the NASDAQ Stock Market. Madoff also sat on the board of
the National Association of Securities Dealers and advised the Securities and Exchange Commission on
trading securities.
It is generally agreed that 70-year-old Madoff knew exactly what he was doing when he defrauded his
clients over several decades. Madoff was sentenced to 150 years in prison on 29 June 2009.
Source: Adapted from International Banker 2021, ‘Bernie Madoff’s Ponzi scheme (2008)’, International Banker,
29 September, accessed August 2023, https://internationalbanker.com/history-of-financial-crises/bernie-madoffs-ponzi-
scheme-2008.

Phoenix Companies
A significant problem for corporate regulators relates to directors and sometimes larger shareholders
who control companies as de-facto directors without actually being appointed and who deliberately use
limited liability to avoid liabilities. Usually, this applies only within smaller corporations — normally
private corporations.
Typically, what occurs is that the directors/managers of the original corporation allow it to fail,
owing large amounts of money (often to tax authorities). A new corporation, operated by the same
directors/managers, is then created to carry on the existing business activity. The new corporation rises
from the ashes of the old and, using a term from Egyptian mythology, these new corporations are commonly
referred to as phoenix companies.
The directors/managers of the failed corporation step away from and leave unpaid the debts of the old
company. It is quite common for the phoenix company to be given a trading name that is similar to the
old, failed corporation — meaning that the trading reputation remains intact. Clever implementation of
these arrangements means that care is taken not to hurt important business relationships. Therefore, while
some third parties who are not important to the new entity are afflicted badly, including tax authorities, the
new corporation successfully carries on the old business. However, where the old corporation’s name and
therefore reputation are poor among its business partners and customers, the phoenix company will trade
under an entirely different name.
In short, the use of phoenix companies involves the deliberate misuse of the legal protections related to
limited liability. The shareholders (usually also being the directors) of a failed corporation rely on limited
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 liability to escape the debts of the failed corporation only to start again with renewed limited liability in a
new corporation that trades again in the same way.
Importantly, two new pieces of legislation that were passed in Australia in 2012 allow stronger responses
to phoenix companies. Both of them amend the Corporations Act. The first amendment operates so that
some corporations can be de-registered more easily. The second amendment provides for directors of new
corporations with highly similar names to previously failed corporations in which they were involved
to be specifically and personally liable for the debts of the old corporation which the new corporation
effectively replaces.
While it can be seen that disqualification of directors involved in multiple insolvencies is one way of
dealing with phoenix companies, other measures are necessary. This is because disqualification alone
has not caught a sufficient number of misbehaving directors. Australia’s approach is typical of measures
in many jurisdictions that are designed to prevent the abuse of limited liability by directors who take
advantage of corporate entities and of their appointments to and departures from their boards.
.......................................................................................................................................................................................
CONSIDER THIS
Visit the ATO website covering the issue of phoenix companies (www.ato.gov.au/General/The-fight-against-tax-
crime/Our-focus/Illegal-phoenix-activity) and reflect on the key themes that emerge as you read the ATO’s material.

THE SLACIP ACT 2022

Critical infrastructure failure can have significant repercussions for financial markets and the broader
economy. The Australian Government defines critical infrastructure as:
those physical facilities, supply chains, information technologies and communication networks which, if
destroyed, degraded or rendered unavailable for an extended period, would significantly impact the social
or economic wellbeing of the nation or affect Australia’s ability to conduct national defence and ensure
national security (Cyber and Infrastructure Security Centre 2023).

Critical infrastructure entities encounter various risks, ranging from physical threats and cyber-attacks to
natural disasters and operational disruptions. Proactively managing these risks becomes crucial in ensuring
the resilience of the infrastructure and maintaining the stability of the financial market. Recognising
the significance of ensuring critical infrastructure, the Security Legislation Amendment (Critical Infras-
tructure Protection) Act 2022 (Cwlth) (the SLACIP Act) was enacted to amend the Security of Critical
Infrastructure Act 2018 (Cwlth) (the SOCI Act). The SLACIP Act introduces two key measures:
1. a new obligation for responsible entities to create and maintain a critical infrastructure risk
management program
2. a new framework for enhanced cybersecurity obligations required for operators of systems of national
significance (SoNS).
The SLACIP Act came into effect on 2 April 2022. The reforms in the SLACIP Act seek to make
risk management, preparedness, prevention and resilience business as usual for the owners and operators
of critical infrastructure assets, and to improve information exchange between industry and government
to build a more comprehensive understanding of threats. These reforms are intended to give Australians
reassurance that essential services are resilient and protected. Entities (both foreign and domestic, including
companies) that own and operate critical infrastructure assets in Australia need to comply with the
provisions of these Acts. This may include developing and reporting on a critical infrastructure risk
management program, registering critical infrastructure assets and reporting cybersecurity incidents.
.......................................................................................................................................................................................
CONSIDER THIS
Navigate to the Cyber and Infrastructure Security Centre at the Australian Government’s Department of Home Affairs
website and find the list of critical infrastructure sectors. Is there anything in the list that surprises you?

4.10 REPRESENTATION
Throughout this module, we have discussed corporate governance relationships and rules and approaches
to make corporate governance better — both in conformance and performance.
We have seen that the most influential stakeholders within an organisation are the board and senior
managers of the corporation. However, there are many other stakeholders, as seen in module 3. The concept
of shareholders and who they are has been discussed at some length and, on many occasions the implicit
question of representation of shareholders in corporate decision making has arisen.
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 Interestingly, shareholders, who are regarded by the law as the ultimate owners with a variety of rights,
are correctly regarded as insiders who have connections with management and control. However, this
correct legal presumption is often not correct in practical terms, in spite of some increased power given to
shareholders in recent times.
In a large corporation, small shareholders have remarkably little influence on the direction of the
corporation and no real control, as individuals, over the decisions made by the board and management.
The opposite is true of large shareholders. They do have influence and often real control through board
positions and potential voting power at general meetings of the corporation. For example, in the US over
the past decade, hedge funds have played an increasingly important and high-profile role in the market, by
taking sizeable stakes in undervalued or struggling corporations and then agitating for change — typically
at the board and senior management level.
Therefore, while small shareholders can be regarded as being outside the corporation, large shareholders
are able to exert their influence inside the corporation. So significant is this fact that there is a model called
the outsider model, which recognises that large numbers of small shareholders are owners but are still
outside in terms of any real control, since they have little representation in real terms.
By contrast, the insider system looks at those who have real power in the corporation. It especially refers
to those who have influence and power through relationships, as can be seen commonly in European and
Asian business structures. Interestingly, substantial shareholders in large and small corporations tend to
look more like insiders as they have real, share-based power, and therefore tend to be better represented in
corporate decision making.
The degree to which shareholders are represented is an area of some concern. You will recall from
module 3 that decisions by boards are required to be in the interests of the corporation as a whole. This
means, in a democratic sense, that they are made in good faith for the majority of shareholders, with no
decisions made for the express purpose of harming or advantaging any minority group of shareholders.
Accordingly, a variety of desirable mechanisms are recommended by the OECD Principles, UK FRC
Code and ASX Principles to deal with actual or potential shareholder concerns about their rights and about
governance generally. Many of these mechanisms exist and shareholder rights are guaranteed by specific
legislative provisions in many countries.
For example, in Australia, the oppression remedy in the Corporations Act provides an important
safeguard for minority shareholder rights in the case of wrongdoing, inaction or abuse of power by the
corporation. However, such safeguards are not present in other jurisdictions.
For individual shareholders, rights stated in the OECD Principles that are commonly protected by
detailed legislation include:
• the right to attend and vote at all general meetings
• the right to relevant information
• the right to buy and sell shares freely (at least in listed corporations)
• the right to not be abused as shareholders
• the right to protect property interests in shares — indeed there is a large range of rights with corollary
obligations on directors and other officers.
Table 4.7 describes some of the ways in which shareholder representation and power may occur within
a corporation.

TABLE 4.7 Shareholder representations

Representation —
some forms Description and examples

General meetings Each shareholder has a guaranteed right to attend and vote at the general meeting of
shareholders — including rights to vote in respect of executive remuneration.

Nominee director A director appointed to represent the interests of a large shareholder or a particular group
of shareholders. Such a person is unlikely to satisfy independence criteria. They will also
be faced with conflicts of interest, as their duty must be to the office of director and not to
the person who arranged their place on the board. Nominee directors will eventually need
to be voted onto the board by the shareholders, and their duty will be to act in good faith
in the best interests of the company and to act for proper purposes. Nominee directors
commonly face difficult conflicts of interest as they in fact represent a single large interest
and the law requires them to act for all shareholders.

(continued)
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 TABLE 4.7 (continued)

Representation —
some forms Description and examples

Investor advocate Shareholder associations and committees made up of particular classes of shareholder.
Some associations become investors in their own right, giving them the opportunity to
attend and vote at general meetings. These can be considered an element of shareholder
activism.
Examples include:
• Australian Shareholders’ Association (ASA)
• New Zealand Shareholders’ Association (NZSA)
• Investment and Financial Services Association (IFSA)

Research and These firms typically conduct independent research and analysis on the corporate
advisory firms governance and financial position of a corporation, as well as surveys of shareholders,
customers and suppliers. Publication of the results in mainstream media provides a form
of shareholder representation. They can also be ratings agencies. These firms are also
intermediaries in markets.
Examples include:
• Institutional Shareholder Services
• Glass Lewis & Co

Institutional investor Some investors actively seek corporate governance, personnel, strategic or capital
management changes to improve the performance of their investments. While such
investors are undoubtedly acting in their own best interests, their representations are
made on behalf of all shareholders in the quest to add long-term, sustainable value. Their
real role is open to very strong questioning. Under what legitimate source of authority
does a single high-wealth organisation, managed by a group of professional managers
with only limited accountability to the owners of the wealth, stand as a credible arbiter of
what comprises good corporate governance?
Examples include:
• California Public Employees’ Retirement System (CalPERS)
• Hermes Investment Management

Source: CPA Australia 2023.

THE REPRESENTATIONAL ROLE OF

INSTITUTIONAL INVESTORS
Advice and rules relating to institutional investors have been under consideration for a long time. In
1991, for example, the Institutional Shareholders’ Committee (ISC) produced The Responsibilities of
Institutional Shareholders in the UK (ISC 1991). In 2007, the ISC published a supplement, Statement
of Principles (ISC 2007), which sets out best practice for institutional shareholders and agents in relation
to their responsibilities in respect of investee companies. In 2010, the UK FRC developed and published
the first iteration of its Stewardship Code (UK FRC 2012). The code has since evolved, including:
[i]n 2016, [when] the FRC introduced a tiering approach to differentiate the quality of reporting from Code
signatories. Then following a comprehensive consultation process, the Code was substantially revised in
2019 to include a new, wider definition of stewardship, to apply to a range of asset classes and to have a
greater focus on stewardship activities and the outcomes of those activities (UK FRC 2022, p. 7).

A US-based group called the Investor Stewardship Group (ISG) has produced a ‘framework for U.S.
Stewardship and Governance comprising of a set of stewardship principles for institutional investors
and corporate governance principles for U.S. listed companies’ (ISG n.d.). This approach is interesting
from the perspective that it is an attempt by one organisation to influence both institutional investors and
corporations. There is a further document that does something similar called the Commonsense Principles
of Corporate Governance 2.0 (Governance Principles 2018). A section of the Commonsense Principles of
Corporate Governance covers the territory of investors’ roles in corporate governance. These principles
set down the respective roles of shareholders, asset managers and institutional asset owners in governing a
company. The common-sense principles state the following in the case of shareholder rights in the context
of voting on the affairs of companies.
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 a. Public companies should allow for some form of proxy access, subject to reasonable requirements that
do not make proxy access unduly burdensome for significant, long-term shareholders. Among the larger
market capitalization companies that have adopted proxy access provisions, generally a shareholder
(or group of up to 20 shareholders) that has continuously held a minimum of 3% of the company’s
outstanding shares for three years is eligible to include on the company’s proxy statement nominees
for a minimum of 20% (and, in some cases, 25%) of the company’s board seats. A higher threshold of
ownership (e.g., 5%) often has been adopted for smaller market capitalization companies (e.g., less than
$2 billion). In either case, as a general matter, only shares in which the shareholder has a full, unhedged
economic interest should count toward satisfaction of the ownership/holding period requirements.
b. Dual class voting is not a best practice. If a company has dual class voting, which sometimes is intended
to protect the company from short-term behavior, the company ordinarily should have specific sunset
provisions, based upon time or a triggering event, which would eliminate dual class voting. In addition,
all shareholders should be treated equally in any corporate transaction.
c. Written consent and special meeting provisions can be important mechanisms for shareholder action.
Where they are adopted, there should be a reasonable minimum amount of outstanding shares required in
order to prevent a small minority of shareholders from being able to abuse the rights of other shareholders
or waste corporate time and resources.
d. Poison pills and other anti-takeover measures can diminish board and management accountability to
shareholders. Insofar as a company adopts a poison pill or other antitakeover measure, the board
ordinarily should put the item to a vote of the shareholders and clearly explain why its adoption is
in the best interests of the company’s shareholders. On a periodic basis, the board should review such
measures to determine whether they remain appropriate (Governance Principles 2018, pp. 6–7).

There are also detailed sections for asset managers that include notions of asset managers needing to
use proxy votes and that they are in the business of managing the wealth of their clients irrespective of
whether their clients are individuals or institutions.
.......................................................................................................................................................................................
CONSIDER THIS
Read reading 4.1 ‘Open letter endorsing Commonsense Corporate Governance Principles’ and reflect on key points
throughout. Compare the role that an asset manager or institutional investor has when compared with the role of a
financial planner or personal financial adviser. How are these different?

An interesting question arises in relation to some institutional investors, such as CalPERS. These
organisations primarily exist in order to manage the wealth owned by others. They also act as pseudo-
market regulators and self-appointed arbiters of good corporate governance standards. The power and
activities of such institutional investors becomes complex. There is little doubt that the basic motivations
behind such approaches are sound. Also, the overall approaches of CalPERS do not seem to demonstrate
any failings.
However, as professionals, we need to look carefully at organisations such as CalPERS. It is likely that
decisions and approaches by such organisations towards corporate governance preferences will be driven
by the perceptions and preferences of the current managers within the relevant organisation at any time.
We need to be aware that these managers are at the same time, it seems, seeking returns for the wealth
owners and also seeking to influence global approaches to corporate governance. Difficulties — including
potential conflicts of interest — seem likely to arise, at least sometimes.
However, where a group of large institutional investors pool their capabilities in order to develop industry
standards, the likelihood of valuable generic outcomes surely must be greater. An example of this is the
Financial Services Council’s standards — which include a code of ethics, code of conduct and other
important guidance for investment managers (FSC n.d.).
Whether or not large institutional investors will always be best placed to comment on corporate
governance matters, there is no doubt that they can and do fill a role as valuable as shareholders. Their
relative size in the market, and their ability to comment where less powerful shareholders could not, can
be seen in example 4.32. The example deals with some publicly reported matters occurring within News
Corp. There, CalPERS is the institutional shareholder reported as expressing major concerns. CalPERS
states reservations about the approaches of the board of News Corp. The independent directors of News
Corp however state that they do not share the concerns so strongly felt by CalPERS.
As background to CalPERS’ concerns about News Corp, an Australian Financial Review article
identified that CalPERS ‘owns 5.49 million News Corp Class A (limited voting) and 1.38 million
Class B (full voting) shares, worth about USD$110 million. The Murdoch family controls 39% of
News Corp’s 798 million voting shares’ (Potter 2011). The report also identifies that there are a further
1.82 billion non-voting shares on issue by News Corp, of which the Murdoch family own relatively few.
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Reduced or no-voting share rights are addressed by CalPERS in its suggestion that there is a corrupt
voting structure.
Notwithstanding CalPERS’ stated concerns, we may assume that an entity buys shares with full
knowledge of their rights, including voting rights. Perhaps CalPERS’ stated concerns therefore may be
considered as in principle concerns relating to News Corp structures, as it may not seem valid to complain
about a specific circumstance that was voluntarily accepted with full information.
As you read example 4.32, you are expected to employ professional judgement in considering the facts.
For example, the independent directors of News Corp fully reject the criticisms of CalPERS, and we should
not dismiss this independent judgement as being of no importance.

EXAMPLE 4.32

News Corporation Backs Murdoch Despite Shareholder Threat

The independent directors of News Corporation gave their unequivocal backing to the management
team headed by Rupert Murdoch, even as one of the company’s largest shareholders threatened to take
action to address the ‘corrupt’ voting share structure that entrenches the Murdoch family’s control of
the company.
The endorsement came hours after News Corp chairman and CEO Rupert Murdoch and his son James,
the deputy chief operating officer and chairman of News International (the British newspaper operating
company at the heart of a phone hacking scandal that threatens to engulf the company) endured a three-
hour grilling at the hands of a UK Parliamentary select committee.
Independent director Viet Dinh said in a statement on behalf of the independent directors that the ‘News
Corporation Board of Directors was shocked and outraged by the allegations concerning the News of the
World, and we are united in support of the senior management team to address these issues.’ … ‘In no
uncertain terms, the Board and management team are singularly aligned and committed to doing the right
thing,’ the statement said.
The Australian Financial Review reported on Tuesday that some directors had raised the idea of
Mr Murdoch stepping down as CEO in favour of Chase Carey, the highly regarded chief operating
officer, and remaining chairman. Bloomberg reported similar plans but said they were contingent on how
Mr Murdoch fared before the UK select committee.
News Corp director Thomas Perkins scotched the reports, saying Mr Murdoch enjoyed the full support
of the board and the existing succession plan had not been brought up in light of the hacking scandal at
the now defunct News of the World tabloid.
However, one of News Corporation’s largest shareholders threatened to take action to address the
‘corrupt’ voting share structure that entrenches the Murdoch family’s control of the company, as Rupert
and James Murdoch parried a British parliamentary select committee’s questions.
Californian Public Employees Retirement Scheme senior portfolio manager Anne Simpson said the
News Corp voting structure ‘pervert(s) the alignment of ownership and control’ and warned that
the USD237 billion fund did not intend to be a spectator in the hacking scandal that had slashed
USD8 billion from the company’s value before Tuesday’s select committee hearing.
Ms Simpson, who heads CalPERS’ corporate governance program, said, ‘The situation (the hacking
scandal) is very serious and we’re considering our options. We don’t intend to be spectators — we’re
owners’ … ‘The market reaction shows how seriously this is being taken — to the tune of USD8 billion at
the moment. I can’t say what the options are at the moment, but we have strong experience in governance
reform,’ Ms Simpson told The Australian Financial Review in an email … Ms Simpson, meanwhile, hit out
at what she described as the ‘corruption’ of governance processes at News Corp. ‘News Corp does not
have one share one vote. This is a corruption of the governance system. Power should reflect capital at
risk. CalPERS sees the voting structure in a company as critical,’ Ms Simpson said. ‘One share one vote’ is
a CalPERS core principle, because we believe that the control of a company should reflect its ownership.
That’s capitalism — it’s a design feature that’s vital. Dual class voting is one way to pervert the alignment
of ownership and control.’
Rupert Murdoch, who in another lapse from strict corporate governance standards is both chairman
and CEO, told the select committee he wasn’t responsible for the phone-hacking at New Corp’s News
of the World newspaper and that the blame lay with ‘the people that I trusted to run it’. James similarly
deflected responsibility.
Source: Potter, B 2011, ‘News backs Murdoch despite shareholder threat’, Australian Financial Review, 21 July,
accessed August 2023, www.afr.com/companies/media-and-marketing/news-backs-murdoch-despite-shareholder-threat-
20110720-i719b.

After surviving the immediate media storm following the revelations regarding the phone hacking
scandal in the United Kingdom, and the closure of the News of the World newspaper at the centre of
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the controversy, Rupert Murdoch initially faced down the repeated market calls for him to step down
as CEO of News Corp (remaining in the role of the chair) and demands to separate the newspaper
interests and television and film interests of News Corp. Then, in 2013 Murdoch responded to the calls
and formed two companies with most of its television and film assets being included in a new company,
21st Century Fox. The remaining 130 newspapers (including the Wall Street Journal and the Times of
London), educational businesses and other assets were established in a new company with the old name of
News Corp (The Economist 2013).
The reluctant splitting of the conglomerate media corporation into two more focused media concerns
led to a dramatic increase in the price of 21st Century Fox shares and the stabilisation of the newspaper
companies shares. With his Midas touch apparently returned, Rupert Murdoch now felt able to address
the two related problems that had damaged the corporate governance reputation of the company for a
considerable time: firstly the concentration of power in his hands, and secondly the apparent lack of any
convincing succession strategy (Clarke 2016).
In a complicated governance manoeuvre 21st Century Fox announced in 2015 that James Murdoch
would become CEO, while Rupert Murdoch would remain as Executive Chairman, and Rupert’s other son,
Lachlan Murdoch, would become Co-Executive Chairman (with the long serving Chase Carey stepping
down as Chief Operating Officer). At News Corp, Rupert Murdoch remained as Executive Chairman, with
Lachlan Murdoch as Non-Executive Chairman and Robert Thomson as Chief Executive. Commentators
suggested that these arrangements had more to do with dynasty than governance, and the fact that no
place could be found for Rupert’s daughter Elizabeth (widely acknowledged as the most talented and
independently successful of Murdoch’s children from her success as a UK television entrepreneur) revealed
it was not the most robust dynastic settlement (Knight 2015).

QUESTION 4.10

Refer to example 4.32.

Explain why normal small shareholders (not institutional shareholders) in News Corp may have
had concerns about Murdoch family control when, in fact, the family did not hold a majority
of shares. Also explain why institutional shareholders may have had concerns. With whom did
CalPERS more readily align, given that, at the time, it held 1.38 million Class B (full voting) and
5.49 million Class A (partial voting rights) shares of the total of 738 million voting shares?

EXPANDING ETHICS
It is becoming increasingly common for business codes of conduct to specify good business ethics. These
codes of conduct do not apply only to employees and managers. Codes of conduct need to deal with a vast
array of relationships and business matters.
One interesting expansion taking place is that many purchasers now insist that suppliers must display at
least minimum ethical standards. A powerful example occurred more than 10 years ago when the Finnish
company, Nokia, began sourcing large volumes of inputs from factories in developing economies. Nokia
took the approach that employees who worked in overseas factories to make goods that would be bought
and used by Nokia must work in good, safe working conditions and be paid appropriately. If a supplier
could not meet the minimum standards required by Nokia, then Nokia would not do business with them.
An extensive example of a code of ethics that has a broad array of internal and external stakeholder
governance requirements can be seen in HSBC’s ‘Ethical and environmental code of conduct for suppliers
of goods and services’ (HSBC 2018). Included in this code, for example, is a set of employment conditions
that suppliers need to comply with. As professional accountants, we can immediately see the importance
of meeting HSBC’s ethical rules if the supplier is to continue supplying to HSBC.
It is clear that good governance practices protect boards, management, shareholders and many other
stakeholders, including the financial markets and the economy. HSBC’s focus on ethical conduct is
part of the company’s commitment to meeting expectations, not only of its shareholders, but also of its
customers, regulators and society as a whole — that is, being a responsible corporate citizen (the subject of
module 5). Poor ethics, combined with unlawful behaviour, can damage corporations dramatically.
For example, recent public statements about Olympus Corporation have focused on impropriety within
the corporation and subsequent shareholder losses, as shown in example 4.33.
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 The Olympus case study illustrates the way that boards can dramatically mismanage — and the fact that
this mismanagement hurts corporations, shareholders and indeed entire economies by damaging financial
markets. The Financial Times article is one of many reports identifying that the board of Olympus was
involved in a major scandal. A fundamental cause appears to be the absence of independent directors
on the board, a practice that was widespread in the Japanese corporate governance system, though now
the Japanese code recommends companies accept at least one independent director. Even worse, the
report suggests that there is an apparent reluctance in Japan to lessen the power of entrenched non-
independent board and management structures. But, as with other countries, lessons have been learned
from the Olympus case and other corporate scandals in Japan and the important questions that go to the
heart of ethical corporate governance are being asked:
As the drive for change in Japanese corporate governance accelerates, fundamental questions are being
asked presently in Japan … Whose interests should a company serve? Is it the property of shareholders,
for them to do whatever they want with it, or does it have a wider social purpose? (Seki & Clarke
2013, p. 717).

EXAMPLE 4.33

Olympus Corporation
Former Olympus Chief Warns on Governance
The former chief executive of Olympus, who blew the whistle on the company’s accounting fraud, said
the corporate culture and practices at the root of the scandal remain in place at the camera maker and
warned that Japan was missing an opportunity to adopt much needed corporate governance reforms.
‘I don’t think we have cleansed [Olympus],’ said Michael Woodford, the former president and CEO, who
was sacked after confronting top management about excessive payments related to the acquisition of UK
medical equipment maker Gyrus and others. ‘Nothing has changed and it is business as usual,’ he said.
Mr Woodford also warned that the Olympus affair was not over and pointed out the need to investigate
the more than 100 companies Olympus acquired under former chairman Tsuyoshi Kikukawa, who has
been arrested in connection with the fraud.
The former president and CEO said that while he was heading Olympus he had wanted to bring in
Kroll, the forensic specialist, to investigate whether the camera maker used other acquisitions to cover up
accounting irregularities. ‘I think a lot more scandal will come out.’
His comments came on the eve of Olympus’s extraordinary general meeting on Friday at which
shareholders will vote on the company’s new board as well as the restatement of its accounts.
Olympus has admitted to falsifying its accounts to cover up JPY130 billion in losses incurred through
bad investments dating back to the 1990s.
Japanese police arrested three former executives of Olympus, including its former chairman, who are
suspected of involvement in the fraud, while Tokyo prosecutors last month indicted Olympus on violation
of the Financial Instruments and Exchange Law.
The Olympus scandal has shaken the Japanese business community and undermined foreign investor
confidence in the country’s capital markets.
Tsutomu Okubo, an upper house parliamentarian who chairs a ruling Democratic Party committee on
corporate governance reform, said earlier this week: ‘It is a serious matter. The Olympus affair attracted
much attention … and it is said that thinking on corporate governance in Japan is lax.’
The Democratic Party is preparing to submit legislation aimed at improving corporate governance but
it has been watered down due to opposition from the powerful business lobby Keidanren.
Speaking to the media, Mr Woodford said the choice of Olympus’s new chairman and other board
members and the process whereby new directors have been nominated indicated governance had not
been reformed at Olympus.
Two key appointees have close ties with Olympus’s main bank, Sumitomo Mitsui, while another has had
a long career with Bank of Tokyo Mitsubishi, making them insufficiently independent, he said.
‘The Olympus scandal would have been a wonderful opportunity to really get it right.’ Instead, he said,
investors hesitate to invest in Japan and question the integrity of company accounts. ‘Japan is seen to
be having more and more question marks,’ Mr Woodford said.
Source: Nakamoto, M 2012, ‘Former Olympus chief warns on governance’, Financial Times, 19 April, accessed August
2023, www.ft.com/cms/s/0/668ea860-8a0d-11e1-87f0-00144feab49a.html. Used under licence from the Financial Times.
All Rights Reserved.

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WHISTLEBLOWER PROTECTION
Whistleblowing can be defined as the ‘disclosure by organisation members (former or current) of illegal,
immoral or illegitimate practices under the control of their employers, to persons or organisations that
may be able to effect action’ (Miceli & Near 1984, p. 689). In many instances of substantial management
failures, including major occupational health and safety breaches, management frauds and other illegality,
the reports of whistleblowers have been the only mechanism that caused an investigation into inappropriate
actions or behaviour.
The growing incidence of corporate scandals and crashes over recent decades has resulted in an
international focus on developing laws and policies that encourage and protect whistleblowers. The
whistleblower, however, must take great care to act only within the legal protections provided by detailed
laws. The whistleblower is still at great risk of retribution or ‘payback’. Action may be taken through the
legal system for slander and/or libel, even with the legal protections that are in place.
Without protection, it is also quite likely that a whistleblower would have been considered as a traitor or
disloyal, as a person who in fact deserves retribution for their ‘disloyal’ conduct. Such people have been
subject to campaigns of vilification, dismissal, legal action and bankruptcy. There are anecdotes suggesting
that suicide has even been an outcome.
Modern legislative protection is designed to enable whistleblowing in a managed way. Reflecting this
fact, boards often have internal codes that reflect the value of careful whistleblowing approaches and
implement practical whistleblowing protections that meet legal requirements and work within the specific
organisation. Such an approach by boards is a valuable addition to good corporate governance.
Whistleblowing laws arose first in the United States, as long ago as the 1863 United States False Claims
Act (revised in 1986) — and they are now found in many countries. Most commonly, whistleblowing laws
have developed to protect government interests (as in the US in 1863) but they have grown beyond that
limited domain. For example, internationally, occupational health and safety laws protect many employees
from victimisation and retribution for reporting compliance breaches.
In response to corporate failures such as Enron, the US Sarbanes–Oxley Act (2002) provides for
whistleblower protection where an employee of a listed company ‘blows the whistle’ to an external entity,
such as a government body, or within the corporation in relation to fraud against shareholders (US Congress
2002, s. 806). The protection provided to whistleblowers is against being discharged, demoted, suspended,
threatened, harassed or in any manner discriminated against by the corporation or any ‘officer, employee,
contractor, subcontractor, or agent’ of the corporation. In addition, the Sarbanes–Oxley Act requires audit
committees to establish procedures for hearing complaints. The Act affects all US ‘stock exchange listed’
corporations internationally, because even US subsidiaries of these corporations in overseas locations, and
their auditors, must comply with it.
Whistleblower legislation has been in place in Australia from 2014, and from 1 January 2020 all
public companies, large proprietary companies and corporate trustees of registrable superannuation
entities in Australia have been required by legislation to have a whistleblower policy. As an example of
a corporate whistleblower policy, Westpac established the Westpac Group Speaking Up Policy, which
provides guidance on how to raise concerns about suspected or actual illegal or unethical behaviour. The
policy also includes reference to applicable whistleblower laws, such as the protections in the Corporations
Act, discussed below, and industry initiatives such as the Australian Bankers’ Association’s ‘Guiding
Principles — Improving Protections for Whistleblowers’ (Westpac Group n.d.). The policy states:
Westpac is committed to conducting our business with honesty, fairness and integrity. We take unlawful
and unethical behaviour very seriously. If you suspect something is not right, we encourage you to Speak
Up as soon as possible (Westpac Group n.d.).

It is not our task in this subject to consider the many different detailed legal rules that exist internationally.
However, as professional accountants, we must be able to handle the rules, or seek relevant guidance on
them, as they occur in our own jurisdictions. There will be important differences from one jurisdiction
to another. Boards and management must ensure that the rules are implemented appropriately within the
local rules and within the particular corporation.
The rules that apply under the Corporations Act, in common with whistleblower legislation internation-
ally, attempt to balance the value of whistleblowers and the need to protect their rights with the rights of
the corporation and the importance of confidentiality and good corporate governance. Equally, while it is
important that employees are free to blow the whistle, it is also important that malicious employees do not
have the opportunity to unfairly harm corporations and other stakeholders including shareholders, other
employees and customers.
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Australian Whistleblowers’ Protection Legislation
The Corporations Act whistleblower regime (Part 9.4AAA of the Act) was introduced in 2014 to
provide protection to whistleblowers that report suspected breaches of the Corporations Act (and relevant
regulations such as accounting standard breaches). Under the original regime, suspicions could only be
stated by a person who is allowed to be a whistleblower and only to specified persons, as described in
the Corporations Act. Suspicions could not be made anonymously and must not be malicious. If all the
rules were satisfied, then substantial protections were available to the whistleblower and harsh punishment
applied in respect of any attempt to retaliate against or punish those who are legitimately protected
whistleblowers.
The Treasury Laws Amendment (Enhancing Whistleblower Protections) Act 2019 (Cwlth) amended
Part 9.4AAA of the Corporations Act, the Taxation Administration Act 1953 (Cwlth), the Banking Act
1959 (Cwlth) and the Insurance Act 1973 (Cwlth) to expand and strengthen whistleblower protections
in the corporate, financial and credit sectors. The legislation prescribes that a person is protected as a
whistleblower if they are:
• a current or former officer (this includes senior managers and directors and the corporation secretary)
• a current or former employee
• a current or former supplier (a contractor or their employee)
• a family member of any of the above.
The legislation provides for anonymous disclosure and applies provided the whistleblower has reason-
able grounds to suspect misconduct (even if they turn out to be mistaken).
As whistleblowing does not involve proof but only ‘reasonable suspicion’, it is important that these
initial suspicions are not published or broadcast. Equally, because the suspicions may apply in respect
of any breach of corporations law, the breach could involve, for example, board members, managers or
auditors. Accordingly, the legislation specifies a range of potential recipients of the information, including
ASIC, APRA and various ‘eligible recipients’, including officers or senior managers, auditors, actuaries
or a person authorised by the corporation to receive disclosures.
The legislation is intended to protect whistleblowers from retaliation, and it also stipulates that, if any
negative consequences occur, or harm has been done to an employee because of protected whistleblowing,
civil rights are made available to the employee under the Act. These civil rights are enforced through
orders against employers and anybody else who has hurt the whistleblower, and may involve substantial
financial penalties (up to 10 per cent of a body corporate’s turnover). Such orders can include reinstatement
of employment and compensation. As observed with the Sarbanes–Oxley Act, criminal prosecutions can
also occur under the Corporations Act against those who abuse whistleblower protection laws.
The new regime requires all public companies, large proprietary companies and the corporate trustees
of registrable superannuation entities to have a whistleblower policy that meets the requirements specified
in the legislation. The requirements include details of how the company will investigate disclosures and
how the company will protect and support whistleblowers. Example 4.34 illustrates how a whistleblower
acted to stop rogue trading.

EXAMPLE 4.34

National Australia Bank — Dealing Room Failure

An example may be seen in the case of dealing room failure at NAB, which was widely reported in 2004.
Following that case, NAB made great changes to prevent recurrence. National regulatory changes also
occurred to improve governance standards within the sector generally. In the NAB dealing room, failure
in improper internal procedures, involving an activity called ‘rogue trading’, generated substantial losses.
Fortunately, before large losses became even larger, the procedures and the losses were discovered.
This was through the action of a ‘whistleblower’ who told senior management of the concerns held. The
whistleblower acted appropriately and before the matter became public, presumably preventing further
damage to finances and reputation. The whistleblower acted without any formal legislative protection that
exists today — and the question arises as to how many others in similar positions in similarly challenging
circumstances would have done the same thing.
To understand the context of this rogue trading and the actions of the whistleblower (notwithstanding
personal risks), consider the following statements, which were part of a transcript of a television national
television discussion.

Kerry O’Brien, presenter: Two rogue traders involved in a financial scandal at banking giant NAB are
behind bars tonight after a judge found they’d been enmeshed in a culture of malleable, profit-driven
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 morality that went off the rails. Senior trader David Bullen was sentenced today to a minimum of
2.5 years’ jail for his role in creating false profits on NAB’s foreign currency trading desk, which cost
the bank $360 million. And junior trader Vince Ficarra will serve a minimum of 15 months. They’re the
last two men of a trading-room team of four to receive jail terms over a scandal that severely damaged
NAB’s reputation and resulted in a major internal shake-up. With fascinating insights provided by
taped phone conversations of the dealers at work, Heather Ewart takes a look at their high-risk culture
and at whether other potential cowboys are likely to take a salutary lesson from the outcome.

Source: Extract from Ewart, H 2006, ‘Former NAB traders jailed’, 7.30 Report (TV program transcript), Australian
Broadcasting Corporation, 4 July, accessed August 2023, https://www.abc.net.au/news/programs/730. Reproduced with
permission.

Cases like this were important in establishing the need for legislative protection and also resulted in
direct internal ‘whistleblower protection’ policies being established by many corporations.
Note that the NAB case, which followed the collapse of HIH Insurance (which we discussed in
module 1), can be seen as a factor in substantial changes to the legislation affecting, and regulation of,
the financial sector (i.e. financial institutions of various types), including banks. These changes may well
have helped Australia avoid being seriously affected by the GFC, as these new approaches meant Australian
financial institutions did not have the apparent freedoms of other countries such as Ireland, Iceland or even
the United States.
As you read example 4.35, consider that in the very tough Enron management environment, no
relevant whistleblower protections were available at the time (i.e. it was before the Sarbanes–Oxley
Act). It is presumed that modern whistleblowing protection would have more easily allowed people like
Sherron Watkins to confront the undoubted risks involved and to take action with a far greater level of
personal safety.

EXAMPLE 4.35

Sherron Watkins (Enron)

Sherron Watkins joined Enron Corporation in 1993, after working for Arthur Andersen for the previous
eight years. She ultimately rose to the position of vice president of corporate development in Enron.
During the course of her work at Enron as a senior executive, Watkins became aware of some highly
questionable accounting practices involving aggressive revenue recognition practices and the extensive
use of off-balance sheet entities (which enabled Enron to keep significant liabilities off its balance sheet).
In a memo to the chairman (and founder) of Enron, Ken Lay, in August 2001, Watkins expressed the view
that she was ‘incredibly nervous that we [Enron] will implode in a wave of accounting scandals’. This
was also followed up with personal meetings between Watkins and Lay. Lay ignored these warnings. In
December 2001, Enron did indeed implode, becoming the largest (at that time) bankruptcy in US history.
Watkins’ memo was subsequently discovered by investigators sifting through Enron documents after the
bankruptcy and released by a congressional committee (to which Watkins testified) in early 2002.
Watkins was acclaimed as a whistleblower by some but Ackman, writing in Forbes Journal of her inaction
and failure to blow the whistle despite her knowledge, stated that ‘far from whistle-blowing, Watkins’
actions actually provide cover for Lay and the Enron board’ (Ackman 2002).
The fact that Watkins did so little in the face of damning evidence is an indication of the importance of
protecting whistleblowers. Perhaps if Watkins had been protected and had acted quickly, then many
problems of Enron caused in the early 2000s could have been avoided or at least reduced. As it is,
Watkins, who has been criticised for acting late, would have potentially been the target of otherwise proven
‘wrongdoers’. In fact the initial response of the Enron chair to Watkins’ email warning of the financial risks
Enron faced was to consider dismissing Watkins. Enron’s lawyers counselled against this course of action
primarily because it might bring further publicity regarding the financial position of the company.

QUESTION 4.11

Briefly describe ‘whistleblowing’ and explain why whistleblower protection has become an impor-
tant component of good corporate governance.

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 Further, if Watkins was whistleblowing today, and in Australia, what guidance would you give
to her regarding her legal protection? Refer to ASIC’s Information Sheet 238 (https://asic.gov
.au/about-asic/asic-investigations-and-enforcement/whistleblowing/whistleblower-rights-and-
protections).

DISCLOSURE OF SUSTAINABILITY-RELATED
FINANCIAL INFORMATION
The latest development in the protection of financial markets is the provision by companies of sustainability
related financial information. This is a global development that includes the previously mentioned
IFRS S1 and S2 standards, the European Union’s CSRD and the SEC’s proposals. The IFRS S1 and
S2 developments are designed to provide ‘primary users of general purpose financial reports’ with
information on ‘sustainability-related risks and opportunities that could reasonably be expected to affect
an entity’s prospects’ (IFRS S1, paras 1, 11). ‘Entity’s prospects’ include future impacts on cashflows,
‘access to finance or cost of capital over the short, medium or long term’ (IFRS S1, para. 3). Companies
will need to use scenario analysis, both qualitative and quantitative, to determine these impacts. These
disclosures will provide investors with the information they need to decide where to invest their funds,
and prompt boards to protect the value in companies by recognising and responding to sustainability risks
(including transition and physical risks) and challenges (including achieving net zero by 2050). This will
contribute to the protection of financial markets by ensuring efficient and informed resource allocation of
funds by investors and companies that are resilient to sustainability issues, including climate change and
stranded assets.
However, the response by some companies has not been in accordance with the thinking behind
these developments. Some companies have responded with greenhushing, greenwashing or regulatory
arbitrage; these are not generally considered to be legitimate responses. In South Pole’s 2023 report,
Net Zero and Beyond, of the 1200 companies surveyed, ‘nearly a quarter (23 per cent) are deciding
not to publicise their progress’ towards net zero. ASIC has recently added greenwashing to its strategic
priorities and published its regulatory interventions (for the period 1 July 2022 to 31 March 2023)
in report 763, ASIC’s recent greenwashing interventions (ASIC 2023). This results in this report included
11 infringement notices and one commencement of civil proceedings.
.......................................................................................................................................................................................
CONSIDER THIS
Locate a definition of the term ‘regulatory arbitrage’ and comment on why the European Central Bank (2021) included
the paragraph below in its conclusions and policy advice.

Building on improved disclosures and standards, consistent regulatory and supervisory approaches will
help to address climate-related and environmental financial risks. Maintaining global consistency will be
important to avoid regulatory arbitrage, with ongoing work in this area being conducted by the FSB, the
Basel Committee on Banking Supervision, the European Banking Authority (EBA) and others. Currently,
the work at both the international and the EU level focuses on whether the current prudential frameworks
adequately cover climate-related financial risks or whether there are any gaps. Subsequently, the need
for potential regulatory and/or supervisory measures will be considered to ensure financial institutions are
effectively addressing climate-related financial risks.

Credit and ESG rating agencies also play a vital monitoring role in ensuring companies are held
accountable for their environmental performance and sustainability commitments. This monitoring role
is fulfilled by continuous assessment of companies’ climate change practices, close review of their
climate-related disclosures, monitoring of their compliance with relevant climate-related regulations, and
identification of climate-related risks that could affect firms’ financial performance and stability.
.......................................................................................................................................................................................
CONSIDER THIS
Visit MSCI’s website (www.msci.com/our-solutions/esg-investing/esg-ratings) to gain an understanding of how ESG
performance is rated.

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SUMMARY
Part C began with an overview of financial markets, their regulation and the role of information within
the markets. The regulation of capital markets is both domestic and global and has become increasingly
complex over time. Various corporate collapses across the globe over the years have created tighter
regulations on companies but curbing market misconduct remains a challenge. Particular issues that can
affect the operation of the market include insider trading, market manipulation, bribery and corruption,
rogue trading, Ponzi schemes and the use of phoenix companies. Specific regulation (including protection
for whistleblowers) is in place to address these problems. The role of shareholders in ensuring appropriate
decisions are taken in relation to governance of companies during general meetings was also explored and
we presented the idea that ethics is expanding into more facets of corporate conduct. Part C also discussed
three additional market protection mechanisms: critical infrastructure security requirements, enhanced
whistleblower protections and disclosure of information related to sustainability risks and opportunities.
The key points covered in this part, and the learning objective they align to, are as follows.

KEY POINTS

4.6 Identify some important rules that exist for the protection of financial markets and the value
of corporations.
• Regulators administer laws that are designed to ensure markets are run in an orderly fashion with
no unfair advantages being given to any parties.
• ASIC administers the Corporations Act and also oversees the work of the ASX, which is the main
trading market for shares and other instruments.
• Both ASIC and the ASX have a responsibility for continuous disclosure given that disclosure must
be made to the market via the ASX and enforcement of the law is within ASIC’s remit.
• AUSTRAC regulates and oversees the collection of information from a range of market participants
to determine whether money laundering or terrorist financing has been taking place.
• The RBA regulates the market for clearance and settlements.
• APRA is the prudential regulator that provides institutions with a license or registration to operate
as lending bodies. It is responsible for regulating the way in which banks and similar institutions
conduct their business.
• The ASX Listing Rules specify the rules under which companies listed on the ASX exchange
must operate.
• Market manipulation laws exist in order to ensure that those who seek of engage in insider
trading and coordinate groups of people selling or buying stocks are prosecuted. These tactics
are designed to manipulate share prices artificially and often to the disadvantage of ordinary
shareholders.
• Other actions that are prohibited by market protection rules include bribery and corruption, rogue
trading, Ponzi schemes and the use of phoenix companies.
• Australia has enacted legislation to protect whistleblowers who report corporate misconduct.
• IFRS standards S1 and S2 contain provisions designed to protect the financial markets and the
value of corporations.
• Entities now have a legal obligation to include critical infrastructure in their risk management
activities.

REVIEW
In this module, we have examined how corporate governance theories, principles and guidelines are put
into practice.
Part A of the module examined elements of good corporate governance that contribute to corporate
success, including the diversity of skills, experience and perspectives represented on the board of directors.
Part B of the module examined the operational responsibilities of the board, including compliance with
a range of legislation that covers matters such as employee rights, fair competition in the market, consumer
protection, data security and sustainability.
The protection of the financial markets and the value of the corporation were the subjects of part C. In
particular, we examined the regulation of participants in the financial market to ensure the markets operate
fairly and efficiently. We also examined how shareholder rights are represented within the corporation,
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the expanding role of ethics within corporations and measures in place to protect whistleblowers who
expose misconduct.
In combination, the above practices help those charged with corporate governance to demonstrate
accountability.

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MODULE 5

CORPORATE
ACCOUNTABILITY
LEARNING OUTCOMES

After completing this module, you should be able to:

5.1 explain the concept of social and environmental responsibility and its relevance to governance
5.2 describe the obligations of corporations in relation to their social and environmental behaviours
5.3 discuss the different theoretical perspectives about what motivates organisations to present social and
environmental information
5.4 identify the components of corporate social responsibility or sustainability reports
5.5 identify the limitations of conventional financial accounting in relation to the recognition of social and
environmental costs and benefits
5.6 describe the mandatory reporting requirements for social and environmental performance reporting
5.7 describe the elements and frameworks of non-mandatory reporting for social and environmental
performance reporting
5.8 discuss the reasons why an entity would use non-mandatory reporting
5.9 explain the relevance of climate change to corporate accountability, and identify some related measure-
ment issues
5.10 evaluate the role of corporate governance mechanisms in enhancing an organisation’s social and
environmental performance.

ASSUMED KNOWLEDGE

Knowledge from modules 1–4 of this study guide is assumed.

PREVIEW
Corporations come into existence and continue to operate via legislative and regulatory compliance. They
source economic capital resources from shareholders and lenders to whom they owe a fiduciary duty and
are therefore accountable. These resources are then used to produce profits. Profits are put to two uses.
They are either kept within the company to fund future operations, or they are returned to the providers
of the capital (shareholders and lenders) as repayments of capital and/or reward for the use of that capital
and the risks they took in providing it to the company. The market value placed on a company reflects
the riskiness and quantum of its future expected returns. These statements reflect one view of corporate
responsibility — shareholder responsibility — and gave rise to corporate governance and agency theory.
More recently, a different view has arisen. Under this view, a company comes into existence and
continues to operate under an implied social licence. This licence recognises that companies also use
environmental resources and human capital in the production of their profits. Therefore, according to this
view, companies are also accountable to the ‘owners’ of those forms of capital, and there should be a return
for their use. This view is known as corporate social responsibility.
Still more recently, these two perspectives have merged alongside the imperative of sustainable
development. Corporations are viewed as requiring and depending on economic, environmental and human
capital. Corporations make use of and impact the environment, the environment is where people exist,
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and people provide resources to corporations not only as workers but also as consumers and lenders.
This realisation led to the emergence of environmental, social and governance (ESG) to ensure that the
risks and opportunities associated with environmental and social (human) capital are reflected in the value
placed by analysts on corporations (UNEP FI 2004). This view is known as corporate sustainability.

QUESTION 5.1

If the issues to be addressed were environmental (E) and social (S), why did the acronym end
up as ESG? Read the introduction of the Who cares wins: Connecting the financial markets to
the changing world report (www.unglobalcompact.org/docs/issues_doc/Financial_markets/who_
cares_who_wins.pdf) to find out why governance (G) was included.

Corporate reporting has evolved alongside changing views of the corporation. Historically, financial
reports were sufficient. More recently, environmental and social reporting have become more common,
and with the advent of corporate sustainability, ESG reporting and sustainability reporting have emerged.
An understanding of terminology in this space is crucial. For example, ‘ESG’ and ‘sustainability’ are
not interchangeable terms. Table 5.1 provides a list of definitions and examples of key terms.

TABLE 5.1 Definitions and examples of key terms

Concept Definition Example

Sustainability A term that recognises the need for short- and See https://sdgs.un.org/goals
long-term action to ensure that environmental,
social and economic benefits and impacts
remain balanced over time, with no one area
sacrificed for another.

Corporate social The responsibility of an organisation for See www.iso.org/iso-26000-social-

responsibility (CSR) the impacts of its decisions and activities responsibility.html
(products, services and processes) on society
and the environment through transparent and
ethical behaviour that:
• contributes to sustainable development,
including the health and welfare of society
• takes into account the expectations
of stakeholders
• complies with applicable law
• is consistent with international norms
of behaviour
• is integrated throughout the organisation and
its relationships.

Sustainable Development that meets the needs of the See https://sustainabledevelopment.

development present without compromising the ability of un.org/content/documents/
future generations to meet their own needs. 5987our-common-future.pdf

Environmental, social A concept that focuses on the measurement See www2.deloitte.com/ce/en/

and governance and assessment of environmental, social and pages/global-business-services/
(ESG) governance aspects of organisations. ESG has articles/esg-explained-1-what-is-
a strong focus on the needs of investors. esg.html

Source: CPA Australia 2023.

An implication of the above is that corporate accountability now encompasses sustainability. Sustain-
ability is a broad concept that can be applied at levels beyond the corporate sector. For example, individuals
can pursue sustainability within their personal lives, and governments are increasingly committing to
sustainability initiatives. CSR represents one way in which companies can move towards greater levels
of sustainability, especially in the long term. It represents the formalisation of a commitment towards
achieving sustainable outcomes at the company level and is a necessary foundation for corporate efforts
aimed at becoming more sustainable. ESG is a concept that seeks to measure a company’s overall
sustainability performance in a way that is often concerned with the needs of investors. The focus is
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on quantification, and companies are being increasingly scored on their ESG performance by ratings
organisations such as S&P and, as mentioned in an earlier module, Morgan Stanley Capital International
(MSCI). Despite the differences between CSR and ESG, the terms are often used interchangeably. When
encountering these terms, it is important to understand the nature and context of their usage to avoid
confusion. CSR is a values-based commitment by an organisation to the environment and society; ESG is
the metrics by which this commitment is measured.
A company’s commitment to social responsibility through CSR depends on its organisational objectives
and overall purpose. This can be linked to some of the emergent theories of corporate governance covered
in module 3. For example, there is increasing recognition that companies have an obligation beyond the
maximisation of investor wealth and that other stakeholders must also be considered if the organisation is
to succeed and stay viable in the long term. Stakeholder theory recognises that businesses need to manage
the requirements of these divergent groups. One way in which this can be achieved is via a commitment to
CSR. Consistent with CSR theory, there are benefits for organisations engaging in, and encouraging their
employees to engage with their community.
The concepts discussed so far are all framed with reference to the following three pillars of sustainability:
• planet (or environment)
• people (or social)
• profit (or economic).
These pillars are each aligned with many of the reporting developments discussed in this module.
In 2015, the United Nations adopted an agenda of 17 Sustainable Development Goals (SDGs), shown
in figure 5.1. Sustainable development is a central concept in this module.

FIGURE 5.1 United Nations’ 17 Sustainable Development Goals

Source: UN 2015, ‘Sustainable development goals’, accessed August 2023, www.un.org/sustainabledevelopment.

For the purposes of this module, sustainable development is defined as:

Ensuring that the needs of today’s world are met while at the same time ensuring that the ability for future
generations to meet their own needs is not compromised (WCED 1987, p. 16).

This definition is derived from the report Our Common Future (WCED 1987), also known as the
Brundtland Report. This definition, alongside the UN’s SDGs, has helped frame the development of
sustainability reporting.
The disclosure of information about sustainability performance and processes has become so common
that it is now considered mainstream reporting by most major corporations around the world. This increase
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in reporting about social and environmental impacts and performance occurred alongside an increase in
regulation worldwide.
This module builds an understanding of the demand for broader reporting on social, environmental and
sustainability impacts and the benefits and challenges of providing such reports.
Part A of the module discusses the limitations of financial reporting in relation to the recognition
of the social and environmental impacts of organisations. Part B then discusses the drivers for greater
accountability and the emergence of corporate social responsibility (CSR) reporting. Part C links this to
theories used to explain the need for social and environmental information. Part D presents a history of
CSR reporting and examines the extent to which some of the concepts related to social and environmental
performance are capable of being measured. Part E identifies the main mandatory reporting requirements
developed to ensure greater corporate accountability and discusses some of the more widely adopted or
higher profile non-mandatory reporting initiatives. Part F concludes the module with a review of reporting
practices related to climate change.

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PART A: FINANCIAL REPORTING AND
ITS LIMITATIONS
INTRODUCTION
Traditional reports produced for organisations by the accounting profession focus on financial information.
The financial position at a point in time and financial performance over a period of time indicated by these
reports serve as measures of an organisation’s success or failure in serving the interests of its shareholders.
Increasingly, a broader range of stakeholders are recognised to have a legitimate interest in the actions
and impacts of organisations. These interests are broader than the financial position and performance of
the organisation. Although the relationship between sustainability and long-term financial prospects is
becoming better understood and increasingly considered in financial reporting, the financial reporting
model that practitioners traditionally learn and apply is focused on providing information to providers
of economic capital. It is not designed to meet the information needs of stakeholders interested in
sustainability, community and environmental outcomes.
In this part of the module, we shall explore how the traditional approach to financial reporting falls short
of providing for the broader dimensions of corporate accountability. We shall explore this by reflecting
on the Conceptual Framework for Financial Reporting (Conceptual Framework; IASB 2018) and, in
particular, the scope of financial reporting, elements of financial reporting, the practice of discounting
future cash flows, concepts of relevance and faithful representation, the focus on short-term results and
the entity assumption.

5.1 SCOPE OF REPORTING

Accounting has historically focused on financial information and the preparation of financial reports. The
objective of financial reporting is described by the Conceptual Framework as follows.
The objective of general purpose financial reporting is to provide financial information about the reporting
entity that is useful to existing and potential investors, lenders and other creditors in making decisions
relating to providing resources to the entity. Those decisions include:
(a) buying, selling or holding equity and debt instruments;
(b) providing or settling loans and other forms of credit; or
(c) exercising rights to vote on or otherwise influence, management’s actions that affect the use of the
entity’s economic resources (para. 1.2).

This demonstrates that inherent in the nature of financial reporting is the focus on the rights of shareholders
and lenders, specifically those who are not involved in management, and who have limited power to obtain
information about the organisation. As such, shareholders, along with debt capital providers, are the primary
intended audience for financial reporting. The Conceptual Framework also states that other users (such
as members of the general public) are not the focus of this reporting (para. 1.10).
By emphasising the financial information relevant to capital providers, the Conceptual Framework
reflects a shareholder primacy perspective. This implies a very narrow interpretation of accountability,
restricting reporting only to those aspects associated with financial performance. However, focusing on
financial results alone has its limitations. For example, financial reporting alone cannot answer important
questions about social and environmental performance, including the following.
• How high is employee morale and turnover?
• Are customers being supplied with appropriate products and services?
• Is the supply chain operating ethically without instances of modern slavery?
• Are the human rights of all people affected by the organisation being respected?
• What financial impact will transitioning to net zero by 2050 have on future returns, the value of assets
and the viability of the current business model?
• Are there physical risks associated with climate change that will impact future returns, and what is the
quantum of that risk?
It is now increasingly recognised that accounting has a broader scope beyond financial matters and that
accounting reports should incorporate financial and non-financial information related to sustainability.
Shareholders and creditors are increasingly interested in this type of information, recognising that
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organisations unable to demonstrate good corporate citizenship pose potential risks, especially when set
against an increase in social and environmental legislation being adopted around the world. There is also
growing recognition that other stakeholders have a right to information about the social and environmental
impact of companies.
The increased focus on sustainability and its financial impacts can be seen in developments such
as the formation of the International Sustainability Standards Board (ISSB) under the auspices of
International Financial Reporting Standards (IFRS) Foundation. The ISSB released two standards, IFRS S1
and IFRS S2, in 2023. These standards provide guidance for the disclosure of sustainability-related
financial information, and disclosures of climate-related risks and opportunities respectively. The ISSB
is primarily concerned with the needs of financial markets in the development of standards, suggesting
a shift in historical investor attitudes towards sustainability. Other international developments include
the US Securities and Exchange Commission’s (SEC’s) 2022 proposal titled The Enhancement and
Standardization of Climate-Related Disclosures for Investors in the United States and the Corporate
Sustainability Reporting Directive (CSRD) and related European Sustainability Reporting Standards
(ESRSs) in the European Union (EU).

5.2 ELEMENTS OF FINANCIAL REPORTING

The Conceptual Framework provides that the five elements of financial reporting are assets, liabilities,
equity, income and expenses. However, the approach that the Conceptual Framework takes to define these
elements often excludes many sustainability factors. For example, the Conceptual Framework defines an
asset as a:
… present economic resource controlled by the entity as a result of past events (para. 4.3).

Control is a central attribute of the asset definition. If a resource is not controlled by an organisation,
it cannot be considered to be the organisation’s asset. Similarly, according to the expense definition, its
consumption or use will probably not be considered an expense of the reporting entity. Many important
social and environmental resources that are of interest to stakeholders do not satisfy the definition of an
asset as they are public goods not controlled by an entity and not exchanged in market transactions. These
include clean air, water, native forests, flora and fauna, and community wellbeing. Because they are shared
public goods and are not exchanged in market transactions, organisations are not required to account for
their use in financial reports, even if they are integral to commercial processes.
Some manufacturing processes, for example, use clean air or water and return it to the environment in a
form that is of reduced quality. As these environmental resources are not recognised by the reporting entity
as assets, any reduction in their quality is also not recognised by the entity (unless fines are imposed).
A second example is expenses. For financial reporting purposes, the Conceptual Framework defines
expenses as:
… decreases in assets, or increases in liabilities, that result in decreases in equity, other than those relating
to distributions to holders of equity claims (para. 4.69).

This definition of expenses depends on the recognition of an asset or liability. Therefore, the depletion
of, or the impact on, these shared public goods by the corporation are not recognised as expenses. To many
people, the framing of these accounting elements represents a limitation of financial reporting. Deegan
(2012), for example, argues the following.
Imagine that an entity destroys the quality of water in its local environment, thereby killing all local sea
creatures and coastal vegetation. Under conventional financial accounting, if the entity incurs no fines or
other related cash flows as a result of its actions, no externalities would be recognised. Reported profits,
calculated by applying generally accepted accounting principles, would not be directly affected, nor would
reported assets.
The reason no expenses would be recognised is that resources such as the local waterways are not
controlled by the reporting entity, and therefore they would not be recognised as the entity’s assets.
Thus the use (or abuse) of resources would go unrecognised. If conventional financial reporting practices
were followed, the performance of such an organisation could, depending on the financial transactions
undertaken, be portrayed as very successful (Deegan 2012, p. 1214).

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 A separate conceptual framework for non-financial information may be considered desirable. However,
to date, such a framework has proved elusive. Although there have been calls for greater harmonisation of
standards in this area, leading to the formation of the ISSB, there remains much to be resolved before a
conceptual framework for non-financial information is likely to be agreed. For example, Abhayawansa and
Adams (2022) found that, of the numerous non-financial reporting frameworks currently in existence, there
is as yet no agreement on fundamental issues such as materiality, and the report’s audience and objectives.

5.3 THE PRACTICE OF DISCOUNTING FUTURE

CASH FLOWS
A common practice in financial reporting is the discounting of future cash flows. Specifically, paragraph 36
of IAS 37 Provisions, Contingent Liabilities and Contingent Assets requires that ‘the amount recognised
as a provision shall be the best estimate of the expenditure required to settle the present obligation at the
end of the reporting period’. Discounting future cash flows is also commonly used in cost–benefit analysis
of various courses of action contemplated by organisations where costs (in the form of cash outflows) are
compared with the benefits (in the form of cash inflows).
When the concept of discounting is considered in relation to social and environmental issues, notwith-
standing that some of the related costs may not be in the form of cash outflows, ethical problems can
arise. Many social and environmental issues involve very long timeframes (consider climate change, as
one example). Discounting the cost of something that will occur in the future may be seen as shifting the
problems of one generation on to future generations — something that is arguably not consistent with
the sustainability agenda. Secondly, if we discount obligations that may arise in the distant future in the
current period then they may not be considered material even if from an ethical perspective they are highly
material. Example 5.1 provides a quantitative illustration of this.

EXAMPLE 5.1

Discounting Away the Liabilities

Consider an organisation whose current activities are creating a need for future environmental expenditure
of a remedial nature. The work will not be undertaken for many years. As a result of discounting, the
organisation would recognise little or no cost now.
For example, if the organisation was anticipating that the activities would lead to a clean-up bill of
$100 million in 30 years’ time, and with a normal earnings rate of 10 per cent, the current expenses
to be recognised in the financial statements under generally accepted accounting principles would be
$5.73 million.
A reduction in the discount rate to 6 per cent would see this liability increase to $17.4 million. Using
a discount rate of 1.4 per cent would change this amount considerably to $65.9 million in present
value terms.
The calculations for these amounts are as follows.
$100m
10% discount rate: = $5.7 million
(1.10)30
$100m
6% discount rate: = $17.4 million
(1.06)30
$100m
1.4% discount rate: = $65.9 million
(1.014)30

Materiality as a requirement of financial reporting is a key hurdle to disclosing future liabilities as it

considers the magnitude of an amount relative only to the current period of financial performance. Without
the requirement of materiality, disclosure of such a liability and its variable long-term impacts on future
financial performance would be less problematic.

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5.4 RELEVANCE AND FAITHFUL REPRESENTATION
Specific recognition criteria must be met before we recognise any element of accounting in financial
statements. The Conceptual Framework provides general recognition criteria for assets and liabilities that
are also linked to the recognition of equity, income and expense in paragraph 5.7.
An asset or liability is recognised only if recognition of that asset or liability and of any resulting income,
expenses or changes in equity provides users of financial statements with information that is useful,
i.e. with:
(a) relevant information about the asset or liability and about any resulting income, expenses or changes
in equity (see paragraphs 5.12–5.17); and
(b) a faithful representation of the asset or liability and of any resulting income, expenses or changes in
equity (see paragraphs 5.18–5.25).

For all five elements of financial accounting, both relevance and faithful representation are key
considerations as they are considered as fundamental qualitative characteristics of financial reporting.
This has significant ramifications for sustainability reporting issues. Measurement of impacts that relate
to sustainability issues can be complex and difficult, and questions are often raised over whether the
information prepared using many of the measures that are currently available achieves the standards of
faithful representation required of measurements used in financial accounting.
Take the example of a potential environmental liability such as clean-up after a chemical spill. If the
corporation argues that it cannot be reliably measured to ensure faithful representation, it may be left off
the balance sheet (IAS 37, para. 14(c)). If it is not recognised as a liability, then associated expenses will
also not be recognised. The implication is that if it is not easily and reliably measured, then it cannot be
important. Nonetheless, that chemical spill may be very important indeed to many of the organisation’s
stakeholders as it may result in the increased likelihood of a loss of revenue and increased costs (of capital,
staff changes, fines, etc.) due to reputational damage.

5.5 FOCUS ON SHORT-TERM RESULTS

Current reporting practices tend to emphasise relatively short-term performance reporting — often at
quarterly, half-yearly or yearly intervals. As accountants, we tend to emphasise short-term (annual)
performance through our practices of dividing the life of the asset up into somewhat artificial periods
of time. Managers are also often rewarded in terms of measures of performance such as annual profits.
This can have the effect of discouraging us from making long-term investments in new technologies,
including those that will provide longer term social and environmental benefits. This acts to dissuade
us from investment expenditure in more sustainable modes of operation that might not generate positive
financial results for many years.
To achieve sustainable outcomes in which the three pillars of sustainability are balanced over time,
a longer term perspective is required. Changing our understanding of ‘capital’ can make it easier for
accountants and managers to shift focus away from the short term. For example, although overlooked
in financial reporting, arguably some of the most important ‘assets’ upon which a business relies for its
long-term success relate to both people and the natural environment. These can be referred to as ‘social
capital’ and ‘natural capital’ respectively.
Social capital recognises the importance of employees, customers and the community in which
organisations operate. If a business fosters positive relationships with these groups by operating to a high
standard consistent with shared values, this can lead to community support for activities and improved
financial results via happy and productive workers and customers whose needs are being met. However,
developing social capital might mean having to forego short-term economic benefits achieved by, for
example, laying off staff, disrupting the local community through expanded operations or increasing prices
for products and services when not justified.
Natural capital is much the same. The importance of natural capital was emphasised in the World
Business Council for Sustainable Development-led ‘Pitch for Nature’ promotion, which sought to highlight
the many benefits businesses receive from nature, demonstrating that no business would be able to
operate without access to natural resources (Pitch for Nature n.d.). If businesses cannot operate without
natural resources, it makes sense to protect those resources. However, again, this might involve giving up
the potential for short-term profit to make long-term gains.
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 It can also be argued that businesses have an ethical responsibility to take these different forms of capital
seriously. This is especially true if a commitment to sustainable development (e.g. via the SDGs) has been
made, as this requires consideration of intergenerational equity and ensuring the environment and natural
resources of the planet are conserved and protected for future generations. Thus, while financial accounting
often leads to short-term thinking, corporate sustainability necessarily requires a long-term focus.

5.6 THE ENTITY ASSUMPTION

A central assumption of financial accounting is the entity assumption, which requires an organisation to
be treated as an entity distinct from its owners, other organisations and other stakeholders. Anything the
entity does that does not affect its own financial position or performance (in that period or future periods)
is ignored. This is despite any negative (or positive) impact (i.e. externalities) that might be imposed on or
accrue to others. This means that the externalities caused by reporting entities will typically be ignored,
and that performance measures, such as profitability, are incomplete from a broader societal perspective.
.......................................................................................................................................................................................
CONSIDER THIS
Download a listed company’s set of financial statements. Look at the primary financial statements. What can you see
in those numbers that has links to the social or environmental activities of the company?

SUMMARY
The Conceptual Framework defines the objective of financial reporting in terms of the provision of
financial information to support the decisions of providers of capital. Therefore, conventional financial
reports prepared for organisations by the accounting profession are required to give an account of the
financial performance of an entity over a specific period of time and the financial position of an entity at
a point in time.
The Conceptual Framework also defines the elements of financial reports in a way that excludes
recognition of many aspects of an organisation’s performance that are of interest to a broad range of
stakeholders. Such reports also focus on short-term results and tend to ignore the organisation’s impacts
on social, environmental and sustainability issues and therefore financial reports have serious limitations
in ensuring that an organisation can be held accountable for its actions that affect a diverse range
of stakeholders.
The next part of the module will examine how reporting is changing in response to some of these issues.
The key points covered in this part, and the learning objective they align to, are as follows.

KEY POINTS

5.5 Identify the limitations of conventional financial accounting in relation to the recognition of
social and environmental costs and benefits.
• The Conceptual Framework defines a scope of financial reporting focused on providing information
to capital providers.
• Financial reporting in accordance with accounting standards was never designed to cover areas
such as reporting on social and environmental matters.
• The financial reporting framework places emphasis on determining which assets and liabilities may
be recorded in the accounts based on strict criteria.
• The Conceptual Framework’s strict definition, recognition and measurement criteria for the key
elements of financial reporting mean organisations’ financial reports omit the externalities generated
in pursuits of profits.
• Periodic reporting may cause managers and board of directors of companies to have a sole focus
on financial targets rather than longer term social or environmental objectives.
• The foundational elements of financial reporting — the focus on short-term results, the entity
assumption and the definition of materiality as magnitude relating to the current period of financial
performance — do not allow organisations’ full impact on social and environmental issues, and
society and the environment’s impact on organisations, to be reflected in financial reports.

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PART B: THE CHANGING
REPORTING LANDSCAPE
INTRODUCTION
As discussed in part A, financial reporting is intended to provide financial information to inform the
decisions of capital providers. Thus, it is limited in its usefulness for stakeholders with a broader array
of interests. As a result, various stakeholders have sought to expand the scope of reporting.
In addition, various events have influenced the development of reporting and disclosure to satisfy
accountability requirements. Some of these are the increasing focus on global warming and the pursuit
of net zero by 2050, the realisation that social and environmental issues have an impact on organisations’
profitability and the increased popularity of socially responsible investments. Legislative developments
are also impacting corporate reporting, both in Australia and overseas. Examples include the Corporate
Sustainability Reporting Directive (CSRD) in the EU and New Zealand’s The Financial Sector (Climate-
related Disclosures and Other Matters) Amendment Act 2021.
This part of the module explores these events and forces, and discusses how various perceptions of
corporate responsibility and accountability have contributed to the development of sustainability reporting.
We also examine the potential for, and current role of, government intervention to promote sustainability
reporting and the accountant’s role in supporting corporate accountability.

5.7 RECENT EVENTS AND FORCES

The current business environment is changing, with the need for greater action, accountability and
transparency in relation to corporate sustainability increasing at a seemingly exponential pace. With greater
attention being given to topics such as global warming, the pursuit of net zero by 2050, modern slavery,
the impact of inflation following the COVID-19 pandemic and stakeholder activism associated with each
of these, the public wants to know how businesses are addressing these issues. This has led to increased
pressure on businesses to improve reporting to demonstrate corporate accountability.
It is now widely accepted by the scientific community that the world is going through a period of global
warming that threatens business and society. The Net Zero by 2050 report from the International Energy
Agency (2021) found that even if current government pledges to reduce carbon emissions are successful,
we will fall short of reaching net zero by 2050 with disastrous results. The immediacy of the issue is
forcing businesses to account for their current carbon emissions and demonstrate how they are reducing
them (i.e. transition planning). This has led to the development of collaborative groups such as the Science
Based Targets initiative (SBTi), and businesses working together to develop new ways of reducing and
accounting for emissions.
Social issues are also gaining greater prominence, with the role of businesses in addressing human rights
issues and modern slavery now enshrined in legislation from various countries. In Australia, for example,
the Modern Slavery Act 2018 (Cwlth) requires large entities to account for the modern slavery risks they
face not just within their own operations but also in their supply chains. The need to consider the broader
value chain has moved organisations into new territory, and many have struggled to identify who their
suppliers are and how to access information beyond tier 1 (i.e. direct suppliers). Importantly, the nature of
this type of legislation also means that non-reporting entities are likely to become caught up in the need
to provide an account of their actions to larger customers, which means businesses of all sizes need to be
across these issues.
A further issue on the radar of policymakers and social advocates is the rise in inflation following
the COVID-19 pandemic. The Reserve Bank of Australia observes that the high inflation seen in many
countries following the pandemic has been accompanied by high corporate profits and a fall in real wages
(Reserve Bank of Australia 2023). Although they go on to argue that this is less relevant in Australia outside
the mining sector, it is expected that businesses will be placed under increasing pressure to demonstrate
that they are not taking advantage of the global financial situation at a time when households are struggling.
The challenges outlined thus far, as well as others such as food security, forced migration and loss of
biodiversity, have brought with them an increasingly educated public who are engaging in more and more
disruptive activities in an attempt to ensure businesses are acting in a way that is consistent with society’s
values. Access to social media has increased the potential reach of activist activities, and problems that a
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business may elect to ignore can quickly go viral. Stakeholder activism is a growing concern for businesses,
and associated demands for corporate accountability are expected to directly impact business activities now
and in the future.
The examples discussed in this section demonstrate that it is now expected that ongoing business
decisions will incorporate sustainability-related considerations. Society will expect to be informed about
how organisations, governments and other entities are performing in these areas. The accounting profession
will need to adapt continually to these growing expectations. Additional data will need to be collected and
processed, and information assured and disclosed.

5.8 SUSTAINABILITY INCENTIVES

The World Business Council for Sustainable Development (WBCSD) emphasises that a growing range of
environmental issues have an impact on a company’s profitability, for example:
• revenue effects associated with market growth or decline due to changes in customer preferences for
environmentally sustainable products and production methods
• clean-up costs or fines for non-compliance with environmental regulations
• insurance cover incorporating environmental risk
• research and development programs to stay ahead of environmental regulation.
The statement of financial position can also be affected through, for example:
• impairments in the value of land as a result of contamination
• plant write-offs as a result of changes to clean production capacity
• changes in the net realisable value of stock related to consumer preferences for environmentally
harmless products
• liabilities (through remediation requirements).
The WBCSD pointed out that chief financial officers in many companies have, for a number of years,
been assessing environmental issues and their effect on operational costs and shareholder value. For
example, Shell experienced a loss of 30 per cent of its market share in Germany during a period of
discontent with its planned disposal of the Brent Spar oil-storage facility. It is likely that companies that
are not perceived to be committed to sustainability will be at a competitive disadvantage. The potential
effects of such changes on global finance markets illustrate the imperative of developing a sound basis for
a broader concept of accountability reporting.
In 2009, members of WBCSD produced a report entitled Vision 2050, which shows how it is possible for
nine billion people to live well without exhausting the natural capitals of the world (WBSCD 2009). They
discussed a range of market and fiscal incentives and mechanisms, as well as changes in social values that
would be needed to meet the Vision 2050 goals. An organisation’s reputation can be essential to economic
survival, as it affects relationships with key stakeholders that help an organisation not only survive but
also prosper. For example, in the context of environmental performance, the image of an organisation can
affect its relationships with supply chain and business partners, its ability to attract and retain talent, and
its access to green markets (i.e. consumers who care about the environmental performance of companies
and products).
Improving corporate reputation, as well as better identifying risks and opportunities in a resource-
constrained world with changing societal expectations, is also one of the key drivers behind integrated
reporting (discussed later in this module), which emphasises the benefits of organisations telling their
unique value-creation story. This also becomes more critical in an era where there are investors looking at
the way in which a company deals with environmental and social issues, in addition to properly managing
and growing a business from a financial perspective. Socially responsible investing is an area that has grown
since the 1990s, and organisations such as the Global Sustainable Investment Alliance report regularly on
the size of the responsible investment market. Example 5.2 contains data from their 2020 report.
Among the most influential recent developments to explicitly recognise the importance of sustainability-
related information to capital markets is the founding of the ISSB under the IFRS Foundation. The ISSB’s
four key objectives are:
1. to develop standards for a global baseline of sustainability disclosures;
2. to meet the information needs of investors;
3. to enable companies to provide comprehensive sustainability information to global capital markets; and
4. to facilitate interoperability with disclosures that are jurisdiction-specific and/or aimed at broader
stakeholder groups (IFRS 2023a).
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 In June 2023, the ISSB released its first two sustainability standards, IFRS S1 General Requirements
for Disclosure of Sustainability-related Financial Information (IFRS 2023b) and IFRS S2 Climate-related
Disclosures (IFRS 2023c). Both IFRS S1 and IFRS S2 came into effect for annual reporting periods
beginning on or after 1 January 2024. The Australian Government has proposed that Australia’s mandatory
climate-related financial disclosures regime be aligned as far as practicable with IFRS S1 and S2, including
Scope 1, 2 and 3 greenhouse gas emission disclosure requirements, which mandate that companies disclose
all material greenhouse gas emissions in their value chain from their second reporting year onwards.
IFRS S1 and IFRS S2 focus on risks and opportunities that ‘could reasonably be expected to affect
the entity’s cash flows, its access to finance or cost of capital over the short, medium or long term’
(IFRS 2023b). Thus, IFRS S1 and S2 are expected to demonstrate the link between sustainability
information and organisational value more clearly to shareholders and other capital market stakeholders,
which may in turn impact shareholder wealth.

EXAMPLE 5.2

Global Sustainable Investment up 15 per cent in Two Years

The Global Sustainable Investment Alliance (GSIA) has released its biennial Global Sustainable Investment
Review 2020, showing that global responsible investment assets reached USD35.3 trillion at the start of
2020, representing a growth of 15 per cent in two years.
In its fifth edition, the biennial Global Sustainable Investment Review brings together the results from
regional market studies by the responsible investment forums of Europe, the US, Japan, Canada, Australia
and New Zealand. It also includes additional regional highlights from the United Kingdom, China and other
areas of Asia, as well as Latin America and Africa.

‘The Global Sustainable Investment Review 2020 reveals the continued interest in and growth of
sustainable investment across multiple markets from 2018–2020’, said Lisa Woll, CEO of US SIF and
the US SIF Foundation . . .
‘The Global Sustainable Investment Review 2020 demonstrates that sustainable investment is a
major force shaping global capital markets, and, in turn is influencing companies and others seeking
to raise capital in those global markets’, said Simon O’Connor, Chair of the GSIA (US SIF 2021).

In Australia and New Zealand responsible investment assets under management reached $906 billion
at the end of 2019. Unfortunately, a direct comparison between this figure and that of previous years is
not possible due to a change in the way sustainable investment was defined in this period.
The review shows sustainable investment assets under management were largest in the US, totalling
$17.1 trillion, followed by Europe with $12.0 trillion and Japan with $2.9 trillion.
Canada experienced the largest increase in sustainable investing assets over the two years with an
absolute growth rate of 48 per cent.
The review also revealed that the largest responsible investment strategy globally is ESG integration,
followed by negative screening, corporate engagement and shareholder action, norms-based screening
and sustainability-themed investment. This represents a shift from 2018, in which negative screening was
found to be the most popular sustainable investment strategy. The shift to ESG integration was most
prominent in Japan.
Sources: Adapted from US SIF 2021, ‘Global Sustainable Investment Alliance releases Global Sustainable Investment
Review 2020’, press release, 19 July, accessed August 2023, www.24-7pressrelease.com/press-release/483353/global-
sustainable-investment-alliance-releases-global-sustainable-investment-review-2020; GSIA 2020, Global Sustainable
Investment review 2020, accessed July 2023, www.gsi-alliance.org/wp-content/uploads/2021/08/GSIR-20201.pdf.
............................................................................................................................................................................
CONSIDER THIS
Read the media release and report in example 5.2. Make a note of what the report finds in relation to the
current attitudes of investors when it comes to looking at where they might place their funds.

BRAND AND REPUTATION

Social and environmental performance can affect an organisation’s future reputation, brands and its ability
to attract talented staff, and maintain consumer and public support. We can consider what happened to
organisations such as Nike, GAP, Reebok, Hennes & Mauritz (H&M) and others in the late 1990s. News
about their suppliers’ use of child labour and poor working conditions in developing countries attracted
increasing negative media attention. It became essential for these organisations to acknowledge these issues
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and put in place governance practices to ensure their suppliers improved their workplace practices. It was
also vital for them to provide information about their remedial actions, thereby rebuilding lost legitimacy.
In 2016, Panasonic and Samsung came under scrutiny after allegations that migrant workers in their
Malaysian supply chains were being exploited and misled about pay. Subsequent investigations brought
to light claims that Nepalese workers in these supply chains were deceived about their salaries, had their
passports confiscated and paid recruitment agents up to GBP1000 to attain employment. The companies
have since taken steps to address these allegations, with Panasonic facilitating human rights seminars for its
suppliers and creating a confidential whistleblower’s hotline, and Samsung imposing bans on recruitment
fees and the retention of workers’ passports and terminating a labour supply company. However, given
the number of suppliers utilised by the companies, and the potentially thousands of sub-contractors they
employ, labour rights groups doubt whether these actions will have the impact needed (Pattisson 2017).
Walmart in the US has been heavily criticised for its workplace practices in its home market.
In 2012 the National Employment Law Project (NELP) published the Chain of Greed report (Cho et al.
2012) into Walmart’s worker exploitation in the US. Also, after the collapse of the Rana Plaza building
caused international outrage, some responsibility for the conditions of the poorly paid garment makers in
Bangladesh has been placed on the western retailers who sold the garments.
Since the GFC, and amid a lingering recession that has intensified pressure from shareholders,
companies are devising new CSR models that are more aligned with their core business goals and services.
For example, blue-chip companies such as Visa and Unilever are creating new markets in the developing
world by closely aligning social causes with their overarching corporate strategies.

RISK MANAGEMENT INCENTIVES

CSR has a strong role to play in the provision of information for risk management purposes. Some risks
are insurable, while the more intangible ones, such as community outrage, require management awareness
as well as mitigating controls. Such non-financial information helps management to better understand the
nature and likelihood of these risks.
For the more easily quantified risks, social and environmental information from an organisation helps
with the negotiation of lower insurance premiums and lower financing costs. Direct-cost impositions
resulting from legislation include clean-up orders, levies and remediation expenses. Indirect costs range
from loss of business to increased risk, resulting in higher insurance and financing costs, and the
opportunity costs of waste production, treatment and disposal. Both direct and indirect environmental
costs, as well as the risks associated with tarnishing brand and reputation (as discussed previously), affect
profitability. One of the aims of CSR reporting is to enable information users to assess these costs and
predict what their future effect might be.
Reducing risk is an additional economic incentive for transparent reporting. Insurance coverage of
environmental risks can represent a major cost to companies. Thus, reducing environmental risks, and
showing how these risks are being identified and managed by reporting on non-financial performance,
may result in economic benefit by reducing financing expenses.
Various stakeholders, including investors, increasingly consider risks associated with climate change
when making investment decisions. There will be a demand for company-specific information on how
climate change has affected, and will affect, the organisation in question. The Task Force on Climate-
related Financial Disclosures (TCFD) was established in 2015 by the G20’s Financial Stability Board
(FSB) to help companies understand the investors’ needs related to their climate-related financial risk
(TCFD 2019). TCFD aimed to develop recommendations about voluntary climate-related risk disclosures
that companies could provide to stakeholders to better address their information needs. It was announced
in July 2023 that the work and monitoring responsibilities of the TCFD would be transferred to the ISSB
from 2024 (IFRS 2023c).
EY’s Global Climate Risk Disclosure Barometer (EY 2022) examined the adoption of TCFD by more
than 1500 companies. Globally, it found that 84 per cent of the companies surveyed made climate-related
disclosures, with around 61 per cent disclosing their decarbonisation strategies. However, the quality of
the disclosures was scored at only 44 per cent, with many companies not providing information on the
financial impact of climate change or aligning this information to their financial reporting.
As climate change becomes an accepted business reality, the insurance industry is increasingly interested
in the possible exposure that organisations face regarding greenhouse gas (GHG) emissions. This could be
in the form of understanding emission levels, strategic position, and the geographic location of operations,
given changing weather patterns. Further, there is a growing trend for investment funds (including leading
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international pension funds) to invest in corporations operating outside their own country. Climate change
and social issues such as working conditions in supply chains will affect not only local investment, but
conceivably also foreign investment to a significant extent.

EXTERNAL BENEFITS OF CSR REPORTING

The external benefits claimed to be associated with CSR are many, as corporations are enabled to
demonstrate how they create value, consider sustainability matters and coordinate their nonfinancial
efficacy in the short, medium and long term.

Cost of Capital Benefits

Voluntary disclosure theory (Verrecchia 1983; Healy & Palepu 1993) argues that a consequence of the
enhanced disclosures is that investors’ trust and confidence are increased, and an increased inflow of
financial capital will occur, which has the potential to lower the capital cost: the cost that a company has to
pay to its providers of financial capital, both shareholders and debtholders. CSR reporting can contribute
to lowering the cost of capital through at least three channels.
1. Signalling the quality of the company. CSR reporting requires a clear vision and commitment to
social and environmental value creation activities and helps to identify risks and opportunities within
the business.
2. Expanding a company’s relevant disclosures to support stakeholder decision making.
3. Reducing the uncertainty in assessing the company’s performance.
This has been examined with respect to CSR reporting by Dhaliwal et al. (2011), who find that there
are cost of capital benefits for companies disclosing CSR reports.

Improved Analysts’ Forecasts

Dhaliwal et al. (2012) found that reporting CSR information affects the capital market through a major
information intermediary, the financial analysts who make buy or sell recommendations on individual
stocks. They observed that the reporting of such information is associated with an increase in analyst
coverage and improved prediction of a company’s future financial performance.

Improved General Perception of the Company

It is important that corporations are well regarded and supported by other parties and the general
community. Reputation risk management is therefore crucial, and the CSR report provides greater
transparency regarding a company’s impact on, and commitment to, the social, ecological and governance
environments. It becomes an effective tool in shaping the public perception that a company is seriously
attempting to account for their sustainability matters and is committed to delivering positive impacts for
society; it also improves the exposure to shareholders and fundholders who are searching for social and
ethical investments.

5.9 SOCIALLY RESPONSIBLE INVESTMENTS

Socially responsible investment (SRI) involves selecting investments based on their social impact. It may
also be known as sustainable investing, green investing or ethical investing. SRI is undertaken by both
institutional and retail (individual) investors.
The UN Principles for Responsible Investment (UNPRI 2021) define responsible investment (RI) as:
a strategy and practice to incorporate environmental, social and governance (ESG) factors in investment
decisions and active ownership.

Signatories (institutional investors) to the UNPRI commit to six principles.

1. We will incorporate ESG issues into investment analysis and decision-making processes.
2. We will be active owners and incorporate ESG issues into our ownership policies and practices.
3. We will seek appropriate disclosure on ESG issues by the entities in which we invest.
4. We will promote acceptance and implementation of the Principles within the investment industry.
5. We will work together to enhance our effectiveness in implementing the Principles.
6. We will each report on our activities and progress towards implementing the Principles (UNPRI 2021).

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 SRI responds to a variety of different investor needs. Some investors look to sustainability factors to
provide information about the long-term health and stability of their investments and the market as a whole.
Others take this further and regard SRI as an ideal about the way money should be used — one way for
people to combine their personal values with the resources available to them. This can also mean that
investment can be used to direct capital towards better-governed and better-managed companies that are
positioned to contribute to the goals of sustainable society.
In many ways, the initiative aims to provide the investor (or the financial capital provider) with additional
information about sustainability factors (or resources and relationships), which will provide information
about the long-term stability of their investments, and the value-creation activities of the organisation.
SRI generally involves some form of investment screening process to determine which assets fit
the investment criteria. The UNPRI (2021) describe three types of investment screening, as shown
in table 5.2.

TABLE 5.2 Investment screening methods

Negative screening Norms-based screening Positive screening

Avoid the worst performers Use an existing framework Include the best performers

• Excluding certain sectors,
issuers or securities for
poor ESG performance
relative to industry peers,
or based on specific ESG
criteria (e.g. avoiding particular
products/services, regions or
business practices)
• Absolute avoidance of activities
such as alcohol, tobacco,
gambling, adult entertainment,
military weapons, fossil fuels,
nuclear energy
• Sets a materiality threshold
(e.g. 10%) based on revenue
exposure or business
activity/operation
• Avoidance of worst-in-class
investments using quantitative
ESG measurements
• Shariah screening, guided
by Islamic principles, is a
subcategory of
negative screening
• Screening issuers against minimum • Investing in sectors, issuers or
standards of business practice projects selected for positive
based on international norms. ESG performance relative to
Useful frameworks include industry peers
UN treaties, Security Council • Active inclusion of companies
sanctions, UN Global Compact, within an investment universe
UN Human Rights Declaration and because of the social or
OECD guidelines environmental benefits of their
• A sub-category of negative products, services and/or
screening which excludes processes
companies or government debt • Endorsing best-in-class or
on account of any failure by the ‘leaders’ in best practice against
issuer to meet internationally peer group using quantitative
accepted ‘norms’ such as the UN ESG measurements
Global Compact, Kyoto Protocol, • Positive thematic development
UN Declaration of Human Rights, such as transitioning companies,
International Labour Organization renewable/clean tech, social
standards, UN Convention Against enterprises or initiatives
Corruption, OECD Guidelines for
Multinational Enterprises
• Can be called ‘controversy
screens’ or negative screening
when companies engage in
unethical behaviour

Source: UNPRI 2020, ‘Screening’, Introductory guides to responsible investment, 29 May, accessed August 2023,
www.unpri.org/introductory-guides-to-responsible-investment/an-introduction-to-responsible-investment-screening/5834.article.

.......................................................................................................................................................................................
CONSIDER THIS
Visit a banking, superannuation fund or investment broker website. Do they have a responsible (or sustainable)
investing policy or statement? Do they disclose their screening process for their products?

Sustainable investing is on the rise globally, with assets under management having surged from
$30.7 trillion in 2018 to $35.3 trillion in 2020, according to the GSIA (2020). Bank Australia (in
example 5.3) was one of the first in Australia to contribute to this.

EXAMPLE 5.3

Customer Owned Bank Issues Sustainability Bond

On 20 August 2018, Bank Australia became the first customer owned bank in Australia to issue a
sustainability bond. The three-year, $125 million bond included assets that help achieve three of the United
Nations Sustainable Development Goals: reduced inequalities, sustainable cities and communities, and
life on land.
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 This was the first time that Bank Australia had issued a bond. Making its first issuance a sustainability
bond was one way for Bank Australia to use the business of banking to create positive change, says
Managing Director Damien Walsh.
‘As a growing bank, we needed to start a bond program to help manage our funding,’ says Damien.
‘The question for us was: how can we issue a bond that aligns with our values and meets our customers’
expectation that we lend to projects with a positive impact?
‘Bank Australia’s sustainability bond will help us finance more lending with a positive impact,’ says
Damien. ‘By issuing a sustainability bond, it also contributes to growing the market for green and social
funding in Australia.’
The sustainability bond was developed to align with international Sustainability Bond Guidelines,
which give investors confidence that the money they lend Bank Australia is used to finance green or
social projects.
The proceeds from this sustainability bond will be used to finance loans including community housing,
specialist disability accommodation and mortgages for energy efficient homes with an added environ-
mental offset.
Source: Bank Australia 2018, ‘Customer owned bank issues sustainability bond’, accessed August 2023, www.bankaust.com.
au/about-us/news.
............................................................................................................................................................................
CONSIDER THIS
Identify the customer base to which the product described in example 5.3 may appeal and the kinds of
initiatives that the bond is expected to benefit.

SOCIAL ENTERPRISES
Related to SRI is the concept of social enterprise as the potential subject of such an investment. Social
enterprises are businesses set up with a social objective in mind. A series of models has been identified:
innovation model, employment model and the ‘give back’ model.
• Innovation model. A company using this model develops products designed to assist communities that
are disadvantaged.
• Employment model. A company using this kind of approach employs people who are disadvantaged at
a fair wage.
• ‘Give back’ model. A company that engages in a ‘give back’ model will typically sell one item but
ensure that, for each sale, an item is donated to somebody in need.
.......................................................................................................................................................................................
CONSIDER THIS
Visit the websites of three companies — each one should represent one of the models outlined above — that appear
in the article on The Good Trade website on social enterprises (www.thegoodtrade.com/features/what-is-a-social-
enterprise). Identify what is unique about their approach to conducting business, and note what they do that is of
social benefit.

5.10 PERCEIVED CORPORATE RESPONSIBILITIES

AND ACCOUNTABILITY
There are extremes in perspectives about the perceived responsibilities and accountabilities of business.
Organisations need to explicitly consider to whom they believe they owe a responsibility, and for what
aspects of their performance, before they decide what information they will report, and how and to whom
they report. Determining to whom the organisation owes a responsibility involves considering who has
specific rights (e.g. investors) compared to those who have a more general interest in the organisation
(e.g. broader stakeholders). For example, shareholders are claimants who have specific rights, such as a
right to dividends. The shareholders gain the right to dividends when they invest, and they give up participa-
tion in management in exchange for obtaining limited liability protection. This combination of claimants
having rights and stakeholders with interests has led to the approach described by the famous economist
Milton Friedman.

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324 Ethics and Governance

 The views of Friedman are one extreme. He argued that the single role of business is to increase its
profits (within the rules of the game). Specifically, he stated that in a freely operating market:
There is one and only one social responsibility of business and this is to use its resources and engage in
activities designed to increase its profits as long as it stays within the rules of the game, which is to say,
engages in open and free competition, without deception or fraud (Friedman 1962, p. 133).

In relation to organisations potentially embracing social responsibilities (i.e. CSR), Friedman

further stated:
Few trends could so thoroughly undermine the very foundation of our free society as the acceptance by
corporate officials of a social responsibility other than to make as much money for their stockholders as
possible. This is a fundamentally subversive doctrine (Friedman 1962, p. 133).

Consistent with the views of Friedman and the shareholder school of thought are those of many corporate
managers, who believe that maximising corporate profits is the main priority. Perhaps this focus on profits
is further strengthened by the fact that many corporate managers are directly remunerated on the basis
of profits (e.g. it is very common for managers to be rewarded by being given a specified percentage of
profits as part of their bonus structure). People who believe that the concentration on profits has not waned
in many organisations — even as the apparent emphasis on CSR has heightened — are often cynical of
corporate claims about being socially responsible.
An alternative view to that of Friedman is that organisations, public or private, earn their right to operate
within the community. This right is provided by the society in which they exist, and not solely by those
parties with a direct financial interest (such as the shareholders who directly benefit from increasing
profits), or by government. In addition to this right to operate provided by society, the privilege of
incorporation, which may provide limited liability and the ability to raise capital from the public, is not
guaranteed but granted by the state. The state, in turn, can dictate the terms and controls on operating
the business.
This view holds that organisations do not have an inherent right to resources and must not just focus on
maximising the welfare of one stakeholder group (e.g. shareholders) to the possible detriment of others.
Society also determines whether an organisation shall have access to natural resources, and whether and
how it is permitted to hire employees and dispose of waste products. Therefore, from this perspective, for
the community to continue to allow such organisations to exist, the benefits generated by an organisation
must be perceived to exceed their costs to society as a whole.
Leading modern-day business advisory firms such as McKinsey & Company and the ‘Big Four’
accounting firms have built a strong business case for the importance of the management of sustainability
to overall business success. For example, McKinsey’s report on sustainability and resource productivity
(McKinsey 2014) presents compelling arguments for business leaders to move with the times and respond
to the critical environment and social issues of the day as part of good business practice.
The Business Roundtable, an association of the chief executive officers of nearly 200 of America’s
most prominent companies, released in August 2019 its updated statement of purpose of a corporation.
Rather than focusing on shareholder value maximisation, the association recognises the importance of
corporations satisfying the needs of a variety of stakeholders and not only those of shareholders.
While each of our individual companies serves its own corporate purpose, we share a fundamental
commitment to all of our stakeholders. We commit to:
• Delivering value to our customers. We will further the tradition of American companies leading the way
in meeting or exceeding customer expectations.
• Investing in our employees. This starts with compensating them fairly and providing important benefits.
It also includes supporting them through training and education that help develop new skills for a rapidly
changing world. We foster diversity and inclusion, dignity, and respect.
• Dealing fairly and ethically with our suppliers. We are dedicated to serving as good partners to the other
companies, large and small, that help us meet our missions.
• Supporting the communities in which we work. We respect the people in our communities and protect
the environment by embracing sustainable practices across our businesses.
• Generating long-term value for shareholders. [They] provide the capital that allows companies to invest,
grow, and innovate. We are committed to transparency and effective engagement with shareholders.
Each of our stakeholders is essential. We commit to deliver value to all of them, for the future success
of our companies, our communities, and our country (Business Roundtable 2019a).
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 QUESTION 5.2

How and to what extent are the views of Milton Friedman reconcilable with a journey towards
sustainable development? Give reasons for your answer.

To many people, the notions of a shareholder primacy perspective and corporate social responsibilities
are mutually exclusive. Clearly, focusing only on shareholders’ financial return is not consistent with the
concept of sustainable development. Sustainable development requires taking into account a business’s
environmental and social impact. It does not elevate short-term profit maximisation (and the maximisation
of shareholder value and, therefore, shareholders’ financial interests) to a higher position than considera-
tions of inter-generational and intra-generational equity. Whether corporations can be expected to place the
interests of others above those of their shareholders or have a moral obligation to take into consideration
their impact on a wider range of stakeholders is still a contested question.
Divergent views on the responsibilities (and accountabilities) of business are nothing new. The opinions
reproduced in table 5.3 were given during a debate in the 1930s; comments from this debate were
reproduced in a report issued by the Corporations and Markets Advisory Committee in 2006. They contrast
the views of Professor Adolf Berle, who embraced the shareholder primacy perspective, with those of
Professor Merrick Dodd, who embraced the view that organisations survive to the extent that they comply
with the social contract negotiated between the organisation and society (see table 5.3).

TABLE 5.3 Shareholder primacy versus social contract

Professor Adolf Berle: Professor Merrick Dodd:

Shareholder primacy perspective Social contract perspective

• Investors, by way of their investment, are the group
risking their own capital. Therefore, it is only fair that
the directors answer to them and to them only.
• Attempts to broaden responsibilities to a wider
group of stakeholders may lead to reducing the level
of legal responsibilities directors owe to anyone.
• Due to the protections and privileges provided by
the act of incorporation (e.g. limited liability and
perpetual succession), the duties owed by the
organisation should not just be to shareholders.
There is also a duty to the broader community,
and it is fair to say that society should expect the
corporation to behave in the general public interest,
rather than in a purely self-interested, profit-
focused manner.
• Directors should, therefore, be permitted to take into
consideration a wider range of stakeholders than
just the shareholders.

Source: CPA Australia 2023.

A disparity of views still exists, although they are increasingly converging. There are many individuals
who support a shareholder primacy perspective of corporate operations, just as there are many who support
a more socially constructed perspective of business operations. An increasing number of corporate leaders
believe that delivering long-term financial returns to shareholders depends on taking into consideration the
concerns of a wider range of stakeholders.
It should be noted that Australian Corporations Law has only recently required corporations to consider
social and environmental impacts when making particular decisions. There are environmental reporting
requirements in paragraph 299(1)(f) of Corporations Act 2001 (Cwlth) and, arguably, when ESG issues
are material, they must also be included in the directors report pursuant to s. 299A. The Australian
Securities Exchange Corporate Governance Council’s (ASX CGC) Corporate Governance Principles
and Recommendations, which was reissued in its fourth edition in 2019, has Recommendation 7.4 which
requires that an entity disclose any material exposures to economic, environmental and social sustainability
risks and, if it does, how it manages these risks. Another important piece of Australian legislation is the
Modern Slavery Act 2018 (Cwlth), which requires some entities to report on the risks of modern slavery
in their operations and supply chains and actions to address those risks (www.legislation.gov.au/Details/
C2018A00153).

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 The major guiding legal principle pertaining to the responsibility of corporate officers in terms of the
strategies used to run a business is provided by s. 181(1) of the Corporations Act. This section, often
referred to as the ‘good faith requirement’, requires that:
A director or other officer of a corporation must exercise their powers and discharge their duties:
(a) in good faith in the best interests of the corporation; and
(b) for a proper purpose (s. 181(1)).

Central to this requirement is that the strategies employed by an organisation need to be in the best
interests of the organisation. Is social and environmental responsibility and an associated consideration of
a broad group of stakeholders in the best interests of an organisation? Perhaps company directors believe
there needs to be a clear link between the actions and the likelihood that corporate profits and value will
be positively influenced. Clearly, the good faith requirement provides some uncertainty for corporate
managers in determining the extent to which they can adopt policies that are perhaps only indirectly in
the best interests of the corporation. This limited approach to recognising broader accountability can be
contrasted with the more positive approach taken in the latest version of directors’ duties stated in UK
corporate law. These laws were updated in 2006 to include specific reference to employees, the community
and the environment.
Specifically, s. 172 of the UK Companies Act 2006 states the following.
Duty to promote the success of the company
(1) A director of a company must act in the way he considers, in good faith, would be most likely to
promote the success of the company for the benefit of its members as a whole, and in doing so have
regard (amongst other matters) to —
(a) the likely consequences of any decision in the long term,
(b) the interests of the company’s employees,
(c) the need to foster the company’s business relationships with suppliers, customers and others,
(d) the impact of the company’s operations on the community and the environment,
(e) the desirability of the company maintaining a reputation for high standards of business
conduct, and
(f) the need to act fairly as between members of the company (UK Companies Act 2006, s. 172).

There are alternative views about whether corporate managers are legally allowed to use shareholder
funds for non-business social endeavours. (The term ‘non-business’ does not encompass CSR-related
initiatives, which are clearly aligned with corporate strategy and expected to improve efficiency, reputation
and contribute to growth.) One view is that the best interests of the company necessarily require
corporations to consider the needs of a broad group of stakeholders and the environment, otherwise the
community will not support the organisation. This view would suggest that s. 181(1) of the Corporations
Act does not discourage sound social and environmental behaviour.
The counter view is that s. 181(1) actually discourages companies from considering the needs of
stakeholders (other than shareholders) and of the environment. That is, companies are legally bound to
maximise profits to shareholders. This view would suggest that, by publicly embracing CSR, companies
can publicly promote their social values, while in reality keeping their value in focus — this being the
company’s share price. Notwithstanding these countervailing arguments and irrespective of legal debates,
there is growing recognition by CEOs worldwide that long-term corporate success requires a commitment
to an economy that serves all people (Business Roundtable 2019b). Boards appear to be increasingly
recognising that corporate success that is inclusive and focused on shared prosperity is more likely to
result in long-term value for both shareholders and the community.
In addition, the shareholder primacy approach is increasingly being challenged by corporations’ non-
financial and indirect financial impact on society, including global warming, corporate environmental
catastrophes and human tragedies such as asbestos-related diseases. The 2010 BP oil spill in the Gulf
of Mexico provides an example of the serious consequences that can occur when things go wrong. That
oil spill will have a long-term effect on the environment and coastal communities around the Gulf. The
costs and damage associated with the spill will also affect the company and therefore its shareholders for
the long term. This is a good example of how issues can combine to create a disaster without any apparent
illegal activities taking place, and shows the importance of organisations being good corporate citizens. A
proactive approach to CSR can help prevent such disasters, while also creating other benefits and long-term
shared value.
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5.11 CORPORATE SOCIAL RESPONSIBILITY
As discussed above, there are different perspectives about what the responsibilities (and accountabilities)
of business are, and as such, there is no universally agreed definition of CSR. Indeed, not only does the term
‘corporate social responsibility’ lack a precise or fixed meaning, but the understanding of CSR continues
to evolve over time. Early notions of CSR assumed corporations would conduct themselves in accordance
with CSR principles, but research suggested that in the absence of regulation this only occurred where
there was significant pressure from other stakeholders. Over time regulation has increased. Many modern
descriptions of CSR tend to focus on compliance with both the spirit and the letter of the law. Other notions
of CSR refer to an approach to business in which the corporation considers a wide range of stakeholders and
seeks to balance their various interests. Typically, societal effects beyond the goods and services provided
by companies and the returns generated for shareholders are categorised as environmental, social and
economic impacts.
A key point is the fact that definitions of corporate accountabilities typically extend the responsibilities
of corporations beyond their shareholders alone, and include activities over and above those relating to the
usual provision of goods and services. However, whether corporations, which are owned by shareholders,
can realistically be expected to balance the needs of other stakeholders — many without any financial
power or influence — with the fundamental question of maximising the wealth of shareholders is a question
that will evoke a different reaction from different people.
Many people believe that corporations have to earn a social licence to operate and have a responsibility
to make choices that benefit society and the environment. There are others who continue to believe
that the fundamental quest of corporations to maximise profits and shareholder value can be achieved
with little consideration of broader stakeholder interests. Still others, such as Unilever, firmly believe
that social responsibility and minimising environmental impacts are essential to long-term growth and
returns to shareholders. It is unrealistic and even dangerous to leave social responsibilities in the hands
of organisations that are guided by ‘enlightened self-interest’. As you will see in this module, there is
an increased emphasis on regulation worldwide, and the corporate accountability imperative now extends
beyond a few enlightened organisations.
The underpinning philosophy is that corporations have a social and environmental impact in addition to
their economic impact and these can enhance or diminish the collective good or wider societal progress.
These new accountabilities are being demanded by civil societal groups with business leaders often
responding to, rather than leading, the debate.
Corporate accountability is evidenced by CSR or sustainability reporting. This involves measuring and
reporting on economic, environmental, social and governance aspects and the processes of an organisation.
Corporate accountability is closely linked to the other four modules in this subject. This broad view
of corporate accountability demonstrates how the professional accountant can have a positive impact on
society (module 1). It shows the importance of the accountant having knowledge of ethics and the tools that
can be used to resolve complex ethical dilemmas (module 2), as well as the key concepts and principles
that underpin corporate governance approaches (module 3). It is also a demonstration of the balancing act
that the accountant can be involved in, as different organisations will have a different balance between the
objective of maximising the wealth of shareholders and the responsibility of making choices that benefit
society and the environment (module 4).
CSR reporting is a process whereby an organisation publicly discloses information about its interactions
with, and impact on, the various societies and environments in which it operates. As we will see, the nature
of this reporting can vary widely between organisations, and across time.

5.12 EXTERNALITIES, POTENTIAL GOVERNMENT

INTERVENTION AND THE ROLE OF ACCOUNTING
Undertaking sustainability reporting requires an organisation to compile various measures of its social,
environmental and economic performance.
However, compiling these measures is not always easy. The activities of organisations create many social
and environmental impacts. Some attributes of an organisation’s social and environmental performance
will be relatively easy to measure, while others will be relatively difficult.
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328 Ethics and Governance

 An externality can be defined as an impact that an entity has on parties that are external to the
organisation where such external parties did not agree or take part in the actions causing, or the decisions
leading to, the cost or benefit.
Externalities can be viewed as positive (benefits) or negative (costs). In most market transactions, the
prices paid for goods or services do not fully reflect all the costs and benefits generated by their production
and consumption (which in itself brings into question measures of performance such as corporate profits).
The implication of this is that the cost of goods or services might be understated and, as a result, a greater
amount of a particular good or service might be produced and consumed than might be the case if the
overall costs to society were considered.
For example, if the air is treated as a ‘free good’ and a heavily polluting organisation does not pay,
or incur liabilities, for the pollution it creates, then its measure of profit — based on generally accepted
accounting principles — may be considered inflated compared to what it would be if costs were assigned
to the pollution. In a freely operating market that does not place a cost on pollution, there is the obvious
implication that production will increase, profits will rise and, at the same time, the environment will
become degraded.
Government intervention can be employed as a means of placing costs on the use of resources that
might otherwise go unrecorded. For example, we can consider the potential introduction of carbon-
related taxes, where organisations are taxed on the basis of the amount of carbon dioxide released into
the atmosphere. Such releases would otherwise be free. By placing a cost on emissions, a government
effectively acts to internalise costs that would otherwise be externalities. This can in turn motivate profit-
seeking organisations to find ways to reduce their emission levels. The higher the price per tonne of carbon
dioxide emissions, the harder we might expect organisations that are affected by the tax to try to reduce
their level of emissions.

QUESTION 5.3

Explain the nature of an externality. Think about an organisation you know and discuss the
following.
(a) What is at least one positive and one negative externality generated by the organisation, and
who are the affected stakeholders?
(b) How could these externalities directly affect the income or expenses (and therefore profit) of
the organisation?
(c) In your opinion, is the failure to recognise externalities a fundamental limitation of our current
financial reporting requirements?
(d) In your opinion, what might be the ethical implications of not accounting for business
externalities?

As investors seek to integrate information on sustainability factors into their investment decisions, this
has accounting implications, including the need for robust and reliable indicators of these factors.
Accounting has emerged as a critical component of addressing this challenge. It is often argued in
business that ‘we can’t manage what we can’t measure’ and most companies do not understand the
complexities of natural capital, nor do they have the approaches or tools for accounting for the natural
capital that their business draws upon. This is changing and some organisations have developed their own
modified techniques to quantify, price or otherwise account for natural capital externalities and therefore
deal with them strategically.
Eventually, the development of these methodologies may allow us to develop aggregated measures of
natural capital (in a similar way to how GDP is used for economic measures), helping us to honestly answer
questions such as, ‘Are we truly sustainable?’
While we might attempt to describe various costs and benefits generated by an entity in qualitative
terms, many costs and benefits will not be recorded in financial terms. Because corporate profits do not
incorporate many externalities, we must treat such financial numbers with caution when considering the
overall performance of an entity.
Perhaps we can question whether a profitable company is also necessarily a ‘good’ company or extend
our assessment to include both its short-term and long-term profitability prospects if it is deemed by critical
stakeholders to be profiting at the expense of society. For example, a large financial institution may close
many smaller regional branches to reduce financial costs, which might improve financial performance
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(e.g. reported profits). This measure of performance (profits) will not reflect many of the externalities
caused by the decision to close regional branches (e.g. the costs associated with unemployed workers
thereafter receiving benefits from government, or the inconvenience caused to regional communities from
no longer having a local bank).
At this stage, however, we should appreciate that in developing a CSR report, an organisation should
consider the various externalities caused by its operation and how it will disclose information about these
externalities. This will also involve identifying the potential stakeholders and how they are being affected.
The broad objectives driving any organisation to undertake sustainability reporting are wide ranging.
At one end, there could be an ethically motivated desire to be transparent about various aspects of its
performance as it affects various classes of stakeholders. At the other end is an economically focused
motive to use social and environmental reporting to protect or enhance shareholder value. The underlying
motives will directly shape the style of report that is presented and the audience it is intending to satisfy.
Once it is determined why an organisation decides to report, this decision will, in turn, inform the
decision as to whom any related information will be directed. Management could determine that the report
is produced to provide information for the interests of its shareholders, or for the interests of a broader
stakeholder community.
Once the target recipients of the report have been determined, management can then consider the
information demands or needs of these particular stakeholders. This will inform what information will
be disclosed and what issues the social and environmental reporting should address. Identifying what
issues an entity is held responsible and accountable for involves dialogue between the organisation and its
identified target stakeholders. Identifying the target stakeholders requires management to reflect in an open
way on the underlying motivations driving them to report: are they based on an accountability approach,
a managerial approach or somewhere in between?
Therefore, an organisation has to identify the:
• objectives of the reporting process (why report?)
• stakeholders to be addressed by the reporting process (for whom is the report intended?)
• information requirements of the stakeholders (what issues is the entity held responsible and accountable
for by its stakeholders — or what issues should the report cover?).

QUESTION 5.4

1. Access the EU’s ESRS 1 General Requirements and complete the following.
(a) Read the paragraphs related to information materiality and stakeholders. Who are the
audiences for the information contained in sustainability statements?
(b) Read the paragraphs related to double materiality, impact materiality and financial
materiality. How are financial materiality and impact materiality related?
2. Access IFRS S1 and read the objective of the standard (paragraphs 1–4) and the definitions
of general purpose financial reports and primary users of general purpose financial reports (in
Appendix A).
(a) Who is the intended audience for the sustainability-related financial disclosures?
(b) How are financial materiality and impact materiality related?
3. Which of the standards is wider in its scope?

.......................................................................................................................................................................................
CONSIDER THIS
In your opinion, which standard (ESRS 1 or IFRS S1) is most closely related to the concepts of CSR and
sustainable development?

SUMMARY
Recognition of the limitations of conventional financial reporting has combined with various events and
forces to drive the development of reporting that supports a broader notion of corporate accountability. The
GFC reduced trust in business, which in turn increased the expectations on business to justify their social
licence to operate. In addition, it is increasingly recognised that organisations’ effects on the community
and environment directly affect corporate value, wealth creation, brand value and reputation. Organisations
that are able to demonstrate accountability in relation to community and environment factors and able to
display risk management approaches to issues such as climate change may be able to attract lower cost
capital, including from SRI funds.
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 While there is ongoing debate about which stakeholders have legitimate claims over an organisation,
many organisations have chosen to report more widely on social and environmental impacts. This is
also reflected in moves by governments and other regulators to require reporting beyond conventional
financial measures.
The accountant has an important role in this expanded form of corporate accountability. The accountant
must have the ability to make ethical decisions, understand the principles of corporate governance, be able
to balance the different and sometimes competing interests of an array of stakeholders, and be able to
develop legitimate ways to measure resources and externalities that have not conventionally been included
in reports.
The key points covered in this part, and the learning objectives they align to, are as follows.

KEY POINTS

5.1 Explain the concept of social and environmental responsibility and its relevance to
governance.
• There is increasing recognition that numerous stakeholders are affected by the actions of
organisations and thus have a legitimate interest in those organisations.
• Organisations’ impacts on the community and the natural environment have become primary
concerns for many stakeholders and thus organisations and regulators have responded by devel-
oping reporting that addresses issues beyond the financial information conventionally presented
in financial reports.
• Information on community and environmental impacts supports decision making by internal and
external stakeholders and helps the organisation maintain its implied social licence to operate.
5.2 Describe the obligations of corporations in relation to their social and environmental
behaviours.
• It is increasingly believed that organisations must manage their social and environmental perfor-
mance as it affects their access to capital, their financial performance and their financial position
through factors such as reputation, risk, changing customer preferences, fines for non-compliance
with regulations, and the cost of remediating the natural environment.
• Organisations seek to obtain and keep an implied social licence to operate, which occurs when a
society accepts the organisation’s activities because they are beneficial and not detrimental to a
range of stakeholders, beyond shareholders.
• Corporations are required to consider social and environmental impacts by para. 299(1)(f) of the
Corporations Act, the ASX corporate governance rules and the Modern Slavery Act. In the UK,
the Companies Act specifically requires organisations to have regard to the environmental and
community impacts of the organisation’s activities.
5.8 Discuss the reasons why an entity would use non-mandatory reporting.
• While the mandatory requirements to report issues beyond the requirements of financial reports
are limited, many organisations choose to report on their social and environmental impacts.
• Reporting on social and environmental impacts helps build stakeholders’ trust in the organisation
and thus supports the organisation’s social licence to operate.
• Increasingly, investors are seeking SRIs and thus organisations can access this capital, and
potentially at lower cost, by demonstrating their social and environmental credentials.
• Environmental and social pressures represent potential risks to organisations’ future operations.
Reporting on these risks demonstrates to investors that the organisation is managing them.
• The notion of who has a legitimate claim over the organisation is a matter of debate, but
increasingly it is recognised that any stakeholder affected by the activities of an organisation has
a valid interest.
5.10 Evaluate the role of corporate governance mechanisms in enhancing an organisation’s social
and environmental performance.
• Reporting on social and environmental performance provides information that can support the
decisions of internal and external stakeholders.
• External reporting of social and environmental performance increases the accountability of an
organisation for that performance and thus promotes better corporate governance.
• Social and environmental performance have become important issues to a wide range of
stakeholders and thus those charged with governance have paid increasing attention to those
aspects of the organisation’s performance. Pressure to report on these aspects in turn creates
pressure to improve performance.

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PART C: THEORIES LINKED TO CSR
INTRODUCTION
The notion of corporate social responsibility can be explored and explained from numerous perspectives.
This part of the module examines some of the most widely accepted theoretical approaches that explore
the nature of and need for CSR. Importantly, most of the differences between these theories can be
linked back to different views about the nature of corporations and their role in society (Gray, Adams &
Owen 2014).
First, we will discuss the dominant theory of enlightened self-interest, followed by alternative stake-
holder and legitimacy theories. Finally, institutional theory is introduced as an emerging approach to
understanding behaviour in CSR.
Note that, whereas the theories we considered in module 2 reviewed ethical decision making by
individuals, the theories discussed in this module have been developed from the perspective of the
behaviour of organisations and groups of organisations. There are some links between theories of
individual and organisational ethics, but there are also differences.
The following material serves as an introduction to what is a very complex debate, and the interested
candidate can refer to the references included in this module to extend their knowledge of these
different theories.
.......................................................................................................................................................................................
CONSIDER THIS
As you work your way through the theories outlined next, try to work out which underlying theory or theories BHP
Group Limited and Wesfarmers Limited appear to be working to, using each company’s most recent annual report
and any other relevant documents as the basis for your analysis.

5.13 ENLIGHTENED SELF-INTEREST

The theoretical approach of enlightened self-interest is linked to the shareholder primacy perspective about
the role of corporations in society, but explains the circumstances under which CSR-related activities may
be considered. As outlined earlier, this perspective argues that the best outcomes for society come about
when individual firms are allowed the freedom to pursue their own interests and maximise their utility in
free markets. These arguments tend to reflect the teleological positions of utilitarianism and ethical egoism
(see module 2).
From the perspective of enlightened self-interest, CSR activities are at least considered and will be
undertaken if they result in an overall increase to shareholder value. Therefore, CSR could and should
be undertaken if there is a business case for that activity, or if it is in the interests of the shareholders. A
good part of the literature on CSR has been devoted to demonstrating the ways in which CSR improves
shareholder value and therefore makes business sense. Some of these include:
• improved employee recruitment, motivation and retention
• greater learning and innovation
• better customer confidence and reputation
• improved risk and governance profile and risk management
• enhanced competitiveness and market positioning
• avoiding costs and risks of regulation
• greater operational efficiency
• increased analyst interest and accuracy, affecting valuation
• attracting investors and other capital providers, and achieving lower costs of capital.
Proponents argue that corporations will voluntarily adopt those CSR practices that offer their business
some kind of benefit.
This theory represents a dominant view of the role of corporations in societies. However, in recent
decades, this dominant approach has been questioned on many levels. Some argue that free markets create
many of the social and environmental issues that led to demands for corporate accountability in the first
place, mainly because of externalities associated with the activities of the organisation. Others criticise
this approach from a teleological perspective — that we cannot separate values and ethics from economic
activities. Some of these criticisms have coalesced around alternative theories of CSR, which are reviewed
in the following sections.
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.......................................................................................................................................................................................
CONSIDER THIS
In the introduction to this module we defined sustainable development as:

Ensuring that the needs of today’s world are met while at the same time ensuring that the ability for future
generations to meet their own needs is not compromised.

This definition is derived from the report, Our Common Future (WCED 1987, p. 16), also known as the Brundtland
Report. If organisations are guided in their CSR obligations by enlightened self-interest, could such organisations
also be seen as embracing sustainable development in the way it has been defined above, based on the Brundtland
Report? Are the two concepts compatible?

5.14 STAKEHOLDER THEORY

Stakeholder theory offers a different perspective about why organisations should and do practise CSR.
This approach was first articulated in 1984 by Freeman, and since has produced a diverse literature and
a number of approaches. In the following sections we first look at what a stakeholder is and then at two
branches; a normative branch (which embraces broad notions of accountability) and a managerial branch
(which embraces the view that managers act to maximise shareholder value).

WHO ARE STAKEHOLDERS?

When going beyond mandated and regulated reporting (such as statutory financial reporting by public
companies), organisations determine to which stakeholders they report. But who or what is a stakeholder?
For the purposes of our discussion, a stakeholder of an organisation can be broadly defined as ‘a party that
is affected by, or has an effect upon, the organisation in question’ (Freeman 1984).
As discussed in module 4, there are many potential groups or agents that could be considered
stakeholders for a given organisation. Stakeholders often include diverse groups such as employees,
management, shareholders, communities, society, government and the state, and even the environment
and future generations. In practice, organisations usually have considerable scope in defining who their
stakeholders are, and further scope in deciding how these stakeholders should be managed.
.......................................................................................................................................................................................
CONSIDER THIS
Examine the annual reports of BHP Group Limited and Wesfarmers Limited that you selected for the purposes of this
part of the module. Identify and note the key stakeholders that the company describes. Note where this information
appears and how the groups are described.

NORMATIVE STAKEHOLDER THEORY

A normative, or ethical, perspective on stakeholder theory is deeply rooted in deontological ethical theory,
which emphasises duties and values (see module 2). This perspective argues that all stakeholders for an
organisation have inherent worth, and therefore, all stakeholders have the right to be treated fairly by
any organisation. Here, the firm is a vehicle for coordinating stakeholder relationships. Managers have a
fiduciary duty to all stakeholders, rather than just shareholders. When conflicts and competing interests
arise between stakeholders, management should strive to achieve an optimal balance, rather than focus
purely on shareholders.
Accountability is an important part of stakeholder relationships in normative stakeholder theory. That is,
the firm and its managers are accountable not just to shareholders, but also to stakeholders. All stakeholders
have a right to information about how this accountability is being discharged. CSR, from this perspective,
is a responsibility of organisations rather than being demand-driven.
As this theory is normative in nature, it emphasises what organisations should do and provides
prescriptions about behaviour. This is not how organisations actually act — but rather an ideal of behaviour.
In practice, a more managerial focus may be embraced by researchers to explain the activities of corporate
management. This is also associated with different ethical justifications and is known as managerial
stakeholder theory.

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MANAGERIAL STAKEHOLDER THEORY
The managerial branch of stakeholder theory focuses on the stakeholders considered to have power and
influence. Under this view, managerial action is based on advancing the interests of the organisation.
Therefore, it does not reject positive interaction with all stakeholders; however, the underlying purpose
of the interaction is self-interest (and in many ways it is similar to enlightened self-interest discussed
previously).
As a result, stakeholders who are regarded as more important or powerful in their ability to influence
shareholder value will attract additional effort and attention from managers. Power in itself will be
specific to the particular stakeholders of an organisation. It may be tied to such things as the command
of limited resources (finance, labour), access to influential media, ability to legislate against the company
(e.g. particular governments or regulatory bodies) or ability to influence the consumption of the organisa-
tion’s goods and services.
Information, including information about social and environmental performance, which is provided to
stakeholders, can represent a powerful tool. This tool is used by the organisation to control, manage,
influence or even manipulate various stakeholders. Corporate social disclosures are, therefore, viewed
as a mechanism to improve reputation and relationships with shareholders, creditors and other interested
parties, as described by Gray, Owen and Adams (2010, p. 26):
Information — including financial accounting and social accounting — is a major element that can be
deployed by the organisation to manage (or manipulate) the stakeholder to gain their support and approval
(or to distract their opposition and disapproval).

This theory therefore takes fewer cues from deontological theory, as it tends to see stakeholders as the
means to an end, rather than an end in themselves. In reality, organisations will often show both types of
justification for their reporting.

QUESTION 5.5

Excerpts from the annual reports of two of Australia’s largest companies follow. Consider the
differences in how they view stakeholders.
Wesfarmers:

Our primary objective is to deliver a satisfactory return to shareholders. We believe it is only

possible to achieve this over the long term by:
• anticipating the needs of our customers and delivering competitive goods and services
• engaging fairly with our suppliers, and sourcing ethically and sustainably
• taking care of the environment
• looking after our team members and providing a safe, fulfilling work environment
• supporting the communities in which we operate
• acting with integrity and honesty in all of our dealings (Wesfarmers 2023, p. 2).

Stockland:

Stockland was founded in 1952 with a vision to ‘not merely achieve growth and profits but to
make a worthwhile contribution to the development of our cities and great country’. It is this
recognition, that business has more to offer society than profits alone, that has seen us endure
(Stockland n.d.).

Are these approaches more consistent with the enlightened self-interest, normative or manage-
rial stakeholder theory?

5.15 ORGANISATIONAL LEGITIMACY

Within legitimacy theory, legitimacy itself is seen as a resource on which an organisation depends for
survival. It is something that is conferred on the organisation by society, and it is something that is desired
or sought by the organisation. It is a resource that the organisation is thought to be able to influence or
manipulate through various disclosure-related strategies.

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THE SOCIAL CONTRACT
The notion that there is a social contract between an organisation and the society in which it operates
underpins legitimacy theory. The social contract is not easy to define, but the concept is used to represent
the multitude of implicit and explicit expectations that society has about how the organisation should
conduct its operations. It refers to when a community trusts, approves and accepts the operations of a
corporation and its activities.
This means that corporations do not necessarily have a clean slate to do whatever maximises shareholder
value, but must instead keep within the bounds of reasonable or expected behaviour and activities in a
community. For example, minerals and resource companies in particular are sensitive to their own social
contract, particularly in the wake of controversial coal seam gas developments of the last few years. Origin
Energy points to this in the following quote.
The scale of our operations affects neighbouring communities — sometimes positively and sometimes in
ways that create challenges requiring careful management. People living near our operations can be affected
by increases in traffic, noise and dust. They may also be affected by socio-economic factors resulting from
our presence, such as increased housing costs and competition for labour. Origin must manage these issues
sensitively and acknowledge the loss of control and power people in the community may feel as a result of
our large-scale infrastructure projects (Origin Energy 2015).

LEGITIMACY THEORY
The main premise of legitimacy theory is that an organisation will take action to manage community
perceptions in order to survive. Corporations need to at least appear to be operating within the established
rules of society, that is, within the bounds of the social contract. When there is disparity between what the
organisation appears to be doing and the terms of its social contract, there will be a threat to its legitimacy,
and therefore to its future survival and success.
In this context, CSR is one strategic tool that organisations can use to influence the community’s
perceptions of them. Lindblom (1994) suggests a number of courses of action that organisations can take
to obtain, maintain or repair legitimacy.
• Change and inform — perform activities in a manner that is appropriate, given the expectations of
society, and then inform the relevant stakeholders about these actual behaviour changes, as well as the
performance results.
• Change perceptions without actual change — convince those who are evaluating the organisation that
change has occurred without actually changing performance, activities or behaviour.
• Deflect attention and manipulate perceptions — switch the focus away from areas of concern to other
issues where the organisation is performing well, and use emotional symbols and rhetoric to influence
expectations.
• Change criteria for evaluation — try and influence the levels of performance expected, and attempt to
highlight that certain criteria used by society are unreasonable (Lindblom 1994).
It is important to note that what is regarded as acceptable or legitimate behaviour will change over time,
as society changes. Behaviour that was once acceptable may later become unacceptable. The organisation
must continually adapt to maintain its status of legitimacy in society, and must also adapt to changes in the
social contract.

5.16 INSTITUTIONAL THEORY

Institutional theory is an approach that has emerged as a result of dissatisfaction with the preceding
approaches. It adopts a different perspective on corporate accountability that focuses on explaining why
organisations tend to appear more similar over time. Institutional theory looks not only at individual
organisations, but also at organisational fields (e.g. industries). Compared with those theories, institutional
theory is less normative and not so grounded in ethical theory, focusing more on explaining real-
world behaviour.
Institutional theory is useful because the practice of CSR has changed considerably over the last decades.
KPMG conducts regular surveys of corporate responsibility reporting. In 2002, they found that 45 per cent
of Global Fortune Top 250 companies were publishing a CSR report (KPMG 2017).

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 The 2013 KPMG report stated:
Companies should no longer ask whether or not they should publish a CR [corporate responsibility] report.
We believe that debate is over. The high rates of CR reporting in all regions suggest that it is now standard
business practice worldwide (KPMG 2013, p. 11).

By 2017, over 75 per cent of ‘the world’s largest companies were publishing a CSR report. The 2017
report stated:
There was a time when corporate social responsibility information was considered strictly ‘non-financial’
and not relevant to include in annual financial reports. The corporate responsibility report as we know it
today was born from those beliefs. But times are changing (KPMG 2017, p. 6).

Institutionalisation is a process of homogenisation (usually referred to as isomorphism) in organisational

practices over time. Institutionalisation results in the widespread adoption of innovation or new practices
in a field to the point of stability or even inertia. According to DiMaggio and Powell (1983) there are three
main isomorphic processes:
• coercive — when powerful stakeholders pressure a number of organisations in a field to adopt a practice
leading to conformity with that practice
• mimetic — when organisations imitate the behaviour of their peers and competitors to gain competitive
advantage and reduce uncertainty
• normative — when group norms are established that pressure organisations to change practices
(DiMaggio & Powell 1983).

According to institutional theory, organisations conform and homogenise because failing to do so

threatens their legitimacy, access to resources and survival capabilities. According to the theory, CSR
reporting is becoming institutionalised over time and has become an established norm.
A 2022 report by KPMG found that 79 per cent of N100 companies report on sustainability or ESG
matters. Compared to the 30 percentage point change from 2013 to 2017, the change from 2017 to 2022
is just 4 percentage points, indicating a levelling off or plateau in the reporting trend. However, the report
states that:
Over the past two decades, sustainability reporting has been largely voluntary, so the purpose of this
survey was to offer meaningful insights about how to improve levels of disclosure by business leaders,
sustainability professionals, and company boards. Today, we are on the precipice of adopting mandatory
and regulated sustainability reporting and the reporting landscape is poised to change drastically (KPMG
2022, p. 3).

It would appear that the although the various theoretical perspectives of the corporation provide
motivation for a certain (albeit reasonably high — at 79 per cent) degree of non-mandatory CSR reporting,
it will take legislation and regulation to increase this figure to 100 per cent.

SUMMARY
There are numerous theories that help explore and explain the notion of corporate social responsibility.
Each theory is useful in that it offers a different perspective on CSR and thus offers different ways to
consider and understand CSR. Table 5.4 provides a summary of some of the key differences between
these theories.

TABLE 5.4 Corporate social responsibility theories

Theory View of the corporation Why engage in CSR? Key concept

Enlightened As an instrument to maximise Some CSR activities offer benefits Shareholder

self-interest shareholder value to shareholders.

Stakeholder As a nexus of relationships CSR can show how a company Stakeholder

theory between stakeholders interacts with and values
its stakeholders.

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 Legitimacy As contingent on the approval To prove their worth to society and Social contract
theory of a community maintain their existence.

Institutional As operating within a context of Companies tend to imitate Peers

theory other firms’ behaviours their peers.

Source: CPA Australia 2023.

It is important to realise that these theories are often complementary, and many overlap. Indeed, they are
frequently invoked together by corporations to explain their approach to corporate accountability. Finally,
it is also important to realise that theories are always subject to interpretation.
The key points covered in this part, and the learning objective they align to, are as follows.

KEY POINTS

5.3 Discuss the different theoretical perspectives about what motivates organisations to present
social and environmental information.
• The theory of enlightened self-interest suggests organisations provide social and environmental
information to stakeholders if the organisation itself will benefit from doing so (e.g. by less regulation,
better reputation or improved access to capital).
• Stakeholder theory recognises that a wide range of stakeholders have some legitimate claim over
the organisation. This legitimacy may arise from the recognition that the stakeholders are affected
by the activities of the organisation or from the recognition that the stakeholders have power and
resources that can affect the organisation.
• Organisational legitimacy theory suggests the organisation needs to justify and earn its right to
operate given the impacts it can have on society and the environment. This right to operate is in
the form of a social licence, an implied agreement between the organisation and society that the
organisation will conduct in accordance with society’s expectations.
• Institutional theory suggests organisations’ behaviour tends to converge, so that as some organi-
sations adopt CSR, other organisations will follow.

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PART D: THE EMERGENCE OF CSR
INTRODUCTION
There is a rich history of CSR reporting that, just like financial reporting, has developed differently
according to geographic region. Gray, Adams and Owens (2014) summarise these differences and chart
the development of CSR reporting. For example, within the Australian context, Guthrie and Parker (1989)
examined the CSR reporting practices of BHP Ltd for the 100 years from 1885 to 1985. They found
that throughout the period of their analysis, BHP disclosed various items of information about its social
performance, and from around 1950 also began disclosing information about its environmental impacts.
While there is a history of some organisations making CSR disclosures, within the Australian context,
the practice of CSR reporting became more widespread in the early 1990s. At that time, many mining
companies, some water and energy utility organisations and some organisations in other industries began
releasing stand-alone reports (often referred to as environmental reports) that documented various aspects
of their environmental performance. They did this on a voluntary basis as there were no laws or regulations
in place at that time compelling them to do so.
In the mid-1990s, various organisations started producing more information about their social perfor-
mance. More recently, most leading companies are producing reports — often referred to as ‘Sustainability
reports’ or ‘Corporate social responsibility reports’ (these labels are often used interchangeably) — that
incorporate various aspects of their economic, social and environmental performance. Again, there are no
laws or regulations that compel organisations to release publicly available CSR or sustainability reports.
However, the greater emphasis on a broader accountability has been accompanied by an increase in
associated regulation of CSR reporting worldwide, so that, for some organisations, the broader corporate
accountability imperative has gone from desirable, to expected, to required. Key legislative changes that
have required companies to take CSR reporting seriously include modern slavery legislation in various
jurisdictions such as the California Transparency in Supply Chains Act 2010, the UK Modern Slavery
Act 2015 and the Australian Modern Slavery Act 2018, among others. Reporting on climate-related finan-
cial information is also required in select jurisdictions including the United Kingdom. More comprehensive
reporting requirements relating to ESG are being used in select locations, often under a ‘comply or explain’
system, including Malaysia, Hong Kong, Singapore and the Philippines. However, the most comprehensive
recent developments in this area hail from the EU with the passing of the Corporate Sustainability
Reporting Directive and related European Sustainability Reporting Standards. Companies subject to the
requirements must report on sustainability information from 1 January 2024. These developments are
expected to change the sustainability and CSR reporting landscape in an unprecedented way. Nonetheless,
it remains to be seen if these developments will result in better reporting or simply more reporting in
this area.
Not only is regulation seen as an increasingly important driver of CSR reporting, but frameworks such
as the Global Reporting Initiative (GRI) and voluntary guidance from regulators and stock exchanges are
also increasing the incidence of reporting. In this part of the module we discuss the three main pillars of
sustainability: environmental, social and economic sustainability.

5.17 ENVIRONMENTAL SUSTAINABILITY

Environmental sustainability involves making responsible decisions and taking actions that are in the
interests of protecting the natural world, with particular emphasis on preserving the capability of the
environment to support human life.
There are several compelling arguments for environmental sustainability. From a humanistic perspec-
tive, environmental sustainability is critical because humans rely on the natural environment for survival
and therefore have a responsibility to address the problems they cause. The intergenerational argument
contends that not being sustainable is an unfair burden to place on future generations, who ultimately
will have to live with the consequences of our current behaviour. The naturalistic argument claims that
nature has an intrinsic value, and deserves preservation for its own sake. While you may find some of these
arguments more convincing than others, they are mutually reinforcing and together make a compelling case
for pursuing environmental sustainability.

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 The role of business in environmental sustainability has been highlighted by a series of high profile
environmental disasters that have had a vast effect on the environment, ecology and our society. Some of
these disasters are described in example 5.4.

EXAMPLE 5.4

Environmental Disasters
Bhopal, India, 1984
Over 500 000 people were exposed to highly toxic chemicals that leaked from a Union Carbide India Ltd
plant; an estimated 22 000 people died.
Chernobyl, Ukraine, 1986
A nuclear power plant accident killed over 4000 people, caused 350 000 people to be permanently
resettled, and is still associated with environmental contamination, illness, deformities and cancers.
Deepwater Horizon, Gulf of Mexico, 2010
An explosion and sinking of a BP deep-water oil rig resulted in oil flowing for 87 days before the well
was capped, discharging an estimated 4.9 million barrels of oil into the ocean with extensive damage to
wildlife, marine ecology, coastlines and tourism across a huge area.
Brumadinho dam, Brazil, 2019
A dam failed at Córrego de Feijão iron ore mine operated by Brazilian company Vale in Minas Gerais,
killing at least 237 people and causing extensive environmental damage.

These environmental incidents are shocking, and have received considerable interest from society, the
media and government. However, it is not just disasters that have piqued society’s interest in environmental
sustainability. We are increasingly aware of the resource constraints and limitations of the world we live
in. For example, fresh water is a finite resource that is critical to life, but also underpins the productivity
of industrial, mining, agricultural and urban development. We are increasingly aware that our water
resources are limited; this represents a huge risk to human life and commercial activity. It is important
to note that, although businesses contribute to these problems, they may also have tools to address these
complex problems.
Some of the key environmental sustainability issues today include the following.
• Climate change. The change in global and regional climate patterns is associated with more intensive
emission of atmospheric carbon dioxide and other greenhouse gases resulting from the use of fossil
fuels. The role of business in resolving challenges associated with climate change is critical, and this
involves, but is not limited to, a detailed review of business processes. Responses to this issue include: the
UN’s Paris Agreement, which aims to limit the increase in global temperatures ‘to well below 2 degrees
Celsius, while pursuing efforts to limit the increase to 1.5 degrees’; and the Nationally Determined
Contributions that the parties to the agreement make (UNFCCC n.d.).
• Waste. Waste is the by-product of production that cannot be reprocessed, recovered or purified. As
global commercial activity escalates, more waste is produced and discarded or released into the
environment in a manner that can cause harmful change. Responses to this issue include an increased
emphasis on value and supply chain mapping and risk management, and using circular rather than linear
(economy) principles.
• Pollution. Businesses create pollution when production processes lead to the introduction of harmful
substances or contaminants into the natural environment. Responses to this issue include the net zero
carbon dioxide emissions by 2050 goal (Intergovernmental Panel on Climate Change (IPCC) 2018),
decarbonisation targets that will see fossil fuels replaced by renewable energy sources, and reporting
against the GHG Protocol, which provides frameworks for measuring and managing greenhouse gas
emissions including carbon dioxide (GHG Protocol n.d.a).
• Biodiversity. This refers to ‘all the different kinds of life you’ll find in one area—the variety of animals,
plants, fungi, and even microorganisms like bacteria that make up our natural world. Each of these
species and organisms work together in ecosystems, like an intricate web, to maintain balance and
support life’ (WWF n.d.). Ecosystems are complex and interdependent, so when a business affects one
element of an ecosystem, this can result in profound changes to other parts of that system. Responses
to this issue include: the Taskforce on Nature-related Financial Disclosures (TNFD) risk management
and disclosure framework, which is designed for organisations to report and act on nature-related
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 risks (TNFD n.d.); and the UN’s ‘high seas’ treaty that aims ‘to ensure the conservation and sus-
tainable use of marine biological diversity of areas beyond national jurisdiction [BBNJ]’ (UN General
Assembly 2023, p. 4).
.......................................................................................................................................................................................
CONSIDER THIS
Source and compare diagrammatic representations of the term ‘circular economy principles’. Each stage in a
product’s life cycle (design, manufacturing, distribution, consumption and end of life) presents an opportunity for
waste reduction or improvements in environmental sustainability. How are companies such as BMW, Volvo, Ikea and
Patagonia taking advantage of this opportunity? Do you think they are motivated by CSR, corporate sustainability
or both?

5.18 SOCIAL SUSTAINABILITY

Social sustainability can be understood as the ability of a system to continue to function at a reasonable
level of social well-being. Thus, an organisation is socially sustainable when its activities not only
meet the needs of its current stakeholders but also support the ability of future generations to maintain
healthy communities.
Traditionally, social sustainability has been considered the role of government; however, there is a
growing acceptance that companies also have an important role to play. Socially sustainable activities
of an organisation may include maintaining mutually beneficial relationships with employees, customers,
the supply chain and the community.
As with environmental sustainability, there are many examples of when companies have not demon-
strated their commitment to social sustainability. One prominent example of this is the 2013 collapse of
the Rana Plaza building in Bangladesh, where 1138 people died, many of whom were poorly paid garment
makers who worked extremely long hours in very unsafe conditions. The disaster caused international
outrage, and some responsibility for the conditions of the workers was placed on the western retailers who
sold the garments. The Rana Plaza disaster showed that, as an increasingly globalised and interdependent
world, we are becoming more aware of the linkages between companies, markets and complex global
problems such as poverty and inequity.
Some topical issues in social sustainability include the following.
• Child labour. The employment of children in business or industries is illegal in most parts of the world,
yet remains a widespread practice, with an estimated 215 million child labourers worldwide. It often
places children at risk of harm and interrupts their education. World Vision argues child labour ‘deprives
children of their childhood, their potential and their dignity’ (World Vision 2019).
• Ethical trading. This includes operating in markets with integrity and legality. Unethical trading
practices may include corruption, anti-competitive behaviour, bribery, aggressive or predatory pricing,
unethical marketing or unfair uses of power in markets.
• Supply chain management. Many corporations, particularly multinationals have extensive, complex
supply chains for the products they manufacture. There are increasing demands for corporations to be
more accountable, not only for their own activities, but also for those of the companies that supply them,
as was the case in the Rana Plaza disaster.
Social sustainability is not just a global issue. It also relates to local communities, as example 5.5
illustrates.

EXAMPLE 5.5

Victoria’s Social Procurement Framework

The Victorian Government introduced a Social Procurement Framework (Victorian Government 2019) to
encourage and expand social procurement activities across the whole of government. Social procurement
is the use of an organisation’s purchasing practices to generate social value. The framework specifically
targets purchasing from:
• Victorian social enterprises (i.e. organisations that aim to achieve a social mission, such as creating
employment for disadvantage jobseekers)
• Victorian Aboriginal businesses (i.e. for-profit, Traditional Owner corporations, social enterprises and
community enterprises that are at least 50 per cent Indigenous-owned)
• other supplies of social benefits.
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 In addition, the framework provides mechanisms to encourage suppliers to generate social and
sustainable outcomes. For example, in providing services to the Melton City Council, Citywide partnered
with the Brotherhood of St Laurence to create positions for disadvantaged jobseekers.

5.19 ECONOMIC SUSTAINABILITY

The economic dimension of sustainability concerns organisations’ impact on the economic conditions
of its stakeholders and on economic systems at local, national and global levels. In the case of an
organisation, it means using available resources to their best advantage (both efficiently and responsibly)
so the organisation can continue to function over a number of years at a given level of activity. The idea
is to promote the use of those resources in a way that does, and is likely to continue to, provide long-
term benefits.
Economic stability is important as we live in a market-based capitalistic society, and it is important
that corporations remain economically viable and vibrant in this system. The GFC of 2007–08 originated
in financial markets and led to a global recession from which we are still recovering. The impacts of the
GFC were widespread and extended across financial markets, banking systems and national economies,
and ultimately had huge social consequences. This included some people losing their savings, houses,
and financial security and also led to widespread lack of faith in our financial system. It showed how
complex and interconnected our economic markets are, and how vulnerable many parts of our society
are to economic conditions. It also pointed to deep flaws in the ways corporations operate. These issues
include the following.
• Long-term viability of businesses. Our reporting and financial systems are geared more towards the
short term. This potentially leads to myopic decision making and an institutionalised failure to manage
businesses for the longer term. This argument has generated demands for more attention to be paid to
the performance and activities of businesses in the long term.
• Stability of the economic system. The GFC, like other economic crises before it, showed how complex
and interconnected our economic systems are. Further, economic systems are an integral part of human
communities, and breakdowns can have widespread consequences. Corporate behaviour can play a large
role in creating a stable economic system.
• Transparency. Transparency refers to openness and authenticity about a corporation’s operations and
strategy. Economic sustainability can be affected by many different factors; transparency allows external
stakeholders to appreciate the exposure of corporations to risks.

5.20 LINKING ENVIRONMENTAL, ECONOMIC AND

SOCIAL SUSTAINABILITY
It is important to jointly consider the three aspects of sustainability — environmental, social and
economic — and how they intersect. A common way to think of the three aspects is as three overlapping
spheres or three pillars necessary to achieve sustainable development, as shown in figures 5.2 and 5.3.
Most national and international initiatives, and many advocacy efforts, focus on only one pillar at a
time. For example, the United Nations Environment Programme (UNEP) and the environmental protection
agencies (EPAs) of many nations focus on the environmental pillar. The World Trade Organization (WTO)
and the Organisation for Economic Cooperation and Development (OECD) focus mainly on economic
sustainability. A company or other reporting organisation that focuses on one pillar in isolation risks its
sustainable future and reputation. There may of course be different emphases that are appropriate, but an
organisation should consider all three pillars in its sustainable business strategy and risk management.
As the GFC demonstrated, weakness in one pillar can have consequences for the other pillars. As a
result of the GFC, many nations and states cut back or postponed stricter environmental laws or investment,
since their budgets were running deficits. Many environmental non-governmental organisations (NGOs)
saw their income fall, and income spent on social programs also declined.

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 FIGURE 5.2 The three overlapping spheres of sustainable development

Environmental
(planet)

Bearable Viable

Sustainable

Social Economic

Equitable
(people) (prosperity)

Source: Adapted from Rodriguez, SI, Roman, MS, Sturhahn, SC & Terry, EH 2002, ‘Sustainability assessment and reporting for
the University of Michigan’s Ann Arbor campus’, Center for Sustainable Systems, accessed August 2023, https://css.umich.edu
/sites/default/files/css_doc/CSS02-04.pdf; Barbier, EB 1987, ‘The concept of sustainable economic development’, Environmental
Conservation, vol. 14, no. 2, pp. 101–110.

FIGURE 5.3 The three pillars of sustainable development

SUSTAINABILITY
Environmental

Economic
Social

Source: CPA Australia 2023.

These three pillars of sustainable development are often included in CSR reporting. Many organisations,
in their CSR reporting, will discuss their sustainability initiatives in accordance with these three pillars.
As we will see later in this module, the most widely used guidelines for sustainability reporting, the
Global Reporting Initiative (GRI), structure their sustainability indicators so as to provide insights into
an organisation’s significant economic, environmental and social impacts.

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.......................................................................................................................................................................................
CONSIDER THIS
Identify and make note of two environmental disasters and their economic impact. Reflect on what these events
mean in a financial context for a company, as well as other impacts they may have (e.g. on share price or business
reputation, the environment and the community in which they took place).

5.21 THE BOARD OF DIRECTORS’ RESPONSIBILITY

FOR SUSTAINABILITY AND ORGANISATIONAL
INITIATIVES
There is a growing recognition that boards and those in charge of organisations have an increased respon-
sibility for taking into consideration broader factors that are beyond financial profits and performances
(Hopwood, Unerman & Fries 2010; OECD 2011; IIRC 2013). It is argued that leaders of organisations
have ethical responsibilities to create a sustainable society, and that there is a business case for operating
in an environmentally and socially sustainable manner. There is growing demand from a broad range
of stakeholders for organisations to better manage the entity’s consumption of natural resources, and
formally incorporate environmental, social and governance factors in risk assessment processes. Company
management faces the organisational challenge of simultaneously trying to manage environmental and
social performances for the benefit of the community (external stakeholders) while maintaining financial
performance for shareholders.
One important element of the business case, and a reflection of the increased demands from society, is
that specific regulations are asking organisations to report more broadly than financial performance and
position. For example, from 1 July 2019 the Modern Slavery Act requires businesses that meet the threshold
to report on the steps that they have taken to address modern slavery risks in their operations and supply
chains. Also, across the world we see that climate change initiatives are becoming a significant driver of the
costs and benefits to business. For example, in Australia, large businesses that exceed relevant thresholds
are required to report to the government their greenhouse gas emissions, greenhouse gas projects, energy
use and production under the National Greenhouse and Energy Reporting Act 2007 (Cwlth) (NGER Act).
In addition to the direct effects of specific regulations, the business case for sustainability considers
other effects on the business, from changing relations with customers, suppliers and other stakeholders,
to the costs and risks of doing business. There is evidence of a positive relationship between a business’s
credibility on sustainability issues and its ability to win and retain customers, as in Hopwood, Unerman and
Fries (2010). Their research also draws links between a focus on sustainability and increasing competitive
advantage through innovation and new products, and the business’s ability to attract, motivate and retain
staff. The business is also likely to manage risk better if it has a conscious focus on sustainability risks, and
to reap the rewards of direct cost reductions through operational efficiencies and avoiding waste, travel and
regulatory costs. The increase in business profitability and ability to manage risks will benefit the business’s
reputation and brand, including its licence to operate and its ability to raise external funds.
There is a growing sense that traditional financial reporting is not sufficient. The landscape for non-
financial reporting has changed at different speeds in different countries and regions. Governments are
making policy changes and the consequential procedural changes impose new reporting requirements
on companies. In fact, KPMG in their 2013 survey analysed the reports of more than 4100 companies
globally — including the world’s 250 largest companies — concluding that ‘The high rates of CR
(corporate responsibility) reporting in all regions suggest it is now standard business practice worldwide’
(KPMG 2013, p. 11). They also identified that much of this increase was associated with increased
regulatory requirements. In addition, some company managers are voluntarily adopting new reporting
practices in response to the desire for better information for a wider range of stakeholders. A similar
survey published in 2017 by KPMG found that about three quarters of the reports of 4900 companies
used corporate responsibility reporting in 49 countries (KPMG 2017). KPMG also noted that the level of
assurance — that is the external review of corporate responsibility reports — has doubled over 12 years
with a total of 67 per cent of reviewed reports getting assurance. High rates of assurance are intriguing,
given sustainability reporting is essentially a voluntary exercise. This is an indication of both the acceptance
of the role of corporate responsibility reporting and also the demand for this information to be assured
before being provided to stakeholders.

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 In response to these concerns, we have seen a significant development in the evolution of corporate
reporting, the integrated reporting initiative. Integrated reporting provides a broader accountability of an
organisation’s resources and relationships than does financial reporting, by requiring a consideration of all
resources and relationships (including social and environmental) that impact the value creation activities
of the organisation.
At the same time we are seeing the development of different organisational forms. Of particular interest
are social enterprises, which are organisations that exist to fulfil a mission consistent with public or
community benefit, trade to fulfil that mission, and reinvest a substantial proportion of their profit or
surplus in the fulfilment of that mission. Social enterprises are argued to represent a form of hybrid
organisation, having both business and charitable characteristics. Traditionally commercial enterprises,
public organisations and charities were distinct entities; however these traditional boundaries are becoming
increasingly blurred.
An example of this new organisational form are the companies that are recognised as B-Corporations.
A B-Corporation involves a certification process that recognises ‘a new type of company that uses
the power of business to solve social and environmental problems’ (B-Corp n.d.). In 2015 there were
1307 registered B-Corporations from 41 countries. Companies that have been certified by B-Corporation
are able to distinguish themselves from other companies by offering a positive vision of a better way
to do business. In 2019 the total of B-Corporations grew to over 2500 corporations. Those corporations
are spread across more than 50 countries and over 150 industries. Companies that have B-Corporations
certification include ice cream chain Ben & Jerrys, the online social media portal Hootsuite, the project
funding portal Kickstarter and Danone, which is a food and beverage company that operates in the United
States, Indonesia, Spain, Egypt and the United Kingdom.
As the environment in which companies operate becomes more complex, risk management has been
increasingly emphasised. As we have already seen with the introduction of ESRS 1 and IFRS S1, risk
management has expanded to specifically include climate and other sustainability-related risks. Boards,
either through existing directors’ duties or proposed legislation, will be increasingly responsible for
managing these risks. As boards are also responsible for strategy, they may find opportunities in risk
management to add value through changes. This may include changes to business models and supply
chains, product innovation, improved brand and customer loyalty, operational cost savings and improved
access to or reduced cost of capital.
.......................................................................................................................................................................................
CONSIDER THIS
In EY Europe’s 2023 Long-term value and corporate governance survey, 64 per cent of respondents agreed with
the statement, ‘We face short-term earnings pressure from investors, which impedes our longer-term investments
in sustainability’. The report goes on to state that ‘The quality of engagement between boards, management and
investors is a critical factor in addressing this tension’, and that directors need to improve the narrative and make a
better case for longer term investment in sustainability at the expense of short-term earnings (EY Europe 2023). If
you were an investor in a listed company, what narrative would make you more willing to accept lower dividends in
the short term?

5.22 INTRODUCTION TO THE KEY

REPORTING CONCEPTS
In this section we provide a brief introduction to some of the key concepts before we consider the drivers
for accountability and discuss issues and practices around their measurement and reporting.

ACCOUNTABILITY
Central to this module and directly tied to the decision to report information (whether it be CSR or financial
information) is the concept of accountability. We can define accountability as the duty to provide a report,
or an account, of the actions and decisions made about those areas of activity for which an organisation is
deemed to be responsible. These may be financial or non-financial and usually focus on the use of resources
that have been entrusted to an organisation’s care. If we are to accept that an entity has a responsibility (and
a duty of accountability) for its social and environmental performance, then we, as accountants, should
provide ‘an account’ (or report) of an organisation’s social and environmental performance — perhaps
by releasing a publicly available CSR report, including additional information in the annual report or
disclosing information online.
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 Therefore, a central aspect of corporate accountability and the role of corporate reporting is to inform
relevant stakeholders about the extent to which actions for which an organisation is deemed to be
responsible have been fulfilled. Reporting, whether it be CSR reporting or otherwise, is a vehicle for an
organisation to fulfil its requirement to be accountable.

SUSTAINABILITY REPORTING
Sustainability reporting is the process of producing a sustainability report (published by an organisation)
about the economic, environmental and social impacts caused by the organisation’s everyday activities.
Other aspects that are commonly expected of an organisation’s sustainability report include information
about the organisation’s values and governance model, and links between its corporate strategy and its
commitment to a sustainable global economy.

NATURAL CAPITAL
Natural capital can be understood as the world’s stocks of natural assets. It includes air, water, land, soil,
geology and biodiversity. It is a finite resource, and the demands of a growing and increasingly prosperous
global population means that escalating demands are being placed on an already overstretched resource.

NATURAL CAPITAL ACCOUNTING

The process of calculating the total stocks and flows of natural capital available to and used by an
organisation, or other possible reporting units, such as an ecosystem or region, is known as natural
capital accounting.

INTEGRATED REPORTING
Integrated reporting is a process founded on integrated thinking (discussed next) that results in a periodic
integrated report by an organisation about aspects of its value-creation process. Bringing together the
main parties involved in corporate reporting, the International Integrated Reporting Council (IIRC) has
produced a conceptual framework for the preparation of a concise, user oriented corporate report entitled
an ‘integrated report’, which captures an organisation’s resources and relationships using a ‘six capitals
concept’ and requires a description of a company’s business model, allowing a better communication of
its value creation proposition over the short, medium and longer term.

INTEGRATED THINKING
An important component of integrated reporting is ‘integrated thinking’, which is ‘the active consideration
by a company of the relationships between its various operating and functional units and the capitals that the
organisation uses and affects’ (IIRC 2013, p. 2). Some of the expected advantages that an organisation gains
from undertaking integrated thinking are that it advances the alignment of the organisation’s strategic focus
with both its financial and non-financial performance. With greater comprehension of how a company
creates value and of the social and environmental impact of its activities, it is more likely that management
will recognise the imperative of integrating sustainability concerns into business strategies.

TARGETS
A target is a desired end result, usually stated quantitatively, that a goal is designed to achieve. Net zero
(carbon emissions) by 2050 is an example of a target.

METRICS
A metric is a quantifiable or measurable value or data point used to describe or measure a specific
characteristic. For example, a company may use GHG emissions reported as kilograms, tonnes (metric
tonnes), or kilotonnes of carbon dioxide (or carbon dioxide equivalent) emissions as a metric. Emission
quantities are variously shown as KgCO2 , MtCO2 , KtCO2 or KgCO2 e, MtCO2 e, KtCO2 e with the ‘e’
signifying ‘equivalent’.

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.......................................................................................................................................................................................
CONSIDER THIS
(a) Visit the Science Based Targets initiative website to find out what a science based target is.
(b) Visit the UN’s website and locate the Global Indicator Framework for the Sustainable Development Goals. What
is the difference between Goals, Targets and Indicators (metrics)? Is there anything listed for Goal 13 that
surprises you?

5.23 WHAT IS MEASURABLE?

Measurement refers to collecting, analysing and assigning quantitative values to an issue. Measuring
sustainability issues is important in corporations as it allows these issues to be integrated into established
business decision-making processes. Think of the common business adage: ‘You can’t manage what you
can’t measure’. With measurement, it is easier to understand the scale of various issues, to track how they
change over time, compare them, and to improve performance.
However, the reality is that measuring many social, environmental and sustainability issues is very
challenging. Unlike financial reporting, where we have generally accepted ways of measuring and report-
ing financial value, our ability to measure social, environmental and sustainability issues is considerably
less developed, and is still very much a work in progress. Issues to be resolved include dealing with
indeterminacy (or uncertainty), as well as interdependencies between pieces of information. One of the
difficulties in this area is understanding how all of the different components interact and the effect they
have on each other. Accordingly, it may be helpful to think of reporting for social, environmental and
sustainability issues as comprising:
• quantification — expressing an issue or change in numerical terms (e.g. 75 per cent of staff feel they
have adequate training and development opportunities)
• monetisation — converting a quantified value into currency as a standard unit of measurement
(e.g. ‘we invested $1 million in staff development and training’)
• narrative reporting — expressing an issue in qualitative form (e.g. what is the management approach
or strategy to staff development?).
You may be familiar with each of these as they reflect similar approaches in financial reporting.
There are also a wide variety of approaches to measuring and reporting social, environmental and sus-
tainability issues — they vary considerably in the degree to which they adopt quantification, monetisation
and narrative reporting. This provides scope for organisations to report in different ways on their social,
environmental and sustainability activities. Further, it is important to remember that all of these types of
measurement are in a constant state of development and refinement. How companies measure their social,
environmental and sustainability impact in 10 years’ time will undoubtedly look very different from what
is reported in corporate accounts today. In the following sections we provide a sample and discussion of
some key challenges in each of these areas.
There can be quite a range of information available to organisations when they are identifying their
available CSR information. Quite often companies collect data for other mandatory reporting requirements,
such as work health and safety (WHS) obligations, or to comply with environment regulations, such as
greenhouse gas and energy consumption requirements, and this information, which is usually quantified
(and sometimes monetised), is relevant for CSR reporting. In fact, most information used to report on
other mandatory requirements could be considered in the information set as being potentially relevant to
stakeholders. One important practical consideration is whether the data is in an easily accessible format
that can be collated and reported in a systematic fashion. Organisations often have separate systems located
in different departments that capture all the different types of data that have been mentioned. Therefore,
there are real challenges in being able to collate and integrate this data in one place.

SOCIAL REPORTING
In general, there are some areas for which we have better developed measures for social issues. This
includes areas such as:
• labour practices and workplace — including diversity and equal opportunity, employment standards
and turnover, training and development
• human rights — including compliance with human rights Acts, policies and management of issues such
as freedom of association, collective bargaining, child labour and forced labour
• society — including investments in local communities, anti-corruption and anti-competitive behaviour
• product responsibilities — including customer health and safety, product labelling and ethical marketing.
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 Further, many corporations often collect much of this information as standard practice anyway,
particularly in the areas of workplace and staff. This may include compliance with international labour
standards such as International Labour Organization (ILO) conventions, and some components of
balanced scorecards.
There are some areas in which social reporting and measurement is much harder.
• Social issues involve quality concerns and a level of subjectivity that can be hard to meaningfully capture
in quantitative or monetised approaches. For example, a mining company may report that they provide
education to 80 per cent of employees’ children in a mining community. However, this figure provides
no indication of the quality of that education, whether it meets the educational needs of children, or
whether it remains culturally acceptable. Nor does it inform us of why the remaining 20 per cent have
not received an education and what the implications are.
• In CSR reporting, the concept of entity is relaxed. That is, corporations often need to report on value
created outside the organisation rather than just captured within the organisation. It can be hard to
identify what issues can be attributed to a particular organisation and not to others. For example, consider
the supply chain of a large corporation such as Walmart. How many of the social issues that emerge from
this whole supply chain is Walmart responsible for? What are the implications of this?
• Time is an important measure for social issues. There is often a significant lag between an activity and
when the impact of the activity is felt in a community or society (e.g. the effect of education). This can
be hard to capture when simply measuring indicators and KPIs.
One approach to putting a value on social investment is social return on investment (SROI). This
approach is discussed in example 5.6.

EXAMPLE 5.6

Social Return on Investment

SROI is an approach to measuring social change that comes about as a result of an organisation’s
activities. Based on a set of principles, SROI tracks the inputs, outputs and social outcomes (e.g. better-
trained staff) and then uses financial proxies (e.g. productivity benefits of better-trained staff) on each
of these items to calculate an SROI that is similar to financial return on investment. It is a popular
approach that is gaining traction, particularly in the not-for-profit or profit for a purpose (social enterprise,
B-Corporation) sector, but it does face considerable criticism.
In particular, the SROI figure is contingent on a large number of judgements, assumptions and financial
proxies and is thus far less reliable than comparable financial figures. It is also relatively time and resource
intensive to undertake, and is most usefully applied to a particular project or activity, rather than mapping
all the many possible issues a large corporation is dealing with. In addition, some people argue that it is
simply not appropriate to place dollar values on social issues.

ENVIRONMENTAL REPORTING
Environmental reporting accounts for how corporations draw from and affect the natural environment.
In recent years, there have been important advances in developing standardised methodologies for
accounting for certain environmental aspects of business, such as greenhouse gas emissions. Nonetheless,
understanding and measuring environmental impact can be a very complex process. Further, there are
significant differences in the environmental impact of different industries.
The areas that have seen greater development of measurements and indicators include:
• materials usage and product resource consumption
• resource usage — including energy and water
• emissions, effluents and waste
• transport usage
• compliance with and breaches of mandatory and voluntary environmental regulations.
Some of these areas have relatively well established approaches; for example, the IPCC through the
Task Force on National Greenhouse Gas Inventories has produced detailed methodological guidance for
reporting on greenhouse gas emissions, and the World Resources Institute and the World Business Council
for Sustainable Development with the GHG Protocol.
Many corporations produce environmental measurement information, which is similar to social report-
ing, through existing voluntary and mandatory environmental regulations, such as the NGER Act and
federal and state/territory Environmental Protection Acts.
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 Environmental reporting is still a complex and challenging area, and some areas that have been identified
as needing further development include the following.
• Reporting on biodiversity (flora, fauna and ecosystems) is very challenging, particularly as there is no
generally accepted unit of measurement and reporting systems are often exploited.
• Similar to social reporting, environmental reporting includes measures of impact beyond the control of
the organisation. Measuring the environmental effect of supply chains increases the level of complexity
and scope of reporting.
• Many environmental estimates include discount rates for future impact (similar to discounting for the
time value of money). In an environmental context, applying a discount rate to future environmental
impact has ethical implications — that is, it suggests that future generations are less important than
current generations.
• Environmental impact measurement is often confined to and ‘siloed’ in particular areas (e.g. water use
and greenhouse gas emissions) and there is a need to determine how these different measures fit together
to provide an overall assessment of environmental impact.
IFRS S2 requires disclosure of GHG information, including companies’ absolute GHG emissions
generated (expressed as tonnes of carbon dioxide or carbon dioxide equivalent emissions, MtCO2 e),
classified as Scope 1, Scope 2 and Scope 3. Definitions and examples of these categories are shown in
table 5.5.

TABLE 5.5 Overview of the GHG scopes

Emissions type Scope Definition Examples

Direct emissions Scope 1 Emissions from operations Emissions from combustion in owned or
that are owned or controlled controlled boilers, furnaces, vehicles, etc.;
by the reporting company emissions from chemical production in
owned or controlled process equipment

Indirect Scope 2 Emissions from the generation Use of purchased electricity, steam,
emissions of purchased or acquired heating or cooling
electricity, steam, heating,
or cooling consumed by the
reporting company

Scope 3 All indirect emissions (not Production of purchased products,

included in Scope 2) that transportation of purchased products or
occur in the value chain use of sold products
of the reporting company,
including both upstream and
downstream emissions

Source: GHG Protocol 2011, Corporate value chain (scope 3) accounting and reporting standard, September, p. 28, accessed August
2023, https://ghgprotocol.org/sites/default/files/standards/Corporate-Value-Chain-Accounting-Reporing-Standard_041613_2.pdf.

Scope 3 emissions are divided into 15 categories (GHG Protocol 2011):

1. purchased goods and services
2. capital goods
3. fuel- and energy-related activities
4. upstream transportation and distribution
5. waste generated in operations
6. business travel
7. employee commuting
8. upstream leased assets
9. downstream transportation and distribution
10. processing of sold products
11. use of sold products
12. end-of-life treatment of sold products
13. downstream leased assets
14. franchises
15. investments.
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 In line with the global target of net zero by 2050, many large corporations are setting targets around
emission reductions. BHP’s emission targets are shown in example 5.7.

EXAMPLE 5.7

BHP’S GHG Emissions Targets

BHP Group Limited is the largest mining company in the world and focuses on extracting, processing and
marketing metals, minerals, coal, iron ore and petroleum products on a global scale. The company aims
to reduce its Scope 3 GHG emissions by working with its customers and suppliers in their value chain.
BHP’s 2030 goal is to develop technologies and pathways to reduce Scope 3 emissions by 30 per cent
in steelmaking (where coal is used to make steel) and in the shipping of their products.
By 2050, the company aims to reduce the Scope 3 emissions of direct suppliers and from all shipping of
BHP products to net zero, depending on availability of carbon neutral solutions. BHP states that reducing
Scope 3 emissions by 2050 will be challenging, particularly for their customers in steelmaking. However,
the company aims to support their customers and suppliers in the transition to carbon neutral steelmaking
and other processes in their value chain.
Source: Adapted from BHP Group Limited n.d., ‘Climate change’, accessed August 2023, www.bhp.com/sustainability/
climate-change.

QUESTION 5.6

Access the GHG Protocol’s 2011 Corporate Value Chain (Scope 3) Accounting and Reporting
Standard (https://ghgprotocol.org/corporate-value-chain-scope-3-standard) and match each of
the following emission sources to the appropriate Scope 3 emissions category:
(a) working from home
(b) flying to a business conference
(c) eBay or Amazon sending you your purchases
(d) steel manufacturing from BHP’s iron ore
(e) disposing of vehicle tyres
(f) manufacturing the shelving used in supermarkets.

ECONOMIC REPORTING
The final element of CSR refers to the sustainability of an organisation’s economic performance. This
includes financial performance measured by generally accepted accounting principles, but this by itself
may be too limited. What is often unreported, but is frequently desired by users of sustainability reports,
is the organisation’s contribution to the sustainability of a larger economic system. This can include a
wide variety of non-financial performance indicators and narratives, and is usually aimed at economic
performance, market presence and indirect economic impacts. A study by Cohen and colleagues (2012)
identified the indicators most commonly reported in large public corporations. These include (in order of
their decreasing frequency):
• market share — referring to the percentage or size of market share for the company, division, unit or
particular products
• quality rankings — such as prizes or performance against particular benchmarks
• customer satisfaction — including describing customer service initiatives, loyalty, awards or campaigns
• employee satisfaction — comparison of loyalty and awards and comparison to competitors
• turnover rates — employee turnover compared with competitors and industry averages
• innovation — describing innovations introduced across the organisation’s value chain. Innovation is
sometimes measured in monetary terms, such as the amount spent on research and development, or it
can be quantified, such as the number of patents awarded (Cohen et al. 2012).

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 QUESTION 5.7

Marks & Spencer, a UK-based retail company, produces an annual report based on its sustainability
strategy, known as Plan A. The strategy is now fully integrated within the business with responsi-
bility resting with the company’s managing directors (Marks & Spencer 2023).
Scroll through the 2023 report (https://corporate.marksandspencer.com/sites/marksandspencer
/files/sustainability-report-2023.pdf) and examine the way in which the company reports its
progress in relation to targets in the various environmental and social issues.
Identify the grading scheme the company uses and evaluate whether it is effective. Consider also
whether the progress overview is sufficiently comprehensive to allow stakeholders to ascertain the
sustainability performance of the company.

SUMMARY
Sustainability is the concept of ensuring that actions today do not impact on the ability of future generations
to meet their needs. CSR reporting began to become widespread in the early 1990s when companies
with significant environmental impacts began releasing stand-alone reports on their environmental per-
formance. In the mid-1990s, various organisations started producing more information about their social
performance. More recently, most leading companies are producing ‘Sustainability reports’ or ‘Corporate
social responsibility reports’ that incorporate measures and narratives relating to economic, social and
environmental performance. These three aspects are the three pillars of CSR and tend to be interdependent
at both the organisational and system-wide levels.
Organisations’ management has become more responsible for CSR due to recognition of ethical
obligations, pressure from stakeholders and an increase in regulation of CSR and CSR reporting.
CSR reporting is still developing. There are challenges in terms of measurement in particular, but
concepts and frameworks such as the GRI and guidance from regulators and stock exchanges are
contributing to the development of approaches for CSR reporting.
The key points covered in this part, and the learning objective they align to, are as follows.

KEY POINTS

5.4 Identify the components of corporate social responsibility or sustainability reports.

• The terms CSR report and sustainability report are often used interchangeably.
• CSR and sustainability reports cover three aspects of sustainability: environmental, social and
economic. These aspects are interdependent and a lack of sustainability in one is likely to affect
the other two.
• Environmental sustainability relates to the natural environment and in particular issues such as the
efficient use of natural capital (the world’s stock of natural resources), climate change, pollution,
waste and biosecurity.
• Social sustainability refers to the ongoing functioning and stability of society and relates to issues
such as ethical trading, ethical supply chain management, avoidance of child labour, and the need
for organisations to contribute to the overall welfare of society.
• Economic sustainability relates to the efficient use of resources, the ongoing viability of business,
the stability of the economic system as a whole and transparency.
• A CSR or sustainability report should support the accountability of the organisation for its
environmental, social and economic performance.
• Integrated thinking is an important element of CSR and sustainability reporting, as it actively
considers the interaction of the three core pillars of sustainability.

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PART E: CORPORATE GOVERNANCE AND
CSR REPORTING
INTRODUCTION
So far, we have discussed issues associated with the management and collection of CSR information,
and the increased corporate and social responsibility expected of organisations. There is of course a
link between managing and reporting, with reporting and the associated accountabilities often driving
better corporate governance. In this part of the module, we cover the increased reporting expectations for
CSR information.
We will outline the increased mandatory reporting requirements that are driving change in reporting.
We will also discuss the major voluntary guidelines and non-mandatory reporting requirements against
which organisations report. Voluntary reporting has evolved from desirable to expected and is now
virtually mainstream for most major corporations around the world. KPMG (2017) found that a staggering
78 per cent of the world’s top companies (G250) include CSR data in their annual reports. By 2022 this
had risen to 96 per cent (KPMG 2022).
The accounting profession and the professional accounting bodies have played a critical role in
driving the move to increased reporting of CSR information by developing generally accepted reporting
frameworks. In this part of the module, we will examine various initiatives to develop these frameworks.
It has also been recognised that CSR information is useful not only for external reporting purposes, but
also for internal decision making, to help understand the risks and opportunities facing an organisation and
make better, more informed decisions. If you pick up most organisations’ corporate reporting information,
you will see increased emphasis on CSR information. CPA Australia is no exception, and in fact is leading
the way in its journey to implement integrated reporting, following the principles and guidelines of the
IIRC in annual published integrated reports since 2013.

5.24 WHAT IS REQUIRED? (MANDATORY

REPORTING)
As we outlined earlier in this module, a greater emphasis on a broader accountability expected of
organisations has been accompanied by an increase in associated regulation worldwide, so that, for some
organisations, the broader corporate accountability imperative has gone from being desirable, to expected,
to now being required. The move towards mandatory reporting has been caused by a range of factors.
These include government regulation due to community pressure and lobby groups, as well as regulations
arising in response to specific corporate activity that has harmed the environment or community. Reporting
is also required to enable governments to comply with international agreements to reduce emissions
and pollution.
Mandatory reporting obligations are gathering pace, and some are jurisdictionally dependent. The two
major developments in this area are being driven by IFRS and the European Commission (EC). IFRS,
through the ISSB, has released IFRS S1 and IFRS S2 with an effective date of 1 January 2024. Entities are
to apply these standards for annual reporting periods beginning on or after this date. As at August 2023,
the ISSB is consulting on its next priorities, which will potentially include:
• biodiversity, ecosystems and ecosystem services
• human capital
• human rights
• integration in reporting (IFRS 2023d).
As at August 2023, the Australian Treasury had completed consultation on the design of a climate-
related financial disclosures regime with a view to implement Australian standards by the first tranche of
entities from 1 July 2024 (The Treasury 2023).
The EC’s Directive on Corporate Sustainability Reporting (CSRD) requires:
large companies and listed small and medium-sized companies (SMEs), as well as parent companies of
large groups, to include in a dedicated section of their management report the information necessary to
understand the company’s impacts on sustainability matters, and the information necessary to understand
how sustainability matters affect the company’s development, performance and position.
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 This information must be reported in accordance with European Sustainability Reporting Standards
(ESRSs), to be adopted by the Commission by means of delegated acts that must specify the content
and, where relevant, the structure to be used to present that information. This information shall include
information related to short-, medium- and long-term time horizons, as applicable, and it shall contain:
(i) a brief description of the undertaking’s business model and strategy;
(ii) a description of the time-bound targets related to sustainability matters set by the undertaking;
(iii) a description of the role of the administrative, management and supervisory bodies with regard to
sustainability matters, and relevant expertise and skills or access to them;
(iv) a description of the undertaking’s policies in relation to sustainability matters;
(v) information about the existence of incentive schemes linked to sustainability matters;
(vi) a description of the due diligence process implemented by the undertaking with regard to sustain-
ability matters;
(vii) the principal actual or potential adverse impacts connected with the undertaking’s own operations
and with its value chain;
(viii) any actions taken by the undertaking in relation to actual or potential adverse impacts, and the result
of such actions;
(ix) a description of the principal risks to the undertaking related to sustainability matters;
(x) indicators relevant to the required disclosures. Where applicable, it shall contain information about
the undertaking’s own operations and about its value chain, including its products and services, its
business relationships and its supply chain (EC 2023a).

In 2022, European Financial Reporting Advisory Group (EFRAG) was appointed technical adviser to
the EC and given the mandate to develop draft ESRSs. Several sets of ESRSs are to be planned and, as at
August 2023, 12 have been developed, as shown in table 5.6.

TABLE 5.6 The 12 European Sustainability Reporting Standards

Group Number Subject

Cross-cutting ESRS 1 General requirements

Cross-cutting ESRS 2 General disclosures

Environment ESRS E1 Climate

Environment ESRS E2 Pollution

Environment ESRS E3 Water and marine resources

Environment ESRS E4 Biodiversity and ecosystems

Environment ESRS E5 Resource use and circular economy

Social ESRS S1 Own workforce

Social ESRS S2 Workers in the value chain

Social ESRS S3 Affected communities

Social ESRS S4 Consumers and end users

Governance ESRS G1 Business conduct

Source: EC 2023b, Questions and answers on the adoption of European sustainability reporting standards, EU, Press Corner,
accessed August 2023, https://ec.europa.eu/commission/presscorner/detail/en/qanda_23_4043.

REQUIREMENTS EMBODIED WITHIN THE CORPORATIONS

ACT AND ACCOUNTING STANDARDS
In Australia, corporate annual reports are required to comply with the Corporations Act, relevant
accounting standards, and, if the entity is listed, with the listing requirements of the ASX. Consistent
with the shareholder primacy approach, the disclosure requirements, as they pertain to annual reports,
focus on providing information about financial performance to those parties with an economic interest in
the reporting entity. However, recent requirements have been broadened or clarified, so it could be argued
that more of an enlightened self-interest approach is currently being applied.
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 Figure 5.4 outlines the sections of an annual report where current mandatory reporting requirements
of a social and environmental nature embodied in the Corporations Act and accounting standards are
normally reflected.

FIGURE 5.4 Sections of an annual report where mandatory social and environmental reporting requirements
are normally reflected

Major sections of annual reports Mandatory reporting requirements

Chairman and Chief Executive Officer

joint report

Directors’ report Section 299A Corporations Act

Financial statements

Disclosures related to accounting

Notes to the financial statements
standards (s. 296 Corporations Act)

Directors’ declaration and independent

auditor’s report

ASX corporate goverance

Corporate governance information
recommendations

Source: CPA Australia 2023.

In relation to reporting information about environmental performance, para. 299(1)(f) of the

Corporations Act is relevant. This section requires that in the directors’ report, which must be included
in the annual report, directors must give details of the entity’s performance in relation to environmental
regulations ‘if the entity’s operations are subject to any particular and significant environmental regulation
under a law of the Commonwealth or of a State or Territory’. However, this section does not require
corporations to disclose the financial impact of non-compliance with environmental regulations.
Section 299A of the Corporations Act is also relevant. Under this provision, listed companies are
required to include in the directors’ report any information that shareholders would reasonably require
to make an informed assessment of the company’s:
• operations
• financial position
• business strategies and prospects for future financial years.
In 2019, the Australian Securities and Investment Commission (ASIC) released a regulatory guide
(RG 247) on enhancing companies’ consistent conformity with operating and financial review (OFR)
reporting requirements under s. 299A(1) of the Corporations Act (ASIC 2019). Of specific interest is
that an OFR should include a discussion about environmental and other sustainability risks where those
risks could affect the entity’s financial performance or the outcomes disclosed, taking into account the
nature and business of the entity and its business strategy. For example, it may be that environmental risks
would be more likely to affect a mining company’s financial prospects than those of a bank.
Corporations in Australia must comply with accounting standards by virtue of s. 296 of the Corporations
Act, which requires company directors to ensure that the company’s financial statements for a financial
year comply with accounting standards. Two accounting standards of direct relevance to our discussion
are IAS 37 and IAS 16.
According to IAS 37 Provisions, Contingent Liabilities and Contingent Assets, obligations relating to
environmental performance could be included in either ‘provisions’ or ‘contingent liabilities’, depending
on the circumstances. The defining characteristic of a ‘provision’ as opposed to other ‘liabilities’ is that the
timing and amount of the ultimate payment are uncertain. However, as mentioned earlier, it would appear
that many organisations elect not to quantify certain environmental obligations (such as those relating to
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remediating contaminated sites) because they question the probability of the ultimate payment or believe
they cannot measure the obligation reliably.
IAS 16 Property, Plant and Equipment requires that the cost of an item of property, plant and equipment
include the initial estimate of the costs of dismantling and removing the item and restoring the site on which
it is located. The entity incurs this obligation either when the item is acquired or as a consequence of having
used the item during a particular period for purposes other than to produce inventories during that period.
Therefore, if the construction of a particular plant or its use (other than in producing inventory) causes any
contamination to land, there is an expectation that an estimate of this cost would have been made when
the asset was put in place ready for use. This cost is to be included as part of the total cost of the property,
plant and equipment, with an equivalent amount being included in the liability provisions of the entity.

CSR-RELATED CORPORATE GOVERNANCE DISCLOSURES

In 2019, the ASX Corporate Governance Council published the fourth edition of its Corporate Governance
Principles and Recommendations.
The disclosure of corporate governance information is critical for public companies and their capital
markets. Accordingly, each ASX principle includes a recommendation for disclosure of information
regarding that individual principle. This includes Recommendation 7.4, which states that ‘a listed entity
should disclose whether it has any material exposure to environmental or social risks and, if it does, how
it manages or intends to manage those risks’ (ASX CGC 2019, p. 27). These disclosures are made in the
corporate governance statement.
Appendix 4G is a key to these disclosures. Listed companies must file these two documents (corporate
governance statement and Appendix 4G) with their annual report with the ASX. Footnote 1 in the
Appendix 4G template provided by the ASX contains the following (ASX CGC 2020).
“Corporate governance statement” is defined in Listing Rule 19.12 to mean the statement referred to in
Listing Rule 4.10.3 which discloses the extent to which an entity has followed the recommendations set by
the ASX Corporate Governance Council during a particular reporting period.
Listing Rule 4.10.3 requires an entity that is included in the official list as an ASX Listing to include in its
annual report either a corporate governance statement that meets the requirements of that rule or the URL of
the page on its website where such a statement is located. The corporate governance statement must disclose
the extent to which the entity has followed the recommendations set by the ASX Corporate Governance
Council during the reporting period. If the entity has not followed a recommendation for any part of the
reporting period, its corporate governance statement must separately identify that recommendation and the
period during which it was not followed and state its reasons for not following the recommendation and
what (if any) alternative governance practices it adopted in lieu of the recommendation during that period.
Under Listing Rule 4.7.4, if an entity chooses to include its corporate governance statement on its website
rather than in its annual report, it must lodge a copy of the corporate governance statement with ASX at the
same time as it lodges its annual report with ASX. The corporate governance statement must be current as
at the effective date specified in that statement for the purposes of Listing Rule 4.10.3.
Under Listing Rule 4.7.3, an entity must also lodge with ASX a completed Appendix 4G at the same
time as it lodges its annual report with ASX. The Appendix 4G serves a dual purpose. It acts as a key
designed to assist readers to locate the governance disclosures made by a listed entity under Listing Rule
4.10.3 and under the ASX Corporate Governance Council’s recommendations. It also acts as a verification
tool for listed entities to confirm that they have met the disclosure requirements of Listing Rule 4.10.3.

Previously filed annual reports, corporate governance statements and 4G appendixes can be viewed from
the publicly available ASX announcements by searching in ‘Search for past announcements’ at www2.asx.
com.au/markets/trade-our-cash-market/todays-announcements.

NATIONAL GREENHOUSE AND ENERGY REPORTING ACT

The National Greenhouse and Energy Reporting Act 2007 (Cwlth) (NGER Act) introduced a national
framework for the reporting and dissemination of information about greenhouse gas emissions, greenhouse
gas projects, and energy use and production of corporations. From 2011, the NGER Act is administered by
the Clean Energy Regulator (CER) by virtue of the Clean Energy Regulator Act 2011 (Cwlth) (CER Act).
The aim of the CER is to reduce emissions while encouraging business competitiveness (CER 2019a).

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354 Ethics and Governance

 According to the CER website, the objectives of the NGER Act are to:
• inform government policy;
• inform the Australian public;
• help meet Australia’s international reporting obligations;
• assist Commonwealth, state and territory government programs and activities; and
• avoid duplication of similar reporting requirements in the states and territories (CER 2019b).

The first annual reporting period began on 1 July 2008. Under the NGER Act, businesses are required
to apply for registration with the CER if they:
• are a constitutional corporation
• meet a reporting threshold for greenhouse gases or energy use or production for a reporting
(financial) year.
The NGER Act requires the ultimate Australian holding company of a corporate group to apply for
registration if its corporate group exceeds any one or more of the following thresholds for a financial year
as provided in table 5.7.

TABLE 5.7 National Greenhouse and Energy Reporting Act — reporting thresholds

Reporting 2010–11 and subsequent

year 2008–09 2009–10 financial years

Facility 25 kilotonnes (kt) of 25 kt of greenhouse gas 25 kt of greenhouse gas

threshold greenhouse gas emissions emissions (CO2 equivalent) emissions (CO2 equivalent)
(CO2 equivalent) (Scope 1 and
Scope 2 emissions)

100 terajoules (TJ) of energy 100 TJ of energy consumed 100 TJ of energy consumed
consumed or produced or produced or produced

Corporate 125 kt of greenhouse gas 87.5 kt of greenhouse gas 50 kt of greenhouse gas

threshold emissions (CO2 equivalent) emissions (CO2 equivalent) emissions (CO2 equivalent)
(Scope 1 and
Scope 2 emissions)

500 TJ of energy consumed 350 TJ of energy consumed 200 TJ of energy consumed

or produced or produced or produced

Source: CER 2023, ‘Reporting thresholds’, accessed August 2023, www.cleanenergyregulator.gov.au/NGER/Reporting-cycle/

Assess-your-obligations/Reporting-thresholds.

Corporate groups that meet an NGER threshold must report their:

• greenhouse gas emissions
• energy production
• energy consumption
• other information specified under NGER legislation.
The data must generally be provided on behalf of the corporate group by its registered holding company
(known as the ‘controlling corporation’).
Aggregated greenhouse gas emissions and energy consumption data for the group will be published by
the CER for each reporting period (financial year) on a website by 28 February in the following year. In
addition, the CER may choose to publish such information for each member or business unit of the group.
Individual companies may also decide to publish this information on their corporate websites.
While the intention of the requirements is to increase corporate transparency in relation to emissions,
s. 25 of the Act does allow registered corporations providing information under the NGER Act to request
that information about a specific facility, technology or corporate initiative be withheld from publication,
if it would, or could, reveal trade secrets or other confidential information that has a commercial value
that may be destroyed or diminished as a result of its disclosure. Having said this, even if such a request
is accepted, the CER may nonetheless publish a range within which the relevant data falls.
A failure to report in accordance with the NGER Act exposes the reporting entity to penalties of up to
2000 penalty units for failure to apply for registration, and daily fines of up to 100 penalty units for each
day of non-compliance. It also exposes the executive officers of the corporation to be liable for a civil
penalty, at least where the officer knew the failure would occur (or was reckless or negligent as to whether
it would), was in a position to influence the conduct of the corporation relating to the failure, and failed to
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take all reasonable steps to prevent the contravention. This approach, of imposing liability on management
for contraventions of environmental-related legislation (which is also seen in other public good legislation
such as health and safety, and competition legislation), is increasingly common.

MODERN SLAVERY ACT 2018

Australia’s Modern Slavery Act (www.legislation.gov.au/Details/C2018A00153) requires entities based
in or operating in Australia that have consolidated revenue in excess of $100 million per reporting period,
to report on how they identify and address risks of modern slavery in their operations and supply chains.
Modern slavery relates to issues such as human trafficking and child labour.
The report takes the form of a ‘modern slavery statement’ that must:
(a) identify the reporting entity; and
(b) describe the structure, operations and supply chains of the reporting entity; and
(c) describe the risks of modern slavery practices in the operations and supply chains of the reporting
entity, and any entities that the reporting entity owns or controls; and
(d) describe the actions taken by the reporting entity and any entity that the reporting entity owns or
controls, to assess and address those risks, including due diligence and remediation processes; and
(e) describe how the reporting entity assesses the effectiveness of such actions; and
(f) describe the process of consultation with:
(i) any entities that the reporting entity owns or controls; and
(ii) in the case of a reporting entity covered by a statement under section 14 — the entity giving the
statement; and
(g) include any other information that the reporting entity, or the entity giving the statement, considers
relevant (Modern Slavery Act, s. 16(1)).

More information on modern slavery can be found at www.ag.gov.au/crime/people-smuggling-and-

human-trafficking/modern-slavery.

NATIONAL POLLUTANT INVENTORY

The National Pollutant Inventory (NPI) was the first national environment protection measure to be
established by the National Environment Protection Council (NEPC). The NEPC operates under the
National Environment Protection Council Act 1994 (Cwlth) and enables the public to find out, via the
internet, what businesses are discharging into the environment, as well as showing what actions an
organisation may be taking to reduce its emissions.
The NPI requires industrial facilities operating in Australia to estimate emissions of 93 substances
exceeding a specified threshold amount (substances reportable under the NGER Act are not required to be
reported under the NPI). The NPI reporting period is from 1 July to 30 June each year and most reporting
facilities have to lodge their reports with the NPI by 30 September each year. The relevant state or territory
environment protection agency will then assess the reports and forward them to the federal government
for inclusion on the publicly accessible NPI database (NPI n.d.).
The NPI reporting requirements are set out at www.dcceew.gov.au/environment/protection/npi/
reporting. Industry facilities estimate their emissions annually using a variety of techniques and report
these to the states and territories. The data submitted is available in the NPI database at www.dcceew.
gov.au/environment/protection/npi/data, which is accessible at no charge. A review of the NPI was released
in 2021 and is available at www.dcceew.gov.au/sites/default/files/documents/npi-review-report-2021a.
pdf. While seven recommendations were made, it was generally agreed that the current NPI model should
remain essentially unchanged.

WORK HEALTH AND SAFETY ACT 2011

In Australia most states and territories have adopted a version of the model Workplace Health and Safety
(WHS) laws. This means that persons conducting a business or undertaking (PCBU) must report notifiable
incidents involving an employee, contractor or member of the public that occur in the workplace to the
appropriate WHS regulator immediately (Safe Work Australia n.d.). Notifiable incidents include:
• death of a person
• a serious injury or illness
• a dangerous incident (Safe Work Australia n.d.).
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 The PCBU must also preserve the site where the incident occurred. Fines may be imposed for not
complying with this regulation, such as in New South Wales, where a fine can be applied of a maximum
34 630 penalty units for a corporation for gross negligence or recklessness that results in death or serious
injury or illness (Work Health and Safety Act 2011 (NSW), s. 31).
.......................................................................................................................................................................................
CONSIDER THIS
Access Safe Work Australia’s website and find out what constitutes ‘a serious injury or illness’. Is there anything listed
that surprises you?

5.25 GUIDELINES AND NON-MANDATORY

REPORTING
As indicated earlier, there has been an increased emphasis in reporting on CSR information, associated
with increased mandatory reporting regulations to support the specific initiatives. For those organisations
wishing to disclose CSR information, there are a number of guidelines and frameworks released that
suggest how organisations might report. Some organisations may feel that some of these voluntary
requirements are effectively mandatory, as the reporting is so common that it is becoming the norm, and
they will be seen to be lagging behind current practice if they do not report. Many of the underlying
practices that are being performed here (e.g. WHS or compliance with environmental regulations) are
obligatory requirements already, and so the step forward to providing some level of reporting on this
activity should not be onerous or difficult.
There is a range of organisations that develop guidance and guidelines for companies and other entities
when it comes to non-mandatory reporting. These guidelines can be adopted by any company if the board
of directors and senior management believe the reporting framework is appropriate as a tool to explain
what the business is doing in the area of CSR. Table 5.8 presents an overview of the various organisations
that develop guidelines for non-mandatory reporting of CSR information.

TABLE 5.8 Organisations developing guidance for non-mandatory reporting of CSR information

Body Description Website

Dow Jones Sustainability The Dow Jones Sustainability Indices www.spglobal.com/spdji/en/indices/

Indices provide an assessment of the sustainability esg/dow-jones-sustainability-world-
performance of leading companies. index

Equator Principles The Equator Principles provide a https://equator-principles.com

framework for financial institutions to
identify, assess and manage social and
environmental risks in the projects they
advise on or consider financing.

GHG Protocol The GHG Protocol is an international https://ghgprotocol.org

accounting framework for quantifying
greenhouse gas emissions.

Global Reporting Sustainability reporting standards have www.globalreporting.org

Initiative (GRI) been developed by the GRI since 1997,
initially as guidelines and later as a set
of formal standards. The guidelines and
reporting standards have been used by
entities around the world.

International Organization The ISO is an independent, non- www.iso.org

for Standardization (ISO)
governmental international organisation
with a membership of over 160 national
standards bodies, each of which
represents the stakeholders in
their country.

(continued)

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 TABLE 5.8 (continued)

Body Description Website

OECD Guidelines for The OECD Guidelines for Multinational www.oecd.org/corporate/mne

Multinational Enterprises
on Responsible Business
Conduct
Enterprises on Responsible Business
Conduct are a set of guidelines for
multinational businesses aimed at
promoting positive contributions by
enterprises to economic, environmental
and social progress worldwide.

United Nations Global The UNGC is a principle-based framework https://unglobalcompact.org

Compact (UNGC) containing 10 principles on which
businesses can report.

Source: CPA Australia 2023.

Although not explicitly included in table 5.8, the ISSB is also developing sustainability reporting
standards that may or may not become mandatory in different jurisdictions. Since its formation in
2021, the ISSB has been working to build on the work of existing market-led investor-focused reporting
initiatives, which have now been integrated into the ISSB. These include: the Climate Disclosure Standards
Board (CDSB), the TCFD, the Value Reporting Foundation’s Integrated Reporting Framework and the
Sustainability Accounting Standards Board (SASB).
.......................................................................................................................................................................................
CONSIDER THIS
Access Atlassian’s latest Sustainability Report. Which of the organisations listed in table 5.8 feature in the report?

Apart from the organisations listed in table 5.8, a number of Australian industry bodies have also released
their own CSR reporting guidance (and many of these make specific reference to the GRI Guidelines).
Among the Australian industry bodies that have released reporting guidance are the:
• Minerals Council of Australia, in a document titled Enduring Value: The Australian Minerals Industry
Framework for Sustainable Development (MCA 2015)
• Australian Forestry Standard, with the development of two Australian standards: Sustainable Forest
Management (AS 4708) and Chain of Custody for Forest Products (AS 4707) (Responsible Wood 2019).
We can only speculate why industry bodies such as those mentioned develop documents or codes
requiring public sustainability reporting. One perspective might be that requiring public reporting and
developing guidelines for its members could mean that mandatory (and perhaps more onerous) reporting
would not be imposed on the industry by government regulation. In a sense, industry might have sought
to capture the regulatory process.
Another reason why particular industries introduce codes and associated reporting requirements could
be that industry leaders believe they have a responsibility to disclose information to the public about how
organisations use the environmental resources entrusted to them. That is, organisations might believe they
have an accountability that should be observed. Another possible (related) perspective is that industries
seek to legitimise their practices, and ensure that they can maintain their social licence to operate and keep
within the bounds of reasonable or expected behaviours in a community.
Having considered some Australian industry guidance, we now discuss other international guidance or
initiatives that organisations might choose to voluntarily adopt. Table 5.8 isn’t an exhaustive list of the
organisations providing guidance, but it does include the major organisations, each of which will now be
explored in more detail.

DOW JONES SUSTAINABILITY INDICES

The Dow Jones Sustainability World Index (DJSI n.d.) was launched in 1999 and provides a global
sustainability benchmark that tracks the share performance of a set of the world’s leading companies chosen
on the basis of a sustainability score calculated from specific economic, environmental and social criteria.
The economic criteria include corporate governance and risk management. The environmental criteria
include the company’s environmental reporting performance. The social criteria include labour practices,
philanthropy and human resources practices. The assessment against these criteria is based on a range of
publicly available information and direct contact with the companies.
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358 Ethics and Governance

 The index uses a ‘best in industry’ approach rather than excluding particular industries. The DJSI World
index and the corresponding DJSI the regional and country levels serve as benchmarks for investors who
wish to integrate sustainability considerations into their portfolios.

EQUATOR PRINCIPLES
The Equator Principles are a voluntary set of standards intended to act as a framework for financial
institutions to identify, assess and manage social and environmental risks in the projects they advise on
or consider financing. Specifically, the framework aims to ensure that negative impacts on communities,
ecosystems and the climate are, ideally, avoided or otherwise are minimised, mitigated or offset.
Originally launched in 2004, the Equator Principles have been revised over time, with the third version
released in 2013 and the fourth version (EP4) was released in July 2020 with effect from 1 October 2020
(EP Association 2020).
Equator Principles Financial Institutions (EPFIs):
• will not provide:
1. Project Finance
2. Project-Related Corporate Loans to Projects, or
3. Project-Related Refinance and Project-Related Acquisition Finance to Projects
which do not comply with the relevant Equator Principles requirements.
• will request that the client communicates its intention to adhere to the requirements of the Equator
Principles when subsequently seeking long term financing as:
4. Bridge Loans, and
5. Project Finance Advisory (EP Association 2020, pp. 3–4).

The 10 Equator Principles apply across all industry sectors with varying thresholds for each of the
five financial product categories listed. This includes project capital costs in categories 1 and 2 of
USD10 million or more and for category 3 loan amounts of USD50 million or more for loan periods
of two years or longer.
The principles include Principle 3, which assesses the extent to which projects comply with applicable
environmental and social standards. Due diligence will include evaluation against:
• host country legislation in relation to environmental and social issues,
• the International Finance Corporation’s 2012 Performance Standards on Environmental and Social
Sustainability (IFC 2012), and
• the World Bank’s 2007 Environmental, Health, and Safety Guidelines to be used in conjunction with
the relevant industry sector guidelines (World Bank 2007).
Principle 7 states that the assessment process used under Principle 3 must be subject to independent
review including how any non-compliance might be addressed.
Principle 1 states that the EPFI will place all projects into one of the following three categories.
• Category A — Projects with potential significant adverse environmental and social risks and/or impacts
that are diverse, irreversible or unprecedented;
• Category B — Projects with potential limited adverse environmental and social risks and/or impacts that
are few in number, generally site-specific, largely reversible and readily addressed through mitigation
measures; and
• Category C — Projects with minimal or no adverse environmental and social risks and/or impacts (EP
Association 2020, p. 8).

As at August 2023, there were 140 EPFIs across 39 countries including five from Australia, 10 from
Japan and five from the United States. All EPFIs report annually.
.......................................................................................................................................................................................
CONSIDER THIS
Visit the Equator Principles website (https://equator-principles.com/members-reporting) and access one EPFI’s
report to see how they report against their Equator Principles commitment (Citigroup, OCBC or ANZ might be good
candidates). Also take note of the other reporting frameworks they use.

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THE GREENHOUSE GAS PROTOCOL
The Greenhouse Gas Protocol (GHG Protocol) is one of the most widely used international accounting
frameworks for quantifying greenhouse gas emissions. The GHG Protocol represents a partnership
between the World Resources Institute (an environmental ‘think tank’ in Washington DC that receives
funding from a large number of corporate donors) and the World Business Council for Sustainable
Development (a coalition of 200 international companies). The GHG Protocol is used by many greenhouse
gas (GHG) standards and programs throughout the world. For example, it provides the basis for quantifying
GHG emissions under the NGER Act in Australia, and the EU Greenhouse Gas Emissions Allowance
Trading Scheme (EU ETS), both of which were discussed in section 5.24.
The GHG Protocol was designed with the following objectives in mind.
• To help companies prepare a GHG inventory that represents a true and fair account of their emissions,
through the use of standardised approaches and principles.
• To simplify and reduce the costs of compiling a GHG inventory.
• To provide business with information that can be used to build an effective strategy to manage and reduce
GHG emissions.
• To increase consistency and transparency in GHG accounting and reporting among various companies
and GHG programs (WRI & WBCSD 2005, p. 3).

The GHG Protocol has been enhanced since its introduction in 2001 and each of the individual standards
and protocols in force at the time of writing is briefly described below (GHG Protocol n.d.b).
The Corporate Accounting and Reporting Standard (Corporate Standard) provides methodologies for
businesses and other organisations to report their total emissions of greenhouse gases covered by the
Kyoto Protocol:
• CO2 (carbon dioxide)
• CH4 (methane)
• N2 O (nitrous oxide)
• HFCs (hydrofluorocarbons)
• PFCs (perfluorocarbons)
• SF6 (sulphur hexafluoride)
• NF3 (nitrogen trifluoride).
The Protocol for Project Accounting (Project Protocol) is a set of methods and principles to enable
organisations to quantify the greenhouse gas benefits of projects that aim to mitigate climate change by:
• reducing greenhouse gas emissions (e.g. using less fossil fuel–generated energy)
• removing greenhouse gases from the atmosphere (e.g. planting forests)
• storing greenhouse gases (e.g. growing forests or sequestering gases underground).
The Project Protocol is supported by industry-specific guidance for land use and forestry, and
electricity projects.
The Corporate Value Chain (Scope 3) Accounting and Reporting Standard enables companies to assess
the emissions impact of their entire value chain and thus identify which aspects present the most potential
for emission reductions. Scope 3 emissions are those generated by others in the wider economy as a
consequence of an organisation’s activities. An example would be emissions caused by airline travel
undertaken by an organisation’s staff in the course of their work activities. The standard provides a method
for accounting for Scope 3 emissions upstream and downstream of a company’s operations and facilitates
partnering with suppliers and customers to reduce climate change impacts throughout the value chain.
The Product Life Cycle Accounting and Reporting Standard presents a methodology to evaluate the full
life cycle emissions of a product. This helps organisations evolve towards more sustainable products, as
they can measure the greenhouse gases associated with each aspect of a product’s life cycle, including
raw materials, manufacturing, transportation, storage, use and disposal and thus focus on specific efforts
to reduce emissions at each stage. The standard is also expected to help organisations communicate with
stakeholders about the environmental aspects of their products.
The GHG Protocol for Community-Scale Greenhouse Gas Emission Inventories provides a method for
identifying, measuring and reporting the emissions of a city. This enables the inhabitants and administrators
of cities to understand the sources of their emissions, take targeted action to reduce emissions, and measure
and assess their progress from one period to another. Hundreds of cities around the world have committed
to using the protocol. The protocol also supports aggregation of data to inform regional- and national-level
emissions inventories.
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 The GHG Protocol Mitigation Goal Standard is intended to provide government agencies with guidance
for developing GHG emission mitigation goals and monitoring and reporting how their policies and actions
are contributing to progress towards meeting those targets. The standard is supported by a variety of tools,
including a calculation tool and reporting templates. The standard was developed in conjunction with the
Policy and Action Standard, described next.
The GHG Protocol Policy and Action Standard provides a standardised methodology for estimating and
reporting how specific policies and actions (principally those of government) have impacted on greenhouse
gas emissions and removals. It works alongside the Mitigation Goal Standard described above. Together
they help identify the most effective areas to target for mitigation and assist with reporting of comparable
data to assess and demonstrate progress against the goals.
The greenhouse gas protocol is referenced by most emissions reporting guidance and standards and
legislation including IFRS S2, the GRI standards, the ESRSs, ISO’s IWA 42:2022(E) Net Zero guidelines
and the NGER Act.

THE GLOBAL REPORTING INITIATIVE

Arguably, the most widely accepted CSR or sustainability reporting guidance is produced by the Global
Reporting Initiative (GRI). The GRI is an international, multi stakeholder effort to create a common
but credible framework for voluntary reporting of the economic, environmental and social impact of
organisational-level activity (GRI n.d.a).
The GRI was launched in 1997 as an initiative to develop a globally accepted reporting framework to
enhance the quality of sustainability reporting. It is a joint initiative of the Coalition of Environmentally
Responsible Economies (CERES) and the Tellus Institute with involvement of the United Nations
Environment Program (UNEP). The aim is to enhance transparency, comparability and clarity, amongst
other principles.
The GRI’s first reporting guidelines were released in 2000 and were further developed over the following
years before being replaced in 2016 by a set of GRI standards. These standards were further amended in
October 2021 with three types — universal, sector and topic — effective from 1 January 2023.
The standards were developed through years of consultation with experts and stakeholders and are
intended to represent global best practice for reporting on economic, environmental and social impacts.
Organisations that adopt the GRI standards use three universal standards — GRI 1: Foundation 2021,
GRI 2: General Disclosures 2021 and GRI 3: Material Topics 2021 — and then apply sector and topic-
specific standards that suit their characteristics and topics that they identify as material.
When reporting, organisations can either report:
• ‘in accordance with the GRI Standards. Under this approach, the organization reports on all its material
topics and related impacts and how it manages these topics’ or
• ‘with reference to the GRI Standards’. Under this approach an organisation uses ‘only selected
GRI Standards or parts of their content’ (GRI n.d.b, p. 5).
GRI 1 contains eight reporting principles:
• accuracy
• balance
• clarity
• comparability
• completeness
• sustainability context
• timeliness
• verifiability (GRI 2021).
GRI 2 specifies the general disclosures that all reporters need to make while GRI 3 explains how to
determine and manage an organisation’s most material topics, and also includes how the Sector Standards
are incorporated into the process.
To date (August 2023) three Sector Standards have been released: GRI 11: Oil and Gas Sector 2021,
GRI 12: Coal Sector 2021 and GRI 13: Agriculture, Aquaculture and Fishing Sectors 2021.
The 200, 300 and 400 series of Topic Standards set out the economic, environmental and social
disclosures that need to be made for material topics. These include GRI 207: Tax 2019, GRI 306: Waste
2020 and GRI 411: Rights of Indigenous Peoples 2016 and are updated on a needs basis.
Many organisations worldwide report in accordance with the GRI standards and there is a degree of
interoperability between the GRI standards, the ESRSs and IFRS 1 and 2.
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.......................................................................................................................................................................................
CONSIDER THIS
Download GRI 1 and compare the list of reporting principles with the Conceptual Framework discussed in part A of
this module.

INTERNATIONAL ORGANIZATION FOR STANDARDIZATION

ISO is an independent, non-government body that produces international standards on a range of topics.
A standard generally contains practical information and best practice guidance and possibly an agreed way
of doing something or a solution to a global problem (ISO 2019). In the sustainability space the following
standards contain relevant guidance.
• ISO 14001:2015 Environmental management systems — Requirements with guidance for use and related
standards including:
– ISO 14007:2019 Guidelines for determining environmental costs and benefits
– ISO 14008:2019 Monetary valuation of environmental impacts and related environmental aspects
– ISO 14015:2022 Guidelines for environmental due diligence assessment
– ISO 14016:2022 Guidelines on the assurance of environmental reports
• ISO 26000:2010 Social responsibility
• ISO 31000:2018 Risk management — Guidelines (ISO 2023).
The development of standards is done by technical committees with each committee supported by the
central secretariat. Once standards are published, they are available for the public to buy and use. Some ISO
standards (management system standards) are supported by a certification process that allows organisations
to publicise their certification or use it in tendering or for contractual purposes (ISO 2019).

OECD GUIDELINES FOR MULTINATIONAL ENTERPRISES ON

RESPONSIBLE BUSINESS CONDUCT
The OECD Guidelines for Multinational Enterprises on Responsible Business Conduct (OECD 2023)
(OECD Guidelines) are ‘not legally binding on companies, but they are binding on signatory governments,
which are required to ensure the Guidelines are implemented and observed’ (OECD n.d.). An updated set
of the OECD Guidelines was released in 2023, with the changes including ‘updated recommendations for
responsible business conduct across key areas, such as climate change, biodiversity, technology, business
integrity and supply chain due diligence, as well as updated implementation procedures for the National
Contact Points for Responsible Business Conduct’ (OECD 2023).
The OECD Guidelines aim to promote positive contributions by enterprises to economic, environmental
and social progress worldwide.
The OECD Guidelines for Multinational Enterprises on Responsible Business Conduct (the Guidelines)
are recommendations addressed by governments to multinational enterprises. The common aim of the
Adherents to the Guidelines is to encourage the positive contributions enterprises can make to economic,
environmental, and social progress and to minimise the adverse impacts on the matters covered by the
Guidelines that may be associated with an enterprise’s operations, products and services. Responsible
business conduct can enable the creation of a level playing field across global markets, foster a dynamic
and well-functioning business sector, and enhance the business contribution to sustainable development
outcomes, including solutions to address and respond to climate change (OECD 2023, p. 10).

Within the OECD Guidelines, it is stated that enterprises should take into account the established
policies of the countries in which they operate and consider the views of other stakeholders. Enterprises
should contribute to economic, environmental and social progress with a view to achieving sustainable
development. In relation to the environmental obligations, the OECD Guidelines state:
Within the framework of laws, regulations and administrative practices in the countries in which they
operate, and in consideration of relevant international agreements, principles, objectives, and standards,
enterprises should conduct their activities in a manner that takes due account of the need to protect the
environment, and in turn workers, communities and society more broadly, avoids and addresses adverse
environmental impacts and contributes to the wider goal of sustainable development (OECD 2023, p. 33).

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362 Ethics and Governance

UNITED NATIONS GLOBAL COMPACT
The UNGC was designed by the office of the Secretary-General, then Kofi Annan, with input from the
International Chamber of Commerce. The UNGC is a principle-based framework for businesses, with a
set of 10 principles. It is the world’s largest corporate citizenship initiative and, as a voluntary initiative, it
exists to assist the private sector in the management of risks and opportunities in the environmental, social
and governance realms with the purpose of achieving the UN’s SDGs by 2030. To make this happen, the
UNGC supports companies to:
1. Do business responsibly by aligning their strategies and operations with Ten Principles on human rights,
labour, environment and anti-corruption; and
2. Take strategic actions to advance broader societal goals, such as the forthcoming UN Sustainable
Development Goals, with an emphasis on collaboration and innovation (UNGC n.d.a).

Businesses become signatories to the UNGC and demonstrate actions to support the principles by
submitting formal ‘Communications on progress’ on an annual basis. The UNGC’s principles are
derived from:
• the Universal Declaration of Human Rights
• the International Labour Organization’s Declaration on Fundamental Principles and Rights at Work
• the Rio Declaration on Environment and Development
• the United Nations Convention Against Corruption.
The UNGC asks companies to embrace, support and enact, within their sphere of influence, a set of
core principles in the areas of human rights, labour standards, the environment and anti-corruption. The
principles are as follows.
Human rights
Principle 1: Businesses should support and respect the protection of internationally proclaimed human
rights; and
Principle 2: make sure that they are not complicit in human rights abuses.
Labour
Principle 3: Businesses should uphold the freedom of association and the effective recognition of the right
to collective bargaining;
Principle 4: the elimination of all forms of forced and compulsory labour;
Principle 5: the effective abolition of child labour; and
Principle 6: the elimination of discrimination in respect of employment and occupation.
Environment
Principle 7: Businesses should support a precautionary approach to environmental challenges;
Principle 8: undertake initiatives to promote greater environmental responsibility; and
Principle 9: encourage the development and diffusion of environmentally friendly technologies.
Anti-Corruption
Principle 10: Businesses should work against corruption in all its forms, including extortion and bribery
(UNGC 2011, p. 6).

As at August 2023, there were over 17 000 participants from over 160 countries involved in the compact.
This included 380 participants from Australia, 443 from India, 248 from Malaysia and 1098 from the
United States (UNGC n.d.b). Australian organisations that have signed up to the principles include Telstra,
National Australia Bank, ANZ Bank, Wesfarmers, Commonwealth Bank, BHP and Westpac.
The UNGC is also responsible for the setting of sustainable development goals (SDGs) and for reporting
progress towards them. The Sustainable Development Goals Report 2023 (special edition) shows that
‘progress on more than 50 per cent of targets of the SDGs is weak and insufficient; on 30 per cent, it has
stalled or gone into reverse’ (UN 2023, p. 2). This is shown in figure 5.5.

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 FIGURE 5.5 Progress assessment for the 17 Sustainable Development Goals 2023 or latest data

G1
G2
G3
G4
G5
G6
G7
G8
G9
G10
G11
G12
G13
G14
G15
G16
G17

0 10 20 30 40 50 60 70 80 90 100

On track or target met Fair progress, but acceleration needed

Stagnation or regression Insufficient data
Source: UN 2023, The Sustainable Development Goals Report 2023 (special edition), p. 8, 10 July, accessed August 2023, https://
unstats.un.org/sdgs/report/2023.
.......................................................................................................................................................................................
CONSIDER THIS
Visit the website of the UNGC (https://unglobalcompact.org/sdgs) to locate the indicators for Goal 11, then reflect
on why the progress and availability of data for that goal might be so poor. How might this be related to CSR?

QUESTION 5.8

This section has discussed a number of major reporting frameworks. Outline the benefit of reporting
frameworks for organisations and stakeholders.

5.26 OTHER INITIATIVES

SOCIAL AUDITS
Earlier in this module, we discussed the importance of organisations complying with community expecta-
tions and the necessity for organisations and industries to comply with the social contract. We noted that
failure to comply with community expectations can have significant implications for the profitability and
survival of an organisation.
With the above in mind, many organisations undertake a ‘social audit’ (which should not be confused
with an audit or verification of an organisation’s social and environmental impact or CSR report). A
social audit can be seen as representing the process an organisation undertakes to investigate whether
it is perceived, by particular stakeholder groups, to be complying with the social contract (their social
responsibilities). Social responsibilities include practices both within the organisation and across its supply
chain in relation to:
• labour practices (conditions of work, health and safety at work, training in the workplace)
• fair operating practices (anti-corruption, fair competition, social responsibility in the value chain)
• consumer issues (fair marketing and contractual practices, consumer health and safety, dispute resolu-
tion, consumer data protection and privacy).
Many organisations provide guidance and assessment frameworks for social audits including:
• ISO with ISO 26000
• Social Accountability International with SA 8000
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364 Ethics and Governance

• the International Labour Organisation (ILO) through its International Labour Standards (note that the
ILO also maintains several databases including NATLEX, a database of national labour, social security
and related human rights legislation)
• the Ethical Trading Initiative through its Base Code
• the Supplier Ethical Data Exchange (SEDEX) through its SEDEX Members Ethical Trade Audit
(SMETA)
• the Sustainable Apparel Coalition with the Higgs Index
• World Responsible Accredited Production through its WRAP program
• amfori (previously the Foreign Trade Association) with its Business Social Compliance Initiative
(BCSI).
Figure 5.6 presents a list of the principles contained in the BSCI code of conduct.

FIGURE 5.6 BSCI code of conduct principles

The Rights of Freedom of Association and Collective Bargaining

Our enterprise respects the right of workers to form unions or other kinds of worker’s associations and to
engage in collective bargaining.
Fair Remuneration
Our enterprise respects the right of workers to receive fair remuneration.
Occupational Health and Safety
Our enterprise ensures a healthy and safe working environment, assessing risk and taking all necessary
measures to eliminate or reduce it.
Special Protection for Young Workers
Our enterprise provides special protection to any workers that are not yet adults.
No Bonded Labour
Our enterprise does not engage in any form of forced servitude, trafficked or non-voluntary labour.
Ethical Business Behaviour
Our enterprise does not tolerate any acts of corruption, extortion, embezzlement or bribery.
No Discrimination
Our enterprise provides equal opportunities and does not discriminate against workers.
Decent Working Hours
Our enterprise observes the law regarding hours of work.
No Child Labour
Our enterprise does not hire any worker below the legal minimum age.
No Precarious Employment
Our enterprise hires workers on the basis of documented contracts according to the law.
Protection of the Environment
Our enterprise takes the necessary measures to avoid environmental degradation.
Source: amfori 2023, ‘The amfori BSCI Code of Conduct’, accessed August 2023, www.amfori.org/content/amfori-bsci-
code-conduct-.

The results of a social audit often form an important component of an entity’s publicly released social
report, which in itself might form part of a broader CSR or sustainability report. To prevent organisations
presenting social audit information that is not legitimate, many of these framework providers also offer a
certification process, some of which are administered by social compliance auditors. The Association of
Professional Social Compliance Auditors (APSCA) is one of the industry associations that supports social
compliance auditors.
.......................................................................................................................................................................................
CONSIDER THIS
Access the Ethical Trade Initiative’s Base Code (www.ethicaltrade.org/eti-base-code) and compare it to the BSCI
code of conduct. Are there any differences?

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 QUESTION 5.9

(a) What is a social audit and why would an organisation undertake one?
(b) Why would the results of a social audit be incorporated in an organisation’s CSR report?

CORPORATE GOVERNANCE MECHANISMS AIMED AT

IMPROVING SOCIAL AND ENVIRONMENTAL PERFORMANCE
We previously highlighted the updated Recommendation 7.4 in the ASX Corporate Governance Principles
and Recommendations (ASX CGC 2019). This recommendation states that an ‘entity should disclose
whether it has any material exposure to environmental or social risks and, if it does, how it manages or
intends to manage those risks’.
Embedding a sustainability focus into an organisation’s corporate governance systems and processes
is a challenge. Because CSR is driven by cultural and behavioural elements, it can be difficult to bring
about meaningful change with regulation alone. However, a more sustainable business can be achieved
in a number of ways. Sustainability policies, strategies and performance risk indicators need to be
developed as an integral part of the overall corporate strategy to reflect the requirements of sustainable
development as well as the priorities of stakeholders. Strategies should clarify corporate responsibility
positioning decisions in light of benchmarking information. Business strategy alignment should also be
periodically validated.
Companies can put in place formal structures that have a strong sustainability focus. For example,
many organisations now have formal board committees dedicated to sustainability issues and also appoint
environmental managers who report directly to the board.
A stakeholder engagement process can also be part of a well-functioning corporate governance system.
Companies often do not understand their stakeholders well and, as a result, many do not even try to
encourage their participation in shaping the future of the company. Stakeholder engagement involves
discovering what really matters to the key stakeholders, providing them with feedback on corporate
strategies and performance, and identifying what and how things can be changed.
An influential source of guidance on corporate governance as it relates to the environment is the
International Organization for Standardization’s (ISO) 14000 family of standards (ISO n.d.). Of most
relevance to this topic is ISO 14001 Environmental Management Systems — Requirements with Guidance
for Use, which was originally issued in 1996, with a third revised edition published in September
2015. Many organisations throughout the world have voluntarily elected to comply with this standard.
The standard recommends that senior management of an organisation devise an environmental policy,
which must include a commitment to both compliance with environmental laws and company policies,
continual improvement and prevention of pollution. Once the policy is put together, a system is then
created and documented that ensures that the environmental policy is carried out by the organisation. This
involves planning, implementation and operations, checking and corrective action, and management review
(ISO 2014).
Another relevant release from the ISO is ISO 26000, Guidance on Social Responsibility, which provides
guidance on social responsibility for all types of organisations. This includes guidance on:
(a) Concepts, terms and definitions related to social responsibility;
(b) Background, trends and characteristics of social responsibility;
(c) Principles and practices relating to social responsibility;
(d) Core subjects and issues of social responsibility;
(e) Integrating, implementing and promoting socially responsible behaviour throughout the organisation
and, through its policies and practices, within its sphere of influence;
(f) Identifying and engaging with stakeholders; and
(g) Communicating commitments, performance and other information related to social responsibility (ISO
2010, p. 7).

KPMG’s Survey of sustainability reporting 2022 expands on the links between compensation and the
achievement of targets.
Sustainability-linked compensation at leadership levels can improve performance in areas such as meeting
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climate goals and increasing diversity. The inclusion of sustainability targets and metrics into compensation

366 Ethics and Governance

 also sends a signal to investors and other stakeholders that the company’s leadership is serious about
sustainability.
KPMG professionals researched whether companies include sustainability-linked compensation for their
Board or leadership. So far, 40 per cent of G250 companies use it. This is a positive indicator, as practices
within the G250 tend to filter into the N100. Currently, less than one-quarter of N100 companies compensate
their leaders based on attainment of sustainability-based goals (24 per cent) (KPMG 2022, p. 72).

This indicates that some companies are using this governance mechanism in an effort to meet
sustainability targets.

ENVIRONMENTAL MANAGEMENT ACCOUNTING

While a great deal of our discussion relates to the external reporting of CSR information, there are
numerous ways that CSR information can be used internally to increase the efficiency of an organisation —
both from a financial and an environmental perspective (the so-called win-win scenario). One such way
is through the introduction of environmental management accounting. The International Federation of
Accountants (IFAC) defines environmental management accounting broadly as:
The management of environmental and economic performance via management accounting systems and
practices that focus on both physical information on the flow of energy, water, materials, and wastes, as
well as monetary information on related costs, earnings and savings (IFAC 2005, p. 16).

The Association of International Certified Professional Accountants (AICPA) and the Chartered Institute
of Management Accountants (CIMA) adopt this definition (CGMA 2019). To assess costs correctly,
it is important to collect both financial and non-financial data (e.g. materials use, personnel hours and
other cost drivers). Environmental management accounting places a particular emphasis on materials and
materials-driven costs because the use of energy, water and materials, as well as the generation of waste
and emissions, is directly related to many of the effects organisations have on their environments.
Many organisations purchase energy, water and other materials to support their activities. For example,
in a manufacturing organisation, some of the purchased material is converted into a final product that is
delivered to customers. But most manufacturing operations also produce materials that were intended to
go into the final product but became waste instead because of operating inefficiencies or product quality
issues. Manufacturing operations also use energy, water and materials that are never intended to go into
the final product but were to manufacture the product (such as water to rinse out chemicals). Many of
these materials eventually become waste streams that must be managed. In addition, most organisations
generate greenhouse gas emissions as part of their operations, often through energy use, but potentially
directly as well.
One of the first steps required when implementing an environmental management accounting system is
to define which environmental costs will be accounted for (or managed).
AICPA and CIMA (CGMA 2019) categorise environmental costs as:
• prevention costs — associated with preventing adverse impacts on the environment
• appraisal costs — associated with assessing compliance with policies related to environmental
performance
• internal failure costs — associated with eliminating environmental impacts caused by the organisation
• external failure costs — associated with environmental damage caused outside the organisation.
Thus, the costs to be accounted for may be restricted to those currently recognised by an organisation
pursuant to ‘conventional’ accounting practices or they could be extended to include externalities. Where
focus is on costs currently being recognised, it might be that the way they are currently being accounted
for is impeding efforts to improve an organisation’s operations. It is possible for potentially important
environmental costs to be hidden in the accounting records, where a manager cannot find them easily. One
particularly common way in which environmental costs may be hidden is if they are assigned to overhead
accounts rather than directly to the processes or products that created the costs. The opinion that overhead
accounts can conceal or even distort information relating to environmental costs is not new and is consistent
with the views of the United Nations Division for Sustainable Development:
Conventional management accounting systems attribute many environmental costs to general overhead
accounts, with the consequence that product and production managers have no incentive to reduce
environmental costs and executives are often unaware of the extent of environmental costs … A rule
of thumb of environmental management is that 20 per cent of production activities are responsible for
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 80 per cent of environmental costs. When environmental costs are allocated to overhead accounts shared
by all product lines, products with low environmental costs subsidize those with high costs. This results in
incorrect product pricing which reduces profitability (UNDSD 2001, p. 1).

The accumulation of various costs (overheads) in overhead accounts is something that many of us
have been taught as part of our accounting education despite the fact that doing so can impede our
organisation’s ability to manage the consumption of various overheads, all of which may have environmental
consequences. That is, the practice of using overhead accounts can counter other initiatives implemented to
address CSR. Where a variety of costs are being accumulated in overhead accounts, subsequent allocation
of the accumulated costs to particular products are frequently made in terms of such bases as sales volume,
production output, floor space occupied by particular departments, machine hours or labour hours. This
might, however, be an inaccurate way to allocate some typical environmental costs.
While making the task of cost allocation easier, using such simplistic allocation bases as those identified
above may lead to the misallocation of many costs, including those relating to the environment. An example
would be hazardous waste disposal costs, which could be high for a product line that uses hazardous
materials and low for one that does not. In this case, the allocation of hazardous waste disposal costs
on the basis of production volume would be inaccurate, as would be product pricing and other decisions
based on that information. The overarching benefit of environmental management accounting is better
informed decisions. More specifically, AICPA and CIMA (CGMA 2019) suggest the benefits of explicitly
identifying environmental costs are improved sales, reduced sales erosion, reduced costs (through reduced
waste), reduced costs of environmental remediation and improved reputation. Additional benefits could
include identifying opportunities that might lead to new revenues through recycling; pricing that more
accurately reflects the non-monetary costs of production; and the creation of societal benefits through
reduced environmental impacts.
Different approaches can be taken to resolve the issue of hidden environmental costs. One common
solution is to set up separate cost categories for the more obvious and discrete environmental management
activities. The less obvious costs that will still appear in other accounts will need to be more clearly
labelled as environmental so they can be traced more easily. An assessment of the relative importance
of environmental costs and cost drivers of different process and product lines, in line with the general
practice of activity-based costing (ABC), can help an organisation determine whether the cost allocation
bases being used are appropriate for those costs.
From the above discussion, we can see that simply changing the way we accumulate and allocate costs
can provide us with an enhanced ability to understand and control various environmental costs. Apart
from the way we accumulate costs, opportunities relating to reducing such things as waste can also be
enhanced if we classify particular costs differently. What should be understood at this point is that relatively
inexpensive changes to an entity’s accounting system can be made that might lead to real changes in the
ability to control resource usage.
Another potential problem with environmental management accounting is that accounting records do
not usually contain information on future environmental costs, even though they may be quite significant.
As outlined earlier, accounting records also lack many other less tangible environmental costs. An example
is costs incurred when a poor environmental performance results in lost sales to customers who care about
environmental issues. These types of costs may be difficult to estimate, but they can be both real and
significant to an organisation’s financial health.
What should be appreciated is that we, as accountants, can make modifications to our current accounting
systems to assist our organisations to act in a more environmentally responsible manner. Apart from
enabling better management within an organisation, such modifications will also enable us to provide
a better account of certain costs (e.g. waste) to external stakeholders.

CIRCULAR ECONOMY
The concept of the circular economy is of increasing interest to businesses. The circular economy
represents a new model for production and consumption that goes beyond traditional linear material use,
and focuses on ensuring materials and products stay within the production and consumption cycle for
as long as possible. Originally, in order to achieve a circular economy, the focus was on the three Rs:
reduce, reuse and recycle. However, recently, this has been expanded to also include: redesign, repair,
renew and recover. Internationally, many countries are encouraging a shift towards circular thinking via
policy development. Such countries include the Netherlands, China and Japan.
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 It has been argued that accounting systems are needed if countries and businesses are to successfully
transition to a circular economy. While accounting for the circular economy remains challenging, select
groups are working to change this. One such group is Coalition Circular Accounting (CCA) based in
the Netherlands. Information about this group can be found at www.circle-economy.com/programmes/
finance/coalition-circular-accounting.

5.27 SURVEYS OF REPORTING PRACTICE

Producing a stand-alone CSR report has become a widespread practice. One way to understand the extent
of reporting is through various surveys undertaken by different organisations. In this regard, and for a
number of years, KPMG has been undertaking international surveys of CSR reporting. KPMG analysed
the reports of more than 4100 companies globally in 2013 — including the world’s 250 largest companies.
Its results led KPMG to conclude that ‘the high rates of [CSR] reporting in all regions suggest it is now
standard business practice worldwide’ (KPMG 2013, p. 11). KPMG results showed the following.
• Of the 250 largest companies in the world (G250 companies), 93 per cent reported on their CR activities
(KPMG 2013, p. 22).
• CSR reporting rates in Asia-Pacific over the two years to 2013 dramatically increased (KPMG 2013,
p. 11), with 71 per cent of companies based in Asia-Pacific publishing a CSR report. This was an increase
of 22 per cent since 2011 when less than half (49 per cent) did so.
• Australia was one of the 41 countries surveyed that saw the highest growth in CSR reporting since
2011, with a growth rate of 25 per cent. The other countries that saw significant growth were India
(+53 per cent), Chile (+46 per cent) and Singapore (+37 per cent) (KPMG 2013, p. 11). These growth
rates emphasised the increase in CSR reporting in the Asia-Pacific region.
• More than half of the organisations for all industry sectors reported on CSR, meaning reporting could
be considered standard global practice irrespective of industry. In the 2011 KPMG survey, less than half
of the sectors had reporting rates above 50 per cent.
• Worldwide, more than half (51 per cent) of the reporting companies included CSR information in their
annual financial reports (KPMG 2013, p. 11). This was a significant increase over the previous two
surveys. In 2011 only 20 per cent reported this way, while in 2008 only 9 per cent reported this way.
This emphasised the increasing importance given to this information and, as KPMG stated, this type of
reporting could arguably be considered standard global practice.
• However, including CSR information in the annual report does not imply that companies have embraced
the concept of integrated reporting (discussed earlier in this module). Integrated reports are published
by only one in 10 companies that report on CSR (KPMG 2013, p. 12). This is because integrated
reporting is an evolving practice involving iterative application by companies that have sought to apply
the framework.
The latest KPMG survey completed in 2022 had a larger sample size with 5800 companies from
58 countries, territories and jurisdictions reviewed (KPMG 2022, p. 3). Key findings from that survey
include the following.
• The number of the world’s largest companies that acknowledge climate change as posing a financial
risk to their business increased to 64 per cent (KPMG 2022, p. 9).
• UN SDGs were included within 74 per cent of reports from the top 250 companies in the world (KPMG
2022, p. 57). However, reporting on the SDGs was noted to focus on quantity over quality (KPMG 2022,
p. 10).
• The focus is now on ESG as opposed to CSR with 46 per cent of companies surveyed reporting on
environmental risks, 43 per cent reporting on social risks and 41 per cent reporting on governance risks
(KPMG 2022, p. 62).
• The United Kingdom and South Africa were found to be leading the world across reporting on all ESG
areas (KPMG 2022, p. 62).
• Less than half of the companies surveyed are reporting on biodiversity loss (KPMG 2022, p. 9).
• For the first time, the survey considered the role of the board in taking responsibility for sustainability-
related matters. Only 34 per cent of the entire sample had leadership-level representation related
to sustainability, although this increased slightly (to 45 per cent) when considering the largest
250 companies in the world (KPMG 2022, p. 70).
• The rate of independent assurance of sustainability reporting information has almost doubled among
the largest Chinese companies but remained steady elsewhere, with 63 per cent of the largest companies
now seeking some kind of assurance for their reports (KPMG 2022, p. 34).
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 While the survey results are interesting, they fail to reflect that organisations can, and do, report
information selectively and that voluntary reporting gives an opportunity for organisations to only elect to
report typically favourable information about their economic, social and environmental performance.
.......................................................................................................................................................................................
CONSIDER THIS
Download the KPMG Survey of Corporate Responsibility Reporting 2022 (https://assets.kpmg.com/content/dam/
kpmg/xx/pdf/2022/10/ssr-small-steps-big-shifts.pdf) and note the areas in which company reporting is strongest
and the areas in which it is weakest. What measures could be implemented to improve the quality of reporting
by companies?

5.28 EXAMPLES OF BEST PRACTICE AND

INNOVATIVE REPORTING
In this section, we briefly consider some cutting‐edge CSR reports and provide illustrations of reporting
that appears to be relatively innovative. As we would expect, given the predominantly voluntary nature
of CSR reporting, there are often variations in the quality of reporting, although arguably, at least within
larger corporations, the difference between the standards of reporting is decreasing to some extent.
One approach we can adopt to identify cutting edge CSR reporters is to review the results of annual CSR
or sustainability reporting awards. A leading example of one of these awards is that run by Australasian
Reporting Awards Limited (ARA n.d.), an independent not-for-profit organisation supported by volunteer
professionals from the business community and professional bodies concerned about the quality of
financial and business reporting. The awards provide an opportunity for organisations to benchmark their
reports against the ARA criteria, and are open to all organisations that produce an annual report. The
winner of the 2019 ARA Report of the Year Awards was seafood company Sanford Limited. Sanford had
taken great care to communicate its vision and strategic outcomes, including sustainability, environment
and integrity issues. In addition to the successes, the judges commended the company for acknowledging
the less positive results among its overall performance and explaining how they could be turned around
in future. CLP Holdings won the sustainability report of the year; Lendlease won the integrated reporting
award; and Woodside Petroleum won the governance reporting award (ARA 2019).
There are other report awards that are also used to reward and encourage reporting innovation. The
Finance for the Future Awards, which was founded by the Institute of Chartered Accountants in England
and Wales, the Prince’s Accounting for Sustainability Project and the Asia Sustainability Reporting
Awards, are examples. These awards seek to highlight enhanced non-financial reporting to stakeholders.
.......................................................................................................................................................................................
CONSIDER THIS
Visit the Finance for the Future Awards website (www.financeforthefuture.org) and find the page that outlines the
awards criteria. Take note of what the convenors of the awards see as being particularly important.

These awards might also serve to motivate organisations to improve the quality of information provided
and increase the number of companies making such disclosures. The awards aim to identify and reward
innovative attempts to report CSR-related information. The judging criteria of such awards can be used as
guidance in determining what and how to report.
The Works Design Communications (2018) business conducts an annual study on sustainability
reporting trends and best practice, which also serves as a guideline for companies seeking to undertake
innovative reporting. In 2018, the key findings were that use of the interactive features of PDFs had
improved markedly, improving accessibility; social media promotion of CSR reporting messages had
moved towards best practice; and reporting was increasingly aligned to key reporting frameworks. Other
innovative features identified were interviews with company CEOs; reporting against relevant UN SDGs;
and the use of icons, infographics and interactive visualisations.
The above discussion shows the variety of reporting approaches being adopted to provide information
about the sustainability-related performance of organisations and highlights emerging innovations and best
practice. Many decisions are required to be made, which can be contrasted with financial reporting, where
the extent of regulation means that there is relatively limited scope for experimentation or innovation.

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SUMMARY
Organisations face increased mandatory reporting requirements related to corporate governance and CSR.
In addition, many organisations voluntarily provide additional disclosures and reports, some of which are
based on voluntary guidelines and non-mandatory reporting requirements from a variety of sources.
The accounting profession and the professional accounting bodies have played a critical role in the
development of CSR reporting. For such reporting to become widely accepted, comparable and useful,
there is a need for a generally accepted framework for corporate governance and CSR reporting. The
accounting profession is heavily involved in the development of such frameworks.
The information that appears in CSR reports is useful not only for external purposes, but also for internal
decision making. The exercise of disclosure creates accountability and requires information to be gathered,
which can highlight the risks and opportunities facing an organisation. These insights can be used to inform
future decisions.
The key points covered in this part, and the learning objectives they align to, are as follows.

KEY POINTS

5.6 Describe the mandatory reporting requirements for social and environmental performance
reporting.
• In Australia, a number of legislative and other requirements exist that mandate aspects of social
and environmental performance be reported in a variety of ways.
• The Corporations Act ss. 299(1)(f) and 299A imply aspects of CSR reporting and ASIC has
issued regulatory guidance noting that the operating and financial review required by s. 299A(1)
should include a discussion of sustainability risks. The Corporations Act also gives legal force to
accounting standards.
• Accounting standards IAS 37 and IAS 16 require aspects of CSR reporting.
• The ASX Corporate Governance Principles and Recommendations require listed entities to disclose
exposure to environmental and social risks.
• The NGER Act requires businesses that generate substantial greenhouse gas emissions or that
generate or consume substantial amounts of energy to report their emissions, energy production,
energy consumption and other information.
• The National Pollutant Inventory is a publicly accessible register of industrial pollution that is
informed by mandatory reports from various industrial facilities.
• The Modern Slavery Act requires certain entities to issue a modern slavery statement detailing
their efforts to identify and address instances of modern slavery (such as human trafficking or child
labour) in their operations or supply chain.
5.7 Describe the elements and frameworks of non-mandatory reporting for social and environmen-
tal performance reporting.
• A range of voluntary frameworks exist to guide reporting of social and environmental performance
outside the mandatory requirements. Two of the most widely adopted have been the GRI and
IR frameworks (note the IR framework now falls under the ISSB).
• The Global Reporting Initiative issued guidance for the preparation of sustainability reports from
2000 and recently issued a set of formal standards for use by entities wishing to report in accordance
with GRI recommendations.
• The formation of the ISSB is the most recent and potentially game-changing development in non-
mandatory reporting for social and environmental performance. Drawing on the extensive resources
of the IFRS, the ISSB has released two standards to date and focuses on the needs of markets
and investors.
• Common to all of the non-mandatory reporting frameworks is the intention to create reports that
provide useful information about an organisation’s performance on social, environmental and other
issues to support decisions by internal and external stakeholders.

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PART F: CLIMATE CHANGE REPORTING
INTRODUCTION
Human activity is leading to an increased concentration of greenhouse gases in the atmosphere which in
turn is expected to lead to climate change, with a host of associated risks. Various attempts have been made
by the international community to mitigate climate change and its potential adverse effects.
To understand humans’ contribution to climate change, one must understand the greenhouse effect,
through which natural gases in the Earth’s atmosphere allow infra-red radiation from the sun to warm the
Earth’s surface and at the same time prevent heat from escaping the Earth’s atmosphere back into space.
Human actions are increasing the concentrations of these gases, which is causing changes in the Earth’s
climate — changes that are projected to intensify as greenhouse gas emissions continue to rise. The IPCC’s
Sixth Assessment Report states that:
Human-caused climate change is already affecting many weather and climate extremes in every region
across the globe. Evidence of observed changes in extremes such as heatwaves, heavy precipitation,
droughts, and tropical cyclones, and, in particular, their attribution to human influence, has strengthened
since [Assessment Report 5 in 2013] (IPCC 2022, p. 12).

The authors further note that:

[Human-caused climate change] has led to widespread adverse impacts on food and water security,
human health and on economies and society and related losses and damages to nature and people (high
confidence). Vulnerable communities who have historically contributed the least to current climate change
are disproportionately affected (high confidence) (IPCC 2022, p. 6).

As the IPCC’s Sixth Assessment Report emphasises, temperature rises have already and are likely to
continue to have dramatic economic, environmental and social effects.
There is increasing interest in reporting for issues related to climate change, including accounting for
greenhouse gas emissions and incorporating climate change risk into risk assessments. Reporting is also
required to support the operation of emissions trading schemes. The remainder of this module examines
the importance of accounting for climate change and the techniques used.

5.29 THE INTERNATIONAL RESPONSE TO CLIMATE

CHANGE RISK
The international community has become increasingly concerned with the adverse effects of climate
change. In Rio de Janeiro, in June 1992, many countries joined an international treaty, the United
Nations Framework Convention on Climate Change (UNFCCC). As of August 2018, the UNFCCC has a
membership of 198 countries (UNFCCC 2019).
The UNFCCC established an institutional framework at the international level within which countries
were to begin reducing emissions (known as ‘mitigation’) and adapting to the effects of climate change
(known as ‘adaptation’). It also required, for the first time, countries to measure, account for and report
their aggregate emissions of a range of greenhouse gases (as well as estimates of greenhouse gases stored in
‘sinks’ such as new forests) across all sectors of their economies. The overall objective of the treaty was to
stabilise greenhouse gas concentrations in the atmosphere in order to avoid dangerous human interference
in the climate system. However, the treaty did not set any mandatory limits on greenhouse gas emissions
for individual countries, nor did it contain any enforcement mechanisms (UNFCCC 2014).
These elements were introduced later, when parties to the convention met in Japan in 1997 and agreed
to the Kyoto Protocol. The protocol commits industrialised countries to reduce their emissions by specific
quantities within prescribed timeframes. Thirty-seven industrialised nations agreed to legally binding
reductions in greenhouse gas emissions of an average of below 5 per cent against 1990 levels during
the first commitment period, spanning 2008 to 2012.
The protocol left it to those countries to determine the best means by which to achieve their targets, while
allowing their domestic emissions reductions to be ‘supplemented’ by internationally traded offset credits.
Recognising that developed countries are principally responsible for the current high levels of greenhouse
gas emissions as a result of more than 150 years of industrial activity, the protocol places a heavier burden
on them compared to the developing countries.
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 Subsequent to the Kyoto Protocol, no binding individual or aggregate emissions reduction targets were
agreed upon at the 2009 Copenhagen Accord, the 2010 Cancun agreements or the Conference of the Parties
(COP) to the UNFCCC at Durban in 2011. In Doha, Qatar, in December 2012, the Doha Amendment to the
Kyoto Protocol was adopted, launching a second commitment period, from 2013 to 2020. From September
2019, about 30 countries agreed to fulfill their commitments for 2013–2020.
In November 2013, at the 19th session of the UNFCCC COP in Warsaw, governments agreed to
negotiate a new international climate treaty for adoption at the 21st COP in Paris in December 2015.
This agreement is intended to take effect from 2020 and to replace the Kyoto Protocol by setting new
binding national emissions reduction targets to limit the global temperature rise to no more than 2°C, and
if possible to 1.5°C. New pledges will need to be more ambitious in light of World Bank estimates that the
emissions reduction pledges in the Kyoto Protocol are no longer sufficient to prevent a 2°C temperature
rise. Further, any new agreement will need to include key emerging economies such as China, Brazil,
India and Russia and developed countries will need to provide technology, finance and capacity-building
support for developing countries to start on a clean-growth trajectory.
The Paris Agreement requires each country to determine and report on its contributions to mitigate
climate change. Trust in international agreements to limit future greenhouse gas emissions will depend on
the ability of each nation to make accurate estimates of its own emissions, monitor their changes over time
and verify one another’s estimates with independent information. Clearly, a strong opportunity exists for
accountants to contribute.
While various negotiations occur between countries at an international level, at an individual level —
either as individual consumers or as members of an organisation — we can all make choices that will either
increase or decrease our own contribution to climate change. That is, rather than relying solely on CSR
and/or the government, we must also consider personal social responsibility (PSR).
For example, we can embrace PSR to change the amount of energy we consume (and to some extent,
the amount of energy we use that comes from renewable sources). We can also consider the necessity for
particular travel and the mode of travel being used. Similarly, we can consider the amount of waste we are
generating and how we can reduce that waste. Additionally, the extent to which we really need to satisfy
all our wants, particularly those wants that contribute highly to climate change, should be reconsidered.
The emphasis here is that tackling issues such as climate change requires the community to also embrace
the need for change and not simply rely upon (or blame) organisations for the necessary improvements.
Organisations are key contributors to various environmental issues but, within the capitalist system that
dominates world economies, organisations typically respond to the demands of individuals. As consumers
of products and services manufactured or generated by organisations, individuals must accept some
responsibility for the environmental issues that organisations create.

5.30 CLIMATE CHANGE ACCOUNTING TECHNIQUES

Climate change is an issue that highlights the complexities associated with integrating aspects of environ-
mental performance with financial decision making. It also provides an illustration of the incompleteness
of existing accounting methodologies, when we consider issues associated with social and environmental
externalities. Financial reporting practices tend to disregard externalities due to such issues as the way we
define and recognise the elements of accounting and because of such principles as the entity principle.
The predominant mechanisms to price carbon are taxation, and ‘cap-and-trade’ or emissions trading
schemes (ETSs). Our focus in this section is on ‘cap-and-trade’ systems, which are designed as a market-
based approach to dealing with carbon emissions. This builds on the discussion in previous sections about
specific cap-and-trade schemes, such as the EU Emissions Trading Scheme (EU ETS). It is the failure of
the market to recognise many social and environmental externalities which, at least in part, is being blamed
for the current challenge posed by climate change.
The concept of an emissions trading market is based on giving carbon a price per tonne so that products
can be more fully costed and the costs of emissions internalised. As emissions become an internal cost, they
also highlight the need for more specific and consistent reporting, while providing significant incentives
for firms to improve operations. This will mean that, depending on the individual industry and method of
operation, there will be both winners and losers in the market. Those organisations that produce products
generated through carbon-intensive processes will find that their costs will rise compared to other less
carbon-intensive producers and this would conceivably mean that, through passing on the higher costs,
they would lose customers.
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 This economic sensitivity is the reason why the establishment of a carbon market can be contentious. It
will mean that certain industries will find their costs rising more than other less carbon-intensive industries.
It might also create an international disadvantage if other countries do not place a cost on carbon.
Clearly, requiring the recognition of costs that have not previously been recognised will require many
industries to adapt and change. The intention of placing a price on carbon emissions is to create change in
the way we do things because what we have been doing until now (i.e. not accounting for carbon) is not
sustainable. This will create some economic hardship for some organisations and individuals. However,
this would seem to be a non-issue when the greater good (which is paramount) is achieved.
Under a cap-and-trade system, ‘allowances’ or ‘credits’ are used to provide incentives for companies to
reduce emissions by assigning a monetary value to pollution. In the EU, each carbon allowance permits
the holder to emit one tonne of carbon dioxide (CO2 ) or equivalent. The ‘cap’ phase of the program
begins when a government or regulatory body establishes an economy-wide target for the maximum level
of aggregate emissions permitted by companies in a specified time frame. Then, a specific number of
emissions allowances equal to the national target is allocated (or auctioned) to participating companies
based on a formula that generally includes past emissions levels. Over time, it is expected that the number
of permits (or units) made available will be reduced by the government in line with the quest to reduce
carbon emissions.
The ‘trade’ aspect of the program occurs when a company’s actual emissions are greater or less than the
number of allowances it holds. Companies that emit less than the number of permits they hold will have
excess allowances; those whose emissions exceed the number of permits they hold must acquire additional
allowances. Additional (or excess) allowances can be purchased (or sold) directly between companies,
through a broker or on an exchange. Excess allowances can be ‘banked’ and used to satisfy compliance
requirements in subsequent years. It is argued that cap-and-trade programs provide companies with added
flexibility to choose the most cost effective way to manage their emissions.
As of August 2019, 27 ETS programs operated throughout the world at regional, national and sub-
national (states, provinces, cities) levels. The most active carbon market at the transnational level was
in Europe where the EU ETS began in 2005. In 2013, it moved into Phase III with more stringent
emissions targets to keep on track for a 60−80 per cent reduction by 2050. Despite its flaws, Phase II of the
EU ETS reduced greenhouse gas emissions by an estimated 2.5–5 per cent per year. Phase IV began in 2021
with the imperative that the sectors covered by the EU Emissions Trading System (EU ETS) must reduce
their emissions by 43 per cent compared to 2005 levels. To achieve this, the overall number of emission
allowances declined at an annual rate of 2.2 per cent from 2021 onwards, compared to the previous
1.74 per cent (EC n.d.). As at 31 March 2023, the World Bank listed 36 implemented ETS schemes.
These schemes covered 9161 MtCO2 e or 18.17 per cent of global GHG emissions (World Bank 2023).
Table 5.9 lists these schemes, the year they were implemented and the GHG emissions covered by each
scheme. As can be seen from table 5.9, compared to 2013, there are now nine more ETS schemes and the
EU ETS is now the second largest behind China’s National ETS scheme.

TABLE 5.9 ETS schemes at 31 March 2023

GHG emissions covered

Name of the initiative Year of implementation [MtCO2 e]

Alberta TIER 2007 148

Austria ETS 2022 32

BC GGIRCA 2016 0

Beijing pilot ETS 2013 35

California CaT 2012 279

Canada federal OBPS 2019 7

China national ETS 2021 4500

Chongqing pilot ETS 2014 73

EU ETS 2005 1354

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374 Ethics and Governance

 Fujian pilot ETS 2016 125

Germany ETS 2021 305

Guangdong pilot ETS 2013 278

Hubei pilot ETS 2014 125

Indonesia ETS 2023 300

Kazakhstan ETS 2013 136

Korea ETS 2015 507

Massachusetts ETS 2018 5

Mexico pilot ETS 2020 280

Montenegro ETS 2022 N/A

New Brunswick ETS 2021 6

New Zealand ETS 2008 38

Newfoundland and Labrador PSS 2019 4

Nova Scotia CaT 2019 13

Ontario EPS 2022 38

Oregon ETS 2021 21

Quebec CaT 2013 59

RGGI 2009 83

Saitama ETS 2011 7

Saskatchewan OBPS 2019 9

Shanghai pilot ETS 2013 107

Shenzhen pilot ETS 2013 25

Switzerland ETS 2008 5

Tianjin pilot ETS 2013 75

Tokyo CaT 2010 12

UK ETS 2021 113

Washington CCA 2023 57

Source: World Bank 2023, ‘Carbon pricing dashboard’, accessed August 2023, https://carbonpricingdashboard.worldbank.org/
map_data.

5.31 ACCOUNTING FOR THE LEVELS OF EMISSIONS

Various regulatory requirements, discussed earlier in this module, also require organisations to account for
their emissions and any ‘offsets’ they receive (e.g. an organisation might be able to calculate how much
carbon is absorbed by a forest it controls and this amount can be offset against the emissions from the
organisation’s production operations). Earlier in this module we discussed various initiatives that have
been developed to enable an organisation to measure its emissions (e.g. the GHG Protocol).
IFAC has developed a resource for accountants titled Greenhouse Gas Building Blocks for Accountants
(IFAC 2023). It explains the different levels or scopes that companies can report on, including: Scope 1
(direct emissions generated by the organisation); Scope 2 (indirect emissions based on energy consump-
tion); and Scope 3 (indirect emissions arising from the organisation’s impacts on the wider economy). By
evaluating different scopes, the full value chain of the business is considered.

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.......................................................................................................................................................................................
CONSIDER THIS
Access and read IFAC’s Greenhouse Gas Building Blocks for Accountants (https://ifacweb.blob.core.windows.net/
publicfiles/2023-05/GHG-Reporting-Building-Blocks-Accountants.pdf). What additional data will need to be collected
to account for downstream Scope 3 emissions if your organisation were to use the supplier-specific method?

In Australia, entities and corporate groups that meet the reporting thresholds (i.e. large emitters) must
report their Scope 1 and Scope 2 emissions under the NGER Act (discussed earlier). However, as at August
2023, companies that do not meet the reporting thresholds under the NGER Act are not subject to any direct
regulation of emissions accounting, reporting or offsetting in Australia, including in relation to the role
of offsets. Companies are prohibited by s. 18 of the Australian Consumer Law (which is a schedule to
the Competition and Consumer Act 2010 (Cwlth)) and its state equivalents from making misleading or
deceptive claims, including in relation to carbon offsetting, carbon neutrality and ‘green marketing’.
Having said this, such companies can choose to account for and report their emissions and offsets in
accordance with any one of a number of existing voluntary standards. The reporting framework that is the
most frequently used and forms the reporting basis of many of the regulatory carbon reduction schemes is
the GHG Protocol (WRI & WBCSD 2005) discussed earlier in this module.
Some examples of emissions trading schemes and reporting regulations are provided in table 5.10.

TABLE 5.10 Major emissions trading/reporting schemes

Scheme Mandatory or
(start year) Jurisdiction Emission sources Reporting requirements voluntary

National Australia Large corporations involved By October each year, Mandatory

Greenhouse in combustion of fuels for registered corporations
and Energy energy; fugitive emissions must provide annual
Reporting from the extraction of reports covering
(NGER) Scheme coal, oil and gas, industrial greenhouse gas emissions,
(2008) processes and energy production and
waste management. energy consumption from
the operation of facilities
during that financial year.

US EPA GHG United States Suppliers of certain Reports are submitted Mandatory
Reporting products that would result annually to the EPA.
Program (2010) in greenhouse emissions Reporting is at the
if released, combusted or facility level, except for
oxidised; direct-emitting certain suppliers of fossil
source categories; and fuels and industrial
facilities that inject CO2 greenhouse gases.
underground for geologic
sequestration or any
purpose other than
geologic sequestration.

China National China Power sector with Annual self-reporting with Mandatory
ETS (2021) expansion to other sectors provincial level verification.
over time.

EU ETS (2005; 27 EU Large industrial and energy- Annual self-reporting to the Mandatory
Phase IV is Member intensive installations in competent authority in the
2021−30) States plus power generation and administering state.
Norway, manufacturing industries.
Iceland and International aviation
Liechtenstein (since 2012).
Maritime sector (from 2024).
Separate trading scheme
ETS2 for fuels used in
buildings, road transport
and industry to begin in
2027 or 2028.

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 KETS (2015) Republic of Phase 1 (2015−17): heavy Annual reporting of Mandatory
Korea emitters in the steel, emissions by the end
cement, petro-chemistry, of March.
refinery, power, building,
waste sectors and
aviation industries.
Phase 2: 2018–20: heat and
power, industry, building,
transportation, waste
sector, and public.
Phase 3: from (2021–25):
transport (freight, rail,
passenger, and shipping),
and construction industries.

Germany ETS Germany Heating and transport fuels. Mandatory annual Mandatory
(2021) self-reporting.

Source: ICAP (International Carbon Action Partnership) 2023, Emissions trading worldwide: ICAP status report 2023, accessed
July 2023, https://icapcarbonaction.com/system/files/document/ICAP%20Emissions%20Trading%20Worldwide%202023%20
Status%20Report_0.pdf.

5.32 CORPORATE GOVERNANCE AND

CLIMATE CHANGE
In Australia, ASIC is a key player in ensuring climate change is addressed by companies. An ASIC report
released in 2018 highlighted the lack of climate disclosure content in IPO prospectuses and annual reports
(ASIC 2018). The report made the following four key recommendations for listed companies.
Consider climate risk
Directors and officers of listed companies should adopt a probative and proactive approach to emerging
risks, including climate risk.
Develop and maintain strong and effective corporate governance
Strong and effective corporate governance helps in identifying, assessing and managing material risks.
Comply with the law
Section 299A(1)(c) requires disclosure of material business risks affecting future prospects in an operating
and financial review, which may include climate change: see Regulatory Guide 247 Effective disclosure in
an operating and financial review (RG 247).
Disclose useful information to investors
Specific disclosure is more useful than general disclosure.

The new sustainability accounting standard IFRS S2 Climate-related Disclosures, which comes into
force for annual reporting periods commencing on or after 1 January 2024, is expected to help report
preparers in this regard.
IFRS S2 requires an entity to disclose information that enables users of general purpose financial reports
to understand:
a. the governance processes, controls and procedures the entity uses to monitor, manage and oversee
climate-related risks and opportunities;
b. the entity’s strategy for managing climate-related risks and opportunities;
c. the processes the entity uses to identify, assess, prioritise and monitor climate-related risks and
opportunities, including whether and how those processes are integrated into and inform the entity’s
overall risk management process; and
d. the entity’s performance in relation to its climate-related risks and opportunities, including progress
towards any climate-related targets it has set, and any targets it is required to meet by law or regulation
(IFRS 2023e).
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 In June 2022, ASIC produced INFO 271 to assist issuers to avoid greenwashing when offering or
promoting sustainability-related products. Among other things, products must be true to label, exclude
vague terminology and explain investment screening criteria (ASIC 2022). INFO 271 includes examples
of products that do not meet these criteria, some of which are included in example 5.8.

EXAMPLE 5.8

Examples of Greenwashing
Example of a Product that isn’t True to Label
A sustainability-related product is labelled ‘No Gambling Fund’. However, under its terms, the product
may ‘invest in companies that earn less than 30% of their total revenue from gambling activities’.
Example of Vague Terminology Requiring Further Clarifying Disclosures
On its website and various social media platforms, an issuer claims that it is committed to making
investments that ‘contribute towards positive impacts for its investors and the world’. However, the issuer
does not disclose what it considers to be ‘positive impacts for its investors and the world’ or how its
investments contribute to those stated outcomes.
Example of Inadequate Disclosure Regarding Sustainability-related Investment Screens
An issuer makes the following promotional statement about its sustainability-related product: ‘We
target investments in companies that have robust plans to manage cybersecurity and data privacy risks
(depending on the nature of their business).’ However, the issuer’s terms state that this screen only applies
in relation to technology companies. This qualification has not been prominently disclosed in the respective
communications and disclosures.
ASIC has been active in intervening where it sees greenwashing occurring and has issued requests for
corrective disclosures, infringement notices and commenced civil penalty proceedings.

Source: ASIC 2022, ‘How to avoid greenwashing when offering or promoting sustainability-related products’, INFO 271,
June, accessed August 2023, https://asic.gov.au/regulatory-resources/financial-services/how-to-avoid-greenwashing-when-
offering-or-promoting-sustainability-related-products.

SUMMARY
Human activity, including much business activity, results in the release of greenhouse gases to the
atmosphere. The increased concentration of greenhouse gases in the atmosphere enhances the natural
greenhouse effect, leading to climate change, which entails numerous risks to sustainability.
The international community has responded by attempting to reach international consensus on curtailing
emissions (or at least curtailing growth in emissions) in a bid to mitigate climate change and its associated
adverse effects. The United Nations Framework Convention on Climate Change (UNFCCC) requires
countries to report their aggregate emissions of a range of greenhouse gases (as well as estimates of
greenhouse gases stored in ‘sinks’ such as forests).
Emissions trading schemes and carbon taxes have been introduced in some countries to place a cost
on emissions and thus provide an incentive for emission reductions. The operation of these requires
measurement and reporting of emissions. Accounting for emissions is also required by various regulations.
Accounting for emissions involves measuring emissions directly generated by the organisation, emissions
resulting from the generation of power used by the organisation, and indirect emissions from sources such
as the use of vehicles by the organisations employees.
In Australia, only certain entities are required to report.
Climate change is increasingly becoming a topic for discussion in annual reports. This is mainly from
a risk management perspective and is actively being addressed by ASIC.
The key points covered in this part, and the learning objective they align to, are as follows.

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 KEY POINTS

5.9 Explain the relevance of climate change to corporate accountability, and identify some related
measurement issues.
• The UNFCCC requires countries to report on their total greenhouse gas emissions and to take steps
to reduce emissions.
• In Australia, certain entities are required to report on their greenhouse gas emissions.
• In many countries, a price has been placed on emissions by way of an emissions trading scheme
or a carbon tax. These provide an incentive to reduce emissions.
• Climate change risks are a widespread concern and this has brought pressure on organisations to
be accountable for their contribution to climate change.
• Organisations that account for greenhouse gas emissions measure and report on emissions
directly generated by the organisation’s activities, created in the generation of power used by the
organisation, and indirectly generated through ancillary activities.
• Organisations are able to choose how to account for and report their emissions. One common
framework is the GHG Protocol.

REVIEW
Organisations have increasingly accepted the need to be accountable to a wide range of stakeholders
who are concerned with many aspects of the performance of the organisation. One prominent way
that organisations have responded is through the adoption of CSR principles and associated reporting.
The development of such reporting reflects the need to achieve and demonstrate environmental, social
and economic sustainability. The need to report these issues has in turn generated demand for new
reporting frameworks.
There is no doubt that this aspect of an organisation’s reporting, both internally and externally, will
continue to grow in importance over time. CSR reporting is at the heart of enabling us to measure and
monitor our CSR impact, which is why governments and the international community are increasingly
expecting organisations to report this in a reliable and comprehensive manner.
As we have outlined, along with an expanded view of their corporate and social responsibilities,
organisations are increasingly making additional voluntary CSR disclosures. In fact, disclosing information
about various aspects of their sustainability performance has become so common that it is now considered
virtually mainstream reporting by most major corporations around the world. This is in response to
stakeholder demands, ethical responsibilities, regulation, and enlightened self-interest, whereby the
organisation benefits from issuing these types of reports.
Broader accountability has been accompanied by a recent increase in regulation worldwide. We have
seen this in Australia with increased CSR disclosures in directors’ reports and corporate governance
disclosures in annual reports, as well as disclosures outside annual reports, such as the reporting of
greenhouse gas emissions required under the NGER legislation.
Initiatives such as the development of the International Integrated Reporting Framework attempts
to make CSR information more mainstream by concisely incorporating financial and non-financial
information in a single corporate report.
The area of CSR reporting provides abundant opportunities for accountants of the present and future.
Accountants combine raw data into meaningful, useful information, and by effectively communicating
information to support decisions, accountants add value. By supporting that process with analysis and
recommendations, the accountant moves from being a pure information provider to being a strategic
support partner.
By assessing and reporting on social and environmental information alongside traditional financial and
management accounting, accountants can aid in promoting sustainable development and contributing to
greater inter-generational equity. This information forms the foundation for allowing proper and informed
engagement and debate between various parties. However, the information required is increasingly of
a non-financial nature, and traditional financial accounting methods are not suited to reporting on this
information. Therefore, a broader range of knowledge will be required to present this broader base of
information. To support this role, theoretical foundations, valuation methods, reporting approaches and
communication tools will all have to continue to evolve.
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Pdf_Folio:384
GLOSSARY
AASB Australian Accounting Standards Board
acceptable level A level at which a member using the reasonable and informed third party test would
likely conclude that the member complies with the fundamental principles.
accountability The fact or condition of being accountable.
ACNC Australian Charities and Not-for-profits Commission
agency theory A theory that seeks to explain the relationships between principals and agents. It is
typically used to talk about and analyse the relationships between shareholders as owners of a business
and the agents, the board and between the board and CEOs.
agents Individuals or organisations that work on behalf of an entity.
anti-competitive practices Practices designed to obstruct other companies or individuals having access
to a particular market.
APESB Accounting Professional and Ethical Standards Board
ASIC Australian Securities and Investments Commission
ASX Australian Securities Exchange
AUASB Auditing and Assurance Standards Boards
audit client An entity in respect of which a firm conducts an audit engagement.
audit committee A subset of a board that oversees the financial reporting and financial issues being
dealt with by a company.
balance of probabilities The civil burden of proof. A jury in a civil case must be convinced that events
as described during the case may have occurred.
beyond reasonable doubt The criminal burden of proof. It requires a jury to be satisfied that there is no
reasonable doubt about the evidence presented in court to the guilt of an individual.
bid-rigging Collusive price rigging behaviour where companies coordinate bids for procurement or
project contracts.
board of directors Collective name for the directors of a company.
bonding costs Costs incurred by the agent to demonstrate to the principal that they are furthering the
objectives set down by the principal.
business judgment rule A protection under the Corporations Act for directors related to the duty of care
and diligence.
CA ANZ Chartered Accountants Australia and New Zealand
cartel conduct Conduct undertaken by an association of manufacturers or suppliers that deliberately
collude to keep prices of goods or services high.
caveat emptor Latin for ‘buyer beware’.
child labour The use of children as cheap labour and often in dangerous circumstances.
churning The placing of buy and/or sell orders for shares with the object of artificially increasing the
market turnover.
civil liability Violation of obligations arising in a civil law relationship between parties.
clawback A contractual clause often seen in employment contracts or remuneration schemes that allows
vested (generally variable) compensation to be reclaimed or recovered. Typically activated when a post
vesting event, such as misconduct or fraud, comes to light.
climate change A change of climate that is attributed directly or indirectly to human activity, which
alters the composition of the global atmosphere and which is in addition to natural climate variability
observed over comparable time periods.
collusive behaviour Behaviour that indicates groups in the same industry are collaborating in
transactions or a transaction in a manner designed to exclude the participation of others.
common law Judge made law rather than law made through a parliament. It relies on the establishment
of precedent.
company secretary A company officer responsible for compliance matters such as
document lodgement.
competition policy A policy area that looks at protecting the public interest by ensuring that companies
do not engage in practices that do not cause unfair practices to develop.
competitive advantage A situation that places a company or individuals in a superior market position.

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GLOSSARY 385
consumers People or groups that consume (use) goods and services. If a person or group also purchased
the goods and services, they are also known as ‘customers’.
contingent fees Fees calculated on a decision arranged at an earlier time for performing any service in
which the amount of the fee depends on the outcome of a transaction or the result of services
performed. If a court or public authority sets up fees, then these are not contingent fees.
corporate governance The system of rules, practices and processes by which a corporation is directed
and controlled.
corporate social responsibility Corporate self-regulation where companies and other entities
recognise that they have a commitment to reflect broader community concerns such as social and
environmental issues.
Corporations Act Corporations Act 2001 (Cwlth)
co-regulation Regulation of a profession or other group of people that is undertaken by a
professional body or association and government organisations. Co-regulation reflects a shared
regulatory responsibility.
CPA Australia One of the three main accounting bodies in Australia.
criminal Someone who has been convicted of criminal offences.
criminal intent Intention to deliberately cause harm to another through the commission of a
criminal offence.
criminal liability Liability for offending in breach of provisions of criminal law.
criminal sanctions Punishment for criminal offending.
cultural diversity Existence of a variety of cultures within an organisation or the broader community.
cultural relativism A theory that behaviour must be examined or judged in the context of the culture in
which it takes place.
delegation The handling of responsibility by a board or senior management for certain tasks by others.
deontological Ethical theories that deal with decisions being made on the basis of duties and obligations.
director ‘Director of a company or other body means:
(a) a person who:
(i) is appointed to the position of a director; or
(ii) is appointed to the position of an alternate director and is acting in that capacity; regardless of
the name that is given to their position; and
(b) unless the contrary intention appears, a person who is not validly appointed as a director if:
(i) they act in the position of a director; or
(ii) the directors of the company or body are accustomed to act in accordance with the person’s
instructions or wishes.
Subparagraph (b)(ii) does not apply merely because the directors act on advice given by the person in
the proper performance of functions attaching to the person’s professional capacity, or the person’s
business relationship with the directors or the company or body.’ (Corporations Act, section 9)
diversity The state of being diverse and of having variety. In a governance setting, this usually equates
to ensuring there is a blend of genders, ages, experience and work backgrounds around a board table to
ensure a breadth of ideas can be presented during decision making.
duty of care The duty that directors and senior managers have for the welfare of employees and others
that engage with the entity for which they have governance responsibility.
economic stability An economic state in which there are only minor fluctuations.
egoism An ethical theory that treats self-interest as the key foundation of morality.
enlightened self-interest An ethical theory that says those who act in the interests of others are serving
their own interest at the same time.
environmental sustainability Responsible engagement with the environment to avoid unnecessary
depletion or degradation.
Equator Principles Principles for the management of risks associated with social and environmental
phenomena in project finance.
ethical egoism Self-interested ethics.
ethical relativism An ethical position that states that all points of view are valid and that individuals
determine what is moral and right for them.
ethical standards Standards stipulating the behaviour that is acceptable of people in certain professions.
ethical trading Trading that is done in accordance with certain principles such as ensuring
that companies from which products are sourced do not engage in child labour or present
environmental risks.
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386 GLOSSARY
ethics Principles underlying the behaviour or conduct of individuals or groups.
exclusive dealing The situation where a company decides to deal only with certain customers or
geographic regions.
externality A benefit or cost caused by a producer that is not financially incurred or received by that
producer. It can come from either the production or consumption of goods or services and can be
positive or negative. The benefits and costs can also be private (to an individual or organisation) or
social (i.e. affecting society as a whole).
financial markets Markets on which shares and other kinds of equity are traded.
FRC Financial Reporting Council of Australia whose functions include oversight of the accounting and
auditing standards setting processes for the public and private sectors, and providing strategic advice
in relation to the quality of audits conducted by Australian auditors.
garnishee notice A court order that allows a person or business to recover money that is owed by
another party by way of debt. This may involve the pursuit of payment from a third party such as an
employer or bank.
giving right to To grant one the moral or legal permission, privilege or authority to have or
own something.
goal congruence The alignment of a goal pursued by an agent with the strategies of a company board or
senior management of an entity.
governance The way entities police their own internal conduct.
greenhushing Deliberately under-reporting or seeking to hide an organisation’s environmental or ESG
efforts and performance to avoid public scrutiny.
greenwashing Making false or misleading claims as to the environmental sustainability of products
or operations.
GRI Global Reporting Initiative
heuristics The use of a practical method to solve problems in the moment rather than looking at
a framework.
humanistic perspective Humanism includes the notion that people can be responsible for their
own happiness.
IFAC International Federation of Accountants
IIRC International Integrated Reporting Council
insider trading The situation where people who have access to privileged commercial knowledge use it
to their own advantage before others can in the market place.
insolvent trading The state in which an entity is trading but is doing so illegally because it is unable to
meet its debt obligations.
integrated reporting Broad-based reporting frameworks focused on financial and non-financial
information that is developed by the International Integrated Reporting Council.
IPA Institute of Public Accountants
ISO International Organization for Standardisation
justice Just behaviour or treatment.
legitimacy theory A theory that deals with the concept that entities such as businesses have a social
contract to perform a range of actions in order to receive approval and other rewards.
limited liability The state in which shareholders or members of an entity are responsible for the
liabilities of an entity to the value of the shares they hold.
loss leader A product or service that is used by a company as a way of introducing customers to a more
expensive good or service.
malus Reduction, cancellation, forfeiture or other termination of (generally variable) compensation
(before it is vested) as a result of underperformance. Typically included as a clause in an employment
contract or remuneration scheme.
market-based systems Systems of corporate structures that have outsiders or shareholders involved in
the ownership and governance of entities.
market manipulation Acts undertaken by individuals or groups of individuals designed to manipulate
the stock market and cause individual company stocks to rise or fall depending on the nature of the
acts involved.
market sensitive Information that is deemed to be significant enough to cause share prices to rise or fall.
market sharing The practice where competitors may divide markets, customers and regions between
themselves to limit competition.
monetisation Turning an idea or concept into one that generates revenue.
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GLOSSARY 387
monitoring costs Costs incurred by a principal in ensuring agents are doing what is asked of them and
behaving appropriately.
monopolist corporations Companies that are able to reduce supply below the competitive level in order
to maximise profits, including through artificially high prices.
morals Standards of behaviour expected.
narrative reporting Reporting that tells a story about an entity or an individual beyond
financial performance.
natural capital The stock of natural resources, for example, water, air and land.
naturalistic argument The argument that nature has an intrinsic value and deserves preservation for its
own sake.
net zero by 2050 The objective to reduce net greenhouse gas emissions to zero by the year 2050 in an
effort to restrict a global temperature increase to 1.5 degrees Celsius above pre-industrial levels.
normative theories Ethical theories that seek to establish norms of behaviour rather than codify or
merely explain existing behaviour.
not-for-profit Legal or social entities formed for the purpose of producing goods or services, and whose
status does not permit them to be a source of income, profit or financial gain for the individuals or
organisations that establish, control or finance them.
officer ‘Officer of a corporation (other than a corporate collective investment vehicle) means:
(a) a director or secretary of the corporation; or
(b) a person:
(i) who makes, or participates in making, decisions that affect the whole, or a substantial part,
of the business of the corporation; or
(ii) who has the capacity to affect significantly the corporation’s financial standing; or
(iii) in accordance with whose instructions or wishes the directors of the corporation are
accustomed to act (excluding advice given by the person in the proper performance of
functions attaching to the person’s professional capacity or their business relationship with
the directors or the corporation); or
(c) a receiver, or receiver and manager, of the property of the corporation; or
(d) an administrator of the corporation; or
(e) an administrator of a deed of company arrangement executed by the corporation; or
(ea) a restructuring practitioner for the corporation; or
(eb) a restructuring practitioner for a restructuring plan made by the corporation; or
(f) a liquidator of the corporation; or
(g) a trustee or other person administering a compromise or arrangement made between the
corporation and someone else.’ (Corporations Act, section 9)
output restrictions Conduct where competitors ‘agree’ to apply restrictions on output that will cause
shortages in markets and thus result in price rises.
ownership concentration A situation where one or more parties owns a controlling block of shares in a
company and is effectively able to control or influence the management of the company.
philosophical Relating to the study of philosophy.
philosophy A particular system of thought or the study of systems of thought and ideas.
phoenix companies Companies that have emerged after the collapse of another company through
insolvency, often with the same directors and the same or similar line of business. These companies
often leave a trail of unpaid debt.
physical risks Risks related to the physical impacts of climate change, including acute risks (e.g. the
increasing severity of extreme weather events) and chronic risks (e.g. longer term shifts in climate
patterns). Examples include damage to physical assets, supply chain disruptions, sea level rises, and
chronic heat waves.
pollution Introduction into the environment of substances that have harmful or poisonous effects.
Ponzi schemes Schemes involving earlier investors (potentially including through share-based
transactions) being given a return by simply diverting the capital contributions of later investors to the
earlier investors.
pools Organised groups of investors who agree to buy the shares of particular corporations and, as prices
rise due to growing market interest, to sell at a time before the market price collapses.
price-fixing Pricing agreements between competitors in order to ensure that they maintain their own
market share.
principals Key individuals or group of individuals involved in an agency relationship.
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388 GLOSSARY
principles-based approach An approach to regulation or problem solving based on a conceptual
framework or broadly stated principles.
profession An occupational area or vocation that involves prolonged training and a formal qualification.
professional activity An activity requiring accountancy or related skills undertaken by a member,
including accounting, auditing, tax, management consulting and financial management.
professional ethics Standards of behaviour expected of a profession or professions.
professional scepticism A state of mind where people (particularly auditors) are alert to the possibility
of half-truths, fraud and insufficiency of evidence.
proprietary companies A private company incorporated under the Corporations Act that have no more
than 50 shareholders or members.
prospectus An offer document put to possible or existing investors for an offer of equity in a company.
public companies Companies incorporated under the Corporations Act that have more than
50 shareholders or members. They may also be listed on the ASX.
public interest Anything affecting the rights, health or finances of the public at large.
puffery Term used for advertising content that is misleading.
quantification Seeking evidence by quantifying or measuring in numbers.
redress Paying compensation or making reparations for a previous wrong or grievance.
regulatory arbitrage A business process of making use of more favourable laws in one jurisdiction to
circumvent less favourable regulation elsewhere.
regulatory fiat A regulatory process associated with a decree or pronouncement that is legally binding.
relationship-based systems A system in which companies rely for their governance on the
representation of interests on the board of directors such as workers, customers, banks, local
communities and other groups that have some ties to the entity.
remuneration Payments people receive for services performed for an entity, which may include
payments based on incentives.
resale price maintenance When a supplier stipulates that the goods it provides must only be resold at or
above a certain minimum price.
residual costs or losses Costs that occur despite the fact that principals are doing their best to ensure
that the agents behave appropriately and in alignment with the corporate vision and objectives.
Principals cannot avoid losses irrespective of how well they monitor agents.
restricted egoism An ethical theory that relates to self-interest being the subject of morals, but is
constrained by laws and regulations.
right A moral or ethical entitlement.
risk-based approach An approach to regulation based on the relative degree of associated risk. An
activity or entity with a higher degree of risk will have a relatively higher degree of regulation and
compliance imposed on it.
rule-based codes Codes that are based on prescriptive behaviours.
rules-based approach An approach to regulation or problem solving based on the specification of
situation-specific rules.
runs Phenomenon that involves groups of market participants who work together with the intention of
creating market effects by either buying shares or disseminating rumours in order to attract new buyers
into the market.
safeguards Actions, individually or in combination, that the member takes that effectively reduce
threats to compliance with the fundamental principles to an acceptable level.
SDGs Sustainable Development Goals
second opinion An opinion obtained to seek further assurance on whether an initial view on a matter
was reasonable.
self-regulation Measures a profession takes to regulate the conduct of its own members. This is in
contrast to regulation imposed by parliament and enforced by a regulator.
social sustainability Identifying and managing business impacts, both positive and negative, on people.
stakeholder A person or group with an interest in an issue or organisation.
stewardship theory A theory that suggests people in power (the agents or stewards) will act for the
benefit of those who have engaged them.
stranded assets Assets that are no longer able to earn an economic return (determined at some
point prior to the end of their economic life) because of factors related to the transition to a
low-carbon economy. Factors include changes in regulation, technology and consumer demand.
Pdf_Folio:389

GLOSSARY 389
supply chain management The management of flows of goods and services to and throughout an
organisation as a part of its business.
sustainability The ability of an environment to be maintained at a certain level.
teleological Ethical theories that are based on the rightness, goodness or worth of the end results
of decisions.
threats Actions or behaviours that may cause a member to breach the fundamental principles of the
ethical code APES 110.
those charged with governance The person(s) or organisation(s) (e.g. directors, corporate trustees)
with responsibility for overseeing the strategic direction of the entity and obligations related to the
accountability of the entity.
tier 1 An organisation’s direct suppliers, meaning partners they directly contract and conduct business
with. Suppliers to tier 1 suppliers are known as tier 2 suppliers. Suppliers to tier 2 suppliers are known
as tier 3 suppliers.
TPB Tax Practitioners Board
trade union An organisation that is formed to represent the interests of workers in one or more
industries on matters related to wage negotiations.
transition risk The risk faced by businesses as society shifts to a low-carbon economy, including policy
and legal risks, technology risks, market risk and reputation risk. Examples include laws that prevent
certain activities, litigation around the adequacy of disclosures, stranded assets, and increased costs.
UK FRC Financial Reporting Council in the United Kingdom whose functions include
regulating auditors, accountants and actuaries, and setting the UK’s Corporate Governance
and Stewardship Codes.
unconscionable conduct Conduct that results in people being harmed by unfair or unfairly imposed or
created contracts.
utilitarianism An ethical theory that looks at decision making that places the greatest good for a group
of individuals over the good for an individual.
virtues Behaviour showing high moral standards.
whistleblowing The act of breaching corporate or government confidentially to report misconduct or
malpractice in the public interest.

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390 GLOSSARY
SUGGESTED ANSWERS
MODULE 1
QUESTION 1.1
(a) The following table sorts the accounting boards, bodies, organisations and legislation from table 1.1
by their primary function (accountability, governance or ethics).

Accountability Governance Ethics

• AASB • ASX • APESB

• ACNC • CA ANZ
• APRA • CPA Australia
• ASIC • CPA Australia’s 2022 Constitution
• ATO • CPA Australia By-Laws
• AUASB • IFAC
• AUSTRAC • IOSCO
• Australian Sanctions Office • IPA
• Competition and Consumer Act 2010 • PIOB
(Cwlth) • The Monitoring Group
• Corporations Act 2001 (Cwlth) • TPB
• FRC
• IFEA
• IFRS Foundation
• Modern Slavery Act 2018 (Cwlth)
• OAIC
• Security Legislation Amendment (Critical
Infrastructure) Act 2021 (Cwlth)
• Security Legislation Amendment (Critical
Infrastructure Protection) Act 2022 (Cwlth)
• Treasury Laws Amendment (Enhancing
Whistleblower Protections) Act 2019 (Cwlth)

An understanding of the environment within which professional accountants operate should include
the items shown in each section of the diagram in figure 1.1 as well as how they interact. For
example, IFAC promulgates the education standards around which PAOs such as CPA Australia, IPA
and CA ANZ develop and assess initial education programs and accredit university degrees. IFAC
is also responsible for auditing standards and standards for accounting in the public sector. The
IFRS Foundation is responsible for overseeing the two standard setters that develop the conceptual
framework for financial reporting, international accounting standards and international sustainability
standards.
In Australia, the AUASB and the AASB (overseen by the FRC) develop the Australian variants of
the international standards in accounting, sustainability, and auditing and assurance, which are given
force at law by the Corporations Act. In turn, the Corporations Act gives rise (albeit indirectly) to
ASIC, which monitors accountants’ application of these standards.
(b) As mentioned above, IFAC is a global organisation responsible for promulgating the education
and auditing standards that apply to its member organisations (including CPA Australia). It also
promulgates a code of ethics. Responsibility for this work is vested in several IFAC boards (IAESB,
IAASB, IPSASB and IESBA). Two of these boards — the IAASB and the IESBA — are overseen
by the International Foundation of Ethics and Audit. IFAC’s member organisations then interpret and
apply these international standards and codes to their respective jurisdictions. This often results in local
variants — for example, Australia’s accounting and auditing standards, Australia’s code of ethics and
CPA Australia’s CPA Program. Responsibility for this work is vested in AUASB, APESB and CPA
Australia. Please note that a similar trickle-down approach for accounting standards occurs with IFRS,
IASB and AASB.

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SUGGESTED ANSWERS 391

 A newly created body, known as the International Sustainability Standards Board (ISSB), operates
under the oversight of the IFRS Foundation, and its standards will be adopted in Australia in a similar
fashion to the accounting standards issued by the IASB.
(c) Your glossary of acronyms should include those contained in table 1.1. Please add to the glossary as
the course progresses.

QUESTION 1.2
Example 1.2
In this example, the accountant believed they had the right to economic benefits because of their expertise.
However, they exceeded the norm for liquidator charges. The consequences were that creditors would
have received lower entitlements and eventually, when they were discovered, the accountant was ordered
to repay the excess. Longer term, this may impact their reputation including the ability to secure work or,
at the very least, they could expect their fees for future work to be subject to scrutiny.

Example 1.3
In this example, the accountant acquired economic benefits without exercising her skills and professional
judgement for the benefit of the client. As a consequence the client had a lower amount invested in
superannuation resulting in financial hardship. The accountant was banned from providing financial
services for three years and may have suffered reputational damage as a result.

QUESTION 1.3
The advisory group that IFAC uses to provide advice on the educational needs of the accounting profession
is the International Panel on Accountancy Education. Panel members can be nominated by IFAC members
(including CPA Australia) and Forum of Firms members (including the Big Four accounting firms:
Deloitte, Ernst and Young (EY), Klynveld Peat Marwick Goerdeler (KPMG) and Price Waterhouse
Coopers (PwC)).

QUESTION 1.4
Many authors’ views are described in module 1. The variety of views shows that there is a wide range of
interpretations about the actions of professional accountants in terms of serving the public interest. There
are those whose motives are selfish, and whose overarching desire is to establish a monopoly group that
maintains a position of prestige and power within the community. There are others who believe that many
professionals have a genuine desire to contribute to society, without the need for significant monetary
reward or political power.
In such a large profession, it is likely that there are many individuals who fit into the different categories
that have been described. While we often hear about the disgraceful or harmful actions and outcomes
from corporate collapses and failures, there are many untold examples of selfless efforts and sacrifices that
provide a significant contribution to the community.

QUESTION 1.5
The following examples illustrate many situations where accountants might apply professional judgement,
although this list is not exhaustive. Your answer may have included four of the following:
• making decisions about workflows and staff recruitment needs
• making staff selection decisions and choosing accounting team member roles
• advising clients on business decisions
• advising managers on accounting information relevant for business decisions
• identifying environmental cost parameters and advising management, and devising reporting
mechanisms
• planning for all types of professional assignments
• interpreting accounting standards and other professional pronouncements
• identifying business and audit risks
• making assumptions in forecasts and estimates
• placing quantitative assessments on future liabilities for clients and others
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392 SUGGESTED ANSWERS

• providing overall opinions on the adequacy of internal control, the reliability of accounting records and
the sufficiency of audit evidence
• drawing conclusions on the going concern assumption in relation to a business
• evaluating materiality levels for the presentation of financial reports
• relying on management representations
• exercising judgement about the adequacy of non-financial information to be disclosed
• setting and revising budgeting parameters
• estimating levels of activities
• developing and assessing costing methods
• assisting with the strategic directions of clients.

QUESTION 1.6
Historically, accountants have been data specialists who collate, organise and analyse data; and those skills
will continue to be in demand. If we consider the role of the machine with respect to AI, the machine’s role
is to identify patterns in data and the machine may not be able to understand what those patterns mean or
identify the causal relationship that may exist and from which critical learnings can be taken. Accountants,
as humans, are able to take the recognition of the pattern and make an interpretation as to why it may be
occurring or how the pattern can be used to take a particular course of action in the future.
The future of accountants in an age where data mining, big data and AI are utilised in almost all industries
will include the use of this data to make more professional judgements and interpretations, and think
outside the box. Accountants will move even further away from being ‘number crunchers’, as machines
will be able to perform the number crunching a lot more accurately and efficiently. Accountants will need
good data skills to be able to interpret and analyse data, and use professional judgement. The accounting
profession should not be fearful of AI; rather, the profession should embrace technology as a tool.

QUESTION 1.7
The ‘force of law standards’ provisions are found within the Corporations Act.

Section 296 Compliance with accounting standards and regulations

(1) The financial report for a financial year must comply with the accounting standards.

Section 307A Audit to be conducted in accordance with auditing standards

(1) If an individual auditor, or an audit company, conducts:
(a) an audit or review of the financial report for a financial year; or
(b) an audit or review of the financial report for a half‐year;
the individual auditor or audit company must conduct the audit or review in accordance with the
auditing standards.
(2) If an audit firm, or an audit company, conducts:
(a) an audit or review of the financial report for a financial year; or
(b) an audit or review of the financial report for a half‐year;
the lead auditor for the audit or review must ensure that the audit or review is conducted in accordance
with the auditing standards.

QUESTION 1.8
This situation highlights the importance of implementing an appropriate system of quality management.
Policies and procedures developed by individual firms need not be complex or time-consuming to be
effective. However, APES 320 Quality Management for Firms that provide Non-Assurance Services
requires firms to address each of the following elements of a system of quality management:
• governance and leadership
• professional standards
• acceptance and continuance of client relationships and specific engagements
• resources
• engagement performance
• information and communication
• monitoring and remediation.
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SUGGESTED ANSWERS 393

 Although we have not yet studied ethics (see module 2), it is useful to assess your current understanding
of ethics. You may like to review this question and solution after completing module 2 to identify how your
study of that module changes your approach to the question. Ethical requirements are featured in Compiled
APES 110 Code of Ethics for Professional Accountants (including Independence Standards) and, as we
shall see in more detail in module 2, the Code addresses the fundamental principles of professional conduct:
• integrity
• objectivity
• professional competence and due care
• confidentiality
• professional behaviour.
Policies and procedures must be in place to identify and evaluate circumstances and relationships that
create threats to compliance with the fundamental principles. Appropriate action must be taken to eliminate
or reduce these threats to such a level that compliance with the fundamental principles is not compromised.
Therefore, professional accountants must identify any actual or perceived conflicts of interest, not only
between their clients but also between their clients and their employees and manage these conflicts in
accordance with any ethical requirements. The firm’s personnel already have an obligation to maintain
the confidentiality of information acquired as a result of professional and business relationships, and not
to disclose such information without authority from the client or employer unless there is a legal duty to
disclose. In this case, it would have been prudent to ensure that the employees providing bookkeeping
services were also free of any conflicts of interest.
Policies and procedures addressing the ethical requirements need to be communicated to all personnel,
reinforced by the firm’s leaders through education and training, monitored and supported by a defined
process for dealing with non-compliance. It is important that policies and procedures that address ethical
requirements are continually reviewed and take into account changes in circumstances including staff
changes, client acquisitions and structural changes such as mergers.
The trust and confidence of clients is crucial for any ongoing professional relationship, and avoiding
conflicts of interest builds this trust. It is necessary for professional accountants to ensure that there are
appropriate policies and procedures to address their clients’ concerns and to respond to clients’ concerns.

QUESTION 1.9
(a) ‘Adverse event’ is defined in Article 76 of CPA Australia’s Constitution.
(b) CPA Australia’s By-Laws define GMPC as the person:
(a) appointed from time to time by the Chief Executive Officer to hold the position or undertake the duties
of ‘General Manager Professional Conduct’ of CPA Australia and where there is a change of title, the
person who is accountable for the day-to-day management of the professional conduct unit; and
(b) to whom the Board has delegated (non-exclusively and in addition to any other specific delegation of
power whether described in these By-Laws or elsewhere), the powers conferred by Articles 13, 36, 37,
40 and 49(e) of the Constitution.

QUESTION 1.10
The findings and decisions from CPA Australia’s Disciplinary Tribunals against CPA Australia members
are found on its website: www.cpaaustralia.com.au/about-cpa-australia/governance/member-conduct-
and-discipline/outcomes-of-disciplinary-hearings. Names are not always published if, for example, there
are extenuating circumstances.

QUESTION 1.11
Some SMEs seek business advice extensively from external accountants; however, it is apparent that many
SMEs are not yet taking this approach. The challenge for the profession is to engage with SMEs so that the
role of external accountants as business advisers (doing far more than traditional bookkeepers, accountants
and tax return agents) is better understood by all SMEs.
IFAC (2010) identified that researchers have found ‘fortress mentality’ SME operators who simply
do not know how accountants could function as their valued business advisers. Other researchers have
identified that business advising is growing in range and quality. SMEs operated by those with a fortress
mentality need to be better informed about the range and quality of external business advice from
accountants.
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394 SUGGESTED ANSWERS

 IFAC also identified that, as a matter of logic, SMEs need external business advice and that change
needs to occur. IFAC demonstrated that change is occurring (for example, in the business advising role of
in-house accountants) and that more change is needed. It is apparent that external accountants must learn
how to better communicate with clients and ensure that SMEs with no in-house accountants do not suffer
by not having access to good business advice. External accountants must learn to depict their role as team
players with those who manage SMEs and ensure that their role in value creation is understood.
The following summary explains how IFAC (2010) discussed the issue.
Some owner-managers want to ‘go it alone’ rather than expose their problems to outsiders, depicting
this as a ‘fortress enterprise’ mentality. Owners displaying this attitude wanted to hide their weaknesses
and typically they would justify their approach by saying that outside advice was ‘irrelevant or poor.’ As
they were not using outside advice anyway — how would they know?
Other researchers have pointed out that the ‘range and quality of advice available’ in relation to business
advising from external advisers is growing. This has been a derivative of the work of external advisers
helping SMEs to meet regulatory requirements and can be seen in the increased number of advisers and
the increasing advisory skills in relation to ‘regulatory and day-to-day and strategic challenges’.
It is apparent that SMEs do require external advice because many smaller entities have no internal
accounting staff. Much advice has been in relation to meeting regulatory requirements, but demand is
also evident in relation to business monitoring and quality control. Importantly, IFAC states that ‘this
is not merely confined to financial compliance’. While it is clear that a compliance bias has continued,
external advice and support have been sought from accountants as general business advisers in relation to
employment, health and safety, and environmental regulations.

QUESTION 1.12
From careful reading of reading 1.2, it is apparent that:
• Roel van Veggel acts as CFO and has a clear understanding of the business, its key revenue and cost
activities
• the strong accounting team that Roel built is providing assistance
• he takes control of risks, freeing André Rieu to concentrate on his music and related skills to build the
overall business
• Roel has become a manager beyond his CFO role and helps Rieu ‘focus less on administrative issues
while providing greater support about strategic decision-making activities’
• Roel has also taken steps to ensure that communication within the company is at a very high standard.

QUESTION 1.13
The four issues raised are:
• incentives to manipulate or misstate accounting information
• lack of auditor independence
• poor audit quality
• too much flexibility and loopholes in reporting practices.
One overarching reason that the profession may lose credibility from these problems is they can all be
linked to members of the profession acting in a self-interested way that ignores serving the public interest.
Another reason is linked to the interpretation that accountants are not as technically skilled and capable
as they claim. This is especially the case when issues of poor audit quality are raised.
Lack of auditor independence can lead many people to doubt the usefulness or worth of audits. Instead
of being perceived as a public service, audits may be seen as a waste of time and only performed to generate
extra fees for accountants.
Strategies for dealing with these issues may include more restrictive accounting standards and rules to
minimise creative accounting, and greater penalties for inaccurate financial reporting, including fines and
jail terms. Expanded disclosure requirements for accounting estimates and treatments may also be helpful.
One proposed solution for addressing auditor independence is to have auditors appointed to a particular
company by an independent body, rather than by the company itself. This should help avoid the inherent
conflict of interest that exists with the current way auditors are appointed.

QUESTION 1.14
This question does not require an answer.
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SUGGESTED ANSWERS 395

MODULE 2
QUESTION 2.1
(a) Example 2.2 relates to the issue of presentation of information to avoid deception. This conflicts with
numerous requirements of the Code of Ethics, and further information about these conflicts can be
found in part C of the module. They include the fundamental principle of integrity, in relation to being
knowingly associated with a report that ‘omits or obscures required information [to be included] where
such omission or obscurity would be misleading’ (para. R111.2). There is also a conflict with the notion
of professional behaviour. It would be inappropriate for a member of a professional accounting body
bound by this Code of Ethics.
Example 2.3 illustrates conflict of interest. For further discussion of conflict of interest, read and
take notes on the relevant sections in the Code related to conflicts of interest for members in business
and members in practice These sections cover conflicts of interest in detail.
(b) One possible answer is that both are examples of truth versus loyalty. In both examples there is a
pre-existing relationship with either the employer or the clients. The accountant should look beyond
the relationship and take actions that results in a truthful outcome.
(c) Gil may consider distancing himself from the report and not having anything to do with it. A further
course of action for Gil is resignation if he believes this conduct will continue and he is convinced he
is incapable of dealing with a toxic environment.
Jane can choose to discuss the issue with her client and alert her client as to her concerns. The other
way in which Jane may deal with this is to distance herself from this behaviour by resigning because
the conduct is unprofessional.

QUESTION 2.2
The candidate is confusing the concept of egoism with utilitarianism. An ethical egoist is one who evaluates
the rightness of a proposed action by choosing a course of action that maximises the net positive benefits
to oneself. A utilitarian act or decision is one that produces the greatest benefit to the greatest number
of people.
The definition advocated by the candidate is more consistent with egoism.
While both theories are based on consequential analysis, the major distinction between egoism and
utilitarianism is the perspective from which consequences are analysed. Egoism considers consequences
as they apply to advancing one’s own interest, whereas utilitarianism considers consequences to all
parties affected.
A second problem with this definition relates to the cost–benefit or outcome analysis. The phrase
‘measurable monetary rewards over costs’ implies that relevant outcomes should include only those that
can be measured in monetary or dollar terms. This is inconsistent with the utilitarian principle’s inclusion
of both economic and non-tangible or psychological outcomes (e.g. pleasure and pain).

QUESTION 2.3
Jack is thinking about his ethical challenges in the context of egoism, which is an ethical framework that
deals with the self-interest having primacy over the overall good.
Jane takes a view looking at the rights of the parties involved in the relationship dispute and is concerned
that the former husband is taking advantage of a situation in order to lower the amount given in any
settlement to his former partner.

QUESTION 2.4
(a) The Code has been designed to stipulate what the profession across the globe believes is an appropriate
standard of behaviour for the accounting profession.
(b) The Code applies to all members of professional accounting bodies, but specific sections of the Code
provide guidance for members in business and members in practice.
(c) Members in not-for-profit organisations are covered by the Code of Ethics because all members must
follow the fundamental principles and reviews their activities in accordance with the Code.
(d) R stands for ‘requirements’ and A stands for ‘application material’.
(e) ‘Shall’ denotes something that is imperative while the other two words — ‘may’ and ‘might’ — will
reflect something a member could do based on the circumstances.
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396 SUGGESTED ANSWERS

QUESTION 2.5
TABLE 2.3 Fundamental principles

Definition (para. 110.1 A1)

Integrity To be straightforward and honest in all professional and business relationships.

Objectivity To exercise professional or business judgement without being compromised by:

(i) Bias;
(ii) Conflict of interest; or
(iii) Undue influence of, or undue reliance on, individuals, organisations, technology
or other factors.

Professional competence To:

and due care (i) Attain and maintain professional knowledge and skill at the level required to
ensure that a client or employing organisation receives competent Professional
Activities, based on current technical and professional standards and relevant
legislation; and
(ii) Act diligently and in accordance with applicable technical and professional
standards.

Confidentiality To respect the confidentiality of information acquired as a result of professional and

business relationships.

Professional behaviour To:

(i) Comply with relevant laws and regulations;
(ii) Behave in a manner consistent with the profession’s responsibility to act in the
public interest in all Professional Activities and business relationships; and
(iii) Avoid any conduct that the Member knows or should know might discredit
the profession.

Source: APESB 2022, Compiled APES 110 Code of Ethics for Professional Accountants (including Independence Standards),
APESB, Melbourne, accessed August 2023, https://apesb.org.au/wp-content/uploads/2023/05/Compiled_APES_110_Dec_2022.pdf.

QUESTION 2.6
TABLE 2.4 Statements aligned with principles

Statement Principle

This fundamental principle deals with implicit fair dealing and truthfulness. Integrity

Members are obliged to ensure their professional judgement is not compromised Objectivity
due to undue influence by others.

A member is required to ensure they act diligently and in accordance with Professional competence
professional standards that apply to their work. and due care

A member needs to be conscious about inadvertent disclosure of client Confidentiality

information.

A member should not associate themselves with documents where the member Integrity
believes the content is materially false.

Conduct that a reasonable and informed third party would be likely to conclude Professional behaviour
adversely affects the good reputation of the profession is conduct that is or may be
defined as conduct discrediting the profession.

Information acquired as a result of working on an engagement shall not be Confidentiality

disclosed unless there is a legal or professional duty to do so.

It may be a breach of a principle if a member associates themselves with Integrity

statements or information that was provided recklessly.

Members shall avoid conduct that they know may discredit the profession. Professional behaviour

A member shall make clients or employers aware of any limitations of the services a Professional competence
member is providing to them. and due care

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SUGGESTED ANSWERS 397

 TABLE 2.4 (continued)

Statement Principle

Members should not be involved with the publication of information where the Integrity
presentation of information omits or obscures the true substance of a situation.

Members shall not mislead clients or potential clients with claims that misrepresent Professional behaviour
their actual qualifications or experience.

Proper authorisation shall be obtained before certain kinds of information are Confidentiality
shared with parties that are not involved in an engagement within a company or
professional practice.

A member shall disassociate themselves from information that is false, provided Integrity
recklessly or omits information that might otherwise lead a reader to interpret a
situation differently if a full and clear account of a situation was presented.

Ending a relationship between a client or employing organisation does not mean Confidentiality
that a member is free to share information with other parties or on social media.

Disparaging references or unsubstantiated comparisons to the work of others shall Professional behaviour
not be made by a member.

A member shall take necessary measures to ensure people working under their Professional competence
authority are properly supervised and trained. and due care

A member shall not undertake a professional engagement if there is a situation Objectivity

or relationship that may unduly influence the member’s exercise of professional
judgement if they were to engage in that activity.

Information acquired as a result of professional and business relationships shall not Confidentiality
be used for the personal advantage of the member or the advantage of a
third party.

Members have a professional duty or right to disclose information where not Confidentiality
prohibited by law to comply with quality reviews conducted by CPA Australia or
responding to an inquiry or investigation by CPA Australia.

Source: Adapted from APESB 2022, Compiled APES 110 Code of Ethics for Professional Accountants (including Independence
Standards), APESB, Melbourne, accessed August 2023, https://apesb.org.au/wp-content/uploads/2023/05/Compiled_APES_110_
Dec_2022.pdf.

QUESTION 2.7
(a) There are a number of stakeholders in this case. Below is a list of the stakeholders and the likely
impacts on them:
• Scott London — embarrassment, public humiliation, loss of stakeholders and reputation, breach of
trust, prison and monetary fine
• KPMG, London’s former employer, who has had a former partner of the firm trading on inside or
non-public information — embarrassment to the firm, employees of the firm and clients, loss of
clientele, potential need to review existing procedures
• Accounting profession in general — ethical conduct of a senior member of the accounting profession
is subject to public scrutiny and undermines the reputation of the accounting profession
• US Securities Exchange Commission and FBI, enforcement agencies — need to devote extra
resources to investigating London’s conduct
• KPMG audit clients — inside information is used by London and clients were named in relation
to London’s trading when they had no knowledge of his conduct, or his violation of trust and
confidentiality
• New York Stock Exchange — negative impact on the integrity of trading on the securities market
generally and of trading in KPMG audit clients specifically
• Bryan Shaw — embarrassment and public humiliation
• London’s family and friends — embarrassment, public humiliation, and breach of trust
• Traders in securities of KPMG audit clients — lack of awareness that London and Shaw were trading
in securities using inside information, thus placing other securities traders at a disadvantage.
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398 SUGGESTED ANSWERS

(b) Integrity (APES 110, subsection 111). London has breached his client’s trust by disclosing confidential
information to his close friend for personal gain. London had an obligation to be honest in his
professional relationships with clients and his involvement in insider trading was dishonest conduct.
Objectivity (APES 110, subsection 112). London’s professional judgement was compromised by his
conflicts of interest in relation to his securities trading and his dealings with KPMG and audit clients.
Professional competence and due care (APES 110, subsection 113). London may have been
technically competent in the work he performed, but he did not show due care to his clients and KPMG,
as he did not provide his services in accordance with relevant laws and regulations. Being involved in
insider trading showed a lack of due care to his clients.
Confidentiality (APES 110, subsection 114). London traded in securities based on non-public
information obtained in his role at KPMG. The confidentiality principle imposes an obligation on
accountants to refrain from using to their personal advantage, or to the advantage of third parties (in
this case, Bryan Shaw), confidential information acquired as a result of professional relationships.
Professional behaviour (APES 110, subsection 115). London should have complied with the relevant
laws and regulations so as to avoid any discredit to the accounting profession. His failure to comply
with the securities laws and KPMG’s internal procedures has indeed brought discredit to it. It can be
concluded that London placed his own self-interest ahead of his duties to the audit clients, KPMG, the
securities market and the accounting profession.

QUESTION 2.8
(a) No, they do not need to be a member ‘but would possess the relevant knowledge and experience to
understand and evaluate the appropriateness of the Member’s conclusions in an impartial manner’
(para. 120.5 A6).
(b) An inquiring mind ensures that all of the relevant information is available to the member before they
apply the framework. It involves ensuring that the information that they have is complete, consistent,
current and the source is free from bias and self-interest (para 120.5 A2).
(c) To reach valid conclusions, the member needs to ensure that:
• they have sufficient expertise to make the judgement (and consult with others if they need to) and
• their own preconceptions and biases are not affecting their judgement (para. 120.5 A5).

QUESTION 2.9

TABLE 2.5 Threat categories

Threat category Definition

Intimidation The threat that a Member will be deterred from acting objectively because of actual or
perceived pressures, including attempts to exercise undue influence over the Member.

Advocacy The threat that a Member will promote a client’s or employing organisation’s position to the
point that the Member’s objectivity is compromised.

Self-review The threat that a Member will not appropriately evaluate the results of a previous judgement
made, or an activity performed by the Member or by another individual within the Member’s
Firm or employing organisation, on which the Member will rely when forming a judgement as
part of performing a current activity.

Self-interest The threat that a financial or other interest will inappropriately influence a Member’s
judgement or behaviour.

Familiarity The threat that due to a long or close relationship with a client, or employing organisation, a
Member will be too sympathetic to their interests or too accepting of their work.

Source: APESB 2022, Compiled APES 110 Code of Ethics for Professional Accountants (including Independence Standards),
APESB, Melbourne, accessed August 2023, https://apesb.org.au/wp-content/uploads/2023/05/Compiled_APES_110_Dec_2022.pdf.

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SUGGESTED ANSWERS 399

QUESTION 2.10
Note: Explanations for each circumstance are provided below table 2.6.

TABLE 2.6 Examples of threats — accountants in business and accountants in public practice

Self-interest

Intimidation
Self-review

Familiarity
Advocacy
Circumstance

Members in Business

1. A Member holding a Financial Interest in, or receiving a loan or ✓

guarantee from, the employing organisation.

2. An individual attempting to influence the decision making process of ✓

the Member, for example with regard to the awarding of contracts or the
application of an accounting principle.

3. A Member determining the appropriate accounting treatment for a ✓

business combination after performing the feasibility study supporting
the purchase decision.

4. A Member having the opportunity to manipulate information in a ✓

prospectus in order to obtain favourable financing.

5. A Member being responsible for the financial reporting of the employing ✓

organisation when an Immediate or Close Family member employed by
the organisation makes decisions that affect the financial reporting of
the organisation.

6. A Member having a long association with individuals influencing ✓

business decisions.

7. A Member or Immediate or Close Family member facing the threat of ✓

dismissal or replacement over a disagreement about:
• The application of an accounting principle.
• The way in which financial information is to be reported.

8. A Member being offered a gift or special treatment from a supplier of ✓

the employing organisation.

9. A Member participating in incentive compensation arrangements ✓

offered by the employing organisation.

10. A Member having access to corporate assets for personal use. ✓

Members in public practice

1. A Member being threatened with dismissal from a client engagement or ✓

the Firm because of a disagreement about a professional matter.

2. A director or officer of the client, or an employee in a position to exert ✓

significant influence over the subject matter of the engagement, having
recently served as the Engagement Partner.

3. An Audit Team member having a long association with the Audit Client. ✓

4. A Member quoting a low fee to obtain a new engagement and the fee ✓
is so low that it might be difficult to perform the Professional Service in
accordance with applicable technical and professional standards for
that price.

5. A Member having prepared the original data used to generate records ✓

that are the subject matter of the Assurance Engagement.

6. A Member acting as an advocate on behalf of a client in litigation or ✓

disputes with third parties.

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400 SUGGESTED ANSWERS

 7. A Member having a Close or Immediate Family member who is a ✓
Director or Officer of the client.

8. A Member being informed that a planned promotion will not occur ✓

unless the Member agrees with an inappropriate accounting treatment.

9. A Member having accepted a significant gift from a client and being ✓

threatened that acceptance of this gift will be made public.

10. A Member issuing an assurance report on the effectiveness of the ✓

operation of financial systems after implementing the systems.

11. A Member lobbying in favour of legislation on behalf of a client. ✓

12. A Member having access to confidential information that might be used ✓

for personal gain.

13. A Member promoting the interests of, or shares in, a client. ✓

14. A Member having a Direct Financial Interest in a client. ✓

15. A Member feeling pressured to agree with the judgement of a client ✓

because the client has more expertise on the matter in question.

16. A Member discovering a significant error when evaluating the results ✓

of a previous Professional Service performed by a member of the
Member’s Firm.

17. A Member having a close business relationship with a client. ✓

18. An individual who is being considered to serve as an appropriate ✓

reviewer, as a safeguard to address a threat, having a close relationship
with an individual who performed the work.

Source: APESB 2022, Compiled APES 110 Code of Ethics for Professional Accountants (including Independence Standards),
APESB, Melbourne, accessed August 2023, https://apesb.org.au/wp-content/uploads/2023/05/Compiled_APES_110_Dec_2022.pdf.

Explanation
Members in Business
1. The member is in a situation where the financial arrangements compromise their judgement. They
have a self-interest in the outcome. This situation may also give rise to an intimidation threat if
management uses the loan or guarantee as leverage to get the member to boost profits rather than
what is ethically appropriate.
2. This is an example of a familiarity threat because somebody is trying to leverage their business
relationship to achieve a desirable outcome.
3. This situation gives rise to a self-review threat. It may be more appropriate for the accounting treatment
to be recommended by another party who has not gone through the feasibility study.
4. This is an advocacy threat. Information is being doctored in order to build a case based on misleading
information to a financier.
5. This an example of a familiarity threat. The fact that the member’s family member was involved in
decision making could make it difficult for them to deal with decision making.
6. This is an example of a familiarity threat. A member may be unable to properly question their
colleagues’ judgement because of a long-standing relationship.
7. This is an example of an intimidation threat. The member might want to do the right thing, but their
refusal to agree with the application of an accounting principle leads to a threat of loss of employment.
8. This is a self-interest threat because the member is being given a benefit from a supplier who may
expect preferential treatment in return.
9. This is a self-interest threat. A member may feel compelled or pressured by incentive arrangements to
take actions that help the entity increase its revenue at the expense of the welfare of customers.
10. This is a self-interest threat because the member may become dependent on access to corporate assets
and, as such, reluctant to challenge management decisions for fear of losing that benefit.
Members in Public Practice
1. This is an intimidation threat because the member is being threatened with termination.
2. This is a familiarity threat because the individual concerned would know the professional practice as
well as the client. An intimidation threat may also arise if the director or officer use their previous
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relationship as a way of getting a desired outcome.

SUGGESTED ANSWERS 401

 3. This is a familiarity threat because the audit team member may not ask necessary questions if they
believe the audit client should be trusted.
4. This involves a self-interest threat because the member is only interested in securing work regardless
of the cost to quality.
5. This involves a self-review threat. You cannot audit your own work.
6. This involves an advocacy threat because advocacy implies taking the client’s side rather than applying
independent judgement as would occur in an audit or assurance engagement.
7. This involves a familiarity threat because the member may feel reluctant to make a decision that
disadvantages their relative.
8. This involves the possibility that the member’s own financial interest (the promotion and presumably
an increase in salary) will inappropriately influence their choice of accounting treatment.
9. This is an intimidation threat because it raises the question of what the client would want in return for
not publicising the gift.
10. This involves a self-review threat because the member is auditing their own work.
11. This is an advocacy threat because the member is not fulfilling the role of an independent adviser.
12. This is a self-interest threat because the member may do or say whatever is necessary to keep
themselves employed to continue getting access to material.
13. This is an advocacy threat. Promotion of a client’s interests is advocacy.
14. This is a self-interest threat because it ties the member’s personal financial interests to those of a client.
15. This is an intimidation threat. The client is using their expertise to pressure the practitioner into
agreeing with their judgement.
16. This involves a self-interest threat. The member then needs to decide whether to report the error and
consider the consequences.
17. This is a self-interest threat, and that member may be unable to appropriately deliver independent
professional services.
18. The relationship between the reviewer and the individual who performed the task may mean that the
reviewer may be too accepting of the individual’s work and not scrutinise it as carefully as they would
if the relationship did not exist.

QUESTION 2.11
Toby has a self-interest threat, and it would be inappropriate for Toby to provide advice to the client. One
way of dealing with this threat to fundamental principles is for Francis to take on the client engagement.

QUESTION 2.12
The company can consider the fundraising proposal, but Celia has a conflict of interest because she is
on the management committee. It is possible that there is a familiarity threat and self-interest threat
present in the situation. The board of the company should consider the fundraising matter without Celia in
the room.

QUESTION 2.13
Smith, Jones & Associates
The Code of Ethics (para. R320.8) requires the auditor to obtain professional clearance from the previous
auditor. Specifically, the auditor must request the client’s permission to communicate with the previous
auditor and, on receipt of permission, should ask the previous auditor to provide all relevant information in
order to decide whether to accept the audit. This information should be treated in the strictest confidence.

Ace Tax Services

The work envisaged does not replace the work currently performed by Ace Tax Services. You are asked to
provide audit services because the previous auditor is now retired. Ace Tax Services provides tax services
to your client, not audit services; thus, professional clearance is not required. However, you may, as a
professional courtesy, send a letter of notification to Ace Tax Services advising the firm of the work
being undertaken.

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402 SUGGESTED ANSWERS

QUESTION 2.14
Toby must consider whether the hospitality is likely to compromise the work he does and also how his
work is perceived because hospitality that is significant may create a familiarity threat. When in doubt, it
is best to not accept hospitality except in circumstances where it is insignificant.

QUESTION 2.15
The invitations to lunch and dinner pose a familiarity threat. The company clearly wishes to become
a preferential supplier, irrespective of whether the inducement is intended or not intended to influence
the tendering process. Both independence in appearance and in fact are needed. Inducements could
also lead to an intimidation threat where a supplier might seek to use hospitality as leverage against a
company not wanting to use their entity as a supplier. Remember that situations can give rise to more than
one threat.

QUESTION 2.16
(a)
TABLE 2.15 Guidance for managing non-compliance

Steps for professional services other than audits

Steps for audits (paras R360.10–360.28 A1) (paras R360.29–360.40 A1)

1. Obtain an understanding of the matter 1. Obtain an understanding of the matter

2. Address the matter 2. Address with management and those charged

with governance

3. Determine if further action is needed 3. Communicate with the entity’s external auditor

4. Document the steps and outcomes 4. Determine if further action is needed

5. Document the steps and outcomes

Source: CPA Australia 2023.

(b) It requires a member to make a decision as to whether the imminent breach warrants immediate action
in terms of reporting. Paragraph R260.22 provides further guidance on this matter.

QUESTION 2.17
An accountant is required to ‘act in the public interest’ (para. 100.1). This would require Kath to act in
the interest of the client’s employees and report the client’s non-compliance with laws and regulations in
a timely manner.
Kath has been responsible for managing the client’s payroll for three and a half years so should be
aware of the outcome of the regulator’s payroll audit three years ago. Kath has an obligation to provide
professional competence and due care to her clients (subsection 113). DDV Accounting was informed of
the regulator’s findings and provided with information about the legal labour rates and conditions that apply
in the jurisdiction. Kath, an accountant with DDV Accounting, therefore has a duty to provide professional
competence and due care to ensure her client updated their payroll records and were paying their employees
at the correct rates.

QUESTION 2.18
Where there is a legal requirement to maintain confidentiality, you must comply with it. However,
NOCLAR is not only concerned with disclosing an actual or suspected non-compliance to an appropriate
authority; it also requires accountants to obtain an understanding of the matter, address the matter,
determine whether anything else must be done, and document the whole process.
If there is no law or regulation that requires you to maintain confidentiality, you may decide to disclose
a non-compliance with laws and regulations to an appropriate authority, even if there is a confidentiality
clause in the negotiated contract and terms of engagement with a client. In such cases, whether you are
legally protected is a matter of legal determination, and you are strongly encouraged to seek legal advice.
Furthermore, you must discuss your obligation to comply with the Code of Ethics, including NOCLAR,
with existing and prospective clients, and clarify that any confidential clauses in your contracts and terms
of engagement are subject to your responsibility to comply with the Code and its requirements.
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SUGGESTED ANSWERS 403

QUESTION 2.19
Accountants have long been trusted to assure the community of reliable and accurate financial information.
According to this view, integrity underpins and supports high-quality information for the efficient
functioning of capital markets. Consequently, people who rely on the services provided by accountants
expect those accountants to be highly competent and objective. Therefore, those who work in the field of
accounting must not only be well qualified but must also possess a high degree of integrity.
Promoting integrity within the profession through leadership, policies, information and culture will in
turn produce desirable behavioural attributes in accountants, such as honesty, fairness, a commitment
to others and compliance with relevant laws and regulations. Only then will the profession reduce the
incidence of accounting failures. To this end, integrity is intrinsically linked to trust, which is vitally
important to the reputation of individuals, reporting entities and the profession. Without trust, the work of
accountants would be ignored. Integrity and trust are also linked to the public interest ideal, which obliges
accountants to advance the interests of the public before the interests of others. This duty is mandatory and
applies without exception.

QUESTION 2.20
(a) The Code of Ethics states that, in connection with marketing of professional service, a member in
public practice ‘shall be honest and truthful’ (para. R115.2). James Chan is not an expert in the
assurance of elder care services and advertising himself as such is false, misleading and deceptive.
This is a self-interest threat to the principles of professional care and due diligence and professional
behaviour.
(b) His traditional audit skills will not enable him to provide high-quality elder care assurance services
without proper training in this area. If he wishes to proceed, he should get the requisite expertise or
hire or contract staff with the required expertise.

QUESTION 2.21
(a) The threat concerned is an intimidation threat.
(b) The junior accountant should refuse to pay the invoices and, if required, see another senior manager
to report the conduct concerned.

QUESTION 2.22
The APESB Code of Ethics, including NOCLAR, does not impose a responsibility on accountants in
business to actively look for any non-compliance with laws and regulations. However, accountants need
to respond to any actual or suspected non-compliance when they encounter it or are made aware of it.
Accountants who have management responsibilities or are accountants of the governance team must ensure
that the activities of the employing organisation are carried out in accordance with applicable laws and
regulations (para. 360.10).
The Code does not impose a responsibility on accountants to know laws and regulations that are
not related to their responsibilities or those laws and regulations that are not required to be known to
competently perform their roles. The principle of professional competence and due care (subsection 113)
requires accountants to maintain professional knowledge and skill required so that they perform their
professional activities competently, while the principle of professional behaviour (subsection 115) requires
accountants to comply with relevant laws and regulations.

QUESTION 2.23
The definition of independence in the Code of Ethics has two parts. The first part relates to independence of
mind. Can the professional conducting the audit say that they only have their professional judgement about
the fact pattern before them in mind? The second part of the definition relates to whether the perception
of independence is compromised by any actions or relationships an auditor may have.
The two fundamental principles that independence ultimately concerns are objectivity and integrity.

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404 SUGGESTED ANSWERS

QUESTION 2.24
Do you have a direct or indirect material financial interest in a client or its Objectivity
subsidiaries/affiliates?

Do you have a financial interest in any major competitors, investees or affiliates of Objectivity
a client?

Do you have any outside business relationship with a client or an officer, director or Objectivity,
principal shareholder having the objective of financial gain? confidentiality

Do you owe any client any amount, except as a normal customer, or in respect of a Objectivity
home loan under normal lending conditions?

Do you have the authority to sign cheques for a client, or make electronic Objectivity
payments on their behalf?

Are you connected with a client as a promoter, underwriter or voting trustee, Objectivity
director, officer or in any capacity equivalent to a member of management or
an employee?

Do you serve as a director, trustee, officer or employee of a client? Objectivity

Has your spouse or minor child been employed by a client? Objectivity

Has anyone in your family been employed in any managerial position by a client? Objectivity

Are any billings delinquent for clients that are your responsibility? Objectivity

Have you received any benefits such as gifts or hospitality from a client, that are Objectivity,
not commensurate with normal courtesies of social life? professional behaviour

QUESTION 2.25
There are circumstances in which non-audit services may threaten the integrity or the objectivity of
an external financial statement audit. Non-audit services may create self-review threats if the output of
the services becomes subject to audit. Other services may also create a self-interest threat because the
additional revenue may be something the firm may be reluctant to lose, Parts 4A and 4B of the Code
identify various threats and how a practice may introduce safeguards in certain situations.

QUESTION 2.26
(a) The culture of an organisation may be formally expressed through written policies and codes of
ethics, or may be informally expressed through the words and actions of significant others such as
the organisation’s leaders. If the culture is strong and supports high ethical standards, it should have a
powerful and positive influence on employees’ behaviour. Generally, the more ethical the culture of
an organisation, the more ethical employee behaviour is likely to be.
The firm had undergone significant change during the 1980s and 1990s. Arthur Andersen became
a business that focused on financial gains at the expense of its third-party obligations. This focus on
self-interest was also evidenced by the firm’s behaviour in relation to the document shredding.
(b) Audit firms such as Arthur Andersen traditionally provided to their audit clients a range of non-audit
services that were consistent with their skills and expertise. The provision of non-audit services (which
include all fees that do not constitute audit services) to assurance clients is an activity that often
provides additional value for an audit client. Consequently, audit clients benefit from the non-audit
services provided by their audit firms, who have a good understanding of the client’s business.
However, the provision of non-audit services may jeopardise the independence of the account-
ing firm. Two perceived threats could be: (1) self-interest (profit over quality of service); and
(2) self-review threats whereby the audit team may be reluctant to criticise the non-audit services
provided by their colleagues within the same firm. Critics argue that, in such situations, audit firms are
influenced to serve client satisfaction ahead of their professional responsibilities.
If it is not possible to eliminate or reduce the threat created by application of safeguards, the service
should be refused. However, when the non-audit service is not related to the subject matter of an audit
engagement, the threats to independence will generally be insignificant.
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SUGGESTED ANSWERS 405

(c) Under the Code of Ethics, the following safeguards may be applicable in reducing, to an acceptable
level, threats created by the provision of non-assurance services to audit clients:
• ensuring staff involved in the provision of non-assurance services are not involved in the audit to
avoid a self-review threat
• ensuring that the audit and non-assurance services that can be provided under ethical standards are
managed through a different division/partner
• avoiding the need to assess threats to fundamental principles by banning the provision of non-audit
services to a specific client.
(d) Arthur Andersen failed to act according to the public interest principle by:
• not ensuring independence
• failing to disclose Enron’s financial position to investors
• shredding documents related to its audit of Enron.
Arthur Andersen put the interests of Enron (its client) before the interests of the public. It failed
to give precedence to the interest of the public and so failed to act according to the public interest
principle.

QUESTION 2.27
The culture of such wholesale referral, and doing so to a select number of firms, itself represents a potential
violation of the Code of Ethics. Paragraph AUST R330.5.2 states that ‘A Member in Public Practice shall
not receive commissions or other similar benefits in connection with an Assurance Engagement’. Referral
fees may fall within the intent of this section. If it does there is a possible self-interest threat to compliance
with the principles of objectivity and professional competence and due care.
Also of concern is what could possibly be called an intimidation threat to Jerry. The lack of choice
afforded to Jerry in making these referrals, by the workload and punitive culture, implicates him in the
potential violation. Furthermore, in referring clients to the specialist firms in this complete and wholesale
fashion, Jerry is unable to maintain an ongoing relationship with the client. The pressure placed on
employees such as Jerry through the high workload means insufficient time and knowledge are applied
either to the client or to the referral. This may well lead to Jack being in breach of the fundamental principle
of professional care and due diligence.

QUESTION 2.28
There are many factors that may cause an employee to compromise their personal ethical standards.
Although the ethical culture of the firm is a primary influence, there are many other factors (supporting or
countering the existing culture) that could influence behaviour. The list is not exhaustive. You will find that
a careful examination of your own corporate environment and discussion with colleagues in business will
highlight numerous other factors. The intention here is to highlight some of the major and more obvious
influences on personal behaviour, which include the following.
• Tight or unrealistic targets cause pressure to cut corners and therefore quality.
• Remuneration or reward systems often overemphasise profit-oriented bonuses, causing actions that
focus on profit maximisation — possibly at an ethical cost.
• The ethical culture of an organisation creates an environment that condones questionable acts.
• Top management — through its management style — sets the tone for inappropriate behaviour.
• A lack of explicit rules defining acceptable behaviour (such as a code of conduct) or, alternatively, codes
that are not enforced may result in instances of inappropriate behaviour.

QUESTION 2.29
The notion of trust in the professional–client relationship is fundamental to the concept of professionalism.
Without public trust, the status of the accounting profession would be reduced considerably. Unfortunately,
the actions of a questionable few can affect the reputation of the entire profession. For this reason, it is the
aim of the profession to maintain a proper ethical image. This is possible by informing and reminding
accountants that their primary responsibility is to serve the public (rather than self) interest. This is
normally achieved by implementing and enforcing the Code of Ethics.

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406 SUGGESTED ANSWERS

QUESTION 2.30
Law generally codifies society’s customs and values, and undoubtedly any changes to law are reflections of
changes in society’s attitudes. But it is wrong to suggest that legal compliance will amount to satisfactory
ethical conduct. Generally, it will be more accurate to claim that legal compliance sets the minimum
standard for ethical conduct, implying that the standard of ethical conduct is higher than that expected
from the law. The real dilemma, for which there is no easy solution, is to what extent is moral conduct
higher than legal conduct? Similarly, breaking the law does not necessarily mean conduct is immoral. The
law in question could be outdated or simply wrong.

QUESTION 2.31
Gifts are a common practice for companies operating internationally. The problem for many companies
and their accountants is that gifts can influence business behaviour, giving rise to possible conflicts. In
some cultures, gift giving and receiving are simply expected. For an ethical relativist, there is no universal
standard of right or wrong but only the standard of a particular society. The problem for many people is that
they may feel constrained to accept such practices while knowing or feeling that they are unacceptable.
The decision to accept or reject the gift is a difficult issue. Refer to the guidelines provided in the Code
to help you make a decision. You have a number of options available to you, such as informing your
superiors or referring to company policy for guidance. In general, it is normally the size of the gift and the
intention of the giver that determines whether it is unethical. In this case, the intention appears honourable;
therefore, it is the size of the gift that will determine whether you should reject the gift. Company policy
will normally provide guidance in this area.
If the gift is deemed to be of considerable value, then it must be returned. A thank you note with an
explanation will ease any potential ill feelings. Nowadays, with the extent of trade internationalisation,
businesspeople worldwide are well informed on the courtesies of gift giving and receiving.

QUESTION 2.32
A solution has not been provided for this question, so please self-assess your answer to (c) by comparing
your analysis of the case study to that given in APES GN 40.

QUESTION 2.33
To apply this model, we ask four questions:
1. Do the benefits outweigh the harms to oneself?
In this case, the benefits of lower cost production combined with equivalent quality provide benefit,
although potential harm linked to poor reputation must be considered.
2. Do the benefits outweigh the harms to others?
Benefits to others include employment that may not otherwise be available. The harms include poor
working conditions and significant danger from fires, for example, which have had a devastating impact
in Bangladesh.
3. Are the rights of individual stakeholders considered and respected?
Despite compliance with local regulations, it is possible that the rights of Delta Ltd’s employees are not
being fully respected. The pressure to have lower costs and lower prices may have led to compromises in
factory design and to working conditions that fail to respect these rights.
4. Are the benefits and burdens justly distributed?
The main benefits appear to accrue to the managers of Alpha Ltd and also to the managers of Delta Ltd.
The employees of Delta Ltd will also benefit from salary and wages, but the burden they bear may not be
justly distributed. The rightful benefits of some of these employees may be reduced in order to provide
additional benefit to other stakeholders — for example, lower prices for customers.
Recommendation
There is no single correct answer to this issue. The purpose of this model is to ensure all relevant factors are
considered from a variety of perspectives. Your final recommendation will depend on the specific answers
provided, based on the specific details of the case.

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SUGGESTED ANSWERS 407

QUESTION 2.34
The following points should be noted when applying the AAA model.
1. What are the facts of the case?
Davis has to confront a possible conspiracy by those senior to him in the organisation (aided and abetted
by the external auditors to present an inaccurate picture). Booker was apparently a successful family firm
that was taken over by a larger company. Davis was asked to stay in his position with the subsidiary but
would now have to report to the senior management of Booker and the parent company.
At the time of the takeover, Davis considered that the fixed assets were assigned their fair market value
and that the purchase price included $450 000 for goodwill. The figures seemed reasonable. Later, the end
of financial year consolidated financial statements for 2019 did not show the $450 000 as goodwill; instead
the entry had been used to raise the overall value of fixed assets. The auditors had rendered an opinion
lacking requisite detail.
The parent company stood to gain from ‘cooking the books’ in its negotiations with the unions. Union
claims were based on company profits, which were reduced because the depreciation charges for the assets
exceeded the amortisation charge for the goodwill.
2. What are the ethical issues in the case?
(a) Who are the stakeholders? The ethical issues will most likely arise out of conflicting interests between
and among the stakeholders. The stakeholders can be listed as follows.
• Davis — he has knowledge of the accounting manipulation and feels he has an obligation to act on
this information.
• Shareholders or owners — accounting adjustments can affect the share price, profit and balance
sheet figures, all of which affect shareholder wealth and investment decisions.
• Unions — they use net profit as a basis for negotiating wage levels, so reduced profit from the
accounting adjustment will affect their bargaining position.
• The CEO of the parent company — he or she is ultimately responsible for the fair presentation of
the financial reports; in this case, the CEO will ultimately be held accountable for the manipulation
or may, in fact, be the instigator.
• The external auditors — they have signed off on the accounts that are potentially misleading.
(b) What are the ethical issues? Most of these concern Davis’s integrity, namely:
• his integrity versus his job security
• his integrity versus his loyalty to the firm
• his integrity versus the reputation of the external auditors
• his integrity versus the reputation of the parent company’s CEO
• the company’s financial health versus the unions’ right to information.
An ethical issue or dilemma arises when there are two or more equally compelling courses of action
without clear resolution. The conflict could involve two or more obligations, duties, principles, rules or
loyalties. But irrespective of the nature of the conflict, the two principles, duties and so on, contradict each
other. Similarly, each alternative has negative and positive outcomes, and choosing one alternative will
come at the expense of the other.
In this case, Davis’s integrity is at odds with his self-interest and the interests of the company as well as
with external parties such as the shareholders and the union. In brief, if Davis remains silent, he protects
his self-interest, but this comes at a cost to the unions and shareholders (who act according to diminished
information) and to his own integrity. If Davis acts on this information, he protects his integrity, but it
may disadvantage his career. Each alternative Davis faces produces negative and positive outcomes and
supports different principles.
3. What are the norms, principles and values related to the case?
Here we are obviously concerned with integrity. We are also concerned with ethical concepts such as
obligation, rights, justice and harm. The following items appear relevant to our analysis:
• integrity
• fairness in dealing with the unions
• doing no harm and trying to prevent harm being done to the various stakeholders
• loyalty
• right to know (unions)
• job security (Davis’s self-interest)
• independence (professional standard).
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408 SUGGESTED ANSWERS

4. What are the alternative courses of action?
Here we wish to identify the major options. Creative solutions should be encouraged, especially those that
are closer to win–win solutions. The options, for discussion purposes, include the following.
• Do nothing — accept the judgement of the external auditors.
• Raise the matter with the internal auditors, the external auditors or both.
• Report the matter to the CEO of the parent company.
• Report the matter to the unions.
5. What is the best course of action that is consistent with the norms, principles and values identified?
Here we wish to test the strength or importance of the various norms, principles and values raised earlier,
and start to move towards a decision on what to do. In particular, we need to be concerned if any
stakeholder is seriously harmed. Do you consider that Davis’s integrity and the principles that he adopts
as an accountant have been sufficiently harmed as to require action on his part? If you think that they have
been harmed, what action do you recommend and why? Perhaps a discussion with the CEO in the first
instance would be appropriate. Do you think that the interests of the unions have been sufficiently harmed
as to require action? If you do, is the first step to discuss it with the CEO?
The primary function of this step is to determine whether there is one principle or value, or a combination
of principles or values, so compelling that a particular option is clear (e.g. correcting a major defect that
is almost certain to cause loss of life).
6. What are the consequences of each possible course of action?
For illustrative purposes, we identify three options for action. These need to be discussed for both their
short- and long-term consequences (note the utilitarian influence on the model in this case).
(a) Do nothing.
• Unions may suffer in negotiations.
• Davis’s conscience and sense of integrity may suffer, and his reputation may also suffer if it appears
that he has prepared the accounts.
• The company may get a more favourable contract.
• The (internal and external) auditors ‘win’.
• Davis’s job is probably not in jeopardy.
(b) Raise the matter with the auditors (or the CEO), with possibly the same result.
• They may stand fast.
• They may change their reports on the statements.
• Unions will benefit from the change.
• Davis’s conscience is clear.
• The company may pay more wages.
• Davis’s job may be in jeopardy.
(c) Raise the matter with the unions.
• Auditors will be challenged.
• Labour negotiations may be tougher.
• Davis is likely to be in trouble.
• The company may pay higher wages.
7. What is the decision?
The action you take is for you to decide. Having decided, provide reasons for your choice. For instance, if
you recommend that Davis raise his concerns with the CEO, this has the chance of establishing long-term
gains for all if the CEO is prepared to take a principled stand and give ethical leadership on this matter.
Our preferred solution is that Davis should raise the matter with the CEO. By sending a memorandum
to the CEO, Davis is clearly making a stand and preserving his integrity. He is acting in the public interest
and is attempting to comply with Subsection 113 Professional Competence and Due Care by having the
$450 000 recorded as goodwill. Of course, Davis is in a potentially dangerous situation if the CEO refuses
to comply. If he refuses, Davis could either:
• resign and maintain his professional reputation and integrity, or
• back down and keep his job but with a loss of reputation and integrity.
Therefore, Davis should resign if no action is taken by the CEO.
In light of the justification provided above in support of our preferred option, we do not recommend the
‘do nothing’ approach as it is not consistent with the professional duties required of an accountant.

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QUESTION 2.35
1. What are the facts of the case?
The projected estimates for future revenues of the Deep Vein mine are probably inaccurate, overstating the
investment’s worth. The inaccuracy is being knowingly maintained in the financial reports of Millennial,
and in this fashion, it is deceiving its investors. In addition to this, the investment is in contradiction to
the principles of investment articulated by Millennial’s CFO. Jenna is being pressured to conceal the
inaccuracy via intimidation, or the implication of intimidation.
2. What are the ethical issues in the case?
(a) Who are the stakeholders? The principal stakeholders are:
• Millennial’s management
• Millennial’s employees
• Millennial’s investors
• Deep Vein’s proposed operators (depending on the investment of funds such as Millennial)
• rival investment funds (less direct stakeholders)
• Jenna.
(b) What are the ethical issues? These are:
• the deliberate deception of investors regarding investments by Millennial
• the failure to act in accordance with stated business objectives and managerial decisions
• the intimidation of staff to maintain deception and prevent disclosure.
3. What are the norms, principles and values related to the case?
This case relates to several of the fundamental principles of the APESB Code of Ethics, and to the normative
values expressed in several of the ethical theories discussed in part B.
Fundamental principles of the Code:
• Subsection 111 — Integrity — in particular paragraph R111.2, which specifies that:
A Member shall not knowingly be associated with reports, returns, communications or other information
where they believe that the information:
(a) Contains a materially false or misleading statement;
(b) Contains statements or information furnished recklessly; or
(c) Omits or obscures required information where such omission or obscurity would be misleading.

• Subsection 113 of the Code — Professional competence and due care — in particular the obligation
of due care requiring that accountants ‘act diligently in accordance with applicable technical and
professional standards’ (para. R113.1(b)).
• Subsection 115 of the Code — Professional behaviour — in particular the requirement to ‘comply with
relevant laws and regulations and avoid any conduct that the Member knows or should know might
discredit the profession’ (para. R115.1).
Values articulated in the ethical theories:
• Egoism — the emphasis on satisfying self-interest relates to the consequences of Jenna’s decision
for herself.
• Utilitarianism — the emphasis on satisfying the interests of the greatest number affected by the action
relates to the consequences of Jenna’s decision for all relevant stakeholders.
• Ethics of duties (deontology) and ethics of rights both apply, and work reciprocally. Investors and
potential investors have a contractual right to know the state of the company’s finances, and the company
has a contractual duty to provide this information.
4. What are the alternative courses of action?
Jenna could:
(a) prepare the report as recommended incorporating Deep Vein’s estimates
(b) disclose the probable value of the investment (including her revised estimates)
(c) consult with someone in senior management, perhaps notifying the CFO, given the proposed
investment’s conflict with his stated objectives.
5. What is the best course of action that is consistent with the norms, principles and values identified in
Question 3?
Disclosing the probable value of the investment and approaching a senior manager would both satisfy
requirements of fundamental principles of objectivity, professional competence and due care and
professional behaviour. They would also accord with the company’s duty to provide accurate information
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410 SUGGESTED ANSWERS

and the right of investors and potential investors to accurate reporting. Both courses of action also accord
with the interests of the majority of people affected (utilitarianism) if we assume that a poor investment
choice will affect more stakeholders (e.g. investors, employees) negatively than positively. Disclosing the
probable value of the investment is unlikely to accord with Jenna’s own self-interest (egoism), as it is likely
to threaten her job security. Approaching a senior manager, such as the CFO, may or may not accord with
her self-interest, depending on whether management takes a sympathetic attitude to her disagreement, or
sides with her manager, though it may offer her a safeguard.
Preparing the report as recommended incorporating Deep Vein’s estimates would accord more with
Jenna’s self-interest (egoism) but would violate the conditions specified by the fundamental princi-
ples of objectivity, professional competence and due care and professional behaviour of the Code.
It would probably harm the interests of more stakeholders than it would benefit (failing the utilitar-
ian test) and violate the contractual duties and rights specified between Millennial, its investors and
potential investors.
6. What are the consequences of each possible course of action?
Course of action (a)
Following the recommendation may result in future earnings failing to meet projected estimates, and hence
in investors failing to receive the return on investment they have been led to expect, resulting in investor
dissatisfaction and mistrust in the fund’s management. This may result in investors taking their business
to Millennial’s rivals, with a lesser chance of investors attempting formal redress against the company.
Furthermore, should the misrepresentation be exposed at some later date, Jenna may be held liable.
Course of action (b)
The consequences of disclosing the actual value in her report depends on whether that disclosure is
communicated to the investors.
• If it is not communicated, there will be no difference in effect apart from a negative effect on Jenna’s
job security. It may, though, protect Jenna from liability for the misrepresentation should it be exposed
at a later date.
• If it is communicated, there may be some investor dissatisfaction, with a minimal chance of petitioning
the board or similar investor activism.
Course of action (c)
Similarly, the consequences of approaching a senior manager depend on whether they are sympathetic to
Jenna’s perspective, or instead they side with her manager.
• If the senior manager sides with her manager, there will be no difference apart from a negative effect on
Jenna’s job security, even more so than in course of action (a).
• If the senior manager sympathises with Jenna, the investment proposal may be altered, potentially
benefiting investors (though disadvantaging Deep Vein). If the investment strategy cannot be altered at
that point in time, full disclosure may nevertheless be enabled, again with the possible result of investor
dissatisfaction. Moreover, this option offers Jenna a safeguard that may remove her liability for the
misrepresentation, should it be exposed at a later date, and offer her protection against backlash.
7. What is the decision?
Here we should compare the primary norms, principles and values from questions 3 and 5 with the
consequences from question 6, and select one of the courses of action from question 4.
The primary norms, values and principles suggest either to include the revised estimate in the report, or
to consult with a senior manager, perhaps the CFO. However the consequences of these two options are
the most uncertain and pose the highest risk for Jenna.
There is no guarantee that the inaccuracy will ever come to light, and so going against her supervisor may
simply jeopardise her job security with no other effect. However, if the inaccuracy is disclosed in some
other way, the company may well assign all responsibility to Jenna, as she signed off on the accounts,
making her legally liable for the misrepresentation, and her integrity may be brought into question.
The action you consider preferable is your own decision but should be supported with good reasons.
Our recommendation would be that Jenna consults with a senior manager, perhaps the CFO, as it will
enable her to maintain her obligations under subsections 111, 113 and 115 of the Code and maintain
Millennial’s fiduciary obligations, as well as offering Jenna a possible safeguard, though it may cause a
backlash from her manager.

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SUGGESTED ANSWERS 411

MODULE 3
QUESTION 3.1
Small proprietary company
(2) A proprietary company is a small proprietary company for a financial year if it satisfies at least 2 of
the following paragraphs:
(a) the consolidated revenue for the financial year of the company and the entities it controls (if any)
is less than $50 million*, or any other amount prescribed by the regulations for the purposes of
this paragraph;
(b) the value of the consolidated gross assets at the end of the financial year of the company and
the entities it controls (if any) is less than $25 million*, or any other amount prescribed by the
regulations for the purposes of this paragraph;
(c) the company and the entities it controls (if any) have fewer than 100*, or any other number
prescribed by the regulations for the purposes of this paragraph, employees at the end of the
financial year.
Large proprietary company
(3) A proprietary company is a large proprietary company for a financial year if it satisfies at least 2 of the
following paragraphs:
(a) the consolidated revenue for the financial year of the company and the entities it controls (if
any) is $50 million*, or any other amount prescribed by the regulations for the purposes of
paragraph (2)(a), or more;
(b) the value of the consolidated gross assets at the end of the financial year of the company and the
entities it controls (if any) is $25 million*, or any other amount prescribed by the regulations for
the purposes of paragraph (2)(b), or more;
(c) the company and the entities it controls (if any) have 100*, or any other number prescribed by the
regulations for the purposes of paragraph (2)(c), or more employees at the end of the financial year
(Corporations Act 2001, s. 45A(2)–(3)).
*Updated amounts come from s. 1.0.0.2B of the Corporations Regulations 2001.

QUESTION 3.2
No solution is provided. Candidates are to use the ASIC information to self-assess.

QUESTION 3.3
(a) and (b) You should have downloaded the two documents and your answer may include the similarities
and differences shown in the following table.

Excerpts

Box 2.3 from the ASX Principles Provision 10 of the UK FRC Code Comparison

• is, or has been, employed in an
executive capacity by the entity or any
of its child entities and there has not
been a period of at least three years
between ceasing such employment
and serving on the board
• is or has been an employee of the
company or group within the last
five years
Similar, but the UK FRC
Code specifies a period
of five years versus the
ASX Principles of
three years.

• receives performance-based
remuneration (including options
or performance rights) from, or
participates in an employee incentive
scheme of, the entity
• has received or receives additional Similar, but the UK FRC
remuneration from the company apart Code extends criteria
from a director’s fee, participates to include pension
in the company’s share option or a scheme.
performance-related pay scheme,
or is a member of the company’s
pension scheme

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412 SUGGESTED ANSWERS

 • is, or has been within the last
three years, in a material business
relationship (e.g. as a supplier,
professional adviser, consultant or
customer) with the entity or any of
its child entities, or is an officer of, or
otherwise associated with, someone
with such a relationship
• has, or has had within the last three Similar, but the UK FRC
years, a material business relationship Code extends the
with the company, either directly or relationship to include
as a partner, shareholder, director or cross directorships with
senior employee of a body that has respect to other entities.
such a relationship with the company
• holds cross-directorships or has
significant links with other directors
through involvement in other
companies or bodies

• is, represents or has been within • represents a significant shareholder Similar, but the ASX
the last three years an officer or Principles extend a
employee of, or professional adviser historical time period of
to, a substantial holder three years.

• has close personal ties with any • has close family ties with any of the Similar.
person who falls within any of the company’s advisers, directors or
categories described above senior employees

• has been a director of the entity for
such a period that their independence
from management and substantial
holders may have been compromised.
• has served on the board for more than Similar, but the UK FRC
nine years from the date of their first Code specifies a time
appointment. Where any of these or period as a factor which
other relevant circumstances apply, impacts independence.
and the board nonetheless considers
that the non-executive director is
independent, a clear explanation
should be provided.

Source: Extracts from ASX CGC 2019, Corporate governance principles and recommendations, 4th edn, p. 14, accessed August
2023, www.asx.com.au/documents/asx-compliance/cgc-principles-and-recommendations-fourth-edn.pdf. © Copyright 2019 ASX
Corporate Governance Council; UK FRC (UK Financial Reporting Council) 2018, The UK corporate governance code, July,
accessed August 2023, www.frc.org.uk/getattachment/88bd8c45-50ea-4841-95b0-d2f4f48069a2/2018-UK-Corporate-Governance-
Code-FINAL.pdf.

(c) The ASX Corporate Governance Council recommends that the tenure of board members that have
served more than 10 years be assessed regularly to ensure that they still meet the definition of
independence.

QUESTION 3.4
The Small Business Guide in the Corporations Act 2001 (Cwlth) states that the company secretary
has specific responsibilities under the Corporations Act, including responsibility for ensuring that the
company:
• notifies ASIC about changes to the identities, names and addresses of the company’s directors and
company secretaries
• notifies ASIC about changes to the register of members
• notifies ASIC about changes to any ultimate holding company
• responds, if necessary, to an extract of particulars that it receives and that it responds to any return of
particulars that it receives.

QUESTION 3.5

TABLE 3.3 Shareholder powers

Section Shareholder power

136 By special resolution the power to adopt, modify, or repeal a constitution or parts thereof.

162 By special resolution the power to change the company to a different type.

173(2) The right to inspect or get copies of member, option holders, or debenture holder registers.

(continued)

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SUGGESTED ANSWERS 413

 TABLE 3.3 (continued)

Section Shareholder power

201P Power by resolution to prevent directors from setting a board limit unless approved by a
general meeting.

203D Power by resolution to remove a director by ordinary resolution of members.

208 Power to approve related party benefits (public companies only).

234 Power to apply to the Court for an oppression remedy under s. 233 (which includes winding up
of the company).

246B If the constitution does not exist or doesn’t set out a procedure the power by special
resolution to vary or cancel class rights.

249D(1) Power to request directors to call a general meeting if requested by members with at least 5%
of the votes.

249N Power to put advisory resolutions at general meetings.

251B Power to request access to minutes of member meetings.

314 and 316A The right to a financial report, directors’ report and an auditor’s report.

327B and 329 The right to vote at an AGM on the appointment of an auditor.

QUESTION 3.6
Conflicts of interest can arise when an agent receives delegated powers. The agent is required to act in the
best interests of the principal. However, the temptation to act for the agent’s own interest can be strong, as
agents often control the flow of information and are sometimes subject to less supervision.

QUESTION 3.7
Agency theory recognises that agents may prioritise showing loyalty (and, therefore, accept the costs
of bonding). However, the agent is not the principal and, therefore, will not act in the same way as the
principal. Insofar as the agent does not achieve what would have been achieved by the principal, this is
termed ‘residual loss’. Residual loss can arise because of deliberate (self-seeking) actions by the agent
or unintentionally, by mistake or by simply not understanding the principal’s goals. Whatever the final
cost, we can describe the incongruence of goals between agent and principal as critical to understanding
residual loss.
The existence of agency relationships means that there is a need to monitor activity so that residual loss
is identified and then can be further explored to rectify problems arising from lack of goal congruence
between the agent and principal. This means that there will be monitoring costs. The law, for example,
demands financial audits and full public reporting as part of monitoring. Aside from legally required
monitoring, there are many ways in which monitoring can be carried out and, therefore, a vast array of
ways in which monitoring costs will be incurred.
Residual loss and monitoring costs are both borne by the principal and, as they are paid out of the
company’s resources, will clearly result in a diminution of the company’s value.

QUESTION 3.8
(a) Information asymmetry refers to the differential of knowledge or information that two parties to a
transaction possess. A simple example is the parties involved in buying a second-hand vehicle. In most
cases, the salesperson will have more knowledge of the vehicles that they are selling than the buyer.
Moral hazard describes the situation where one party acts knowing that the other party will bear the
risk and any associated costs. This is often the result of information asymmetry.
(b) Where information asymmetry exists, there is potential for:
• poor decisions being made because complete information may not be available to the party making
the decision
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414 SUGGESTED ANSWERS

 • ‘sneaky’ or risky actions being taken because the party taking the action knows that they will not be
‘found out’ and, if they are, they will not bear the risk or the consequences.
Within a company, information asymmetry may exist between the following parties:
• boards and members
• management and boards
• employees and management.
• management and external stakeholders.

QUESTION 3.9
Note that there is not always a clear distinction between performance and conformance. For example,
budgeting is a useful tool in achieving improved performance, but it also provides a useful conformance
and control mechanism to ensure resources are effectively managed and monitored.

Conformance Performance

• Taking steps designed to protect the • Determining the company’s vision and mission.
company’s financial position and its ability
to meet its debts and other obligations as they
fall due.

• Adopting clearly defined delegations of • Reviewing opportunities and threats to the company in
authority from the board to the chief executive the external environment, and strengths and weaknesses
officer (CEO) or a statement of matters within the company.
reserved for decision by the board.

• Ensuring systems are in place that facilitate • Considering and assessing strategic options for
the effective monitoring and management the company.
of the principal risks to which the company
is exposed.

• Determining that the company has instituted
adequate reporting systems and internal
controls (both operational and financial)
together with appropriate monitoring of
compliance activities.
• Adopting a strategic plan for the company, including
general and specific goals, and comparing actual results
with the plan.

• Establishing and monitoring policies directed • Adopting an annual budget for the financial performance of
at ensuring that the company complies with the company and monitoring results on a regular basis.
the law and conforms to the highest standards
of financial and ethical behaviour.

• Determining that the company accounts • Agreeing on performance indicators with management.
conform with Australian Accounting Standards
and are true and fair.

• Determining that satisfactory arrangements are
in place for auditing the company’s financial
affairs and that the scope of the external audit
is adequate.
• Selecting and, if necessary, replacing the CEO, setting an
appropriate remuneration package For the CEO, ensuring
adequate succession plans are in place for the CEO, and
giving guidance on the appointment and remuneration of
other senior management positions.

• Selecting and recommending auditors to
shareholders at general meetings.
• Adopting formal processes for the selection of new
directors and recommending them for the consideration
of shareholders at general meetings, with adequate
information to allow shareholders to make
informed decisions.

• Ensuring that the company has in place a • Reviewing the board’s own processes and effectiveness,
policy that enables it to communicate and the balance of competence on the board.
effectively with shareholders, other
stakeholders and the public generally.

• Approving and working with and through the CEO.

Source: Adapted from Bosch, H 1995, Corporate practices and conduct, 3rd edn, Pitman, Melbourne, p. 9. Reproduced with
permission.

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SUGGESTED ANSWERS 415

QUESTION 3.10
Usually, the expected benefits of audit committees include:
• improving the quality of financial disclosures
• acting as a forum for the resolution of disagreements between management, the internal auditor and the
external auditor
• ensuring that an effective whistleblower system is in place.
The Enron audit committee failed to achieve these desired outcomes. Possible reasons why they were
not obtained can be linked to the limitations of audit committees, which include:
• committee members may have been selected because of their association with the CEO or chair, thus
reducing their real independence
• audit committees may have been formed as a means of giving the appearance of good corporate
governance without achieving any useful purpose for the organisation.
The main positive points include:
• all members of the Enron audit committee were non-executive directors
• all members were highly qualified.
However, negative aspects include:
• the lack of any real independence of many committee members. For example:
– John Wakeham had a consulting contract with the company
– Wendy Gramm’s employer had received funding from Enron, as had her husband (a US Senator).
• Enron did not voluntarily disclose information about relationships that could harm the independence of
audit committee members
• the possibility that the age of the chair of the audit committee (72 years) affected his ability to participate
effectively as chair.
In addition to the issues about how the committee was structured, there were issues about how the
committee behaved. Although questionable practices were raised, there was a lack of remedial action.
There appeared to be a lack of rigour in pursuing the committee’s role.
Improvements should have focused on both the structure and the committee’s activities. Having
non-executive directors is not enough. There needs to be independent non-executive directors who actively
perform their roles in a diligent manner.

QUESTION 3.11
Full disclosure is the foundation upon which the integrity of equity markets is built. Without an equal
sharing of available information, investors who are informed will have an advantage over those who are
not. This can lead to exploitation of uninformed shareholders, and the growth of equity markets would be
inhibited by the resulting lack of confidence. As equity markets mature, there is an increasing emphasis
on full and continuous disclosure which modern communication technologies facilitate.
Essentially, markets are built upon trust. Once this trust is damaged, such as when it is revealed that
privileged groups have monopolised information for their own benefit, it is very difficult to rebuild trust.
Therefore, full disclosure and transparency are not only the practical mechanisms by which markets operate
efficiently, they are the central ethical principles of markets.

QUESTION 3.12
Internationally, there is a clear correlation between market failure and corporate collapse, with renewed
interest in extending regulations. It is only natural when investors have lost considerable amounts of money
that attention is given to the viability of regulatory systems. However, as corporate governance relates to
both wealth generation and risk management, these duties require continuous and simultaneous perfor-
mance. Avoiding mandatory restrictive over-regulation requires active market regulation, particularly at
times of expansion. The drive to make corporations improve corporate performance and governance, and
enhance corporate accountability needs to continue as an essential part of building sustainable economies
and enduring companies.

QUESTION 3.13
The market-based system of corporate governance has the following strengths:
• dispersed ownership and strong institutional investors
• primacy of shareholder interests in company law
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• emphasis on protection of minority shareholder interests in law and regulation
• stringent requirements for disclosure
• fluid capital investment in dynamic economy
• competitive performance.
The weaknesses of a market-based system of corporate governance include:
• overly dominant and overpaid CEOs
• weak boards of directors
• failures in reporting and transparency
• short-term investment
• instability of governance and investment
• cyclical volatility in a dynamic economy.

QUESTION 3.14
The advantages of the European relationship-based system are as follows.
• Diverse interests are represented on the board of directors.
• Insider groups monitor management, reducing agency problems.
• A wider group of stakeholders is actively recognised (including employees, customers, banks, suppliers
and local communities).
• Close relationships with banks provide stable finance.
• Inter-corporate shareholdings provide stability of ownership.
• Strong established governance procedures are established.
• Longer-term business strategies are possible.
The disadvantages of the European relationship-based system include:
• potentially weak discipline of management by the securities market
• potentially weak market for corporate control, eliminating threats of takeover for poorly performing
companies
• historical lack of development of institutional investors, with finance highly dependent on banks
• historical lack of emphasis on the public disclosure of information
• shareholder agreements and voting restrictions that allow minority groups to exercise control
• perception that governance procedures are time-consuming and elaborate
• interlocking business networks that can create complacency rather than competitiveness.

QUESTION 3.15

TABLE 3.9 Governance codes

Element of regulatory framework (table 2.2)

Maximum term of
Disclosure office for board
in annual members before
Basis for company re-election
Country framework Approach report Surveillance (figure 4.1)

Australia Listing rule Comply or Required Stock exchange 3 years

explain

India Law or regulation Binding Required Securities regulator 3 years

and stock exchange

Japan Listing rule Comply or Required Stock exchange 2 years

explain

Germany Law or regulation Comply or Required Different stakeholders 5 years

explain appointed by
government

Source: Adapted from OECD 2023c, OECD corporate governance factbook 2023, Table 2.2 and Figure 4.1, accessed September
2023, www.oecd-ilibrary.org/finance-and-investment/oecd-corporate-governance-factbook-2023_6d912314-en.

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QUESTION 3.16
Sub-principle II.G states that minority shareholders should be protected from abusive actions by controlling
shareholders. However, sub-principle II.A.4 states that basic shareholder rights include participating and
voting in general shareholder meetings.
There may be times when the majority of the organisation’s shareholders want a particular event to occur,
but this may be perceived to go against a small minority who do not want this to happen. The minority
may view this as an abusive action, while the majority may regard it as a legitimate business transaction.
An example where this may arise is when a company votes on a significant issue, such as an equity
raising that dilutes current shareholdings, or a sale of a major component of the business, or a significant
change in strategy. In this situation, the intention of the action becomes important — it will generally be
permissible if it is done for the benefit of the company as a whole, with no intention to deliberately hurt
the minority. The law in this case becomes complex.

QUESTION 3.17
These three actions all create issues in relation to the OECD Principles (OECD 2023).
1. There are no independent board members, therefore the composition of the board of directors does not
appear to satisfy sub-principle V.E.1, which states that ‘boards should consider assigning a sufficient
number of independent board members capable of exercising independent judgement to tasks where
there is a potential for conflicts of interest’.
2. The restriction on selling shares does not satisfy sub-principle II.A.2, which suggests that basic
shareholder rights include the right to convey or transfer shares.
3. The publication of the carbon neutral goal without an accompanying sustainability report does not
satisfy sub-principle VI.A.4, which states that:
If a company publicly sets a sustainability-related goal or target, the disclosure framework should
provide that reliable metrics are regularly disclosed in an easily accessible form to allow investors to
assess the credibility and progress towards meeting the announced goal or target.

Therefore, the company is obliged to produce a sustainability report or at least disclose their progress
towards the target.

QUESTION 3.18
All references below are to the UK FRC Code (UK FRC 2018).
(a) The audit committee is responsible for reviewing the company’s internal controls (Provision 25).
(b) A formal evaluation of its own performance should be conducted by the board on an annual basis
(Provision 21).
(c) The same individual should not have the roles of chairman and chief executive at the same time
(Provision 9). One important reason for this is that the chair should be independent, which cannot
be the case if the position is held by the CEO. In addition to this, there needs to be clear separation of
duties and the avoidance of giving a single person too much power.

QUESTION 3.19
• The chair is not independent as required, as this director holds a significant shareholding (Provisions 9
and 10).
• At least half the board, excluding the chairman, should be independent (Provision 11). The board
currently has at least five members who are not independent (the four executives and the chair).
• There should be three independent members of the audit committee. The chair and the CFO are not
independent and the chair should not be a member of the audit committee (Provision 24).
• The company also needs to have a remuneration committee (Provision 32) and a nomination committee
(Provision 17).

QUESTION 3.20
No answer is supplied for this question.

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QUESTION 3.21
The challenge of public sector enterprise governance is that it is informed by a broad public service mission,
while private enterprise may focus more on the bottom line profit. That is, while the public sector enterprise
will be required to work within a budget, the definition of its mission is often broad enough to demand
careful assessment of the priorities the enterprise must pursue. Often for public sector enterprises, there is
unlimited demand for services from the public, and therefore the analysis of priorities and the assessment
of performance in meeting those priorities needs to be finally tuned.
In this context, good governance is required to deliver on the three Es — economy, efficiency and
effectiveness. With such wide and competing economic and social objectives, the boards of public
enterprises need to build good relationships with wider stakeholders to fully understand their needs, while
engaging with government to remain fully accountable. There must be a clear delineation of the roles
and powers of government ministers and boards, and capable directors, while boards need to be given the
opportunity to do their work with responsibility and accountability, and without undue intervention from
government ministers.

MODULE 4
QUESTION 4.1
The two-strikes rule provides a new type of power to shareholders who are dissatisfied with the
remuneration report. This report, as part of the corporation’s annual report, discloses the salaries paid
to senior executives. If shareholders are unhappy, the first strike may occur at the next AGM if at least
25 per cent of the eligible shareholders vote against accepting the remuneration report. Shareholders
ineligible to vote include managers, directors and any associated shareholders. The second strike may
occur a year later at the next AGM, if the next remuneration report is similarly rejected by at least
25 per cent of the eligible shareholders. Following the second strike, the whole board, except for the
managing director is subject to a spill vote. The spill vote takes place the same day and only eligible
voters are involved in that voting. The spill occurs if 50 per cent of eligible voters vote in favour of the
spill, because the big step of dislodging the whole board should not be decided by only 25 per cent of
eligible voters.
The old ‘spilled’ board continues until the next shareholders’ meeting, which must take place within
90 days in order to elect a new board. Candidates can include new potential directors nominated by
shareholders so the old board can be largely replaced. The vote for the new board involves all shareholders,
including the previously ineligible shareholders, who now vote for the new board. This has the potential
to allow their often very large voting power to reinstate the old board. However, the message sent by
the eligible shareholders about who should be members of the new post-spill board of directors will be
powerful and hard to ignore.
Note also that at least (any) two of the old ‘spilled’ directors must continue as directors in addition to
the ‘unspilled’ managing director.

QUESTION 4.2
A disqualified person is not permitted to hold an office in a corporation, which includes not being permitted
to act as a director or be a senior manager. To act as an officer while disqualified is an offence and is subject
to criminal punishments.
Automatic disqualification means that the disqualified person is not necessarily informed that they are
disqualified. For example, a person involved in corporate crime, or even a non-corporate crime that involves
dishonesty and is not just a minor wrong, is most likely to be automatically disqualified because they are
criminally open to punishment. Accordingly, officers need to be aware of the possibility of automatic
disqualification if they are ever found guilty of an offence. Five years is usually the period of automatic
disqualification.
Where a court or a regulator such as ASIC orders disqualification, it will be because a legislated wrong
has occurred. This can include civil wrongs where proof is on the balance of probabilities. Periods of
disqualification are commonly up to 20 years (and sometimes more). Note that the disqualified person
is advised when the court or regulator states the outcome as an order to the relevant person. Aside from
disqualification, such orders are often in conjunction with civil or even criminal penalties.

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QUESTION 4.3
(a) Ideally, independent directors are not paid any performance bonuses. They should receive only flat
payments, in accordance with an overall payment policy approved by shareholders. As such, they are
not personally influenced by levels of pay. Independent directors should not be on a board too long (as
also discussed in module 3) so that they are able to stay independent and free from external influence.
Independent directors can, therefore, make decisions that are for the good of the company as a
whole (which is a specific legal formula about the relationship between the board and shareholders)
from a more objective stance than directors who are not independent. Non-independent non-executive
(NINE) directors are less able to make unbiased decisions and certainly appear more biased to ordinary
shareholders because they have relationships that deny independence. Executive directors should not
be allowed to make decisions regarding their own remuneration.
(b) This is a difficult question to answer in detail as every corporation is different and the remuneration
committee will look at many complex factors. Below are two possible methods.
• The CEO bonus should be based on achieving a certain return on investment (ROI), or a percentage
linked to achievement above a certain ROI. Care must be taken not to allow the remuneration
incentive to overcome organisational priorities and great care must be taken to ensure that excessive
risk is not accepted in the hope that great remuneration may result.
• The bonus should be paid partly in cash to emphasise an immediate return for current performance,
and partly in share options, with perhaps a two-year exercise date, to encourage the CEO to stay in
their current position and continue to build share value. After two years, the options will be worth
more and will be exercisable, giving a good reward after two years.
This approach could also apply to senior managers. The possible concepts and approaches under this
question are numerous and form a key part of the determinations of a good remuneration committee.
(c) Shareholders rely on the deliberations of the remuneration committee and its recommendations to
the board. Shareholders may question remuneration in annual meetings — including through the
two-strikes rule in Australia and related measures in other jurisdictions. The major considerations
need to be carefully analysed and undertaken by the remuneration committee and by the board,
in the absence of executive directors who are the recipients of the remuneration decisions. The
shareholders should be able to rely on good boards and active diligent independent directors for good
remuneration decisions.

QUESTION 4.4
A board may do many things to help ensure that the relationship between the corporation and the
external auditor is independent. One important item for which auditors are responsible is a statement
of independence that they must make to the corporation. This audit statement must be a part of the
corporation’s annual report, along with the actual audit report itself.
Apart from including the auditor’s statement of independence in the annual report, the board can consider
other important measures that will help to make independence easier to achieve. We have not looked at
every such measure, but they include clearly stated policies and practical procedures that:
• ensure an independent auditor is engaged to perform the audit
• establish a correctly structured audit committee so that this body can be identified easily by the auditor
as comprising those charged with governance
• ensure that the audit committee understands that it is the body through which all audit communications
are normally expected to take place
• define the way management should behave when their activities are the subject of audit activities. This,
importantly, will also include the CEO and the CFO.
In addition, appropriate measures should be in place to ensure that employees’ interactions and dealings
with the auditor are at arm’s length.

QUESTION 4.5
(a) In examples 4.16 and 4.17 the ultimate responsibility for decision making rests with the board, therefore
the boards of both corporations were lax in allowing anti-competitive practices to go on. For example,
Intel, the largest computer chip maker in the world, used its status to stifle its competition and to
unfairly pressure customers into doing business with it. Indeed, it can be argued that the directors
breached their fiduciary duties by allowing such anti-competitive behaviour. In either case, it might be
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 difficult to demonstrate that the board had actual or constructive knowledge of the wrongdoing to the
extent that its failure to respond to the alleged red flags was a breach of its fiduciary duties to properly
monitor corporate compliance. Compliance oversight is a key role of the board, so the directors should
have systems in place to prevent or at least warn them of these anti-competitive practices.
Corporate governance should ensure the constructive use of market power. Effective board oversight
of legal compliance can strengthen the corporation today and into the future, and allow it to avoid
accusations of wrongdoing with respect to domestic or global competition law. The board can be
assisted in doing this by establishing a strong and impartial ‘compliance committee’ that consists of
independent directors and by instituting appropriate compliance policies, procedures and programs.
Directors should ask themselves to what extent they are prepared to bear the negative consequences
of non-compliance. They should also check which early warning systems and processes have been put
in place for ensuring that the corporation’s practices are not anti-competitive, since the impact, both in
terms of reputation and bottom line, can be extremely damaging when a corporation fails to live up to
its regulatory compliance duty.
(b) Companies form strategies to make profits, and eliminating competitors or pursuing anti-competitive
action may help achieve those profits. So, from this perspective, competition laws may stifle an
aggressive corporation’s ability to be competitive.
However, in a market driven by competition, there is always an incentive to bring about technological
advances and innovations that provide consumers with new or better-quality products and services. As
such, from the perspective of a corporation that seeks competitive advantage in a market, it can be
harmful to stifle competition in the long run as inertia (lack of change or development) can set in. The
corporation will lose its competitive edge and new entrants to the market will ultimately succeed with
new, innovative products and/or cheaper prices.
(c) To distinguish themselves from their competitors and thus gain an advantage that is not
anti-competitive, corporations can initiate policies to develop and maintain customer relations through,
for example, the provision of comprehensive before- and after-sales services or continuing to offer
innovative products at competitive prices. Corporations can also establish a reputation for honesty and
integrity, and engender customer loyalty through the provision of excellent service. In other words,
meeting and exceeding competition and consumer laws is a way to drive competitive advantage without
resorting to the types of anti-competitive practices illustrated in examples 4.16 and 4.17.

QUESTION 4.6
(a) The purchasing managers of both Shark and Loose would likely be in breach of laws that prohibit
cartel conduct including this highly visible price fixing. In addition to the purchasing managers, the
corporations themselves would also be in breach, as the actions of employees are also those of the
corporation. Notwithstanding that the purchasing managers may have been acting contrary to corporate
policy, and not informing the corporations, they are still acting on behalf of their corporation. This will
lead to the corporation also being accountable for its conduct.
(b) Potential penalties include individual jail terms and fines, and fines for the corporations, which could
be as high as USD10 million or more (e.g. in Australia, the US and the EU). In addition to penalties,
compensation would also be payable to Goods Ltd as the affected party. Compensation may be very
large, depending on the economic damage suffered by Goods Ltd. Note that, if the misconduct is not
established as a crime proven beyond reasonable doubt, it is likely that the matter will be held as a
civil matter. The civil balance of probabilities standard of proof is easier to satisfy. While a civil wrong
does not establish a crime, it can result in a financial pecuniary penalty which may be at exactly the
same level as the criminal fine would have been. In Australia, a penalty unit is a standardised monetary
amount used to determine the fines, and the fines are calculated by multiplying the value of one penalty
unit by the number of units that the offence or contravention carries. The value of a penalty unit is
prescribed by the Crimes Act 1914 (Cwlth) and is currently $313 for offences committed on or after
1 July 2023.
(c) Acting alone, there would be no collusion and therefore no cartel conduct. There is simply no
agreement or understanding between competitors. Here, an individual corporation has decided to deal
with a certain customer in a certain way. This type of unilateral decision making is generally not a
problem, and on the facts stated, Shark and Loose should be safe.

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QUESTION 4.7
The conduct is misleading or is likely to mislead. To make a specific statement about an objective matter
is acceptable if it is essentially correct. The problem is that there is an objective matter that has been
ignored and that makes the specific statement objectively invalid. The advice received by the beverage
manufacturer clearly states that the higher carbohydrate content is statistically insignificant with respect
to the drink’s ability to improve endurance. Ignoring this objective fact and using only that which was
favourable to the drink maker constitutes misleading conduct.
Where misleading conduct is found, a range of outcomes apply, such as compensation orders, injunctions
or adverse publicity orders.

QUESTION 4.8
Financial market protection rules apply to everyone who breaches a market protection rule. To break the
rule, you do not need to be a director, an employee or an accountant — merely a person who breaks a
rule that applies to you as a person meddling with the market. If a director is involved, which is common
because they often hold secret market sensitive information, then they also may easily breach other laws
relating to directors’ duties.
It is clear that:
• Paroo has information (knowledge of the takeover bid)
• the information has not been disclosed and is not readily available in the market
• the information will have a material impact on the share price once it is released.
The information about the takeover is therefore inside information. Paroo is not permitted to act upon
this information or disclose it. By purchasing shares, Paroo has engaged in insider trading, deliberately
using knowledge not known to the market in order to acquire shares at a price that would encourage others
to buy those shares had they been privy to the information.
Paroo has also misused her position as a director and has misused information gained as a director. She
has also not acted in good faith in the best interests of the corporation and has not used her powers for
proper purposes.

QUESTION 4.9
Justice McClelland, the judge in the case, commented on Hartman’s immaturity and his lack of values. He
stated, ‘paying $350 000 to a recent graduate of 21 years of age carrying out a task of modest responsibility
underlines the extent to which the values which underpin our society can be compromised’.
We need to understand the role that greed and self-interest can play in creating circumstances that may
cause poor corporate behaviour to flourish. In this instance, Hartman had high expectations of rewards due
to him. It seems that he decided to increase his rewards by secretly manipulating aspects of the market
known to him and then using the secret information as an insider, which is also insider trading.
The market manipulation related to the fact that, as the judge stated, ‘in the course of buying and
selling in significant volumes, the offender came to appreciate that large-volume trading could have the
effect of raising or lowering the price of a stock within a short timeframe’. Hartman, recognising that the
market would be manipulated by this activity, used his secret inside information by telling others that this
manipulation would occur and by trading opportunistically for himself.
An interesting aspect of these circumstances is the fact that large-volume trading itself, if done in order
to drive prices up or down, will be unlawful. If a large volume is bought or sold as a simple trade without
the intention to drive prices, then there is not necessarily anything unlawful occurring. We can see in
Hartman’s case that he treated his ability to be involved in these price-inducing large trades as a known
manipulation activity. He attained his benefit from the actual insider trading. The case demonstrates the
way that markets can be subject to misdealing. We saw this also with the Calvin Zhu and David Jones
cases, and there are many such examples.

QUESTION 4.10
The Murdoch family held slightly less than 40 per cent of the shares in News Corp. This was not a
majority. However, as no other voting group held anything close to this percentage, it meant that News
Corp was controlled by the Murdoch family. This could have been seen in the fact that family members held
dominant executive management positions as well as board positions. At the time of the report (2011), the
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phone-tapping scandal involving News Corp was at its height, and the CEO and Chairman of the Board
were both the same person — Rupert Murdoch.
Normal small shareholders, whose individual votes provide no real power in many corporations, will be
able to exert even less influence where a single, closely aligned group of shareholders (i.e. the Murdoch-
aligned votes) has dominance of the type described.
We see here that the institutional investor CalPERS is offended by the nature of the board structure,
by reported corporate activities and by the way that the voting system is organised. The voting system
concern, if relating to ‘non-voting’ and ‘partial-voting’ shares, arguably may not be justified. This is
because CalPERS presumably bought shares aware of the voting rights. If it wishes all of its shares to
have voting rights then it is free to sell its non-voting shares and acquire only voting shares. If CalPERS’
concerns relate to the absence of power available to voting shares because of the Murdoch family’s voting
block, then the concerns are more understandable. It is also a concern that cannot be corrected unless
corporations laws change dramatically. A fundamental feature of all corporate governance is that those
who own the shares (including the Murdoch family) have the right to vote those shares. Even so, it is the
duty of all directors to act in the interests of the corporation as a whole. That means decisions must be made
for the benefit of all shareholders — not to the advantage of a few or to deliberately hurt any shareholders.
CalPERS, as an institutional investor, has about 1 per cent of the voting shares. We also see strong
animosity from CalPERS towards the voting and power structure within News Corp. Accordingly, we
might expect CalPERS to more readily align with other disgruntled shareholders. Indeed, the impact
of shareholder demands for News Corp to be split into 21st Century Fox for the film and television
interests and News Corp for the newspaper interests was eventually heeded by Murdoch, and for several
years proved a highly successful strategy. However, Rupert Murdoch has not listened to shareholders’
complaints regarding the governance and management structure of both companies and, in 2015, was
resolved to continue with the Murdoch family firmly in control (with his sons James and Lachlan holding
the controlling positions with himself), despite wide concerns among shareholders and other commentators
that this might prove an unstable succession strategy.

QUESTION 4.11
‘Whistleblowing’ describes the action of a person who discovers behaviour that they believe or reasonably
suspect is wrong and then brings their concerns to the attention of the appropriate people. Ideally, the
appropriate people will investigate the suspicions and, if proven correct, will take the necessary action
to address and rectify the situation. This concept is important in governance as whistleblowers are now
protected by legislation (where whistleblowers act in ways defined by relevant local legislation), including
the Treasury Laws Amendment (Enhancing Whistleblower Protections) Act 2019, the Corporations Act
2001 (Cwlth) and the Taxation Administration Act 1953 (Cwlth). Even junior employees can make their
concerns known without risk of punishment or legal action, as long as they act consistently with the law
protecting them. This means that senior and junior managers are more open to inquiry and this openness
not only discloses wrongs but makes wrongs less likely to occur.
We would advise Watkins that, in Australia today, she would be protected by specific legislation.
However, she must ensure that she satisfies prescribed rules to obtain that protection, which include that
she can only be a protected whistleblower if she is:
• a current or former officer (this includes senior managers and directors and the corporation secretary)
• a current or former employee
• a current or former supplier (a contractor or their employee)
• a family member of any of the above.
Watkins would be able to make the allegations anonymously provided she has reasonable grounds to
suspect misconduct, however, these allegations cannot be published or broadcast. Watkins must make her
allegations known only to specified recipients of that information, which include:
• ASIC
• APRA
• various eligible recipients’, including officers or senior managers, auditors, actuaries or a person
authorised by the corporation to receive disclosures.
If all these requirements are met, then Watkins would be protected in Australia.
If the company was to retaliate against Watkins, she would have a civil rights course of action available to
her and these rights may result in a substantial financial penalty against those who hurt the whistleblower.
Watkins should expect that Enron has a whistleblower policy that meets the requirements of the legislation
and that she would be adequately supported if she chose to be a whistleblower.
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MODULE 5
QUESTION 5.1
As evidenced by the following quote from the report (www.unepfi.org/fileadmin/events/2004/stocks/
who_cares_wins_global_compact_2004.pdf), governance (G) was an enabler in ensuring social (S) and
environmental (E) issues were addressed through policies and measures such as:
• disclosure
• transparency
• accountability
• executive remuneration plans.
Sound corporate governance and risk management systems are crucial pre-requisites to successfully
implementing policies and measures to address environmental and social challenges. This is why we have
chosen to use the term ‘environmental, social and governance issues’ throughout this report, as a way of
highlighting the fact that these three areas are closely inter-linked.
In particular, we believe that corporate governance systems can play a key role in implementing many of
the recommendations in this report, particularly with regard to better transparency and disclosure, linking
executive compensation to longer-term drivers of shareholder value and improving accountability (The
Global Compact 2004, p. 2).

QUESTION 5.2
This will be a matter of opinion but, arguably, if Milton Friedman’s view (i.e. that as long as organisations
operate within the rules or laws, they should act only to maximise shareholder wealth) is adopted, then
sustainable development is not a realistic goal. Sustainable development requires current generations not
to concentrate on maximising their own wealth, but to consider the needs of all people currently on the
planet as well as future generations. It also requires due consideration to be given to the environmental
impact of an organisation’s operations.
However, as will be shown by a number of the corporate accountability initiatives in this module,
maximising shareholder wealth does not have to be inconsistent with a broader sustainability focus. With
a broader community interest in sustainability issues, a broader sustainability focus by management can
identify risks and opportunities that can preserve or increase shareholder value (especially long-term
shareholder value) and/or maintain or enhance corporate reputation.

QUESTION 5.3
(a) An externality is defined as an impact that an entity has on parties that are external to the organisation
where such external parties did not agree or take part in the actions causing, or the decisions leading
to, the cost or benefit. Depending on the organisation in question, you may have identified a number
of positive and negative externalities.
For many organisations, negative externalities might include:
• emissions into the atmosphere with implications for climate change (this would impact on many
stakeholders, including the environment and future generations)
• waste emitted into waterways with implications for water life and drinking water quality (this would
impact on local communities, the environment and potentially future generations)
• production of goods that create waste that goes to landfill, thereby using land that might potentially
be used for other, more productive purposes (stakeholders affected here would include local
communities, the environment and future generations)
• the retrenchment of staff, thereby causing social costs inclusive of welfare payments paid by
government (stakeholders affected here would include the former employees, their families, local
communities and government).
Positive externalities could include the creation of products or services that have widespread social
or environmental benefits. For example, an organisation might breed endangered species and release
these to the environment. Or an organisation might provide an in-house literacy program that allows
workers who are parents to read to their children.

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(b) Although most externalities would not directly affect an organisation’s profit or loss, some may have an
indirect effect. For example, from an indirect perspective, poor social and environmental performance
could impact an organisation’s compliance with its social contract and this in turn might affect the
demand for its products as well as the availability of factors of production — such as labour (i.e. if an
organisation has created a poor reputation for its social or environmental performance, it might have
difficulty attracting employees, capital and so forth).
Increasingly, a number of externalities are being recognised as costs (i.e. internalised). For example,
consider carbon-related taxes (but whether the taxes charged reflect the ‘true cost’ of the damage being
done is another issue).
(c) You will have your own opinion about whether the failure to recognise externalities represents a failure
of current financial reporting systems. This module will expose you to current corporate reporting
systems that have broader reporting mandates and will identify and report on certain externalities in
accordance with their objectives.
(d) Possible ethical implications of business not being held accountable for its externalities are wide
ranging and have both short-term and long-term implications such as the following.
• When businesses chase the lowest cost manufacturing sites around the world and the lowest
employee costs, they typically destabilise the local society and when they move on, it leaves
large-scale unemployment in the neighbouring communities.
• Local governments and local communities typically have to pick up the costs of business externali-
ties such as the clean-up costs associated with abandoned mines, the medical costs of treating people
who suffer from lung cancer as a result of cigarette smoking, and the costs for asbestos sufferers
and sufferers of other workplace-related diseases.
• Consumers can be physically harmed and die prematurely from toxic industrial wastes that are not
adequately disposed of.
• The global commons can be polluted and degraded from over-intensive commercial farming and
arable land turned into dustbowls.
• Developing countries can be deprived of access to water where mining and other companies overuse
local water supplies.

QUESTION 5.4
1. (a) The intended audiences are stakeholders of the organisation who need to make decisions and the
European public.
(b) Financial materiality is a subset of impact materiality. All impacts, regardless of whether they have
a potential financial impact, may be considered material.
2. (a) The intended audience is primary users of general purpose financial reports for making decisions
about the provision of resources to the entity (existing and potential investors, lenders and
other creditors).
(b) It appears that impact materiality and financial materiality are seen as one and the same. Only
impacts that have a potential financial consequence are considered material.
3. It appears that ESRS 1 is wider in scope from both audience and materiality perspectives.

QUESTION 5.5
Although Wesfarmers mentions other stakeholders, their approach appears to be more closely aligned with
an enlightened self-interest approach. This is seen in the focus on business and shareholders. Creating
value for stakeholders appears to only be a secondary concern to Wesfarmers. It appears they are largely
interested in financial returns. If the company did interact with stakeholders, it would be according to
managerial stakeholder theory.
Stockland, on the other hand, seems to adopt a stakeholder perspective. The excerpt shows that
shareholders are seen as only one of a variety of stakeholders that the company is managed for.
Their emphasis on stakeholders for their intrinsic value (rather than their ability to generate profit for
shareholders) is more consistent with normative stakeholder theory.

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QUESTION 5.6
Item Scope 3 category

(a) Working from home 7. Employee commuting

(b) Flying to a business conference 6. Business travel

(c) eBay or Amazon sending you your purchases 9. Downstream transportation and distribution

(d) Steel manufacturing from BHP’s iron ore 10. Processing of sold products

(e) Disposing of vehicle tyres 12. End of life treatment of sold products

(f) Manufacturing the shelving used in supermarkets 1. Purchased goods and services

QUESTION 5.7
Marks & Spencer uses a four-stage progress key to illustrate where it is at in terms of meeting its objectives
under Plan A. These progress points or milestones are:
1. missed
2. behind
3. progressing or achieved
4. no target.
How effective this is in communicating to the stakeholders and the broader community is a matter of
professional judgement, but it is clear that Marks & Spencer is keen to not only have targets but also
to demonstrate how the company has performed in relation to the current year’s targets. It is useful to
look at the 2022/23 performance column and compare it to the 2021/22 performance column. The lack
of targets set against community items could also be debated, as some may argue that without targets to
meet, progress in these areas may stall. Upon reviewing the areas covered in the progress overview, it can
be argued that there is scope to include more areas based on the material covered in the full report, as
this would provide an easy way for stakeholders to review progress against all areas of sustainability as
opposed to just a few. It might also be useful know what the longer term targets are and the strategies that
will be used to achieve them.

QUESTION 5.8
The benefits of the frameworks are that they provide the criteria against which to report. As such,
they give us the basis and measurement of the subject matter, and aid comparability of information
across organisations. Organisations may also be able to leverage certifications gained for publicity and
contract purposes.

QUESTION 5.9
(a) A social audit can be seen as the process that an organisation undertakes to investigate whether it is per-
ceived by particular stakeholder groups to be complying with the social contract negotiated between the
organisation and the respective stakeholder groups. The reason why an organisation might undertake
a social audit can be explained in conjunction with a consideration of legitimacy theory. A breach
of the social contract can create significant costs for an organisation and, therefore, organisations
often undertake social audits to examine whether their operations appear to be conforming with the
expectations of particular societies or particular stakeholders.
(b) Stakeholders often want some form of verification that the information presented in a CSR or
sustainability report is accurate and/or complete. A social audit can provide some assurance in this
regard and, as such, often forms an important component of an entity’s CSR/sustainability report.

Pdf_Folio:426

426 SUGGESTED ANSWERS

INDEX
AAA see American Accounting
Association
AARF see Australian Accounting
Research Foundation
abuse of market power 264–6
ACCC Immunity Policy for Cartel
Conduct 268
ACCC v. Metcash Trading Ltd [2011]
FCAFC 151 267
acceptable level 75, 79–80, 82, 91, 95
accountability 3–4, 145, 203, 344–5
accountants 1, 3, 8, 14, 15, 28–30, 42,
50, 89–91, 164, 316
accounting work environments
29–35
and effective governance 147
as external advisers to SMEs 31
enlightened self-interest 7–8
ethical issues encountered by 52
examples of ethical failures by
103–6
key professional relationships 28
public interest or self-interest 3–7
reasons for misconduct 52
relationships and roles 28–9
responses to ethical challenges 53
responsible decision making 3–7
accounting 147
entrepreneurialism 8–9
firm regulation 21–3
information 3
professionalism 8–9
restoring credibility to 40
role of 328–32
social impact of 35–7
standards 352–4
accounting profession 3, 25
application of professional judgement
17–18
attributes of 13–19
co-regulation of 16
code of ethics 17
community service 15
distinctive ethos or culture 17
ethical challenges within 51–7
existence of governing body 19
extensive education process 14
high degree of autonomy and
independence 15–16
ideal of service to community 14–15
market control view 12–13
professional discipline 16
pursuit of excellence 15
systematic body of theory and
knowledge 13–14
traditional view 12–13
wellbeing of society 15
Accounting Professional and Ethical
Standards Board (APESB) 5, 15,
19–20
accounting professionalism, ideals of
8–9
Pdf_Folio:427
accounting work environments 29–35
accountants as external advisers to
SMEs 31
financial advice environment 34
not-for-profit sector environment
34–5
private or business sector environment
31–3
public practice environment 29–31
public sector environment 33–4
ACNC see Australian Charities and
Not-for-profits Commission
acting with sufficient expertise 92
activity-based costing (ABC) 368
agency costs 141–2
agency issues and costs 140–2
agency theory 139–40
agents 127, 133, 139, 145
AICD see Australian Institute of
Company Directors
altruism 3
Amadio case 276–7
American Accounting Association
(AAA) 115
model 115–18
analysts’ forecasts 322
Anglo-American corporation law 159
anti-competitive behaviour 264–73
abuse of market power 264–6
agreements between competitors
267–8
approvals procedures 272–3
cartel conduct 267–8
mergers and acquisitions 267
resale price maintenance 271–3
unilateral restrictions on supply
270–1
anti-competitive practices 262
APES GN 40 Ethical Conflicts in the
Workplace – Considerations for
Members in Business 113–14
APESB see Accounting Professional
and Ethical Standards Board
approvals procedures, anti-competitive
behaviour 272–3
APRA see Australian Prudential
Regulation Authority
APSC see Australia Public Sector
Commission
arbitrator 263
ASA see Australian Shareholders’
Association
ASBFEO see Australian Small Business
and Family Enterprise Ombudsman
ASIC see Australian Securities and
Investments Commission
assets 37–8, 116–17, 314
assurance services 21, 100
ASX Corporate Governance Council
135
ASX Corporate Governance Council’s
Corporate Governance Principles
and Recommendations (ASX
Principles) 135, 146, 169,
187–95, 222, 227, 231–2, 241, 293,
326, 354, 366
ASX Listing Rules 124, 129–30, 187,
192
ASX Principles see ASX Corporate
Governance Council’s Corporate
Governance Principles and
Recommendations
AUASB see Auditing and Assurance
Standards Board
audit and review of financial statements
97–100
audit client 100, 169, 239
audit committee 77, 154, 192, 237
approaches to 158
benefits of 155–6
limitations of 155–6
audit deficiencies 36–7
audit quality 238–40
audit reform 169
audit regulation 238–40
auditing and accounting standards 237
Auditing and Assurance Standards Board
(AUASB) 5, 16, 19
auditors 18, 19, 37, 39, 65, 102, 155,
157, 237, 238, 241
auditor’s report 237
Australasian Reporting Awards Limited
370
Australia Public Sector Commission
(APSC) 203
Australian Accounting Research
Foundation (AARF) 16
Australian Accounting Standards Board
(AASB) 5, 16, 19
Australian Business Registry Services
(ABRS) 126
Australian Charities and Not-for-profits
Commission (ACNC) 5, 35, 245,
246
Australian Consumer Law 256, 257,
274, 376
Australian Corporations Law 326
Australian Institute of Company
Directors (AICD) 205, 227, 228
Australian Prudential Regulation
Authority (APRA) 5, 223
Australian Securities and Investments
Commission (ASIC) 5, 8, 123,
237, 238, 353
Australian Securities and Investments
Commission Act 2001 (Cwlth) 11,
19
Australian Shareholders’ Association
(ASA) 149
Australian Small Business and Family
Enterprise Ombudsman (ASBFEO)
205
Australian Stock Exchange 169
Australian Taxation Office (ATO) 5,
126
INDEX 427
AWA Ltd v. Daniels (1992) 10 ACLC 933
137
Bank Australia 323
Banking Act 1959 (Cwlth) 300
basic religious charities 197
B-Corporation 344
beyond reasonable doubt 251–3
BHP Group Limited 349
bid-rigging 268
Big Four accounting firms 29–30, 325
biodiversity, environmental sustainability
339–40
board 151–7, 173
chair 151
committees 153–4
functions 152–3
primary functions of 152
responsibilities 152–3
structure, roles and responsibilities
173
structures and relationships 138
board appointments, financial failure and
221–6
directors departures 223
disqualification 225–6
election of directors 221–2
evaluation of board performance 222
removal of director 223–5
board of directors 52, 136, 137, 145,
151, 175, 218
responsibility of 343–4
bonding costs 140, 142
brands 320–1
bribery and corruption 288–90
international experience of 289–90
Brundtland Report see Our Common
Future
Building Better Governance 203
business consumers 273, 277
business ethics 50, 55, 260
business judgment rule 129
business leadership capabilities 41
Business Roundtable 325
CA ANZ see Chartered Accountants
Australia and New Zealand
cap-and-trade systems 373, 374
capital markets 166, 322
cartel conduct 267–8
allocating customers, suppliers or
territories 268
bid-rigging 268
output restrictions 268
price-fixing 268–70
cash flows, discounting 315–16
caveat emptor 273
CDSB see Climate Disclosure Standards
Board (CDSB)
Centro case 128, 132–3, 238, 253
chain of command 117
charities and not-for-profit sector,
governance issues in 245–9
Chartered Accountants Australia and
New Zealand (CA ANZ) 5, 16, 19
chief executive officer (CEO) 24, 138
child labour 340
churning 286
Pdf_Folio:428
428 INDEX
civil liability 252 Conceptual Framework for Financial
civil outcomes and penalties 252–3 Reporting
civil penalty 253, 355 discounting future cash flows
Clean Energy Regulator Act 2011 315–16
(Cwlth) (CER Act) 354 elements of 314–15
climate change reporting 339 entity assumption 317
accounting techniques 373–5 relevance and faithful representation
corporate governance and 377–9 316
emissions, accounting for levels of scope of 313–14
375–7 short-term performance reporting
environmental sustainability issues 316–17
339 confidentiality 2, 40, 55, 67, 70, 72, 94
international response 372–3 conflicts of interest 81–3, 127
Climate Disclosure Standards Board conformance 19, 145–7, 152, 156
(CDSB) 358 consumer protection 273–4
co-regulation 2, 11, 16, 43 caveat emptor to 273
code of ethics 17 misleading conduct and
Code of Ethics for Professional representations 274–6
Accountants see Compiled regulation and 274
APES 110 Code of Ethics for unconscionable conduct 276–9
Professional Accountants consumers 162–3, 251
(including Independence Standards) and customers 273–9
codes of conduct 261, 273, 297 contemporary ethical challenges 53–7
coercive isomorphism 336 continuous disclosure 129–30, 282,
collusive behaviour 267 283
Commercial Bank of Australia Ltd v. corporate accountability 310, 318–19,
Amadio (1983) 151 CLR 447 328
276–7 Corporate Accounting and Reporting
commissions 13, 48, 85, 206, 286 Standard 360
committees 153–4 corporate culture 108, 219
common law 11, 250–2 corporate failure, common causes of
Commonsense Principles of Corporate 218–20
Governance 294 poor risk management 220
communication 2, 21, 43, 93–4, 108, remuneration 220
141, 154, 233, 276, 284 wilful blindness 220
community service 15 corporate governance 145
company law 173 and climate change 377–9
company performance 166 and CSR reporting 351
company regulation 126 and fraud 246
company secretaries 135–6 ASX Listing Rules 187
company, improving general perception auditors 157
322 board 151–7
compensation 119, 220, 230, 233, 234, codes 176
252, 254, 258, 267, 283 continued evolution of 242–4
Competition and Consumer Act 2010 disclosures 354
(Cwlth) 5, 250 diversity 226–9
competition and stakeholders 263 events and responses 167
competition law 139, 252, 255, 262, family-owned businesses 196
263, 267, 271, 272–3 framework 148–65
competition policy 262, 263 improving 240–2
competitive advantage 263 India 175–8
competitors, agreements between international approaches 169–78
267–8 international perspectives 166
Compiled APES 110 Code of Ethics for Japan 175
Professional Accountants The UK Corporate Governance Code
(including Independence Standards) (UK FRC Code) 185–7
15, 17, 21, 25, 40, 48, 50, 64, 67, management 163–5
102 market-based systems 170–2
applying code to members in business non-corporate sector 204–6
and public practice 81–95 not-for-profit organisations 197–200
audit, review and assurance OECD Principles see G20/OECD
engagements 95–102 Principles of Corporate
fundamental principles and conceptual Governance
framework 69–80 of France enterprises 173–4
compliance program 255, 256, 263 of German enterprises 173
compliance requirements 124, 125, 374 principles of 146, 169
conceptual framework approach 74–80 private benefit, conflict of interest
identifying threats see threats 248
 public sector enterprises 200–4
Ramsay Report 168–9
recommendations 169
regulators 157–9
responsibilities and accountability
324–7
shareholders 148–51
SME see small- and medium-size
enterprises
social and environmental performance
366–7
stakeholders 159–63
theories of 138–44
corporate governance codes 227
corporate law 143
in Japan 175
Corporate Law Economic Reform
Program (CLERP) 155
Corporate Law Economic Reform
Program (CLERP) Act 2004
(Cwlth) 169
corporate powers
board 137–8
CEO 138
corporate social responsibility (CSR)
328, 344
climate change reporting 372–8
corporate governance and 351
emergence of 338
financial reporting and limitations
313
reporting landscape, changing 318
surveys of current reporting practice
369–70
theories 332
corporate social responsibility (CSR)
theory 142
corporate stakeholders 159
Corporate Value Chain (Scope 3)
Accounting and Reporting Standard
360
corporations 123, 166
Centro case 128, 132–3
company secretaries and their duties
135–6
compliance requirements 124, 125
corporate governance see corporate
governance
corporate powers see corporate
powers
corporate structures 126
Corporations Act 123
director identification numbers 126
director independence 134–5
directors and their duties 126–31
governance theories see governance
theories
James Hardie case 128, 133
nature of 136–8
officers or agents 133
proprietary companies 124
proprietary vs. public companies
124–6
public companies 124
types of 124
Corporations Act 2001 (Cwlth) 6, 10,
11, 19, 123, 130, 135, 137, 218,
235, 250, 299, 326, 353
Pdf_Folio:429
Corporations and Markets Advisory
Committee (CAMAC) 227, 234,
326
corporation’s best interests, duty to act in
127
cost of capital 302, 320, 322
cost–benefit analysis 60–1
COVID-19 pandemic 243
and stakeholder activism 318
audit deficiencies and 37
policymakers and social advocates
318
creative accounting 38
criminal 252
intent 252
liability 252
offence 252
penalties 252
sanctions 252
crowd-sourced funding (CSF) 123
cultural diversity 112, 174
cultural relativism 112
culture 17, 108, 109, 111–12, 185
custody of client assets 95
customer owned bank 323–4
customers 162–3
customer satisfaction 349
data privacy 278–9
de-professionalisation 8
decision making 3, 74, 106, 107, 111,
113–15, 117–18, 147
decisions 48, 49
deontological theories (duty based) 58
justice 63–4
rights 62–3
differing time horizons 141–2
direct costs 321
direction 145
director identification numbers 126
director independence 134–5
director penalty notices (DPNs) 255
directors
appointment of 136, 221
categories 134
election of 221–2
removal of 223
resignation 223
directors and their duties 126–31
act in good faith 127
act with care and diligence 128–9
avoid conflict of interest 127
exercise powers for proper purpose
127–8
prevent insolvent trading 130–1
remain informed about company
operations 129–30
retain discretionary powers 128
disclosures 173
and remuneration 233
corporate governance 354
discounting future cash flows 315–16
discretionary powers 128
disqualification 225–6
ethics of 226
distinctive ethos or culture 17
diversity 226–9
adopting 228–9
audit quality and audit regulation
238–40
auditing the financial statements
236–8
compliance with the Corporations Act
235–6
executive remuneration and
performance 229–35
Dodd–Frank Wall Street Reform and
Consumer Protection Act 2010
158, 233
domestic consumers 273
Dow Jones Sustainability World Index
(DJSI) 358
due care 71–2
economic reporting 349–51
economic stability 341
economic sustainability 341
economic system, stability of 341
economy, and legal system 251–4
laws leading to criminal penalties
252
laws with civil outcomes and penalties
252–3
proof, penalties and redress 251–2
redress compared with penalties
253–4
efficiency 3, 203, 241, 284
egoism 58–60
emissions
accounting for levels of 375–7
trading/reporting schemes 376
empire building 141
employee representation 173
employees 162, 349
satisfaction 349
employment model 324
enlightened self-interest 3, 7–8, 59,
328, 332–3
Enron 156, 169, 218–20, 237, 241,
282, 299, 301
entity assumption 317
entrepreneurship 8
environmental behaviours 327
environmental disasters 339
environmental management accounting
367–8
environmental performance 334
corporate governance mechanisms
improving 366–7
Environmental Protection Acts 347
environmental reporting 347–9
environmental sustainability 327,
338–43
Equal Opportunity for Women in the
Workplace Act 1999 (Cwlth) 227
equality 64
Equator Principles 357, 359
Equator Principles Financial Institutions
(EPFIs) 359
equity, financial reporting 316
ethical courage 107
ethical decision making 106
American Accounting Association
model 115–18
factors influencing 107–12
individual factors 107–8
INDEX 429
 organisational factors 108–11
philosophical model of 114–15
professional factors 111
societal factors 111–12
ethical decisions, impact of 48–9
ethical egoism 59
vs. utilitarianism 62
ethical failures by accountants 103–6
ethical obligations 260–2
failure in relation to employees 261
trade and labour unions 261–2
ethical relativism 112
ethical standards 11
ethical theories 57
deontological theories 62–4
normative theories 57–8
teleological (consequential) theories
59–62
virtue ethics 64–7
ethical trading 340
ethics 3, 48, 297–8
ethical challenges within accounting
profession 51–7
overview 49–51
professional ethics 48
ethics of character 58
deontological theories (duty
based) see deontological theories
(duty based)
teleological (consequential)
theories see teleological
(consequential) theories
European Union Emissions Trading
Scheme (EU ETS) 373, 374, 376
excessive non-financial benefits 141
exclusive dealing 270–1
executive directors (ED) 134
exercise powers for proper purpose
127–8
expenses, financial reporting 316
external audit 157
external auditors 157, 168, 237, 241
externalities 328–32
fair pay and working conditions
258–60
faithful representation, financial
accounting 316
family and leave entitlements 260
family-owned businesses 196
FASEA see Financial Adviser Standards
and Ethics Authority
FCA see Federal Court of Australia
fees 83–5
fictional entities 123
financial accounting distortions 39–40
financial advice environment 34
Financial Adviser Standards and Ethics
Authority (FASEA) 34
financial failure 218–40
board appointments 221–6
corporate failure 218–20
financial markets 280
protecting 283–92
role of information and the media
281–3
role of market regulators 281
role of ratings agencies 283
Pdf_Folio:430
430 INDEX
financial reporting 169
and limitations 313
discounting future cash flows
315–16
elements of 314–15
entity assumption 317
relevance and faithful representation
316
scope of 313–14
short-term performance reporting
316–17
Financial Reporting Council (FRC) 6,
10
Financial Stability Board (FSB) 234
Task Force on Climate-related
Financial Disclosures 321
financial statements, auditing 236–8
forecasts, analysts’ 322
fraud 39, 52, 175, 244–6
free debate 283
FRC see Financial Reporting Council
free good 329
FSB see Financial Stability Board
fundamental principles of Code of Ethics
69–80
confidentiality 72
integrity 70–1
objectivity 71
professional behaviour 72–4
professional competence and due care
71–2
fundraising documents, misuse of
287–8
G20/OECD Principles of Corporate
Governance (OECD Principles)
166–7
corporate governance framework
178–9
disclosure and transparency 181–2
equitable treatment of shareholders
179–80
institutional investors, stock markets,
and intermediaries 181
market-orientated economies 178
responsibilities of the board 182–3
sustainability and resilience 183–5
gender balance of boards 227
gender diversity, in Australian
boardrooms 227
GetSwift Ltd 130
GFC see Global Financial Crisis
GHG Protocol for Community-Scale
Greenhouse Gas Emission
Inventories 360
GHG Protocol Mitigation Goal Standard
361
GHG Protocol Policy and Action
Standard 361
‘give back’ model 324
global financial crisis (GFC) 8, 130,
219, 234, 321
Global Reporting Initiative (GRI) 338,
342, 357, 361
Global Sustainable Investment Alliance
(GSIA) 319
golden handshakes 233
good faith requirement 327
goods and services market, protecting
262–78
competition and stakeholders 263
consumers and customers 273–9
regulating anti-competitive behaviour
264–73
workable competition 262
governance 3, 121, 145
accountants and effective 147
and performance 147
importance of 146–7
governance issues
in charities and not-for-profit sector
245–9
in government bodies 244–5
governance theories
CSR theory 142–4
stakeholder theory 142
government bodies, governance issues in
244–5
government intervention 328–31
greenhouse gas (GHG) emissions 321
Greenhouse Gas Protocol (GHG
Protocol) 360
greenwashing 302
Hayne Royal Commission 13
heuristics 113
Hong Kong competition law 267
Hornsby Building Information Centre
Pty Ltd v. Sydney Building
Information Centre Ltd (1978) 140
CLR 216 274
humanistic perspective 338
human rights 63, 346
IAS 16 Property, Plant and Equipment
354
IAS 37 Provisions, Contingent Liabilities
and Contingent Assets 353
IESBA see International Ethics
Standards Board for Accountants
IFAC see International Federation of
Accountants
IFRS see International Financial
Reporting Standards
incentives 83–5, 319–22
income, financial reporting 314
independence 95–6
chair of board 242
independent non-executive directors
(INED) 134
indirect costs 321
individual factors, decision making
107–8
individual shareholders 149
inducements 85–7
information and the media 281–3
information asymmetry 150–1
innovation model 324, 349
innovative reporting, examples of
370–2
insider trading 52, 181, 283–5
insolvent trading 130–1
Institute of Public Accountants (IPA)
6, 16
institutional investors, representational
role of 294–7
institutional shareholders 149–50
Institutional Shareholders’ Committee
(ISC) 294
institutional theory 335–8
integrated reporting 344, 345
integrated thinking 345
integrity 70–1, 91–2, 203
intergenerational argument 338
Intergovernmental Panel on Climate
Change’s (IPCC) Sixth Assessment
Report 372
internal auditors 157, 237
internal control, and risk management
241
international auditing standards 237
international competition legislation and
regulators 264
International Ethics Standards Board for
Accountants (IESBA) 67
International Federation of Accountants
(IFAC) 6, 14, 31, 52, 147, 240,
367
International Financial Reporting
Standards (IFRS) 236
International Integrated Reporting
Council (IIRC) 345
International Organization of Supreme
Audit Institutions (IntOSAI) 200
International Organization for
Standardization (ISO) 357, 362
International Standards on Auditing
(ISAs) 236
international stock exchanges 280
intimidation 94–5
intimidation threat 76–7
IntOSAI see International Organization
of Supreme Audit Institutions
investigating case manager (ICM) 24
ISAs see International Standards on
Auditing
ISC see Institutional Shareholders’
Committee
ISO 14001 Environmental Management
Systems-Requirements with
Guidance for Use 366
ISO 26000 Guidance on Social
Responsibility 366
isomorphism 336
James Hardie case 128, 133
justice 63–4
KETS 377
key management personnel 224, 225
key performance indicators (KPIs) 93,
232
KMP see key management personnel
KPIs see key performance indicators
KPMG 343, 369
Kyoto Protocol 360, 372, 373
labour practices 346
lack of auditor independence 39
laws and regulations 111
leadership 21, 34, 41, 42, 57, 173, 203
legal and contractual rights 63
legal compliance and governance
255–6
Pdf_Folio:431
legal system 250–6
economy and 251–4
legal compliance and governance
255–6
legitimacy theory 335
lenders 162–3
liabilities, financial reporting 315
limited liability 123, 126, 175
L J HL Bolton Engineering Co. Ltd v. TJ
Graham & Sons Ltd 1957 1 QB 159
151
long-term viability of businesses 341
loss leader 271
Mainzeal 131
management 163–5
managerial stakeholder theory 334
mandatory reporting 351–7
accounting standards 352–4
Corporations Act 353
CSR-related corporate governance
disclosures 354
Modern Slavery Act 2018 (Cwlth)
356
National Greenhouse and Energy
Reporting Act 2007 (Cwlth)
354–6
National Pollutant Inventory 356
Work Health and Safety Act 2011
(Cwlth) 356–7
market disruption penalties 269
market dominance 266
market efficiency 284, 285, 287
market manipulation 282, 285–92
bribery and corruption 288–90
phoenix companies 291–2
Ponzi schemes 290–1
principles relating to 286
rogue trading 290
types 286–8
market regulators 281
market sensitive 129, 280
market share 264, 268, 319, 349
market sharing 268
market-based systems 170–2
Marks & Spencer 350
McKinsey & Company 325
measurement, sustainability issues
346–51
mergers and acquisitions 267
mimetic isomorphism 336
misleading conduct and representations
274–6
Modern Slavery Act 2018 (Cwlth) 6,
326, 356
monetisation 346
monitoring costs 140
monopolist corporation 262
moral agency 65–7
moral courage 71
narrative reporting 346
National Australia Bank (NAB) 228,
300–1
National Broadband Network (NBN)
263
National Employment Law Project
(NELP) 321
National Greenhouse and Energy
Reporting Act 2007 (Cwlth) (NGER
Act) 343, 348, 354–6
National Pollutant Inventory (NPI) 356
natural capital 316, 319, 329, 345
natural capital accounting 345
naturalistic argument 338
net zero by 2050 302
Neville’s Bus Service Pty Ltd v. Pitcher
Partners Consulting Pty Ltd [2018]
FCA 2098 4
New York Stock Exchange (NYSE)
171
nomination committee 154
nominee directors 128
non-compliance with laws and
regulations (NOCLAR) 67, 87–91
for members in public practice 90–1
non-corporate sector 204–6
non-executive directors, payment for
231
non-independent non-executive directors
(NINED) 134
non-mandatory reporting 331, 357–64
Dow Jones Sustainability World Index
(DJSI) 358–9
Equator Principles 359
Global Reporting Initiative 361
Greenhouse Gas Protocol 360–1
International Organization for
Standardization (ISO) 362
OECD Guidelines for Multinational
Enterprises on Responsible
Business Conduct 362–3
United Nations Global Compact
363–4
normative isomorphism 336
normative stakeholder theory 333
normative theories 57–8
not-for-profit organisations 197–200
not-for-profit sector environment 34–5
objectivity 71
obligations to employees 257–62
ethical obligations 260–2
fair pay and working conditions
258–60
family and leave entitlements 260
occupational health and safety 258
occupational health and safety 258
OECD Guidelines for Multinational
Enterprises on Responsible
Business Conduct 362–3
One Person Tribunal (OPT) 24
openness 203
operating and financial review (OFR)
reporting 353
operational management 164–5
Organisation for Economic Co-operation
and Development (OECD) 146,
219, 240, 243
organisation wealth 319–22
organisational factors, decision making
108–11
organisational initiatives
board of directors’ responsibility for
343–4
organisational legitimacy 334–5
INDEX 431
Origin Energy 335
Our Common Future report 311
Outboard Marine Australia Pty Ltd v.
Hecar Investments No. 6 Pty Ltd
(1982) 66 FLR 120 262
output restrictions 268
Panasonic 321
parental leave legal action 260
pecuniary penalty 253
performance 145, 147, 203
performance-based remuneration
232–3
perpetual succession 123
personal social responsibility (PSR)
373
persons conducting a business or
undertaking (PCBU) 356
philosophical model, of ethical decision
making 114–15
philosophy 55, 57, 158, 328
phoenix companies 291–2
pollution, environmental sustainability
339
Ponzi schemes 290–1
pools 287
poor audit quality 38–9
poor corporate governance 218
poor ethical cultures 109
poor ethics 297
poor risk management 220
potential conflicts 127
predatory pricing 265
preparation and presentation of
information 91–2
price-fixing 266
PricewaterhouseCoopers (PwC) 238
principles-based approach 158
Product Life Cycle Accounting and
Reporting Standard 360
product responsibilities 346
professional 12
professional accountants 3, 43
business leadership capabilities 41
career perspectives 42–3
soft skills, knowledge and experience
42
technical skills, knowledge and
experience 41
professional accountants in business
(PAIB) 31, 240
employed in large businesses 32
IFAC research 33
in small and medium enterprises
32–3
Professional Accountants in Business
(PAIB) Committee 156
professional appointments 93–4
professional behaviour 72–4
professional competence 71–2
professional conduct officer (PCO) 24
professional discipline 16, 23–5
penalties and appeals 24–8
regulation of member conduct 23–4
professional ethics 48
professional factors, decision making
111
Pdf_Folio:432
432 INDEX
professional judgement, application of
17–18
professions 1, 9–11, 26
credibility of 37–40
credibility under challenge 37
key issues causing reduced credibility
37–40
professional discipline 23–8
quality assurance process 20–3
regulatory process 19–28
self-regulation 11
self-regulation to co-regulation 11
social contract between society and
10
trust and 13
Project Protocol 360
proof, penalties and redress 251–2
proprietary companies 124
vs. public companies 124–6
prospectus 287
Protocol for Project Accounting 360
provision of non-assurance services, to
audit client 100
public commentary 283
public companies 124
proprietary vs. 124
public disclosure 283
public interest 3–7, 68–9
public practice environment, accountants
29–31
roles 30
sub-types 29
public sector 203
enterprises 200–4
environment 33–4
puffery 276
quality assurance process 20–3
quality rankings 349
quantification 346
Ramsay Report 168–9
Rana Plaza building collapse 321, 340
ratings agencies 283
rational decision making 107
Recommendation of the Council on
Principles of Corporate
Governance 146
redress compared with penalties 253–4
referrals 94
regulation 157–8
of member conduct 23–4
regulators 157–9
regulatory arbitrage 302
relationship-based systems
Asian approaches 174–6
European approaches 172–4
relativism 112
relevance, financial accounting 316
relevant market 262, 267
remuneration 83–5, 136–7, 186, 212,
220, 224, 229–35
disclosure, transparency and 233
executive directors and other senior
executives 231–2
international debates 230
non-executive directors 231
payments for past and future
performance 231–5
performance-based 232–3
risk and GFC 234
tightening rules regarding 233–4
remuneration committee 139, 154
reporting best practice, examples of
370–1
representation 292–303
expanding ethics 297–8
institutional investors, representational
role of 294–7
whistleblower protection 299–302
reputation 320–1
resale price maintenance 264, 271–3
Reserve Bank Act 1959 (Cwlth) 202
Reserve Bank of Australia (RBA) 202
residual loss 140–2
responsible decision making 3–7
responsible investment 319–20
Responsible Investment Association of
Australia (RIAA) report 319
Restoring Trust in Audit and Corporate
Governance 167
restricted egoism 60
rights 62–3
human rights 63
legal and contractual rights 63
risk avoidance 141
risk committee 156–7
risk control systems 241
risk management 156, 240–1
incentives 321–2
internal control and 241
risk-based approach 158
risk-based regulation 158
rogue trader 220, 290
rogue trading 290, 300
rule-based codes 74
rules-based approach 158
runs 287
safeguard 68, 75, 80, 82, 84, 91, 92,
99, 101
Samsung 321
Sarbanes–Oxley Act (2002) 40, 154–8,
158, 169, 171, 192, 220, 232,
241–2, 299
second opinions 94
Securities and Exchange Commission
(SEC) 233
Security Legislation Amendment
(Critical Infrastructure Protection)
Act 2022 (Cwlth) 7, 292
self-interest 12–13
accountants 3–7
self-managed superannuation funds
(SMSF) 9
self-regulation, professions 11
senior members in business 89
serious penalties 130
shareholder primacy
approach 327
vs. social contract 326
shareholders 136–7, 143, 148–51
activism 166
appointment of directors 136
remuneration 136–7
 representation 292–303
rights and participation mechanics
173
spills, reaction to 225
threat 296
wealth 319–22
short-term performance reporting
316–17
small- and medium-size enterprises
(SMEs) 32–3
SMSF see self-managed superannuation
funds
Social Accountability 8000 International
Standard (SAI 2014) 364
social audits 364–6
social contract 10, 326, 335
shareholder primacy vs. 326
social enterprises 324
social impact of accounting 35–7
social justice rationale 227
social performance 338
corporate governance mechanisms
improving 366–7
social reporting 346–7
social responsibility 328
social return on investment (SROI) 347
social sustainability 340–1
socially responsible investment (SRI)
322–4
societal factors, decision making
111–12
society 346
soft-dollar benefits 85
special purpose financial statements 97
stakeholder theory 142, 333–4
managerial 334
normative 333
stakeholders 159–63, 333
concept 159
consumers (customers) 162–3
employees 162
issues 173
map 159–62
relationships 160
suppliers and lenders 162–3
stewardship 203
stewardship theory 139
stranded assets 302
succession and diversity 186
supervisory body independence and
leadership 173
suppliers 162–3
supply chain management 340
Pdf_Folio:433
surveys, of current reporting practice The UK Corporate Governance Code
369–70 (UK FRC Code) 185–7, 206
sustainability 345 UK Financial Reporting Council
board of directors’ responsibility for (UK FRC) 134
343–4 UK FRC Code see The UK Corporate
bond 323–4 Governance Code
environmental, economic and social UN 17 Sustainable Development Goals
341–3 (SDGs) 311, 363–4, 369–70
reporting 345 UN Principles for Responsible
Sustainability Accounting Standards Investment (UNPRI) 322
Board (SASB) 358 unconscionable conduct 276–9
sustainability committee 157 unethical decisions, impact of 48–9
sustainability related financial Unilever 321
information 302 United Nations Framework Convention
sustainable distribution 54–5 on Climate Change (UNFCCC)
sustainable investment 320 372
United Nations Global Compact
Task Force on Climate-related Financial (UNGC) 363–4
Disclosures (TCFD) 321–2, 358 United Press International (UPI) 283
Tax Practitioners Board (TPB) 7, 11 United States False Claims Act 299
unsupportive management 108
Taxation Administration Act 1953
utilitarianism 60–2
(Cwlth) 300
vs. ethical egoism 62
teleological (consequential) theories
59–62
egoism 59–60 Victorian Public Sector Commission
utilitarianism 60–2 (VPSC) 203
teleology 62 virtue ethics 58, 64–7
The Good Trade 324 moral agency 65–7
The Privacy Act 1988 (Cwlth) 278 virtues 64
The UK Corporate Governance Code Visa 321
134, 167 Vision 2050 319
third-line forcing 270–2 voluntary disclosure theory 322
threats 76 VPSC see Victorian Public Sector
addressing 80 Commission
categories 76
evaluating 79–80 waste, environmental sustainability
examples of 77 339
identifying 76–8 weaknesses, in internal control 241
top-tier management 108 whistleblower protection 299–302
TPB see Tax Practitioners Board legislation 300–2
trade union 261 whistleblowing 107, 299
transparency 203, 341 wilful blindness 220
and remuneration 233 Woodside Petroleum Limited 370
Treasury Laws Amendment (Enhancing Work Health and Safety Act 2011
Whistleblower Protections) Act (Cwlth) 356–7
2019 (Cwlth) 7, 300 workable competition 262
trust and professions 13 workforce and stakeholders 185
turnover rates 349 workplace 346
two-strikes rule 225 Workplace Gender Equality Act 189
workplace injuries 258
UK Bribery Act 2010 289 World Business Council for Sustainable
UK Companies Act 2006 327 Development (WBCSD) 319
INDEX 433