Business Ethics

Test Bank
Chapter 5 Corporate Governance

A. Structured Questions
1. Explain what is meant by a ‘code of corporate governance’ and describe the general
purpose of such a code in listed companies.

2. Explain the contributions of independent directors to good corporate governance practices

in public corporations.

B. Case Study

Disarray Board

Sinar Berhad is a listed company on the Bursa Malaysia Securities. The Kuar family is the
controlling shareholder of the company. Peter Kuar, the eldest son in the Kuar family, is
calling the shots in Sinar Berhad. He is very particular about making money and ensuring the
company fully complies with various laws and regulations.

In a recent management committee meeting, Lisa, the company secretary, highlighted the
need to adopt the principles and best practices of corporate governance. It is one of the
continuing obligations of a listed company in Malaysia. Lisa briefed the meeting on the
following points:
 Peter Kuar owns 28% of the common shares in Sinar Berhad. He is both the Chief
Executive Officer (CEO) and Chairman. He has been the director of Sinar Berhad
since its inception in 1990.
 Kuar Lek Soon is Peter Kuar’s younger brother. He is the Marketing Director. He has
12% of the common shares in Sinar Berhad.
 Vincent Lee is Peter Kuar’s nephew. He is a medical doctor in private practice.
Vincent is the non-executive director of Sinar Berhad. He is always busy running his
clinic and is regularly absent from the board’s meetings. Vincent is the sole non-
executive director.
 Zarina is a qualified accountant. Peter Kuar brought her into Sinar Berhad as Finance
Director five years ago. Peter and Zarina studied together in Oxford University. She
has extensive experience in managing the financial affairs of listed companies in the
UK and Malaysia.
 Sinar Berhad does not have a nomination and remuneration committee. The audit
committee consists of Zarina, Peter Kuar and Vincent Lee.
 Sinar appointed Tim, Lee, Bakar and Co. as its external auditor recently. This
accounting firm was also responsible to provide strategy and accounting advisory
services to Sinar five years ago. One of the three partners, Lee Ming Choon, is a close
friend of Peter Kuar.

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Questions

1. Evaluate the board structure and composition of Sinar Berhad in relation to the principles
of corporate governance covered in the Malaysian Code on Corporate Governance.

2. Based on your evaluation, explain appropriate recommendations to improve the corporate

governance practices in Sinar Berhad.

Answers

A. Structured Questions

1. Code of corporate governance codified the principles and best practices of good
governance and described optimal corporate governance structures and internal processes.
The code essentially aims to set out principles and best practices on structures and
processes that listed companies may use in their operations towards achieving the optimal
governance framework.
The Code is essentially a guide to listed companies’ board of directors on a number of
key components of effective board practice. It is based on the underlying principles of all
good governanceaccountability, transparency, probity and focus on the sustainable
success of an entity over the longer term.

2. Strategic planning and consultancy advice INEDs are individuals with vast skills,
experience and well-established networks or connections with regulators and industry
players. They can bring in technical and non-technical expertise to the company. This
element helps the executive management to see ‘a big picture’ or macro-environment
factors by looking at issues from a broader perspective in setting the strategic direction of
the company as well as formulating strategic plans for the company.

Provide check and balance and objective adviceINEDs provide a check and balance
against the domination of the executive group in the board because they have no
relationship or affiliations whatsoever with the company and of officers. Hence, the
element of biasness is absent in which they can make an independent or objective stance
on conflict of interest issues as well as scrutinizing corporate activities and management
proposals objectively.

Establish the culture of openness and transparencyINEDs play a major role in

enhancing accountability of the top management/BOD to shareholders in which they take
active interest in the activities of the management. In the audit committee, for example,
INEDS could discipline the management in terms of preparing accurate, timely, reliable
and transparent financial information.

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 Play control roleINEDs play the control role for the board in safeguarding the interests
of shareholders. They monitor the performance and activities of the management team so
as to ensure they are in line with shareholders’ objectives. EDs cannot be relied upon to
carry out this role because they are said to be opportunistic and bound to deviate from
pursuing shareholders’ interest.

Constructively challenging managementINEDs can challenge the view of the

management by asking questions until they get an acceptable answer. This is done in
order for the management to consider every possible risk and potential of the company,
say, in strategy formulation.

B. Case Study

Answers to both 1 and 2.

(a) Peter Kuar is both Chairman and Chief Executive Officer

The Malaysian Code of Corporate Governance (Revised 2012) states that firms should
clearly divide the roles and responsibilities of a chairman of the board and chief executive
officer. This recommendation is meant to ensure a balance of power in the board of
directors and to prevent any person from having unfettered powers of decision. Further, if
the firms decide to combine the two roles, they should publicly explain the rationale of
such a decision.

In the case of Sinar, Peter Kuar holds key positions, the chairman and CEO. On top of
that, he is also a controlling shareholder by virtue of having 28% of common shares in
Sinar. He is clearly a very powerful person in the company. This issue of having power of
decision concentrated in the hands of one individual in the board of directors is a grave
concern in corporate governance.

Recommendations:
 It is best that Sinar appoints another person as the chairman of the company,
preferably an independent director. Peter Kuar can remain as the CEO.
 If Sinar decides to still have Peter Kuar as the chairman and CEO, then the company
must clearly explain the rationale of this decision in its annual report. Further, Sinar
must appoint additional independent directors to its board of directors in order to
ensure board independence from the adverse influence of executive directors in the
board’s deliberation and decision-making.

(b) Board composition

The Malaysian Code of Corporate Governance (2012) states that if firms decide to
combine the roles of chairman and CEO, there must be a strong independent element in
the board. This recommendation also relates to the appointment of a sufficient number of

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 independent directors to the board. Bursa Malaysia Listing Requirements call for at least
one-third of the board members to consist of independent directors.

The Listing Requirement defines an independent director as a director who is independent

of management and free from any business or other relationship which would interfere
with the exercise of an independent judgement or the ability to act in the best interests of
the company.

Currently, Sinar has four directors of which only one is a non-executive director. Sinar
does not comply with the corporate governance requirements pertaining to board
composition. Kuar Lek Soon and Zarina clearly do not fall under the category of
independent directors. Kuar Lek Soon is the son of Peter Kuar and an executive director
(i.e. Marketing Director). Zarina is a Finance Director. Peter Kuar nominated her to be the
executive director of Sinar. Vincent Lee is also not qualified as an independent director.
He is the nephew of Peter Kuar. Sinar is in a serious breach of the Listing Requirements.
The board of directors as it is severely lacks independence.

Recommendations:
 Sinar should expedite the appointment of independent directors into its board of
directors. The number must be sufficient as prescribed in the Listing Requirements.
This action is particularly crucial if Peter Kuar wants to remain as chairman cum chief
executive officer.
 Given the existing composition of the board, Sinar should appoint at least two
independent directors. These new appointments will bring the board composition of
Sinar with regard to the number of independent directors to be in line with the Listing
Requirements. Sinar will have six directors of which two are independent directors
(i.e. one-third of its board members are independent directors).

(c) Nomination and Remuneration Committees

The Malaysian Code of Corporate Governance (Revised 2012) calls for the board of
directors to establish nomination and remuneration committees to assist the board in
issues relating to the nomination of directors and development of a suitable compensation
scheme for the executive directors. Each committee should consist of at least three
independent directors or one third of the total number, whichever is higher. The chairman
of each committee must be an independent director.

Sinar Berhad does not have both nomination and remuneration committees.

Recommendation:
The board should set up both committees. The structure and composition of each
committee must be in line with the best practices of the Malaysian Code on Corporate
Governance.

(d) Audit Committee

The Listing Requirement regulates the structure, composition and roles of an audit
committee. The committee must comprise a minimum of three directors with the majority
being independent. At least one audit committee member must be a member of the
accounting profession and have a suitable qualification in the discipline.

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 Sinar Berhad has an audit committee. However, the composition does not meet the
Listing Requirements. This is a serious breach that must be rectified immediately. Zarina
is an executive director, whilst Vincent Lee is a non-executive director and he cannot be
classified as an independent director. Peter Kuar should not be in the audit committee.

Recommendations:
Sinar needs to appoint the two independent directors quickly (refer to the earlier
recommendation in No.2) and both must be appointed to the audit committee. Peter Kuar
and Zarina should resign from this committee. One of the independent directors should be
a qualified accountant and a member of Malaysian Institute of Accountants or a
professional accounting body. Then, Sinar will have three non-executive directors in the
audit committee comprising Vincent Lee and the two new independent directors, the
majority being independent directors.

(e) External Auditor

An external auditor must be independent from any business relationship with the client
company. The partners of the audit firm must not have any business and personal
relationship with the client company and its top executives. These requirements are
necessary to preserve the independence of the external auditor. The independence of an
external auditor is of a paramount importance in corporate governance because
shareholders rely on them to safeguard their interests from potential financial
manipulation by top executives.

The independence of Tim, Lee, Bakar and Co. is of suspect because of two reasons. First,
the accounting firm provided strategy and accounting advisory services (a non-audit
service) to Sinar five years ago. They are now expected to perform an audit possibly on
accounting transactions that they have a role to approve previously. Second, one of the
three partners, Lee Ming Choon, is a close friend of Peter Kuar. Hence, the ability of the
accounting firm to provide an independent external audit to the shareholders of Sinar may
be compromised.

Recommendation:
The audit committee (with the revised composition) should review the appointment of
Tim, Lee, Bakar and Co. as the external auditor of Sinar Berhad. A new and independent
external audit firm should be identified and proposed to shareholders for appointment at
shareholders’ meeting.

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