AC341

Corporate Governance, Risk Management and Financial

Audit
Section 1 – Corporate Governance
Issues in corporate governance
Week 2
Dr Renuka Fernando
Learning outcomes
After this seminar you should be able to:
● Critically evaluate the extent to which company disclosures about
corporate governance, social and environmental matters are reliable
and helpful to stakeholders
● Be aware of the increasing focus on board performance review
● Understand how CG disclosures can fail to ensure high quality CG and
the role of investigative journalists and whistleblowers
(Wirecard and Enron)
Outline of today’s seminars
● House keeping
● Assessment – formative and summative
● Corporate governance issues, covering two questions:
○ How would you assess the quality of corporate governance for a company?
○ What have been requirements regarding environmental disclosures and what
challenges do they present?

● Wirecard
Housekeepin
g
Some admin
● Office hours in 3.04, 12:30 to 13:30. Please email for an
appointment (not student hub)
● If you have any questions, please come see me or email at
r.fernando@lse.ac.uk

● Other key contacts

○ Attendance: Gary Cowe (g.crow@lse.ac.uk)
○ Extensions / adjustments: Pik Liew (p.liew@lse.ac.uk)
○ Moodle / readings: Jack Heaney (J.Heaney@lse.ac.uk)
Assessment
Formative

Formative essay question (750 words)

What do you understand by ‘corporate governance’ and how does it

relate to corporate purpose?

DUE: Friday October 21st at 13:00, via Moodle

Summative – Group project (40%)

This is a group project with a maximum of 5 individuals. The format of

the project submission can be:
• a video, podcast or other media recording with a duration of no more
than 8 minutes; or
• a powerpoint presentation, timed to no more than 10 minutes

DUE: project uploaded to Moodle by Monday 5th December at 13:00

and presented in seminar on 9th December (pre-recorded video or live
powerpoint presentation).
Summative – Group project (40%)
The project should address ONE of TWO questions noted.

Either:
To what extent does regulation and internal controls mitigate key risks?

OR:
If you were in charge of the Financial Reporting Council (FRC)
transitioning into Audit, Reporting and Governance Authority (ARGA),
what would you prioritise (and why) to improve corporate governance
and audit quality?
Summative – Take home (60%)

One essay which should be no more than 1,750 words.

The title for the essay will be provided on the last day of Michaelmas
Term (week 11) released on Friday 9th December at 13:00

DUE: Friday 16th December at 13:00, via Moodle.

Guidance on structuring essays/presentations
Overall:
○ Answer the question
○ Clear structure and expression
○ Include sub-arguments
○ Support all claims with evidence
○ Include a bibliography
Question: “Which is the best pet to
own?”
● Introduction:
○ tell the reader *why* this question is important
○ state your answer cleary
○ say *how* you will argue (e.g. what categories of evidence will you include)
● Arguments
○ Argument = assertion (where you make a claim and/or clearly define the side you want to
argue)+ evidence
○ Include paragraphs for each category of argument (e.g. emotional support and cost) with
sub-arguments.
○ Acknowledge counter-arguments but state *why* you don’t think they override your
overarching argument.
○ Don’t contradict yourself! Be clear which view you support.
● Conclude concisely - don’t introduce any new evidence.
Tips
● Readings: write ½ -1 page summary of each reading (key concepts,
debates / arguments and conclusions) – divide out in your groups
● Keep running document of assertions and examples (can often use
across topics)
● Practice discussion question as exam questions
Group work (10 minutes)
“Which is the best pet to own?”
Section 1
Corporate Governance
Section 1: Corporate governance

1. Introduction
2. Regulation
3. UK Corporate Governance Code, EU & US regulation
4. Issues in corporate governance
Key concepts from last week
• Corporate Governance: align interests of management to
shareholders and / or stakeholders of an entity through regulation,
systems and behaviour.
• Company purpose
• View 1: Legal fiction
• View 2: Real entity

‘Standards’: Government (BEIS, policy setting), FRC (regulator and code)

Regulation: Companies Act and Corporate Governance Code (disclosures,
reports and duties)
Approaches: principles versus rules
What might we conclude from last week…
(and how its related to assessment)
Corporate Governance is complex. Critically discuss.

Introduction
Corporate Governance is complex due to:
1. Different views of the company purpose
2. Many actors involved and;
3. Different approaches to regulation
Today’s seminar on Corporate governance

1. Introduction
2. Regulation
3. UK Corporate Governance Code, EU & US regulation
4. Issues in corporate governance
 Readings
• Required reading
• Chartered Governance Institute (2021). Review of the effectiveness of
independent board evaluation in the UK listed sector (pages 6-9)
• Fortune Magazine (3/5/2001). ‘Is Enron Overpriced?’ by Bethany McLean.
Wirecard. Please read this FT article “

• Additional material
• ‘Enron: The smartest guys in the room’. A documentary film directed by Alex
Gibney.
Outline – Corporate Governance Issues

Issues in corporate governance:

• Whistleblowing protection
• Board effectiveness evaluation practices
• ESG and CSR norms
• Investor and proxy advisory firm pressure for ESG
• Measuring corporate performance and corporate governance
• Media scrutiny of corporate governance
• Other sources of corporate governance for stakeholders
• Corporate governance and Covid-19
Outline – Corporate Governance Issues
Issues in corporate governance:
• Whistleblowing protection
• Board effectiveness evaluation practices
• ESG and CSR norms
• Investor and proxy advisory firm pressure for ESG
• Measuring corporate performance and corporate governance
• Media scrutiny of corporate governance
• Other sources of corporate governance for stakeholders
• Corporate governance and Covid-19
What is a whistleblower?

• A worker who reports certain types of wrongdoing seen at work the

disclosure of which is in the public interest.
• In England, whistle-blowers are protected by law – the Public Interest
Disclosure Act 1998 and should not be treated unfairly or be dismissed
because of their whistleblowing.
• Enterprise and Regulatory Reform Act 2013 have introduced a series of
changes to the Public Interest Disclosure Act 1998 including amendments
to protect whistleblowers from bullying or harassment by co-workers
and an extension of the meaning of ‘worker’ for the purpose of defining
who comes within the remit of the whistleblowing provisions.
Whistleblower protection US
• Sarbox requires:
• a written code of ethics and
• auditing procedures for the receipt, retention, and treatment of complaints regarding
accounting, internal accounting controls and auditing matters
• Both the NYSE and NASDAQ require listed companies to implement compliance standards
extending beyond the Sarbanes-Oxley’s requirements
• Sarbanes-Oxley and the Dodd-Frank Wall Street Reform and Consumer Protection
Act anti-retaliation provisions.
• Dodd-Frank bounty programme: whistleblowers receive between 10% and 30% of
sanctions above $1 million recovered by the SEC based on information they
provide to the SEC.
Protect (whistleblowing charity) views
current law to be ineffective
“How many more scandals will it take for the Government to see the power of
whistleblowing? Carillion. Mid Staffs. Grenfell. Wikileaks. Boeing. are just some of
the many high-profile scandals to have rocked society in recent years. Would these
scandals have ever happened if healthy speak up/listen up cultures existed?
Protect is campaigning for a new whistleblowing law to ensure whistleblowers in
the UK get the best possible support before, during, and after they raise concerns;
and accessible protection when things go wrong.
Current legislation – the Public Interest Disclosure Act – is not protecting enough
whistleblowers and only covers a person after they have blown the whistle
and if they can then prove they suffered from whistleblowing.”
https://protect-advice.org.uk/campaign-for-a-new-whistleblowing-bill/
FT Jan 24th, 2020
https://www.ft.com/content/cb9eeeb6-3dd5-11ea-a01a-bae547046735
BEIS Report

• “The Government wishes to support genuine whistleblowing.”

• Whistleblowing protections should be extended from employees to anyone with a direct
economic relationship to the audited entity (e.g., shareholders, suppliers, customers, and other
creditors).
• Such an expanded scope would have broad implications and would require substantial changes
to the existing whistleblowing framework, which focuses on protected disclosures by workers.
The Government acknowledges wider interest in making reforms to the whistleblowing
framework and has committed to conducting a review in due course.
Response to consultation (2022) –
more review
Outline - Issues

Issues in corporate governance:

• Whistleblowing protection
• Board effectiveness evaluation practices
• ESG and CSR norms
• Investor and proxy advisory firm pressure for ESG
• Measuring corporate performance and corporate governance
• Media scrutiny of corporate governance
• Other sources of corporate governance for stakeholders
• Corporate governance and Covid-19
Board effectiveness evaluation:
company vs investors?
Paragraph 14:
“Boards have a responsibility for the health of the company and need
to take a long-term view. This is in contrast to the priorities of some
investors, not all of whom will be aligned with the pursuit of success
over the long-term. An effective board will manage the conflict
between short-term interests and the long-term impacts of its
decisions; it will assess shareholder and stakeholder interests from the
perspective of the long-term sustainable success of the company.”
 Board effectiveness evaluation
• The Code recommends FTSE 350 companies have externally facilitated board evaluations at least every
three years to “monitor/improve balance of skills, composition, succession and diversity, practices in
decision-making. Benefits include: a fresh perspective, new ways of thinking, and a critical eye to board
composition, dynamics and effectiveness.”
• Also in specific circumstances e.g. when there is a new chair, “a known problem requiring tactful handling”
or an external perception that the board has been ineffective.
• Board evaluation outcome to be discussed by the board and the chair is “encouraged” to summarise the
outcomes and actions of the board evaluation process in their statement in the annual report.
• 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.

(see paragraphs 109-111, FRC Guidance on Board Effectiveness, 2018)

Example of a board evaluation service

“One of Board Evaluation's core diagnostic methodologies, this is a tried and tested
tool consisting of around 100 questions that takes, on average, about 45 minutes for
each individual Board Director to complete. This is normally done on-line….directors
to express their views on the competence and effectiveness of the Board in dealing
with the full spectrum of issues.

The results are analysed and interpreted by our consultant(s) who feed back the
findings and highlight important issues with the Chairman, key Board personnel, or
the entire Board. As well as enabling a Board to rate and assess its own
performance, The Board Evaluation tool can also allow directors to comment on the
performance of their colleagues.”

https://www.board-evaluation.co.uk/index.php/services
BEIS commissioned the governance
institute (icsa) to review evaluations
• The Department for Business, Energy and Industrial Strategy (BEIS) noted
variation in the standards or thoroughness of board evaluations.

“Several respondents, particularly institutional investors, suggested that the

market for independent board evaluations should be reviewed with a view to
introducing minimum standards... Respondents argued that whilst many
companies are embracing best practice in dealing with issues identified in
evaluations, some do not. Additionally, some respondents pointed out that
the standards or thoroughness of these evaluations can vary significantly.”
(paragraph 2, 2019 icsa consultation document).
Evaluation requirements => business
opportunities!
• In 2017/18 over thirty different board reviewers were used by FTSE
350 companies alone (Governance Institute Blog
https://www.icsa.org.uk/blog/evaluating-board-evaluators)

• In 2019 the Governance Institute (ICSA) issued a consultation

document on whether there is a need for:
• A code of practice for the providers of board evaluation services, and formal
arrangements for implementing and monitoring such a code.
• Voluntary principles to be applied by listed companies when engaging
external reviewers to undertake board evaluations
 ICSA Recommendations
(Jan 2021)
• Change in terminology: ‘board performance review’ instead of ‘board evaluation’

• New Code of Practice for board performance reviews for FTSE 350 companies (initially voluntary)
• Reviewers should sign up (and ICSA calls for FRC to issue additional voluntary guidance for companies to
disclose if their reviewer was a signatory to the new Code of Practice).
• Competence: Excludes review firms that simply supply companies with software or other tools for its
internal review
• Independence:
• Board reviewers allowed to provide other services to their clients, but both reviewers and companies should explain how any
conflicts of interest or threats to the independence of the reviewer are managed in these circumstances, and companies should
indicate in the annual report whether the fees paid for the board performance review exceed those paid for other services.
• Companies should disclose if the reviewer has any other connections with the person leading the appointment process for the
company and board reviewers should disclose their policies relating to the length of their relationship with clients.

• The FRC should continue to focus on board performance review practice and reporting.
• BEIS should commission a review three years after the Code of Practice is established to consider if
measures should be mandatory.
Discussion question
● How would you assess the quality of corporate
governance for a company (focus on board
effectiveness)?
Discussion question
● How would you assess the quality of corporate
governance for a company?
○ Generally
○ Governance Institute proposals
○ What can we learn from the Wirecard and Enron
cases?
CG Information for stakeholders
● Disclosures made by the company
● Disclosures made by media/whistleblowing
For reference: disclosures required by UK
companies (see previous seminar)
● UK Companies Act (2006) - (audit, remuneration, principal risks, carbon
emissions and some employee and social issues e.g. gender analysis)
● UK Corporate Governance Code (2018) for listed companies
● Listing rules (FCA regulated)
● EU Non-financial reporting directive (NFRD) - Directive 2014/95/EU
○ NB corporate sustainability reporting directive (CSRD) proposed to require
sustainability disclosures by all large companies
● The Equality Act 2010 (Gender Pay Gap Information) Regulations 2017
● Guidance on Board Effectiveness (FRC)
CG Code disclosures on board effectiveness
● Board leadership and company purpose
● Division of responsibilities
● Composition, succession and evaluation
Let’s have a look at a recent board
effectiveness disclosure
M&S board effectiveness disclosure

Let’s have a look at the disclosures about:

● Board roles
● Board committees
● Nomination committee
Corporate governance in the pandemic
● Health and safety - of the workforce and management team,
minimising potential litigation
● Ensuring board and management resilience
● Operational and risk oversight
● Business continuity - liquidity, minimising liabilities
● Maintaining shareholder relations in the crisis and the threat of
activism.
Discussion question
● How would you assess the quality of corporate
governance for a company (board effectiveness)?
○ Generally
○ Governance Institute proposals
○ What can we learn from the Wirecard and Enron
cases?
Board evaluation requirements
● Every year - disclose self reported evaluation of board
performance
● Every three years - external evaluation by an independent
evaluator
CG code requires FTSE 350 companies to

● Undertake an externally facilitated evaluation at least every

three years.
● Identify the external evaluator in the annual report and state if
it has any other connection with the company or individual
directors.
● Disclose outcomes and actions taken and how it will influence
board composition.
What is the focus of board reviews?
To inform a continual process of self-improvement, recognising
that even the best boards are always work in progress.

And … or…

To provide an objective assessment of whether the board is or is

not effective, in either absolute or relative terms.
Contents of a board performance review
● Mix of skills, experience and knowledge on the board
● Leadership regarding the purpose, direction and values of the company

● Succession and development plans

● How the board works together as a unit
● The tone set by the chair and the chief executive
● Key board relationships, particularly chair/chief executive, chair/senior
independent director, chair/company secretary and Exec/NEDs
● Effectiveness of individual directors and board committees - and how
they
are connected with the main board.
Board effectiveness evaluation at M&S (2021)
M&S board effectiveness disclosure
Problems with board performance reviews
● Potential issues with comparability - in 2017/18 over thirty different
board reviewers were used by FTSE 350 companies
● Market concentration - 4 organisations undertook 63% of
evaluations and one organisation completed 30% of all evaluations.
● No reliable data on appointment process and conflicts of interest/
secondary services supplied to board evaluation clients
● Maintaining minimum standards of practice - and anecdotal
evidence of companies denying evaluators access to board members.
Governance Institute (ICSA) 2019

Issued a consultation document on the need for:

● A code of practice for the providers of board evaluation services, and

formal arrangements for its implementation and monitoring.
● Voluntary principles to be applied by listed companies when engaging
external reviewers to undertake board evaluations.
● Guidance for listed companies on disclosure regarding the conduct
and
outcomes of their board evaluation, in accordance with the 2018 UK
Corporate Governance Code.
Outline – Issues

• Whistleblowing protection
• Board effectiveness evaluation practices
• ESG and CSR norms
• Investor and proxy advisory firm pressure for ESG
• Measuring corporate performance and corporate governance
• Media scrutiny of corporate governance
• Other sources of corporate governance for stakeholders
• Corporate governance and Covid-19
ICSA proposals - board performance reviews
● New Code of Practice for board performance reviews for FTSE 350
companies (initially voluntary)
● Competence: Excludes review firms that simply supply companies with
software or other tools for its internal review
● Independence: reviewers and companies should explain how any
conflicts of interest or threats to the independence of the reviewer are
managed in these circumstances
Corporate social responsibility (CSR) and
Environmental, social and governance
reporting (ESG)
• Rapid increase in interest among investors (with shareholder support)
• SEC disclosures related to business description, litigation, elements of
Management’s Discussion and Analysis, risk factor disclosure
• In late 2019, the US Chamber of Commerce released a set of best practices to
guide companies in making voluntary disclosure about ESG topics and steer the
development of a widely-adopted approach to voluntary ESG reporting without
the need for additional regulatory mandates.
• Companies can be subject to additional disclosure requirements under state law
(for example, certain companies doing business in California are required to
disclose measures they take to eliminate slavery and human trafficking in their
supply chains).
ESG guidance

• Many companies consider three influential guides when determining

if and what to disclose regarding CSR issues:
• The Global Reporting Initiative Sustainability Reporting Standards.
• The Sustainability Accounting Standards Board Implementation Guide.
• The Task Force on Climate-Related Financial Disclosures.

• IFRS has recently started a project to consider whether it should

develop sustainability standards to exist alongside the established
international financial reporting standards.
Outline - Issues

• Whistleblowing protection
• Board effectiveness evaluation practices
• ESG and CSR norms
• Investor and proxy advisory firm pressure for ESG
• Measuring corporate performance and corporate governance
• Media scrutiny of corporate governance
• Other sources of corporate governance for stakeholders
• Corporate governance and Covid-19
Investor pressure - BlackRock
• In the annual letter from BlackRock's chairman/CEO annual letter to its
portfolio companies, it stated it would vote against directors at companies
that do not introduce/extend sustainable business practices and
sustainability-related disclosures. https://
www.blackrock.com/corporate/investor-relations/larry-fink-ceo- letter
• “Our investment conviction is that sustainability- and climate-integrated
portfolios can provide better risk-adjusted returns to investors. And with
the impact of sustainability on investment returns increasing, we believe
that sustainable investing is the strongest foundation for client portfolios
going forward.”
 Investor pressure - BlackRock
“The importance of serving stakeholders and embracing purpose is becoming
increasingly central to the way that companies understand their role in society. As I
have written in past letters, a company cannot achieve long-term profits without
embracing purpose and considering the needs of a broad range of stakeholders. A
pharmaceutical company that hikes prices ruthlessly, a mining company that
shortchanges safety, a bank that fails to respect its clients – these companies may
maximize returns in the short term. But, as we have seen again and again, these
actions that damage society will catch up with a company and destroy shareholder
value. By contrast, a strong sense of purpose and a commitment to stakeholders
helps a company connect more deeply to its customers and adjust to the changing
demands of society. Ultimately, purpose is the engine of long-term profitability.”
 Investor pressure - State Street Global
Advisors (SSGA)
• SSGA stated it would vote against directors of its S&P 500 companies that lag in the
SSGA’s "R-Factor” score of ESG:
• “Having already engaged with companies on a number of governance matters for
many years, we see that shareholder value is increasingly being driven by issues
such as climate change, labor practices, and consumer product safety. We believe
that addressing material ESG issues is good business practice and essential to a
company’s long-term financial performance – a matter of value, not values.
• “Ultimately, we have a fiduciary responsibility to our clients to maximize the
probability of attractive long-term returns – and will never hesitate to use our
voice and vote to deliver better performance. This is why we are so focused on
financially material ESG issues.”
• https://www.ssga.com/us/en/institutional/ic/insights/informing-better-decisions-with-esg
Apple publishes human rights policy
following investor pressure
FT Dec 19th 2019: “Apple faces shareholder vote on human
rights policies”

FT Sept 4th 2020: “Apple’s board of directors approved the

policy and quietly published it ahead of a deadline of
September 5 for shareholders to submit motions for next
year’s investor meeting.”
Proxy advisory firm influence
Proxy advisory firms (e.g. Institutional Shareholder Services (ISS) and Glass Lewis)
recently adopted new policies by which they will generally recommend voting
against nominating committee chairs (and potentially other directors) at
companies with no female directors unless certain mitigating factors apply.
Today’s discussion questions
● How would you assess the quality of corporate governance for a
company?

● What are the requirements regarding environmental and social

disclosures and what challenges do they present?
Examples of environmental & social disclosures
● Energy and carbon
● General social/environmental
● Gender pay gap
● Corporate culture
Excerpt from M&S Strategic Report 2020
Excerpt from M&S Strategic Report 2020
The Equality Act 2010 (Gender Pay Gap Information)
Regulations 2017
● Applies to private and voluntary-sector organisations with 250 or
more employees.
● Must publish data on gender pay gap
● Came into effect on 6th April 2017, with the first reports being due in
April 2018.
 Extracts, M&S strategic report on
corporate culture
● Creating a team of empowered, responsive and commercial leaders. We
have continued to attract world-class talent and have built a strong team ...
● Putting the store voice at the heart of the business. Trading areas of the

business have begun to work more closely with the stores. There are now
weekly buyers and sellers calls where store and the commercial teams
review the prior week’s trading and develop action plans, and a weekly
store feedback call on how plans are landing…
● Data-driven decision-making Becoming a data and digitally enabled

business is at the core of our transformation ...Tablets have now been rolled
out to every store management team so they can access the information
they need to run their stores – includingstore-level profit and loss accounts.
How insightful are these statements? What metrics underpin them?
Walking the walk, or talking the talk?
● An involving, engaging culture where everyone can get on.
This year, we launched new clear behaviours, after extensive
collaboration with colleagues. They are ‘talk straight’, ‘own it
and get it done’, ‘make every penny count’ and ‘all in for the
customer’. Talk straight really resonated, reflecting the need to
encourage plain speaking, and the business tone of voice has
started to become more direct.
Based on what we have seen, can you
identify potential píoblems with the
usefulness of enviíonmental and social
disclosuíes?

ⓘ Staít píesenting to display the poll íesults on this slide.

FRC commentary on disclosures (Nov 2020)

● “Some companies continue to treat the Code as a box-ticking

exercise…”
● “Many companies stated the importance of diversity at board
level and in the succession pipeline but offered little
explanation to set out what they are doing to deliver that.”
Measuring ESG performance
● Lack of standardisation - especially for social issues (e.g. human
trafficking and corporate culture)
● Complex landscape of measurement guidance
● Difficulty in ensuring reliable auditing (as we will see, auditing
financial results is hard enough!)
● Boilerplate or vague disclosures
● Potential for greenwashing (glossy brochures and positive
descriptions of activities)
Problems with ESG and CSR
• How to measure performance?
• Variability in disclosure especially for social issues (e.g. human trafficking and
board effectiveness)
• Difficulty in ensuring reliable auditing
• Greenwashing
• Is ESG interest cyclical? (Ford, Friedman… Jamie Dimon.) NB Jamie Dimon (JP
Morgan Chase CEO) received a 1.6% raise to $31.5 million in 2019 after record
earnings by JPMC ($1.5 million in salary and $30 million in performance-
based incentives) Source: CNBC Jan 22 2020
https://www.cnbc.com/2020/01/23/jamie-dimon-gets-a-raise-to-31point5-million-after-record-2019-profit-at-jp-
morgan.html#:~:text=the%20company%20surged.-
,Dimon's%20compensation%20package%20includes%20%241.5%20million%20in%20salary%20and
%20%2430,stock%2
0compensation%2C%20according%20the%20filing.
Proxy firm rating offerings
Outline – Issues

• Whistleblowing protection
• Board effectiveness evaluation practices
• ESG and CSR norms
• Investor and proxy advisory firm pressure for ESG
• Measuring corporate performance and corporate governance
• Media scrutiny of corporate governance
• Other sources of corporate governance for stakeholders
• Corporate governance and Covid-19
Outline – Issues

• Whistleblowing protection
• Board effectiveness evaluation practices
• ESG and CSR norms
• Investor and proxy advisory firm pressure for ESG
• Measuring corporate performance and corporate governance
• Media scrutiny of corporate governance
• Other sources of corporate governance for stakeholders
• Corporate governance and Covid-19
Measuring corporate performance

• Financial results
• Objectivity?
• Comparability - IFRS/US GAAP
• Fair Value accounting
• Quality of external assurance/ trust in audit
• Environmental, social and governance
• ESG ratings and rankings agencies
• Guidelines on measurement (GRI)
• Social impact reporting (subjectivity, deadweight issues, auditing)
 Is Enron Overpriced? By: McLean, Bethany,
Fortune 3/5/2001, Vol. 143, Issue 5
• It's in a bunch of complex businesses. Its financial statements
are nearly impenetrable. So why is Enron trading at such a
huge multiple?
• … the critics are gushing. "Enron has built unique and, in our
view, extraordinary franchises in several business units in very
large markets," says Goldman Sachs analyst David Fleischer.
• Enron now trades at roughly 55 times trailing earnings. That's
more than 2 1/2 times the multiple of a competitor like Duke
Energy, more than twice that of the S&P 500…
Is Enron Overpriced? By: McLean,
Bethany, Fortune 3/5/2001
• “the company remains largely impenetrable to outsiders…
Start with a pretty straightforward question: How exactly
does Enron make its money?”
• McLean noted that Enron’s business model was obscure (a
“black-box”), it had high debt levels and a limited cash flow.
Her article triggered concerns for shareholders and analysts.
Fall-out from the McLean article

• In November, Enron shareholders filed a $40 billion lawsuit after the

company's stock price, which achieved a high of US$90.75 per share
in mid-2000, plummeted to less than $1 by the end of November
2001 and the SEC began an investigation
• On 2nd December 2001, Enron filed for bankruptcy and many
executives at Enron were indicted for a variety of charges and some
were later sentenced to prison.
• Arthur Andersen was found to have destroyed evidence, lost its
license to audit public companies and closed.
Media scrutiny as a form of CG
Outline – Issues

• Whistleblowing protection
• Board effectiveness evaluation practices
• ESG and CSR norms
• Investor and proxy advisory firm pressure for ESG
• Measuring corporate performance and corporate governance
• Media scrutiny of corporate governance
• Other sources of corporate governance for stakeholders
• Corporate governance and Covid-19
Creditor protection
• Debt covenants were viewed as corporate governance devices
• Aim to control behaviour of managers by:
• Preventing certain activities
• Requiring maintenance of certain financial ratios
• Enable advance warning to debt holders of covenant breaches
• But – increasingly covlite loans
• “More than 90% of U.S. leveraged loans issued this year have been covenant-lite, a
new record, further marking a two-decade-long transformation of the asset class in
which nearly all newly issued loans have shed lender protections that once had been
standard.” (S&P Global, 2021)
• Institutional changes may explain this especially the rise of private equity
and low yields
Outline – CG video 3 - Issues

• Whistleblowing protection
• Board effectiveness evaluation practices
• ESG and CSR norms
• Investor and proxy advisory firm pressure for ESG
• Measuring corporate performance and corporate governance
• Media scrutiny of corporate governance
• Other sources of corporate governance for stakeholders
• Corporate governance and Covid-19
And finally - corporate governance and
Covid-19
Corporate governance issues presented by the COVID-19 pandemic,
relate to:
• health and safety;
• operational and risk oversight;
• business continuity;
• board and management resilience;
• shareholder relations and activism.
What have we learnt about corporate
governance (CG)?
• What is CG and how is it connected with company purpose?
• What is the regulatory/legislative landscape of CG?
• Issues:
• Whistleblowing protection
• Board effectiveness evaluation practices
• ESG and CSR norms
• Investor and proxy advisory firm pressure for ESG
• Measuring corporate performance and CG
• Media scrutiny of CG
• Other sources of CG for stakeholders
• CG and Covid-19
Key questions covered so far

• How would you assess the quality of corporate governance for a

company?
• What have been requirements regarding environmental disclosures
and what challenges do they present?
• Think about these issues and how they affect corporate governance
• Read Wirecard
Wirecar
d
From fintech star to scandal…

For details of the case of Wirecard, please read this FT

article by Dan McCrum published on June 25 2020:
Wirecard: the timeline | Free to read
How the payments group became one of the hottest stocks in Europe while battling persistent allegations
of fraud

https://www.ft.com/content/284fb1ad-ddc0-45df-a075-
0709b36868db
Wirecard - questions for discussion:
Corporate governance

• What corporate governance devices failed in the case of Wirecard?

• How should regulators respond to this corporate scandal?
Case 1: Wirecard
Jan Marsalek (COO, Wirecard)

Dan McCrum, FT journalist Markus Braun (former CEO, Wirecard)

https://www.ft.com/content/284fb1ad-ddc0-45df-a075-
0709b36868db
 FT investigation into Wirecard *
• 2015 FT questions inconsistencies in the group’s accounts.
• 2017 Clean audit report from EY - shares more than double in price.
• 2018 Wirecard displaces Commerzbank to join the German DAX
stock exchange valued at over €24bn.
• Oct 2018 Whistleblowers contact the FT re a Singapore acquisition
leading to article.
• January 2019 Wirecard claims FT Singapore investigation is “false”
• October 2019 FT publishes documents indicating that profits at
Wirecard units in Dubai and Dublin were fraudulently inflated, and
that customers listed in documents provided to EY did not exist.
Wirecard says the documents are not authentic but investors force it
to appoint KPMG to conduct a special audit.
 FT investigation into Wirecard
• January 2019 BaFin investigates the FT for market manipulation.
April 2019 Wirecard announces a €900m cash from SoftBank and EY
approves the 2018 accounts with minor qualifications.
• July 2019 Wirecard accuses FT of collusion with short sellers
• September 2019 Wirecard issues €500m of bonds classified as investment
grade by Moody’s, the credit rating agency.
• October 2019 FT publishes documents indicating that profits at Wirecard
units in Dubai and Dublin were fraudulently inflated, and that customers
listed in documents provided to EY did not exist.
Wirecard says the documents are not authentic but investors force it to
appoint KPMG to conduct a special audit.
FT investigation into Wirecard
• April 2020 KPMG’s report states:
• it cannot verify that arrangements responsible for “the lion’s share” of Wirecard
profits reported from 2016 to 2018 were genuine
• queries €1bn of cash balances, on the basis that the only evidence for the sum
were documents provided by a Singapore trustee that cut ties with Wirecard
around the time the special audit began.
• Publication of results is postponed to June, a delay attributed to
coronavirus. Any wrongdoing is denied.
• June 18 Wirecard expected to publish audited results for 2019. Instead
it admits that €1.9bn is “missing”
• June 23 Wirecard CEO (former KPMG consultant, Markus Braun) is
arrested on suspicion of false accounting and market manipulation.
• June 25 Wirecard says it will file for insolvency.
Evidence missed by auditors EY

• Missing cash balances

• Complex corporate structure (many shell companies)
• Questionable explanation of business model (how could a payments
company make that much money)
Where were the checks?
• Auditors:
• EY – 2-3m Euros per year (so not very high fees)
• Wirecard seen as prestigious as a success story in German fintech
• Results in 2018 in spite of FT publication
• Supervisory board – until 2018 was ”a joke” – no committees and members
were quite old and had been on the board for more than a decade – were
rubber stamping everything. This changed after the company went onto DAX
when they put new independent directors.
• They commissioned McKinsey to look at their controls - but they didn’t
complete the project they started to improve their systems.
• Supervisory board eventually got KPMG involved to report
From FT online briefing
• A friend of the Alphaville editor tells the FT that he has been offered payment in
exchange for deleting FT Alphaville content
• Jan Marselek tells the FT that another company is about to bid for Wirecard.
• Whistleblowers in Asia were key to uncovering the story – exposing fraud – and
handed over documentary evidence. The more reports were written in Alphaville,
the more whistleblowers came forward.
• Paul Murphy (editor of Alphaville) on whistleblowers: “They acted on moral
grounds .. we salute them”
• Wirecard hired litigation lawyers and an ex-MI5 operative to investigate and
undermine the FT story.
• They tried to suggest that the FT was corrupt and were colluding with short
sellers.
What happened to the Wirecard
directors?
Jan Marsalek – wanted by Interpol
Other directors

Former CEO Markus Braun: Arrested (along with two other former
executives)

Executive Christopher Bauer: Death in Manila, Philippines announced

in August 2020 - but some speculation about whether this is true.
FT journalist in Singapore

• Tracks down big customer of Wirecard in the Philipines (ConePay)

• Turns out to be the home of a retired sailor who knew nothing of
Wirecard.
• But he had received Wirecard bank statements at his home which
provided evidence that
• She looked for PayEasy Solutions – the location was a bus tour
company headquarters.
• In Manila in a scrap yard area, a shed was identified as the address of
another partner business.
Wirecard scandal: A failure of auditing
and CG regulation?
• Clean audit report from EY which had accepted evidence which was
not obtained directly from banks.

AND

• Failure of regulators to engage – even after the FT’s investigation.

Key takeaways
German financial and audit regulation
EU countries have local audit regulators. Germany’s accounting
enforcement comprises:
• A low-budget private regulator (Deutsche Prüfstelle für
Rechnungslegung) that brings together national employers’
associations, trade unions, and industry associations of banks,
insurers, and accountants
• The financial regulator (responsible for securities listings) BaFin
(Bundesanstalt für Finanzdienstleistungsaufsicht).
https://www.piie.com/blogs/realtime-economic-issues-watch/wirecard-debacle-calls-rethink-eu-
not-just-german-financial
BaFin’s actions regarding Wirecard

• Any guesses about what BaFin did in response to the FT investigation

into Wirecard?
BaFin’s actions regarding Wirecard

• Any guesses about what BaFin did in response to the FT investigation

into Wirecard?

• BaFin filed a criminal complaint against the FT, suggesting potential

market manipulation related to the FT’s coverage of Wirecard.
https://www.ft.com/content/8e1948be-6060-11e9-b285-
3acd5d43599e
Wirecard - questions for discussion:
Corporate financial audit

• “Wirecard shows that external financial audit is a waste of resources

and needs fundamental reform”. Discuss.
• “Strengthening the regulatory environment is essential if we are to
have high quality audit.” Discuss.
 Seminar 2
AC341

slido.com #AC341-S2
Today’s discussion questions
● How would you assess the quality of corporate
governance for a company?
○ Governance Institute Consultation
○ What can we learn from the Wirecard and Enron
cases?

● What are the requirements regarding environmental

disclosures and what challenges do they present?
Groupwork (10 minutes) when CG fails
● What happened at Wirecard and Enron?
● In what ways did CG fail?
● What disclosures ultimately informed stakeholders of the
problems?
What is the current government
concern about external board
evaluations?

ⓘ Start presenting to display the poll results on this slide.

Next week
Internal controls
● What are they and why do they matter?
● What are the functions and structure of an IC system?
● How would you design an IC system?
See you next week!