Chapter 3

Corporate Governance

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Key to chapter content ICONS

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CHAPTER 3: Corporate Governance

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Corporate Governance

Definition
 The system by which business corporations are
directed and controlled.

The corporate governance structure specifies the

distribution of rights and responsibilities among
different participants in the corporation.

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Those Charged With Governance (TCWG)

Definition
 Individuals with responsibility for overseeing:
• the strategic direction of the entity
• obligations related to the entity’s accountability
• the financial reporting process.

May be specified by statute or regulation

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Management

Definition
 individuals with executive responsibility for the
conduct of the entity's operations.

TCWG will oversee the actions of management.

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Activity: Typical Stakeholders

Identify FOUR stakeholders (participants), their

relationship and their needs for a business entity.

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Objective of Corporate Governance

 The ultimate objective of a business is to increase

long-term shareholder value by enhancing economic
performance.

 Corporate governance aims to direct the business to

achieve this.

 Corporate governance is generally aimed at listed

companies.
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Organisation for Economic Co-operation and
Development (OECD)
 Released Principles of Corporate Governance in 1999, revised
in 2015.
 Focused on listed companies; relevant to all companies.

Guidance includes:

 Rights and equitable treatment of shareholders

 Role of stakeholders
 Disclosures and transparency
 Board responsibilities

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 UK Corporate Governance Code

 Issued by Financial Reporting Council (FRC), applies to

listed companies in the UK.

 “Comply or Explain” concept, covering 18 Principles.

 Companies report on how they apply the principles, and

confirm compliance, or explain why they have not.

 AA examinable document.
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 Board Leadership and Company Purpose
The board should:
 Ensure effective engagement and participation with
stakeholders
 Establish the company’s purpose, values and strategy –
aligned with its culture.
 Ensure that the resources are available to meet the
company’s objectives and measure performance.
 Establish a framework of controls to assess and manage
risk.
 Ensure that workforce policies and practices are consistent
with the company’s values and support long-term success.
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 Division of Responsibilities (Board Level)

 Have an independent chair.

 The chair leads the board.
 No one individual or small group of individuals dominates
decision-making.
 Clear division of responsibilities between the chair and the
executive leadership.
 Effectively supported by company secretary.

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 Composition, Succession and Evaluations

 Establish formal, rigorous and transparent procedure for

board appointments and an effective succession plan for
board and senior management.
 Majority of member on nomination committee should be non-
executive directors (NEDs).
 Ensure appropriate combination of skills, experience, and
knowledge.
 Annual evaluation of board.

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 Audit, Risk and Internal Control
The board should:
 Establish policies and procedures to ensure the independence and
effectiveness of internal and external audit
 Satisfy itself on the integrity of financial and narrative statements
 Present an assessment of the company’s position and prospects
 Establish procedures to manage risk and oversee internal controls
 Determine the principal risks the company is willing to take to achieve
its long-term strategic objectives.

Met by establishing an Audit Committee (minimum three independent

non-executive directors (NEDs) or only two for smaller companies).

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 Remuneration
 Remuneration policies and practices should be designed to support
strategy and promote long-term success.

 A formal and transparent procedure for developing remuneration policy

should be established through a remuneration committee (minimum
three independent NEDs or only two for smaller companies).

 No director should be involved in deciding their remuneration.

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 Corporate Governance Deficiencies

 Candidates may be asked to identify corporate governance

deficiencies in an entity and make appropriate
recommendations.

 Auditors need to be aware of their role in corporate

governance and maintain independence to carry out duties
with sufficient levels of scepticism and professional
judgement.

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 Activity: Corporate Governance Deficiencies
1. The entity has a six-member board of directors, including executive and non-executive
directors.
2. The CEO serves as the chairman of the board of directors.
3. The board includes two independent NEDs.
4. New board members are selected by a nominations committee headed by the
chairman/CEO.
5. The audit committee comprises two executive directors and the two NEDs.
6. One of the independent non-executive audit committee members recently retired after
serving for ten years as the CFO of a major corporation.

7. The remuneration committee comprises one executive director and one NED, and they
decide the remuneration of all board members.

8. Management is required to assess the effectiveness of internal controls on an annual

basis.

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 Audit Committees

 An audit committee should be comprised of at least three

independent NEDs (two for a smaller company).

 At least one member must have recent and relevant

financial experience.

 As a whole, the committee must have competence relevant

the sector in which the company operates.

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 Audit Committees
Roles and Responsibilities of the Audit Committee include:
 Monitor the integrity of the financial statements
 Advise board whether the annual report provides the information users need
 Review the financial controls, internal control and risk management systems
 Monitor and review the effectiveness of the internal audit function - if no
internal audit, consider annually the need for internal audit
 Make recommendations to the board for auditor (re)appointment and
removal
 Review and monitor the auditor's independence, objectivity and effectiveness
 Develop and implement policy on the engagement of the external auditor to
supply non-audit services
 Review “whistle-blowing” arrangements ….

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Activity: Audit Committees

What are the benefits and limitations

of audit committees?

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 Chapter 3: Summary
 Corporate governance includes oversight of executives, risk and control
activities and auditors
 The five main principles of the UK Code concern:
— Board Leadership and Company Purpose
— Division of Responsibilities
— Composition, Succession and Evaluation
— Audit, Risk and Internal Control
— Remuneration
 The roles of an audit committee of a listed company (three independent NEDs)
concern the financial statements, financial reporting controls, internal audit and
the external auditor.

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 Chapter 2: Practice questions

Study Question Bank

Audit Committee 30 mins

For AA
Attempt the Study Question Bank questions listed above after studying this chapter
Attempt Revision Question Bank questions in your revision phase, after studying all chapters

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Thank you

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