Clarify Applications of Corporate Governance Requirements

Clarify applications of corporate governance requirements

Contents

Key to resources

Introduction

Principles of good governance

Conflict of interest

Summary

Feedback to activity

This learning guide is based on the following resource(s):
Textbook
Adams K, Grose R and Leeson D(2004) Internal Controls and Corporate Governance(2nd edn), Pearson/Prentice Hall
(This textbook is based on the AUS 402 published in 2002. AUS 402 has been updated with the new standard ASA 315 under 2006 legislation).
CD-ROM
Adams K, Grose R and Leeson D(2004)Internal Controls and Corporate Governance – Instructor’s Manual (2nd edn), Pearson/Prentice Hall
Online

Australian Government Auditing and Assurance Standards Board: Select the link Standards and Guidance which brings you to the AUASB Standards and Pronouncements to obtain all the auditing standards. You can downloadASA550 Related Parties.

Key to resources

Resource / Textbook
1 / Performance criterion*13.1 Corporate governance principles, p283
2 / Table 13.1 Composition of boards of Australian companies, p290
3 / Performance criteria 12.5 Examine the role of the government in maintaining good corporate governance, p278
4 / Do self-check questions 13.1a and 13.1b
Then attempt end of chapter questions 13.6, 13.7, 13.8 and 13.9
5 / Performance criterion 13.2 Outline and discuss a framework for a good corporate governance, p285
6 / Performance criterion 12.3 Identify and discuss the role and functions of the key organisations in the corporate governance arena, p275
7 / Table 13.1 Composition of boards of Australian companies, p 290
8 / Attempt the self-check questions 13.2b and 13.2c, p 291
Then do end of chapter questions 13.10, 13.11, 13.12, 13.13 and 13.14, p292

* The term ‘performance criterion’is the reference used in the textbook. It is not related to the performance criteria for the unit of competency addressed in the learning guide.

Introduction

Corporate governance in simple terms, refer to the implementation of control systems to prevent fraud, conflicts of interest and other improper conduct. Most definitions on corporate governance focus on the role and function of the board of directors. It has the responsibility of ensuring that the company is accountable for its decision and performance.

This learning guide will clarify the applications of corporate governance requirements by examining the participants in the corporate governance system. It will also look at issues of conflict of interest in relation to corporate governance.

/ Now go to Resource 1
The location of this and all other resources for this learning guide is in the Key to resourcesat the front of this document.

The participants in the corporate governance system are the individual directors, the Board as an entity in itself, shareholders and other stakeholders including lenders, suppliers and employees.

Individual directors

The directors can be either executive (an employee of the company) or non-executive. External individuals usually bring expertise not available in the executive directors. An example might be a geologist in a mining company.

Although appointed and removed by the shareholders, directors and financial institutions that have large shareholdings in the company, can influence appointments and removals. Until the Telstra T3 sale, the federal government had a 51% shareholding in Telstra Corporation and appointed and removed whom they wanted.Some public companies have nomination and compliance committees that overseeboard appointments (see table 13.1 Composition of boards of Australian companies.)

/ Now go to Resource 2
This is a table showing the composition of boards of Australian companies.

Responsibilities and duties

Even though corporations and the common law are the core areas that provide the rules, regulations and precedents for directors, two specific responsibilities remain constant:

to act in good faith and honestly
to act with reasonable care and diligence.

The directors act for the benefit of the organisation as a whole and for proper purposes.

Examples of good faith and honesty include:

avoiding conflict of interest
avoiding misuse of company information and business opportunities (insider trading and contracts to supply goods or services).

Examples of reasonable care and diligence include:

understanding the company’s business
monitoring the company’s affairs and policies
attending board meetings
reviewing financial statements
objecting to illegal courses of action.

Boards of directors

There are five essential activities undertaken by the board of directors:

formulating strategies and directions (funding, marketing and operating)
setting down policies and guidelines for management to work within in order to achieve the organisation’s goals and objectives
monitoring senior management through regular internal reporting and budget control
setting the direction and level of accountability
appointing and setting the remuneration of senior management.

Shareholders

Unless you have substantial shareholding or group together with other shareholders to form a substantial block, there is very little you can do to influence boards of directors or management on day-to-day operations or the direction the company is taking.

The only opportunity shareholders have to question the board is at the annual general meeting (AGM) when the board presents the audited financial statements for adoption by shareholders.

Until recently, one hundred shareholders could call an extraordinary meeting to question the board on matters of serious concern. This level has been amended to approximately 10% of voting shareholders. Some see this as a reduction of board accountability. Others see it as removing mischievous moves by minority shareholders.

Other stakeholders

Directors see their responsibility as maximising shareholders’ wealth.

To achieve this legally, the corporation must act within the law when dealing with other stakeholders including customers, governments, lenders of funds, employees and suppliers of goods and services.

At this point it is prudent to consider the role of government in corporate governance for examples of laws which attempt to control corporations.

/ Now go to Resource 3
/ Now go to Resource 4
It’s time for self-check questions.
You will find the answers to self-test questions at the end of the chapter in the textbook.
The answers to end-of-chapter questions and case studies are found in the Instructor’s manual for the textbook.

Principles of good governance

We’ll consider the framework for good corporate governance within the Organisation for Economic Co-operation and Development’s (OECD)context of Principles of Corporate Governance.

/ Now go to Resource 5

These principles are:

1rights of shareholders

2equitable treatment of shareholders

3role of stakeholders

4disclosure and transparency

5responsibilities of the board.

The shareholders’ rights (first and second principle)

Let’s start by looking at shareholder’s rights to:

buy, sell or transfer shares
participate in profits
have limited liability
receive end-of-year audited financial statements
attend the annual general meeting of shareholders
raise issues and question the board of directors at the annual general meeting
vote on adoption of financial statements
vote on directors’ remuneration
vote on appointments to the board.

One of the main concerns by the OECD is the equitable treatment of minority shareholders, who have had in the past and will have in the future little or no influence on decisions by boards of directors.

Stakeholdersother than shareholders (third principle)

The corporation has little chance of survival without customers, suppliers, employees and fund lenders. So the relationship is one of mutual benefit that depends on the board and management pursuing policies that recognise the interests of all stakeholders.

Boards of directors (fourth principle)

Recognising that transparency and disclosure can bepowerful tools in promoting the corporation, boards discover that this leads to credibility in the capital, money and share markets.

Within this fourth principle the OECD suggests that disclosure should include:

financial and operating results
objectives, ethics and other public policy commitments
major shareholder percentages and voting rights
directors and senior management remuneration (salary, bonuses and share options)
material foreseeable risks
issues relating to employees and other stakeholders
division of authority between the board and management.

OECD framework – board’s key functions (fifth principle)

The board’s key functions are to:

formulate strategies and directions (funding, marketing and operating)
set down policies and guidelines for management to work within in order to achieve the organisation’s goals and objectives
monitor senior management through regular internal reporting and budget control
set the direction and level of accountability
appoint and set the remuneration of senior management
oversee succession planning
ensure that the integrity of the accounting and financial reporting systems are in place, including the audit process.

Supporting the board’s corporate governance policies on structures and accountability are:

non-executive directors
board committees
board chairman.

/ Now go to Resource 6

The Bosch Committee (1991)

Chaired by Henry Bosch (former chairman of ASIC), the committee published a best practice guide under the title ‘Corporate Practices and Conduct’.
Three points made up the recommendations:

boards should include a majority of non-executive directors
appoint an audit committee
publish and enforce a code of ethics.

Non-executive directors

Most of the committees that have issued principles and standardson corporate governance are concerned with boardsmade up of a majority of executive directors. They see thatexecutive directors may be compromised by beingdirectors andemployees at the same time that could lead not only to a conflict of interest but passive acceptance of actions and policies.

It is the independence of the non-executive director that allows for scrutiny of and objection to board decisions.

Board committees

More and more public companies are forming committees to evaluate and recommend on a wide range of activities, appointments and policies.

Audit committees represent the bulk of board committees in keeping with ASX listing rules, with non-executive directorsusually appointed to chair and manage. Complementing the audit committee is the internal auditor who reports directly to the audit committee chairman to safeguardindependence.

Refer again to the table in Resource 2.

/ Now go to Resource 7
Examine the range of committees operating in listed public companies in the table showing the boards of Australian companies.

Board chairman

There is debate about separating the roles of chairman and CEO, but in the current corporate governance environment of accountability, the majority of listed public companies appoint a chairman and a CEO. The separation of power appears to be good corporate governance.

/ Now go to Resource 8
It’s time to look at some self-check and end of chapter questions.
The answers to end-of-chapter questions and case studies are found in the Instructor’s manual for the textbook.

Conflict of interest

Conflict of interest is an important area of corporate governance. There’s extensive coverage on this area in the Auditing Standard ASA 550Related Parties (2006).

ASA 550 not only complies with International Standard of Auditing ISA550 but has been elevated by the Australian Auditing and Assurance Standards Board to include the wordshall instead ofshould to describe the auditor’s mandatory requirements. These standards were the subject of federal legislation in 2006 and so provide external auditors with increased responsibilities and powers.

The difficulty of identifying related parties is captured in paragraph 20 from ASA 550 which states:

Related parties and related party transactions can be difficult to identify and measure because:

related parties may operate through an extensive and complex range of relationships and structures
related party transactions may not always involve an exchange of consideration
transactions with related parties may not be at arm’s length and may be controlled, manipulated and/or concealed by those charged with governance and management.

Bearing in mind what the Auditing Standard has to say about related parties, look at the following activity based on an interview featured in the ABC program Inside Business.

/ Activity 1

The following interview was conducted by Greg Hoy (Inside Business) with Stan Mather of the Shareholders’ Association and John Fletcher, CEO or Coles Myer.

Read the excerpt of the transcript and consider whether the accusations of conflict of interest are valid.

GREG HOY (reporter): Graves can be misleading. The grand and much-loved Sidney Myer would hardly rest in peace. His rich legacy in turmoil, his vision lost in what shareholders say is perceived conflict of interests that Bill Shakespeare would be proud of.

STAN MATHER, SHAREHOLDERS’ ASSOCIATION: I think it would have been very difficult for the original management of Myer to have envisioned what’s happening now.

HOY: Formerly Simcha Baevski, founder of the Myer department store dynasty, convert to Christianity, famed for philanthropy, known fondly as the merchant prince of retail. His great wealth bequeathed to family, who remain the pinnacle of society in Melbourne, still one of the largest shareholders, since the merger with GJ Coles in 1985 that formed Australia’s biggest retailer. Annual results are a national event.

JOHN FLETCHER, CEO COLES MYER: The leadership team is now in place. We’ve got the team that we want to do this turnaround. They are very good, experienced retailers.

HOY: Today, the merchant prince’s descendants are matched in equity and dwarfed in influence by Solomon Lew, who’s family companies match the Myer’s combined might with a five per cent equity in Coles Myer, for whom the Lews are also suppliers. On the Coles Myer board, he and trusted supporter Mark Leibler are considered a formidable force.

MATHER: One of the things that we would have liked to have seen from the directors who are opposed to Solomon Lew is that if they want to put in place a new board which can do the right things by their reckoning, then they should have been putting up candidates to stand against Mr Lew and Mr Leibler, but they haven’t done that.

HOY: Why not, do you think?

MATHER: I can only assume that they can’t find the candidates who are prepared to face the battle, which is a great shame.

HOY: What pressure is there for you to trade with Solomon Lew’s companies?

FLETCHER: I can say absolutely no pressure, absolutely no pressure.

HOY: So what’s the volume of trade with his companies?

FLETCHER: It’s in the annual report every year. I think we need to be clear that…

HOY: But is it significant?

FLETCHER: Well, in a $26 billion company, the $60 million or $80 million it’s been over the last few years you wouldn’t say necessarily is a significant number. Some people would say $80 million is a lot of money.

(from ‘Inside Business –Battle lines drawn at Coles Myer’, 6 Oct 2006, ABC)

What accusations are being made? Would you consider that there’s been a conflict of interest? Write your response in the space below.

______

Read the feedback at the end of this learning guide.

Auditing Standard ASA 550 Related Parties

In view of the above example of conflict of interest, Auditing Standard ASA550 is very important to the external auditor and the internal auditor if there is one. Prior to these standards being enacted as federal legislation, they were mandatory standards for members of the accounting professional bodies but did not carry the weight of federal legislation. Now the standards give auditors the authority and power to challenge and investigate without fear or favour.

/ Research

To highlight the main thrust of Auditing Standard ASA 550, read some of its significant paragraphs including:

Existence and disclosure of related parties
Communication with those charged with governance
Management representations
Materiality.

You can access the auditing standard from your local TAFE library or from the Australian Government Auditing and Assurance Standards Board website.

Summary

The main players and their relationships provide a framework for good corporate governance. These are the:

boards of directors
individual directors—executive and non-executive
board committees—audit and others
other stakeholders—suppliers, lenders, employees and governments
shareholders—major and minor and their treatment
chairman of the board.

Feedback to activity

Activity 1

The focus of the interview was the ongoing battle between Soloman Lew (supported by Mark Leibler) and the rest of the Coles Myer directors over control and direction of the group. Added to this Soloman Lew had tendered for and won sizable contracts for the supply of goods and services to the Coles Myer Group.

Accusations of conflict of interest were made against Soloman Lew and to some extent Mark Leibler over their ability to tender for goods and services contracts while being directors of the Coles Myer Group. Other suppliers felt they were at a disadvantage when competing with Lew and Leibler and they accused them of having early access to terms, conditions and pricing of tenders. The suppliers also voiced their concerns that Lew and Leibler (being directors) could influence to whom the contracts would be awarded. You will see at the end of the interview John Fletcher (CEO Coles Myer) admits to $60 to $80 million worth of business that Lew and Leibler were doing with the Coles Myer Group.

Clarify applications of corporate governance requirements1