2019-2020 EDITION WENDT VAD SUC a ANIHONVEB> CABRERA Scanned with CamScannerINTRODUCTION TO CORPORATE GOVERNANCE Expected Learning Outcomes After studying the chapter, you should be able to ... at: 2. Describe what governance involves Enumerate the different contexts in which governance can be applied . Name and explain the characteristics of good governance . Explain the meaning, purpose and objectives of corporate governance . Know and describe the principles of effective corporate governance . Understand how the principles of good corporate governance can be applied QU Go Scanned with CamScannerCHAPTER 1 INTRODUCTION TO CORPORATE GOVERNANCE WHAT IS GOVERNANCE? Generally. governance refers to a process whereby elements in society wield power, authority and influence and enact policies and decisions concerning public life and social upliftment. It comprises all the processes of governing — whether undertaken by the government of a country, by a market or by a network — over a social system and whether through the laws, norms, power or language of an organized society. Governance therefore means the process of decision-making and the process by which decisions are implemented (or not implemented) through the exercise of power or authority by leaders of the country and / or organizations. Governance can be used in several contexts such as corporate governance, international governance, national governance and local governance. The focus of this book is on Corporate Governance. CHARACTERISTICS OF GOOD GOVERNANCE Whatever context good governance is used, the following major characteristics should be present: Participation Rule of Law ‘Accountability 000 Transparency = GoveRNance ae Responsiveness | ‘Equity & inclusiveness erfectveness & | Consensus | | oriented _} Scanned with CamScanner4 Chapter 1 ‘These characteristics aré briefly described as follows: Participation Rule of Law Transparency Responsiveness Consensus Oriented Participation by both men and women is a key cornerstone of good governance. Participation could be either direct or through legitimate institutions or representatives. It is important to point out that representative democracy does not necessarily mean that the concern of the most vulnerable in society would not be taken into consideration in decision making. Participation needs to be informed and organized, This means freedom of association and expression on one hand and an organized civil society on the other hand. Good governance requires fair legal frameworks that are enforced impartially. It also requires full protection of human rights, particularly those of minorities. Impartial enforcement of laws requires an independent judiciary and an impartial and incorruptible police force. Transparency means that decisions taken and their enforcement are done in a manner that follows rules and regulations. It means that information is freely available and directly accessible to those who will be affected by such decisions and their enforcement. It also means that enough information is provided and that it is provided in easily understandable forms and media. Good governance requires that institutions and Processes try to serve the needs all stakeholders within a reasonable timeframe. Good governance requires mediation of the different interests in society to reach a broad consensus on what is in the best interest of the whole community and how this can be achieved. It also requires a broad and long-term Perspective on what is needed for sustainable human development and how to achieve the goals of such development, This can only result from an understanding of the historical, cultural and social contexts of a given Society or community. Scanned with CamScannerEquity & Inclusiveness Effectiveness &Efficiency Accountability Introduction to Corporate Governance _$ Ensures that all its members feel that they have a stake in it and do not feel excluded from the mainstream of society. This requires all groups, but particularly the most vulnerable, have opportunities to improve or maintain their well being. Good governance means that processes and institutions produce results that meet the needs of society while making the best use of resources at their disposal. The concept of efficiency in the context of good governance also covers the sustainable use of natural resources and the protection of the environment. Accountability is a key requirement of good governance. Not only governmental institutions but also the private sector and civil society orgunizations must be accountable to the public and to their institutional stakeholders. Who is accountable to whom varies depending on whether decisions or actions taken are internal or external to an organization or institution. In general, an organization or an institution is accountable to those who will be affected by its decisions or actions. Accountability cannot be enforced without transparency and the rule of law. CORPORATE GOVERNANCE: AN OVERVIEW Corporate governance is defined as the system of rules, practices and processes by which business corporations are directed and controlled. It basically involves balancing the interests of a company’s many stakeholders, such as shareholders, management, customers, suppliers, financiers, government and the community. Corporate governance is a topic that has received growing attention in the public in recent years as policy makers and others become more aware of the contribution good corporate governance makes to financial market stability and econornic growth. Good corporate governance is all about controlling one’s business and so is relevant, and indeed vital, for all organizations, whatever size or structure. Scanned with CamScanner6 Chapter t The corporate governance structure specifies the distribution of rights and responsibilities among different participants in the corporation, such as the board, managers, sharcholders, and other stakeholders, and spells out the rules and procedures for making decisions on corporate affairs. By doing this, it also provides the structure through which the objectives are set and the means of attaining those objectives and monitoring performance. PURPOSE OF CORPORATE GOVERNANCE The purpose of corporate governance is to facilitate effective, entrepreneurial and prudent management that can deliver long-term success of the company. In simple terms, the fundamental aim of corporate governance is to enhance shareholders’ value and protect the interests of other stakeholders by improving the corporate performance and accountability. It is also about what the board of directors of a company does, how it sets the values of the business firm. OBJECTIVES OF CORPORATE GOVERNANCE The following are the basic objectives of corporate governance: 1. Fair and Equitable Treatment of Shareholders A corporate governance structure ensures equitable and fair treatment of all shareholders of the company. In some organizations, a group of high- het-worth individual and institutions who have a substantial Proportion of their portfolios invested in the company, remain active through occupation of top-level positions that enable them to guard their interest. However, all shareholders deserve equitable treatment and this equity is safeguarded by a good governance structure in any organization. 2. Self-Assessment Corporate governance enables firms to assess their behavior and actions before they are scrutinized by regulatory agencies. Business establishments with a strong corporate governance system are better able {o limit exposure to regulatory risks and fines. An active and independent board can successfully point out deficiencies or loopholes in the ComPany operations and help solve issues internally on a, timely basis. Scanned with CamScannerIntroduction to “orporate Governance _7 Increase Shareholders’ Wealth Another corporate governance’s main objective is to protect the long- term interests of the shareholders, Firms with strong corporate governance structure are seen to have higher valuation attached to their shares by businessmen. This only reflects the positive perception that good corporate governance induces potential investors to decide to invest in a company. 4, Transparency and Full Disclosure Good corporate governance aims at ensuring a higher degree of transparency in an organization by encouraging full disclosure of transactions in the company accounts. BASIC PRINCIPLES OF EFFECTIVE CORPORATE GOVERNANCE Effective corporate governance is transparent, protects the rights of shareholders and includes both strategic and operational risk management. It is concerned in both the long-term earning potential as well as actual short-term earnitigs and holds directors accountable for their stewardship of the business. The basic principles of effective corporate governance are threefold as presented below: ‘Transparency and Full Disclosure |s the board telling us what is going on? Accountability 1s the board taking responsibil? Good and Effective Governance Corporate Control 's the boara doina the right thing? Scanned with CamScanner8_Chapter 1 Positive al ‘complianc’ nswers to the following questions indicate a firm’s conformance and i with the basic principles of good corporate governance: A. Transparency and Full Disclosure B, Accountabi Does the board meet the information needs of investment communities? Does it safeguard integrity in financial reporting? Does the board have sound disclosure policies and practices? > Does it make timely and balanced disclosure? > Can an outsider meaningfully analyze the organization's actions and performance? Does the board clarify its role and that of management? > Does it promote objective, ethical and responsible decision making? > Does it lay solid foundations for management oversight? > Does the composition mix of board membership ensure an appropriate range and mix of expertise, diversity, knowledge and added value? > Is the organization’s senior official committed to widely accepted standards of correct and proper behavior? C. Corporate Control Has the board built long-term sustainable growth in shareholders’ value for the corporation? Does it create an environment to take risk? > Does it encourage enhanced performance? Does it recognize and manage risk? Does it remunerate fairly and responsibly? Does it recognize the legitimate interests of stakeholders? Are conflicts of interest avoided such that the organization's best interests prevail at all times? vvvv Scanned with CamScannerIntroduction to Corporate Governance _9. ILLUSTRATIVE APPLICATION OF THE BASIC PRI INCIPLES CORPORATE GOVERNANCE AND BEST PRACTICE MES OF RECOMMENDATIONS Principles of Good Corporate Governance Best Practice Recommendations 7, Acompany should lay solid foundation for management and oversight. It should reserved to the board and those recognize and publish the respective roles delegated to management. and responsibilities of board and management. 1-a. Formalize and disclose the functions 2. Structure the board to add value. Have a board of an effective composition, size and commitment to adequately discharge its responsibilities and duties. Za, Aboard should have independent directors. 2+b, The roles of chairperson and chief executive officer should not be exercised by the same individual. 2b. The board should establish @ nomination committee 3. Promote ethical and responsible decision- making. Actively promote ethical and responsible decision-making Za, Establish a code of conduct to guide the directors, the chief executive officer (or equivalent), the chief financial officer (or equivalent) and any other key executives as to: © The practices necessary to maintain confidence in the ‘company's integrity; and «The responsibility and ‘accountability of individuals for reporting and investigating reports of unethical practices 4b. Disclose the policy concerning trading in company securities by directors, officers and employees. Scanned with CamScanner10 Chay q Safeguard integrity in financial reporting Have a structure to independently verify and safeguard the integrity of the company’s financial reporting. qa, Require the chief executive of (or) equivalent) and the chief financial officer (or equivalent) to state in writing to the board that the company's financial reports present a true and fair view, in all material respects, of the company's financial condition and operational results and are in accordance with relevant accounting standards. The board should establish an aucit committee. Structure the audit committee so that it consists of: © Only non-executive or independent directors; — Anindependent chairperson, who is not chairperson of the board; and » Atleast three (3) members. 4c. 3. Make timely and balanced disdosure. 5-a. Establish writien policies and Promote timely and balanced disclosure of procedures designed to ensure all material matters concerning the compliance with IFRS. company. 5-b. Listing Rule disclosure requirements and to ensure accountability at a senior management level for compliance. 6. Respect the rights of shareholders and 6-a. Design and disclose a communications facilitate the effective exercise of those Strategy to promote effective rights. communication with shareholders and encourage effective participation at general meetings. 6-b. Request the external auditor to attend the annual general meeting and be available to answer shareholder questions about the audit. Scanned with CamScannerIntroduction to Corporate Jovernance “Recognize and manage risk. Establish a sound system of risk oversight and ‘management and internal control T-a. The board or appropriate board Committee should establish policies on tisk oversight and management 2a. The chief executive officer (or equivalent) and the chief financial officer (ot equivalent) should state to the board in writing that © The statement given in accordance with best practice recommendation 4-a (the integrity of financial statements) is founded on a sound system of risk management and internal compliance and control which implements the policies adopted by the board; and «The company's risk management and internal compliance and control system is operating effcienty in all material respects. | Encourage enhanced performance. Faily review and actively encourage enhanced board and management effectiveness. Ba, Disclose the process for performance evaluation ofthe board, its committees and individual directors, and key executives. Remunerate fairly and responsibly. Ensure that the level and composition of remuneration is sufficient and reasonable ‘and that its relationship to corporate and individual performance is defined. a, Provide disclosure in relation to the ‘company’s remuneration policies to ‘enable investors to understand: © The costs and benefits of those policies; and + Thelink between remuneration paid to directors and key executives and corporate mance. Sb. The board should establish a remuneration committee. c, Clearly distinguish the structure of non- executive director's remuneration from thal of executives. 9-4, Ensure that payment of equity-based ‘executive remuneration is made in accordance with thresholds set in plans approved by shareholders. Scanned with CamScanner12 Chapter 1 penne 10-a. Establish and disclose a code of conduct to guide compliance with legal and other obligations to legitimate stakeholders. 10. Recognize the legitimate interests of stakeholders. Recognize legal and other obligations to all legitimate stakeholders.