ch07 SM Rankin

Alaa Aliasrei ‫فيس‬ @Aliasrei ‫تلكرام‬ ‫عالء هحسن شحن‬
Solution Manual
to accompany
Contemporary Issues in
Accounting
Michaela Rankin, Patricia
Stanton, Susan McGowan,
Kimberly Ferlauto & Matt Tilling
PREPARED BY:
Sue McGowan
John Wiley & Sons Australia, Ltd 2012
© John Wiley and Sons Australia, Ltd 2012 7.0

CHAPTER 7
CORPORATE GOVERNANCE
Contemporary issues 7.1 Audit committees put risk management at the
top of their agendas
1. Traditionally, audit committees have primarily focused on managing

financial reporting risk (i.e. risk of misstatements in financial statements)
and reviewing aspects such as internal control systems. Do you believe the
expansion of this committee’s role to consider business risk appropriate? (J,
K)
There is no correct answer here and students may have different views. Points to
make could include:
 An essential part of any audit committee, even if focussing primarily on
financial reporting issues, would include an assessment of risk as this would
impact on issues such as going concern, impairment, values in financial
statements etc, so the committee does need to understand the company‘s risk
profile.
 Given significance and importance of risk management (and failures
associated with this in the global financial crisis) there is a need to manage and
control risk. It could be argued that given its other functions, that necessarily
require an understanding of this risk, that the audit committee is well placed to
provide such control and oversight.
 Alternative views are:
o This could overburden audit committees and impede its effectiveness.
o It could be preferable to have a separate risk committee who can
therefore concentrate on business risk
The Institute of Chartered Accountants in Australia together with the UK Financial

Reporting Council and the Institute of Chartered Accountants of Scotland, have
recently published a paper ―Walk the line: Discussions and insights with leading audit
committee members‖ which provides insights from a series of interviews with audit
committee chairmen of publicly listed companies about the role and challenges facing
audit committees. This can be accessed from
http://www.charteredaccountants.com.au/Industry-Topics/Audit-and-
assurance/Current-issues/Recent-audit-headlines/News-and-updates/Thought-
leadership-paper-reviews-the-role-of-the-audit-committee
2. The extract notes a link between compensation structures within companies

and risk management. Explain how these are related? (K, AS)
It should be understood, that compensation structures provide powerful signals about

what an organisation values and rewards. As such they provide a way to direct
employee behaviour. Hence compensation structures should consider how they will

be interpreted by employees and what actions they will encourage (and discourage). If
compensation structures for example reward risk (for example, focusing on short term
targets and not considering long term impacts) then these would be expected to
increase the companies risk profile.
Students may think of some specific examples:
 If a bank pays bonuses on the basis of loans granted but does take into account
the risk associated with the loan (i.e. whether there is likely to be a default by
the customer) this would seem to explicitly encourage granting of loans even
where risk of default is high. (A compensation package to deter this could
either have a ‗claw back‘ provision – so if loan goes ‗bad‘ bonus needs to be
repaid, or have a large part of bonus paid at a later time when the likelihood
of default can be more accurately assessed).
Contemporary issues 7.2 The individual must take responsibility for doing the
right thing
1. This article discusses the issue of a code of conduct in corporate governance.

Discuss whether a code of conduct is important for corporate governance. (J,
AS)
Every organisation has its own unique culture or value set. Most organisations don‘t
consciously try to create a certain culture. The culture of the organisation is typically
created unconsciously, based on the values of the top management or the founders of
an organisation.
The culture of an organisation is vital in corporate governance. A code of conduct is

important in supporting this culture as it outlines explicitly expectations and
responsibilities. It ‗sets the scene‘ as to what is acceptable and what not is acceptable,
actively can encourage and support either unethical or ethical behaviours. It also
provides evidence of the value the company places on such behaviour.
However, as noted in the article, it is also important that the code is supported and that
senior company members are committed and also adhere to the code.
For example, in the case of Enron (as noted in the text) the company was perceived to
have ‗best practice‘ in terms of codes of conduct and corporate governance yet in
reality the culture and actual company practices were less than ethical.
Students may find it useful to look at some examples of codes of conduct. It is likely
that their own university will have one. My own university has a code for staff (and
also one for students) that outlines specific issues (such as respect for others, conflicts
of interest, confidentially) but has a final guideline that staff should consider:
If you would be ashamed if your conduct was reported in a University newsletter or a

local newspaper read by friends and colleagues, you should question whether your
behaviour is ethical.
2. The article states that it is impossible to legislate for ethics. Do you agree
with this? If this is the case, does this mean regulation is ineffective? (J, K,
AS)

Ethics relates to people and how they behave. If people are to act ethically they need
to first, appreciate their actions and decisions involve ethical choices and second, be
willing and able to then make the ‗right‘ decision.
The fact that crimes are committed, and we have gaols full of prisoners, is clear
evidence that legislation (law) itself does not prevent people from acting
inappropriately.
However legislation can still have some impact by:

 Although legislation tends to target clearer and more explicit examples of
unethical behaviour it could be argued that this at least provides insight into
societies expectations (and limits to acceptable behaviour).
 It could be argued to deter some of the worse abuses. Company directors can
be subject to criminal actions and we saw with Enron imprisonment of
directors.
 Legislation can also provide protection to whistle blowers
An alternative view is that legislation can lead to a ‗rules based‘ approach to ethical
behaviour – where the perception is that as long as acts within bounds of legislation
(i.e. to letter of the law) then that behaviour is acceptable.

Review questions
1. Explain what is meant by corporate governance and why it is needed.
Corporate governance in very simple terms is ‗the system by which business

corporations are directed and controlled‘ (Cadbury, cited in Cowan, 2004, p. 15.).
The OECD‘s definition expands on this:
The corporate governance structure specifies the distribution of rights and responsibilities
among the different participants in the organisation — such as the board, managers,
shareholders and other stakeholders — and lays down the rules and procedures for decision-
making. By doing this, it also provides the structure through which the company objectives
are set, and the means of attaining those objectives and monitoring performance.
To have a good corporate governance system ensures that the corporation sets
appropriate objectives, and then puts systems and structures in place to ensure those
objectives which are set are met. It also provides a means for persons both within and
outside the corporation to be able to control and monitor the activities of the
corporation and its management.
With the increasing globalisation of business and competition for capital, companies
that can provide assurances of good corporate governance will have a competitive
edge in the market place and facilitate economic growth.
2. ‘Corporate governance is primarily focused on protecting the interests of

shareholders.’ Discuss.
This would depend on what point-of-view you take:
(a) Traditional — the role of the corporation from a traditional view by Milton
Friedman is that ‗corporate governance is to conduct the business in accordance
with the owner or shareholders‘ desire, which generally will be to make as much
money as possible while conforming to the basic rules of the society embodied
in law and local customs‘.
(b) Pluralist model — the responsibility of corporations goes beyond the narrow
interests of shareholders and should be extended to a wider group of
stakeholders.
(c) Anglo-Saxon model — tends to focus on the problems caused by the

relationship between managers and owners and often takes a control-orientated
approach, concentrating on mechanisms to curb self-serving managerial
decisions and actions.
In practice, shareholders are a key focus on most corporate government systems in

large corporations. Whether the focus should be primarily on shareholders interest is
of course debatable and this would make a good discussion question for the class. Of
course, other entities (such as not-for-profit and public sector entities) should also

practice good corporate governance and these entities would not have ‗traditional‘
shareholders. Students may wish to consider whose interests would be of primary
focus with such entities.
3. What are risks of poor corporate governance and the advantages of good
corporate governance?
Risks of poor corporate governance can be from:

 a company making use of resources to benefit themselves. In some cases, it may
go as far to involve fraud. It is often more subtle in regard to false reporting
because of the desire to maintain the value of benefits provided to corporate
managers.
 corporations taking actions that shareholders may not consider desirable
 corporations ‗hiding‘ or providing ‗false‘ information to shareholders to avoid
consequences
 disparity between payments received by managers or corporations to their
performance.
Ultimately students should realise that such actions can risk the wealth of
shareholders and other stakeholder groups (such as employees and customers), can
increase costs to the corporation and even put at risk the continuation of the
corporation itself.
Advantages of good corporate governance:

 provides assurance that companies are properly managed
 required for an efficient market
 facilitates economic growth.
4. Explain what is meant by the positive accounting theory and its relationship
to corporate governance.
Positive accounting theory, using as its basis contracting theory, views the firm as a
network of contracts or agreements. These contracts determine the relationships with
and among the various parties involved. A key relationship is the agency contract.
An agency relationship by definition has two key parties:
1. a principal who delegates the authority to make decisions to the other party
2. an agent who is the person given the authority to make decisions on behalf of
the principal.
In this context the agent is the manager and the principals are the shareholders. Whilst
the agent has a duty to act in the interests of the principals there is a common
assumption in economic theory which is, if individuals are rational, they will act in

their own best interests and this can lead to the agent making decisions to maximise
their own wealth, rather than the principals.
Principals are also rational and will expect that the managers will not always act
in the shareholders‘ interests. This leads to three costs associated with this agency
relationship:
• monitoring costs. These are costs incurred by principles to measure, observe and
control the agent‘s behaviour.
• bonding costs. These are restrictions placed on an agent‘s actions deriving from
linking the agent‘s interest to that of the principal
• residual loss. This is the reduction in wealth of principals caused by their
agent‘s non-optimal behaviour.
This theory also identifies ways in which managers can act against shareholders‘
interests known as ‗agency problems‘, and that these problems can be reduced by
linking management‘s rewards to certain conditions. Students should refer to Figure
7.1, page 191, which provides an overview of the shareholder–manager relationship in
agency theory. Chapter 5 also explains in more detail this theory.
Corporate governance is concerned with controlling and directing businesses and in

the company context there is a often a clear separation of owners (shareholders) and
managers. Hence an agency relationship exists. A number of the principles in
corporate governance (and these are further reflected in more specific
prescriptions/rules) are espoused to address the problems associated with the agency
relationship as outlined in positive accounting theory.
For example the OECD principles of corporate governance specify that:
• managers‘ remuneration should be linked to shareholder interest and that a key
responsibility of the Board is ‗aligning key executive and board remuneration
with the longer term interests of the company and its shareholders‘.
• the remuneration policy for executives and board members needs to be
disclosed to shareholders.
5. Identify the key areas addressed in corporate governance and provide

examples of practices related to each of these areas. Explain how any
individual practices identified help ensure good corporate governance.
Corporate governance involves ensuring that the decisions made by those managing
the corporation are appropriate, and providing a means to monitor corporate activities
and the decision making itself. It is primarily concerned with managing the
relationship between the shareholders, the key managers of the corporation (this is
usually the Board of Directors), other senior managers within the corporation, and
other stakeholders. Many countries have developed suggested (and sometimes
required) lists of rules or descriptions of the types of practices that should be included
in corporate governance systems. However it is generally acknowledged that there is
no ‗one‘ system of corporate governance. The practices and procedures required or
desired will be affected by:
 The nature of the particular corporation and its activities. For example, in some
companies there are dominant shareholders whereas in others shareholding may
be more widely spread, and

 The environment in which the corporation operates
The text identifies three key areas to be addressed by any corporate governance
system:
1. processes and methods to control and direct the actions of managers of the
corporation to ensure make appropriate decisions
– Specific examples of corporate governance requirements here are minimum
standards of experience for directors; requirements that at least some of
members of board of directors be independent.
2. processes and procedures to ensure that stakeholders (such as shareholders) have

the ability to protect their interests
– Specific examples here would be voting rights and rights of shareholders to
call meetings.
3. to ensure that adequate information is provided to ensure transparency and meet

accountability obligations of management.
– Specific examples here include requirements in relation to annual reports.
Students may also wish to consider how these areas are addressed in the summary of
3 codes of corporate governance in table 7.1).
6. What is the rules-based approach to corporate governance and what are

the advantages and disadvantages of this approach?
Rules-based approach identifies precise practices that are required or recommended

to ensure good corporate governance. For example, there may be a rule that an audit
or remuneration committee be established. The text provides some examples of
specific rules.
The advantages of this approach are:

 It provides at least a set of minimum corporate governance practices that must
be followed by all corporations, and
 There is no uncertainties as to which practices are required. This also assists
with enforcement and with potential liability in terms of litigation.
The disadvantages of this approach are:

 While this provides a minimum set of practices, it is likely that good corporate
governance requires practices beyond the minimum prescribed.
 It also can encourage a ‗check list‘ (form over substance) approach to corporate
governance.
 The legislative backing of rules can result in the view that corporate governance
is about dealing with legal liability rather than about promoting the interests of
shareholders and stakeholders (Bruce, 2004).
 It is generally accepted that there is no ‗one‘ model of corporate governance. A
rules-based approach is essentially a ‗one size fits all‘ approach and does not

take into account the specific circumstances of the particular entity (e.g. such as
distribution of shareholders, nature of environment).
7. What is the principles-based approach to corporate governance and what

are the advantages and disadvantages of this approach?
Principles-based approach is general principles or objectives of the corporate

governance system which it should aim to achieve. For example, the general
principle may be that the corporation should ensure that there is accurate and
adequate disclosure of information. Rather than identifying the exact practices that
may assist in helping meet this aim (such as directing specific times for rotation of
auditors, certification of financial reports) this then places the responsibility on the
managers to consider which practices are appropriate, given their circumstances.
The advantages of this approach are:

 It arguably places a higher level of duty on directors to determine which
corporate governance practices are required, rather than simply accepting a
minimum set of practices as being adequate.
 Its flexibility means that the corporate governance practices can be adapted for
the particular circumstances and environment of the entity
The key disadvantages

 It essentially leaves it to the directors to interpret these principles and decide
which corporate governance practices are needed and so relies on their honesty,
integrity and commitment to good governance. If directors are competent and
act in good faith then this is not a problem, however given that many of the
corporate abuses that have renewed the interest in corporate governance
practices usually stem from people not acting appropriately, this is problematic.
 It can lead to uncertainty about appropriate practices.
8. Explain the problems identified from the global financial crisis in relation
to risk management and how these relate to corporate governance.
The text outlines 4 problems with risk management.

1. a disjointed approach to risk management where risk was not managed or
monitored at the entity level but at individual activity level so no
effective understanding or oversight of risk for the corporation overall
2. information about risks not reaching the board or board members being
able to understand or appreciate the risks involved
3. that the culture (pursuing growth in profits) encouraged risk taking
4. a ‗disconnect‘ or ‗mismatch‘ between company‘s overall risk strategy
and related procedures. For example, many remuneration packages
provided incentives for high risk activities and short term outlooks.
A good corporate governance system ensures that the corporation sets appropriate
objectives, and then puts systems and structures in place to ensure those objectives

which are set are met. It also provides a means for persons both within and outside the
corporation to be able to control and monitor the activities of the corporation and its
management. A key role is to protect the interests of stakeholders (including
shareholders). To do this it is essential that risk is understood, monitored and
managed. However, historically most corporate governance models have not
highlighted the importance of risk management.
In relation to the specific problems identified the following is noted:
1. Ultimate oversight and responsibility for risk management lies with the board.
Risks can be wide ranging and as the ASX code states may include ―operational,
environmental, sustainability, compliance, strategic, ethical conduct, reputation or
brand, technological, product or service quality, human capital, financial reporting
and market-related risks‖. Hence it is important that the board considers the overall
strategy. Managing these risks in isolation (at activity level) is not sufficient.
2. Cleary the board needs information about risks the company faces and how these
are managed. Without sufficient information, and understanding of these, the board
cannot perform its duties. It is claimed this was problematic given the complexity
of the financial instruments associated with in the global financial crisis. The ASX
code now recommends that management provide a report to the Board about the
risk management systems implemented and their effectiveness.
3. Every organisation has its own unique culture or value set. Most organisations
don‘t consciously try to create a certain culture. The culture of the organisation is
typically created unconsciously, based on the values of the top management and
influenced by reward systems, management actions attitudes. A culture of growth
needs to be balanced with consideration to the any attentive risks.
4. There needs to be a consistent approach to risk management and this needs to be

reflected in the company‘s procedures and practices. For example, any formal
policies to reduce or control risk are likely to be s disregarded if compensation
packages actually reward risk
9. Explain the problems identified from the global financial crisis in relation
to remuneration and how these relate to corporate governance.
The text outlines 2 problems identified in relation to remuneration:
1. a disconnect/mismatch between bonuses paid to executives and company

performance. This was seen as particularly problematic given lack on
information about these packages and any ability to curb/stop these bonuses.
There can be really 2 concerns here. First, often there is a perception that
remuneration to some executives is excessive- how can these people warrant such
huge payments. In good corporate governance directors/executives are supposed to
act in the best interests of shareholders. Yet paying what seems unjustifiable amounts
to themselves could be seen as a conflict of interest. Second, remuneration packages
are supposed to be tied to company performance; this is what the Board and other
executives are responsible for and hence what they are rewarded for. Yet despite poor

or deteriorating company performance (even in some cases failure) many executives

still received large (and increased) bonuses. How can this be justified?
2. compensation packages focused on short terms goals and encouraged

excessive risk
It should be understood, that compensation structures provide powerful signals about

what an organisation values and rewards. As such they provide a way to direct
employee behaviour. Hence compensation structures should consider how they will
be interpreted by employees and what actions they will encourage (and discourage). If
compensation structures for example reward risk (for example, focusing on short term
targets and not considering long term impacts) then these would be expected to
increase the companies risk profile.
Students may think of some specific examples:
 If a bank pays bonuses on the basis of loans granted but does take into account
the risk associated with the loan (i.e. whether there is likely to be a default by
the customer) this would seem to explicitly encourage granting of loans even
where risk of default is high. (A compensation package to deter this could
either have a ‗claw back‘ provision – so if loan goes ‗bad‘ bonus needs to be
repaid, or have a large part of bonus paid at a later time when the likelihood of
default can be more accurately assessed).
10. ‘Any corporate governance system is only as good as the people involved
in it’. Discuss.
As the text notes decisions in, and about, corporations are made by people. The
quality of any corporate governance is ultimately affected by the people involved in it.
The following points could be discussed:
 Competence — clearly, if individuals do not have the requisite expertise or
experience then this will adversely impact on decisions they make and reduce
the quality of corporate governance.
 Integrity (ethics) of individuals. Whether or not individuals will act ethically is
affected by a number of factors. These include:
– the individual‘s own moral code
– the culture of the corporation and of peers. This is particularly important
in relation to top management. In a number of corporations it is argued
that either ethical or unethical behaviour permeates due to the stance taken
by the ‗leaders‘.
– the consequences of the decision. For example, if asked to do something
that is not ‗right‘ by a manager and refusing could impact on
employment/future promotion; how ‗wrong‘ is the decision and will it
have a significant impact on others; what is the likelihood of being caught
and what are the consequences if found to be acting unethically).
 Does the quality of individuals become more or less important if you have rules-
based or principles-based corporate governance codes?

– There is no correct answer here. Rules-based allows companies to restrict

practices to the specific rules and, hence, can argue that a form over
substance approach can justify or defend unethical behaviour so long as
rules are followed. Principles-based requires interpretations —
presumably, if individuals do not act ethically there will be flexible
interpretations of these. This is also obviously affected by enforcement
and also legal issues (such as courts and what standards they consider
when determining guilt and penalties for unethical behaviour).
 Does the quality of individuals become more or less important if you have
voluntary or legislated corporate governance codes?
– This relates to the points made above. Again, if voluntary then relies more
on individuals. However, legislated codes again can lead to the same
problems as rules-based approach. The text notes the example in Hong
Kong where codes are high but often not implemented.

Application questions
7.1 Obtain the annual reports of a range of companies in the same industry and
country and search for any disclosures in relation to corporate governance
principles and practices. In relation to these disclosures:
(a) Identify the key areas considered by these companies.
(b) Are there any differences or similarities in corporate governance
practices?
(c) Do you believe you could judge or rank the relative standard of
corporate governance of these companies based on the information
provided? If not, what other information would you need to do so?
(d) Which company would you rank has having the best (or worst)
corporate governance from these disclosures? Explain how you have
arrived at this decision.
(e) Compare your rankings with those of other students. Identify and
discuss the reason for any discrepancies between rankings (J, CT)
No specific answers can be provided as this will depend on the companies considered.
Go online and download a couple of annual reports in the same industry, from 2007 to
2012 and see the differences. Discuss the following in class:
(a) What have you found out about the key areas?
(b) Explain the differences and similarities in class, on your Blackboard or WebCT.
(c) Discuss the judgement you have made.
(d) Did you identify the best and worst cases or corporate governance?
7.2 Obtain the annual reports of a range of companies in the same industry in
different countries and search for any disclosures in relation to corporate
governance principles and practices. In relation to these disclosures:
(a) Identify any differences or similarities in corporate governance
practices.
(b) Can you provide any reasons from the business and regulatory
environments in the countries that would explain these differences? (J,
AS)
No specific answers can be provided as this will depend on the companies considered.
Again go online and download annual reports from various countries to discuss in
class. It may also be useful to consider, identify and compare:
 country economic and business environmental factors
 any specific corporate governance guidelines or requirements issued for
companies in the specific countries considered, for example by local stock
exchanges, as well as considering enforcement mechanisms.
In class, explain the differences or similarities in corporate governance practices.

7. 3 Many small companies argue that corporate governance requirements are

too costly and onerous and should be restricted to the large ‘top’
companies.
(a) Do you think that corporate governance principles should apply to

smaller companies? (J, K)
The basic principles of corporate governance would appear to apply to all companies,
even smaller and medium-size companies. As discussed in question 1, corporate
governance in very simple terms is ‗the system by which business corporations are
directed and controlled‘ (Cadbury, cited in Cowan, 2004, p. 15.).
To have a good corporate governance system ensures that the corporation sets
appropriate objectives and then puts systems and structures in place to ensure those
objectives which are set are met. It also provides a means for persons both within and
outside the corporation to be able to control and monitor the activities of the
corporation and its management.
The basic principles would apply to all corporations, large or small. Although it could
be argued that the mechanisms to achieve these would vary as these issues become
more critical in larger companies with greater separation, and also in smaller
companies cost efficiencies would need to be more carefully considered.
(b) Are there any particular corporate governance practices or principles

that you do not think should apply to smaller companies?
Students answers here may vary. It is suggested that the same principles apply but the
practices may vary. For example, PCW have produced a toolkit for corporate
governance in small and medium enterprises. This suggests that similar principles (as
per ASX) apply however there may be reason for vary specific practices.
 This is link to tool kit http://www.himaa.org.au/Governance/toolkit_print.pdf
(c) What would be the advantages of smaller companies complying with

corporate governance principles?
Advantages of good corporate governance would also apply to smaller companies. In

particular, for small companies these would include:
 provides processes and assurance that companies are properly managed
 managing risk and facilitating economic growth (including entering emerging
markets as investors need assurance that appropriate controls/systems are in place)
.
(d) What might be the consequences for smaller companies of not

complying with corporate governance principles?
These were noted in question 3 above, that risks of poor corporate governance can be
from:

 a company making use of resources to benefit themselves. In some cases, it may go

as far as to involve fraud. It is often more subtle, false reporting because of the
desire to maintain the value of benefits provided to corporate managers.
 corporations taking actions that shareholders may not consider desirable
 corporations ‗hiding‘ or providing ‗false‘ information to shareholders to avoid
consequences
Students may wish to consider the following:

(a) List the particular websites that address corporate governance for small
companies.
(b) Did you find any advantages to small companies having corporate governance
requirements?
(c) What were the consequences?
7.4 A friend cannot understand why executives and directors of companies are
often paid bonuses and not simply paid a set salary.
(a) Using principles from positive accounting theory, explain the reasons
for, and nature of, bonus plans offered to directors and executives. (K)
Need to first explain agency theory which is a key principle in positive accounting
theory. An agency relationship by definition has two key parties:
1. a principal who delegates the authority to make decisions to the other party
2. an agent who is the person given the authority to make decisions on behalf of
the principal.
The separation of ownership and control means that managers can act in their own
interests which may be contrary to the interests of shareholders. Managers have
variety of ways of reducing wealth to shareholders for the benefit of themselves.
These problems include risk aversion, dividend retention and horizon. Given these
specific difficulties (the problems discussed below) to alleviate these problems
managers remuneration is not simply paid as salary but by a bonus linked to variables
that try to reduce these problems. The problems are:
i the risk aversion problem — managers prefer less risk than shareholders because
their human capital is tied to the firm. Shareholders are more diversified because
their human capital is not tied to the firm. Managers can reduce their own risk by
investing in low risk investments rather than maximising the value of the firm
through higher risk projects.
A bonus plan that relates managers’ salaries to profit may encourage less risk
aversion.
ii the dividend retention problem — managers prefer to pay out less of the
company‘s earnings in dividends in order to pay for their own salaries and
perquisites (big offices, expensive business trips).

Relating a part of mangers’ remuneration to profit and requiring that a minimum

dividend payout ratio be maintained can help.
iii the horizon problem—managers are only interested in cash flows for the period
they remain with the firm whilst shareholders have a long term interest in the
firm‘s cash flows.
Principals may relate part of managerial compensation to share prices,
particularly for managers whose tenure is nearing completion.
Bonus schemes can reduce these problems by tying manager‘s remuneration to some
index of the firm‘s performance, which has a high correlation with the value of the
firm (share prices, earnings). This ties managerial compensation to performance.
Remuneration can also be tied to dividend payout ratios or to options or share bonus
schemes
Hence, this explains why is it preferable to pay managers a bonus (linked to

appropriate variables/targets) rather than a set salary.
It may be interesting to examine details of remuneration packages of directors etc

(often these are disclosed in annual reports or available on the companies web page as
a separate remuneration report) and see how these principles are reflected in the
packages.
(b) Because share-based payments to employees (including directors) are

now required to be recognised as expenses, would this reduce the need
to use shares or share options as part of a manager’s remuneration
package?
Theoretically, as the rationale for share options as part of a manager‘s remuneration is

to reduce the potential problems that arise due to the agency relationship between
mangers and shareholders the fact that these are recognised as expense should not
reduce the need for these to be part of the package for managers. The need (i.e. to
reduce potential agency problems) still exists regardless of whether or not these are
recognised as expenses or not.
However recognition as expenses (which involves measuring the value of these

options which previously was ‗undisclosed‘) can lead to more scrutiny of this
component. It may be that this increased visibility of the value of these options leads
people to question the awarding of these to managers. In recent years this scrutiny has
increased as value is made more transparent- and also increased questioning of the
basis for the awarding of these options (for example, if share price or performance has
fallen then many argue that managers should not receive bonuses and there needs to
be a clearer link between management performance and bonuses awarded).

7.5 Obtain the annual report for a listed company and examine the
remuneration packages provided for executives. (J, AS)
Note: these are disclosed in annual reports (or available on the companies web page as
a separate remuneration report) and see how these principles are reflected in the
packages.
A suggested example is the 2010 annual report for AMP — this includes details of the
remuneration package and related benchmarks. You can access this from links from
http://www.amp.com.au/ or the 2011 annual report for Crown Ltd which includes
details of the amounts of potential cash bonuses. You can access this from links from
http://www.crownlimited.com.
(a) Identify the key components of the remuneration packages for

directors and executives. Do the principles of agency theory provide a
rationale for each of these components?
Relate the key components of the remuneration packages identified to the three
problems of agency theory identified. These problems include risk aversion, dividend
retention and horizon and are discussed in the answer to 7.4.
You may wish to consider the following:

 Are the benchmarks/targets for obtaining these bonuses clear?
 Are these reasonable for rewarding performance? For example, if linked to the
share price of the company do they take into account general share price
movements for similar companies? If they do not, then they may be penalising or
rewarding managers for market factors rather than their own performance.
 Are there any components that do not ‗fit‘ with the principles of the
shareholder/manager agency relationship? If so, why do you think these
components are included?
(b) Would these packages provide incentives for these executives to

manipulate accounting figures?
You will need to consider the following:

 If any of the bonuses are linked directly to accounting numbers (such as profit)
then there may be incentives to manipulate to increase bonuses
 If linked to non-accounting numbers (such as dividends or share price) then you
would need to consider market efficiency? For example, if the market would
increase share price if profit increases via changes in accounting profit (i.e. the
market is not efficient) then this would also create incentives to manipulate
accounting figures.
(c) How much information is provided about any bonuses paid? Is this
information sufficient to allow shareholders to determine if these
packages are reasonable?

This will depend on the reports that you have found. You will probably find that in
many cases there is limited information (in particular about benchmarks — often
generic information about benchmarks is included rather than specifics). This makes it
difficult for shareholders to consider however there could be legitimate coemptive
reasons for not disclosing this information.
7.6 In many countries in Asia it is claimed that concentration of

ownership/control by families of companies causes particular difficulties
with corporate governance. For example, Hong Kong billionaire Richard
Li owns 75 per cent of Singapore-listed Pacific Century Regional
Developments. (J, K)
(a) Examine corporate governance guidelines and identify specific

recommendations for practice aimed at protecting minority investors.
This will vary depending on the guidelines examined. For example:
 The ASX principles of best practice do not seem to specifically refer to minority
shareholders. However general principles regarding shareholders and
requirements of independent board members may assist. Link to ASX if this
needed is http://www.asx.com.au/governance/corporate-governance.htm
 The OECD principles do refer to minority shareholder interests in a number of

specific instances.
http://www.oecd.org/dataoecd/32/18/31557724.pdf
 The Chinese code has many references to minority shareholders
http://www.ecgi.org/codes/documents/code_en.pdf
 The Pakistan Corporate Governance guide for family- owned campiness also
specifically identifies the need to respect and protect minority shareholders
http://www.cipe.org/regional/southasia/pdf/CG_Guide_Pakistan_08.pdf
(b) Would these suggested practices be effective where there is a higher

concentration of family control in a company?
There is no correct answer here. However, should consider issues such as:
 Even where codes specifically address issue of minority shareholders how can it
be ensured that rights considered given influence that any dominant
shareholders will have.
 Given that investment is choice and minority shareholders would know of
limitations to their power/influence when investing does this justify should
corporate governance be focused on majority concerns.
Students may also wish to go online and download information on Pacific Century
Regional Developments and consider the specific circumstances of the company.
7.7 Each year various bodies give corporate governance awards. Examples are,
in Malaysia, an annual award is made by Malaysian Business, sponsored by

the Chartered Institute of Management Accountants (CIMA), and with

The Australasian Reporting Awards (Inc.), an independent not-for-profit
organisation makes annual awards. (K, SM)
(a) Locate the criteria on which these awards are based and compare these
for different awards.
For example, the Australasian Reporting Awards and criteria for corporate
governance awards states that ―These Awards seek to recognise the quality and
completeness of disclosure and reporting of corporate governance practices in the
annual reports of business entities in the public and private sectors.‖ for private sector
entities states. Review the criteria section at http://www.arawards.com.au/
(b) Are there any significant differences between the criteria?
This will depend on awards criteria reviewed.
(c) In what areas of corporate governance reporting did winning

companies outperform other companies?
This will depend on information available. For example, the Australasian Reporting
Awards identifies companies that have been ranked as gold, silver or bronze and
specifies what the differences are in being awarded this rating. So it may be useful to
look at reports for companies in these different rankings to identify any differences.
For example, one difference between gold and silver is that gold requires ‗full‘
disclosure whereas silver requires ‗adequate‘ disclosure.
(d) Does the wining of an award for reporting necessarily mean that these
companies have best corporate governance practices?
Students should consider:

 How would you tell if a company did not follow these practices that they have
claimed?
 How likely it is that companies who do not have good corporate governance
practices would disclose this fact? It may be what is not disclosed that is important.
(Remember: Enron was perceived as one of the best but fell short in practice)
7.8 Australian companies listed on the ASX must report on their corporate
governance practices on the basis of ‘comply or explain’. That is, they are
not required to comply with all of the specific corporate governance
practices detailed by the ASX but if they choose not to comply, they must
identify which guidelines have not been ignored and provide a reason for
their lack of compliance. (K, SM)
(a) Examine the corporate governance disclosures of some Australian

listed companies and identify any instances where best practice
recommendations of the ASX have not been met.

Examples are in questions 7.9 and 7.10. Students should be able to find own
examples.
(b) Do you believe that the noncompliance in these instances is justified?
See responses to questions 7.9 and 7.10. Responses will depend on the nature of non-
compliance and also circumstances and reasons given by particular company for non-
compliance.
(c) What are the advantages of having a ‘comply or explain’ requirement

rather than requiring all companies to comply with all best practice
recommendations?
The advantages is that this allows specific circumstances of a company to be

considered when determining appropriate corporate governance practices (so for
example, does not impose a ‗one size fits all‘ approach regardless of the size of the
company). This is consistent with the principles-based approach to corporate
governance. While this allows flexibility, the fact that the need to disclose and justify
non-compliance also allows shareholders and other stakeholders to clearly identify
any instances of non-compliance and also requires management to consider this (it
could be argued as need to disclose if do not comply then management need to
explicitly consider whether or not non-compliance is justified as will be open to
scrutiny).
7.9 In the 2009 annual report of Boral Ltd (an Australia-listed company), the
corporate governance disclosures include the following note:
The Board has considered establishing a nomination committee and

decided in view of the relatively small number of Directors that such a
Committee would not be a more efficient mechanism that the full Board
for detailed selection and appointment practices. The full Board
performs the functions that would otherwise be carried out by a
Nomination Committee. (J, K)
(a) Examine the ASX corporate governance principles and identify the
best practice recommendations in relation to nomination committees.
 ASX Corporate Governance Principles can be found at

http://www.asx.com.au/governance/corporate-governance.htm
The ASX recommendations for a nomination committee are related to Principle 2;

Structure the Board to add value. The specific recommendation for the nomination
committee is 2.4. This indicates that for smaller companies a separate, formal
committee may not realise desired efficiencies.
The recommendation includes:

 A charter establishing roles and responsibilities
 Composition of at least 3 with majority independent and chaired by
independent director

 Responsibilities include making recommendations about required

competencies of directors, succession plans, appointments and process for
evaluation of performance
 Selection and appointment process and re-election of directors
(b) What potential governance problems are these recommendations

designed to meet?
Students should see that given the role of the Board of Directors is it essential that
those on the board are the ‗best‘ people for this role. Also the responsibility to ensure
that the composition of the Board is of the right level of expertise, experience and
independence to ensure that it can meet its obligations, lies with the Board itself, a
nomination committee assists in this by specialising in the recruitment (so ensuring
that the company is able to recruit the ‗best‘ people for these positions) and also
should assist in ensuring a balance of executive and non-executive directors (o to
avoid potential dominance. bias and protect shareholders interests).
If the nomination of Board members is undertaken without a nominations committee

this means that the Board itself is deciding on members without input or review from
any others. Firstly, the Board itself may not have the time or expertise to search and
recruit the best people (especially given their other duties). Also it is difficult for the
Board to consider itself and its members objectively. Historically, in particular the
recruitment of non-executive directors by the chairman of the Board, has been seen as
often compromised at least in terms of independence — clearly, if appointed by the
Board itself, new directors may feel under an obligation to support the people who
have appointed them. Students should recognise that a key risk in the Board making
appointments without a nomination committee is that the existing Board may choose
members who will agree with their own views and not be willing to challenge or
provide objective advice/criticism.
(c) Is Boral’s deviation from these best practice recommendations

justified?
Boral website is boral.com.au. Information about these best practice recommendations

can be found on the website: Boral 2009 annual report relating to Board appointments
and nomination committee and the annual directors review.
Boral site is http://www.boral.com/
Boral have justified their non-establishment of a nomination committee on the basis

of efficiency in light of the small number of Board members (this was 6 but was
increased in 2007 to 8). The ASX guidelines do state that for smaller boards a
nomination committee may not be efficient. Also, Boral notes that they do use an
external consultant in the process of identifying and assessing potential candidates.
This could alleviate some of issues of not having a nomination committee. Students
may arrive at different views as to whether deviations from best practice guidelines
are acceptable.

(d) In March 2010 (see 2010 annual report), Boral did introduce a
Nomination Committee (as part of the Remuneration Committee)
although it is noted that the number of directors remained the same.
What reason can you think of for this change, given Boral’s previously
stated reason for not complying with this best practice
recommendation previously? (J, K)
The 2010 Boral annual report states:
In March 2010, the Board decided that it would be desirable to have a committee to
assist the board with its nomination responsibilities. Accordingly, the responsibilities of
the Remuneration Committee were expanded to encompass nomination responsibilities,
and the Remuneration Committee was reconstituted as the Remuneration and
Nomination Committee. In addition to responsibilities relating to remuneration, the
Committee now has responsibility for making recommendations to the Board on matters
such as succession plans for the Board, suitable candidates for appointment to the
Board, Board induction and Board evaluation procedures. P34
It should be noted that in 2010 although the number of directors remained the same
(at 8) there was a change in 2 directors. Also a comparison of the 2009 and 2012
annual reports reveals that more information is provided about this corporate
governance area in the 2010 annual report and it is also apparent that a review of
company policy in this area was undertaken. For example:
The 2009 Annual report stated:
The Directors believe that limits on tenure may cause loss of experience and expertise
that are important contributors to the efficient working of the Board. As a consequence,
the Board does not support arbitrary limits on tenure and regards nominations for re-
election as not being automatic but based on the individual performance of Directors
and the needs of the Company. (p 33).
The 2010 Annual report stated:
The Directors have adopted a policy that the tenure of Non-Executive Directors should
generally be no longer than nine years. A Non-Executive Director may continue to hold
office after a nine year term only if the Director is re-elected by shareholders at each
subsequent Annual General Meeting. It is expected that this would be recommended by
the Board in exceptional circumstances only.(p 35).
There is no correct answer to why Boral has changed this practice. Possible
reasons/motivations could include:
 The changes in 2 new directors may have motivated the board to review this
policy. They may have decided that the task was more appropriately and
efficiently handled by a committee.
 Increased scrutiny (or expected) on corporate governance practices following
the global financial crisis. In particular in Australia the changes relating to
shareholders voting and rights in relation to directors remuneration could have
prompted company to undertaken these changes.
 It is also likely that the company overall would be under increased scrutiny due
to its performance. As company operating in the building industry, the company
has been adversely affected by the global financial crisis (particularly the impact

on US property market) and also by a downturn in the Australian building

industry. Given the impacts on profits/earnings etc this would be expected to
bring more scrutiny on directors‘ performance/abilities etc.
7.10 In the 2010 Annual report of Biota Ltd (an Australia-listed company), the
corporate governance note disclosed an audit committee composed of two
directors (chaired by an independent nonexecutive director and supported
by one other nonexecutive director). (J, K)
(a) Examine the ASX corporate governance principles and identify the
best practice recommendations in relation to audit committees.
The ASX practices are outlined below in principle 4. Recommendations include:

 Establishing an audit committee
 Structure of this committee
 A formal charter
 Disclosures
(b) What potential governance problems are these recommendations

designed to meet?
Students should recognise that the audit committee recommendations relate to

Principle 4
So the establishment of an audit committee is seen as essential to safeguard the

integrity of the financial reporting. The outline of the audit report above indicates the
problems that this is trying to alleviate. The audit committee is trying to ensure that
the financial information is not compromised (i.e. for example, it aims to ensure that
the selection and appointment of the auditor who checks the reports is independent,
that the financial information provided to shareholders is adequate, and that the
internal control systems and management processes underlying financial reports are
adequate). This committee also assists in tyring to ensure that reporting is not unduly
influenced by management.
(c) Does Biota’s audit committee meet these guidelines and if not, is any
deviation from these best practice recommendations justified?
Information about the company‘s ASX Corporate Governance Council Guidelines can
be found in the 2010 Biota annual report (www.biota.com.au)
Obtain the annual report for Biota and answer the questions.
Clearly Boral has not met the minimum three membership requirements
as recommended by the ASX, although both members are non-executive
independent directors.
It states (p. 12) that ―The Board is of the view that the composition of the Audit and
Risk Committee and the skills and experience of its members are sufficient to enable
the Committee to discharge its responsibilities with the charter. All other non-

executive directors are able to attend meetings at the discretion of the Committee
Chair as observers.‖
Biota could argue that have reduced membership on basis that it is a smaller company
with only 7 directors. Also 6 of the 7 board members are independent, including the
Board Chairman, and it is noted that ―The Board Chairman attends most meetings as
an ex officio member of the committee.‖ The fact that is chaired and supported by
non-executive directors could be argued to alleviate any concerns, as well. Also the
fact that auditor has policy of rotation also may alleviate concerns.
Students may arrive at different views as to whether deviations from best practice
guidelines are acceptable.
7.11 At times there are problems (and subsequent investigations) with corporate
governance, which include deficiencies in financial reporting. (J, K, AS)
(a) Search the website of regulatory authorities (such as the Australian

Securities and Investment Commission or the Securities and Exchange
Commission in the United States) and identify a case that has been
investigated that involves issues of corporate governance.
The ASIC annual report provides a summary of major cases and the media centre
often provides summaries of cases considered or investigated (access from
http://www.asic.gov.au). The ‗key matters‘ section at
http://www.asic.gov.au/asic/ASIC.NSF/byHeadline/Media%20centre has information
on major investigations/cases.
For example in the 2010/11 annual report:

http://www.asic.gov.au/asic/asic.nsf/byheadline/Westpoint+bulletin?openDocument
 has details re breaches of duties by directors
Students will find other cases. For example, on the SEC (US) http://www.sec.gov/
site:
For example http://www.sec.gov/news/press/2012/2012-21.htm discusses a

case of accounting fraud.
(b) Briefly discuss the corporate governance issues and what part financial
reporting played in these.
This will depend on the cases found by students. It may be useful to look at the annual
reports of companies involved in investigations and consider their corporate
governance disclosures (and practices).
(c) Suggest what procedures or practices would prevent these abuses

occurring.

Gain, this will depend on the cases found by students. It may be useful to consider the
nature of cases and problems: e.g. did these require collusion (i.e. involvement of
more than one person); how were problems detected (this may give hint of how could
be prevented and whether corporate governance processes could have assisted); what
corporate governance disclosures did these entities make (do these indicate systems
acceptable).

Case Study Questions
Case Study 7.1 Critical questions of governance
1. This article discusses the issue of corporate governance in family dominated

businesses. Go to the Center for International Private Enterprise website,
www.cipe.org, and locate the Pakistan Institute of Corporate Governance
document ‘The Corporate Governance Guide: Family Owned Companies’.
This guide includes four principles. Do you think these principles would
address the types of problems identified in the extract? (J, AS)
The 4 principles outlined in this guide are:

1. Duty of Loyalty
Directors are supposed to act honestly. The duty of loyalty requires directors to act
honestly and in the best interests of the institution and its shareholders as a whole.
2. Family Governance
Ownership and exercise of rights of all shareholders, including minority
shareholders, should be respected and protected by forming a functional family
council.
3. Employees & Other Stakeholders
The board of directors should appreciate the role of the employees, especially key
management, in the success of the company and should ensure that employees are
treated with fairness and equity and without discrimination.
4. Ethics, Disclosure, and Transparency
The organization should be governed in an ethical and transparent manner under
effective accountability mechanisms.
Student may have different views whether these principles would be effective. The
principles themselves are broad and so it would be assumed that if adhered to these
should be effective in addressing the types of problems identified in the extract. For
example, the extract identifies:
 Trying to use company cash to acquire other family members businesses
 Threat by chairman to employee leaving company
 The CEO‘s wife giving (presumably) non-company work for employee to do
 Employees misusing information from previous employee
The extract also notes that some of these could have been avoided by good corporate
governance practices (such a clarifying roles, and internal controls that prevent
employees who have left from accessing information).
2. Do you think regulation would be effective in dealing with the types of

problems identified? (J, K)
Again students may have different views.

Legislation could possibly target some types of problems: for example, in Australia
we have employment legislation and anti-discrimination legislation that may deter
some of these actions; there could be specific legislation re mis-use of company
information. Corporation legislation could provide ‗rights‘ to minority shareholders in
particular cases (e.g. where related party transactions.

However the role of legislation is necessarily limited. You need to consider

enforcement. This includes not only will it be enforced but how this will be enforced
and whether parties will act to have these enforced. In these situations we have un-
equal power relationships – for example, employees who wish to keep their jobs (or
job prospects at the very least) may be reluctant to act, even if there is legislation.
Legislation cannot cover every scenario, and you cannot legislate for what people
think.
3. The article argues that the larger issue relates to culture and ethics. Do you
agree? How critical is the CEO in this? (K, AS)
Corporate culture and ethics are important. Many articles and books have been written
in recent years about culture in organisations, usually referred to as ‗Corporate
Culture‘. The dictionary defines culture as ‗the act of developing intellectual and
moral faculties, especially through education‘. This writing will use a slightly
different definition of culture: ‗the moral, social, and behavioural norms of an
organisation based on the beliefs, attitudes, and priorities of its members‘. The terms
‗advanced culture‘ or ‗primitive culture‘ could apply to the first definition, but not the
latter.
Every organisation has its own unique culture or value set. Most organisations don‘t
consciously try to create a certain culture. The culture of the organisation is typically
created unconsciously, based on the values of the top management or the founders of
an organisation. Hence the CEO is critical in this. The culture of an organisation is
vital in corporate governance. It ‗sets the scene‘ as to what is acceptable and what not
is acceptable, actively can encourage and support either unethical or ethical
behaviours.
Case Study 7.2 Reining in executive pay
1. This article discusses the recent changes to address alleged excessive

executive remuneration. Identify the main features of the reforms and how
these could be effective. (K, AS)
The article discusses changes in the US under the Financial Reform Act. These are
aimed at improving accountability and transparency.
The main features as described in the article are:
 Increased rights of shareholders: e.g. providing shareholders with rights to
vote (although non-binding) on executive compensation and also to ability
(under certain conditions) to nominate potential board members.
 Increased disclosure: e.g. of executive pay and how relates to actual financial
performance of the company; ratio of CEO compensation to median workers
pay
 Increased control i.e. board compensation committee must be independent
Effectiveness of these reforms is interrelated. For example, adequate disclosure is

required if shareholders are to be able to make an informed vote on whether or not to

approve the compensation package. The type of information disclosed (such as how
relates to actual performance and relationship to ‗median‘ pay) would presumably
‗highlight‘ more clearly any disparities or incongruities. It could be argued that as the
shareholders vote is non-binding, this could be simply ignored; however companies
(and directors) would presumably wish to avoid the situation where shareholders vote
against their packages, particularly if there are provisions to allow these same
shareholders to nominate their own board candidates.
(Further details of reforms can be found in actual legislation but students are not
expected to consider beyond article).
Although not asked in the question it may be useful to consider the Australian
situation where there is now a ‗two- strike‘ rule, where if more than 25% of
shareholders vote no to the company‘s remuneration report at 2 consecutive annual
general meetings then there is a possible ‗spill‘ of the Board.
2. The article argues that the effectiveness of the reforms is based on the
assumptions that shareholders will act. Is this assumption reasonable? What
are the barriers to effective share holder control? (K)
Students may note the following as barriers to effective shareholder control:
 Willingness to act. It could be argued that shareholders with diverse portfolios

are less ‗concerned‘ about specific companies, than their overall portfolios.
They can manage risk by diversification and holding a range of
shares/investments. In such cases they may be reluctant to intervene/take
action. This has also been claimed to apply to some institutional shareholders
who take a passive approach. Any ‗action‘ here is likely to be restricted to
changing their portfolio of shares (e.g. selling shares) rather than actively
acting to challenge or question company management.
 Diversity and fragmentation of shareholders. In many companies there are
numerous minority shareholders. To take effective action such shareholders
would need to ‗combine‘. This is difficult. In many cases few minority
shareholders even attend annual meetings etc. Further, many of these
shareholders may lack sophisticated business expertise.
 Cost of action. This also relates to discussion above. Taking action involves
costs- be these time, money. For minority shareholders (or investors with
diversified portfolios) the costs are likely to outweigh any potential benefits.
 Lack of information. Most shareholders rely on the information provided to
them by the company. If this is deficient then the effectiveness of any action
can be impeded.
3. The article argues that other ‘incentives’ — such as taxation laws and
denying contracts — should be implemented. Do you think such measures
would improve corporate governance practices? (J, K)
The ‗incentives‘ raised in the article are essentially economic incentives. Such
incentives are used to promote or deter certain actions. The incentives mentioned in
the article are:

 Setting a limit to tax deductions for executive pay

 Applying conditions on executive pay to be awarded government contacts
If such incentives were introduced this effectively places a potential ‗real‘ economic
cost on companies (for example, if tax deductions limited for executive pay then any
amounts over the limited cost the company ‗more‘ as no deductions would be
allowed).
Students could argue regarding possible effectiveness:
 In practice it is likely that such ‗incentives‘ agree to and implemented, would

only be applied to extreme cases. Therefore their effectiveness is only limited
to a few companies. Also incentives such as those related to government
contracts would also only impact those companies involved in such contracts.
 Would these costs be material to a particular company- and therefore be an
effective control/deterrent? For large companies, even though executive pay
may appear disproportionate, these costs are usually minimal in the overall
company‘s costs.
 People and companies are very inventive. It is possible (if not likely) that if
such incentives were introduced companies may ‗structure‘ arrangements to
avoid any such limitations. We see examples in relation to the law or even
accounting standards where there can be the claim that the companies are
following the ‗letter‘ of the law but not the spirit‘. If companies can avoid any
limitations by such arrangements then this would impede effectiveness.
Case Study 7.3 Limits to governance; Corporate reforms often have unintended
consequences
1. This article discusses the increased use of regulation in corporate governance

issues arguing that this may produce ‘unintended consequences’. Can you
identify any unintended consequences that could occur? (K, AS)
The basic issue here is that in trying to ‗fix‘ one problem, other problems can arise
that were not expected or intended. The article mentions:
 Change in tax laws to reduce excessive employee remuneration led to a shift
way from salary packages to stock options as a means of rewarding
employees/executives. As these points often required certain conditions to be
met (such as particular share price or earnings) to vest this encouraged actions
to realise these options (and resulted in changing attitude towards risk). Also
if tried to short term hurdles/targets then encourages a short term focus.
 The rationale for having independent directors is outlined in response to
question 2 in relation to this case. However the article suggests given that the
independent directors will necessarily not have as detailed knowledge of the
specific business/company this can result in those executive directors in
practice having more influence/power. Particularly for complex issues (and it
was noted in relation to the financial crisis that the complex financial
instruments were not understood by a number of independent directors) this
would negate the benefits of having an independent director to effectively
review, monitor performance or make independent judgment. As the article

suggests, if the board has a large number of independent directors then the
information advantage that the CEO has could result in real authority being
concentrated in the CEO.
 The article also notes that regulation itself can hamper good corporate
governance. For example, if regulation regarding compensation deters a
company from hiring the ‗best‘ person due; or if requirements for a certain
number of independent directors means that board overall has less knowledge
or expertise than required to effectively manage. In other words, the focus is
on meeting, for example, legislative requirements rather than engaging in good
corporate governance practices.
2. The focus of reforms on the need for sufficient independent directors is

discussed in this article. What is the underlying rationale for inclusion of
independent directors? Should independence override concerns of
competence and expertise? (J, K)
The underlying rationales for independent directors include:

 As independent they can monitor and review performance of management,
presumably without conflicts of interest.
 Can enhance confidence in board as seen as by public as exercising
independent judgement
 Can add expertise that other board members may not possess
 Increase diversity of board. Arguably this leads to more balanced decisions.
Clearly independence should not override concerns of competence and expertise. A

director could be entirely independent yet if they do not have the expertise
required then they will not be able to effectively undertake their role.

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John Wiley & Sons Australia, Ltd 2012

© John Wiley and Sons Australia, Ltd 2012 7.0

1. Traditionally, audit committees have primarily focused on managing

The Institute of Chartered Accountants in Australia together with the UK Financial

2. The extract notes a link between compensation structures within companies

It should be understood, that compensation structures provide powerful signals about

© John Wiley and Sons Australia, Ltd 2012 7.1

1. This article discusses the issue of a code of conduct in corporate governance.

The culture of an organisation is vital in corporate governance. A code of conduct is

If you would be ashamed if your conduct was reported in a University newsletter or a

© John Wiley and Sons Australia, Ltd 2012 7.2

However legislation can still have some impact by:

© John Wiley and Sons Australia, Ltd 2012 7.3

1. Explain what is meant by corporate governance and why it is needed.

Corporate governance in very simple terms is ‗the system by which business

The OECD‘s definition expands on this:

2. ‘Corporate governance is primarily focused on protecting the interests of

This would depend on what point-of-view you take:

(c) Anglo-Saxon model — tends to focus on the problems caused by the

In practice, shareholders are a key focus on most corporate government systems in

© John Wiley and Sons Australia, Ltd 2012 7.4

Risks of poor corporate governance can be from:

Advantages of good corporate governance:

© John Wiley and Sons Australia, Ltd 2012 7.5

Corporate governance is concerned with controlling and directing businesses and in

5. Identify the key areas addressed in corporate governance and provide

© John Wiley and Sons Australia, Ltd 2012 7.6

 The environment in which the corporation operates

2. processes and procedures to ensure that stakeholders (such as shareholders) have

3. to ensure that adequate information is provided to ensure transparency and meet

6. What is the rules-based approach to corporate governance and what are

Rules-based approach identifies precise practices that are required or recommended

The advantages of this approach are:

The disadvantages of this approach are:

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7. What is the principles-based approach to corporate governance and what

Principles-based approach is general principles or objectives of the corporate

The advantages of this approach are:

The key disadvantages

The text outlines 4 problems with risk management.

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In relation to the specific problems identified the following is noted:

4. There needs to be a consistent approach to risk management and this needs to be

The text outlines 2 problems identified in relation to remuneration:

1. a disconnect/mismatch between bonuses paid to executives and company

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or deteriorating company performance (even in some cases failure) many executives

2. compensation packages focused on short terms goals and encouraged

It should be understood, that compensation structures provide powerful signals about

© John Wiley and Sons Australia, Ltd 2012 7.10

– There is no correct answer here. Rules-based allows companies to restrict

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7. 3 Many small companies argue that corporate governance requirements are

(a) Do you think that corporate governance principles should apply to

(b) Are there any particular corporate governance practices or principles

(c) What would be the advantages of smaller companies complying with

Advantages of good corporate governance would also apply to smaller companies. In

(d) What might be the consequences for smaller companies of not

© John Wiley and Sons Australia, Ltd 2012 7.13

 a company making use of resources to benefit themselves. In some cases, it may go

Students may wish to consider the following: