Corporate Governance and Risk Management, Lecture notes of Corporate Finance

Download Corporate Governance and Risk Management and more Lecture notes Corporate Finance in PDF only on Docsity! P3 - Risk Management CH5 – Corporate Governance Page 1 Chapter 5 Corporate Governance Chapter learning objectives: Lead Component Indicative syllabus content A3. Ways of managing risk (a) Roles and responsibilities. • Role of board and others in the organisation for identifying and managing risks • Risk mitigation including TARA – transfer, avoid, reduce, accept • Assurance mapping • Risk register • Risk reports and responses • Ethical dilemmas associated with risk management B3. Explain governance risks (a) Explain the role of board and its committees in managing strategic risk. (b) Explain failure of governance and its impact on strategy. • Separation of the roles of CEO and chairman • Role of non-executive directors • Roles of audit committee, remuneration committee, risk committee and nomination committee • Directors’ remuneration P3 - Risk Management CH5 – Corporate Governance Page 2 1. CORPORATE GOVERNANCE Corporate governance is the system by which companies are directed and controlled. • The system covers the following: • The role of the company directors. • The authenticity of the company accounts. • The relation between the company and the auditors. • The shareholders’ interest in the company. The importance of corporate governance • Companies are required to follow local governance rules to qualify for stock exchange listing. • Corporate governance codes have been developed from the UK governance codes. • The UK follows a principles-based approach whereas the US follows a legislative (rules- based) approach. • Corporate governance helps reduce risk. • Corporate governance gained high importance after a series of sudden corporate collapses. The most publicised failures were: the Maxwell Communications Corporation, Enron, Barings Bank and Worldcom. • Several reasons were identified for these failures: • Unified role of chairman/CEO. • Decisions made in the personal interest of directors rather than those of the shareholders. • Lack of director expertise/knowledge. • Poor control systems. • Lack of independence of auditors. • Lack of interest by the key investing institutions. P3 - Risk Management CH5 – Corporate Governance Page 5 Role of the Chairman Role of the CEO • Runs the boards. • Sets out the vision for the company. • Provides leadership for the board. • Sets out the composition and structure of the board. • Plans and decides on the agenda of board meetings. • Chairs all meetings. • Encourages NEDs to present their ideas to the board. • Chairs AGM and other meetings with shareholders. • Presents the shareholders’ opinions to the board. • Acts as a bridge between shareholders and directors. • Arranges communication at AGM of shareholders with the remuneration, nomination and audit committees. • Runs the company. • Represents the company to stakeholders. • Provides the link between employees and the board. • Implements the strategy decided by the board. • Holds accountability for all company operations. • Puts together a coordinated management team. • Arranges and manages resources for company operations. • Monitors and controls operations and budgets. • Helps select board members. Non-Executive Directors (NEDs) Roles: Responsibilities: • They appoint/remove executive directors. • They decide on the remuneration of the executive directors. • They provide independent criticism of the decisions of executive directors. • They review the performance of the management. • They assist in strategy development. • They evaluate the financial and control systems of the organisation. • Foster a relationship of trust with the executive directors. • Be knowledgeable about the company and the industry. • Keep themselves abreast of changes in business and industry. • Make sure to receive timely, accurate and sufficient information before meetings. • Promote high ethical and governance standards. P3 - Risk Management CH5 – Corporate Governance Page 6 Independence: • There should be as many NEDs as executive directors. • The main responsibility of the NEDs is to oversee the shareholders’ interests. • One senior NED should be available for shareholders’ concerns or sensitive issues. • While hiring an NED, need to balance industry experience with independence. • It is likely that, with greater experience, their independence may be compromised. • It is more effective to hire NEDs with a range of fields of experience. Why NEDs need to be independent: • To provide objectivity in company decisions. • To bring in a variety of experience and knowledge to decision making. • To give voice to shareholders’ concerns in the board. • To reduce risk arising from the personal interests of executive directors. Threats to NED independence: A person cannot be an independent NED if: • He is a major shareholder. • He has family ties with a director. • He is entitled to some other compensation in addition to remuneration as a director. • He has had material business dealing with the company in the past three years. • He has been an employee of the company in the past five years. • He has been on the board for more than nine years. • He is a director in another company. BOARD EFFECTIVENESS The board works effectively when: • There is a variety of skill, experience and knowledge among the members. • There is a formal appointment procedure for the directors. • The directors have enough time to dedicate to company matters. • The directors have formal induction training on appointment. P3 - Risk Management CH5 – Corporate Governance Page 7 • The directors keep updating their knowledge and skills according to industry changes. • All directors are submitted for re-election annually. BOARD ACCOUNTABILITY • The board should present the company’s status and future prospects. • The board decides on the strategy to achieve its objectives. • The board decides how risk-averse or risk-taking the company will be. • The board is responsible for developing and implementing risk management and internal control systems. • The board should review and report on internal control and risk management systems annually. Nominations committee • Evaluates the structure and composition of the board. • Makes sure that the board is sufficiently diverse. • Reviews the proportion of NEDs on the board. • Prevents any one individual from asserting dominance. • Is responsible for succession planning. • Recommends applicants for any vacancies that arise. • Nominates members for re-appointment. • Should be independent from the board. Audit committee • The board forms the audit committee. • It consists of 2-3 independent NEDs. • At least one member should have financial experience. • The committee reviews the reliability of the financial statements. • It reviews and affirms the soundness of internal and financial controls. • It assesses the efficiency of the internal audit department. P3 - Risk Management CH5 – Corporate Governance Page 10 • If a failure is identified, the development norms of the control systems are reviewed. • The annual report includes information on risk management procedures and internal controls. • The annual report includes the board’s acknowledgement of responsibility for these. • It should also include the review process for these systems. EXTERNAL RISK REPORTING Turnbull Report The Turnbull Report forms part of the UK Corporate Governance Code (before it is was called the Combined Code). The requirements of the Turnbull Report include: • Use a risk-based approach to develop internal controls. • Identify objectives. • Determine the risks involved. • Ascertain controls to deal with the risks. • Implement a control system to prevent risks materialising. • Monitor and review controls regularly. • Review should be conducted for: • The control environment. • Control activities. • Risk assessment procedures. • Information/communication. • Monitoring. P3 - Risk Management CH5 – Corporate Governance Page 11 5. Sarbanes-Oxley Act (SOX) • Developed as a result of high profile collapses in the US economy (Enron, Worldcom). • It is detailed legislation for US-based companies. • It differs from the UK code on two points: • SOX is rules-based rather than principles-based, and • SOX demands more detailed documentation for internal controls and their audit. P3 - Risk Management CH5 – Corporate Governance Page 12 6. Chapter summary