AC341
Corporate governance, risk management & financial audit
What is corporate governance?
The company – conventional attributes: Legal entity Limited liability Own property Suing and
being sued (company law) Perpetual succession (company continues operations) Transferable
shares Management under a board structure Borrowing and taxation Formalities and expenses
Publicity
Participants in a company: shareholder, director, manager, employees, auditor, customer, lender, the
environment, community
Overview of corporate governance
Key elements of corporate governance include: Board of directors Shareholders’ rights
Transparency and disclosure Ethical behaviour Management oversight Internal controls and risk
management Stakeholder interests
Companies to utilise their resources efficiently, need a robust CG structure
Corporate governance: general principles
1)Rights and responsibilities of different shareholders – driven by corporate scandals 2)process by
which companies are controlled and operated
Financial crises 1907 led to reform of CG and stabilise companies – fed res created and best practice
frameworks
Corporate governance as a collective action problem
CG attempts to resolve collective actions problems among corporate claim holders.
The system by which companies are directed and controlled.
Good corporate governance provides incentives for managers and directors to pursue objectives
which are in the interests of the company and its shareholders.
Governing is not the same as managing – not running operations but the whole structure. (Source:
Garvey, 2016, chap. 2 in RCtSRM)
OECD Definition
Corporate governance reflects: “…a set of relationships between a company’s management, its
board, its shareholders and other stakeholders. Corporate governance also provides the structure
through which the objectives of the company are set, and the means of attaining those objectives
and monitoring performance are determined.” (page 11) Source: Organisation for Economic Co-
operation and Development (2004). OECD Principles of Corporate Governance.
Corporate governance code - “Companies do not exist in isolation. Successful and
sustainable businesses underpin our economy and society by providing employment and creating
prosperity. To succeed in the long-term, directors and the companies they lead need to build and
maintain successful relationships with a wide range of stakeholders. These relationships will be
successful and enduring if they are based on respect, trust and mutual benefit. Accordingly, a
company’s culture should promote integrity and openness, value diversity and be responsive to the
views of shareholders and wider stakeholders”
Where does governance take place?
Distributed across multiple instrumental
layers, not localised power.
,CG problems
Fair selection of vendors and conflict of interest
Manipulation of expenses/overstated amounts – need regular audit checks
Need clear threshold in policies and competitive tendering process
decisions have risk of financial and/or reputational loss
Key debates in corporate governance The purpose of the corporation: primacy of shareholders vs
other stakeholders (most influential debate – affects rest of CG). The role of corporate boards of
directors – balance between sexes/races? The rights of shareholders Measurement of
performance (CG provides bedrock for performance)
Two views of the company
1) A legal fiction: legal entity distinct from its owners, the shareholders, whose interests the
company should serve.
2) A real entity, economic and social organization composed of and affecting multiple
stakeholders
What do you think are the implications for corporate purpose of these two different views?
Legal - leads to a focus on financial returns and profit maximization. Corporate decisions are justified
by their contribution to shareholders' wealth, and other considerations, like environmental or social
impact, may be secondary or seen as tools to achieve greater financial returns.
Real - pursue objectives like social justice, environmental protection, and community engagement
alongside financial returns.
And what are the implications for corporate governance?
Legal – Performance based bonuses linked to meeting certain earnings targets. Engaging in
aggressive business tactics, potentially at expense of employee welfare.
Real - adopt more participatory decision-making practices and ESG however increased conflict of
interest. Include stakeholder that represents workers in BoD.
What are the ethical implications?
Real - Ethical considerations become central to business strategy rather than being seen as external
constraints or mere marketing tools. However difficult to measure ESG/welfare
Shareholder primacy
Milton Friedman’s view: "In a free-enterprise, private-property system, a corporate executive is an
employee of the owners of the business. He has direct responsibility to his employers. That
responsibility is to conduct the business in accordance with their desires...the key point is that, in
his capacity as a corporate executive, the manager is the agent of the individuals who own the
corporation...and his primary responsibility is to them." Source: A Friedman Doctrine: The Social
Responsibility of Business is to Increase Its Profits. The New York Times, September 13, 1970.
Who are shareholders and what do they want? – not a uniform group
, Shareholders have a residual interest and have voting rights.
Passive investors (e.g. index funds) may not be actively engaged in monitoring and controlling the
companies in which they are invested.
Activist investors (hedge funds) are engaged - but may force short- termism.
Demand stewardship and accountability.
Can you think of an example of a misaligned incentives?
Embezzlement, collusion between activist investors at expense of shareholders
What problems might result for shareholders from this?
Executives may manipulate earnings - actions can benefit shareholders in the short term, they might
mask underlying issues within the company, leaving shareholders vulnerable when the true financial
health is revealed – potential loss of value, control, accountability.
What can shareholders do to mitigate such “agency costs”?
Tie pay to long-term performance, promote responsible risk management mechanisms (increased
checks), forensic accounting
Agency costs – not just a recent phenomenon
1494: Bank owned by the Medici family became insolvent after building up large debts due to a lack
of financial controls and poor management.
1995: A bank which collapsed with losses of £827 million from fraudulent futures contracts a
Singapore futures trader, Nick Leeson, who signed off on his own accounts. The London directors
were subsequently disqualified, as being unfit to run a company.
2001: Directors and executives fraudulently concealed large losses in Enron's projects. A number
were sentenced to prison
2001: Directors used fraudulent accounting methods to push up the stock price
Recent examples of agency costs:
➢ Manipulation of financial information
➢Erosion of trust and transparency
➢Failed regulatory oversight and CG
Broad implications for the economy and society – Wirecard scandal affected Germany’s
reputation for CG
The company as a real entity
Shifting concept of corporate purpose It is possible to trace evidence of business community’s
concern for society for centuries. Formal writings on ‘corporate social responsibility’ (CSR),
however, emerged only in 20th century US.
Shifting concept of corporate purpose
1890-1930: Progressive Era in the US. Growth of welfare capitalism.
1950s-1970s: Growing environmental and health concerns, social activism.
1970-1990s: Series of national and international regulations; several disasters (e.g. Chernobyl
1986) and scandal with Nike supply chain. Concept of “sustainable development” (Brundtland report,
1987) – development that meets today’s needs without compromising future needs.
1990s-today: Increasing level, alignment and integration of law and regulations of ‘ESG’ practices
and reporting in all countries.
A milestone: Unilever Sustainability Living plan (2010) Strategic goal: Double sales while reducing
environmental impact. Three key areas: 1) Health & well-being. 2) Environmental impact. 3)
Enhanced livelihoods.
Set a precedent in shifting corporate governance from shareholder to stakeholder primacy
, Business case
➢ Drive consumer preference for sustainable brands, cost savings, and market growth in developing
regions.
➢ New sustainable products and packaging.
Tensions and implementation challenges
➢ Quantification issues – arbitrary units of measure.
➢ Collaboration with stakeholders (governments, NGOs) added complexity.
➢ Trade-offs between corporate growth and genuine impact reduction.
Still not exempt from greenwashing.
Stakeholder view today
US: ➢ Business Roundtable’s new statement on corporate purpose issued in August 2019
highlighted corporate commitment to stakeholders as well as shareholders.
https://hbr.org/2019/08/181-top-ceos-have-realized-companies-need-a-purpose-beyond-profit
UK: ➢ Corporate Governance Code 2018 asks directors to state the company’s purpose, values,
and strategy. ➢ Purposeful company taskforce (2015): “Profit is not the purpose of a company -
profit is one outcome of identifying and pursuing a purpose that benefits society”.
https://thepurposefulcompany.org/
Roundtable statement on stakeholders
“We commit to: Delivering value to our customers.
• Investing in our employees. This starts with compensating them fairly and providing important
benefits. It also includes supporting them through training and education that help develop new skills
for a rapidly changing world. We foster diversity and inclusion, dignity and respect.
• Dealing fairly and ethically with our suppliers.
• Supporting the communities in which we work. We respect the people in our communities and
protect the environment by embracing sustainable practices across our businesses.
• Generating long-term value for shareholders, who provide the capital that allows companies to
invest, grow and innovate. We are committed to transparency and effective engagement with
shareholders." "Each of our stakeholders is essential. We commit to deliver value to all of them, for
the future success of our companies, our communities and our country."
o ➢ Which stakeholders are missing? ➢ How should companies rank the different needs
and preferences of different stakeholders? ➢ Does current evidence support the
assertions made in the statement? ➢ Who is responsible for ‘social policy’: government
or corporations ESG policies under scrutiny
Missing stakeholders: The statement overlooks government/regulators, NGOs, future generations,
indigenous/local communities, and broader financial stakeholders.
Ranking stakeholders: Based on financial impact, media/public opinion. Altruistic view - Companies
should prioritise based on context, long-term value creation, and ethical/regulatory obligations,
recognizing that stakeholder needs are interconnected.
Evidence support: Research supports the statement—investing in employees, ethical supplier
relationships, sustainability, and customer focus lead to better long-term outcomes for businesses
and shareholders. However, greenwashing persists.
Responsibility for social policy: Both governments and corporations share responsibility.
Governments set regulations, (net zero strategy) but corporations increasingly influence social
outcomes, especially through voluntary actions.
Corporate governance, risk management & financial audit
What is corporate governance?
The company – conventional attributes: Legal entity Limited liability Own property Suing and
being sued (company law) Perpetual succession (company continues operations) Transferable
shares Management under a board structure Borrowing and taxation Formalities and expenses
Publicity
Participants in a company: shareholder, director, manager, employees, auditor, customer, lender, the
environment, community
Overview of corporate governance
Key elements of corporate governance include: Board of directors Shareholders’ rights
Transparency and disclosure Ethical behaviour Management oversight Internal controls and risk
management Stakeholder interests
Companies to utilise their resources efficiently, need a robust CG structure
Corporate governance: general principles
1)Rights and responsibilities of different shareholders – driven by corporate scandals 2)process by
which companies are controlled and operated
Financial crises 1907 led to reform of CG and stabilise companies – fed res created and best practice
frameworks
Corporate governance as a collective action problem
CG attempts to resolve collective actions problems among corporate claim holders.
The system by which companies are directed and controlled.
Good corporate governance provides incentives for managers and directors to pursue objectives
which are in the interests of the company and its shareholders.
Governing is not the same as managing – not running operations but the whole structure. (Source:
Garvey, 2016, chap. 2 in RCtSRM)
OECD Definition
Corporate governance reflects: “…a set of relationships between a company’s management, its
board, its shareholders and other stakeholders. Corporate governance also provides the structure
through which the objectives of the company are set, and the means of attaining those objectives
and monitoring performance are determined.” (page 11) Source: Organisation for Economic Co-
operation and Development (2004). OECD Principles of Corporate Governance.
Corporate governance code - “Companies do not exist in isolation. Successful and
sustainable businesses underpin our economy and society by providing employment and creating
prosperity. To succeed in the long-term, directors and the companies they lead need to build and
maintain successful relationships with a wide range of stakeholders. These relationships will be
successful and enduring if they are based on respect, trust and mutual benefit. Accordingly, a
company’s culture should promote integrity and openness, value diversity and be responsive to the
views of shareholders and wider stakeholders”
Where does governance take place?
Distributed across multiple instrumental
layers, not localised power.
,CG problems
Fair selection of vendors and conflict of interest
Manipulation of expenses/overstated amounts – need regular audit checks
Need clear threshold in policies and competitive tendering process
decisions have risk of financial and/or reputational loss
Key debates in corporate governance The purpose of the corporation: primacy of shareholders vs
other stakeholders (most influential debate – affects rest of CG). The role of corporate boards of
directors – balance between sexes/races? The rights of shareholders Measurement of
performance (CG provides bedrock for performance)
Two views of the company
1) A legal fiction: legal entity distinct from its owners, the shareholders, whose interests the
company should serve.
2) A real entity, economic and social organization composed of and affecting multiple
stakeholders
What do you think are the implications for corporate purpose of these two different views?
Legal - leads to a focus on financial returns and profit maximization. Corporate decisions are justified
by their contribution to shareholders' wealth, and other considerations, like environmental or social
impact, may be secondary or seen as tools to achieve greater financial returns.
Real - pursue objectives like social justice, environmental protection, and community engagement
alongside financial returns.
And what are the implications for corporate governance?
Legal – Performance based bonuses linked to meeting certain earnings targets. Engaging in
aggressive business tactics, potentially at expense of employee welfare.
Real - adopt more participatory decision-making practices and ESG however increased conflict of
interest. Include stakeholder that represents workers in BoD.
What are the ethical implications?
Real - Ethical considerations become central to business strategy rather than being seen as external
constraints or mere marketing tools. However difficult to measure ESG/welfare
Shareholder primacy
Milton Friedman’s view: "In a free-enterprise, private-property system, a corporate executive is an
employee of the owners of the business. He has direct responsibility to his employers. That
responsibility is to conduct the business in accordance with their desires...the key point is that, in
his capacity as a corporate executive, the manager is the agent of the individuals who own the
corporation...and his primary responsibility is to them." Source: A Friedman Doctrine: The Social
Responsibility of Business is to Increase Its Profits. The New York Times, September 13, 1970.
Who are shareholders and what do they want? – not a uniform group
, Shareholders have a residual interest and have voting rights.
Passive investors (e.g. index funds) may not be actively engaged in monitoring and controlling the
companies in which they are invested.
Activist investors (hedge funds) are engaged - but may force short- termism.
Demand stewardship and accountability.
Can you think of an example of a misaligned incentives?
Embezzlement, collusion between activist investors at expense of shareholders
What problems might result for shareholders from this?
Executives may manipulate earnings - actions can benefit shareholders in the short term, they might
mask underlying issues within the company, leaving shareholders vulnerable when the true financial
health is revealed – potential loss of value, control, accountability.
What can shareholders do to mitigate such “agency costs”?
Tie pay to long-term performance, promote responsible risk management mechanisms (increased
checks), forensic accounting
Agency costs – not just a recent phenomenon
1494: Bank owned by the Medici family became insolvent after building up large debts due to a lack
of financial controls and poor management.
1995: A bank which collapsed with losses of £827 million from fraudulent futures contracts a
Singapore futures trader, Nick Leeson, who signed off on his own accounts. The London directors
were subsequently disqualified, as being unfit to run a company.
2001: Directors and executives fraudulently concealed large losses in Enron's projects. A number
were sentenced to prison
2001: Directors used fraudulent accounting methods to push up the stock price
Recent examples of agency costs:
➢ Manipulation of financial information
➢Erosion of trust and transparency
➢Failed regulatory oversight and CG
Broad implications for the economy and society – Wirecard scandal affected Germany’s
reputation for CG
The company as a real entity
Shifting concept of corporate purpose It is possible to trace evidence of business community’s
concern for society for centuries. Formal writings on ‘corporate social responsibility’ (CSR),
however, emerged only in 20th century US.
Shifting concept of corporate purpose
1890-1930: Progressive Era in the US. Growth of welfare capitalism.
1950s-1970s: Growing environmental and health concerns, social activism.
1970-1990s: Series of national and international regulations; several disasters (e.g. Chernobyl
1986) and scandal with Nike supply chain. Concept of “sustainable development” (Brundtland report,
1987) – development that meets today’s needs without compromising future needs.
1990s-today: Increasing level, alignment and integration of law and regulations of ‘ESG’ practices
and reporting in all countries.
A milestone: Unilever Sustainability Living plan (2010) Strategic goal: Double sales while reducing
environmental impact. Three key areas: 1) Health & well-being. 2) Environmental impact. 3)
Enhanced livelihoods.
Set a precedent in shifting corporate governance from shareholder to stakeholder primacy
, Business case
➢ Drive consumer preference for sustainable brands, cost savings, and market growth in developing
regions.
➢ New sustainable products and packaging.
Tensions and implementation challenges
➢ Quantification issues – arbitrary units of measure.
➢ Collaboration with stakeholders (governments, NGOs) added complexity.
➢ Trade-offs between corporate growth and genuine impact reduction.
Still not exempt from greenwashing.
Stakeholder view today
US: ➢ Business Roundtable’s new statement on corporate purpose issued in August 2019
highlighted corporate commitment to stakeholders as well as shareholders.
https://hbr.org/2019/08/181-top-ceos-have-realized-companies-need-a-purpose-beyond-profit
UK: ➢ Corporate Governance Code 2018 asks directors to state the company’s purpose, values,
and strategy. ➢ Purposeful company taskforce (2015): “Profit is not the purpose of a company -
profit is one outcome of identifying and pursuing a purpose that benefits society”.
https://thepurposefulcompany.org/
Roundtable statement on stakeholders
“We commit to: Delivering value to our customers.
• Investing in our employees. This starts with compensating them fairly and providing important
benefits. It also includes supporting them through training and education that help develop new skills
for a rapidly changing world. We foster diversity and inclusion, dignity and respect.
• Dealing fairly and ethically with our suppliers.
• Supporting the communities in which we work. We respect the people in our communities and
protect the environment by embracing sustainable practices across our businesses.
• Generating long-term value for shareholders, who provide the capital that allows companies to
invest, grow and innovate. We are committed to transparency and effective engagement with
shareholders." "Each of our stakeholders is essential. We commit to deliver value to all of them, for
the future success of our companies, our communities and our country."
o ➢ Which stakeholders are missing? ➢ How should companies rank the different needs
and preferences of different stakeholders? ➢ Does current evidence support the
assertions made in the statement? ➢ Who is responsible for ‘social policy’: government
or corporations ESG policies under scrutiny
Missing stakeholders: The statement overlooks government/regulators, NGOs, future generations,
indigenous/local communities, and broader financial stakeholders.
Ranking stakeholders: Based on financial impact, media/public opinion. Altruistic view - Companies
should prioritise based on context, long-term value creation, and ethical/regulatory obligations,
recognizing that stakeholder needs are interconnected.
Evidence support: Research supports the statement—investing in employees, ethical supplier
relationships, sustainability, and customer focus lead to better long-term outcomes for businesses
and shareholders. However, greenwashing persists.
Responsibility for social policy: Both governments and corporations share responsibility.
Governments set regulations, (net zero strategy) but corporations increasingly influence social
outcomes, especially through voluntary actions.
