24eli-11765 cg 601 gaw kachali.doc
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GovernanceTRANSCRIPT
CORPORATE GOVERNANCE CG 601PROJECT PAPER
STUDENT NAME: MARK MISOMALI
STUDENT ID NO: 24ELI-11765
INTAKE AND VENUE: EVENING 24, LILONGWE
LECTURER’s NAME: GAW KACHALI
DATE SUBMITTED: DECEMBER 01, 2011
PREFACE
Many organizations of private or public nature are not spared from the risks of fraud and
corruption. The complex business processes make it impossible to find a common
solution for combating fraud and corruption. Even in similar business processes the
nature of fraud and corruption cannot be predicted. As a result of this a lot of resources
are lost, wasted, and abused. Other organizations have put in strict punitive measures
for the culprits but still this has not relatively reduced incidences of fraud and corruption.
There is growing consensus that organizations with good corporate governance
practices have marginal incidences of fraud and corruption. In this paper I will discuss
the link between corporate governance and prevention of fraud and corruption.
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Table of Contents
Introduction………………………………….……………………………………………….1
Purpose and Methodology……………….…………………………………………………2
Organization of the study……………….………………………………….……………….2
Chapter 1: Corporate Governance Background…………………..……………….…….3
Chapter 2: Composition of the Board………..….…………………….…………….…….5
Chapter 3: The Role of the Board……..………….………………………………….……8
Chapter 4: Board Committees…………………..….……………………………….……10
Chapter 5: Corporate Governance and Fraud…..….…………………………….…….12
Conclusion……………………………………………..….………………………………..13
Appendix…………………………………………………….………………………….…..14
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NEXUS BETWEEN CORPORATE GOVERNANCE AND THE PREVENTION OF
FRAUD AND CORRUPTION IN THE WORK PLACE
CHAPTER ONE: INTRODUCTION
In this chapter, I will attempt to define what corporate governance is; then, I will identify
the key players of corporate governance. The rest of the report will discuss how
corporate governance can be used to prevent fraud and corruption.
Definition
The reader should know that there is no single definition for such a term as corporate
governance. In simplest terms corporate governance means how corporations or
companies are run. R.I. Tricker (1984) observed that if management is about running
the business, governance is about seeing that it is run properly. The Cadbury committee
defines Corporate Governance as the system by which companies are directed and
controlled.
Corporate governance players
In running a company, we can say that there are three major players, namely
shareholders, board of directors, and management. The success or failure of
companies to a large extent depends on the actions of these three major players. The
fight against fraud and corruption should be a collective effort by these three parties.
While fulfilling their duties, the parties must operate within the guidelines of legal and
regulatory framework including other agreed upon rules and procedures of the
company. Consequently Government and other stakeholders are also interested
parties. The board of directors is therefore not only accountable to shareholders but
also to Government and other stakeholders.
The shareholder’s main role is to appoint and provide guidance to the directors. The
directors set strategic direction while the management implements the strategic goals.
Of the three major players, the directors play a pivotal role in ensuring effective
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corporate governance. It is for this reason that much discussion is dedicated to the
composition, role, and function of the board of directors and its committees.
PURPOSE AND METHODOLOGY
This report has been commissioned as part of an academic study for the Executive
MBA course in Corporate Governance. The methods used to collect data are through:-
books
internet
published articles, magazines
ORGANIZATION OF THE STUDY
The study has 5 main chapters as follows:-
Corporate Governance Background
Corporate Governance and Fraud
Composition of the Board
The Role of the Board
Board Committees
Each of those areas is discussed in detail looking at how it relates to the prevention of
fraud and corruption in the work place. At the end of the discussion I present my
conclusion.
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Chapter One: Corporate Governance Background
The concept of corporate governance emerged from the time when ownership and
management of businesses were separated. The concept of stewardship and the role of
auditor emerged from this separation of management and ownership. The owners
wanted to have a way of monitoring the performance of individuals managing their
businesses. Below is a diagram representing this tri-parte relationship:-
Owner
Oversight body Steward
Industrial revolution brought about expansion of enterprises that required heavy
investment of capital which led to emergence of incorporated enterprises. A corporation
is a legal entity but can only act through the agency of natural persons. It is for this
reason that the need for directors arises. The directors are not only agents of the
company but they are also its trustees. Initially, company legislation dealt with all
corporate governance matters such as the appointment of directors, the operations of
board of directors, and the role of auditors. Later events have caused several
developments leading to evolvement of an extensive academic literature dealing with
the principal-agent relationship.
Corporate governance involves putting in place systems and structures for the operation
and control of a company with the following specific aims;-
Fulfilling long-term strategic goals of owners
Taking care of the interests of employees
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A consideration for the environment and local community
Maintaining excellent relations with customers and suppliers
Proper compliance with all the applicable legal and regulatory requirements.
Good governance is integral to the very existence of a company. It builds confidence
amongst stakeholders and prospective investors. Investors are willing to pay higher
price to organizations with internationally accepted norms of corporate governance.
Effective accountability to all stakeholders is the essence of corporate governance.
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Chapter Two: Corporate Governance and Fraud
A proper review of financial statements by directors may reveal errors in recording of
transactions. However, fraudulent transactions, which are carefully recorded with the
intent to conceal, are extremely difficult to identify. Fraud and corruption involves the
perpetrator having intention to deceive causing the deceived person or entity suffering
some kind of loss. Fraud and corruption involves circumventing the systems. Very often
fraud is discovered after lapse of a considerable period of time.
It is for this reason that corporate governance seeks to ensure that the business and
management of corporate entities is carried out in accordance with the highest
prevailing standards of ethics to safeguard and promote the interests of all
stakeholders. For this purpose, it is vital to recognize the importance of stakeholders
and their rights. Communication between stakeholders is considered to be an important
feature of corporate governance.
Developments in corporate governance
There has been renewed interest in corporate governance practices of modern
corporations due to the high-profile collapses of a number of large corporations most of
which involved fraud. Corporate scandals such as the Enron corporation and MCI Inc.
have led to the regulation of corporate governance, such as, The Cadbury Report (UK,
1992), OECD principles of corporate governance (2004), and the Sarbanes-Oxley Act
(US, 2002). These reports present general principles around which businesses are
expected to operate to assure proper governance. These principles are as follows:-
Rights and equitable treatment of shareholders
Organizations should respect rights of shareholders and help them exercise those rights
through effective communication. Since shareholders are normally not involved in the
day-to-day running of the organization, they can provide an independent and objective
view of the way the organization is run. Some loopholes can best be spotted from an
outside look thereby saving the organization from risks of fraud and corruption. Some
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fraud and corruption incidences are perpetrated by the board itself, so allowing
participation of shareholders can act as a deterrent from such bad acts. In addition to
basic duties, a shareholder must focus on such issues as the election of the board,
amendments to the company’s rules, approval of extraordinary transactions. In order to
do this, a shareholder must participate in general meetings.
Interests of other stakeholders
Organizations should recognize that they have social and other obligations to other
stakeholders other than shareholders including employees, suppliers, creditors, local
communities, customers, policy makers. Realizing that there are many interested
parties to the affairs of the organization can enforce discipline and put the board and
management on guard to act with care and prudence.
Role and responsibilities of the board
The board needs sufficient and relevant skills to review and challenge management
performance. It also needs adequate size and appropriate levels of independence and
commitment to fulfill its duties and responsibilities. Management runs the organization
and the board ensures that it is run properly. The recruitment of members into the board
must follow a formal process similar to that followed when recruiting employees of a
company. The board must have the necessary skills, receive adequate orientation and
undergo regular training to effectively discharge its duties and responsibilities. The
primary responsibility for the administration and performance of a company lies with the
directors. Their role is so crucial such that an extensive discussion is reserved for
chapter four.
Integrity and ethical behavior
Integrity should be a fundamental requirement in choosing corporate officers and board
members. Corruption and fraud are basically due to a crisis in ethics. Integrity counts
more in the fight against corruption and fraud than the academic and professional
qualifications. The recruitment process must include background check of individuals
elected into the board to assess their past records.
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Disclosure and transparency
Organizations should clarify and make publicly known the roles and responsibilities of
board and management to provide stakeholders with a level of accountability.
Disclosure of material matters concerning the organization should be timely and
balanced to ensure that all investors have access to clear, factual information.
Prevention of fraud
It is imperative that the board and management take appropriate measures for
prevention and timely detection of fraud. This is possible through the implementation
and continued operation of adequate accounting and internal control systems.
The internal control system extends beyond those matters that relate directly to the
functions of the accounting system and comprise of the control environment and control
procedures. Control environment refers to the overall attitude, awareness and actions of
directors and management regarding the internal control system and its importance in
the company. Factors reflected in the control environment include:-
The function of the board of directors and its committees
Management philosophy and operating style
The company’s organizational structure and methods of assigning authority and
responsibility
Management’s control system including the internal audit function, personnel
policies and procedures and segregation of duties
Management implements the strategies and policies set out by the board of directors.
Management should establish control procedures to achieve entity’s specific objectives.
Specific control procedures include:-
Reporting, reviewing and approving reconciliations
Approving and controlling of documents
Limiting direct physical access to assets and records
Comparing internal data with external sources of information
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Chapter Three: Composition of the Board
A well constituted board is a catalyst for effective corporate governance which can lead
to prevention of fraud and corruption. The following guidelines are worth considering
when composing the board:
The board should comprise a balance of executive and non-executive directors,
with a majority of independent non-executive directors to reduce possibility of
conflicts of interest.
There must be an appropriate balance of power and authority so that no one
individual or group dominates.
All directors should be individuals of integrity and courage to be able to challenge
management.
There must be a minimum of two executive directors, Chief Executive Officer
(CEO) and Chief Financial Officer (CFO) to ensure there is more than one point
of contact between the board and management
The board should be led by an independent non-executive chairman who should
not be CEO of the company. The chairman should be independent and free of
conflicts of interest in order to effectively discharge his duties of providing the
necessary direction of the company
The board should appoint an effective and ethical chief executive officer. The
CEO serves as the chief spokesperson and plays a strategic role in the
operations and success of the company. He should ensure that a positive and
ethical work climate is maintained.
Other factors to consider are the qualifications of the board members, the size of the
board, the time and energy of the board members.
Qualifications
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Board members should be elected based on a demonstrated record of possessing the
specific qualifications and competencies necessary for effective governance. William
Bowen writes that “every trustee should bring a specific competence or experience
needed on the board”. Eligibility for election to another term should be based on
performance and ability to contribute a competency that is still needed by the
organization.
Size
The knowledge, skills, and other resources required should determine the number of
directors to serve on the board. It is very helpful for the board to include directors with
relevant technical skills for the core business to understand the nature and operations of
the company. Every board should consider whether its size, diversity and demographics
make it effective. No one individual should wield more power to dominate the decisions
of the board.
Time
Time is very crucial for board members to attend meetings and contribute towards the
successes of the company. When recruiting board members, consideration should be
given to their availability to attend meetings and participate in other activities.
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Chapter Four: The Role of the Board
The four cornerstones of corporate governance are the board of directors,
management, external audit, and internal audit. The corporate governance framework
should ensure the strategic guidance of the company, the effective monitoring of
management by the board, and the board’s accountability to the company and the
shareholders (OECD Principles of Corporate Governance, 2004).The board provides
oversight ensuring that the company is run properly. The board is the focal point of
corporate governance structure in the company and is the link between the
stakeholders and the company. The functions of the board are broad and include the
following:-
To promote the success of the company by directing and supervising the
company affairs
To cultivate and promote an ethical corporate culture
Appreciate that strategy, risk, performance and sustainability are inseparable.
Identify key risk areas and ensure that management direct its mind to pertinent
risks.
Manage conflict of interests of directors
Ensure that there is an effective risk-based internal audit
Ensure the integrity of financial reporting
Report on the effectiveness of internal financial controls
An article in the Point of View magazine summarizes the 5 things which the board
should be focusing on, and which distinguish exceptional boards from the rest as
follows:-
Effective board leadership
The effective functioning of a board depends on a number of factors, including the mix
of knowledge and experience among the directors, the quality of information they
receive and the ability to operate as a team. The board chairman will ensure that the
board not only evaluate the performance of the CEO, but take the formal assessment of
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their own work seriously and use the findings to develop and hold themselves to
objectives for improvement.
Strategy
The Company’s successes and shareholder satisfaction are dependent on the board
making wise strategic decisions. Every board member must be very clear about what is
expected of them in the strategy discussion. Usually the executive team develops
strategy; the board fine tunes it and then oversees its execution by management,
measuring CEO’s performance against a set of agreed-upon objectives.
Risk Oversight
Risk should be defined in the broadest terms, encompassing not just financial matters
but also areas such as health and safety, the environment, industrial relations and
corporate reputation. Risks are inherent in any business that is going to deliver long-
term value to its stakeholders. The board should determine whether they have optimal
structure for overseeing risk.
Succession
The board should have a rigorous succession planning methodology in place for both
planned and emergency scenarios, to identify the next CEO, the chairman and the rest
of the board. The planning process should start as early as possible, even if this makes
the incumbent uncomfortable.
Sustainability
Boards of listed companies have an obligation to build and protect long-term
shareholder value and to ensure short-term decisions do not jeopardize the
sustainability of the enterprise. All forms of capital – financial, human, natural and social
are essential for value creation. More evidence is mounting that overlooking social
responsibility has negative consequences in the sustainability of organizations.
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The primary responsibility for the administration and performance of a company lies with
the board of directors.
Chapter Five: Board Committees
The board works through committees. The number of committees depends on the
needs of the organization. The King Report requires that at a minimum, each board
should have an audit, and Remuneration committees. Additionally it recommends a
board to have a nomination committee.
Audit committee
The audit committee is the principal governance watchdog in most companies whose
purpose is to provide additional focus on financial issues. According to the Blue ribbon
Committee of US SEC, the role of the audit committee is to function as the “ultimate
guardian of investor’s interest and corporate accountability”.
Remuneration Committee
This is probably the second most important governance committee. Its main tasks are to
review, assess and make recommendations to the main board on matters concerning
directors’ remuneration, incentive schemes, and measurement criteria for the
performance of executive directors.
Nomination Committee
The purpose of this committee is to ensure that the board consists of the skills and
attributes needed by the company. Its functions include reviewing the size and
composition of the board, establishing succession plans, recommending the
appointment of directors.
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Conclusion
From the discussion above, it is clear that there is a link between corporate governance
and the prevention of fraud and corruption at work places. The opportunity to do
business or provide goods and services opens up risks associated with the resources
involved in the transactions. Cases of fraud and corruption are common among private
and public enterprises. The board of directors has fiduciary duties to ensure that
resources of organization are protected from the risk of fraud and corruption. This
requires a competent board composed of members who are honest, have the requisite
skills, knowledge, and ability to strategically position the organization to achieve desired
results while complying with all the necessary rules and regulation. Modern technology
has also come with new challenges making it imperative that the board should have
continuous professional development to gain new management and control techniques.
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Appendix
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