Lecture Corporate governance and ethics: Chapter 13 - Rezaee

Chapter 12 - Contemporary issues in business ethics and corporate governance. After completing this chapter, students will be able to: Address the broad influence of technology in twenty-first-century corporate governance; introduce a theoretical “cybercompany model” to promote the use of information technology in areas of shareholder communication, electronic commerce, electronic financial reporting, and continuous auditing;...

Corporate Governance in Private and Not-for –Profit Organizations

Chapter XIII

Chapter Objectives:

• Discuss the purpose and roles of NPOs.

• Evaluate SOX and its potential application to private companies and NPOs.

• Present the corporate governance principles, mechanisms, and functions found in public companies in a comparable structure for use in private companies and NPOs.

• Elaborate on the duties of the audit committee of NPOs.

• Reiterate the importance of an effective internal control structure for entities of all types and sizes.

Key Terms

Articles of Incorporation charter

Development/fundraising committee

Executive committee

Finance committee

Nonprofit Integrity Act of 2004

Not-for-profit organization

Personnel committee

Program committee

Society of Corporate

Secretaries and Governance

Professionals

Whistleblower programs

Types of NPOs

There are a variety of NPOs created for philanthropic purposes

•State and Local Governments

•Health Care Organizations

•Colleges and Universities

•Charitable Organizations

Purpose and Characteristics of NPO

The primary purpose of NPOs is to serve the public rather than earn profit

Characteristics of NPOs are:

(1) they do not attempt to make a profit and are often exempt from income taxes;

(2) they are owned collectively by their constituents, where ownership is not evidenced by equity shares that can be sold or traded;

(3) their policy and operating decisions are

normally made by majority vote of an elected or appointed governing body

Public Trust in NPO

NPOs, particularly charities, have been under extensive scrutiny regarding their governance, financial integrity, stewardship of resources, and appropriateness of their compensation schemes The IRS has also increased its efforts in reviewing about four hundred foundations regarding their tax-exempt status and compensation decisions

Example:

According to California’s Nonprofit Integrity Act require charities reporting more than $2 million in revenue to have audit committees and their financial reports audited

Governance of NPOs

Emerging corporate reforms, rules, and regulations are having significant implications for the governance and accountability

of NPOs such as higher education institutions, charities, and churches Many provisions of SOX are applicable to NPOs, even though these provisions were intended for public companies

Provisions of SOX that would be appropriate for NPOs are:

(1) establishing an audit committee composed solely of independent directors,

(2) prohibiting the shredding of records,

(3) establishing whistleblower programs,

(4) establishing codes of ethical conduct

Governance Structure of NPOs

Governance principles: Principles of fairness, transparency, 

responsiveness, accountability, resilience,  communication, and disclosure for public  companies are also relevant to NPOs. 

Governance Mechanisms The corporate governance mechanisms of 

NPOs are different from those of public  companies. The primary governance  mechanisms of NPOs are their governing and  advisory boards

The NPO’s internal control structure should also  prevent and detect errors, irregularities, and  fraud, particularly employee embezzlements

Oversight Function of NPOS

NPOs are typically organized as nonprofit corporations with either a board of directors or board of trustees, or as trustees or foundations with

a board of trustees

Duties of the Board of 

Directors/Trustees 

1. Duty of obedience

2. Duty of care

3. Duty of loyalty Board Committees 1. Audit committee

committee

2. Develop strategies to achieve these goals

3. Establish appropriate board committees

4. Appoint officers and executives to run the organization.

5.  Determine  the  compensation  of  executives,  oversee  their  work,  and  evaluate their performance.

6. Review the organization’s programs and services.

7. Oversee financial reporting, internal controls, and audit activities.

8. Oversee compliance with applicable laws.

9. Promote ethical behavior and accountability.

10. Ensure adequacy and effective use of resources.

11. Evaluate the board’s performance.

12. Approve director/trustee compensation, if any.

13. Assess board vacancy and recruit new board members.

14. Ensure executives and staff provide the board with relevant and timely  information to effectively carry out its fiduciary duties. 

15. Set an appropriate “tone at the top”

16. Establish fair whistleblowing policies to encourage employees to come  forward in reporting wrongdoing without the fear of retaliation. 

Oversight Function of NPOS (Cont)

Attributes of Board Members

The effectiveness of the organization’s board depends on the attributes, personal integrity, competence, dedication, insight, and professional qualifications of its members Important

qualities of an effective board member are:

Best Practices

The suggested corporate governance best practices for NPOs consists

of the following checklist of elements for good governance:

1. Make ethical behavior central to a board’s culture

2. Strengthen internal controls

3. Review bylaws

4. Use board committees

5. Use the Internet to inform the public

6. Review investment and spending policies

7. Perform board training and evaluation

Internal Control in NPOs

Internal controls pertaining to compliance with applicable regulations are essential in an NPO to ensure continuation of tax-exempt status

Governance documents of NPOs consist of four major documents: two organization documents (mission statement and code of conduct) and two legal documents (charter and

Bylaws:

1. Mission Statement

2. Code of Conduct

3. Charter

4. Bylaws

Conclusion  

• Many private companies will eventually enter the public markets, and thus, their corporate governance practices will be publicly scrutinized

• There are a variety of NPOs for philanthropic purposes

• The primary purpose of NPOs is to serve the public rather than maximize shareholder wealth through earning profits

• The Panel on the Nonprofit Sector was organized to demonstrate the role of charitable organization

• Many provisions of SOX are very applicable to private ns companies and NPOs, including requirements

for (1) more vigilant and independent directors, (2) audit committees, (3) improvements in the financial reporting process, (4) risk management and internal controls, (5) audit quality, (6) codes of conduct, (7) whistleblower programs, and (8) prohibition of document destruction

• Corporate governance measures are as important and relevant to NPOs as to business firms Specifically, some NPOs often use public funds, contributions, and grants, and are tax exempt They must be monitored closely to ensure their budgets are spent on the intended philanthropic purposes

• Corporate governance principles of fairness, transparency, responsiveness, accountability, resilience, communication, and disclosures discussed in Chapter 2 for public companies are also relevant to private companies and NPOs

• NPOs must rely primarily on internal governance mechanisms to assess performance, reward good performance, and discipline poor performance The primary governance mechanisms of NPOs are their governing and advisory boards

• Directors and trustees of NPOs have three major fiduciary duties: duty

of obedience, duty of care, and duty of loyalty

• The important qualities of an effective board member are vision, leadership, stewardship, skill, diligence, and collegiality

• ICFR, operations, and compliance with applicable laws and regulations, particularly the tax exempt status of many NPOs, are important internal governance mechanisms