ACCA approved study text paper 1 governance risk and ethics

xvii Part A Governance and responsibility 1 Scope of corporate governance ...3 2 Approaches to corporate governance...47 3 Corporate governance practice and reporting ...77 Part B Inter

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Governance, Risk and Ethics

This ACCA Study Text for Paper P1 Governance, Risk

and Ethics has been comprehensively reviewed by

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• Regular Fast Forward summaries emphasising the key points in each chapter

• Questions and quick quizzes to test your understanding

• A practice question bank containing exam- standard questions with answers

• A full index

• All you need in one book

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GOVERNANCE, RISK AND ETHICS

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your exam

In this Study Text, which has been reviewed by the ACCA examination team, we:

 Highlight the most important elements in the syllabus and the key skills you need

 Signpost how each chapter links to the syllabus and the study guide

 Provide lots of exam focus points demonstrating what is expected of you in the exam

 Emphasise key points in regular fast forward summaries

 Test your knowledge in quick quizzes

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Contents

Page

Introduction

Helping you to pass v

Studying P1 vii

The exam paper xiv

Syllabus and study guide xvii

Part A Governance and responsibility 1 Scope of corporate governance 3

2 Approaches to corporate governance 47

3 Corporate governance practice and reporting 77

Part B Internal control and risk 4 Internal control systems 137

5 Risk attitudes and internal environment 157

6 Risks 189

7 Risk assessment and response 215

8 Information, communication and monitoring 251

Part C Professional values and ethics 9 Personal ethics 289

10 Professional ethics 319

11 Corporate social responsibility 359

Practice question bank 405

Practice answer bank 413

Index 443

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Helping you to pass

BPP Learning Media – Approved Content Provider

As ACCA's Approved Content Provider, BPP Learning Media gives you the opportunity to use study

materials reviewed by the ACCA examination team By incorporating the examination team's comments

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Text provides excellent, ACCA-approved support for your studies

The PER alert

Before you can qualify as an ACCA member, you not only have to pass all your exams but also fulfil a three

year practical experience requirement (PER) To help you to recognise areas of the syllabus that you

might be able to apply in the workplace to achieve different performance objectives, we have introduced

the 'PER alert' feature You will find this feature throughout the Study Text to remind you that what you

are learning to pass your ACCA exams is equally useful to the fulfilment of the PER requirement

Your achievement of the PER should now be recorded in your online My Experience record

Tackling studying

Studying can be a daunting prospect, particularly when you have lots of other commitments The different

features of the text, the purposes of which are explained fully on the Chapter features page, will help you

while studying and improve your chances of exam success

Developing exam awareness

Our Texts are completely focused on helping you pass your exam

Our advice on Studying P1 outlines the content of the paper, the necessary skills you are expected to be

able to demonstrate and any brought forward knowledge you are expected to have

Exam focus points are included within the chapters to highlight when and how specific topics were

examined, or how they might be examined in the future

Using the Syllabus and Study Guide

You can find the syllabus and Study Guide on pages xvii-xxvii of this Study Text

Testing what you can do

Testing yourself helps you develop the skills you need to pass the exam and also confirms that you can

recall what you have learnt

We include Questions – lots of them – both within chapters and in the Practice Question Bank, as well as

Quick Quizzes at the end of each chapter to test your knowledge of the chapter content

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Chapter features Each chapter contains a number of helpful features to guide you through each topic

Topic list

Topic list Syllabus reference What you will be studying in this chapter and the relevant

section numbers, together with ACCA syllabus references

Knowledge brought forward from earlier studies What you are assumed to know from previous

studies/exams

Summarises the content of main chapter headings, allowing you to preview and review each section easily

Gives you a useful indication of syllabus areas that closely relate to performance objectives in your Practical Experience Requirement (PER)

Question Gives you essential practice of techniques covered in the chapter

Case Study Real world examples of theories and techniques

Chapter Roundup A full list of the Fast Forwards included in the chapter,

providing an easy source of review

Quick Quiz A quick test of your knowledge of the main topics in the

Studying P1

The P1 Governance, Risk and Ethics syllabus has been written with a different focus from the exams that

you have sat so far The exam is not about learning law, accounting standards or complicated calculation

techniques Instead it seeks to promote the underlying themes of professionalism and accountability

You cannot be professional in one area and unprofessional in another

1 What P1 is about

1.1 Underlying themes

The syllabus shows how accounting is underpinned by governance and ethics, and the need for

accountants to repay the trust that society puts in them A key element of governance is the concept of

accountability, particularly of directors and auditors There is an emphasis on the agency relationship

between stakeholders and business managers, including directors and accountants Governance is itself

supported by sound internal control systems, internal audit and rigorous risk management Judgement,

underpinned by professional competence and ethics, is also a key theme Lastly, students are expected to

consider carefully the concept of professionalism, and to discuss how the accountant should contribute

to society

The paper's main themes should be seen as interconnected: 'Every right implies a responsibility; for each

opportunity there is an obligation and all rewards carry related risks.'

1.2 Governance and responsibility

Chapter 1 demonstrates the importance of the underlying themes of the syllabus Corporate governance is

a central part of the syllabus Instead of going straight into the detailed requirements of the corporate

governance reports, it discusses in detail the concepts that underpin good corporate governance, the

agency relationship, the constituencies (shareholders and other stakeholders) that corporate governance

is designed to serve and the extent of responsibilities towards different stakeholders

Chapter 2 deals with the basis of corporate governance legislation and codes, whether they are based on

principles or a detailed rulebook and how governance codes incorporate wider ideas of social

responsibility Chapter 3 covers governance best practice, drawing on examples from different codes from

all over the world

1.3 Internal control and risk

We consider Sections B to D of the syllabus together in Section B of this book The syllabus highlights the

following issues, as they have proved to be problematic in recent corporate failures

 Internal control

 The identification and assessment of risk

 Controlling and mitigating risk

These issues also play a crucial part in an accountant's responsibility to act in the public interest and the

interests of shareholders

'Sound systems of internal analysis, control and audit underpin all effective corporate governance

systems Effective management at the strategic level rests on the assumption that internal control

activities can be controlled, verified and reported on internally If management loses control of internal

systems and procedures, any claim of sound governance is lost … The same is true of risk Being aware

of all possible risks, understanding their potential impact, as well as the probability of occurrence, are

important safeguards for investors and other shareholders.'

In Chapter 4 therefore we examine the objectives of control and risk management systems We also look

at systems that have been developed internationally, including the COSO enterprise risk management

Chapters 5 to 8 are organised around the stages identified in the COSO enterprise risk management

model Chapter 5 deals with the underlying factors that affect how a business is controlled and how risk is managed These include how much appetite the business has for risk, and how environmental factors

within the business affect control and risk management We also look at the importance of setting business objectives that are consistent with the risk that directors, shareholders and other stakeholders

wish the business to bear

Chapters 6 and 7 deal with the various stages of risk assessment and management, including internal

control procedures that act to reduce risk

Chapter 8 brings out two other elements that are vital in control systems These are a two-way flow of appropriate information between the board and managers and staff This should enable the board and

managers to carry out effective monitoring of operations, and provide feedback so that systems and

controls can be improved The results of business monitoring will also form the basis for external reporting about the company's systems

1.4 Professional values and ethics This section of the syllabus requires you to think carefully about the ethical assumptions that guide individual behaviour and underpin the role of accountants.Chapter 9 is a very important chapter in this text,

dealing with the ethical stances of individuals and also the factors that determine the ethical decisions

individuals take In the exam you may have to argue from a specific ethical position, even if you don't agree with the position

In Chapter 10 you need to look critically at the ethical codes accountants follow as well as the codes that

businesses operate It is true that you need to have a good knowledge of what the accountancy profession's codes say on ethical threats and conflicts and to be able to use that knowledge in

recommending solutions to ethical dilemmas However, you are also expected to question how much help the codes actually are in resolving dilemmas and whether the ethical frameworks are in the best interests

of society and the accountancy profession The exam may ask you to question the role of the accountant

in protecting shareholder wealth and focusing on the performance of capital investment Does this mean that accountancy is a servant of capital and makes the implicit assumptions about morality that capitalism does?

Chapter 11 looks at corporate social responsibility, concentrating on what organisations have done to

address issues such as sustainability and the implications for accounting, disclosure, control systems

2.2 Application skills What application skills do you need? Many P1 questions will include detail in a scenario about a specific organisation The following skills are particularly important when you're dealing with question scenarios

(a) Identifying the most important features of the organisation and the organisation's environment

Clues to these will be scattered throughout the scenario The technical knowledge that you have should help you do this, but you will also need business awareness and imagination There will be

a main theme running through most scenarios that you'll need to identify

(b) Using analysis techniques will give you more insight into the data that you're given

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(c) Selecting real-life examples that are relevant to the scenario You should look at contemporary

business stories and try to identify P1 issues, for example directors' remuneration

(d) Making informed judgements that follow from your analysis about what the organisation is doing

and should be doing

(e) Communicating clearly and concisely your analysis and recommendations Perhaps you will be

reporting to a specific individual If so, you should take into account the needs of this individual

3 How to pass

3.1 Study the whole syllabus

You need to be comfortable with all areas of the syllabus Compulsory Question 1 will always span a

number of syllabus areas and other questions may do so as well In particular, you must have a very good

knowledge and awareness of the themes in the ethical section of the syllabus, as compulsory Question 1

will always include an element on ethics

The examination team has also stressed that study and revision should cover the entire syllabus in detail

Students should not question-spot or prioritise one area of the syllabus over another The examination

team has identified in its examination team's reports those topics which students who question-spotted

clearly believed would not be examined, but unfortunately were

3.2 Focus on themes, not lists

There are quite a number of lists in the texts This is inevitable because corporate governance guidance

quoted as best practice is often in list form Lists are also sometimes the clearest way of presenting

information However, the examination team has stressed that passing the exam is not a matter of learning

and reproducing lists Good answers will have to focus on the details in the scenario and bring out the

underlying themes that relate to the scenario The points in them will have more depth than a series of

single-line bullet points

3.3 Read around

Wider reading will help you understand the main issues businesses face Reading the business pages of

newspapers will highlight key business risks organisations face and topical corporate governance issues

General news pages may cover significant ethical and corporate responsibility issues You should also

refer to websites of organisations promoting social responsibility, such as CERES

3.4 Lots of question practice

You can develop application skills by attempting questions in the Practice Question Bank and later on in

the BPP Learning Media Practice & Revision Kit

4 Answering questions

4.1 Analysing question requirements

It's particularly important to consider the question requirements carefully to make sure you understand

exactly what the question is asking, and whether each question part has to be answered in the context of

the scenario or is more general You also need to be sure that you understand all the tasks that the

question is asking you to perform

Remember that every word will be important If for example you are asked to 'Explain the importance of

identifying all risks that Company X is facing', then you would explain that:

 Taking risks is bound up with strategic decision-making

 Some risks may have serious consequences

 Identifying all risks means they can be prioritised and managed efficiently and effectively

You would not identify all the risks that Company X would be facing

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4.2 Understanding the question verbs

In the report for the first P1 exam, the examination team highlighted lack of understanding of the requirements of question verbs as the most serious weakness in many candidates' scripts The examination team will use question verbs very deliberately to signal what is required

Verbs that are likely to be frequently used in this exam are listed below, together with their intellectual levels and guidance on their meaning

Intellectual level

2 Distinguish Define two different terms, viewpoints or concepts on the

basis of the differences between them

3 Criticise Present the weaknesses of/problems with the actions

taken or viewpoint expressed, supported by evidence

evaluate

Determine the value of in the light of the arguments for and against (critically evaluate means weighting the answer towards criticisms/arguments against)

3 Construct the case Present the arguments in favour or against, supported by

evidence

3 Recommend Advise the appropriate actions to pursue in terms the

recipient will understand

A lower-level verb such as define will require a more descriptive answer A higher-level verb such as

evaluate will require a more applied, critical answer The examination team has stressed that level requirements and verbs will be most significant in this paper; for example, critically evaluating a

higher-statement and arguing for or against a given idea or position The examination team aims to set questions that provide evidence of student understanding

Certain verbs have given students particular problems

(a) Identify and explain

Although these verbs are both Level 1, the examination team sees them as requiring different things You have to go into more depth if you are asked to explain than if you are asked to identify

An explanation means giving more detail about the problem or factor identified, normally meaning that you have to indicate why it's significant If you were asked to:

(i) Identify the main problem with the same person acting as chief executive and chairman

– you would briefly say excessive power is exercised by one person

(ii) Explain the main problem with the same person acting as chief executive and chairman

– you would say excessive power is exercised by one person and then go on to say it would

mean that the same person was running the board and the company As the board is meant

to monitor the chief executive, it can't do this effectively if the chief executive is running the

board You may also be asked to explain or describe something complex, abstract or

philosophical in nature

(b) Evaluate

Evaluate is a verb that the examination team uses frequently Its meaning may be different from the

way that you have seen it used in other exams The examination team expects to see arguments for

and against, or pros and cons for what you are asked to evaluate

Thus for example if a question asked you to: 'Evaluate the contribution made by non-executive

directors to good corporate governance in companies', you would not only have to write about the

factors that help non-executive directors make a worthwhile contribution (independent viewpoint,

experience of other industries) but you would also have to discuss the factors that limit or

undermine the contribution non-executive directors make (lack of time, putting pressure on board

unity)

If the examination team asks you to critically evaluate, you will have to consider both viewpoints

However, you will concentrate on the view that you are asked to critically evaluate, as the mark

scheme will be weighted towards that view

4.3 Analysing question scenarios

When reading through the scenario you need to think widely about how the scenario relates to the

underlying themes of the syllabus, and also important content from whatever areas of the syllabus the

question covers:

(a) Corporate governance

In questions on corporate governance, you are likely to be looking out for weaknesses in the

current arrangements and trying to recommend improvements that are line with governance best

practice

(b) Control systems

With control systems questions, you are most likely to be interested in the design and

appropriateness of the control systems, whether there are obvious shortcomings with them, and

also details of the control environment

(c) Culture

If you are asked about the organisation's culture and ethos, you should be looking for evidence of

directors' views and actions and for signs of how the tone is being set at the top of the

organisation You should also look for evidence of how the ethos is being established further down

the organisation, in particular how the organisation's culture, systems, procedures, reward

mechanisms, human resource policies and training are used to embed the tone of the

organisation

(d) Risks

With risks you are looking for the most significant ones If these are not highlighted, you should

look for the risks that are connected with the organisation's strategy or which relate to

significant changes that the organisation and its business environment are going through, or are

about to go though You should also try to determine the extent to which risk awareness is

embedded in the organisation's culture

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(e) Risk management

If you are asked how organisations should respond to particular risks, you'll need to use the

scenario detail to determine how serious these risks are, and suggest responses that are relevant to counter the risks and appropriate for the organisation It's no use, for example, suggesting that the

organisation sets up a large risk management function if it is not big enough to warrant one

(f) Ethics

With ethical issues you are not just looking to determine the ethical issues at stake You also

need to consider the ethical position of the organisation and individuals and the factors that determine the ethical position These will be significant when you think about solutions to the

ethical problems

(g) Framework

Look out in any question scenarios or frameworks for hints that you may have to provide a critique

of the overall framework or model that is being operated If you're basing your answer on content

from corporate governance or ethical codes, will you have to criticise the principles or rules on which they are founded If you have to make recommendations that benefit shareholders, consider whether the shareholders' viewpoint is the most valid or if other stakeholders' interests should be taken into account

4.4 Consider the moral and ethical frameworks The examination team has stressed that these will affect the judgements you make when answering questions as they do in real life In particular, the stakeholders affected by business and strategic decisions and whether some stakeholders are being favoured over others need to be considered

Remember, the exam is designed to make you take a questioning approach to wide issues, and this may mean having to argue in favour of a viewpoint with which you don't agree

4.5 Content of answers

Well-judged, clear recommendations grounded in the scenario will always score well as markers for this

paper have a wide remit to reward good answers You need to be selective As we've said, lists of points

memorised from texts and reproduced without any thought won't score well

The examination team identified lack of application skills as a serious weakness in many student answers

What constitutes good application will vary question by question but is likely to include:

 Only including technical knowledge that is relevant to the scenario; for example, although the

SPAMSOAP mnemonic can be a useful memory aid, you shouldn't quote it in full just because the question requirements contain the word 'control'

 Only including scenario details that support the points you are making, for example quoting from

the scenario to explain why you're making a particular recommendation

 Tackling the problems highlighted in the scenario and the question requirements

 Explaining why the factors you're discussing are significant

 Taking a top-down strategic approach – remember that at Professional level you're meant to be

adopting the viewpoint of a partner or finance director and that excessive detail about operations is not important

5 Gaining professional marks

As P1 is a Professional level paper, four or five professional level marks will be awarded in the

compulsory question The examination team has stated that some marks may be available for presenting

your answer in the form of a letter, presentation, memo, report, briefing notes, management reporting,

narrative or press statement You may also be able to obtain marks for the layout, logical flow and

presentation of your answer You should also make sure that you provide the points required by the

question

Whatever the form of communication requested, you will not gain professional marks if you fail to follow

the basics of good communication Keep an eye on your spelling and grammar Also think carefully, am I

saying things that are appropriate in a business communication?

6 Brought forward knowledge

You will have covered some of the corporate governance, company law and ethics contents of P1 in law

and auditing papers that you have previously sat

However, because the students studying this paper will have sat different variants of the law and auditing

exams, this text includes full coverage of the knowledge you need for this exam even though some of it

has been covered in other exams

Knowledge brought forward from F9 on ways of quantifying risks and uncertainty and expected results

may also be helpful You may also have to use the techniques for interpreting financial information that

you covered in F7

7 ACCA ethics module

We would strongly recommend that you sit the module before taking P1 The module will give you

insights to a range of ethical perspectives that will be valuable in your professional career, and will also

assist you in tackling the ethics content of the P1 syllabus and indeed the syllabuses of other Professional

The exam paper Format of the paper The exam is a three-hour paper, with 15 minutes' reading time, consisting of two sections

Number of marks

100 Section A will be a compulsory case study question with typically four or five sub-requirements relating to the same scenario information The question will usually assess and link a range of subject areas across the syllabus It will require students to demonstrate high-level capabilities to understand the complexities

of the case and evaluate, relate and apply the information in the case study to the requirements

The case study will be between 400 and 700 words long The examination team has stressed the importance of reading the case in detail, taking notes as appropriate and getting a feel for what the issues are Scenarios may be drawn from any situation involving aspects of governance This is likely to be, but need not be, in an organisational setting

Professional marks will be available in Section A for presentation, logical flow of argument and quality of argument

Section B questions are more likely to assess a range of discrete subject areas from the main syllabus section headings They may require evaluation and synthesis of information contained within short scenarios and application of this information to the question requirements

Although one subject area is likely to be emphasised in each Section B question, students should not assume that questions will be solely about content from that area Each question will be based on a shorter case scenario to contextualise the question

The paper will have a global focus

The exam may include some simple arithmetic calculations Students should not expect complicated calculations but should be prepared to manipulate numerical data, and accordingly a calculator may be helpful

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Analysis of past papers

The table below provides details of when each element of the syllabus has been examined in exams since

June 2008 and the question number and section in which each element appeared Further details can be

found in the Exam Focus Points in the relevant chapters

3b, 4a 4c 4b, 3c,

c

2b 1d, 4c 3b 1c, 2a,

b, c

1e, 3a,

d 2c 3c

1b, 3c 1c 5,7,8 Risk

Covered

in Text

CONTROLLING AND MANAGING RISK

5,8 Risk targeting and monitoring

PROFESSIONAL VALUES, ETHICS AND SOCIAL RESPONSIBILITY

4c 9,11 Different

approaches to ethics and social responsibility

b, c

10 Professions and the public interest

10 Professional practice and codes of ethics

b

10 Conflicts of interest and consequences of unethical behaviour

1b

9,10 Ethical characteristics of professionalism

11 Integrated reporting and sustainability

Syllabus and study guide

The P1 syllabus and study guide can be found below

Syllabus

AB (F1)

GRE (P1)

Professional

Ethics Module

Professional papers

AA (F8)

AIM

To apply relevant knowledge, skills and exercise

professional judgement in carrying out the role of

the accountant relating to governance, internal

control, compliance and the management of risk

within an organisation, in the context of an overall

ethical framework

MAIN CAPABILITIES

On successful completion of this paper, candidates should be able to:

A Define governance and explain its function

in the effective management and control of organisations and of the resources for which they are accountable

B Evaluate the Professional Accountant’s role

in internal control, review and compliance

C Explain the role of the accountant in identifying and assessing risk

D Explain and evaluate the role of the accountant in controlling and mitigating risk

E Demonstrate the application of professional values and judgement through an ethical framework that is in the best interests of society and the profession, in compliance with relevant professional codes, laws and regulations

RELATIONAL DIAGRAM OF MAIN CAPABILITIES

Professional values, ethics and social responsibility (E)(E)

Governance and responsibility (A)(A)

Internal control andreview (B)B)

Identifying, assessing andcontrolling risk (C and D)(C and D)

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RATIONALE

The syllabus for Paper P1, Governance, Risk and

professional level It sets the other Essentials andOptions papers into a wider professional,organisational, and societal context

The syllabus assumes essential technical skills and knowledge acquired at the Fundamentals level where the core technical capabilities will have been acquired, and where ethics, corporate governance, internal audit, control, and risk will have been introduced in a subject-specific context

The GRE syllabus begins by examining the whole area of governance within organisations in the broad context of the agency relationship This aspect of the syllabus focuses on the respective roles and responsibilities of directors and officers to organisational stakeholders and of accounting and auditing as support and control functions

The syllabus then explores internal review, control, and feedback to implement and support effective governance, including compliance issues related to decision-making and decision-support functions

The syllabus also examines the whole area of identifying, assessing, and controlling risk as a key aspect of responsible management

Finally, the syllabus covers personal and professional ethics, ethical frameworks – and professional values – as applied in the context of the accountant’s duties and as a guide to appropriate professional behaviour and conduct in a variety of situations

DETAILED SYLLABUS

A Governance and responsibility

1 The scope of governance

2 Agency relationships and theories

3 The board of directors

8 Governance: reporting and disclosure

9 Public sector governance

B Internal control and review

1 Management control systems in corporate governance

2 Internal control, audit and compliance in corporate governance

3 Internal control and reporting

4 Management information in audit and internal control

C Identifying and assessing risk

1 Risk and the risk management process

2 Categories of risk

3 Identification, assessment and measurement of risk

D Controlling risk

1 Targeting and monitoring risk

2 Methods of controlling and reducing risk

3 Risk avoidance, retention and modelling

E Professional values, ethics and social responsibility

1 Ethical theories

2 Different approaches to ethics and social responsibility

3 Professions and the public interest

4 Professional practice and codes of ethics

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5 Conflicts of interest and the consequences of

unethical behaviour

6 Ethical characteristics of professionalism

7 Social and environmental issues in the

conduct of business and of ethical behaviour

APPROACH TO EXAMINING THE SYLLABUS

The syllabus will be assessed by a three-hour

paperbased examination The examination paper will

be structured in two sections Section A will be

based on a case study style question comprising a

compulsory 50-mark question, with requirements

based on several parts with all parts relating to the

same case information The case study will usually

assess a range of subject areas across the syllabus

and will require the candidate to demonstrate high

level capabilities to evaluate, relate and apply the

information in the case study to several of the

requirements

Section B comprises three questions of 25 marks

each, of which candidates must answer two These

questions will be more likely to assess a range of

discrete subject areas from the main syllabus

section headings, but may require application,

evaluation and the synthesis of information

contained within short scenarios in which some

requirements may need to be contextualised

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Study Guide

A GOVERNANCE AND RESPONSIBILITY

1 The scope of governance

a) Define and explain the meaning of corporate governance.[2]

b) Explain, and analyse the issues raised by the development of the joint stock company as the dominant form of business organisation and the separation of ownership and control over business activity.[3]

c) Analyse the purposes and objectives of corporate governance in the public and private sectors.[2]

d) Explain, and apply in context of corporate governance, the key underpinning concepts

of [3]

i) Fairness ii) Openness/transparency iii) Innovation

iv) Scepticism iii) Independence iv) Probity/honesty v) Responsibility vi) Accountability vii) Reputation viii) Judgment ix) Integrity e) Explain and assess the major areas of organisational life affected by issues in corporate governance.[3]

i) Duties of directors and functions of the board (including setting a responsible ‘tone’ from the top and being accountable for the

performance and impacts of the organisation)

ii) The composition and balance of the board (and board committees) iii) Relevance and reliability of corporate reporting and external auditing iv) Directors’ remuneration and rewards v) Responsibility of the board for risk management systems and internal control

vi) The rights and responsibilities of shareholders, including institutional investors

vii) corporate social responsibility and business ethics

f) Compare, and distinguish between public, private and non-governmental

organisations (NGO) sectors with regard to the issues raised by, and scope of, governance.[3]

g) Explain and evaluate the roles, interests and claims of, the internal parties involved in corporate governance.[3]

i) Directors ii) Company secretaries iii) Sub-board management iv) Employee representatives (eg trade unions)

h) Explain and evaluate the roles, interests and claims of, the external parties involved in corporate governance.[3]

i) Shareholders (including shareholders’ rights and responsibilities) ii) Auditors iii) Regulators iv) Government

vi) Small investors (and minority rights) vii) Institutional investors (see also next point)

i) Analyse and discuss the role and influence

of institutional investors in corporate governance systems and structures, for example the roles and influences of pension funds, insurance companies and mutual funds.[2]

2 Agency relationships and theories

a) Define and explore agency theory.[2]

b) Define and explain the key concepts in agency theory.[2]

i) Agents ii) Principals iii) Agency iv) Agency costs

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v) Accountability

vi) Fiduciary responsibilities

vii) Stakeholders

c) Explain and explore the nature of the

principal-agent relationship in the context of

corporate governance.[3]

d) Analyse and critically evaluate the nature of

agency accountability in agency

relationships.[3]

e) Explain and analyse the following other

theories used to explain aspects of the

agency relationship.[2]

i) Transaction costs theory

ii) Stakeholder theory

3 The board of directors

a) Explain and evaluate the roles and

responsibilities of boards of directors.[3]

b) Describe, distinguish between and evaluate

the cases for and against, unitary and

two-tier board structures.[3]

c) Describe the characteristics, board

composition and types of, directors

(including defining executive and

non-executive directors (NED).[2]

d) Describe and assess the purposes, roles and

responsibilities of NEDs.[3]

e) Describe and analyse the general principles

of legal and regulatory frameworks within

which directors operate on corporate

boards.[2]

i) Legal rights and responsibilities

ii) Time-limited appointments

iii) Retirement by rotation

iv) Service contracts

v) Removal

vi) Disqualification

vii) Conflict and disclosure of interests

viii) Insider dealing/trading

f) Define, explore and compare the roles of the

chief executive officer and company

chairman.[3]

g) Describe and assess the importance and

execution of, induction and continuing

professional development of directors on

boards of directors.[3]

h) Explain and analyse the frameworks for assessing the performance of boards and individual directors (including NEDs) on boards.[2]

i) Explain the meanings of ‘diversity’ and critically evaluate issues of diversity on boards of directors.[3]

4 Board committees

a) Explain and assess the importance, roles and accountabilities of, board committees

in corporate governance.[3]

b) Explain and evaluate the role and purpose

of the following committees in effective corporate governance.[3]

i) Remuneration committees ii) Nominations committees iii) Risk committees

iv) Audit committees

5 Directors’ remuneration

a) Describe and assess the general principles

of remuneration [3]

i) Purposes ii) Components iii) Links to strategy iv) Links to labour market conditions

b) Explain and assess the effect of various components of remuneration packages on directors’ behaviour [3]

ii) Performance related iii) Shares and share options iv) Loyalty bonuses v) Benefits in kind vi) Pension benefits c) Explain and analyse the legal, ethical, competitive and regulatory issues associated with directors’ remuneration.[3]

6 Different approaches to corporate governance

a) Describe and compare the essentials of

‘rules’ and ‘principles’ based approaches to corporate governance Includes discussion

of ‘comply or explain’.[3]

b) Describe and analyse the different models

of business ownership that influence different governance regimes (eg family firms versus joint stock company-based models).[2]

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c) Describe and critically evaluate the reasons behind the development and use of codes of practice in corporate governance

(acknowledging national differences and convergence).[3]

d) Explain and briefly explore the development

of corporate governance codes in based jurisdictions.[2]

principles-i) Impetus and background ii) Major corporate governance codes iii) Effects of

e) Explain and explore the Sarbanes-Oxley Act (2002) as an example of a rules-based approach to corporate governance.[2]

i) Impetus and background ii) Main provisions/contents iii) Effects of

f) Describe and explore the objectives, content and limitations of, corporate governance codes intended to apply to multiple national jurisdictions.[2]

i) Organisation for economic cooperation and development (OECD) Report (2004)

ii) International corporate governance network (ICGN) Report (2005)

7 Corporate governance and corporate social responsibility

a) Explain and explore social responsibility in the context of corporate governance.[2]

b) Discuss and critically assess the concept of stakeholder power and interest using the Mendelow model and how this can affect strategy and corporate governance.[3]

c) Analyse and evaluate issues of ‘ownership,’

‘property’ and the responsibilities of ownership in the context of shareholding.[3]

d) Explain the concept of the organisation as a corporate citizen of society with rights and responsibilities.[3]

8 Governance: reporting and disclosure

a) Explain and assess the general principles of disclosure and communication with shareholders.[3]

b) Explain and analyse ‘best practice’ corporate governance disclosure requirements.[2]

c) Define and distinguish between mandatory and voluntary disclosure of corporate information in the normal reporting cycle.[2]

d) Explain and explore the nature of, and reasons and motivations for, voluntary disclosure in a principles-based reporting environment (compared to, for example, the reporting regime in the USA).[3]

e) Explain and analyse the purposes of the annual general meeting and extraordinary general meetings for information exchange between board and shareholders.[2]

f) Describe and assess the role of proxy voting in corporate governance.[3]

9 Public sector governance

a) Describe, compare and contrast public sector, private sector, charitable status and nongovernmental (NGO and quasi-NGOs) forms of organisation, including purposes and objectives, performance, ownership and stakeholders (including lobby groups)[2]

b) Describe, compare and contrast the different types of public sector organisations at subnational, national and supranational level[2]

c) Assess and evaluate the strategic objectives, leadership and governance arrangements specific to public sector organisations as contrasted with private sector[3]

d) Discuss and assess the nature of democratic control, political influence and policy implementation in public sector organisations including the contestable nature of public sector policy[3] e) Discuss obligations of the public sector organisations to meet the economy, effectiveness, efficiency (3 E’s) criteria and promote public value[3]

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B INTERNAL CONTROL AND REVIEW

1 Management control systems in corporate

governance

a) Define and explain internal management

control.[2]

b) Explain and explore the importance of

internal control and risk management in

corporate governance.[3]

c) Describe the objectives of internal control

systems and how they can help prevent fraud

and error.[2]

d) Identify, explain and evaluate the corporate

governance and executive management roles

in risk management (in particular the

separation between responsibility for

ensuring that adequate risk management

systems are in place and the application of

risk management systems and practices in

the organisation).[3]

e) Identify and assess the importance of the

elements or components of internal control

b) Explain, and discuss the importance of,

auditor independence in all client-auditor

situations (including internal audit).[3]

c) Explain, and assess the nature and sources

of risks to, auditor independence Assess the

hazard of auditor capture.[3]

d) Explain and evaluate the importance of

compliance and the role of the internal audit

function in internal control.[3]

e) Explore and evaluate the effectiveness of

internal control systems.[3]

f) Describe and analyse the work of the internal

audit committee in overseeing the internal

audit function.[2]

g) Explain and explore the importance and characteristics of, the audit committee’s relationship with external auditors.[2]

3 Internal control and reporting

a) Describe and assess the need to report on internal controls to shareholders.[3]

b) Describe the content of a report on internal control and audit.[2]

c) Explain and assess how internal controls underpin and provide information for accurate financial reporting.[3]

4 Management information in audit and internal control

a) Explain and assess the need for adequate information flows to management for the purposes of the management of internal control and risk.[3]

b) Evaluate the qualities and characteristics of information required in internal control and risk management and monitoring.[3]

C IDENTIFYING AND ASSESSING RISK

1 Risk and the risk management process

a) Define and explain risk in the context of corporate governance.[2]

b) Define and describe management responsibilities in risk management.[2]

c) Explain the dynamic nature of risk assessment.[2]

d) Explain the importance and nature of management responses to changing risk assessments.[2]

e) Explain risk appetite and how this affects risk policy.[2]

2 Categories of risk

a) Define and compare (distinguish between) strategic and operational risks.[2]

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b) Define and explain the sources and impacts

of common business risks.[2]

i) Market ii) Credit iii) Liquidity iv) Technological v) Legal vi) Health, safety and environmental vii) Reputation

viii) Business probity ix) Derivatives c) Describe and evaluate the nature and importance of business and financial risks.[3]

d) Recognise and analyse the sector or industry specific nature of many business risks.[2]

3 Identification, assessment and measurement of risk

a) Identify, and assess the impact upon, the stakeholders involved in business risk.[3]

b) Explain and analyse the concepts of assessing the severity and probability of risk events.[2]

c) Describe and evaluate a framework for board level consideration of risk.[3]

d) Describe the process of and importance of, externally reporting on internal control and risk.[2]

e) Explain the sources, and assess the importance of, accurate information for risk management.[3]

f) Explain and assess the ALARP (as low as reasonably practicable) principle in risk assessment and how this relates to severity and probability.[3]

g) Evaluate the difficulties of risk perception including the concepts of objective and subjective risk perception.[3]

h) Explain and evaluate the concepts of related and correlated risk factors.[3]

D CONTROLLING AND MANAGING RISK

1 Targeting and monitoring of risk

a) Explain and assess the role of a risk manager in identifying and monitoring risk.[3]

b) Explain and evaluate the role of the risk committee in identifying and monitoring risk.[3]

c) Describe and assess the role of internal or external risk auditing in monitoring risk.[3]

2 Methods of controlling and reducing risk

a) Explain the importance of risk awareness at all levels in an organisation.[2]

b) Describe and analyse the concept of embedding risk in an organisation’s systems and procedures.[3]

c) Describe and evaluate the concept of embedding risk in an organisation’s culture and values.[3]

d) Explain and analyse the concepts of spreading and diversifying risk and when this would be appropriate.[2]

e) Identify and assess how business organisations use policies and techniques

to mitigate various types of business and financial risks.[3]

3 Risk avoidance, retention and modelling

a) Explain, and assess the importance of, risk transference, avoidance, reduction and acceptance.[3]

b) Explain and evaluate the different attitudes

to risk and how these can affect strategy.[3]

c) Explain and assess the necessity of incurring risk as part of competitively managing a business organisation.[3]

d) Explain and assess attitudes towards risk and the ways in which risk varies in relation

to the size, structure and development of an organisation [3]

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E PROFESSIONAL VALUES, ETHICS AND

SOCIAL RESPONSIBILITY

1 Ethical theories

a) Explain and distinguish between the ethical

theories of relativism and absolutism.[2]

b) Explain, in an accounting and governance

context, Kohlberg’s stages of human moral

d) Apply commonly used ethical

decision-making models in accounting and

professional contexts [2]

i) American Accounting Association

model

ii) Tucker’s 5-question model

2 Different approaches to ethics and social

responsibility

a) Describe and evaluate Gray, Owen & Adams

(1996) seven positions on social

responsibility.[2]

b) Describe and evaluate other constructions of

corporate and personal ethical stance.[2]

i) Short-term shareholder interests

ii) Long-term shareholder interests

iii) Multiple stakeholder obligations

iv) Sshaper of society

c) Describe and analyse the variables

determining the cultural context of ethics and

corporate social responsibility (CSR).[2]

d) Explain and evaluate the concepts of 'CSR

strategy' and 'strategic CSR'.[2]

3 Professions and the public interest

a) Explain and explore the nature of a

‘profession’ and ‘professionalism’.[2]

b) Describe and assess what is meant by ‘the

public interest’.[2]

c) Describe the role of, and assess the widespread influence of, accounting as a profession in the organisational context.[3]

d) Analyse the role of accounting as a profession in society.[2]

e) Recognise accounting’s role as a laden profession capable of influencing the distribution of power and wealth in society.[3]

value-f) Describe and critically evaluate issues surrounding accounting and acting against the public interest.[3]

4 Professional practice and codes of ethics

a) Describe and explore the areas of behaviour

covered by corporate codes of ethics.[3]

b) Describe and assess the content of, and

principles behind, professional codes of

b) Explain and evaluate the nature and impacts

of ethical threats and safeguards.[3]

c) Explain and explore how threats to independence can affect ethical behaviour.[3]

d) Explain and explore 'bribery' and 'corruption' in the context of corporate governance, and assess how these can undermine confidence and trust [3]

e) Describe and assess best practice measures for reducing and combating bribery and corruption, and the barriers to implementing such measures.[3]

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6 Ethical characteristics of professionalism

a) Explain and analyse the content and nature of ethical decision-making using content from Kohlberg’s framework as appropriate.[2]

b) Explain and analyse issues related to the application of ethical behaviour in a professional context.[2]

c) Describe and discuss ‘rules based’ and

‘principles based’ approaches to resolving ethical dilemmas encountered in professional accounting.[2]

7 Integrated reporting and sustainability issues in the conduct of business

a) Explain and assess the concept of integrated reporting and evaluate the issues concerning accounting for sustainability (including the alternative definitions of capital.[3]

(i) Financial (ii) Manufactured (iii) Intellectual (iv) Human (v) Social and relationship (vi) Natural

b) Describe and assess the social and environmental impacts that economic activity can have (in terms of social and

environmental ‘footprints’ and environmental reporting)).[3]

c) Describe the main features of internal management systems for underpinning environmental and sustainability accounting such as EMAS and ISO 14000.[1]

d) Explain and assess the typical content elements and guiding principles of an integrated report, and discuss the usefulness

of this information to stakeholders.[3]

e) Explain the nature of social and environmental audit and evaluate the contribution it can make to the assurance of integrated reports [3]

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SUMMARY OF CHANGES TO P1

ACCA annually reviews its qualification so that they fully meet the needs of stakeholders including

employers, students, regulatory and advisory bodies and learning providers These syllabus changes are

effective from September 2015 and thereafter will be updated with effect from 1st September each year,

from September 2016 onwards

The changes are introduced to the syllabus to reflect the latest business and educational developments

affecting this paper These are summarised in the table below

A1c) amended to include private sector c) Analyse the purposes and objectives of

corporate governance in the public and private sectors.[2]

A7b) amended to include the Mendelow matrix A7b) Discuss and critically assess the concept of

stakeholder power and interest using the Mendelow model and how this can affect strategy and corporate governance.[3]

New A9e) added to include examination of the 3 Es

and public value in public sector governance

A9e) Discuss obligations of the public sector organisations to meet the economy, effectiveness, efficiency (3 E’s) criteria and promote public value[3]

B1c) amended to make more explicit reference to

fraud and error in respect of internal control

B1 c) Describe the objectives of internal control systems and how they can help prevent fraud and error.[2]

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Governance and responsibility

P A R T A

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Topic list Syllabus reference

1 Definitions of corporate governance A1

2 Corporate governance and agency theory A2

We start this Text by discussing corporate governance, a fundamental topic in this

paper You have encountered corporate governance already in your law and auditing

studies, but this syllabus requires a deeper understanding of what has driven the

development of corporate governance codes over the last 15 years

We start by looking at the principles that underpin corporate governance codes Some

will be familiar from what you have learnt about ethics in auditing We shall examine

ethics in detail in Part C of this Text, but you'll find that certain ethical themes recur

throughout this book

In Section 2 we show how corporate governance has partly developed in response to

the problem of agency – the difficulty of ensuring that shareholders are able to

exercise sufficient control over directors and managers, their agents In Section 3 we

consider the interests of other stakeholders in corporate governance As we shall see

in later chapters, a key issue in the development of corporate governance is how

much, if at all, directors/managers have a responsibility to consider the interests of

stakeholders other than shareholders The examiner has stressed the need for

understanding that business decisions are affected by, and can affect, many people

inside and outside the business

In the last section we introduce other major corporate governance issues We shall

see how corporate governance guidelines address these in the next two chapters

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Study guide

Intellectual level

A1 The scope of governance

(b) Explain and analyse the issues raised by the development of the joint stock

company as the dominant form of business organisation and the separation of ownership and control over business activity

3

(c) Analyse the purpose and objectives of corporate governance in the public

(d) Explain and apply in the context of corporate governance the key

(e) Explain and assess the major areas of organisational life affected by issues

(f) Compare and distinguish between public, private and non-governmental

organisations (NGOs) with regard to the issues raised by, and the scope

of, governance

3

(g) Explain and evaluate the roles, interests and claims of the internal parties

(h) Explain and evaluate the roles, interests and claims of the external parties

(i) Analyse and discuss the role and influence of institutional investors in

corporate governance systems and structures, for example the roles and influences of pension funds, insurance companies and mutual funds

2

A2 Agency relationships and theories

(c) Explain and explore the nature of the principal-agent relationship in the

(d) Analyse and critically evaluate the nature of agency accountability in

(e) Explain and analyse the following other theories used to explain aspects of

the agency relationship: Transactions cost theory and Stakeholder theory 2

A7 Corporate governance and corporate social responsibility

(b) Discuss and critically assess the concept of stakeholder power and

interest using the Mendelow model and how this can affect strategy and corporate governance

3

Exam guide You may be asked about the significance of the underlying concepts in Section 1, or to analyse a corporate governance scenario in terms of the agency responsibilities directors or auditors have towards various stakeholders, given the claims the stakeholders have on the organisation Questions may also examine the roles of other participants in corporate governance Questions will not always be about listed companies

They will also cover public sector organisations and charities The issues highlighted in the last section could well be important problems in a scenario question To quote the examiner: 'Most questions will involve some focus on, or connection with, the stakeholders and how their agents act on their behalf

Students will have to identify the relevant stakeholders primarily by assessing their power and interest.'

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1 Definitions of corporate governance 12/12

Corporate governance, the system by which organisations are directed and controlled, is based on a

number of concepts, including transparency, independence, accountability and integrity

1.1 What is corporate governance?

Corporate governance is the system by which organisations are directed and controlled (Cadbury report)

Corporate governance is a set of relationships between a company's directors, its shareholders and

other stakeholders It also provides the structure through which the objectives of the company are set, and the means of achieving those objectives and monitoring performance, are determined (OECD)

An exam question on corporate governance might start by asking you to define what corporate governance is

A number of comments can be made about these definitions of corporate governance

(a) The management, awareness, evaluation and mitigation of risk are fundamental in all definitions

of good governance This includes the operation of an adequate and appropriate system of control

(b) The notion that overall performance is enhanced by good supervision and management within set best practice guidelines underpins most definitions

(c) Good governance provides a framework for an organisation to pursue its strategy in an ethical and effective way and offers safeguards against misuse of resources, human, financial, physical or

intellectual

(d) Good governance is not just about externally established codes; it also requires a willingness to

apply the spirit as well as the letter of the law

(e) Good corporate governance can attract new investment into companies, particularly in developing

nations It should mean that shareholders can trust those responsible for running and monitoring

the company

(f) Accountability is generally a major theme in all governance frameworks, including accountability

not just to shareholders but also to other stakeholders, and accountability not just by directors but

by auditors as well

(g) Corporate governance underpins capital market confidence in companies and in the

government/regulators/tax authorities that administer them It helps protect the value of shareholders' investment

1.1.1 History of governance Governance focuses on ownership because ownership, and therefore financing, results in businesses being formed and expanded Different systems of governance are seen as best practice in different countries, as we shall see later in this text However, much of the governance debate has been seen in the context of the so-called Anglo-Saxon model where ownership and management are separate, and companies can obtain a listing on a stock exchange where their shares are bought and sold

1.1.2 Governance in companies and non-governmental organisations Although mostly discussed in relation to large quoted companies, governance is an issue for all corporate bodies, commercial and not for profit, including public sector and non-governmental organisations There are certain ways in which companies might differ from other types of organisation, such as their

ownership (principals), their mission and the legal/regulatory environment within which they operate

Public sector organisations are organisations that are controlled by one or more parts of the state Their

functions are often to implement government policy in secretarial or administration areas Some are

supervised by government departments (for example hospitals or schools) Others are devolved bodies, such as local authorities, nationalised companies (majority or all of the shares owned by the Government), supranational bodies or non-governmental organisations

These organisations are in the public sector because the control over a particular public service, utility or public good is seen as so important that it cannot be left to the profit-motivated sector, which may for example seek to close socially vital loss-making services, such as bus routes

Objectives will be determined by the political leaders in line with government policy They are likely to focus on value for money and service delivery objectives, possibly underpinned by legislation The level

of control may be high, leading to accusations of excess bureaucracy and cost

In many countries there are thousands of charities and voluntary organisations that exist to fulfil a particular purpose, maybe social, environmental, religious or humanitarian Funds are raised to support that purpose Charities are not owned as such, but will be primarily responsible to the donors of funds and

the beneficiaries (those who receive money or other aid) out of the charities' resources Charities will be

subject to their own legal regime that grants privileges (for example tax concessions) but imposes requirements on how funds can be spent and the charities' assets managed

As well as being crucial to passing P1, you also need to be able to define governance and explain its function as part of the effective management and control of organisations to fulfil performance objective 2

of your PER

1.2 Corporate governance concepts One view of governance is that it is based on a series of underlying concepts

1.2.1 Fairness The directors' deliberations and also the systems and values that underlie the company must be balanced

by taking into account everyone who has a legitimate interest in the company, and respecting their rights and views In many jurisdictions, corporate governance guidelines reinforce legal protection for certain groups, for example minority shareholders It should mean the company deals even-handedly with others

Transparency means open and clear disclosure of relevant information to shareholders and other

stakeholders, as well as not concealing information when it may affect decisions It means open discussions and a default position of information provision rather than concealment

Disclosure in this context obviously includes information in the financial statements, not just the

numbers and notes to the accounts but also narrative statements such as the directors' report and the operating and financial or business review It also includes all voluntary disclosure; that is, disclosure

above the minimum required by law or regulation Voluntary corporate communications include management forecasts, analysts' presentations, press releases, information placed on websites and other reports such as standalone environmental or social reports

The main reason why transparency is so important relates to the agency problem that we shall discuss in

Section 2, the potential conflict between owners and managers Without effective disclosure the position could be unfairly weighted towards managers, since they have far more knowledge of the company's activities and financial situation than the owner/investors Avoidance of this information asymmetry

requires not only effective disclosure rules but also strong internal controls that ensure the information that is disclosed is reliable Information also needs to be published in sufficient detail to meet the needs

of shareholders/owners Publication of abbreviated information may be counter-productive and may give the impression of concealment rather than openness

Linked with the agency issue, publication of relevant and reliable information reassures investors and underpins stock market confidence in how companies are being governed and thus significantly

influences market prices International accounting standards and stock market regulations based on

corporate governance codes require information published to be true and fair Information can only fulfil

this requirement if adequate disclosure is made of uncertainties and adverse events It is therefore clear that financial data will be insufficient without supporting explanation

Circumstances where concealment may be justified include discussions about future strategy (knowledge

of which would benefit competitors), confidential issues relating to individuals and discussions leading to

an agreed position that is then made public

Case Study

Ethics guru Chris Macdonald has raised a number of issues with the concept of transparency

1 The requirement of transparency to check how directors (agents) are doing indicates a big problem with governance If shareholders had complete confidence in directors, there would be no concern about transparency

2 Transparency assumes that those who receive information are well informed but problems may arise through misinterpretation The example quoted was a hospital executive being criticised for having the perk of expensive membership of an exclusive private club However, if the executive was responsible for fundraising, the club would provide networking opportunities with members who could make large donations to the hospital

3 In the context of directors' remuneration (discussed in Chapter 3) evidence suggests that full transparency can ratchet up average reward A chief executive, seeing how much other chief executives in their sector are earning, may want their rewards to match theirs A remuneration committee may regard the fact that its chief executive is earning below average remuneration as poor publicity for the chief executive and the company

4 Full transparency of rewards of one type may lead to those in positions of trust to seek less visible, and perhaps more costly, rewards For example, the 2009 scandal about excessive expenses being claimed by UK Members of Parliament was linked to the political unacceptability of increasing MPs' salaries significantly To head off a revolt by members, the Conservative Government in the 1980s introduced a big increase in members' expense allowances, with the minister responsible allegedly telling MPs 'go out boys and spend it.'

Weighing up transparency against confidentiality may be difficult and hence the examiner tests it regularly

Remember that sometimes there may be valid commercial reasons for keeping information away from those who may use it against the company On the other hand, greater transparency and providing a full explanation for controversial actions can be an effective means of responding to critics

1.2.3 Innovation The concept of innovation in the approach to corporate governance recognises the fact that the needs of businesses and stakeholders can change over time It also has an impact on how organisations respond to meeting the 'comply or explain' requirement contained in various codes of corporate governance that are currently in effect

1.2.4 Scepticism The UK Corporate Governance Code, under the heading of 'Leadership', encourages non-executive directors (NEDs) to adopt an air of scepticism so that they can effectively challenge management decisions in their role of scrutiny Applying professional scepticism is also an important part of the role of auditors and audit committees ISA 200 defines professional scepticism as: 'An attitude that includes a questioning mind, being alert to conditions which may indicate possible misstatement due to error or fraud, and a critical assessment of audit evidence.' This does not mean that all management decisions and evidence have to be approached with suspicion or mistrust; but rather that an open and enquiring mind

must always be employed A healthy corporate culture and environment is one that encourages and enables such scepticism to thrive

1.2.5 Independence

Independence is the avoidance of being unduly influenced by vested interests and free from any

constraints that would prevent a correct course of action being taken It is an ability to stand apart from inappropriate influences and be free of managerial capture, to be able to make the correct and

uncontaminated decision on a given issue

Independence is a quality that can be possessed by individuals and is an essential component of professionalism and professional behaviour

An important distinction generally with independence is independence of mind and independence of appearance

 Independence of mind means providing an opinion without being affected by influences

compromising judgement

 Independence of appearance means avoiding situations where an informed third party could

reasonably conclude that an individual's judgement would have been compromised

Independence is an important concept in relation to directors; in particular, freedom from conflicts of interest Corporate governance reports have increasingly stressed the importance of independent non- executive directors, directors who are not primarily employed by the company and who have very strictly

controlled other links with it They should be in a better position to promote the interests of shareholders and other stakeholders Freed from pressures that could influence their activities, independent non-

executive directors should be able to carry out effective monitoring of the company and its management

in conjunction with equally independent external auditors on behalf of shareholders

Non-executive directors' lack of links and limits on the time that they serve as non-executive directors should promote avoidance of managerial capture – accepting executive managers' views on trust

without analysing and questioning them

As you will remember from Paper F8, the independence of external auditors from their clients is also

important in corporate governance (covered further in Chapter 10) As the auditor is acting on behalf of the shareholders and not the client, close friendship with the client may influence the external auditor's

judgement, and mean that the external auditor is not effectively representing the shareholders' interests

Internal auditors also need to be independent of the colleagues whom they are auditing (discussed in

Why is the independence of external auditors so important?

Answer

(a) Shareholders and other stakeholders need a trustworthy record of directors' stewardship to be able

to take decisions about the company Assurance provided by independent auditors is a key quality control on reliability

(b) An unqualified report by independent external auditors on the accounts should give them more credibility, enhancing the appeal of the company to investors

(c) A lack of independence may mean that an effective audit is not done Thus the shareholders are not receiving value for the costs of the audit

(d) A lack of independence may lead to a failure to fulfil professional requirements Failure to do this undermines the credibility of the accountancy profession and the standards it enforces

1.2.6 Probity/honesty Hopefully this should be the most self-evident of the principles It relates to not only telling the truth but also not misleading shareholders and other stakeholders Lack of probity includes not only obvious examples of dishonesty, such as taking bribes, but also reporting information in a slanted way that is designed to give an unfair impression

Guidance in the UK charitable sector has defined probity in terms of receipt of gifts or hospitality by trustees The Code stresses that all gifts should be clearly recorded, and trustees should not accept gifts with a significant monetary value or lavish hospitality They should certainly not accept gifts or hospitality which may seem likely to influence their decisions

1.2.7 Responsibility Responsibility means management accepting the credit or blame for governance decisions It implies clear definition of the roles and responsibilities of the roles of senior management

The South African King report stresses that, for management to be held properly responsible, there must

be a system in place that allows for corrective action and penalising mismanagement Responsible

management should do, when necessary, whatever it takes to set the company on the right path

King states that the board of directors must act responsively to, and with responsibility towards, all stakeholders of the company However, the responsibility of directors to other stakeholders, both in terms

of to whom they are responsible and the extent of their responsibility, remains a key point of contention in

corporate governance debates We shall discuss the importance of stakeholders later in this chapter

The limits of responsibility and how responsibility is enforced will be a recurring theme throughout this text, developed further in:

 Chapters 2-3, on corporate governance

 Chapters 4-8, covering directors' responsibilities in respect of risk management and internal control

 Chapters 9-10, covering accountants' responsibilities to clients and society

 Chapter 11, covering corporate social responsibility

Corporate accountability refers to whether an organisation (and its directors) is answerable in some way

for the consequences of its actions

Directors being answerable to shareholders have always been an important part of company law, well before the development of the corporate governance codes For example, companies in many regimes have been required to provide financial information to shareholders on an annual basis and hold annual general meetings However, particularly because of the corporate governance scandals of the last 30

years, investors have demanded greater assurance that directors are acting in their interests This has led

to the development of corporate governance codes, which we shall consider in the next chapter

Making accountability work is the responsibility of both parties Directors, as we have seen, do so through

the quality of information that they provide whereas shareholders do so through their willingness to

exercise their responsibility as owners, which means using the available mechanisms to query and

assess the actions of the board

Public sector accountability

The accountability relationship will be different for bodies owned or run by national or central government

The nature of the relationship may be clear – that government determines objectives How accountability

is demonstrated and enforced may depend though on how coherent the objectives are The main problem will often be where the body's main objectives are non-economic, but the Government also wishes to limit the amount it spends on the body

As with responsibility, one of the biggest debates in corporate governance is the extent of management's

accountability towards other stakeholders, such as the community in which the organisation operates This

has led on to a debate that we shall discuss in Chapter 10 about the contents of accounts themselves

In the context of public service, the UK Nolan Committee on Standards in Public Life commented that

holders of public office are accountable for their decisions and actions to the public, and must submit

themselves to whatever scrutiny is appropriate for their office

A wider issue with the extent of accountability in the public sector is the extent of accountability towards different groups in society For example, politicians can be seen as being accountable to the body of

taxpayers as a whole – it is their interests that parliamentary bodies have been established to represent

However, politicians are also accountable to a group within the category of taxpayers – the voters who voted for them This raises the issue of what happens if the actions politicians take advantage their voters, but disadvantage other taxpayers More controversially, there is the issue of the extent to which politicians should be accountable to donors who pay significant sums to finance their political activities

The examiner has commented:

'When I say accountability, I mean companies to investors, professionals to their values, business systems to their stakeholders and so forth.'

These comments emphasise that accountability, like responsibility, is a topic that underpins much of the rest

of this text and will be a key feature in many exam questions The comments indicate that it is possible to be accountable to an abstract set of values However, much of the discussion about accountability focuses on the extent of accountability to stakeholders, particularly when stakeholder interests differ

Reputation is determined by how others view a person, organisation or profession Reputation includes a reputation for competence, supplying good quality goods and services in a timely fashion, and also being

managed in an orderly way However, a poor ethical reputation can be as serious for an organisation as a

poor reputation for competence

The consequences of a poor reputation for an organisation can include:

 Suppliers' and customers' unwillingness to deal with the organisation for fear of being victims of sharp practice

 Inability to recruit high-quality staff

 Fall in demand because of consumer boycotts

 Increased public relations costs because of adverse stories in the media

 Increased compliance costs because of close attention from regulatory bodies or external auditors

 Loss of market value because of a fall in investor confidence

Case Study

Over the past few years the American retail giant Wal-Mart has made efforts to improve its reputation in various ways These have included improving its labour and healthcare records, donating to not for profit organisations and promoting the case that it helps economic growth and provides healthy groceries This has partly been for strategic purposes, as the company has sought to open stores in cities in face of local hostility, due to the adverse effect on other local retailers

Unfortunately Wal-Mart's attempts to portray itself as more ethical have been undermined by a recent bribery scandal, as we shall see in Chapter 10

We shall see later on in this Text how risks to an organisation's reputation depend on how likely other risks are to crystallise