ADMINISTRATIVE CONTROL Governance Structure, Organizational Structure

By: Eka Darmadi Lim 3094802 Gerry Geraldo Y 3094806 Reni Handuweni 3104011 Isa Tridjojo 3105802 Class: Y

University of Surabaya Faculty of Business and Economics International Class (IBN & PA) 2012

Administrative Control Administrative control systems direct employee behavior through the organizing of individuals and groups, the monitoring of behavior and who you make employees accountable to for their behavior, and the process of specifying how tasks or behaviors are to be performed or not performed. We consider three groups of administrative controls; organization design and structure (Abernethy and Chua, 1996; Alvesson and Karreman, 2004; Emmanuel et al., 1990; Otley and Berry, 1980), governance structures within the firm (Abernethy and Chua, 1996), and the procedures and policies (Macintosh and Daft, 1987; Simons, 1987). Organizational design can be an important control device, as by using a particular structural type an organization can encourage certain types of contact and relationships (Abernethy and Chua, 1996; Alvesson and Karreman, 2004; Emmanuel et al., 1990). Flamholtz (1983) argued that organizational structure is a form of control which works through functional specialization, and contributes to control through reducing the variability of behavior and, in turn, increasing its predictability (p. 158). Although many researchers consider organizational design to be a contextual variable, and not part of organizational controls, we include it as it is something managers can change, as opposed to something that is imposed on them. The governance structure relates to the companys board structure and composition, as well as its various management and project teams. Governance includes the formal lines of authority and accountability (Abernethy and Chua, 1996), as well as the systems which are in place to ensure that representatives of the various functions and organizational units meet to co-ordinate their activities both vertically and horizontally. Meetings and meeting schedules, for example, create agendas and deadlines which direct the behavior of organization members. As the governance structure can be designed in many ways in any given organization, researchers should not group them together, but instead study how they link to each other and to other controls. The use of policies and procedures is the bureaucratic approach to specifying the processes and behavior within an organization. Policies and procedures include

such approaches as standard operating procedures and practices (Macintosh and Daft, 1987) and rules and policies (Simons, 1987). Policies and procedures include what Merchant and Van der Stede (2007) call action controls, i.e. behavioral constraints, pre-action reviews, and action accountability. As Merchant and Van der Stedes (2007) action controls constitute only part of what we have labeled administrative controls, our typology provides a more complete conception of the administrative tools managers use to control behavior, as compared to their object of control framework. Corporate Governance A corporation is a mechanism established to allow different parties too contribute capital, expertise, and labour for their mutual benefit while the investor/shareholder only participate in the profits of the enterprise without taking responsibility for the operations. Management who runs the company dont have the responsibility to provide the funds personally so the laws has been passes that give shareholders limited ability and correspondingly, limited involvement in a corporations activities include the right to elect directors who have a legal duty to represent the shareholders and protect their interest. Corporate governance is the framework of rules and practices by which board of directors ensures accountability, fairness, and transparency in a company's relationship with its all stakeholders (financiers, customers, management, employees, government, and the community). It involves regulatory and market mechanisms, and the roles and relationships between a companys management, its board, its shareholders and other stakeholders, and the goals for which the corporation is governed. The board of directors, therefore, has an obligation to approve all decisions that might affect the long-run performance of the corporation that means that the corporation is fundamentally governed by the board of directors overseeing the top management, with the concurrence of the shareholder so corporate governance refers to the relationship among these three groups in determining the direction and performance of the corporation.

The corporate governance framework consists of (1) explicit and implicit contracts between the company and the stakeholders for distribution of responsibilities, rights, and rewards, (2) procedures for reconciling the sometimes conflicting interests of stakeholders in accordance with their duties, privileges, and roles, and (3) procedures for proper supervision, control, and information-flows to serve as a system of checks-and-balances. Corporate governance systems and management control systems are linked. A corporate governance focus is slightly broader than is an MCSs focus. An MCSs focus takes the perspective of top management and asks what can be done to ensure the proper behaviors of employees in the organizations. The corporate governance focus is on controlling the behaviors of top management and, through their direction, those of all the controlling the other employees in the firm. Corporate governance adds the concern for controlling the behaviors of top management.

Principles of corporate governance Contemporary discussions of corporate governance tend to refer to principles raised in three documents released since 1990: The Cadbury Report (UK, 1992), the Principles of Corporate Governance (OECD, 1998 and 2004), the Sarbanes-Oxley Act of 2002 (US, 2002). The Cadbury and OECD reports present general principals around which businesses are expected to operate to assure proper governance. The Sarbanes-Oxley Act, informally referred to as Sarbox or Sox, is an attempt by the federal government in the United States to legislate several of the principles recommended in the Cadbury and OECD reports.

Rights and equitable treatment of shareholders : Organizations should respect the rights of shareholders and help shareholders to exercise those rights. Interests of other stakeholders: Organizations should recognize that they have legal, contractual, social, and market driven obligations to non-shareholder stakeholders, including employees, investors, creditors, suppliers, local communities, customers, and policy makers.

Role and responsibilities of the board: The board needs sufficient relevant skills and understanding to review and challenge management performance.

Integrity and ethical behaviour: Integrity should be a fundamental requirement in choosing corporate officers and board members 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.

The Sarbanes-Oxley Act of 2002 designed to protect shareholders from the excesses and failed oversight that characterized failures. Several key elements of SarbanesOxley were designed to formalize greater board independence and oversight. The act also established formal procedures for individuals (known as whistleblowers) to report incidents of questionable accounting and auditing. Firms are prohibited from retaliating against anyone reporting wrongdoing. The SarbanesOxley Act of 2002, also known as the 'Public Company Accounting Reform and Investor Protection Act' (in the Senate) and 'Corporate and Auditing Accountability and Responsibility Act' (in the House) and more commonly called SarbanesOxley, Sarbox or SOX, is a United States federal law that set new or enhanced standards for all U.S. public company boards, management and public accounting firms. It is named after sponsors U.S. Senator Paul Sarbanes (D-MD) and U.S. Representative Michael G. Oxley (R-OH). The bill was enacted as a reaction to a number of major corporate and accounting scandals including those affecting Enron, Tyco International, Adelphia, Peregrine Systems and WorldCom. These scandals, which cost investors billions of dollars when the share prices of affected companies collapsed, shook public confidence in the nation's securities markets. The act contains 11 titles, or sections, ranging from additional corporate board responsibilities to criminal penalties, and requires the Securities and Exchange Commission (SEC) to implement rulings on requirements to comply with the law. Harvey Pitt, the 26th chairman of the SEC, led the SEC in the adoption of dozens of rules to implement the SarbanesOxley Act. It created a new, quasi-public agency, the Public Company Accounting Oversight Board, or PCAOB, charged with overseeing, regulating, inspecting and disciplining accounting firms in their roles as auditors of public companies. The act also covers issues such as auditor independence, corporate

governance, internal control assessment, and enhanced financial disclosure. The nonprofit arm of Financial Executives International (FEI), Financial Executives Research Foundation (FERF), completed extensive research studies to help support the foundations of the act. The act was approved by the House by a vote of 423 in favor, 3 opposed, and 8 abstaining and by the Senate with a vote of 99 in favor, 1 abstaining. President George W. Bush signed it into law, stating it included "the most far-reaching reforms of American business practices since the time of Franklin D. Roosevelt. The era of low standards and false profits is over; no boardroom in America is above or beyond the law." In response to the perception that stricter financial governance laws are needed, SOXtype laws have been subsequently enacted in Japan, Germany, France, Italy, Australia, India, South Africa, and Turkey. Debate continues over the perceived benefits and costs of SOX. Opponents of the bill claim it has reduced America's international competitive edge against foreign financial service providers, saying SOX has introduced an overly complex regulatory environment into U.S. financial markets. Proponents of the measure say that SOX has been a "godsend" for improving the confidence of fund managers and other investors with regard to the veracity of corporate financial statements. SarbanesOxley contains 11 titles that describe specific mandates and requirements for financial reporting. Each title consists of several sections, summarized below. 1. Public Company Accounting Oversight Board (PCAOB) Title I consists of nine sections and establishes the Public Company Accounting Oversight Board, to provide independent oversight of public accounting firms providing audit services ("auditors"). It also creates a central oversight board tasked with registering auditors, defining the specific processes and procedures for compliance audits, inspecting and policing conduct and quality control, and enforcing compliance with the specific mandates of SOX.

2. Auditor Independence Title II consists of nine sections and establishes standards for external auditor independence, to limit conflicts of interest. It also addresses new auditor approval requirements, audit partner rotation, and auditor reporting requirements. It restricts auditing companies from providing non-audit services (e.g., consulting) for the same clients. 3. Corporate Responsibility Title III consists of eight sections and mandates that senior executives take individual responsibility for the accuracy and completeness of corporate financial reports. It defines the interaction of external auditors and corporate audit committees, and specifies the responsibility of corporate officers for the accuracy and validity of corporate financial reports. It enumerates specific limits on the behaviors of corporate officers and describes specific forfeitures of benefits and civil penalties for non-compliance. For example, Section 302 requires that the company's "principal officers" (typically the Chief Executive Officer and Chief Financial Officer) certify and approve the integrity of their company financial reports quarterly.[4] 4. Enhanced Financial Disclosures Title IV consists of nine sections. It describes enhanced reporting requirements for financial transactions, including off-balance-sheet transactions, pro-forma figures and stock transactions of corporate officers. It requires internal controls for assuring the accuracy of financial reports and disclosures, and mandates both audits and reports on those controls. It also requires timely reporting of material changes in financial condition and specific enhanced reviews by the SEC or its agents of corporate reports. 5. Analyst Conflicts of Interest Title V consists of only one section, which includes measures designed to help restore investor confidence in the reporting of securities analysts. It defines the codes of conduct for securities analysts and requires disclosure of knowable conflicts of interest. 6. Commission Resources and Authority

Title VI consists of four sections and defines practices to restore investor confidence in securities analysts. It also defines the SEC's authority to censure or bar securities professionals from practice and defines conditions under which a person can be barred from practicing as a broker, advisor, or dealer. 7. Studies and Reports Title VII consists of five sections and requires the Comptroller General and the SEC to perform various studies and report their findings. Studies and reports include the effects of consolidation of public accounting firms, the role of credit rating agencies in the operation of securities markets, securities violations and enforcement actions, and whether investment banks assisted Enron, Global Crossing and others to manipulate earnings and obfuscate true financial conditions. 8. Corporate and Criminal Fraud Accountability Title VIII consists of seven sections and is also referred to as the "Corporate and Criminal Fraud Accountability Act of 2002". It describes specific criminal penalties for manipulation, destruction or alteration of financial records or other interference with investigations, while providing certain protections for whistle-blowers. 9. White Collar Crime Penalty Enhancement Title IX consists of six sections. This section is also called the "White Collar Crime Penalty Enhancement Act of 2002." This section increases the criminal penalties associated with white-collar crimes and conspiracies. It recommends stronger sentencing guidelines and specifically adds failure to certify corporate financial reports as a criminal offense.

10. Corporate Tax Returns Title X consists of one section. Section 1001 states that the Chief Executive Officer should sign the company tax return. 11. Corporate Fraud Accountability Title XI consists of seven sections. Section 1101 recommends a name for this title as "Corporate Fraud Accountability Act of 2002". It identifies corporate fraud and records tampering as criminal offenses and joins those offenses to specific penalties. It also revises sentencing guidelines and strengthens their penalties. This enables the SEC to resort to temporarily freezing transactions or payments that have been deemed "large" or "unusual". Board of Directors The role of the board of directors in corporation, they concerned that inside board members may use their position to feather their own nests and that outside board members often lack sufficient knowledge, involvement, and enthusiasm to do an adequate job of monitoring and providing guidance to top management. Board of directors is governing body (called the board) of a company that usually selected by stakeholders of the company from the annual general meeting to govern the firm and look after the subscribers interests. The member of board of directors usually includes executive directors as well as expert or respected person chosen from the wider community called non-executive directors. The board has the ultimate decision-making authority and in general board of directors is empowered to set the company policy, objectives and overall direction, adopt bylaws, name members of the advisory, executive, finance, and other committees, hire, monitor, evaluate, also fire the managing director and senior executives. Board of directors is the one who determine and pay the dividend and issue additional shares of the company

Though all its members might not be engaged in the company's day-to-day operations, the entire board is held liable under the doctrine of collective responsibility for the consequences of the firm's policies, actions, and failure to act. Board of directors have a fiduciary duty to foster the long-term success of the corporation for the benefit of shareholders, and also sometimes for debt holders and the basic fiduciary duty has multiple elements such as: Duty of care: duty to make decisions in an informed way (If a director or the board as a whole fails to act with due care and, as a result, the corporation is in some way harmed, the careless directors or directors can be held personally liable for the harm done) Duty of loyalty: duty to advance corporate over personal interest Duty of good faith: duty to be faithful and devoted to the interests of the corporation and its shareholders Duty not to waste: duty to avoid deliberate destruction of shareholder value To carry out their responsibilities, broads must ensure that they are independent and accountable to shareholders, and they must exert their authority for the continuity of executive leadership with proper vision and values. There are two main control responsibilities of board of directors. First, they safeguard the equity investors interests by ensuring that management seeks to maximize the value of the shareholders stakes in the corporation. Second, they protect the interests of the other corporate stakeholders (such as, employees, suppliers, customers, competitors, or the society at large) by ensuring that the employees in the corporation act in a legally and socially responsible manner. Responsibility of board of directors vary from country to country depending on the state in which in which the corporate charter is issued. 200 directors from eight countries (Canada, France, Germany, Finland, Switzerland, the Netherlands, the United Kingdom, and Venezuela) has been interviewed and they revealed strong

agreement on the following of five board of directors responsibilities which are: 1. Setting corporate strategy, overall direction, vision and mission. 2. Hiring and firing the CEO and top management. 3. Controlling, monitoring, or supervising top management. 4. Reviewing and approving the use of resources. 5. Caring for shareholder interest. These results are in agreement with a survey by the National Association of Corporate Directors, in which U.S. CEOs reported that the four most important issues boards should address are corporate performance, CEO succession, strategic planning, and corporate governance. The boards are divided into two ways: Inside directors is a board member who is an employee, officer or stakeholder in the company. Inside directors sometimes called management directors, inside directors typically officers or executives employed by the corporation. Outside directors is any member of a company's board of directors who is not an employee or stakeholder in the company. Outside directors are paid an annual retainer fee in the form of cash, benefits and/or stock options. Corporate governance standards require public companies to have a certain number or percentage of outside directors on their boards as they are more likely to provide unbiased opinions. There is no clear evidence indicating that a high proportion of outsiders on a board result in improved financial performance. Research from large and small corporation reveals a negative relationship between board size and profitability. The Agency Theory states that the problems arise in corporations because the top management is not willing to bear responsibility for their decisions unless they own a substantial amount of stock in the corporation. While the Stewardship Theory

proposes that, because of their long tenure with the corporation, insiders tend to identify with the corporation and its success rather than use the firm for their own ends, these executives are thus most interested in guaranteeing the continued life and success of the corporation. The question is how trustworthy are these executives? Do they put themselves or the firm first? In the agency theory top management are in effect hired hands that may very likely to be more interested in their personal welfare than that of the shareholders. Agency theory is concerned with analyzing and resolving two problems that occurs in relationships between the shareholders and their top management, which are: 1. The agency problem that arises when (a) the desires or objectives of the owners and the agents conflict or (b) it is difficult or expensive for the owners to verify what the top management is actually doing. 2. The risk-sharing problem that arises when the owners and agents have different attitudes toward risk. Executives may not select risky strategies because they fear losing their jobs if the strategy fails. These problems will occur increases when stock is widely held, when the board of directors is composed of people who know little of the company or who are personal friends of top management, and when a high percentage of board members are inside directors. The stewardship theory is in contrast, the theory suggest that executives tend to be more motivated to act in the best interest of the corporation than in their own self-interests. The stewardship theory argues that in many instances top management may care more about a companys long-term success than do more short-term oriented shareholders. Outside directors may sometimes serve on so many boards that they spread their time and interest too thin to actively fulfill their responsibilities, the value with having more outside board member point out that the term outsider is too simplistic because some outsiders are not truly objective and should be considered more as insiders than as outsiders.

Audit Committee Auditing is the process of attesting to assertions about economic actions and events. It is therefore frequently referred to as an attestation service. Attestation itself is a threepart process, which are gathering evidence about assertions, evaluating that evidence against objective criteria, and communicating the conclusion reached. Corporate Governance Relationships

Management
Prepare financial statements

Auditor
Audits financial statement and provides assurance

Board of Directors
(selected by stockholders) and its audit committee

Other Third Parties

(e.g. creditors, suppliers, government agencies)

Stockholders

The audit client should view as the board of directors and its audit committee. The auditor communicates to other outside constituencies within the overall governance structure that starts with the board of directors. Audit committee is a subcommittee of the board of directors that is composed of independent, outside directors. It has the oversight responsibility on behalf of the full board of directors and its stockholders for the outside reporting of the company

(including annual financial statements), risk monitoring and control processes, also both internal and external audit functions. In simple way audit committee is members of a company's board of directors who are responsible for the conduct of internal and external auditors. Qualified and independent Audit committee must be: Minimum three directors. Two-thirds of the members of audit committee shall be independent directors. All members shall be financially literate and at least one member shall have accounting or related financial management expertise Chairman to be an independent director Chairman of Audit Committee shall be present at AGM to answer shareholder queries Finance director, head of internal audit and a representative of the statutory auditor may be present as invitees for the meetings of the audit committee The Company Secretary shall act as the secretary to the committee The role of audit committee of the board of directors assist the board of directors in fulfilling its responsibility such as: 1. Oversight of the companys financial reporting process 2. Recommending to the Board, the appointment, re-appointment and, if required, the replacement or removal of the statutory auditor and the fixation of audit fees. 3. Approval of payment to statutory auditors for any other services rendered by the statutory auditors. 4. Reviewing, with the management, the annual financial statements before submission to the board for approval, with particular reference to: 5. Reviewing, with the management, the quarterly financial statements before submission to the board for approval 6. Reviewing, with the management, performance of statutory and internal auditors, adequacy of the internal control systems 7. Reviewing the adequacy of internal audit function, if any, including the structure of the internal audit department, staffing and seniority of the official

heading the department, reporting structure coverage and frequency of internal audit 8. Discussion with internal auditors any significant findings and follow up there on 9. Reviewing the findings of any internal investigations by the internal auditors into matters where there is suspected fraud or irregularity or a failure of internal control systems of a material nature and reporting the matter to the board. 10. Discussion with statutory auditors before the audit commences, about the nature and scope of audit as well as post-audit discussion to ascertain any area of concern. 11. To look into the reasons for substantial defaults in the payment to the depositors, debenture holders, shareholders (in case of non payment of declared dividends) and creditors. 12. To review the functioning of the Whistle Blower mechanism, in case the same exists. 13. Carrying out any other function as is mentioned in the terms of reference of the audit committee.

Audit committee should meet at least four times in a year with a gap of not more than four months and the quorum shall be either two members or one third of the members of the audit committee whichever is greater, but there should be a minimum of two independent members present. The audit committee has a power to investigate any activity within its terms of reference and seek information from any employee. They also obtain outside legal or other professional advice and secure attendance of outsiders with relevant expertise, if it considers necessary.

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