FINS3626 Notes

1. Introduction to corporate governance

What is corporate governance?

There is no single definition of corporate governance. The general definition is how a
complex organisation is directed and controlled. It involves outlining the roles between
shareholders and relevant stakeholders who may have influence on the corporation. The
areas examined are internal control and regulations, board structures and roles of
directors, accounting and auditing committees. The focus however, has recently shifted
from shareholders (narrow view; agency theory) to stakeholders (broad view;
stakeholder theory).
Agency Theory: Shareholders are the owners and hires the management to run the
company in their place. Conflict arises when the managers (agents) make decisions not
in the best interest of owners (principals) forcing shareholders to control management
through policies and incentives (agency costs).
Transaction Cost Theory: suggests that companies are growing so large they essentially
become markets and substitute allocation of resources. It removes market transactions
and management directs and controls production. It is ideal to internalise costs as it
removes uncertainty and risk of volatile prices. This paradigm assumes managers are
opportunists and will act in their own interest.
The difference between the two is the way that managers are categorised. Agency
theory assumes moral hazard and agency costs while transaction costs describes as
opportunistic. Another difference is the unit of analysis for agency is an individual while
the other is a transaction.
Stakeholder theory: a concept that involves philosophy, ethics, politics, law and
economic theories in the decision making of a company. It suggests that companies
have become so large that they account not just for shareholders but the greater
community. Stakeholders relationship suggests that it is an exchange whereby
stakeholders or suppliers contribute to the company and expect return. Social
responsibility is in the forefront of current political and social climate and companies are
to act in a socially ethical manner.
Corporate governance involves four main components: People, principles, cultures &
values and tools & mechanisms.
o Principles include:
Ensuring basis for effective corporate governance framework
Rights & equitable treatment of shareholders and ownership functions
Role of stakeholders
Disclosure and transparency
Responsibilities of the board
o Tools and mechanisms:
Codes
Charter
Committees
Policies and procedures

2. Regulation and Internal Arrangements

Two types of regulation

o Self Regulation

Advantages:
Proximity: closer to industry; detailed and current market and
industry information
Flexibility: Corporations can construct their own policies to best fit
firm objectives; lack of political constraints
Compliance: greater involvement in industry may result in rules that
seem more applicable and reasonable to individual firms.
Collective Interests of Industry: competitors can police each other
Disadvantages:
Conflict of Interest:
Inadequate Sanctions: may mete out modest sanctions for serious
violations
Underenforcement: May be insufficiently moderated
o Government Regulation: Corporation policies are constructed by government
bodies such as ASIC, AASB, APRA
Advantages:
Responsibility to the Public
Resources
Legislative Support
Disadvantages:
Political Constraints
Lack of Involvement with the industry
Lack of Risk taking
How should regulations be imposed?
o Rules: outlines that must follow and compels you to comply through punishment
or threat
Advantages:
Simplicity: ease of compliance; outline clear guidelines
Certainty: outcomes are predictable; less discretion & variations
Disadvantages:
Complex: when lawmakers try to address every issue it become
tedious (tax)
Oversimplification of complex concept: can be manipulated
Requires updates
o Principles: recommendations that outlines options are most appropriate,
recommend, should
Advantages:
Flexibility: regulate how individual companies see fit
More incline to take risk
Disadvantages:
Requires skill in judgement making
Difficult to compare with different companies
Higher chance of mistake
Current Regulations
o ASX CG: continuous process of amendments and recommendations; " the
Principles and recommendations are not mandatory and do not seek to prescribe
the corporate governance practices that listed entity must adopt"; Listing rules

state that corporate governance practices should conform with the council's
recommendations and if not, then to disclose reasons why
1. Lay solid foundation for management and oversight
2. Structure the Board to add value
3. Act ethically and responsibly
4. Safeguard integrity in corporate reporting
5. Make timely and balanced disclosure
6. Respect the rights of security holders
7. Recognise and manage risk
8. Remunerate fairly and responsibly
CLERP (Corporate Law Economic Reform Program): 2004 Act in response to
corporate collapses; Focused on remuneration disclosures and auditing; truth and
fairness
1. Remuneration disclosure, directors' report and financial reporting and
shareholder participation and information
2. Continuous disclosure reforms
3. Audit reform
4. Conflict of interest management, prospectus and product disclosure
statement requirements and exemptions, enforcement and amendments
Sarbanes-Oxley Act: key dimension
1. Governance: the board oversees financial reports and management;
focus on independence
2. Management Certification
3. Audit Committee: provide audit of financial reporting process and
financial statements; comprise of experts and independent directors
4. Public company accounting oversight board: standard of independence
and ethics for auditors; requires three opinions:
whether financial statements are fairly stated
management assessment of internal control over financial reports
whether internal controls over financial reporting process are
effective
5. Internal controls: requires management to complete assessment of
internal controls; auditors prohibited from providing non-auditing services
but may document internal control