Roles and Responsibilities of

Management
Chapter VI

Chapter Objectives:

Introduce the managerial function of corporate governance.

Understand the roles, responsibilities, and duties of corporate
senior executives, including the CEO and CFO.
Identify the components of executive compensation and illustrate
how each of

these components relates to effective corporate

governance.
Identify the financial reporting requirements of public companies
and SOX provisions that pertain to management certifications of
financial reports and internal controls.
Be aware of financial reporting challenges facing public companies
including off balance sheet arrangements, aggregate contractual
obligations, and critical accounting policies and practices.
Discuss managements responsibilities for ICFR.
Provide an overview of the costs and benefits resulting from Section
404 compliance.

Key Terms
Chief audit executive (CAE)
Chief risk officer (CRO)
Corporate development officer (CDO)
Enterprise risk management (ERM)
EXtensible Business Reporting Language (XBRL)
Financial Accounting Standards Board (FASB)
Institute of Internal Auditors
Research Foundation
International Accounting Standards Board (IASB)
International Financial Reporting Standards (IFRS)
Joint Committee on Taxation
other postemployment benefits (OPEB)
tax shelter

Management Responsibilities
Operating Process. The operating process entails: (1) operating
activities of designing products and services, marketing and
delivering products, invoicing products, and servicing customers;
(2) investing activities of investing in both human and capital
resources; and (3) financing activities of funding investments and
expenditures through internal growth, issuing stocks, or incurring
debt.
Financial Reporting Process. Management should report both
financial and nonfinancial KPIs that assist investors to predict the
companys future cash flows from operating, investing, and
financing activities.
Compliance
Process.
The
compliance
process
involves
compliance with all applicable rules, regulations, laws, and
standards, including regulatory, legal, tax, environmental, social,
and ethical standards and best practices.

Corporate officers
CEO.
CEO
(1)
(2)
(3)
(4)
(5)

CEO faces some challenges, including:

fiduciary duties (including duty of loyalty and duty of care)
self-serving and self-dealing,
succession planning,
Duality (please refer to chapter 4),
financial knowledge and understanding.
CFO
The role of the CFO consists of both strategic performance
and reporting compliance activities.
CDO
Corporate development officers position is especially
important for the companies which are actively involved in
mergers and acquisitions process.

Corporate officers
CRO
Chief Risk Officer is a part of Enterprise Risk Management
(ERM) framework. So, in the post-SOX era CRO doesnt only
have to identify and control risk, but also has to identify
growth opportunities.
CICO
A keen focus on internal control in the post-SOX period has
necessitated companies to centralize their compliance efforts
with internal control requirements. One way to synergize the
compliance activities is to establish a new managerial
position of the chief internal control officer (CICO) or to
strengthen the existing position of CCO.

Executive Compensation
Components of Executive Compensation.
1.
2.
3.
4.
5.
6.
7.

Salary
Annual Incentive compensation (bonus)
Long-term incentive compensation
Stock options award (those should be recognized as expense in the
income statements according to the provisions of SFAS No. 123(R))
Employment
contracts,
severance,
and
change-of-control
payments
Retirement arrangements
Stock ownership.

Executive Compensation Disclosure - On July 26, 2006, the SEC

approved comprehensive changes in the disclosure requirements
and to comply with these requirements, companies should provide
greater disclosure in their proxy statements, annual reports, and
registration statements regarding total compensation of their
directors, principal executive officer, principal financial officer, and
three highest-paid officers.

Financial Reporting Requirements

Public companies with more than $10 million of assets whose shares are held by
more than 500 investors are required to file auditors annual reports (Form 10-K or
10-KSB) and quarterly reviewed reports (Form 10-Q or 10-QSB) with the SEC.

The annual report of public companies normally contains the following

financial information:
1. Audited financial statements, including their notes
2. MD&A of financial condition and results of operations
3. Management certifications of financial statements and internal controls
4. Managements assessment of the effectiveness of ICFR
5. ACR
6. Independent auditors report on financial statements
7. Independent auditors report on the effectiveness of ICFR
8. Five-year summary of selected financial data
9. Summary of selected quarterly financial data for the past two years
10. Quarterly market data for the past two years, including high and low
stock prices for common stock, dividends paid, and price earnings ratio.
Section 302

Financial Reporting Requirements

Small Reporting Companies
The SEC proposed its principles-based rules for smaller
companies for so-called nonaccelerated filers companies
below the $75 million market capitalization.

Financial Reporting Challenges

Off Balance Sheet Arrangements Disclosures.
Amendment adopted in January 2003 by SEC requires a company
to provide an explanation of its off balance sheet arrangements in
a separately captioned subsection of the MD&A section of
disclosure documents filed with the SEC.
Aggregate Contractual Commitments.
Public companies, particularly accelerated filers (market
capitalization of more than $75 million), are required to disclose
their annual reports filed with the SEC in a table with their
aggregate amounts of specified categories of contractual
obligations shown on a yearly basis.
Disclosure of Critical Accounting Policies.
Public companies are required to provide the following disclosures
for each of the identifiable critical accounting estimates in the
MD&A: (1) description, (2) significance, (3) sensitivity analysis, (4)
historical changes, (5) communication to audit committee, (6)
identification of segments, (7) segment-specific effects.

Financial Reporting Challenges

(Cont)
Initial Adoption of Accounting Policies.
The initial adoption of accounting policies is required when
economic events and business transactions (1) occur for the
first time and have a significant effect on the companys
financial presentation, (2) become material that were
previously considered immaterial in their effect on the
companys financial reporting, and (3) occur that are
significantly different from previous events and transactions.
Disclosure of Changes in Existing Accounting Policies.
SEC rules and accounting standards require public companies
to disclose changes in their existing accounting policies and
practices.
Acceleration of Periodic Report Filing Dates and RealTime Disclosures.
Section 409 of SOX authorizes the SEC to issue rules requiring
companies to make public disclosure of their financial
information on a rapid and current basis.

Financial Reporting Challenges

(Cont)
Non-GAAP Financial Measures.
The SEC in January 2003 issued rules and amendments to
address public companies disclosure or release of certain
financial information that is presented on the basis of
methodologies other than GAAP. (Recognition G)
Voluntary Changes in Accounting Policies.
SFAS No. 154 requires companies that make a voluntary change
in their accounting policies to apply the change retrospectively
by revising prior years financial statements rather than showing
the cumulative effect of accounting changes as one lump sum.
Accounting Pensions and Other Postemployment Benefits.
FASB issued SFAS No. 158 (September 2006), Employers
Accounting for Defined Benefit Pension and Other Postretirement
Plans, which requires companies to recognize on their balance
sheet the funded status of their pension and OPEB plans as of
December 31, 2006, for calendar year companies.

Financial Reporting Challenges

(Cont)
Principles-Based
versus
Rules-Based
Accounting
Standards.
The SECs study recommends a hybrid of focusing on an
objectives-based approach in establishing accounting
standards.
Conceptual Framework for Financial Reporting.
FASB and IASB - new conceptual framework project.

A hierarchy of accounting
qualities

Financial Reporting Challenges

(Cont)
Earnings Management
Earnings management is made possible and is often
legitimately accomplished within the flexibility of GAAP rather
than through noncompliance with GAAP.
Financial Restatements.
Number of companies who filled restatements

Financial Reporting Challenges

(Cont)
Convergence in Financial Reporting
The development of IFRS is now considered one of the most
commonly
used
accounting
languages
worldwide.
Convergence of IFRS and U.S. GAAP should benefit the global
capital market primarily because such convergence reduces
the differences in global accounting policies and practices

Internal Control Reporting and

Executive Certifications
SOX and SEC-related implementation rules require public
companies to design and maintain effective internal controls
and disclosures for assessment and reporting of their
disclosure controls and procedures and ICFR.
Internal Control Variations

Internal Control Over Financial

Reporting
Management responsibilities under Section 302 of SOX.
2. Management responsibilities under Section 404 of SOX.
1.

The CEOs and CFOs of small- and medium-size and foreign

companies still certify their ICFR under Section 302 of SOX for
their 20042005 filings and onward. However, the SEC has
postponed Section 404 compliance for smaller companies
(market capitalization of less than $75 million) and foreign
companies to their fiscal years ending on or after December
15, 2007.
Section 404 requires management and auditors to test and
report on the effectiveness of internal controls above and
beyond the requirements of Section 302.

Section 404
Section 404 Costs

Benefits of Section 404 Compliance

Sustainable Section 404 Compliance

the actual cost of auditing ICFR is in

the range of $1.5 million to $10
million, with an average of $2.6
million for Fortune 1000 companies
The expected benefits of compliance with
Section 404 are (1) more investor
confidence in financial reports, (2) more
accurate and reliable financial reports, (3)
more financial fraud prevention and
detection, (4) more effective ICFR that
improves operating, investing, and
financing activities, and (5) lower cost of
capital.
companies should shift away from a
project approach to a continuous process
of integrating sustainable compliance into
their corporate governance structure.

SEC Interpretive Guidance on ICFR

The SECs interpretive guidance.

The overriding principles of guidance are:
1. Adequacy
2. Effectiveness
3. Entity-level controls
4. Ongoing monitoring
5. Fraud risk considerations

Enterprise risk Management

Relationships of objectives and components of ERM

Enterprise risk Management

Components of ERM

Tax Accounting
Tax shelters not only have detrimental effects on tax
collections, but also the stock and the cost of debt prices can
be affected.
The Joint Committee on Taxation defines a tax shelter as a
schema designed to avoid taxation without exposure to loss
or economic risk.
Tax courts have established several judicial doctrines to curb
corporate tax shelters

Conclusion
Management

roles and responsibilities are to ensure operational

efficiency; enhance the quality, reliability, integrity, and transparency
of financial reports; and ensure compliance with applicable laws,
regulations, rules, and standards.
Management is responsible for all managerial functions, including
decision making, performance assessment, fair presentation of
financial reports, and the achievement of the goal of increasing
shareholder value while protecting the interests of all stakeholders.
The success and long-term survival of the company is in the hands
of the CEO, and thus, the personal attributes, ethical values, and
professional characteristics of the CEO should match and be in line
with the companys values, visions, and strategic plans.
Key challenges facing CEOs include (1) CEO fiduciary duties, (2) CEO
succession planning, (3) CEO duality, (4) CEO financial knowledge and
understanding, (5) CEO pay and skill, and (6) self-serving and selfdealing CEOs.

Executive compensation includes salary, annual incentive

compensation (bonus), long-term incentive compensation, stock
option awards, stock award units, severance, change-of-control
payments, retirement arrangements, and stock ownership.

Conclusion
Several provisions of SOX directly or indirectly affect executive
compensation packages, including (1) prohibition of personal loans to
directors and executives, (2) reporting insider trading, (3) insider
trading during pension fund blackout periods, and (4) forfeiture of
certain bonuses and profits.
Two provisions of SOX pertain to management certifications of
financial reports. Section 302 of SOX requires the principle executive
and financial officers of the company to certify each periodic report
filed with the SEC. Under Section 906 of SOX, each periodic report
containing financial statements filed by a reporting company must be
accompanied by certification of the CEO and CFO of the company.
Earnings management is defined as a managerial discretionary
practice of timing strategic and operating decisions or choosing
accrual estimates to manage short-term earnings. Any illegitimate
earnings management can cause financial restatements.
A high-quality financial report is defined in this book as a financial
report that is relevant, useful, reliable, and transparent.
Financial information is considered transparent when it provides
shareholders and other stakeholders a clear understanding of the
companys KPIs.

Conclusion
Principles-based accounting standards are expected to be more
understandable, allow the use of more judgment by auditors on the
quality of financial information
Financial restatements continue to be the major factor in the erosion
of investor confidence and public trust.
The development of IFRS is now considered one of the most
commonly used accounting languages worldwide. Convergence of
IFRS and U.S. GAAP should benefit the global capital market.
The SEC requires that public companies design and maintain
adequate and effective disclosure controls and procedures.
Section 302 of SOX requires the management of public companies to
assess and report on the effectiveness of disclosure controls and the
procedures of both quarterly and annual reports.
Section 404 of SOX requires management to document and assess
the design and operation
of the companys ICFR and report on its assessment of the
effectiveness of ICFR.
Section 404 of SOX requires the independent auditor to attest to and
report on managements assessment of the effectiveness of the
companys ICFR.