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ACCA SBL March-June 2019 Exams

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1

ACCA Strategic Business Leader (SBL)
PROFESSIONALISM, ETHICAL CODES, GOVERNANCE AND REPORTING
1.
Professionalism, ethical codes and the public interest
2.
Fraud, bribery, whistle-blowing and company ethics
3.
Governance
4.
Integrated Reporting

3
9
21
33

CORPORATE STRATEGY
5.
Strategy - real life examples
6.
Strategic planning models
7.
Advantages and disadvantages of strategic planning
8.
The rational model in more detail
9.
Environmental analysis

10. Competitor analysis - Porter’s five forces
11. Capabilities
12. Internal analysis
13. SWOT Analysis
14. Determining strategy
15. Diversification
16. Methods of growth
17. Strategic choice

37
39
43
45
49
55
59
63
69
71
77
81
83

RISK AND RISK MANAGEMENT
18. The types of risk facing an organisation
19. Responses to risk
20. Enterprise risk management

85
91

99

INFORMATION TECHNOLOGY, MARKETING
21. Data, Information, knowledge and IT
22. Controls in IT systems
23. The Internet, E-Business and Big Data
24. Marketing

107
111
115
127

FINANCE, DECISION-MAKING AND CONTROL
25. Organisational audit and control
26. Finance
27. Budgeting and standard costing
28. Capital rationing and sensitivity analysis
29. Marginal and relevant costing; ABC
30. Ratio analysis
31. Forecasting
32. The purpose and process of management and leadership
33. Corporate culture
34. Organisational structure
35. Outsourcing, shared services and disruptive technologies

139
145
149
157

161
167
171
177
185
189
197

CHANGE MANAGEMENT
36. Process change and the pursuit of excellence
37. Classification of business process changes
38. Change management

203
209
213

PROJECT MANAGEMENT
39. Project management

219

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3

PROFESSIONALISM, ETHICAL CODES,

GOVERNANCE AND REPORTING

Chapter 1
PROFESSIONALISM, ETHICAL CODES
AND THE PUBLIC INTEREST
1. Professionalism
The Marriam-Webster dictionary defines ‘professionalism’ as:
“the conduct, aims, or qualities that characterise or mark a profession or professional person”
and it defines a ‘profession’ as:
“a calling requiring specialist knowledge and often long-term and intensive academic preparation’.
Certain attributes are implied or required by these definitions:
๏

Competence (specialist knowledge is worthless if it is wrong, out-of date or a mystery)

๏

Honesty and integrity (to apply knowledge and competence properly)

๏

Reliability (clients expect to have their requirements met on time)

๏

Flexibility (for example, staying late, working weekends to meet deadlines)

๏

Respect for others (for example, recognising that others might have valid but different views)

๏

Self-control (no matter how much provoked, professionals should remain calm and businesslike

2. Public interest
IFAC (The International Federation of Accountants) defines public interest as:
“The net benefits derived for, and procedural rigour employed on behalf of of, all society in relation
to any action, decision or policy”
The ‘public’ includes investors, shareholders, employees, pensioners consumers, suppliers, tax
payers, electorates and citizens.

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Although the impact of accountants varies amongst these groups, there is a fundamental
obligation for the accountancy profession to act in the public interest.
‘Interests’ include:
๏

increased economic certainty in the marketplace

๏

sound decision-making

๏

sound and transparent financial information

๏

comparability across different organisations and jurisdictions

๏

sound corporate governance

๏

Effective performance management

๏

Increased efficiency and better resource utilisation

Accountancy professionals play a vital role in delivering the public interests shown above and they
should:
๏

Provide sound financial and non-financial reporting to shareholders, investors, taxpayers and
all parties in the market place directly and indirectly impacted by financial and non-financial
reporting from all organisations - including public sector organisations.

๏

Provide truthful, effective communication with parties (boards, shareholders management
and others) directly and indirectly related to the corporate government processes for which
they are responsible.

Essentially, acting in the public interest can be viewed as accountants exercising social
responsibility. Their duties do not simply rest with their clients of employers and they are
encouraged or required to make positive impacts on all stakeholders.

3. Professional ethics
The ACCA Code of Ethics and Conduct (‘the Code’) is based on the IFAC Handbook of the Code of
Ethics for Professional Accountants, of the International Ethics Standards Board of Accountants
(IESBA).
If a member cannot resolve an ethical issue by following this Code or by consulting the ethics
information on ACCA’s website he or she should seek legal advice as to both his or her legal rights
and any obligations he or she may have.
The Code sets out certain fundamental principles about how its members should behave. It also
recognises how its members could be subject to certain threats which would compromise their
behaviour and suggests ways in which members can safeguard themselves against the operation
of those threats.
The guide applies to all members of ACCA working in industry, commerce and public practice. It
also applies to all ACCA students. Note that its operation is not restricted to auditors and covers
ACCA members working in industry and commerce.

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The ethical framework recognises that there are:
๏

Ethical principles to be followed

๏

These are subject to risks

๏

Accountants should use safeguards to avoid or to respond to risks.

4. Fundamental professional ethical principles
The fundamental principles are as follows:
๏

First, integrity. This means that members should be honest, straightforward. If they see
something is amiss, they should say so; they shouldn’t try to conceal it; they shouldn’t ‘turn a
blind eye’; they shouldn’t try to be ambiguous, they should state things plainly.

๏

Secondly, objectivity, members should be influenced by the facts and the facts only. They
must avoid bias, conflict of interest and undue influence.

๏

Third, members should exercise professional competence and due care. They must keep
themselves up-to-date with legislation and recent developments. They shouldn’t take on
work which they are not qualified for or for which they have no skills. They must be diligent,
they must be careful.

๏

Fourth, confidentiality. Members, particularly perhaps those who are auditors, have access
to information which is highly confidential and which is price sensitive. That information must
be held confidentially. Members should not disclose confidential information unless they
have a legal or professional duty to do so. An example of a legal duty to disclose information
can arise if a member thinks that a client or the person they are working for is involved in
money laundering. Many countries have very strong regulations nowadays that money
laundering suspects should be reported to the authorities.

๏

Finally, members should show professional behaviour. They should comply with the law
and they should avoid any actions which discredit the profession. So, for example, when they
are trying to advertise their services they shouldn’t say that other members are bad or poor.
They should confine themselves to promoting what they are good at; they shouldn’t rubbish
other professionals.

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5. Threats to professional ethics
Threats to professional ethics arise from
๏

Self-interest

๏

Self review

๏

Advocacy

๏

Familiarity

๏

Intimidation.

Note also management threats where the auditor performs managerial functions for the client. This
is not listed by the IESBA, but covered under several of the above, such as self-interest and
familiarity.
Where such threats exist, the ACCA member must put in place safeguards that eliminate them or

reduce them to clearly insignificant levels. Safeguards apply at three levels: safeguards in the work
environment, safeguards that increase the risk of detection, and specific safeguards to deal with
particular cases. If a member is unable to implement fully adequate safeguards, then the member
must not carry out the work.
Some of the following threats are likely to apply predominately to members in public practice, but
many apply to all types of employment

5.1. Self-interest threats
Self-interest threats are the following:
๏

Financial: For example, if an auditor owns shares in the client or employer. The member could
be accused of wanting the company profits to look good, so that the share price rises thereby
enriching the member.

๏

Close business relationships are also threats. For example, if a partner retired from an audit
partnership and then immediately went to work for a client, they could be accused for having
lined themselves up for a job and to do that they perhaps did not do their audit rigorously. A
period of at least two years should pass before an ex-partner takes up an appointment with a
client. Having a partner on the client board is also unacceptable.

๏

Close family and personal relationships between the ACCA member and owners or directors
of the company they are working with create the possibility of suggestions that the member’s
work has been neither objective nor independent, and that the accountant did not show the
proper degree of integrity.

๏

Loans and guarantees to the ACCA member should be looked at carefully. If the other party is
a bank and it makes a loan on a normal business terms, for example a mortgage, this would
normally be regarded as acceptable. Certainly no loans or financial relationships should exist
between a client and the member if it is not normal business for the client to make loans.

๏

Overdue fees, for example, for consultancy work, put the ACCA member some risk as there is
a possibility that client will never pay those fees. This could lead to accusations any work
performed (such as preparing a cash-flow forecast) will try to ensure that the company
survives so that the fee will be paid. If there are overdue fees the member should not make
the situation worse and should not incur any more chargeable time until those fees have
been settled.

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๏

Contingent fees are obviously dangerous. A contingent fee, for example, would be where
the ACCA member is paid is paid a small fee if a report being prepared is unfavourable, but a
large fee if it is favourable.

๏

High percentage fees. If the auditor earns a high percentage of total income from one audit
client, then the auditor will rely too much on that client and can’t afford to lose them. This can
give the client too much leverage over the auditor. Generally the auditor should not earn
more than 10% of total fees from any single public interest audit client.

๏

Low-balling refers to the practice of quoting a very low audit fee to a client and then hope
that profits would be made another work awarded by the client. This means really that the
audit does not pay for itself so how, therefore, could a proper audit be done? Winning an
audit is a competitive business and the audit fee is an important factor to clients. However, an
auditor could find it difficult to claim that a proper audit has been carried out if a loss was
made on the audit. Fees should be profitable for the auditor.

๏

Recruiting staff on behalf of a client should not be done. The danger here is that if members
of staff are recruited by the auditor, particularly financial staff, then subsequently the auditor
might be reluctant to criticise the performance of those staff members as the advice they
gave on recruitment looks bad. Similar considerations should be taken into account when the
auditor performs any management function for the client.

7

5.2. Self review threats
Self review threats arise when an auditor does work for a client and that work may then be subject
to checking during the subsequent audit. For example, if the auditor prepares the financial
statements, and then has to audit them, or the auditor performs internal audit services and then
has to check that the system of internal control is operating properly. Auditors could obviously be

reluctant to criticise the work which their own firms have earlier undertaken, and this could
interfere with independence and objectivity. Generally auditors must be very careful when
undertaking such work. Certainly it is common for auditors to do other work, what is important that
the work is done by an entirely different team from the audit firm.
Really, checking your own work is a waste of time.

5.3. Advocacy threats
Arise if promoting a position or opinion to the point that subsequent objectivity is compromised.
An example would be where you represent a company at a meeting with a bank to raise a loan.

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5.4. Familiarity threats
Familiarity threats arise because of the close relationship between members and a client or
employer so that independence is compromised. The close relationship can arise by friendship,
family or through business connections. There is no general definition of what’s meant by close
relationships, but if you were a consultant and your brother was the Finance Director of a client
firm then there probably is a close relationship! If however the finance director was a remote cousin
of yours, there might not be a close relationship. Note that there does not have to be any family or
legal relationship: friendship can threaten independence and integrity.

5.5. Intimidation threats
The final groups of threats are intimidation threats. These can deter ACCA members from acting

properly. Examples could be threatened litigation, blackmail, bad staff assessments, no promotion,
or there might even be physical intimidation, though it is to be hoped that that is rare. Blackmail
could be more subtly applied and might relate back for example to a period where the ACCA
member was not acting in accordance with the required ethical standards.

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9

Chapter 2
FRAUD, BRIBERY, WHISTLE-BLOWING
AND COMPANY ETHICS
1. Fraud
1.1. Introduction
Fraud is an intentional act involving deception to gain unjust or illegal advantage.
There are two types:
๏

Fraudulent financial reporting. For example, overstating profits to generate high directors’
bonuses, boost the share price or to achieve a good sale price for the company.

๏

Misappropriation of assets. For example theft of cash or inventory.

Managers and those charged with governance are responsible for the prevention or detection of
fraud. Auditors should always be aware of an organisation’s susceptibility to fraud.

1.2. The pre-conditions for fraud
Three conditions or risk factors are necessary for fraud to be committed:
๏

Incentive

๏

Opportunity

๏

Attitude/dishonesty

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Risk factor

Examples relating to fraudulent
financial reporting

Examples relating to the

misappropriation of assets.

Incentive

๏

Pressure from shareholders
to perform

๏

Personal financial pressure

๏

๏

Fear of losing job

Greed

๏

๏

Incentives related to
performance

Dislike of the employer (I’ll
get my own back!)

๏

Poor internal control

๏

Poor internal control

๏

Poor corporate governance
eg a dominant chief
executive who is also
chairman

๏

High-value portable
inventory

๏

Cash-based business

๏

Poor supervision

Opportunity

Attitude

๏

Results dependent on many
estimates and a high degree
of judgement

๏

Poor ethics

๏

Poor ethics

๏

Poor morale

๏

Dislike of the employer

๏

Excessively aggressive targets ๏

10

Other employees’ behaviour
(and you become convinced
that the ‘fiddle’ is normal and
therefore acceptable)

1.3. An anti-fraud strategy
An anti-fraud strategy, ie the deterrence of fraud, has three elements:
๏

prevention

๏

detection

๏

response

These interrelate as follows:

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Deterrence is the result of prevention (too difficult to get to the inventory to steal it), detection (you
will be subject to random searches as you leave the factory) and response (you will definitely be
prosecuted).
Surrounding these specific anti-fraud strategies there are:
๏

Legislation:

for example, what types of actions (such as, insider
trading) are illegal?

๏

Risk management:

an awareness by the organisation’s senior managers
and directors of where the main dangers of fraud lie
and then suitable controls being put in place.

๏

Corporate governance.

๏

Ethical culture:

For example, non-executive directors providing
independent advice about behaviour. Audit

committee being available to support internal audit
and whistleblowers.
for example, making it clear that ‘shady’ practices are
wrong and will not be tolerated by the company.
Training in ethical behaviour will be important

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2. Whistleblowing
Whistleblowing is defined as “making a disclosure that is in the public interest”.
Many frauds are known about or suspected by people who are not involved in the dishonesty. The
challenge for management is to encourage these ‘innocent’ people to speak out and to
demonstrate that it is very much in their own interest to do so. Reporting mechanisms are a very
important element of risk management and fraud deterrence.
There can be many conflicting emotions influencing the potential ‘whistleblower’:
๏

working group/family loyalties

๏

intimidation

๏

fear of consequences

๏

suspicion rather than proof.

The organisation’s anti-fraud culture and reporting processes can be a major influence on the
whistleblower, as it is often fear of the consequences that has the impact. To the whistleblower the
impact of speaking out can be traumatic, ranging from being dismissed to being shunned by other
employees. Confidential reporting mechanisms might help.
In the UK, whistleblowers (employees, trainees, agency workers) are protected by law if they report:
๏

a criminal offence, eg fraud

๏

someone’s health and safety is in danger

๏

risk or actual damage to the environment

๏

a miscarriage of justice

๏

the company is breaking the law, eg doesn’t have the right insurance

๏

you believe someone is covering up wrongdoing

Personal grievances (eg bullying, harassment, discrimination) aren’t covered by whistleblowing
law, unless your particular case is in the public interest.
To enjoy legal protection, disclosures by whistleblowers must actually be in the public interest.
Therefore, to be protected by the law the whistleblower must:
๏

have made the disclosure in good faith – in other words you must be disclosing the
information because it is in the public interest and is clearly wrong

๏

reasonably believe that the information is substantially true

๏

reasonably believe you are making the disclosure to the right prescribed person.

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3. Bribery
3.1. Introduction
Bribery can be defined as: offering financial or other advantage to perform a relevant function or
activity improperly
For example:
๏

Any function of a public nature.

๏

Any activity connected with a business.

๏

Any activity performed in the course of a person’s employment any activity performed by, or
on behalf of, a group of persons.

These functions or activities may be anywhere in the world.
Many countries have anti-bribery legislation that can lead to prosecution of both companies and
employees.

3.2. Types of bribery and potential offences
๏

Bribing another person

๏

Receiving a bribe

๏

Bribing a foreign public official that is someone who holds an administrative, legislative or
judicial position intending to influence them in gaining business or an advantage in
connection with business

๏

A commercial organisation failing to prevent bribery.

Note that “hospitality” that is reasonable and proportionate is acceptable.
Facilitation payments are payments to induce officials to carry out their proper functions, but
perhaps to carry out those functions more quickly, such as fast clearance of goods through
customs. Countries are divided on whether these ‘grease money’ payments are criminal activities or
not.

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3.3. The Six principles

Businesses can make use of the following six principles when deciding whether their approach to
preventing bribery is adequate:
๏

Proportionate procedures
Proportionate to risks faced and size of company.

๏

Commitment by management
Management should assess the nature and extent of risks faced and develop appropriate
procedures to manage that risk.

๏

Due diligence
The company should apply due diligence procedures in respect of company personnel who
are at greater risk of offering bribes.

๏

Communication
To ensure all employees / connected persons are aware of the company’s culture and attitude
includes training and education procedures.

๏

Monitoring and review
Procedures should be regularly reviewed and improved as necessary.

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4. Company ethics
4.1. The importance of ethics
When it comes to corporate ethics you do not have to appeal to a moral or ethical stance to see
that companies should be ethical. An ethical stance can be justified on a purely economic basis.
This rests on the fact that if the company acts unethically or immorally, it will usually be found out,
and when it is found out it is usually punished, either through the operation of the law,
compensation, or by the loss of goodwill and reputation. Therefore, an ethical company reduces
risk.
Everyone can make mistakes but if you own up to mistakes then you are limiting the damage, and
you are reducing the risk that further damage will be done and the punitive damages that may
later be awarded against you.
If risk is lower so too is cost. Ethical organisations often have to spend less ensuring that regulations
are followed. Lower risks also means that banks and other providers of capital will be willing to
supply the money at lower rates. In general lower returns are required because risk and return go
together.
๏

If your reputation is good, you are more likely to find good, willing partners with whom you
can co-operate perhaps to form joint ventures or perhaps just to be satisfied customers.

๏

A good reputation will tend to attract better employees. No one really wants to be associated
if possible with a company which has a poor reputation.

๏

Finally, a good reputation should increase goodwill and increase sales. Companies which are
regarded as being unethical tend not to be trusted and certainly not liked by customers.
Customers will always be trying to find an alternative.

Therefore for very sound commercial reasons, it pays companies to be ethical.
Organisations have an effect on their environment and the human stakeholders with whom they
interact. These effects can often produce ethical dilemmas that organisations have to deal with.

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4.2. Tucker’s five question approach to ethical behaviour
This is a useful tool for determining the most ethical outcome in a given situation. Not all criteria
might be relevant in every situation. The questions are:
๏

Is it profitable?

๏

Is it legal?

๏

Is it fair?

๏

Is it right?

๏

Is it sustainable or environmentally sound?

Not all of these questions will produce definitive answers. In particular:
๏

‘Is it profitable?’ requires comparisons to the profitability of other courses of action.

๏

‘Is it fair?’ is influenced by whose perspective you are looking at the problem from and
different stakeholders are likely to have different views.

๏

‘Is it right?’ will depend on your ethical stance which in turn depends on your culture, religion,
outlook and so on.

4.3. Corporate codes of ethics
This can be defined as: a written set of guidelines issued by an organisation to its workers and
management to help them conduct their actions in accordance with its values and ethical
standards.
Areas covered can include:
๏

Equal opportunity/discrimination

๏

Bullying

๏

Use of the internet

๏

Reporting wrong-doing

๏

Bribery

๏

Money-laundering

๏

Response to conflicts of interest

The code must be fully supported by top management if it is to be effective. Staff training is also
needed to illustrate decision-making processes. A code that is properly implemented can bring the
following advantages to an organisation:
๏

Emphasises the organisation’s values.

๏

Guidance to employees and directors.

๏

Risk reduction through avoidance of regulatory and legal problems.

๏

Good public relations and reputation.

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Here is an excerpt from Amazon’s code of ethics:
I. Compliance with Laws, Rules and Regulations
Employees must follow applicable laws, rules and regulations at all times.
II. Conflicts of Interest
…employees are expected .. to act … in the best interests of Amazon.com. A "conflict of interest" exists
when an employee's personal interest interferes with the best interests of Amazon.com. For example, a
conflict of interest may occur when an employee or a family member receives a personal benefit as a result
of the employee's position with Amazon.com. … the Legal Department will consider the facts and
circumstances of the situation to decide whether corrective or mitigating action is appropriate.
III. Insider Trading Policy
Employees of the Company may not a) trade in stock or other securities while in possession of material
non-public information or b) pass on material non-public information to … or recommend to others that
they trade in stock or other securities based on material non-public information.
IV. Discrimination and Harassment
Amazon.com provides equal opportunity in all aspects of employment and will not tolerate any illegal
discrimination or harassment of any kind…
V. Health and Safety
Amazon.com provides a clean, safe and healthy work environment. Each employee has responsibility for
maintaining a safe and healthy workplace by following safety and health rules and practices and reporting
accidents…Violence and threatening behaviour are not permitted. …
VI. Price Fixing
Employees may not discuss prices or make any formal or informal agreement with any competitor
regarding prices …
VII. Bribery; Payments to Government Personnel
Employees may not bribe anyone for any reason, whether in dealings with governments or the private
sector. ….
VIII. Record-keeping, Reporting, and Financial Integrity
Amazon.com's books, records, accounts and financial statements must be maintained in appropriate

detail..
IX. Questions; Reporting Violations
Employees should speak with anyone in their management chain or the Legal Department when they have
a question about the application of the Code of Conduct …The Amazon.com Legal Department has
developed … reporting guidelines for employees who wish to report violations of the Code of Conduct. …
Amazon.com will not allow retaliation against an employee for reporting misconduct by others in good
faith…Employees who violate the Code of Conduct will be subject to disciplinary action up to and
including discharge.
X. Periodic Certification
The Legal Department will designate certain employees who, based on their level of responsibility or the
nature of their work, will be required to certify periodically that they have read, understand and complied
with the Code of Conduct.
XI. Board of Directors
With respect to their service on behalf of the Company, Amazon.com's Board of Directors must comply
with the relevant provisions of this Code of Conduct…

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5. Ethical conflict and its resolution
An ethical conflict arises when a person encounters one or both of the following:
๏

Obstacles to following an appropriate course of action due to internal or external pressures

๏

Conflicts in applying relevant professional and legal standards.

Here are some examples of ethical conflicts:
๏

You are a pharmaceutical company developing new drugs. How much testing should be
carried out before the drugs can be marketed? More testing might identify unwanted sideeffects, but more testing will delay treatment for people who are very ill.

๏

Your factory is old and inefficient and you are thinking of moving to new one with more
efficient use of energy, in another area of the country with better transport connections.
Carbon foot-print will be reduced, but existing employees will lose their jobs.

๏

You run an airline. You transport passengers for business and leisure and to visit overseas
family members. However, airlines also cause noise and air pollution.

๏

House-builders create accommodation for families, but they might build over attractive land
and displace wild-life.

๏

You are an accountant reporting to a lender on the prospects of a client. A poor report will

lead to business closure and redundancies but an optimistic report might lead to the lender
losing their investment.

๏

You might be asked by a manager to remain silent about certain matters that would have an
adverse impact on the financial accounts of an organisation, thereby testing the employee’s
loyalty to his or her manager on the one hand, and the responsibilities as a professional on
the other

๏

You might may consider that the employer’s policies are unethical and may find it difficult to
reconcile personal values with those of the organisation

Once an ethical conflict is encountered, a member may be required to take steps to best achieve
compliance with the rules, fundamental principles and the law. The IFAC Code offers a framework
through which ethical dilemmas may be addressed.

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When faced with ethical conflicts, the decision taker should:
(1)

Consider the facts of the situation
‣ Identify all relevant facts.
‣ Do not rely on word of mouth, or assumptions. Is it really your problem?
‣ Can anybody else help?

(2)

Consider the ethical principles involved
‣ Does it feel right?
‣ How would you feel if you saw it in a newspaper?
‣ How would you feel about your peers, friends, family knowing about it?
‣ Have you referred to the ACCA Code of Ethics?
‣ Have you referred to your internal Code of Ethics/Conduct and other internal policies?

(3)

Consider the related fundamental principles
‣ Tucker’s five question approach might be of help

(4)

Consider relevant internal procedures
‣ Many organisations will have well-developed procedures that should be followed in the
first instance

(5)

Consider the alternative courses of action
‣ Escalate internally; consider grievance procedures.

‣ Document every action you take to resolve the conflict.
‣ Escalate externally to auditor, legal advisors, professional body.

(6)

Consider the consequences of each alternative course of action.
‣ How will the individuals, organisations and key stakeholders be affected?
‣ Are there conflicts between the effects on different stakeholders?
‣ Understand the effects of non-action– to the organisation, to yourself and to society.

Ultimately, if resolution seems unlikely, disassociate yourself from the issue – in writing if necessary.
Legal advice may be needed if this affects your employment status or if you are implicated in any
way with the issue.
Note that in some cases there might be a statutory duty to report on problems (eg money
laundering).

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Chapter 3
GOVERNANCE
1. Why corporate governance is needed
Corporate governance is a system by which companies are directed and controlled.
The problem is that although the shareholders own companies, the day-to-day management and
direction of large companies is given to the Board of Directors. In large companies, many
shareholders are relatively passive and the Board of Directors are given more or less free rein to
make whatever decisions they wish.
Shareholders are the principals in the relationship: they own the company and the company
should be run for their benefit.
Directors are the agents and should run the company for the shareholders’ benefit
Auditing was instituted so that, at least once a year when the accounts were presented to the
members of the company, the auditors would examine the accounts and give some expression of
opinion to the members of the company as to whether the accounts were true and fair. Without
that assurance the members of the company really would have a little idea as to whether or not the
accounts were worth relying on. The auditors therefore examine the financial statements and this
adds credibility to those statements, the shareholders have a much better idea of the performance
of the directors and the company.
Appoint independent

Measure
performance

Auditor
Adds credibility
Financial Statements

Prepare FS
Appoint

Shareholders

Own

Company

Directors

Manage

Note that shareholders appoint the independent auditors, they also appoint the directors.

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The problem is, however, that once directors were appointed, shareholders often didn’t take much
further interest in what the directors were doing and there is at least an annual gap between sets of
financial statements and audits. This gave directors ample opportunities to pursue their own
ambitions when running the company. For example:
๏

Arranging over-generous remuneration and share options

๏

First class travel

๏

Luxury cars

๏

Excessive expense allowances

๏

Pursuing risky strategies because it was shareholders who would stand to lose rather than
directors if the strategy failed.

Scandals such as Enron, Worldcom in the early 2000’s and perhaps banking problems in 2008
showed that this hands-off approach was entirely inadequate and additional safeguards have been
instituted to try to ensure that directors act in the best interests of the members of the company.
Note that corporate governance is likely to be less of an issue in small companies (where the
owners are directors) and partnerships (where the owners manage the business. Organisations
such as trusts and charities can have governance issues when they become large enough for there
to be a separation between those who are charged with governance (trustees, governors) and
those who run the organisations on a day-to-day basis (managers).

2. Corporate Governance, ethics and the law
Ethical directors should always seek to act in the best interests of their shareholders, but often did

not. Sometimes, as explained above, this was deliberate so that directors could enrich themselves
at the expense of the shareholders. Sometimes it was accidental such as not understanding the
risks and returns that shareholders were happy with. Therefore, to encourage better (and more
ethical) corporate governance most advanced economies has introduced corporate governance
rules, laws and guidelines.

2.1. OECD Principles of corporate governance
The Organisation of Economic Cooperation Development (OECD) has put forward some principles
of corporate governance. It is then up to countries to implement detailed laws or codes to
implement these principles.
๏

The corporate governance framework should promote transparent and fair markets, and the
efficient allocation of resources. It should be consistent with the rule of law and support
effective supervision and enforcement.

๏

The corporate governance framework should protect and facilitate the exercise of
shareholders’ rights and ensure the equitable treatment of all shareholders, including
minority and foreign shareholders. All shareholders should have the opportunity to obtain
effective redress for violation of their rights. [For example, all shareholders should have access
to the same information at the same time.]

๏

The corporate governance framework should provide sound incentives throughout the
investment chain and provide for stock markets to function in a way that contributes to good
corporate governance. [This recognises that many private investors now invest in companies
indirectly, through institutional investors such as investment trusts. So, for example, the

principles state that institutional investors acting in a fiduciary capacity should disclose their

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corporate governance and voting policies with respect to their investments, including the
procedures that they have in place for deciding on the use of their voting rights.]
๏

The corporate governance framework should also recognise the rights of all stakeholders, not
just share-holders, and should encourage active cooperation between the entities and
stakeholders in creating wealth, jobs and sustainability of financially sound entities.

๏

The corporate governance framework should ensure that timely and accurate disclosure is
made on all material matters regarding the corporation, including the financial situation,
performance, ownership, and governance of the company.

๏

The corporate the corporate governance framework should ensure the strategic guidance of
the entity, effective monitoring of management by the board and the board’s accountability
to the entity and their shareholders. [This covers requirements relating to the appointment of

board members, ethical behaviour by board members and the application of care and due
diligence]

The OECD’s principles then have to be put into action by participating countries and it is up to each
country to decide how best to do this.

2.2. International Corporate Governance Network
The International Corporate Governance Network (ICGN), founded in 1995 at the instigation of
major institutional investors, represents investors, companies, financial intermediaries, academics
and other parties interested in the development of global corporate governance practices. One of
its objectives is to facilitate international dialogue on issues of concern to investors.
High standards of corporate governance, including effective dialogue between companies and
their shareholders, the ICGN believes, are a prerequisite for companies to compete effectively and
for economies to prosper. The ICGN also believes that it is in the public interest to encourage and
enable the owners of corporations to participate in their governance.

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