1. TOPIC 5- CORPORATE GOVERNANCE ACC00106- CONTEMPORARY ISSUES IN ACCOUNTING DR LYNN BARKESS, S2 2014 1

2. TOPIC 5 – CORPORATE GOVERNANCE UNIT -LEARNING OBJECTIVES Overall unit objectives 4. define corporate governance and assess the effectiveness of various corporate governance mechanisms 6. critically evaluate contemporary a external company reporting practices DR LYNN BARKESS, S2 2014 2

3. TOPIC 5 –CORPORATE GOVERNANCE TOPIC LEARNING OBJECTIVES 1. define corporate governance and assess the effectiveness of various corporate governance mechanisms 2. apply concepts from agency and stakeholder theories to explain corporate governance; 3. list various corporate governance mechanisms 4. describe the minimum corporate governance mechanisms recommended by the ASX DR LYNN BARKESS, S2 2014 3

4. TOPIC 5 –CORPORATE GOVERNANCE LEARNING OBJECTIVES 5.explain and evaluate the use of independent directors as means of achieving corporate governance; 6.explain and evaluate the use of executive compensations packages as means of achieving corporate governance; 7.describe the annual report and other disclosure requirements related to corporate governance; DR LYNN BARKESS, S2 2014 4

5. TOPIC 5- STUDY TIME Study learning materials 2 hrs Read supplied readings12 hrs Undertake activities and review Activities10 hrs 24hrs DR LYNN BARKESS, S2 2014 5

6. BASIC CORPORATE GOVERNANCE Its board of directors! DR LYNN BARKESS, S2 2014 6

7. DEFINITION OF CORPORATE GOVERNANCE #1 “NARROW” Agency Theory Perspective “… the process of supervision and control intended to ensure that the company's management acts in accordance with the interests of the shareholders “ (Parkinson (1994) as quoted in Table 1 Solomon 2007, page 13). DR LYNN BARKESS, S2 2014 7

8. DEFINITION OF CORPORATE GOVERNANCE #2 “BROAD” Adopted by Solomon “… the system of checks and balances, both internal and external to companies, which ensures that companies discharge their accountability to all their stakeholders and act in a socially responsible way in all areas of their business activity. “ (Solomon 2007 (reading 5.1), page 14). DR LYNN BARKESS, S2 2014 8

9. DEFINITIONS OF CORPORATE GOVERNANCE #3 ASX “the framework of rules, relationships, systems and processes within and by which authority is exercised and controlled in corporations”. (ASX Corporate Governance Principles and Recommendations (reading 5.2), page 3) DR LYNN BARKESS, S2 2014 9

10. DEFINITIONS OF CORPORATE GOVERNANCE “Effective corporate governance structures encourage companies to create value, through entrepreneurialism, innovation, development and exploration, and provide accountability and control systems commensurate with the risks involved”. (ASX Corporate Governance Principles and Recommendations (reading 5.2), page 13) DR LYNN BARKESS, S2 2014 10

11. THEORIES OF CORPORATE GOVERNANCE Agency theory. Stakeholder theory. Solomon suggests that these frameworks share commonalities and overlap theoretically (covered in reading 5.1, Solomon 2007, chapter 1) DR LYNN BARKESS, S2 2014 11

12. AGENCY THEORY “…competition would take care of corporate governance.” Disclosures and practices based on business reasons. However, markets are not perfectly competitive. Which has lead to the intervention by regulators and the development in Australia and internationally - policy documents - codes of best practices DR LYNN BARKESS, S2 2014 12

13. STAKEHOLDER THEORY – ETHICAL BRANCH Accountability to a broad range of stakeholders. Impact of companies on : Employees, customers, suppliers, local community and environment. DR LYNN BARKESS, S2 2014 13

14. STAKEHOLDER THEORY “…may be viewed as a conceptual cocktail, concocted from a variety of disciplines and producing a blend of appealing sociological and organisational flavours” (Solomon 2007, page 23) DR LYNN BARKESS, S2 2014 14

15. STAKEHOLDER THEORY – ETHICAL BRANCH Normative theory Companies should have a sound system of corporate governance to ensure they uphold their responsibility to a broad range of stakeholders DR LYNN BARKESS, S2 2014 15

16. AGENCY AND STAKEHOLDER THEORIES Agency theory – principal agent relationship is a subset of the more general Stakeholder theory where the agency relationships extend the concept To the relationships between the entity as a whole and the broader society in which it operates DR LYNN BARKESS, S2 2014 16

17. CORPORATE GOVERNANCE MECHANISMS 1.Independent Directors 2.Audit Committees 3.Executive Compensation DR LYNN BARKESS, S2 2014 17

18. CORPORATE GOVERNANCE MECHANISMS- INDEPENDENT DIRECTORS What is an independent (outside) director ? 1.Is a non-executive director 2.Not a member of management 3.Free of any business or other relationship that could materially interfere with or could reasonably be perceived to materially interfere with the independent exercise of their judgement. DR LYNN BARKESS, S2 2014 18

19. CORPORATE GOVERNANCE MECHANISMS- INDEPENDENT DIRECTORS Roles  Chair of the board should be an independent directors (ASX 2.2)  Majority of the board should be independent directors (ASX 2.1) Pitfalls  Jensen and Murphy (2004, reading 5.5) recommend to limit number of independent directors (R-15 p55)  outside CEO’s bring expertise to the board  May view the board through CEO eyes and not challenge the CEO on day to day issues– with the exception of serious problems DR LYNN BARKESS, S2 2014 19

20. CORPORATE GOVERNANCE MECHANISMS Board sub-committees -Nomination committee (ASX 2.4)  Comprising majority of independent directors  Chaired by independent director  Have at least 3 members  examine the selection and appointment practices of the company  Charter setting out the roles and responsibilities  Formal and transparent process for appointment and re- election of directors DR LYNN BARKESS, S2 2014 20

21. CORPORATE GOVERNANCE MECHANISMS Board sub-committees- Independent audit committee (ASX 4.1)  Focus on issue relevant to the integrity of the companies financial reporting  Assess the performance of external auditors and internal audit function  Examine the provision of non-audit services  Have a charter, reports to the board DR LYNN BARKESS, S2 2014 21

22. CORPORATE GOVERNANCE MECHANISMS Board sub-committees- Remuneration Committee (ASX 8.1) Review and recommendations to board on  Remuneration, recruitment, retention, and termination policies and procedures for senior executives  Senior executives remuneration and incentives  Superannuation arrangements  Remuneration framework for directors  Remuneration by gender DR LYNN BARKESS, S2 2014 22

23. EXECUTIVE COMPENSATION ASX Principle 8 – Remunerate fairly and responsibly, states “Companies should ensure that the level and composition of remuneration is sufficient and reasonable and that its relationship to performance is clear.” DR LYNN BARKESS, S2 2014 23

24. EXECUTIVE COMPENSATION There are numerous examples in Australia and elsewhere of excessive executive remuneration that has no correlation with the long-term value of companies. Shareholders, tax payers and other stakeholders are wearing the costs of executives’ risky behaviour. DR LYNN BARKESS, S2 2014 24

25. EXECUTIVE COMPENSATION The purpose of remuneration is to: - attract the right executives ( at the lowest cost ) - retain the right executives and - motivate executives to maximise long-term firm value (reading 5.5) DR LYNN BARKESS, S2 2014 25

26. EXECUTIVE COMPENSATION Types of remuneration -Cash as salary -Risky performance related cash -Shares -Restricted shares of share options -Retirement benefits -Non-pecuniary benefits…. (page 19) DR LYNN BARKESS, S2 2014 26

27. EXECUTIVE COMPENSATION The effects of remuneration systems on performance and corporate governance is an area that has received much attention. It has long been recognized that remuneration systems that correlate management’s salary with financial performance can motivate them to increase financial performance. DR LYNN BARKESS, S2 2014 27

28. EXECUTIVE COMPENSATION However, remuneration systems can motivate incompetent and opportunistic managers to use their power to fake the earnings of the firm they manage. Refer to “agency costs of over-valued stock” for example, (p 46). DR LYNN BARKESS, S2 2014 28

29. EXECUTIVE COMPENSATION Forging the accounts is not possible in the long-term and because management is assumed to be incompetent in the long-term there is unlikely to be a positive correlation between financial performance and compensation. It is naïve to think that a performance measure can correct deficiencies in corporate governance, judgement or decision analysis. DR LYNN BARKESS, S2 2014 29

30. ASX PRINCIPLES AND RECOMMENDATIONS Not prescriptions merely guidelines “if not why not” system (ASX) Disclosure in a separate CG statement in the annual report  All ASX Principles and Recommendations DR LYNN BARKESS, S2 2014 30

31. ASX PRINCIPLES Principle 1- Lay solid foundations for management and oversight Principle 2- Structure the Board to add value Principle 3- Promote ethical and responsible decision making Principle 4- Safeguard integrity in financial reporting Principle 5- Make timely and balanced disclosure Principle 6- Respect the rights of shareholders Principle 7- Recognise and manage risk Principle 8- Remunerate fairly and responsibly DR LYNN BARKESS, S2 2014 31

32. DISCLOSURE (AASB 1046) Directors  Name, Positions held, Tenure  Changes (new and retired) Directors  Cash salary, fees and commissions  Bonuses (incl. long-term incentive plans)  Post-employments benefits (e.g. pensions and superannuation)  Equity compensation (e.g. value of share and options)  Termination benefits DR LYNN BARKESS, S2 2014 32

33. DISCLOSURE (AASB 1046) Directors Remuneration Cash salary, fees and commissions  Bonuses (incl. long-term incentive plans)  Post-employments benefits (e.g. pensions and superannuation)  Equity compensation (e.g. value of share and options)  Termination benefits DR LYNN BARKESS, S2 2014 33

34. AASB 124- RELATED PARTY DISCLOSURES A related party transaction is a transfer of resources, services or obligations between a reporting entity and a related party, regardless of whether a price is charged. To enable users of financial statements to form a view about the effects of related party relationships on an entity, it is appropriate to disclose the related party relationship when control exists, irrespective of whether there have been transactions between the related parties DR LYNN BARKESS, S2 2014 34

35. SHAREHOLDER ACTIVISM How can shareholders influence CG practices and disclosures  voting at AGMs;  calling other meetings with senior management; and  campaign by a shareholder or a group of shareholders to achieve change. DR LYNN BARKESS, S2 2014 35

36. SHAREHOLDER ACTIVISM-ASA The Australian Shareholders' Association (ASA) was established as a not-for-profit organisation in 1960 to protect and advance the interests of investors. improvements in transparency andaccountability  company performance  executive remuneration  treatment of minority shareholders, risk management and dividend policy DR LYNN BARKESS, S2 2014 36

37. SHAREHOLDER ACTIVISM-ASA  liaises regulators, lawmakers, industry groups and accounting bodies.  represents its members' views on a number of accounting and financial industry bodies  holds regular members' meetingsmembers' meetings  conducts adult education workshops aimed at improving members' financial literacy.education workshops  Directors and other volunteers draw no fee or other remuneration for their services. DR LYNN BARKESS, S2 2014 37

38. CORPORATE GOVERNANCE RATINGS – CORPORATE MONITOR- Legal compliance - corporate governance, trade practices, fair trading. Instances of organised shareholder activism or complaints on behalf of shareholders. Governance awards. CEO Remuneration. Non Executive Director remuneration Auditor's remuneration for services other than auditing Board committee structures and independence Concentrated shareholdings DR LYNN BARKESS, S2 2014 38

39. GLOBAL CORPORATE GOVERNANCE QUOTIENT This corporate governance quotient was developed by the Institutional Shareholders Service (ISS) to rate publicly traded companies on the quality of their CG Correlations have been found between good CG practices and increased shareholder value. DR LYNN BARKESS, S2 2014 39

40. GLOBAL CORPORATE GOVERNANCE QUOTIENT board structure and composition; charter and bylaw provisions; audit issues; anti-takeover practices; executive and director compensation; progressive practices such as board performance review; director and officer stock ownership; and director education. DR LYNN BARKESS, S2 2014 40

41. SUMMARY -TOPIC 5 Define Corporate Governance Theories of Corporate Governance Agency Theory Stakeholder Theory Corporate Governance Mechanisms Independent Directors Audit Committees Executive Compensation ASX Principles and Recommendations AASB Disclosures Shareholder Activism Corporate Governance Ratings Next Topic 6 Critical Accounting Theory DR LYNN BARKESS, S2 2014 41