Financial Reporting – Corporate Governance


Corporate Governance

Let’s start with some more recapping from last time:

  • The gearing ratio measures what proportion of a business is funded by borrowing
  • Depreciation does not count as a cash expense
  • Current assets are usually only held during one operating cycle, so they are expected to be sold within a year
  • The market value of a company cannot be shown on the balance sheet, as it depends on the number of shares x the share price, neither of which appear on the balance sheet.

What is corporate governance?

  • The system by which businesses are controlled, or governed.
  • It specifies the rights and responsibilities that apply to different people in the business, such as owners, the board, managers and shareholders.
  • It makes the procedures for doing things known

Simpler explanation:

  • The way suppliers of finance to a business are assured that they will get a return on their investment

Scandals

  • There have been accounting scandals at big firms in the past
  • This decreases the confidence that investors have
  • So corporate governance is reformed to restore confidence
  • In the UK we have codes of practice that outline what the best practice in difference areas of corporate governance is
  • If a business chooses not to comply with the codes of practice they must say why not. Most businesses issue an annual corporate governance report

Reforms

There are 3 guiding principles in the reforms:

  • Disclosure
  • Accountability
  • Fairness

The combined code 2008

  • Every listed company needs a board of directors
  • There should be a clear division of responsibilities between the chairman and the CEO
  • There should be a balance between executive and non-executive members (executive means full time)
  • The board should receive timely information
  • Appointments to the board should be subjected to rigorous, formal and transparent procedures
  • All directors should be subjected to re-election regularly
  • Renumeration should be sufficient to attract, keep and motivate directors of the quality required to run the company
  • There should be formal and transparent procedures for developing policy on renumeration
  • The board should communicate both ways with shareholders
  • Boards should use the AGM to communicate with private investors
  • Shareholders have a responsibility to use their votes
  • The board should publish an assessment of the company’s position and performance that is balanced and understandable
  • Internal controls must be in place that protect the shareholder’s wealth
  • Formal and transparent arrangements for financial reporting should be in place
  • The board should undertake a formal and rigorous examination of its own performance annually

The Board of Directors

They do 3 main things:

  • Decide strategic direction for the company
  • Exercise control
  • Maintain external relations

Exercising Control

We can split this into 4 areas:

  • Carrying out the strategic plan
  • Maintaining integrity of financial statements
  • Evaluating and managing risk
  • The way that directors are nominated and remunerated

The chairman of the board

Is expected to:

  • Hold board meetings often
  • Make sure the board’s agenda reflects the key issues
  • Give board members relevant, reliable and timely information
  • Provide enough time at meetings to discuss key issues
  • Allow all directors to voice their opinions
  • Guide discussions so that the focus stays on key issues

Auditing

Company law means that directors must prepare annual financial statements. This involves:

  • Selecting suitable accounting policies and applying them consistently
  • Making prudent and practical judgements and estimates
  • Stating whether appropriate accounting standards have been used
  • Applying the going concern convention when appropriate

Internal Audit

Involves a review of:

  • The internal control systems, to make sure that they safeguard the company’s assets and prevent fraud
  • The accounting systems to make sure they provide reliable information
  • Internal processes to se whether they are efficient and provide value for money

The audit committee:

  • Monitors the integrity of financial statements
  • Reviews the company’s internal controls
  • Makes recommendations concerning the appointment of external auditors
  • Monitors the external auditor
  • Establish policies about the supply of non-audit services by the external auditor

Director’s Pay

  • Usually a mixture of fixed and variable pay, eg a base salary mixed with performance based awards

Performance targets should:

  • Sync with the goals of the company
  • Lead to a convergence of director and shareholder’s interests
  • Reflect director achievement
  • Be protected from financial manipulation

Share Options

  • Give directors the option of buying shares in the company at an agreed price
  • Usually the market price on grant date.
  • See ‘Apple backdating options’ for more information
  • Option must be used on an agreed date

There are several benefits by offering options:

  • Aligns director and shareholder interests
  • Strengthens the psychological bond between director and company
  • Retains board members
  • Involves no financial outlay for the company at the granting time

Problems:

  • If share price falls, the incentive is lost
  • This may be beyond the control of the directors
  • Director might have a large proportion of their wealth in the form of equity
  • Excessively focusing on share price might not be best for the company
  • Option pricing has been manipulated in the past

Shareholder Involvement

  • Increasingly shareholders involve themselves in challenging board decisions such as director pay
  • Debatable if this makes a difference to company performance
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About Shaun
I'm super cool and I do computer science (unrelated to the coolness)

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