The International Corporate Governance System

Audit Roles and Board Oversight

F. Lessambo

• Publisher: Palgrave Macmillan
• Year: 2016
• Print ISBN: 9781349471782, 9781137360007
• eBook ISBN: 9781137360014
• Topic: Business
• Subtopic: Corporate Finance
• Index: Business

This book provides a comprehensive approach to Corporate Governance, Audit Process and Risk Management. Furthermore, it provides an analytical and comprehensive approach of the issues facing governance directors, internal and external auditors, risk managers, and public officials conducting assessments based upon the Report on Standards and Codes.

Part I

Comparative Corporate Governance

1

Corporate Governance Framework

1.1 General

Corporate governance can be defined as the material obligations of a company toward shareholders, employees, customers, suppliers, creditors, tax, and other supervisory authorities.¹ From the above definition, we can infer that corporate governance is a set of relationships framed by corporate by-laws, articles of association, charters, and applicable statutory or other legal rules and principles, between the board of directors, shareholders, and other stakeholders of an organization that outlines the relationship among these groups, sets rules as to how the organization should be managed, as well as its operational framework.² Concerns for corporate governance emerged in the 1980s, when US pension funds decided to invest the bulk of their stockholdings in index funds. A series of financial scandals starting in the 1980s have raised questions about US and other developed economies’ corporate governance ethics. After the Chrysler rescue in 1980; the Black Monday stock market crash in 1987; the Long-Term Capital Management (LTCM) stock market failure in 1998; the Enron, Tyco, Swissair, Vivendi, Kmart, Parmalat, Siemens, Ahold, and WorldCom fiascos; the US sub-prime market and its string of failures (i.e. Bear Stearns, Lehman Brothers, Merrill Lynch), corporate governance has become the predominant debate in academic, business, and even political circles.

Almost all around the world, corporate governance has become the topic, the heated debate among unfettered free market proponents and market-ruled-basis advocates.

The International Corporate Governance Network (ICGN), a not-for-profit organization was solicited to lecture on corporate governance in various jurisdictions: 1997, in London with the sponsorship of the Corporation of the City of London; 1997, in Paris, with the sponsorship of the Paris Bourse; 1998 in San Francisco; 2001 in Tokyo; 2007 in Cape Town, sponsored by the Johannesburg Stock Exchange; 2008 in Seoul (South Korea).

The modern financial ideology of ‘laissez-faire’ that was the ‘modus operandi’ of businesses and regulators over decades has become obsolete. To attract investors, companies are attaching to their financial statements, a brief oversight of their corporate governance.

The corporate governance discussion in public has now departed from how to best organize accountability and responsibility at the helm of the company. It has moved on to a more fundamental debate about corporate roles in society, basic attitudes and behaviors in businesses, which are perceived as more powerful than governments.³

Empirical evidence suggests that good corporate governance increases the efficiency of capital allocation within and across firms, reduces the cost of capital for issuers, helps broaden access to capital, reduces vulnerability to crises and makes corruption more difficult to occur. Furthermore, recent research has found a relationship between the state of corporate governance in an economy and the severity of the crises that it suffers.⁴

1.2 The legal framework

The legal system of a country determines the corporate governance structure in relation to the rules regarding the ownership and board structures, mergers and liquidations, as well as shareholders’ rights. The discrepancies among legal frameworks explain in most part the approaches retained. Some authors, particularly La Porta et al. (LLSV) argued that the rights or treatment of investors in any given country depends solely on the statutory laws and their enforcement.⁵. La Porta views legal origin of laws as the primary determinant that affects almost all other variables affecting corporate governance.⁶

LLSV considered laws protecting investors in 49 countries and defined an anti-director right index composed of five components: (i) vote by mail, (ii) deposit of shares prior to the shareholders’ meeting, (iii) representation of minorities on the board of directors, (iv) oppressed minorities’ mechanisms, (v) minimum percentage of shares that entitles a shareholder to call an extraordinary shareholder meeting. LLSV applied the ‘anti-director’ index and came out with the ‘awkward’ conclusion that Anglo-Saxon countries offered greater shareholder protection than civil-law countries. When the string of corporate governance scandals hit the US and shareholders were stripped by greedy managements, LLSV refined their legal theory with the addition of a new index, the ‘the anti-self-dealing’ against expropriation by insiders. The authors reached the same conclusion: Anglo-Saxon jurisdictions offer greater shareholder protection than the civil-law countries. A deep analysis of the methodology used by these authors shows the wrongness of the approach. LLSV classified legal systems into two sectors – Anglo-Saxon v. civil law – losing sight of the fact that, at some point it becomes inaccurate to talk about ‘Anglo-Saxon’, and the so-called ‘Anglo-American’ corporate governance does not really exist. As explained in Chapter 6, the UK system of corporate governance differs significantly from the US system of corporate governance, and all other countries the authors included in the ‘Anglo-Saxon’ are more like the UK, thus almost totally different from the US. Indeed, the UK system of corporate governance is becoming more relational, more like an insider system, with the key difference being the UK institutional investors’ role is more creative as they partake in the enlargement of the City Code on Takeovers and Mergers.

1.3 The political framework

The political theory of corporate governance, developed by Roe⁷ and Gourevitch⁸ argues that the differences in ownership structure and corporate governance models cannot be explained solely by legal origin and enforcement. To these authors, the missing component, and by far the most important, is politics. Gourevitch, particularly, investigated the impact of political variables on corporate governance and argued that corporate governance patterns vary with other features of the economy, inter alia, job security, product market competition, education and training systems, financial structures, and income inequality.

1.4 The economic framework

Beside the legal structure, the corporate governance structure in any given country is also dependent on the economic framework in place. Gourevitch, particularly, investigated the impact of political variables on corporate governance and argued that corporate governance patterns vary with other features of the economy, among other things, job security, product market competition, education and training systems, financial structures, and income inequality.⁹

1.5 Corporate governance structure

The two main structures of corporate governance observed all around the world are: (i) the concentrated corporate structure; and (ii) the diluted corporate structure.

1.5.1 The concentrated corporate governance structure

Within the concentrated corporate governance structure, ownership and/or control is concentrated in the hands of a small group, whether a family, a group of families or holding company, who manage the daily business of the corporation. Concentrated corporate governance structure is more common in civil law countries such as Germany, France, and Japan. The concentration of ownership and/or control can be achieved through various means: creation of different types of stocks with different voting weight, proxy votes, and voting trusts. Concentrated corporate structure has some positive points, among others, stability in the long run given that the dominant team has fewer debates in the decision making. It has also some negatives including, for example, abuse of dominant position and power, lack of legal rights for the minority, lack of outside control.

1.5.2 The diluted corporate governance structure

In general, within diluted corporate governance structure, ownership and/or control is scattered among the shareholders. There is no individual, family or group of families holding the majority of the outstanding voting stocks. Diluted corporate governance structure is common within capital market-orientated countries or jurisdictions, where most companies raised their capital through the issuance of securities in the capital markets. The United States and the United Kingdom follow such a corporate governance structure.

Shareholders within a diluted corporate structure rely upon a board of directors to manage the corporation business and maximize their profits. Management decisions, depending on their size or effect, are taken by either the shareholders or the board depending on the corporation by-laws and the state corporate laws.

1.6 Corporate governance core principles

Corporate governance is organized around four core principles: (i) fairness; (ii) accountability; (iii) responsibility; and (iv) transparency.

1.6.1 Fairness

In conducting the corporation affairs, the board must be fair and convey the appearances of being fair. For more complex or difficult issues, fairness requires that the board seek an independent knowledgeable entity to assess the particular complexity of the issue.

1.6.2 Accountability

Accountability implies that some actors have the right to hold other actors to a set of standards, to judge whether they have fulfilled their responsibilities in light of these standards, and to impose sanctions if they determine that these responsibilities have not been met. A sound corporate governance model relies on two distinct accountability relationships: between the governing body and the shareholders and other stakeholders, and between the governing body and the management team.

1.6.3 Responsibility

Corporate managers’ responsibilities shall not be limited to producing truthful financial statements or paying their fair share of tax. Businesses also have to respond to the expectations of the democratic societies in which they operate. These expectations are often not embedded in codes, or written in formal law. Corporate responsibility refers to the actions taken by businesses in response to such expectations in order to enhance the mutually dependent relationship between business and societies. A firm needs to be part of the socie...

Table of contents

• Cover
• Title
• Part I Comparative Corporate Governance
• Part II Audit Roles
• Part III Board Oversight
• Appendices
• Notes
• Bibliography
• Glossary of the Terms
• Index