CORPORATE GOVERNANCE CG 601PROJECT PAPER

STUDENT NAME: MARK MISOMALI

STUDENT ID NO: 24ELI-11765

INTAKE AND VENUE: EVENING 24, LILONGWE

LECTURER’s NAME: GAW KACHALI

DATE SUBMITTED: DECEMBER 01, 2011

PREFACE

Many organizations of private or public nature are not spared from the risks of fraud and

corruption. The complex business processes make it impossible to find a common

solution for combating fraud and corruption. Even in similar business processes the

nature of fraud and corruption cannot be predicted. As a result of this a lot of resources

are lost, wasted, and abused. Other organizations have put in strict punitive measures

for the culprits but still this has not relatively reduced incidences of fraud and corruption.

There is growing consensus that organizations with good corporate governance

practices have marginal incidences of fraud and corruption. In this paper I will discuss

the link between corporate governance and prevention of fraud and corruption.

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Table of Contents

Introduction………………………………….……………………………………………….1

Purpose and Methodology……………….…………………………………………………2

Organization of the study……………….………………………………….……………….2

Chapter 1: Corporate Governance Background…………………..……………….…….3

Chapter 2: Composition of the Board………..….…………………….…………….…….5

Chapter 3: The Role of the Board……..………….………………………………….……8

Chapter 4: Board Committees…………………..….……………………………….……10

Chapter 5: Corporate Governance and Fraud…..….…………………………….…….12

Conclusion……………………………………………..….………………………………..13

Appendix…………………………………………………….………………………….…..14

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NEXUS BETWEEN CORPORATE GOVERNANCE AND THE PREVENTION OF

FRAUD AND CORRUPTION IN THE WORK PLACE

CHAPTER ONE: INTRODUCTION

In this chapter, I will attempt to define what corporate governance is; then, I will identify

the key players of corporate governance. The rest of the report will discuss how

corporate governance can be used to prevent fraud and corruption.

Definition

The reader should know that there is no single definition for such a term as corporate

governance. In simplest terms corporate governance means how corporations or

companies are run. R.I. Tricker (1984) observed that if management is about running

the business, governance is about seeing that it is run properly. The Cadbury committee

defines Corporate Governance as the system by which companies are directed and

controlled.

Corporate governance players

In running a company, we can say that there are three major players, namely

shareholders, board of directors, and management. The success or failure of

companies to a large extent depends on the actions of these three major players. The

fight against fraud and corruption should be a collective effort by these three parties.

While fulfilling their duties, the parties must operate within the guidelines of legal and

regulatory framework including other agreed upon rules and procedures of the

company. Consequently Government and other stakeholders are also interested

parties. The board of directors is therefore not only accountable to shareholders but

also to Government and other stakeholders.

The shareholder’s main role is to appoint and provide guidance to the directors. The

directors set strategic direction while the management implements the strategic goals.

Of the three major players, the directors play a pivotal role in ensuring effective

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corporate governance. It is for this reason that much discussion is dedicated to the

composition, role, and function of the board of directors and its committees.

PURPOSE AND METHODOLOGY

This report has been commissioned as part of an academic study for the Executive

MBA course in Corporate Governance. The methods used to collect data are through:-

books

internet

published articles, magazines

ORGANIZATION OF THE STUDY

The study has 5 main chapters as follows:-

Corporate Governance Background

Corporate Governance and Fraud

Composition of the Board

The Role of the Board

Board Committees

Each of those areas is discussed in detail looking at how it relates to the prevention of

fraud and corruption in the work place. At the end of the discussion I present my

conclusion.

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Chapter One: Corporate Governance Background

The concept of corporate governance emerged from the time when ownership and

management of businesses were separated. The concept of stewardship and the role of

auditor emerged from this separation of management and ownership. The owners

wanted to have a way of monitoring the performance of individuals managing their

businesses. Below is a diagram representing this tri-parte relationship:-

Owner

Oversight body Steward

Industrial revolution brought about expansion of enterprises that required heavy

investment of capital which led to emergence of incorporated enterprises. A corporation

is a legal entity but can only act through the agency of natural persons. It is for this

reason that the need for directors arises. The directors are not only agents of the

company but they are also its trustees. Initially, company legislation dealt with all

corporate governance matters such as the appointment of directors, the operations of

board of directors, and the role of auditors. Later events have caused several

developments leading to evolvement of an extensive academic literature dealing with

the principal-agent relationship.

Corporate governance involves putting in place systems and structures for the operation

and control of a company with the following specific aims;-

Fulfilling long-term strategic goals of owners

Taking care of the interests of employees

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A consideration for the environment and local community

Maintaining excellent relations with customers and suppliers

Proper compliance with all the applicable legal and regulatory requirements.

Good governance is integral to the very existence of a company. It builds confidence

amongst stakeholders and prospective investors. Investors are willing to pay higher

price to organizations with internationally accepted norms of corporate governance.

Effective accountability to all stakeholders is the essence of corporate governance.

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Chapter Two: Corporate Governance and Fraud

A proper review of financial statements by directors may reveal errors in recording of

transactions. However, fraudulent transactions, which are carefully recorded with the

intent to conceal, are extremely difficult to identify. Fraud and corruption involves the

perpetrator having intention to deceive causing the deceived person or entity suffering

some kind of loss. Fraud and corruption involves circumventing the systems. Very often

fraud is discovered after lapse of a considerable period of time.

It is for this reason that corporate governance seeks to ensure that the business and

management of corporate entities is carried out in accordance with the highest

prevailing standards of ethics to safeguard and promote the interests of all

stakeholders. For this purpose, it is vital to recognize the importance of stakeholders

and their rights. Communication between stakeholders is considered to be an important

feature of corporate governance.

Developments in corporate governance

There has been renewed interest in corporate governance practices of modern

corporations due to the high-profile collapses of a number of large corporations most of

which involved fraud. Corporate scandals such as the Enron corporation and MCI Inc.

have led to the regulation of corporate governance, such as, The Cadbury Report (UK,

1992), OECD principles of corporate governance (2004), and the Sarbanes-Oxley Act

(US, 2002). These reports present general principles around which businesses are

expected to operate to assure proper governance. These principles are as follows:-

Rights and equitable treatment of shareholders

Organizations should respect rights of shareholders and help them exercise those rights

through effective communication. Since shareholders are normally not involved in the

day-to-day running of the organization, they can provide an independent and objective

view of the way the organization is run. Some loopholes can best be spotted from an

outside look thereby saving the organization from risks of fraud and corruption. Some

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fraud and corruption incidences are perpetrated by the board itself, so allowing

participation of shareholders can act as a deterrent from such bad acts. In addition to

basic duties, a shareholder must focus on such issues as the election of the board,

amendments to the company’s rules, approval of extraordinary transactions. In order to

do this, a shareholder must participate in general meetings.

Interests of other stakeholders

Organizations should recognize that they have social and other obligations to other

stakeholders other than shareholders including employees, suppliers, creditors, local

communities, customers, policy makers. Realizing that there are many interested

parties to the affairs of the organization can enforce discipline and put the board and

management on guard to act with care and prudence.

Role and responsibilities of the board

The board needs sufficient and relevant skills to review and challenge management

performance. It also needs adequate size and appropriate levels of independence and

commitment to fulfill its duties and responsibilities. Management runs the organization

and the board ensures that it is run properly. The recruitment of members into the board

must follow a formal process similar to that followed when recruiting employees of a

company. The board must have the necessary skills, receive adequate orientation and

undergo regular training to effectively discharge its duties and responsibilities. The

primary responsibility for the administration and performance of a company lies with the

directors. Their role is so crucial such that an extensive discussion is reserved for

chapter four.

Integrity and ethical behavior

Integrity should be a fundamental requirement in choosing corporate officers and board

members. Corruption and fraud are basically due to a crisis in ethics. Integrity counts

more in the fight against corruption and fraud than the academic and professional

qualifications. The recruitment process must include background check of individuals

elected into the board to assess their past records.

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Disclosure and transparency

Organizations should clarify and make publicly known the roles and responsibilities of

board and management to provide stakeholders with a level of accountability.

Disclosure of material matters concerning the organization should be timely and

balanced to ensure that all investors have access to clear, factual information.

Prevention of fraud

It is imperative that the board and management take appropriate measures for

prevention and timely detection of fraud. This is possible through the implementation

and continued operation of adequate accounting and internal control systems.

The internal control system extends beyond those matters that relate directly to the

functions of the accounting system and comprise of the control environment and control

procedures. Control environment refers to the overall attitude, awareness and actions of

directors and management regarding the internal control system and its importance in

the company. Factors reflected in the control environment include:-

The function of the board of directors and its committees

Management philosophy and operating style

The company’s organizational structure and methods of assigning authority and

responsibility

Management’s control system including the internal audit function, personnel

policies and procedures and segregation of duties

Management implements the strategies and policies set out by the board of directors.

Management should establish control procedures to achieve entity’s specific objectives.

Specific control procedures include:-

Reporting, reviewing and approving reconciliations

Approving and controlling of documents

Limiting direct physical access to assets and records

Comparing internal data with external sources of information

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Chapter Three: Composition of the Board

A well constituted board is a catalyst for effective corporate governance which can lead

to prevention of fraud and corruption. The following guidelines are worth considering

when composing the board:

The board should comprise a balance of executive and non-executive directors,

with a majority of independent non-executive directors to reduce possibility of

conflicts of interest.

There must be an appropriate balance of power and authority so that no one

individual or group dominates.

All directors should be individuals of integrity and courage to be able to challenge

management.

There must be a minimum of two executive directors, Chief Executive Officer

(CEO) and Chief Financial Officer (CFO) to ensure there is more than one point

of contact between the board and management

The board should be led by an independent non-executive chairman who should

not be CEO of the company. The chairman should be independent and free of

conflicts of interest in order to effectively discharge his duties of providing the

necessary direction of the company

The board should appoint an effective and ethical chief executive officer. The

CEO serves as the chief spokesperson and plays a strategic role in the

operations and success of the company. He should ensure that a positive and

ethical work climate is maintained.

Other factors to consider are the qualifications of the board members, the size of the

board, the time and energy of the board members.

Qualifications

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Board members should be elected based on a demonstrated record of possessing the

specific qualifications and competencies necessary for effective governance. William

Bowen writes that “every trustee should bring a specific competence or experience

needed on the board”. Eligibility for election to another term should be based on

performance and ability to contribute a competency that is still needed by the

organization.

Size

The knowledge, skills, and other resources required should determine the number of

directors to serve on the board. It is very helpful for the board to include directors with

relevant technical skills for the core business to understand the nature and operations of

the company. Every board should consider whether its size, diversity and demographics

make it effective. No one individual should wield more power to dominate the decisions

of the board.

Time

Time is very crucial for board members to attend meetings and contribute towards the

successes of the company. When recruiting board members, consideration should be

given to their availability to attend meetings and participate in other activities.

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Chapter Four: The Role of the Board

The four cornerstones of corporate governance are the board of directors,

management, external audit, and internal audit. The corporate governance framework

should ensure the strategic guidance of the company, the effective monitoring of

management by the board, and the board’s accountability to the company and the

shareholders (OECD Principles of Corporate Governance, 2004).The board provides

oversight ensuring that the company is run properly. The board is the focal point of

corporate governance structure in the company and is the link between the

stakeholders and the company. The functions of the board are broad and include the

following:-

To promote the success of the company by directing and supervising the

company affairs

To cultivate and promote an ethical corporate culture

Appreciate that strategy, risk, performance and sustainability are inseparable.

Identify key risk areas and ensure that management direct its mind to pertinent

risks.

Manage conflict of interests of directors

Ensure that there is an effective risk-based internal audit

Ensure the integrity of financial reporting

Report on the effectiveness of internal financial controls

An article in the Point of View magazine summarizes the 5 things which the board

should be focusing on, and which distinguish exceptional boards from the rest as

follows:-

Effective board leadership

The effective functioning of a board depends on a number of factors, including the mix

of knowledge and experience among the directors, the quality of information they

receive and the ability to operate as a team. The board chairman will ensure that the

board not only evaluate the performance of the CEO, but take the formal assessment of

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their own work seriously and use the findings to develop and hold themselves to

objectives for improvement.

Strategy

The Company’s successes and shareholder satisfaction are dependent on the board

making wise strategic decisions. Every board member must be very clear about what is

expected of them in the strategy discussion. Usually the executive team develops

strategy; the board fine tunes it and then oversees its execution by management,

measuring CEO’s performance against a set of agreed-upon objectives.

Risk Oversight

Risk should be defined in the broadest terms, encompassing not just financial matters

but also areas such as health and safety, the environment, industrial relations and

corporate reputation. Risks are inherent in any business that is going to deliver long-

term value to its stakeholders. The board should determine whether they have optimal

structure for overseeing risk.

Succession

The board should have a rigorous succession planning methodology in place for both

planned and emergency scenarios, to identify the next CEO, the chairman and the rest

of the board. The planning process should start as early as possible, even if this makes

the incumbent uncomfortable.

Sustainability

Boards of listed companies have an obligation to build and protect long-term

shareholder value and to ensure short-term decisions do not jeopardize the

sustainability of the enterprise. All forms of capital – financial, human, natural and social

are essential for value creation. More evidence is mounting that overlooking social

responsibility has negative consequences in the sustainability of organizations.

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The primary responsibility for the administration and performance of a company lies with

the board of directors.

Chapter Five: Board Committees

The board works through committees. The number of committees depends on the

needs of the organization. The King Report requires that at a minimum, each board

should have an audit, and Remuneration committees. Additionally it recommends a

board to have a nomination committee.

Audit committee

The audit committee is the principal governance watchdog in most companies whose

purpose is to provide additional focus on financial issues. According to the Blue ribbon

Committee of US SEC, the role of the audit committee is to function as the “ultimate

guardian of investor’s interest and corporate accountability”.

Remuneration Committee

This is probably the second most important governance committee. Its main tasks are to

review, assess and make recommendations to the main board on matters concerning

directors’ remuneration, incentive schemes, and measurement criteria for the

performance of executive directors.

Nomination Committee

The purpose of this committee is to ensure that the board consists of the skills and

attributes needed by the company. Its functions include reviewing the size and

composition of the board, establishing succession plans, recommending the

appointment of directors.

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Conclusion

From the discussion above, it is clear that there is a link between corporate governance

and the prevention of fraud and corruption at work places. The opportunity to do

business or provide goods and services opens up risks associated with the resources

involved in the transactions. Cases of fraud and corruption are common among private

and public enterprises. The board of directors has fiduciary duties to ensure that

resources of organization are protected from the risk of fraud and corruption. This

requires a competent board composed of members who are honest, have the requisite

skills, knowledge, and ability to strategically position the organization to achieve desired

results while complying with all the necessary rules and regulation. Modern technology

has also come with new challenges making it imperative that the board should have

continuous professional development to gain new management and control techniques.

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Appendix

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