F 09420010120134025 PP T 12

Course : F0942 Management Control System
Year
: 2013-2014
Corporate Governance and Boards of

Directors
Slide 13.3
Chapter 13:
Corporate Governance
and Boards of Directors
Kenneth A. Merchant and Wim A. Van der Stede, Management Control Systems, 2nd Edition Pearson Education Limited 2007
Slide 13.4
Board of directors
Shareholders, who typically own a portfolio of firms, delegate

their authority for internal control to a board of directors.
The board is given ultimate control over management.
It monitors and approves management decisions, and
chooses, dismisses, and rewards managers.
Two main control responsibilities:

Safeguard the equity investors interests by ensuring that
management seeks to maximize shareholder value.
Protect the interests of other corporate stakeholders (employees,
customers, suppliers, competitors, and society at large) by ensuring
that the employees in the corporation act in a legally and socially
responsible manner.
Slide 13.5
Board of directors (Continued)
Duty of care
Duty to make/delegate decisions in an informed way.
Duty of loyalty
Duty to advance corporate over personal interests.
Duty of good faith

Duty to be faithful and devoted to the interests of the
corporation and its shareholders.
Duty not to waste

Duty to avoid deliberate destruction of shareholder value.
All of these duties are defined by, and enforced through,

the legal system.
Slide 13.6
To carry out their responsibilities, boards must

ensure that they are independent and accountable
to shareholders, and they must exert their authority
for the continuity of executive leadership with proper
vision and values.
Board independence
Interlocking directorates
Slide 13.7
Boards are given ultimate control over management:

They are singularly responsible for the selection and
evaluation of the corporations CEO and must ensure the
quality of senior management.
Boards also review and approve the corporations longterm strategy and important management decisions,
such as the design of equity and compensation policies that
motivate management to achieve and sustain superior longterm performance.
Board competence
Slide 13.8
Audit committees
Audit committees provide independent oversight

over companies financial reporting processes,
internal controls, and independent auditors.
They enhance a boards ability to focus intensively

and relatively inexpensively (without involving the full
board) on the corporations financial reporting-related
functions.
In publicly-held corporations, audit committees must

be comprised solely of financially-literate outside
(non-employee) directors.
Slide 13.9
Compensation committees
Compensation committees deal with issues related to the

compensation and benefits provided to employees, and
particularly top executives.
Fiduciary responsibility for ensuring that the companys

executive compensation programs are fair and appropriate to
attract, retain, and motivate managers and that they are
reasonable in view of company economics and the relevant
practices of comparable companies:
Rely on the companys HR function for staff support.
Because the design of compensation plans can raise many
complex issues, compensation committees often employ outside
consultants to provide data or expertise that the company does
not have internally.
Slide 13.10
Corporate governance
The sets of mechanisms and processes that help

ensure that companies are directed and managed
to create value for their owners while concurrently
fulfilling responsibilities to other stakeholders
(e.g. employees, suppliers, society at large).
Corporate governance deals with controlling the

behaviors of top management.
Slide 13.11
Corporate governance and MCSs
Corporate governance systems and management

control systems (MCS) are inextricably linked.
A corporate governance focus is slightly broader than
a MCS focus:
A MCS focus takes the perspective of top
management and asks what can be done to ensure
the proper behaviors of employees in the organization.
The corporate governance focus is on controlling the
behaviors of top management and, through their
direction, those of all the other employees in the firm.
Slide 13.12
Corporate governance regimes
Corporate governance approaches and mechanisms

vary widely across countries.
Generally the world is said to be divided into two

corporate governance orientations:
The Anglo-American system that focuses on the primacy
of shareholders as the beneficiaries of fiduciary duties.
The Continental European/Japanese system that has a
broader concern for the rights of other stakeholders.
Slide 13.13
Prevalence
Primarily because of the major business scandals

that were uncovered in the early 2000s, including
Enron, WorldCom, Tyco, Parmalat, and Royal Ahold,
and other abuses, such as stock option back-dating,
interest in corporate governance has skyrocketed.
The U.S. Sarbanes-Oxley Act of 2002
Listing requirements by stock exchanges designed to
strengthen corporate accountability
Corporate governance reforms by legislators and
regulators in several countries
Slide 13.14
Sarbanes-Oxley Act
To improve the transparency, timeliness, and quality

of financial reporting.
Companies registered with the U.S. Securities and

Exchange Commission (SEC) must comply with
Sarbanes-Oxley whether their headquarters are
based in the U.S. or abroad.
In addition, some countries, such as Canada and

Japan, are setting regulations very similar to
Sarbanes-Oxley.
More convergence is expected in the coming years.

Slide 13.15
Key provisions of Sarbanes-Oxley
The external auditing profession, which was

formerly self-regulated, became highly regulated by
the federal government.
The Public Company Accounting Oversight Board
(PCAOB) has the authority, with oversight from the SEC,
to set auditing standards and to monitor auditors actions.
The members of audit committees of companies

boards of directors are required to be more
independent and more financially literate.
Slide 13.16
Key provisions of Sarbanes-Oxley (Continued)
Senior company managers (CEO and CFO) are required to

certify:
That they have reviewed their companys quarterly and annual
financial statements
That the financial statements are fairly presented, with no untrue
statements or omissions of material facts
That they acknowledge responsibility for disclosure controls and
procedures and internal controls over financial reporting
That they have evaluated those controls and procedures and
disclosed any material changes or deficiencies to the auditors and
audit committee.
Penalties for fraud and for obstructing an investigation were

broadened and made more severe.
Slide 13.17
Section 404
But perhaps the most significant, and most

expensive, provision in the Act is the internal controlrelated section of the Act, Section 404.
Prior to Sarbanes-Oxley, good internal controls were

said to be good business practice.
Not only did good controls help ensure fair and accurate
financial reporting, they helped ensure that managers would
have good information with which to make their business
decisions and they helped reduce the incidence of fraud and
asset loss.
Sarbanes-Oxley made good internal controls a legal
requirement, at least for companies publicly traded in
the U.S..
Slide 13.18
Section 404 (Continued)
Section 404 mandates an evaluation of the effectiveness of

a companys internal controls by both management and the
companys external auditor and formal written opinions
about the effectiveness of those controls.
Managers and auditors are required to examine a broad range

of internal controls over financial reporting, including:
Policies and procedures
Audit committee effectiveness
Integrity and ethical behavior programs
Whistleblower programs
Tone at the top
Slide 13.19
Section 404 (Continued)
Since many internal controls (the auditors term)

serve management purposes, as well as financial
reporting purposes, the Sarbanes-Oxley Act has
affected companies MCSs in positive ways.
Virtually everybody agrees that whether or not the

high costs are justified, Sarbanes-Oxley has had
positive effects on both the quality of financial
reporting and the quality of firms MCSs.
e.g., the financial statement restatement rate increased
dramatically since the passing of Sarbanes-Oxley, up from
5.7% in 2003 to 14% in 2005.
Slide 13.20
Effectiveness?
Will following all the tenets of Sarbanes-Oxley

guarantee an infallible control system?
Some experts conclude that the extreme examples

of fraud and corporate failure that motivated
legislators to pass the Act would have occurred
even if Sarbanes-Oxley had existed at the time.

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Course : F0942 Management Control System

Corporate Governance and Boards of

Shareholders, who typically own a portfolio of firms, delegate

Two main control responsibilities:

Board of directors (Continued)

Duty of good faith

Duty not to waste

All of these duties are defined by, and enforced through,

Board of directors (Continued)

To carry out their responsibilities, boards must

Board of directors (Continued)

Boards are given ultimate control over management:

Audit committees provide independent oversight

They enhance a boards ability to focus intensively

In publicly-held corporations, audit committees must

Compensation committees deal with issues related to the

Fiduciary responsibility for ensuring that the companys

The sets of mechanisms and processes that help

Corporate governance deals with controlling the

Corporate governance and MCSs

Corporate governance systems and management

Corporate governance regimes

Corporate governance approaches and mechanisms

Generally the world is said to be divided into two

Primarily because of the major business scandals

To improve the transparency, timeliness, and quality

Companies registered with the U.S. Securities and

In addition, some countries, such as Canada and

More convergence is expected in the coming years.

Key provisions of Sarbanes-Oxley

The external auditing profession, which was

The members of audit committees of companies

Key provisions of Sarbanes-Oxley (Continued)

Senior company managers (CEO and CFO) are required to

Penalties for fraud and for obstructing an investigation were

But perhaps the most significant, and most

Prior to Sarbanes-Oxley, good internal controls were

Section 404 (Continued)

Section 404 mandates an evaluation of the effectiveness of

Managers and auditors are required to examine a broad range

Section 404 (Continued)

Since many internal controls (the auditors term)

Virtually everybody agrees that whether or not the

Will following all the tenets of Sarbanes-Oxley

Some experts conclude that the extreme examples

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