ch04_sm_leo_10e.docx

Solutions Manual to accompany

Company Accounting 10e prepared by

Ken Leo John Hoggett John Sweeting Jeffrey Knapp Sue McGowan

© John Wiley & Sons Australia, Ltd 2015

Chapter 4: Fundamental concepts of corporate governance

Chapter 4 - Fundamental concepts of corporate governance REVIEW QUESTIONS 1. What is corporate governance?

Corporate governance governance is the system by which companies are directed and managed. It influences how the objectives of the company are set and achieved, how risk is monitored and assessed, and how performance is optimised.

2.

Outline four key theories theories of corporate corporate governance. governance. What are their similarities similarities and what are their differences? differences?

Agency theory The separate legal status of the corporation means that the control of the corporation is detached from the equity investment where we witness a separation of ownership from control. This theory relates to the importance of the board remaining independent of management so that they can exercise control on behalf o f the owners. Stakeholder theory Stakeholder theory focuses less on maintaining and enhancing shareholder value and more on providing value to all the company’s stakeholders. Many would argue that these are not mutually exclusive because shareholders, as the residual claimants of free cash flows, have a vested interest in ensuring the company uses its resources for maximum effect. Team production theory Team production theory proposes that corporations provide value by combining the key factors of production (i.e. labour or employees, capital or investors, debt or lenders and suppliers) in a manner that markets cannot.

This theory sees the board as the ultimate power in the firm in contrast to both agency theory (which would portray the shareholders shareholders as holding that position) position) and stewardship theory (which would see various combinations of stakeholders as holding that position). Resource dependence theory This theory posits that boards (and corporate governance) exist to provide companies with the access to resources that they could not gain gain through market or management links. links. Thus, boards exist to provide access to capital, information, power and other important inputs that can assist the company to control its environment Managerial Managerial and class hegemony theory Both managerial and class hegemony theory are allied to resource dependence theory in the sense that all three share the concept concept of people providing access to resources. In contrast to resource dependence theory’s focus on the company, however, c lass hegemony theory is a

© John Wiley and Sons Australia, Ltd 201 5

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Solution Manual to accompany Company Accounting 10e

Marxist-based concept that conceptualises the upper class or business elite as a group manipulating the governance of corporations to perpetuate its power base. Managerial hegemony theory is similar to class hegemony theory in that the governance system and board is seen as the tool of management. It argues that the real power in corporate governance lies with management and that they can take advantage of shareholder weakness to pursue self-interest.

3. What are the three main fiduciary duties of directors and why are they necessary?   

Act in good faith for a proper purpose Not misuse the position or information (ie. Avoid a conflict of interest) Act with due care and diligence

These duties are necessary because of the fiduciary relationship that forms the basis of the relationship between a director and the company.

4.

What are the similarities and differences between a director’s duties under sections 180 and 588G of the Corporations Act.

Both duties are derived from the common law duty of care and dili gence. The duty of care in section 180(1) provides that directors must apply a reasonable degree of care and skill. Section 588G provides that if a director allows a firm to trade while insolvent, they will become personally liable for the debts incurred after the point of insolvency is reached. The duty extends to prevent a company from trading so as to become insolvent. One difference between the 2 sections is that s558G applies to directors only and not to officers.

5.

How are continuous disclosure and insider trading requirements similar, and how are they different?

Continuous disclosure represents the obligation of listed companies to ensure the market is notified of information that a reasonable person would expect to have a material effect on the price or value of the firm’s securities. Insider trading is the offence, which arises when anyone possessing information about a listed company not generally available to the market trades in securities from that firm or “tips off” others to trade in the relevant securities. One similarity between them is that they are both elements of market based regulation for listed companies, given legislative force via the Corporations Act. Another similarity is that there are a number of defences to insider trading and to continuous disclosure requirements for directors.


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One key difference between them is that continuous disclosure is a disclosure requirement of people within the company while insider trading is an offence that outsiders can breach. 6. How can accountants contribute to effective governance? Accountants must produce timely, accurate and reliable reports of the true position of the company. The accounting function will need to provide directors (as well as senior managers) with insights into the strategic factors at play in their organisations. Auditors play a key role in the external flow of information that they provide and the expectation that they will be independent and report breaches.

7.

What are the different types of regulation and how are they related?

“Hard” regulation is also known as black letter law and comprises the legally binding obligations (such as directors’ and officers’ duties under the Corporations Act, 2001). In contrast, “soft regulation” are non-binding obligations and would include items such as non-mandated industry codes of conduct, societal expectations and expert opinion on corporate governance practice. Finally, there are various forms of “hybrid regulation” which are not strictly b inding but generally entail some form of sanction if they are not followed. Examples of hybrid regulations would include the ASX Corporate governance principles and recommendations or industry regulations where the self-regulation could involve some form of penalty such as a fine or suspension administered by a professional body. These various forms of regulation are interrelated and vary from legal regulation with penalties to self-regulation with no penalties.

8.

What is ‘soft’ regulation and what are i ts advantages and disadvantages when compared with ‘hard’ regulation?

“Soft regulation” is non-binding obligations and would include items such as non-mandated industry codes of conduct, societal expectations and expert opinion on corporate governance practice. “Hard” regulation is also known as black letter law and comprises the legally binding obligations (such as directors’ and officers’ duties under the Corporations Act, 2001). The advantage of “soft regulation’ is that it encourages self -regulation of companies to implement certain codes of conduct which can encourage social pressure and an application of the spirit of the regulation rather than strict adherence to the letter of the regulation. It is also less costly for society to implement. The disadvantage is that there are no penalties with “soft regulation” and so it may lack impact.


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The advantages of the “hard regulation” approach are: 

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It provides at least a set of minimum corporate governance practices that must be followed by all corporations, and There are no uncertainties as to which practices are required. This also assists with enforcement and with potential liability in terms of litigation.

The disadvantages of this approach are: 

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While this provides a minimum set of practices, it is likely that good corporate governance requires practices beyond the minimum prescribed. It also can encourage a ‘check list’ (form over substance) approach to corporate governance. Legislative backing of rules can result in the view that corporate governance is about dealing with legal liability rather than about promoting the interests of shareholders and stakeholders. It is generally accepted that there is no ‘one’ model of cor porate governance. A rules-based approach is essentially a ‘one size fits all’ approach and does not take into account the specific circumstances of the particular entity (e.g. such as distribution of shareholders, nature of environment).

9. Explain how the regulation pyramid is used by regulators to enforce regulation.

Regulations are interrelated – the various forms of regulation overlap and reinforce. Regulators can use a series of measures to enforce regulations ranging from encouraging selfregulation through to enforcement with mandatory penalties with no discretion. Good answers would outline all the components of the pyramid and would also provide examples of the escalation of application. Australia has numerous regulators including ASIC, ACCC, APRA, ASX and EPA

10.

What is an independent director and how does this differ from a non-executive director? What are the advantages and disadvantages of independent directors?

Independent directors are those with no relationship with the firm that would, or could be perceived to, materially affect their decision making. Independent directors are in fact a sub-set of non-executive directors. Non-executive directors are either independent or “grey” directors. Grey directors are those that may, at times, experience a conflict of interest due to their positions with other organisations. The ASX Corporate Governance Principles and Recommendations set out a number defining characteristics of independent directors under 2.1 (text Figure 4.5), and identifies examples of interests or relationships where independence could be compromised and would need to be assessed.


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The ASX Corporate Governance Principles and Recommendations set out a number of advantages of having independent directors; the key ones being aims to ensure judgments made by board are in best interests of the entity and not biased towards interest of management. Disadvantages could include: Lack of detailed knowledge of specific company and its operations May not be as ‘invested’ in the specific company as executive directors Potential conflicts of interests Lack of skills or knowledge in particular areas    

11.

Why is s. 588G of the Corporations Act 2001 of major importance to directors?

In essence, this section provides that if a director allows a firm to trade while insolvent, they will become personally liable for the debts incurred after the point of insolvency is reached. It is intended to engender in directors of companies experiencing financial stress a proper sense of attentiveness and responsible conduct directed towards the avoidance of any increase in the company’s debt burden. This duty is different from other director duties as courts will use an objective test in its application. This means that it is not a defence to show your background or circumstances meant you did not know the company was trading insolvently (with some rare exceptions provided for in the defence outlined in s588H); you are deemed to have the knowledge to understand the financial circumstances of the company.

12.

What are the ASX Corporate Governance Council’s Corporate governance pri nciples and recommendations and how do they operate?

On 31 March, 2003 the ASX Corporate Governance Council released its first Principles of good corporate governance and best practice recommendations. This has been subsequently revised a number of times in 2007, 2010 and 2014 and is now known as the ASX Corporate Governance Principles and Recommendations. Details of the Principles and Recommendations are http://www.asx.com.au/regulation/corporate-governance-council.htm

available

from:

The role of the principles is to provide guidance to companies and investors on best practice corporate governance and to increase the transparency of a listed company’s corporate governance practices. These include recommendations to guide companies in how to meet the principles. As such, the recommendations for each Principle are not mandatory; rather, the approach of the ASX is an ‘if not, why not’ approach where companies are asked to (1) detail whether they comply with each best practice recommendation and (2) explain why they do not comply if this is the case. The principles are examples of “hybrid regulation” which are not strictly binding but generally entail some form of sanction if they are not followed.


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13.

What are the similarities and differences between the two major types of international systems of corporate governance?

The similarities between the Anglo and Pluralist systems are that both systems require robust societal legal structures and transparency. The differences between them arise as a result of what is emphasised: Anglo systems (the basis of Australia’s system) emphasise markets and shareholder rights as important legal requirements. Pluralist systems (which form the basis of many Asian and continental European systems) place a greater emphasis on stakeholders.


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CASE STUDIES Case Study 1

Director’s duties and insider trading

Read the extracts from newspaper articles by Blair Speedy (p.188 in the textbook). Required A. What is insider trading?

As noted in the text, according to Farrar (2005, p. 272), insider trading refers to ‘i mproper trading in securities on the basis of price-sensitive information that is not available to the public in order to make a profit or avoid a loss’. B. The articles state that Mr Mason (the Chairman of David Jones) said that sales figures were not price sensitive information. Do you agree? What information is there to refute this statement.

As noted in the articles the test of price sensitivity of information is whether a reasonable person would expect the information to have a material effect on the share price. Given that sales are linked to profitability and particularly here where it is stated ‘the first-quarter result marked a return to sales growth from existing stores after three straight quarters of decline’. Hence this suggests that the information was price sensitive which in fact was evidenced by the 6.6 per cent rise in the share price when the information was released (as the article notes, ‘its biggest one-day gain since June last year’). Clearly if the information caused analysts to revise their outlook it was price sensitive. Further, the fact that the “company brought forward the release to November 1 to calm market speculation” suggests that the price sensitivity of the information was anticipated. C. ASX Listing Rule 12.8 requires a listed entity to have a trading policy. This specifies restrictions in relation to trading of the company’s shares by directors and other key management personnel. Guidance Note 27 suggests that part of this can be met by specifying either prescribed periods for trading or 'black out' periods when trading is not allowed. It also suggests the trading policy include procedures for given written clearance for directors to trade outside 'allowed' periods (often expected to be given by the Chair). The share purchases discussed appear to have met the trading policy of David Jones. Does this mean that the trades are acceptable?

As the article notes the compliance with the company’s trading policy does not negate the requirement to comply with the law and the corporations law is clear that insider trading is illegal and so, if deemed as insider trading, are not acceptable. The Guidance note itself suggests that the trading policy note that: Under insider trading laws, a person who possesses inside information may be prohibited from trading even where the trading occurs within a permitted trading window, or outside a black-out or other prohibited period, specified in the entity’s t rading policy (Guidance Note 27, p. 3).

Whether these trades are ultimately determined to be insider trading will be a matter for the ASIC (and possibly the courts). Further, although there are no specific recommendations regarding trading in shares in t he ASX corporate governance guidelines, under principle 3 it is recommended that the company


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should have a code of conduct and suggestions for content include statements that directors etc will: not take advantage of the property or information of the entity or its customers for personal gain or to cause detriment to the entity or its customers; 

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not take advantage of their position or the opportunities arising therefrom for personal gain.

D. It is claimed by Dean Paatsch , that “there is no way directors can ever trade without being aware of market-sensitive information that is not known by the wider market”. Do you agree with this statement? If so, how can the potential problem of insider trading by directors be prevented?

Students may agree or disagree with this statement, but given Directors position in a company in most circumstances it could be argued this statement would be true. As noted at 3, the ASX listing rules require a company to have a trading policy and this would restrict trading by directors. However, as is evident from t his case, simply having specified trading ‘windows’ or’ blackouts’ does not always prevent opportune trading, as it cannot necessarily be foreseen when price sensitive information is available. However companies could restrict trading at ad hoc times, given expectation or existence of price sensitive information. A number of suggestions to avoid problems are made in the articles. These include: 

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Paying directors in cash rather than shares/stock (although instance here is about purchase of shares not sale of shares). However this is inconsistent with aligning directors and owner interests via remunerating at l east partly in shares. Allowing directors to buy (or sell) shares under a pre-set program. This would mean that timing of such trades was not at the discretion of the director and therefore the y could not undertake opportunistic trading on the basis of insider information.

It could be argued that given the substantial part of remuneration is often paid in shares or the like (to align interests with owners) that trading itself should not be prevented but that deterrents, via corporations law, need to be adequate to discourage insi der trading.


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Case Study 2

Independent directors

Read the following newspaper article by Adam Creighton (p.190 in the text book). Required A. What are problems associated with independent directors (actual or perceived) in this example.

The article has identified that more independent directors on a board are associated with poorer performance. This is attributed to two factors: lack of skills, expertise and experience (or ‘ignorance’ as the article states); and lack of incentive or motivation (which it argues is associated with lack of monitoring). This latter factor could be attributed to the requirement for independence per se; if ‘independent’ of company could be argued less ‘bound’ to its success (or failure). Students may identify other problems (such as association with increased remuneration). B. Outline the requirements and the rationale for the independent directors in the ASX’s principles and recommendations for corporate governance. Do you think these are reasonable?

The ASX Corporate Governance Principles and Recommendations sets out a number of advantages of having independent directors; the key ones being aims to ensure judgments made by board are in best interests of the entity and not biased towards interest of management. Further, it argues that ‘having a majority of independent directors makes it harder for any individual or small group of individuals to dominate the board’s decision making’ (ASX CGC, 2013 p. 15). It considers a director as independent only if he or she is free of any interest, position, association or relationship that might influence, or reasonably be perceived to influence, his or her capacity to bring an independent judgement to bear on issues before the board and to act in the best interests of the entity and its security holders generally (p.15). A list of factors is provided that could indicate that independence may be comprised (these include serving on the board for more than 9 years, and having material contractual or other relationships with the entity). Whether this is reasonable is a matter of opinion but could note the following: The recommendations for independent directors are only one within the principle of structuring the board to add value (Structure the board to add value: A listed entity should have a board of an appropriate size, composition, skills and commitment to enable it to discharge its duties effectively). Hence would also need to consider skill sets etc - not independence on its own. These recommendations of the ASX are not required to be complied with, although listed companies need to explain why they have not complied. This allows flexibilit y where it is considered that other factors would provide benefits rather than complying with independence recommendations. It could be argued that given the requirement to explain where recommendations have not been followed that this may provide a strong incentive to be seen as following the ‘rules’ and perhaps encourage a form over substance approach. However a number of companies do not comply with the independence recommendations (for example, the Chair of the Board for Harvey Norman Ltd is not an independent director). 

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Some of the guidance could be argued as arbitrary. For example, the guidance suggests that being a director of the entity for more than 9 years could indicate independence is compromised. Why is 9 years proposed? This seems arbitrar y. Given the principal- agent relationship and the fact t hat a key role of the board is to monitor management (on behalf of shareholders) some independence from management is required on the Board.

C. The article states that the recommendations for independent directors ‘solved the “principle agent problem by destroying the principle”’ . What is the rationale for this statement?

As noted previously the principle agent problem derives from the separate legal status of the corporation which means that the control of the corporation is detached from the equity investment where we witness a separation of ownership from control. This theory relates to the importance of the board remaining independent of management so that they can exercise control on behalf of the owners (so that management cannot act in their own self-interest at the expense of shareholders). Hence the recommendation for independent directors as in principle they should act in the best interests of shareholders (owners) and maximise wealth for shareholders. The article argues that independent directors are not in fact acting in the best interests of shareholders (as evidenced by poor performance) due to problems identified in answer to 1 above.


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Case Study 3

Executive remuneration and regulation

Read the extract from an article by Terry McCrann (p.191 in the textbook). Required A. What have been the consequences of the introduction of the two-strike rule? Do you think this has improved corporate governance?

The articles identify the following consequences: Has encouraged boards to be more responsive to shareholder concerns in relation to remuneration (and other issues in general) and has seen a substantial reform in pay structures. Boards required to provide information and hence held more accountable. 

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Would argue has improved governance due to: Boards more responsive to shareholder concerns (noted in article t hat ‘has ushered in a new era of engagement with shareholders, who were often dismissed as a necessary nuisance by company directors in the past’). Reform of pay structure reduced excesses and has potential to better align directors with shareholder interests and curb excessive pay. Increased transparency by requiring specific details of remuneration. Provides an ‘easier’ mechanism for shareholders (especially minority) to protest or question as requires only 25% of votes cast. 

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B. What are the criticisms of the two strike rule? Do you think these are valid?

Possible criticisms are: Undemocratic: this argument is based on the fact that the ‘strike’ vote only requires 25% of the votes cast at the AGM. Given that in many instances relatively few votes are actually cast at the AGM as many shareholders are passive investors, this means that a small minority (which may not reflect the opinion of the majority) can result in ‘strikes’. Unnecessary: if minority shareholders dissatisfied only need 5% to call an extraordinary general meeting and to spill the board s till requires a majority of over 50% of all votes. Hence provisions already existed for shareholders to act if dissatisfied. Ineffective: This relates to the point above, that although only need 25% of votes cast to spill board, still require 50% of all votes. Costly: as could require extraordinary general meeting and result in spill of board (and re-elections etc). Misused: intention was as a mechanism for shareholders to express dissatisfaction for remuneration, but may be used where dissatisfied with other aspects ( eg. company performance). 

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Validity of these criticisms: This will depend on personal position. However could argue:


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

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It would appear on the face undemocratic in terms of overall % required, particularly due to the count of only those votes actually cast at the AGM. This could be countered by arguments that: o Provides a mechanism for minority but active investor’s views to be considered. As noted in extracts, strikes can be viewed as advisory as they still require majority for spill of board. If unnecessary, why has it had a positive impact on remuneration packages and engagement with shareholders? Also, even though 5% of shareholders can call an EGM, this is a significant action, whereas the two strikes rule allows shareholders to express concern without taking such action as a firs t step. Again, if ineffective, why has it had a positive impact on remuneration packages and engagement with shareholders? As extracts state, in most cases a second strike has not occurred and so minimal costs involved for most companies. It can be argued that shareholders are using this mechanism to complain or bring notice to issues apart from remuneration. However the extracts suggest that the ‘shareholder community is using the weapon responsibly in a targeted way’.


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PRACTICE QUESTIONS 1.

Do you agree that a majority of directors of listed companies should be independent? Justify your argument, paying particular attention to the implications for the skills base of the board and the ability of the board to monitor management appropriately.

It is not necessary that a majority of directors of listed companies are independent. The more important factor is that the board members have a great understanding of the underlying business as well as being capable of ‘independent thinking’ particularly in relation to the responsibility to control agency costs associated with managers. (Academic studies have failed to find any consistent evidence of a relationship between firm performance and the independence of directors.) Good answers will note the ASX principles are “comply or explain” in approach and the soon-to-be-implemented changes to their Principles of Good Governance have moved away from definitions of independence to “indicators” of governance strengthening this view.

2.

If you believe that agency theory appropriately describes the corporate governance dilemma, what are the implications for what boards should do? How would this differ if you thought resource dependence theory was a more appropriate explanation? Do you think it is one theory or the other? Justify your response and discuss the implications for board structure.

If agency theory is a key factor for corporate governance, boards should consider steps that can be taken to ensure board members remain independent of management so that they can exercise the control on behalf of the company’s owners. One area that this would impact would be the structuring of the board in terms of the number of independent directors. If resource dependence is a key factor for corporate governance, boards should consider what additional resources they require that they could not gain through market or management links. Thus, boards exist to provide access to capital, information, power and other important inputs that can assist the company to control its environment. In practice, both theories play an important role in the area of corporate governance. Two of the key functions that a board must fulfil are monitoring and control and ac cess to resources. Thus boards should consider these factors when appointing board members and ensure that there is an adequate ‘independent’ component as well as a broad knowledge base of the members that includes a good understanding of the central business involved.

3.

Why are continuous disclosure and insider trading provisions important to modern economies? What are the implications of these requirements for a board of directors of a listed company? What are some practical steps a board can take to ensure compliance with these provisions?

The central idea behind both continuous disclosure and the prohibition on insider trading is to build a robust and efficient equities market in Australia because they allow the market to be


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as fully informed as possible when making investment decisions and provide the ability to rely on efficient provision of information. Continuous disclosure is the specific requirement of listed entities under Listing Rule 3.1 (and given legislative force via section 674(1) of the Corporations Act) to keep the market informed of information likely to affect the price of its shares. If the information is confidential (i.e. not known outside the company) then a company may choose not to disclose if a reasonable person would not think it necessary to disclose and the information is insufficiently clear. Obviously, this is a very wide obligation of disclosure and this requires considerable judgment from directors as to when to disclose and when not to disclose as virtually every decision made by a board of directors has the potential to affect the price of its securities. Therefore, listed companies must develop key information management systems that seek to manage the flow of information to the market.

4.

Compare and contrast typical Anglo systems of governance with Pluralistic forms of governance. Which do you think is more effective and why? What are the implications of your choice for the legal system and capital markets?

The Anglo system of corporate governance is based on a well-developed legal system, a mature market economy and the philosophy (or national culture) that the most important role of the board is to supervise management and reduce the agency costs associated with the separation of ownership from control. This protection of shareholder rights (particularly minority rights) is embedded in the legal system (e.g. directors’ duties), capital markets (e.g. continuous disclosure requirements) and corporate and community culture (e.g. the predominance of shareholder value as the ultimate goal of the for-profit company). The Pluralist system of corporate governance is based on a civil law system, a more stakeholder orientated relationship between shareholders, banks and the community, and a more public benefit or communal philosophy or culture. Under this system, a key role of the Board can be to ensure appropriate representation of stakeholders in the direction and control of the corporation. For instance in Germany, which operates a pluralist system, employees often have a right to have representatives sit on the supervisory board. In relation to which is more effective, it is largely dependent on the legal system and cultural backgrounds as to which is more suitable.

5.

‘Any corporate governance system is only as good as the people involved in it.’ Discuss.

As the text notes decisions in, and about, corporations are made by people. The quality of any corporate governance is ultimately affected by the people involved in it. The following points could be discussed: 

Competence — clearly, if individuals do not have the requisite expertise or experience then this will adversely impact on decisions they make and reduce the quality of corporate governance.


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Integrity (ethics) of individuals. Whether or not individuals will act ethically is affected by a number of factors. These include: – the individual’s own moral code – the culture of the corporation and of peers. This is particularly important in relation to top management. In a number of corporations it is argued that either ethical or unethical behaviour permeates due to the stance taken by the ‘leaders’. – the consequences of the decision. For example, if asked to do something that is not ‘right’ by a manager and refusing could impact on employment/future promotion; how ‘wrong’ is the decision and will it have a significant impact on others; what is the likelihood of being caught and what are the consequences if found to be acting unethically).

6.

(a) (b) (c)

(d) (e)

Obtain the annual reports of a range of companies in the same industry and search for any disclosures in relation to corporate governance principles and practices. In relation to these disclosures: Identify the key areas considered by these companies. Are there any differences or similarities in corporate governance practices? Do you believe you could judge or rank the relative standard of corporate governance of these companies based on the information provided? If not, what other information would you need to do so? Which company would you rank as having the best (or worst) corporate governance from these disclosures? Explain how you have arrived at this decision. Compare your rankings with those of other students. Identify and discuss the reason for any discrepancies between rankings

No specific answers can be provided as this will depend on the companies considered. Go online and download a couple of annual reports in the same industry, from 2012 to 2015 and see the differences. Discuss the following in class: (a)

What have you found out about the key areas?

(b)

Explain the differences and similarities in class, on your Blackboard or WebCT.

(c)

Discuss how and what you would use to judge or rank the companies and what further information you would need.

(d)

Discuss the judgment you have made.

(e)

Did you identify the best and worst cases or corporate governance?

7.

Obtain the annual reports of a range of companies in the same industry in different countries and search for any disclosures in relation to corporate governance principles and practices. In relation to these disclosures: (a) Identify any differences or similarities in corporate governance practices. (b) Can you provide any reasons from the business and regulatory environments in the countries that would explain these differences?


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No specific answers can be provided as this will depend on the companies considered. Again go online and download annual reports from various countries to discuss in class. It may also be useful to consider, identify and compare: 

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country economic and business environmental factors any specific corporate governance guidelines or requirements issued for companies in the specific countries considered, for example by local stock exchanges, as well as considering enforcement mechanisms. Which of their governance practices reflect the Anglo versus Pluralist system

In class, explain the differences or similarities in corporate governance practices.

8.

Obtain the annual report for a listed company and examine the remuneration packages provided for executives.

(a) Identify the key components of the remuneration packages for directors and executives.

Note: these are disclosed in annual reports (or available on the company’s web page as a separate remuneration report) and see how these pri nciples are reflected in the packages. A suggested example is the 2013 annual report for AMP — this includes details of the remuneration package and related benchmarks. You can access this from links from http://www.amp.com.au/ or the 2013 annual report for Crown Ltd which includes details of the amounts of potential cash bonuses. You can access this from links from http://www.crownlimited.com. These will normally include fixed components and also components related to short and long term hurdles. (b) Do you think these packages are appropriate to provide incentives for these executives to work in the interests of shareholders?

As fixed components are not related to performance then these would only provide limited incentives to act in shareholder interests. Short term incentives are normally aimed at maximizing profit in the short term. These may also be linked to dividends. Long term incentives are aimed at maximizing value and are normally reflected in share price. Maximizing profit, paying and maintaining dividends and maximizing share value are all in the interests of shareholders (although relative importance on each of these will vary across companies/share holders). You may also wish to consider the following: 

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Are the benchmarks/targets for obtaining any bonuses clear? Are these reasonable for rewarding performance? For example, if linked to the share price of the company do they take into account general share price movements for similar companies? If they do not, then they may be penalising or rewarding managers for market factors rather than their own performance.


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Are there any components that do not seem ‘fit’ with shareholder interests? If so, why do you think these components are included?

(c) How much information is provided about any bonuses paid? Is this information sufficient to allow shareholders to determine if these packages are reasonable?

This will depend on the reports that you have found. You will probably find that in many cases there is limited information (in particular about benchmarks — often generic information about benchmarks is included rather than specifics). This makes it difficult for shareholders to consider, however, there could be legitimate competiti ve reasons for not disclosing this information.

9.

Each year various bodies give corporate governance awards. The Australasian Reporting Awards (Inc.), an independent not-for-profit organisation makes annual awards for corporate governance reporting.

(a) Locate the criteria on which this award is based.

The Australasian Reporting Awards and criteria for corporate governance awards states that “These Awards seek to recognise the quality and completeness of disclosure and reporting of corporate governance practices in the annual reports of business entities in the public and private sectors.” http://www.arawards.com.au/ The corporate governance reporting awards are one of the Special awards for excellence and “use the Principles of Good Corporate Governance and Best Practice Recommendations of the ASX Corporate Governance Council as the guiding criteria for the private sector Awards. The adjudication panel will follow the “if not why not” philosophy of the guidelines and look for reports that provide quality disclosures and clear explanations of how and why certain paths were followed.” http://www.arawards.com.au/ (b) In what areas of corporate governance reporting did winning companies outperform other companies?

The Australasian Reporting Awards identifies companies that have been ranked as gold, silver or bronze (for example, one difference between gold and silver is that gold requires ‘full’ disclosure whereas silver requires ‘adequate’ disclosure). It may be useful to look at reports for companies in these different rankings to identify any differences. (c) Does the winning of an award for reporting necessarily mean that these companies have best corporate governance practices?

Students should consider: 

How would you tell if a company did not follow these practices that they have claimed?

How likely it is that companies who do not have good corporate governance practices would disclose this fact? It may be what is not disclosed that is important. (Remember: Enron was perceived as one of the best but fell short in practice) 


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10. Australian companies listed on the ASX must report on their corporate governance practices on the basis of ‘comply or explain’. That is, they are not required to comply with all of the specific corporate governance practices recommended by the ASX but if they choose not to comply, they must identify which guidelines have not been ignored and provide a reason for their lack of compliance. (a) Examine the corporate governance disclosures of some Australian listed companies and identify any instances where best practice recommendations of the ASX have not been met.

Examples are: 





As discussed in the text Harvey Norman’s 2013 annual report it is di sclosed that the recommendations relating to independence of board members and the Chairman are not met. You can access this report from http://www.harveynormanholdings.com.au/ Kresta Holdings Ltd 2013 annual report discloses that they are compliant except that there is no separate nomination committee. https://www.kresta.com.au/ Students should be able to find own examples.

(b) Do you believe that the noncompliance in these instances is justified?

Responses will depend on the nature of non-compliance and also circumstances and reasons given by particular company for non-compliance. (c) What are the advantages of having a ‘comply or explain’ requirement rather than requiring all companies to comply with all best practice recommendations?

The advantages are that this allows specific circumstances of a company to be considered when determining appropriate corporate governance practices (so for example, does not impose a ‘one size fits all’ approach regardless of the size of the company). This is consistent with the principles-based approach to corporate governance. While this allows flexibility, the fact that the need to disclose and justify non-compliance also allows shareholders and other stakeholders to clearly identify any instances of non-compliance and also requires management to consider this (it could be argued that as they need to disclose if they do not comply then management need to explicitly consider whether or not non-compliance is justified as they will be open to scrutiny).

11. At any time there are problems (and subsequent investigations) with corporate governance, which include deficiencies in financial reporting. (a) Search the website of regulatory authorities (such as the Australian Securities and Investments Commission or the Securities and Exchange Commission in the United States) and identify a case that has been investigated that involves issues of corporate governance.

The ASIC annual report provides a summary of major cases and the media centre (under the Publications link) often provides summaries of cases considered or investigated (access from http://www.asic.gov.au). The ‘key matters’ section at


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http://www.asic.gov.au/asic/ASIC.NSF/byHeadline/Media%20centre major investigations/cases.

has

information

on

(b) Briefly discuss the corporate governance issues and what part financial reporting played in these.

This will depend on the cases found by students. It may be useful to look at the annual reports of companies involved in investigations and consider their corporate governance disclosures (and practices). (c) Suggest what procedures or practices would prevent these abuses occurring.

Again, this will depend on the cases found by students. It may be useful to consider the nature of cases and problems: e.g. did these require collusion (i.e. involvement of more than one person); how were problems detected (this may give a hint of how problems could be prevented and whether corporate governance processes could have assisted); what corporate governance disclosures did these entities make (do these indicate that the systems are acceptable).


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ch04_sm_leo_10e.docx

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