Chapter 12 – Leeson, Di Sisto, Flanders : Overview of Corporate Governance.

Overview of Companies in Australia : text p.303-06. The Australian approach to corporate governance is strengthened by a strong system of corporate legislation & market regulation.

The Corporations Act 2001 – is the legislation that regulates companies in Australia. ASIC – has been given authority by the Govt to administer & enforce the Corporation Act 2001.

Upon registration with ASIC, a company is said to be incorporated & becomes a separate legal entity, separate from company officers & its shareholders – ie. It can sue & be sued in its own name. Shareholders & directors have limited liability, it can own property in its own name & takes on a perpetual succession.

The Directors are agents (human face) of the company, and act on its behalf.

Companies can be classified according to size or to member liability. In relation to size; companies are either public or proprietary.

Public companies must have the word ‘limited’ or ‘ltd’ at the end of their name & their membership is unlimited. They are able to go public to raise funds. They must have at least 3 Directors & 2 must ordinarily reside in Australia. They must have 1 Company Secretary. Public company’s may be listed on the ASX. To do this a company must comply with the ASX listing rules. The rules are based on the principles of promoting shareholder protection & confidence, and upholding the reputation of the market. Listing carries with it strict regulatory & reporting requirements.

The advantages of being listed – ability to go public to raise funds, greater flexibility in capital structure, the determination of market value of the company, and opportunity for shareholders to buy & sell the company shares.

Proprietary companies – also referred to as “private companies”; must have the word “proprietary” in their names and ‘limited’ or Ltd must appear at the end of their name. They must have 1 Director, but do not require a Company Secretary. Their membership is limited to 50 non-employee shareholders. They cannot do anything that would require disclosure to investors. Ie. They cannot issue a disclosure document (prospectus) – to raise funds from the public.

A large proprietary company is required to appoint an auditor & lodge a financial report & director’s report.

Regardless of public or proprietary, most companies in Aust are companies limited by shares. The liability of shareholders is limited to any unpaid amount on their shares. Therefore if shares are fully paid – the shareholder has no further liability to the company.

Companies can also be controlled by other companies. “Subsidiary companies” are companies that are controlled by another entity. Controlling means the controlling entity holds more than 50% of the issued share capital of the other entity – or it controls the casting of more than 50% of the number of votes. “Holding companies” – are companies that own a controlling quantity of shares in another company. When they prepare financial reports – they must prepare ‘consolidated’ financial statements & notes.

A shareholder in a company means you own a fractional part of the company. Shares give the owners the right to vote at members’ meetings, the right to receive dividends & a right to the distribution of profits; if a company winds up. Shares are generally ordinary or preference; which differ on the basis of voting rights & receive dividends.

Dividends represent a distribution of company profits to company shareholders. Dividends cannot be paid out of capital, they can only be paid from company profits. Shareholders confirm by vote (usually at the AGM), the Directors recommendation on dividends. They can reject or reduce dividends – not increase them. Companies do not have a legal duty to pay dividends – some don’t pay them.

Generally companies that pay dividends are those that are highly profitable & have excess funds after having reinvested enough funds back into the business/company. Directors can be personally liable if they allow dividends to be paid, when there are reasonable grounds for suspecting the company is insolvent.

Public companies must hold an AGM at least once in each calendar year and within 5 months at the end of its financial year. Proprietary companies are not required to hold AGM’s, and are able to pass resolutions if all members entitled to vote, sign a document stating agreement. In general 21 days notice is to be given for an AGM; 28 days for companies listed on the ASX.

At the AGM – directors must lay before the shareholders – the financial report, the directors’ report and the auditors’ report.

Financial reports : Balance Sheet as at balance date; Income Statement at end of Financial year; Statement of Cash flows for Financial year; Statement of changes in Equity; and Consolidated Financial statements.

The role of Accounting Standards is to set out specific requirements for the presentation of financial reports & provide minimum requirements for content.

In Aust. The Australian Accounting Standards Board (AASB) is responsible for developing Accounting standards. The Australian Accounting Standards are legally binding under the Corporations Act 2001.

The Directors’ declaration – is also part of the financial report. This states whether the company will be able to pay its debts as & when they are due; and whether in the director’s opinion, the financial statements & notes are in accordance with the Corporations Act 2001. A declaration by the CEO (or CFO) must be included as part of the directors’ declaration.

A copy of the Auditors’ independence declaration must be included as part of the directors’ report.

The Auditor who audits the financial report for a financial year must provide an audit report for members. Definition of Corporate Governance :

Has a range of meanings. In general it is concerned with how corporate bodies are held accountable, in particular the process by which a corporation is held accountable to all of its stakeholders. It concerns the exercise of power in corporate entities.

Definitions : The system by which companies are controlled. Shareholders have delegated many of their responsibilities as owners to the directors who oversee the management of the business on their behalf. Directors are accountable to their shareholders & shareholder participation is necessary to make that accountability effective.

Directors should use their best efforts to ensure that the company is properly managed & constantly improved so as to protect & enhance shareholder wealth in perpetuity & to meet the company’s obligations to all parties with which the company interacts – its shareholders. The essence of any system of good corporate governance is to allow the board & management the freedom to drive their company forward, but to exercise that freedom within a framework of effective accountability.

The OECD define it as : …a set of relationships between a company’s management, its board, its shareholders & other stakeholders. Corporate Governance also provides the structure through which the objectives of the company are set, & the means of attaining those objectives & monitoring performance are determined.

ASX Corp Gov Council (through Justice Owen) : The framework of rules, relationships, systems & processes within and by which authority is exercised & controlled in corporations.

It may best be summarized as a set of principles to ensure corporate direction, responsibility & accountability, and affects all those who manage.

The common feature of most definitions – is the focus on the role & function of the board of directors as the body responsible, for ensuring the company is accountable for its decisions & performance.

Corporate Governance is a set of relationships between management, its board, its shareholders, its auditors & other stakeholders. These relationships determine the direction & performance of the company.

For a Corporate Governance structure to be effective, it should develop with the changing circumstances of the company. It must be designed to reflect those changing circumstances.

Need for good Corporate Governance : text p.307-09.

The ASX Corp. Gov. Council states : Effective corporate governance structures encourage companies to create value, through entrepreneurialism, innovation, development & exploration; and provide accountability & control systems commensurate with the risks involved.

An effective corporate governance structure promotes accountability & transparency – 2 key requirements in promoting & maintaining investor confidence. A good system ensures that: - The company has an adequate system of internal control in place. - There is equitable treatment of all stakeholders. - Accountability rests with those that manage & control the company. - Shareholder confidence is built because transparency of operations & information means that investors are better placed to make more informed decisions.

Improved corporate governance has become a global necessity due to the following factors: - Growth of public investment in public companies, with many small shareholders investing in companies. - Increased role & importance of companies to national economies. - Globalisation of markets, particularly the capital markets leading to greater competition for access to funds.

These factors have led to increased interest in corporate governance to reflect higher expectations by the investment community for companies – particularly public companies. To develop their own structures & procedures to ensure effective management & appropriate standards of corporate behavior.

The term ‘corporate governance’ was hardly heard of 10 years ago!

Organisations involved in Corporate Governance : text p.309-17.

In Australia, reform has largely been in response to both local & international corporate collapses. The response has been a number of legislative & non-legislative reforms that have included the development of the CLERP 9 (the Corporate Law Economic Reform Program). – This led to significant amendments to the Corporations Act 2001.

The US Corp. Gov. framework is based heavily on legislative controls. The UK & Australian frameworks are more principle-based & shareholder-led, reinforced with a strong system of corporate legislation & market regulation.

Australia : (text p.310-14). - The Bosch Committee - Federal Government - CLERP 9. - Shareholder participation - Financial reporting - FRP. - Remuneration of Directors & executives. - Continuous disclosure - Independence of Australian company Auditors ( by Prof Ian Ramsay). - ASX Corporate Governance Council. - ASIC.

International : (text p.314-18). - OECD - UK : Cadbury committee; Greenbury committee; Hampel committee; Higgs & Smith reports. - US : Sarbanes-Oxley Act of 2002; NYSE; Treadway commission; Business Roundtable (BRT); - APEC : - Commonwealth Association for Corporate Governance (Nov 99).

Basic elements of a system of Corporate Governance :

Most common aspect of most definitions of corporate governance is the focus on the role & function of the Board of Directors – as the body responsible for ensuring the company is accountable for its decisions & its performance. Hampel committee highlighted : - A central feature of good corporate governance principles is the development of accountability mechanisms for public companies. - Good Corp Gov. requires that Corp Gov. principles be applied flexibly & with common sense. - Boards are accountable to shareholders but this does not mean that directors should focus solely on the short-term interests of shareholders. - Boards are responsible to a broader group of stakeholders than just shareholders & should take the interests of all stakeholders into account.

A good Corporate Governance system – has a broader focus & includes the following aspects :

 A sound system on internal control – to help ensure accurate & reliable accounting records are produced, assets are safeguarded, irregularities & fraud is prevented or detected.  A system of audit verification – to help ensure that the organization is functioning efficiently & that fraud & other malpractices do not go undetected. Audit is broken into 2 distinct areas : 1. Internal audit function – is a unit within an organization that carries out an independent appraisal activity. Their scope of work extends to all phases of an organisation’s activities. 2. External audit function – involves the use of independent experts from outside the organisation to examine aspects of the organisation’s activities.

ROLE OF GOVERNMENT IN CORPORATE GOVERNANCE :

Federal & State Government have a major influence on the behavior of organisations, particularly companies, and therefore corporate governance systems. Governments make laws that affect Corp Gov. – Corporations Act 2001. This is the major legislation that impacts on companies. Through its legislation, Govts require companies to behave responsibly & be accountable as good citizens.

The justification of Govts holding companies accountable – is that companies are a part of society and through Govt statute, are given a social license to operate. Companies & Shareholders enjoy the advantage of limited liability under statute & therefore have certain responsibilities in exchange for this advantage. The wealth they make/create, comes from society & therefore companies must abide by social laws.