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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 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 of corporate governance. What are their similarities and
what are their 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 of 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 as holding that 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 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

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 of people providing access to resources. In contrast to
resource dependence theory’s focus on the company, however, class hegemony theory is a

© John Wiley and Sons Australia, Ltd 2015 4.1


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 diligence.

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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Chapter 4: Fundamental concepts of corporate governance

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 binding 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 its 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.

© John Wiley and Sons Australia, Ltd 2015 4.3


Solution Manual to accompany Company Accounting 10e

The advantages of the “hard regulation” approach are:


 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:


 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 corporate 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 self-
regulation 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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Chapter 4: Fundamental concepts of corporate governance

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
principles 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 available from:


http://www.asx.com.au/regulation/corporate-governance-council.htm

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.

© John Wiley and Sons Australia, Ltd 2015 4.5


Solution Manual to accompany Company Accounting 10e

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.

© John Wiley and Sons Australia, Ltd 2015 4.6


Chapter 4: Fundamental concepts of corporate governance

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 ‘improper
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 trading 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 the
ASX corporate governance guidelines, under principle 3 it is recommended that the company

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Solution Manual to accompany Company Accounting 10e

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;
 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 this 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:

 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 least 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 they
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 insider trading.

© John Wiley and Sons Australia, Ltd 2015 4.8


Chapter 4: Fundamental concepts of corporate governance

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 flexibility
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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Solution Manual to accompany Company Accounting 10e

 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 arbitrary.
 Given the principal- agent relationship and the fact that 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.

© John Wiley and Sons Australia, Ltd 2015 4.10


Chapter 4: Fundamental concepts of corporate governance

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.

Would argue has improved governance due to:


 Boards more responsive to shareholder concerns (noted in article that ‘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.

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

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Solution Manual to accompany Company Accounting 10e

 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 first 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’.

© John Wiley and Sons Australia, Ltd 2015 4.12


Chapter 4: Fundamental concepts of corporate governance

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 access 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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Solution Manual to accompany Company Accounting 10e

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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Chapter 4: Fundamental concepts of corporate governance

 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. 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:
(a) Identify the key areas considered by these companies.
(b) Are there any differences or similarities in corporate governance practices?
(c) 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?
(d) Which company would you rank as having the best (or worst) corporate governance
from these disclosures? Explain how you have arrived at this decision.
(e) 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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Solution Manual to accompany Company Accounting 10e

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:

 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 principles 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/shareholders).
You may also wish to consider the following:
 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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Chapter 4: Fundamental concepts of corporate governance

 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 competitive 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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Solution Manual to accompany Company Accounting 10e

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 disclosed 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 has information on


major investigations/cases.
(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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