CORPORATE GOVERNANCE - ROLE OF CHARTERED ACCOUNTANTS

[Dr. Sanjiv Agarwal]

Corporate governance and Chartered Accountants are inseparable and one can not expect to practice the good practices without involvement of a finance professional. The paper makes an attempt to understand the concept of corporate governance and role of Chartered Accountants and auditors in practicing good corporate governance. Both in India and abroad, a significant work has been done in this area and the core recommendations of various codes and committees relating to this aspect of governance find place.

Corporate Governance: Overview

The genesis of the corporate governance lies in business scams and failures. The junk bond fiasco in USA and the failure of Maxwell, BCCI and Polypeck in U.K. resulted in the Treadway Committee in USA and the Cadbury Committee in U.K. on corporate governance. The guiding principle being "transparency and ethics should govern corporate world".

Increasing strategic importance of professional management probably constitute the most important aspect of changing profile of corporate governance. Growing importance of professions, which never figured predominantly in the ideological thinking in the nineteenth century has dominated public discussions in twentieth century and will continue  to dominate in times to come. Given the global challenges, only choice left with business and economic enterprises is to follow the corporate governance practices - the path for living, working, surviving, succeeding and excelling in the future.

While laws, rules and regulations are necessary in any society, to protect the interests of shareholders and other stakeholders, in the ultimate analysis, corporate governance is about commitment to values. It is making a distinction between personal and corporate funds in the management of a company; it is about acceptance by the management of the inalienable right of shareholders as true owners and of their role as trustees on behalf of the shareholders.

It is felt that objective of corporate governance i.e., the overall objective of wealth generation and competitiveness for the benefit of all can best be achieved through the twin components of:

·  An "inclusive" approach to directors' duties which requires directors to have regard to all the relationships on which the company depends and to the long, as well as the short-term implications of their actions, with a view to achieving company success for the benefit of shareholders as a whole; and

Wider public accountability: this is to be achieved principally through improved company reporting, which for public and very large private companies will require the publication of a board operating and financial review which explains the company's performance, strategy and relationships (eg with employees, customer and suppliers as well as the wider community).

Meaning of Corporate Governance

Corporate governance, a phenomenon of recent origin in the wake of increasing competition and globalisation, stipulates parameters  of accountability,  control and reporting functions of the  board  of directors and encompasses the relationship among various  participants in determining the direction and performance of the corporation. It also calls for establishing a proper and a viable relationship amongst the various participants of a corporation, the board, management team, shareholders and other stakeholders.

Corporate governance is a process or a set of systems and  processes to  ensure that company is managed to suit the best  interests  of all  stakeholders.  The stakeholders  may  be  internal(promoters, members,  workmen  and executives) and  external  (  shareholders, customers, lenders, dealers, vendors, bankers, community,  government   and   regulators  etc.).  It  is   an   interplay   between companies, shareholders, creditors,  capital  markets,   financial sectors, institutions and law. Corporate governance is concerned  with the establishment of a system whereby the directors are  entrusted with  responsibilities and duties in relation to the  directions  of corporate  affairs. Maximisation of shareholder's wealth  is  the corner stone of good governance.

The concept of corporate governance hinges on total transparency, integrity and accountability of the management which includes non-executive directors. The importance of corporate governance lies in its contribution both to business prosperity and to accountability.

Corporate governance is about the nitty-gritty of how a company fulfils its obligations to investors and other stakeholders. It is about commitment to values and ethical business conduct and a high degree of transparency.

Best practices of corporate governance will broadly include - a definition of practices that define good governance; a code of best practices covering  the constitution of the Board, its various committees, defining their goals and responsibilities, exploring preferred internal systems and disclosure requirements.

Need for corporate governance

Not many realise that corporate governance would not have gained so much acceptance if it had no 'economic payoff'. Corporate governance assumed importance because, on the one hand, competition compelled companies to improve performance and on the other, financial markets began to integrate. Fund managers were then benchmarked to the world's best and faced server competition from other fund managers and intermediaries. In order to retain their own market share, investors, who were otherwise somewhat passive, had to become 'activist'. The freedom of choice on the part of the investor/consumer has played an important part in starting the process of corporate governance.

Factors Influencing Quality of Governance

Quality of governance depends on the following factors:

(i) Integrity of the Management : A Board of directors with a low level of integrity is tempted to misuse the trust reposed by shareholders and other stakeholders to take decisions that benefit a few at the cost of others.

(ii) Ability of the Board : The collective ability, in terms of knowledge and skill, determines the effectiveness of the Board.

(iii) Adequacy of the process: Board of Directors cannot effectively supervise the executive management if the process fails to provide sufficient and timely information to the Board, necessary for reviewing plans and the performance of the enterprise.

(iv) Commitment level of individual board members : The quality of a board depends on the commitment of individuals members to tasks which they are expected to perform as board members.

(v) Financial reporting :Accuracy and transparency in financial statements and disclosure, internal controls and independence of auditors.

(vi) Participation of stakeholders in the management : The level of participation of stakeholders determines the number of new ideas being generated in  optimum utilization of resources and for improving the administrative structure and the process.

(vii) Quality of Corporate Reporting : The quality of corporate reporting depends on the transparency and timeliness of corporate communication with shareholders. This helps the shareholders in making economic decisions and in correctly evaluating the management in its stewardship function.

Role of Chartered Accountants

Although the role of Chartered Accountants in corporate governance is generally understood in the capacity as an auditor, according to me, Chartered Accountant can play a significant role in practicing good corporate governance, as compared to an ordinary person in his different capacities like -

(i) as shareholder or stakeholder of a company

(ii) as an employee or part of management team of the company

(iii) as a member of the board of directors or any of its sub-committees

(iv) as a promoter

(v) as a auditor - internal or external

He can play a crucial role of a crusaider in achieving corporate governance in these different capacities. Every where in the world and especially in developing countries, people are looking at corporate governance more seriously, and the Chartered Accountants have to play an important role in the whole process of governance by helping to balance business practices and objectives of the board whose primary concern should be to sun a company in a profitable manner and at the same time as good law abiding entities. As a corporate guardian, it is the Chartered Accountants who will have to ensure achieving corporate governance.

Role of Auditors

Auditors role in the achievement of corporate governance should be such which facilitates efficient operations through -

i)   audit of agency costs inherent in a division between the provision of capital and the stewardship of the undertaking such capital is invested in;

ii)  seeking to ensure a proper standard of performance and accountability for the benefit of all stakeholders.

It would also be obligatory for the auditors to understand the importance of transparency and public accountability of the company as a means of ensuring that the stakeholders could hold him also account for the external impact of non-disclosures in the statements or non-transparent statements. This principle of disclosure is of fundamental nature, which arises out of freedom to choose and disclose.

Transparency can reinforce sound corporate governance. Transparency should lead to the efficient operation of market forces and the exercise of beneficial economic choices without the need for a legal or regulatory intervention with its distorting and costly effects.

The system of accounting and reporting is an integrated one. It follows that company's accounting and reporting should satisfy a wide range of needs including those of  -

1. shareholders in exercising governance functions (Voice)

2. Creditors who need to have a clear picture of the position and prospects of their debtors (Liquidity)

3. Investors, both actual and potential, who wish to know whether to acquire, retain or sell, a stake in business (Exit and entry)

4. Other stakeholders (including employees and the public) having variety of relationship with the business (Accountability).

The role of the auditors would be to -

Audit the historic financial information in annual report

Review for consistency the surroundings to the annual accounts

Reach a view whether a statements have been 'properly prepared' and are forward looking statements (not necessarily forecasts) and policies.

The auditors have a duty of care to existing shareholders of the company and  also to any other person and purpose to whom and for which they have or are deemed to have expressly or implicitly agreed to owe such duty. This is desirable when we talk of corporate governance.

Disclosure & Transparency

OECD Principals of corporate governance state one of the principles on disclosure and transparency . It states that "  the corporate governance framework should ensure that timely and accurate disclosure is made on all material matters regarding the corporation , including the financial situation , performance, ownership , and governance of the company.

A. Disclosure should include but not be limited to, material information on :

· The financial and operating results of the company.

· Company objectives

· Major share ownership and voting rights.

· Members of the board key executives , and their remuneration.

· Material foreseeable risk factors.

· Material issues regarding employees and other stakeholders.

· Governance structures and policies.

B. Information should be prepared , audited and disclosure and disclosed in accordance with high quality standards of accounting, financial and non-financial, and audit.

C. An annual audit should be conducted by independent auditor in order to provide an external and objective assurance on the way in which  financial statements have been prepared and presented.

D. Channel of disseminating information should provide for fair, timely and cost efficient  access to relevant information by users.

A strong disclosure is control to shareholder's ability to exercise their voting rights. Disclosure also helps improve public understanding of the structure and activities of enterprises, corporate policies and performance with respect to relationship with the committees in which they operate.

Disclosure requirements are not expected to place unreasonable administrative or cost burdens on enterprises. Nor are companies expected to disclose information that may endanger their competitive position unless disclosure is necessary to fully inform the investment decision and to avoid misleading the investor. In order to determine what information should be disclosed at a minimum, many countries apply the concept of materiality. Material information can be defined as information whose omission or mis-statement could influence the economic decisions taken by users of information.

The principles support timely disclosure of all material developments that arise between regular reports, They also support simultaneous reporting of information to all shareholders in order to ensure their equitable treatment.

The application of high quality standards is expected to improve the ability of investors to monitor the company by providing increased reliability and comparability of reporting and improved insight into company performance. The quality of information would depend on the standards under which it is complied and disclosed.

Responsibility and Accountability

Responsibility and accountability go together. Corporate managements are today accountable not to themselves (in terms of monetary measurement of performance), not to the promoters (in terms of reward on returns) and not to shareholder (in terms of dividend yields) alone. Corporate governance has shifted the focus to a broader beneficiary category known as stakeholders which also includes employees and ex-employees, vendors, business partners, customers, clients, regulators, society etc.

A sincere discharge of true accountability towards stakeholders would lead to achieve corporate wealth maximization, investors confidence, corporate image building and enhanced market-capitalisation. This can be achieved with clear and transparent management system and integral philosophy of maximizing wealth. Wider participation of stakeholder hold the key. That is were corporate democracy comes into play.

Audit Committee as a Committee of Board

The Audit committee should ideally comprise of at least 3-4 non-executive directors (wholetime directors to be invitees). The Audit Committee is established to give additional assurance regarding the quality and reliability of the financial information used by the board and financial information issued by the Company. Its activities would normally include reviewing financial statements and inspection reports, ensuring the sound functioning and compliance with various relevant statutes; monitoring (a) control of corporate risks, (b) establishment of an appropriate internal control framework, (c) activities of the internal audit department; and liaison with external auditors. The Audit committee should ensure that adequate mechanism for prevention and detection of frauds, is in place. The Audit Committee should confirm to the board once a year that the internal controls of the company are adequate. The Committee should meet at least four times a year.

Terms of reference for audit committee would include the following (Combined code)-

(a) to review the scope and results of the annual audit and its cost effectiveness and the independence and objectivity of the auditors;

(b) to consider the appointment of the external auditor, the audit fee, and any questions of resignation or dismissal;

(c) to discuss with the external auditor before the audit commences the nature and scope of the audit, and other relevant matters;

(d) to review the half year and annual financial statements before submission to the board, focusing particularly on:

(i) any changes in accounting policies and practices,

(ii) major judgmental areas,

(iii) significant adjustments resulting from the audit,

(iv) the going concern statement,

(v) compliance with accounting standards,

(vi) compliance with stock exchange and legal requirements;

(e) to discuss problems and reservations arising from the audit, and any matters the auditor may wish to discuss (in absence of management where necessary);

(f) to review the external auditor's management letter and management's response;

(g) to review the effectiveness of the company's systems of internal control and to review the company's statement on internal control systems prior to submission to the Board;

(h) to consider the major findings of any internal investigations and management's response;

(i) to review any internal audit programme and ensure that it is adequately resourced;

(j) to consider other topics, as defined by the board.

Conclusion:

To conclude, it can be said that we, as auditors need to serve the entrepreneurs, captains of industry and corporates as change agents and help in wealth creation and achieving corporates excellence. The message is loud and clear. We can not ill afford to be silent, overlooking and laid back. Doing nothing is not an option. Martin Luther King Jr. observed, "We shall have to repent in this generation not so much for the evil deeds of the wicked people but for the appalling silence of good people". He expressed the hope that India's resilient corporate structure would rise up to the occasion and set highest standards of efficiency, productivity, innovation and best business practices.

Milton Friendman's famous formulation "The business of business is business" has outlived its utility and relevance, and societal responsibilities of the corporates have become the buzzword in the international business arena. It is being increasingly recognized that being a responsible corporate citizen is important in ensuring long term success of a company. India's corporate sector has a new tryst with destiny. To face the formidable challenges of the new millennium, the corporate sector has to be empowered with a new vision, dynamic mission and new mandate to follow best practices of governance.