CPA PROGRAM
ETHICS AND
GOVERNANCE
THIRD EDITION
Pdf_Folio:i
Published 2019 by John Wiley & Sons Australia, Ltd,
42 McDougall Street, Milton Qld 4064,
on behalf of CPA Australia Ltd,
ABN 64 008 392 452
First edition published January 2010, reprinted July 2010, revised January 2011, July 2011, reprinted January 2012,
July 2012, updated January 2013, reprinted July 2013, updated January 2014, reprinted July 2014, revised January 2015,
updated January 2016
Second edition published May 2018
Third edition published November 2019
© 2001–2019 CPA Australia Ltd (ABN 64 008 392 452). All rights reserved. This material is owned or licensed by CPA
Australia and is protected under Australian and international law. Except for personal and educational use in the CPA
Program, this material may not be reproduced or used in any other manner whatsoever without the express written
permission of CPA Australia. All reproduction requests should be made in writing and addressed to: Legal, CPA Australia,
Level 20, 28 Freshwater Place, Southbank, VIC 3006, or legal@cpaaustralia.com.au.
Edited and designed by John Wiley & Sons Australia, Ltd
Printed by Blue Star Print
ISBN 9780730381624
Authors
James Beck
Courtney Clowes
Craig Deegan
Patrick Gallagher
Alex Martin
Greg McLeod
Tom Ravlic
Roger Simnett
Jennifer Tunny
Managing Director, Effective Governance Pty Ltd
Director, KnowledgEquity
Professor of Accounting, RMIT University
Director, Governance Tax & Risk Pty Ltd
Manager Financial Policy, Australia and New Zealand Banking Group Ltd
Senior Investigator, Australian Securities & Investments Commission
Consultant
Professor, School of Accounting, University of New South Wales
Senior Research Advisor, Effective Governance Pty Ltd
Third edition updates
Karyn Byrnes (Consultant)
Ellie Chapple (Queensland University of Technology)
Melanie Seifert (Macquarie University)
Advisory panel
James Beck (Effective Governance Pty Ltd)
Prof Thomas Clarke (University of Technology Sydney)
Dr Mary Dunkley (Swinburne University)
Alan Greenaway (Australian Pharmaceutical Industries)
Jennifer Lauber Patterson (Frontier Carbon Limited)
Mike Sewell (Clean Technology Innovation Centre)
Marcia O’Neill (Consultant)
Eva Tsahuridu (CPA Australia)
CPA Program team
Yvette Absalom
Victoria Altomare
David Baird
Shubala Barclay
Nicola Drury
Jeannette Dyet
Yani Gouw
Kristy Grady
Geraldine Howley
Elise Literski
Julie McArthur
Adam Moretti
Ram Nagarajan
Venkat Narayanan
Isha Nehru
Shari Serjeant
Paul Shantapriyan
Alisa Stephens
Zina Suyat
Tiffany Tan
Seng Thiam Teh
Helen Willoughby
Pdf_Folio:ii
ACKNOWLEDGEMENTS
MODULE 1
Figure 1.1, Tables 1.2, 1.4, 1.5: © CPA Australia; Figure 1.2; Brourard F, Merriddee, B, Durocher, S,
Burocher Neison, L 2017, ‘Professional accountants’ identity formation: An integrative framework’,
Journal of Business Ethics, vol. 142, iss. 2, pp. 225–238; Extracts: © Australian Securities & Investments
Commission. Reproduced with permission; © Gregor Allan; © This text is an extract from The Crucial
Roles of Professional Accounts in Business in Mid-sized Enterprises, p. 6, Professional Accountants in
Business Committee, published by the International Federation of Accountants (IFAC), New York in 2008
and is used with permission of IFAC.
MODULE 2
Figures 2.1, 2.2, 2.3: © IFAC; Figure 2.4: © Table 1: The theoretical basis of the central orientations of ethical leadership, from Eisenbeiss, SA 2012, ‘Re-thinking ethical leadership: An
interdisciplinary integrative approach’, The Leadership Quarterly, vol. 23, no. 5, pp. 791–808,
http://dx.doi.org/10.1016/j.leaqua.2012.03.001; Figure 2.6: © Sourced from the copyright owner,
Accounting Professional and Ethical Standards Board Limited (APESB) at November 2019. To ensure you
are aware of the latest information provided by APESB please visit www.apesb.org.au or contact APESB
directly; Figures 2.10, 2.11, Tables 2.2, 2.17: © CPA Australia; Tables 2.5, 2.6, 2.7, 2.9, 2.10, 2.12, 2.13,
2.14: © Sourced from the copyright owner, Accounting Professional and Ethical Standards Board Limited
(APESB) at November 2019. To ensure you are aware of the latest information provided by APESB
please visit www.apesb.org.au or contact APESB directly; Extracts: © Sourced from the copyright owner,
Accounting Professional and Ethical Standards Board Limited (APESB) at November 2019. To ensure
you are aware of the latest information provided by APESB please visit www.apesb.org.au or contact
APESB directly; © State of New South Wales Department of Premier and Cabinet 2019; © Christensen,
BA 1996, ‘Kidders theory of ethics’, Journal of the American Society of CLU & ChFC, 504, 29; © IFAC; ©
Commonwealth of Australia; © Supreme Court of Western Australia; © Australian Criminal Intelligence
Commission 2016; © Australian Securities & Investments Commission. Reproduced with permission.
MODULE 3
Figures 3.1, 3.4, Tables 3.1, 3.6, 3.7, 3.9: © CPA Australia; Figure 3.2: © This article was first published
by Thomson Reuters in the Corporate Governance framework, taken from Kiel, G & Nicholson, G et al.
2012, Directors at Work, Thomson Reuters, Sydney. For all subscription inquiries please phone, from
Australia: 1300 304 195, from Overseas: +61 2 8587 7980 or online at legal.thomsonreuters.com.au/search;
Figure 3.3: © Oxford University Press; Figure 3.5: © Copyright 2019 ASX Corporate Governance Council
Figure 3.6: © State of Victoria Victorian Public Sector Commission 2018; Table 3.5: © Bosch, H 1995,
Corporate Practices and Conduct, 3rd edn, Pitman, Melbourne, p. 9. Reproduced with permission;
Table 3.10: © Commonwealth of Australia 2019; Extracts: © United Nations Conference on Trade
and Development (UNCTD) 2006, ‘Guidance on Good Practices in Corporate Governance Disclosure’,
United Nations, pp. 3–4, accessed October 2015, http://unctad.org/en/docs/iteteb20063_en.pdf; © Copyright 2019 ASX Corporate Governance Council; © The UK Corporate Governance Code, Financial
Reporting Council 201. Reproduced with permission. Contains public sector information licensed under
the Open Government Licence v3.0; © State of New South Wales Department of Justice. For current
information go to www.justice.nsw.gov.au; © Jensen, M & Meckling, W 1976, ‘Theory of the firm:
Managerial behavior, agency costs and ownership structure’, Journal of Financial Economics, vol. 3, no. 4,
pp. 305–60; © Organisation for Economic Co-operation and Development; © Australian Shareholders
Association; © Commonwealth of Australia; © State of New South Wales Department of Justice. For
current information go to www.justice.nsw.gov.au; © Australian Securities & Investments Commission.
Reproduced with permission; © UK Financial Reporting Council; © Commonwealth of Australia 2018;
© John Halligan; © Commonwealth of Australia — Australian Public Service Commission APSC 2007,
Building Better Governance, Australian Government, accessed October 2015, www.apsc.gov.au/buildingbetter-governance; © Sourced from the Federal Register of Legislation at November 2019. For the latest
information on Australian Government law please go to www.legislation.gov.au.
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ACKNOWLEDGEMENTS iii
MODULE 4
Figure 4.2: © Commonwealth of Australia 2018; Tables 4.3, 4.4, 4.6: © CPA Australia; Extracts:
© Kirkpatrick, G 2009, ‘The corporate governance lessons from the financial crisis’, OECD Journal:
Financial Market Trends, vol. 2009/1, accessed October 2015, www.oecd.org/daf/corporateaffairs/
corporategovernanceprinciples/42229620.pdf; © KPGM 2016; © ‘Penrice duo pass two-strike
spill’, Wen, P, The Age, 26/01/2013; © ‘Narev signals end to end CBA’s pay freeze’, Liondis,
G 2013, The Australian Financial Review, 19 August, accessed October 2019, www.afr.com;
© Australian Prudential Regulation Authority 2019; © Douglas McIntyre; © BHP Group Limited;
© ‘PwC, Centro pitch in for investor losses’, Harper, J, The Herald Sun, 11/05/2012; © Australian
Securities & Investments Commissions. Reproduced with Permission; © Parliament of Australia 2019;
© Australian Prudential Regulation Authority 2019; © IFAC; © Organisation for Economic Co-operation
and Development; © ‘Opaque charity sector under fire for accounting failures’,
Ferguson, A, The Australian Financial Review, 17/08/2015; © Commonwealth of Australia 2018;
© Fels, A 1999, ‘Compliance programs: The benefits for companies and their stakeholders’,
ACCC Journal, no. 24, pp. 14–18 © Commonwealth of Australia; © European Union, https://eurlex.europa.eu, 1998–2019; © United Nations Conference on Trade and Development (UNCTD)
2006, Guidance on Good Practices in Corporate Governance Disclosure, United Nations, pp. 3–4,
accessed October 2015, http://unctad.org/en/docs/iteteb20063_en.pdf; © Trade Practices Commission
1991, ‘Consumer protection advertising’, Information circular no. 10, Australian Government
Publishing Service, Canberra; © Commercial Bank of Australia Ltd v. Amadio 1983 151 CLR 447;
© ‘Alarm bells ringing on DJs takeover approach’, Smith, M, The Australian Financial Review,
29/06/2012; © ‘ASIC’s focus on insider trading pays off in Hanlong case’, Moran, S, The Australian,
01/08/2012; © ‘Stocks dealer jailed for insider trading, Drummond, A, The Sydney Morning Herald,
02/12/2010; © ‘Bribery/Anti-corruption: Shell’, Griffiths, C, The Lawyer, 18/03/2011; © Sard Verbinnen
& Co; © ‘News backs Murdoch despite shareholder threat’, Potter, B, The Australian Financial Review,
21/07/2011; © ‘Former Olympus chief warns on governance’, by Michiyo Nakamoto, Financial Times,
FT.COM, 20 April 2012. Used under licence from the Financial Times. All Rights Reserved; © Australian
Broadcasting Agency 2006; © Copyright 2019 ASX Corporate Governance Council; © New Zealand
Government; © Australian Fair Work Ombudsman.
MODULE 5
Figure 5.1: © United Nations; © Figures 5.3, 5.4, 5.5, Tables 5.1, 5.2: © CPA Australia; Figure 5.6:
© Natural Capital Coalition; Figure 5.8: © Task Force on Climate-related Financial Disclosures 2017;
Table 5.5: © GRI Standards 2016, GRI 101: Foundation, p. 7 www.globalreporting.org/standards/media/
1036/gri-101-foundation-2016.pdf; Extracts: © Commonwealth of Australia 2019. All legislation herein
is reproduced by permission but does not purport to be the official or authorised version. It is subject
to Commonwealth of Australia copyright. The Copyright Act 1968 permits certain reproduction and
publication of Commonwealth legislation. In particular, s.182A of the Act enables a complete copy to
be made by or on behalf of a particular person. For reproduction or publication beyond that permitted by
the Act, permission should be sought in writing from the Commonwealth available from the Australian
Accounting Standards Board. Requests in the first instance should be addressed to the National Director,
Australian Accounting Standards Board, PO Box 204, Collins Street West, Melbourne, Victoria, 8007;
© World Business Council on Sustainable Development; © Responsible Investment Association Australasia; © Bank Australia; © Business Roundtable; © Crown and database right; © Commonwealth of
Australia; © Origin Energy; © European Union, https://eur-lex.europa.eu, 1998–2019; © Sourced from the
Federal Register of Legislation at September 2019. For the latest information on Australian Government
law please go to www.legislation.gov.au; © International Integrated Reporting Council; © OECD Publishing; © United Nations Global Compact; © World Resources Institute & World Business Council for
Sustainable Development 2005; © ISO International Standards Organization 2010, ISO 26000 Guidance
on Social Responsibility, accessed September 2015, www.iso.org/obp/ui/#iso:std:iso:26000:ed-1:v1:en;
© ‘Linking CSR performance with pay sends clear sustainability signal’, Yvo de Boer, The Guardian,
13/12/2013; © United Nations Division for Sustainable Development; © Pages 2 and 17 from IPCC, 2013:
Summary for Policymakers. In: Climate Change 2013: The Physical Science Basis. Working Group I Contribution to the Fifth Assessment Report of the Intergovernmental Panel on Climate Change [Stocker, TF,
D Qin, GK Plattner, M Tignor, SK Allen, J Boschung, A Nauels, Y Xia, V Bex and PM Midgley eds.].
Cambridge University Press, Cambridge, UK and New York, USA; © Australian Securities & Investments
Commissions. Reproduced with Permission.
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iv ACKNOWLEDGEMENTS
BRIEF CONTENTS
Subject outline
x
Module 1: Accounting and Society 1
Module 2: Ethics 42
Module 3: Governance Concepts 114
Module 4: Governance in Practice 207
Module 5: Corporate Accountability 292
Glossary 366
Suggested answers
Index 407
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371
CONTENTS
Subject outline
x
MODULE 1
Accounting and Society
1
Preview 1
Part A: Accountants as Members of a
Profession 3
Introduction 3
1.1 Public interest or self-interest? 3
Responsible decision making 3
1.2 Enlightened self-interest 6
1.3 Ideals of accounting —
entrepreneurialism and professionalism 6
1.4 What is a profession? 8
Self-regulation 9
From self-regulation to a co-regulatory
process 10
1.5 What is a professional? 10
1.6 The accounting profession — the
‘traditional’ view and the ‘market
control’ view 11
1.7 Trust and professions 11
1.8 Attributes of a profession 12
A systematic body of theory and
knowledge 12
An extensive education process 13
An ideal of service to the community 13
A high degree of autonomy and
independence 14
A code of ethics for members 15
A distinctive ethos or culture 16
Application of professional judgment 16
The existence of a governing body 17
1.9 The profession’s regulatory process 18
Accounting Professional and Ethical
Standards Board 18
The quality assurance process 19
Professional discipline 20
Summary 22
Part B: Interaction with Society 24
Introduction 24
1.10 Accounting roles, activities and
relationships 24
Relationships and roles 24
Accounting work environments 25
1.11 Social impact of accounting 32
Social impact example — depreciation and
behaviour 32
1.12 Credibility of the profession 34
Credibility under challenge 34
Key issues causing reduced credibility 34
Restoring credibility to accounting 36
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1.13 Capability considerations 37
Business leadership capabilities 37
Technical skills, knowledge and
experience 37
Soft skills, knowledge and experience 38
TSKE and SSKE — career perspectives 38
Summary 39
Review 40
References 40
MODULE 2
Ethics
42
Preview 42
Part A: Professional Ethics 43
Introduction 43
2.1 Impact of ethical or unethical
decisions 43
2.2 Ethics — an overview 44
2.3 Ethical challenges within the
accounting profession 46
Ethical challenges faced by members in
practice and in business 46
2.4 The accounting work environment 48
Summary 49
Part B: Ethical Theories 51
Introduction 51
2.5 Normative theories 51
Ethics of character 52
Ethics of conduct 52
2.6 Teleological (consequential) theories 52
Egoism 53
Utilitarianism 54
2.7 Deontological theories (duty based) 56
Motive 56
Rights 56
Justice 57
2.8 Virtue ethics 58
Moral agency 58
Summary 59
Part C: APES 110 Code of Ethics for
Professional Accountants (including
Independence Standards) 60
Introduction 60
2.9 The public interest — ethics in
practice 61
2.10 The APESB Code of Ethics (APES 110) 62
Part 1 of the Code — fundamental
principles and conceptual framework 63
The conceptual framework (s. 120) 68
Parts 2 and 3 of the Code — applying the
Code to members in business and
public practice 74
Part 4 of the Code — applying the
conceptual framework in the context of
audit, review and assurance
engagements 88
2.11 Examples of ethical failures by
accountants 95
Summary 97
Part D: Ethical Decision Making 99
Introduction 99
2.12 Factors influencing decision making 100
Individual factors 100
Organisational factors 101
Professional factors 103
Societal factors 104
2.13 Ethical decision-making models 105
APES GN 40 Ethical Conflicts in the
Workplace — Considerations for
Accountants in Business 106
Philosophical model of ethical
decision making 107
American Accounting Association
Model 108
Summary 110
Review 111
References 112
Ethics websites 113
MODULE 3
Governance Concepts
114
Preview 114
Part A: Corporations 116
Introduction 116
3.1 Key features of corporations 116
Proprietary companies 117
Public companies 117
Proprietary vs public companies 117
3.2 Directors and other officers 119
Directors and their duties 119
Examples of the exercise of directors’
duties 125
Director independence 127
Company secretaries and their duties 128
3.3 Nature of corporations and division of
corporate powers 129
Shareholder powers 129
Board powers 130
CEO powers 131
3.4 Theories of corporate governance 131
Stewardship theory 132
Agency theory 132
Agency issues and costs 133
Other governance theories 135
Summary 136
Part B: Corporate Governance 138
Introduction 138
3.5 Importance of governance 139
Governance and performance 140
Accountants and effective governance 140
3.6
Corporate governance framework 141
Shareholders 141
The board 144
Auditors 150
Regulators 150
Stakeholders 152
Management 155
Summary 156
Part C: International Perspectives on
Corporate Governance 158
Introduction 158
3.7 Global push for improved governance 158
Specific Australian changes since
2001 160
3.8 Alternative international approaches to
governance 161
Market-based systems 162
Relationship-based systems — European
approaches 163
Relationship-based systems — Asian
approaches 166
Summary 169
Part D: Codes and Guidance 171
Introduction 171
3.9 OECD Principles of Corporate
Governance 171
Principle I. Ensuring the basis for an
effective corporate governance
framework 171
Principle II. The rights and equitable
treatment of shareholders and key
ownership functions 172
Principle III. Institutional investors, stock
markets, and other intermediaries 173
Principle IV. The role of stakeholders in
corporate governance 174
Principle V. Disclosure and
transparency 174
Principle VI. The responsibilities of the
board 175
3.10 UK Financial Reporting Council
Corporate Governance Code 176
3.11 ASX Corporate Governance Council’s
Principles and Recommendations 178
Understanding the ASX Principles 179
The ASX Principles and
Recommendations 179
Summary 186
Part E: Non-corporates and Governance 187
Introduction 187
3.12 Family-owned businesses, and small
and medium-sized enterprises 187
3.13 Not-for-profit organisations 188
ACNC guidance 188
AICD guidance 190
Diversity in the not-for-profit sector 190
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CONTENTS vii
3.14 Public sector enterprises 191
The uniqueness of the public sector
Guidance for public sector
governance 193
3.15 Significance of the non-corporate
sector 195
Summary 196
Review 196
Appendix 3.1 197
References 204
192
MODULE 4
Governance in Practice
207
Preview 207
Part A: Corporate Governance Success
Factors 208
Introduction 208
4.1 Mitigating the risk of financial failure 208
Common causes of corporate failure 208
Selection, monitoring, evaluation and
cessation of board appointments 211
4.2 Diversity — fairness and performance 216
Adopting diversity 218
Executive remuneration and
performance 218
Compliance with the Corporations Act 225
Auditing the financial statements 225
Reviews of audit quality and audit
regulation 227
4.3 Improving corporate governance 229
Risk management 229
Independence of the chair of the
board 230
Continued evolution of corporate
governance 231
4.4 Governance issues in the noncorporate sector 231
Government bodies 231
Charities and not-for-profit sector 232
Summary 235
Part B: Operational Obligations and Oversight 237
Introduction 237
4.5 The legal system 237
The economy and the legal system 238
Legal compliance and governance 241
4.6 Obligations to employees 242
Occupational health and safety 243
Fair pay and working conditions 244
Family and leave entitlements 245
Ethical obligations — employee
governance 246
4.7 Protecting the goods and services
market 247
Workable competition 248
Competition and stakeholders 248
Regulating anti-competitive behaviour 250
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viii CONTENTS
Consumers and customers 258
Summary 263
Part C: Protecting Financial Markets and
Value in Corporations 265
Introduction 265
4.8 Role of markets 265
The role of market regulators 266
The role of information and the media 266
The role of ratings agencies 268
4.9 Protecting financial markets 268
Insider trading 268
Market manipulation 270
4.10 Representation 277
The representational role of institutional
investors 279
Expanding ethics 282
Whistleblower protection 283
Summary 286
Review 287
References 287
MODULE 5
Corporate
Accountability
292
Preview 292
Part A: Financial Reporting and its Limitations 294
Introduction 294
5.1 Scope of reporting 294
5.2 Elements of financial reporting 294
5.3 The practice of discounting future cash
flows 295
5.4 Relevance and faithful representation 296
5.5 Focus on short-term results 296
5.6 The entity assumption 297
Summary 297
Part B: The Changing Reporting Landscape 298
Introduction 298
5.7 Global financial crisis 298
5.8 Incentives tying sustainability issues
to maximising the value of the
organisation and shareholder
wealth 299
Brand and reputation 300
Risk management incentives 301
External benefits to companies from
communicating through CSR reporting:
the relationship between CSR and the
corporate cost of capital 302
5.9 Socially responsible investments 302
Responsible investment 303
Sustainable investment 303
Thematic investment 304
Impact investment 304
Social enterprises 304
5.10 Perceived corporate responsibilities
and accountability 305
5.11 Corporate social responsibility 308
5.12 Externalities, potential government
intervention and the role of
accounting 309
Summary 311
Part C: Theories Linked to CSR 313
Introduction 313
5.13 Enlightened self-interest 313
5.14 Stakeholder theory 314
Who are stakeholders? 314
Normative stakeholder theory 314
Managerial stakeholder theory 315
5.15 Organisational legitimacy 315
The social contract 315
Legitimacy theory 316
5.16 Institutional theory 316
Summary 317
Part D: The Emergence of CSR 319
Introduction 319
5.17 Environmental sustainability 319
5.18 Social sustainability 320
5.19 Economic sustainability 321
5.20 Linking environmental, economic and
social sustainability 322
5.21 The board of directors’ responsibility
for sustainability and organisational
initiatives 323
5.22 Introduction to the key concepts 324
Accountability 324
CSR 324
Sustainability 325
Sustainability reporting 325
Natural capital 325
Natural capital accounting 325
Integrated reporting 325
Integrated thinking 325
5.23 What is measurable? 325
Social reporting 326
Environmental reporting 327
Economic reporting 328
Summary 328
Part E: Corporate governance and CSR
reporting 330
Introduction 330
5.24 What is required? (mandatory reporting) 330
Requirements embodied within the
Corporations Act and accounting
standards 331
CSR-related corporate governance
disclosures 332
National Greenhouse and Energy Reporting
Act 333
Emissions Reduction Fund and Climate
Solutions Fund 334
Modern Slavery Act 2018 334
National Pollutant Inventory 335
Issues of disclosure for Australian
mandatory reporting requirements 335
European Union emissions trading
scheme 336
5.25 Guidelines and non-mandatory
reporting 336
The Global Reporting Initiative 339
Integrated reporting 340
Natural Capital Protocol 341
OECD Guidelines for Multinational
Enterprises 341
CDP and the Climate Disclosure
Standards Board 342
United Nations Global Compact 343
Equator Principles 344
The Greenhouse Gas Protocol 345
Sustainability Accounting Standards
Board 346
Dow Jones Sustainability Indices
(DJSI) 347
5.26 Other initiatives 347
Social audits 347
Corporate governance mechanisms aimed
at improving social and environmental
performance 349
Environmental management
accounting 350
5.27 Surveys of current reporting practice 352
5.28 Examples of best practice and
innovative reporting 353
Summary 354
Part F: Climate Change Reporting 355
Introduction 355
5.29 The international response to climate
change risk 355
5.30 Climate change accounting techniques 356
5.31 Accounting for the levels of emissions 357
5.32 Corporate governance and climate
change 359
Summary 361
Review 361
References 362
Websites monitoring progress 365
Glossary 366
Suggested answers 371
Index 407
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CONTENTS ix
SUBJECT OUTLINE
INTRODUCTION
The purpose of this subject outline is to:
• provide important information to assist you in your studies
• define the aims, content and structure of the subject
• outline the learning materials and resources provided to support learning
• provide information about the exam and its structure.
The CPA Program is designed around five overarching learning objectives to produce future CPAs who
will be:
• technically skilled and solution driven
• strategic leaders and business partners in a global environment
• aware of the social impacts of accounting
• adaptable to change
• able to communicate and collaborate effectively.
BEFORE YOU BEGIN
Important Information
Please refer to the CPA Australia website for dates, fees, rules and regulations, and additional learning
support at www.cpaaustralia.com.au/cpaprogram.
SUBJECT DESCRIPTION
Ethics and Governance
Ethics and Governance is a core component of the knowledge and skill base of today’s professional
accountants. As key business decision-makers, accountants must be proficient in regulatory regimes,
compliance requirements, and governance mechanisms to ensure lawful, ethical and effective corporate
behaviour and operations. A better understanding of ethics and corporate governance frameworks and
mechanisms links with the various roles and responsibilities outlined in other subjects of the CPA Program.
From an individual perspective, this subject provides candidates with the analytical and decision-making
skills and knowledge to identify and resolve professional and ethical issues. The skills and knowledge
obtained in this unit are also important for subjects that specialise in the functional disciplines of accounting
such as Advanced Taxation, Financial Reporting, Strategic Management Accounting and Advanced Audit
and Assurance.
More than ever, today’s professional accountants are less involved in traditional accounting functions
and are more concerned with leadership and management. Today’s accountants are leaders in their field
providing key support to senior management and are directly involved in many important decisions. An
understanding of ethics and governance is essential to those in leadership roles, and to those who support
their leaders. This subject not only develops an awareness of corporate governance but also helps members
(and those whom they support) in discharging their stewardship functions.
Subject Aims
The aims of the subject are to:
• promote awareness of the ethical responsibilities of professional accountants, thereby enabling them to
identify and resolve ethical issues or conflicts throughout their career
• ensure professional accountants understand the importance of governance, including their role in
achieving effective governance
• improve understanding of the role of accounting, and of accountants, in providing information about
the social and environmental performance of an organisation.
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x SUBJECT OUTLINE
SUBJECT OVERVIEW
General Objectives
On completion of this subject, you should be able to:
• explain, from a global perspective, the nature of the accounting profession and the roles of professional
accountants
• apply the key professional responsibilities of an accountant from the perspective of a member of
CPA Australia
• explain the importance of ethics and professional judgment
• describe key governance and regulatory frameworks, including international perspectives on corporate
governance and the roles of various stakeholders
• explain the expectations placed on various internal and external stakeholders arising from organisational
governance responsibilities
• ascertain various compliance and regulatory regimes impacting the global business environment
• identify the strategic, leadership and global issues impacting accountants and the accounting profession
• describe the nature, role and importance of corporate social responsibility, including climate change and
sustainable development.
Module Descriptions
The subject is divided into five modules. A brief outline of each module is provided below.
Module 1: Accounting and Society
Increasingly, professional accounting involves much more than the application of technical knowledge.
Accountants are responsible for providing information and advice that supports important decisions that
affect organisations, people and their lives, and society as a whole. With the privileges and benefits that
accompany professional status come a variety of obligations, foremost of which is the obligation to put
the good of society ahead of personal interests.
This module considers what it means to be a professional accountant in the contemporary global business
context. It examines the wide range of capabilities and skills required, and the various environments in
which accountants work. There is a focus on the roles, relationships and activities of accountants and the
pressures that can challenge a professional accountant in their working life. There is also an emphasis on
what the profession must do to ensure it enjoys the confidence and trust of society and fulfils its role as a
positive social force.
Module 2: Ethics
This module explores the concept of ethics and ethical decision making in the professional and business
context. In other words, it discusses the practical implications of professional ethics based on the notion of
the public interest. The module provides an overview of various different theories on ethics, each of which
can provide perspective and insights that help guide accountants when considering and resolving complex
ethical dilemmas.
The module describes key aspects of the Code of Ethics for Professional Accountants (APES 110) and
demonstrates how to apply this Code when addressing specific ethical issues. The module also aims to
create an understanding of the individual, organisational, professional and societal factors that can exert
influence on an individual’s decision making.
Finally, the module examines decision-making models that provide a structured approach that can help
professional accountants to systematically analyse complex situations, exercise clear judgment and make
more consistent and justifiable decisions.
Module 3: Governance Concepts
Module 3 outlines the key features of the corporate form. These features combine to shape approaches
to corporate governance — the system in place to operate and control the corporation. Good corporate
governance is generally linked to good corporate performance. The nature of corporate governance,
theories of corporate governance and the key components generally found in corporate governance
frameworks are discussed. This includes consideration of relationships between companies, boards of
directors, managers and various other stakeholders.
Major codes and guidance on corporate governance in countries such as Australia and the UK are
considered, along with the role and impact of differing cultural approaches to corporate governance.
Governance in other sectors, including the public sector, is also reviewed.
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SUBJECT OUTLINE xi
The module highlights that professional accountants must have a strong understanding of governance
concepts in order to successfully fulfil their duties and obligations and add value to corporations and entities
of all types and sizes.
Module 4: Governance in Practice
Module 4 builds on the introduction to corporate governance concepts presented in module 3 by explaining
and, where appropriate, demonstrating their practical application. One of the key challenges confronting
those who are involved with modern corporations is to navigate and balance the different, sometimes
conflicting, interests of diverse stakeholders.
The module explores some key corporate governance factors relating to corporations, their boards,
shareholders, various other stakeholders and society at large. The role and operation of the board is
considered, including the role of diversity within the corporation and in the boardroom and its key role in
enabling successful decision making. The debate and responses arising from the recent international focus
on remuneration practices is considered. The module also examines a range of operational matters that
are important within corporations and in respect of which day-to-day attention to rules is required by both
good practice and regulation — including in relation to employment conditions and protections.
The module also covers some of the legal fundamentals that apply within a corporate context and it
considers some key aspects of rules that apply internationally and that are designed to protect competition
and consumers and thus the efficient and fair operation of the marketplace for goods and services. The
module concludes with a brief explanation of some of the rules that relate to financial market protection
and that are, inevitably, highly consistent internationally.
Module 5: Corporate Accountability
The final module provides an explanation of corporate accountability together with information about
its history and evolution. Accountability is shown to be broader than just providing financial results,
and is linked to environmental, social and economic sustainability. The module explores the concept of
‘accountability’ and its direct relationship to both accounting and accountants. As part of this, it investigates
the limitations of traditional financial accounting and financial reporting in relation to the broader interests
of an array of stakeholders, in particular in terms of accounting for and reporting information about an
entity’s social and environmental performance.
The module examines the relationship between different, and sometimes conflicting, managerial
perspectives on corporate responsibilities and accountabilities. It also considers the important decisions
about ‘to whom’, ‘how’ and ‘what’ environmental and social information is to be reported. Different
theoretical perspectives are provided about ‘why’ organisations voluntarily report social responsibility
information.
The module then examines mandatory reporting requirements and some of the non-mandatory frameworks that have been developed and adopted to demonstrate accountability beyond financial performance.
An overview of specific tools and techniques for improving reporting is provided and accounting issues
associated with the important topic of climate change are explored.
Module Weightings and Study Time Requirements
Total hours of study for this subject will vary depending on your prior knowledge and experience of the
course content, your individual learning pace and style, and the degree to which your work commitments
allow you to work intensively or intermittently on the materials. You will need to work systematically
through the study guide, readings and case studies, attempt all the questions (including knowledge checks),
and revise the learning materials for the exam. The workload for this subject is the equivalent of that for a
one-semester postgraduate unit.
An estimated 15 hours of study per week through the semester will be required for an average candidate.
Additional time may be required for revision. The ‘Weighting’ column in the following table provides an
indication of the emphasis placed on each module in the exam, while the ‘Recommended proportion of
study time’ column is a guide for you to allocate your study time for each module.
Do not underestimate the amount of time it will take to complete the subject.
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xii SUBJECT OUTLINE
TABLE 1
Module weightings and study time
Recommended proportion
of study time (%)
Weighting (%)
1. Accounting and Society
15
15
2. Ethics
20
20
3. Governance Concepts
25
25
4. Governance in Practice
25
25
5. Corporate Accountability
15
15
100
100
Module
Exam Structure
The Ethics and Governance exam is comprised of both multiple-choice and extended-response questions.
Multiple-choice questions include knowledge, application and problem-solving questions that are designed
to assess understanding of ethics, governance and corporate social responsibility content. Extendedresponse questions will relate to the case studies provided in the exam. Candidates will be required to
comprehend case facts, recognise and isolate relevant issues, and critically analyse the facts presented and
apply them to the concepts in the study guide to reach a conclusion. The case studies will predominantly
require application and problem solving. Strategy, leadership and international business themes may
provide contexts for assessment in the exam.
Table 1 provides an indication of the approximate proportion of multiple-choice exam questions likely
to come from each part of the subject. The extended-response questions may be sourced from any module
of the study guide.
LEARNING MATERIALS
Module Structure
These study materials form your central reference in the Ethics and Governance subject.
Learning Objectives
A set of learning objectives is included for each module in the study guide. These objectives provide
a framework for the learning materials and identify the main focus of the module. The objectives also
describe what candidates should be able to do after completing the module.
Assumed Knowledge
Any knowledge that a candidate is assumed to have before beginning study of the module is noted.
Learning Resources
This section alerts you to some of the resources available to accompany this module on My Online Learning
and elsewhere online. Readings 1.1, 1.2, 1.3, 4.1 and 5.1 are not assessable.
Preview
The preview outlines what will be covered in the module and how it relates to other modules in the subject.
Study Material
The study material is divided into parts and sections that will help you conceptualise the content and study
it in manageable portions. It is also important to appreciate the cumulative nature of the subject and to
follow the given sequence as closely as possible.
Examples
Examples are included throughout the study materials to demonstrate how concepts are applied to realworld scenarios.
Study Material Activities
Activities are included throughout the study materials to provide you with the opportunity, as you progress
through the subject, to assess your understanding of significant points and to stimulate further thinking
on particular issues. These activities are an integral part of your study and they should be fully utilised to
support your learning of the module content throughout the semester.
SUBJECT OUTLINE xiii
The study material includes two distinct types of activities: questions, and consider this prompts. It is
evident that candidates who achieve good results in the program and in their careers are those who are
able to think, review and analyse situations, and solve problems. The questions will assist you to develop
these skills.
The questions are numbered and require you to prepare answers and to compare those answers with the
suggested answers at the end of the study guide. They test your comprehension of specific sections of a
module and provide immediate feedback on your performance in comprehending the materials covered.
Your answers to these questions do not contribute to your final result, and you are not required to submit
your answers for marking.
Some questions are related to examples included in the modules. These questions are broader in scope
than other questions. They illustrate practical problems that an accountant might face. The case studies
contained in the example boxes require you to apply the theoretical knowledge you studied in the module to
a particular situation. To be able to adequately address issues raised in case studies, a deep understanding of
the module content is required. Simply memorising definitions and lists of technical details is insufficient.
While issues may be relatively clear in some case studies, it is important to realise that often the case
studies will have no correct/incorrect outcomes. The outcomes are quite possibly best expressed as different
viewpoints on problem situations, where viewpoints are supported by reference to relevant theoretical
principles. Moreover, the essence of the case may depend on interpretation of the relevant concept rather
than a simple restatement of that principle or concept.
The consider this prompts invite you to reflect on what you have just read or to go beyond the study
guide to find out more. These activities are not assessable, but are helpful to guide critical thinking, learn
more or to place the module content in context.
Summary
Each part features a summary of the concepts presented.
Key points
The key points feature relates the content covered in the part to the module’s learning objectives.
Review
The review section summarises the main points covered in the module and places it in context with the
other modules studied.
References
The reference list details all sources cited in the study guide. You are not expected to follow up this source
material.
Glossary
The glossary contains a list of the key terms used throughout the study guide. Please refer to the glossary
for definitions of these terms.
Suggested Answers
These are located at the end of the study guide and provide important feedback on the numbered revision
questions included in the module learning materials. Consider them as model answers for your reference.
To assess how well you have understood and applied the material supplied in the text, it is important to
write your answer before you compare it with the suggested answer.
My Online Learning and your eBook
My Online Learning is CPA Australia’s online learning platform, which provides you with access to a
variety of resources to help you with your study. We suggest you view the video ‘Insights for a great
semester of study’ on My Online Learning, which will provide you with some insights on how to plan
your semester. It will also take you on a guided tour of My Online Learning to show you how (and when)
to access the range of resources available.
You will find a wide range of subject-level and module-level resources on My Online Learning. Subjectlevel resources are those that apply to the entire subject. These resources can be used at any time but
are most useful when you’ve completed all the modules for the entire subject — whereas module-level
resources should be used while you work through a particular module in the study guide.
You can access My Online Learning from the CPA Australia website: cpaaustralia.com.au/
myonlinelearning.
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xiv SUBJECT OUTLINE
Help Desk
For help when accessing My Online Learning, either:
• email MemberServices@cpaaustralia.com.au, or
• telephone 1300 73 73 73 (Australia) or +61 3 9606 9677 (international) between 8.30 am and 5.00 pm
(AEST) Monday to Friday during the semester.
eBook
An interactive eBook version of the study guide will be available through My Online Learning. The eBook
contains the full study guide and features instructional media and interactive questions embedded at the
point of learning. The media content includes animations of key diagrams from the study guide and video
interviews with leading business practitioners.
GENERAL EXAM INFORMATION
The Ethics and Governance exam is 3 hours and 15 minutes in duration.
The study guide is your central examinable resource. Where advised, relevant sections of the CPA
Australia Members’ Handbook and legislation are also examinable.
For information on what you can take into your exam, as well as your exam structure and mark
allocations, please refer to ‘Study Companion and Exam Mark Allocations’ in My Online Learning.
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SUBJECT OUTLINE xv
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MODULE 1
ACCOUNTING AND
SOCIETY
LEARNING OBJECTIVES
After completing this module, you should be able to:
1.1 describe the nature and attributes of a profession
1.2 explain the co-regulatory processes of the accounting profession
1.3 differentiate the roles, relationships and activities of accountants
1.4 evaluate the challenges faced by the accounting profession in the global context
1.5 explain the importance of soft and technical skills required of accountants.
LEARNING RESOURCES
Readings 1.1–1.3 can be accessed on My Online Learning.
• Reading 1.1: Executive Summary from the Interim Report of the Royal Commission into Misconduct in the
Banking, Superannuation and Financial Services Industry
• Reading 1.2: ‘Profile: Roel van Veggel — The sweet sounds of success’ (IFAC)
• Reading 1.3: ‘How “soft skills” can boost your career’ (J. Jarvis)
• The APES 110 Code of Ethics for Professional Accountants (APESB 2018), accessed 11 June 2019,
www.apesb.org.au/uploads/standards/apesb_standards/02112018001157_APES_110_Restructured_
Code_Nov_2018.pdf
Note: Students must ensure they download and refer to the stated version of the Code of Ethics for these studies.
It is not necessary to print the entire standard in hardcopy but you may do so if you wish.
PREVIEW
The accounting profession’s role in society is to be a trusted and reliable provider of information that
supports high-quality decision making. The term profession is in common usage, but it may not always be
appreciated exactly what distinguishes a profession from other occupations and what being a professional
means in terms of both obligations and benefits.
Part A of this module describes the key attributes of a profession and provides an in-depth look at what
it means to be a professional accountant. The work of accountants has a strong influence on decisions that
affect many aspects of society, particularly the allocation of resources, and thus the profession is expected
to act with integrity and in society’s best interests.
Foremost, accountants must comply with the framework of principles established by the profession,
including acting in accordance with appropriate standards of governance, accountability and ethics.
This requires a balance between potentially competing interests. The module examines different ways
of viewing and managing competing interests. Successfully managing the balance of self-interest and
public interest maintains a ‘social contract’ between the profession and society, whereby in return for
the value that the profession creates, society allows it the benefits of economic rewards, self-regulation
and autonomy.
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A failure to successfully balance interests results in withdrawal of some of these privileges. This module
examines how some failings in the performance of the profession have led to an increase in external
regulation to create a set of co-regulatory processes that are intended to strengthen the credibility of
the profession. In co-regulation, external regulation works alongside self-regulation of the profession,
which is based on professional and ethical standards, and the imposition of sanctions on those who breach
those standards.
While the role and activities of the accounting professional are changing in response to advances
in technologies such as artificial intelligence, the core notions of integrity, objectivity, professional
competence and due care, confidentiality and professional behaviour remain unchanged.
Part B of the module considers the various work environments, roles and activities of professional
accountants, and the relationships that are created through these roles. The roles accountants can hold
are diverse, and opportunities exist in many sectors and areas of expertise. Regardless of the specific
roles and activities undertaken by an accountant, they must continue to develop their technical skills,
knowledge and experience throughout their working life. In addition, to work effectively, particularly
as their career progresses and their responsibilities expand, accountants must add a portfolio of ‘soft
skills’ to their technical knowledge. These soft skills include communication, persuasion, negotiation and
leadership skills. As with their technical skills, accountants can develop these through experience and
formal continuing professional development activities.
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2 Ethics and Governance
PART A: ACCOUNTANTS AS MEMBERS OF
A PROFESSION
INTRODUCTION
Accountants perform roles and contribute to decisions that have a significant impact on clients, organisations and society. As such, they are expected to act in a professional and ethical manner. In this part of
the module we explore what is meant by the term ‘profession’ and what it means to be a professional. At
the core of any profession is the idea that the members of the profession will act in the best interests of
society and that society will, in return, provide a range of benefits for the profession. Thus, there is an
implied social contract between the accounting profession and society. To maintain the social contract,
accountants must conduct their work in accordance with the core principles of the profession.
1.1 PUBLIC INTEREST OR SELF-INTEREST?
Economies and societies require the free flow of accurate information to function efficiently. The efficiency
of market economies is particularly dependent upon disclosure of accurate financial and non-financial
information. The accounting profession is integral to the process of ensuring people have access to accurate
information. In analysing and presenting information, the professional accountant needs to be able to
clearly distinguish between the public interest in disclosing information and any sense of self-interest.
Ultimately, the accounting profession will only retain its integrity and authority by serving the wider public
interest. The ideals of professionalism and the essential principles of entrepreneurship are compatible when
it is understood that trust is the essential basis of business.
Accounting information is relied on heavily by people who make significant decisions about the
allocation of resources. Accountants, therefore, serve the public interest by creating and distributing
information that conveys a clear and accurate picture of an entity’s financial performance, financial position
and other relevant issues.
Professional accountants also serve the public interest by providing objective, accurate and appropriate
financial and accounting-related advice that is free from bias and based on expertise. This focus on acting
with integrity, objectivity and without bias is linked to the idea of altruism. The term ‘altruism’ describes
positive actions that bring no benefit to an individual and may even be at their own expense.
However, altruism may not be the driving motivation. Like West (2003), Larson (1977) is concerned that
monopolistic professionals are not motivated by a service ideal or the public interest. Larson considers
there is evidence to suggest that professions and professionals are about maintaining monopolies and
extracting unwarranted wealth and influence from that position. This could be more accurately described
as self-interest or enlightened self-interest, rather than altruism.
RESPONSIBLE DECISION MAKING
Accountants make decisions within a systematic framework of principles. These principles include
governance, accountability and ethics. This means that, as a member of a profession, an accountant cannot
simply make decisions according to personal preferences. The skill and knowledge of the accountant
must be exercised within the governance framework of the profession, which stipulates certain codes of
behaviour. Decision making must be within the governance framework of the entity an accountant works
within, not only in terms of the instruments and internal governance rules, but in terms of the policies and
strategies that have been formally approved by the governing body.
In addition, conducting accounting work and reaching decisions must be completed within a framework
of accountability, in terms of the requirements of regulatory authorities, and with the appropriate disclosure
to shareholders and other stakeholders.
Finally, the work of the accountant and any decisions taken must be exercised within a framework of
ethical conduct that informs all aspects of the accountant’s work, which is based on a commitment to
integrity and honesty in the pursuit of professional purposes and client interests.
When all these principles are recognised, there is the possibility of effective action and decision making
as illustrated in figure 1.1. Assignments completed by accountants within a framework of governance,
accountability and ethics will be more authoritative.
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MODULE 1 Accounting and Society 3
A model of responsible decision making
FIGURE 1.1
Governance
Accountability
Ethics
Source: CPA Australia 2015.
Accountants should strive to base their decisions firmly on the principles of governance, accountability
and ethics. The ideal position for balanced decisions is to be at the centre of this figure where governance,
accountability and ethics interconnect. This requires accountants to be rigorous and professional in their
conduct. However, this does not always happen, as is the case described in example 1.1.
QUESTION 1.1
(a) To gain an understanding of the environment within which the accounting profession operates,
visit each of the listed websites in table 1.1 and state which section of the diagram in figure 1.1 it
belongs to.
(b) Visit IFAC’s website to determine the role of the following boards.
i. International Auditing and Assurance Standards Board (IAASB)
ii. International Ethics Standards Board for Accountants (IESBA)
iii. International Accounting Education Standards Board (IAESB)
(c) Begin work on a glossary of acronyms by including the acronyms in the list. Continue to update
this as the course progresses. The list of abbreviations in the back of the Financial Reporting
Council’s (FRC’s) annual report may assist with this.
TABLE 1.1
Accounting boards, bodies, organisations and legislation
Websites and web resources
Description
AASB
www.aasb.gov.au
Australian Accounting Standards Board is responsible for
developing, issuing and maintaining Australian Accounting
Standards and related pronouncements.
ASX
www.asx.com.au
The Australian Securities Exchange is a financial market
exchange offering listing, trading, clearing and settlement
services across a wide range of asset classes.
ATO
www.ato.gov.au
The Australian Taxation Office is the principal revenue
collection agency of the Australian Government.
Their aim is to achieve taxpayer confidence in the Australian
tax and superannuation systems by helping people
understand their rights and obligations, improving ease of
compliance and access to benefits, and managing
non-compliance with the law.
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4 Ethics and Governance
ASIC
www.asic.gov.au
The Australian Securities and Investments Commission is
Australia’s integrated corporate, markets, financial services
and consumer credit regulator. Most of its work is carried out
under the Corporations Act.
Corporations Act (2001)
www.legislation.gov.au/Details/C2019C00216
The Corporations Act is the legislation regulating companies
and it also regulates aspects of work done by accounting
professionals. This includes the areas of audit, financial
report preparation and lodgement and insolvency. The roles
of directors and other company officers are also covered in
this legislation.
OAIC
www.oaic.gov.au
The Office of the Australian Information Commissioner is
the regulatory body that administers the privacy laws in
Australia. It coordinates a complaints process that provides
an opportunity for people’s complaints to be heard.
AUASB
www.auasb.gov.au
The Auditing and Assurance Standards Board is responsible
for developing high quality standards and related guidance
for auditors and providers of other assurance services.
Competition and Consumer Act (2010)
www.legislation.gov.au/Details/C2019C00317
This act seeks to protect people by promoting competition,
fair trading practices and regulation in the area of consumer
protection.
CAANZ
www.charteredaccountantsanz.com
Chartered Accountants Australia and New Zealand is one
of the three largest professional accounting organisations
in Australia and a member of the International Federation of
Accountants (IFAC).
CPAA
www.cpaaustralia.com.au
CPA Australia is one of Australia’s largest three professional
accounting organisations and a member of IFAC.
Privacy Act (1998)
www.legislation.gov.au/Details/C2019C00241
The Privacy Act regulates the privacy and the handling of
personal information.
TPB
www.tpb.gov.au
The Tax Practitioners Board is responsible for the
registration, oversight and discipline of professionals that
are registered to provide varying degrees of tax-related
advice or services. The TPB also recognises professional
bodies (including CPA) whose voting members may then be
assisted to register or maintain their registration(s) with
the TPB.
APESB
www.apesb.org.au
The Accounting Professional and Ethical Standards Board
is an independent, national body that sets the code of
ethics and professional standards with which accounting
professionals who are members of CPAA, CAANZ and IPA
must comply.
IPA
www.publicaccountants.org.au
The Institute of Public Accountants is one of the three largest
Professional Accounting Organisations in Australia and a
member of IFAC.
PAO
A Professional Accounting Organisation is a professional
body (such as CPA) that has oversight of its members.
IFRS
www.ifrs.org
The IFRS Foundation is a not-for-profit, public interest
organisation established to develop a single set of
high-quality, understandable, enforceable and globally
accepted accounting standards — IFRS Standards —
and to promote and facilitate adoption of the standards.
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MODULE 1 Accounting and Society 5
EXAMPLE 1.1
A Costly Error
Three respondents (a consulting company, an accounting partnership, and an executive director and
partner) found themselves in a legal battle with a client, Neville’s Bus Service Pty Ltd (NBS), that cost
them $5.5 million following conduct that NBS alleged was fraudulent, in breach of contract, negligent and
in breach of provisions of Australian Consumer Law.
NBS used the consulting company to help it bid for a bus service tender. An error in calculations meant
that NBS had suffered financial losses, totalling in the first instance $660 000, which was the amount that
would have been added to the tender had the numbers been the subject of routine quality control checks.
NBS alleged that the partner, once the error was found, failed to notify the company. It was also alleged
that the partner actively attempted to conceal the error.
An error in a tender could create a situation where a company might run at a loss because the costs
associated with the novated leases was not included in calculating the bid that was submitted. The court
heard that the bid submitted by the company would still have succeeded if it had submitted an amended
tender bid.
The judgment for this case can be accessed here: www.judgments.fedcourt.gov.au/judgments/
Judgments/fca/single/2018/2018fca2098.
Source: Information from Zuchetti, A 2018, ‘Accountant sued for $5.5m for concealing error’, www.mybusiness.com.au/
management/5313-accountant-sued-5-5m-for-concealing-error.
1.2 ENLIGHTENED SELF-INTEREST
Inevitably, in a market economy, the economic self-interest of a profession will be an important driver
of behaviour. However, this should never be allowed to outweigh the primary commitment to the public
interest. The term ‘enlightened self-interest’ suggests that both purposes may be served together; that is,
it is possible to be committed to the public interest and yet possess a degree of self-interest. The phrase
sometimes employed is ‘doing well by doing good’.
But, if enlightened self-interest leads to actions that are purely self-interested with no benefit to other
parties such as clients, this is not acceptable professional behaviour. There is a careful balance to be
maintained between serving the public interest and pursuing self-interest, and it is the public interest
that is paramount. Can the public interest and self-interest really be integrated in a form of enlightened
self-interest?
This concept of enlightened self-interest is described by Lee (1995) as protecting the public interest in
a self-interested way, and is explained in the following quote, which shows how enlightened self-interest
and the public interest may be integrated.
The accounting profession would account for its existence in relation to the efficiency benefits for society
as a whole, arising from the existence of an institutionally organised body of accounting knowledge . . . In
return for their monopoly position concerning the right to practise particular accountancy and auditing
functions, accountants would see themselves as serving the public interest (Robson & Cooper 1990,
p. 379).
We explore this concept again in module 5 in relation to a different question — why organisations make
the commitment to produce sustainability information and reports.
1.3 IDEALS OF ACCOUNTING —
ENTREPRENEURIALISM AND PROFESSIONALISM
Some argue that professions never really had a public interest or service ideal (Abbott 2014; Johnson 1972).
Others believe it may have existed in the past, but has been abandoned for a more lucrative role as ‘partner in
business’ (Saravanamuthu 2004). Carnegie and Napier (2010) identify the ideals of accounting professionalism as comprising ‘the four Es’ of education, ethics, expertise and entrepreneurship. According to these
authors, placing too strong an emphasis on entrepreneurship, especially where it involves a de-emphasis on
any of the other ideals, may result in a ‘de-professionalisation’ of accounting. This de-professionalisation
may occur because the pursuit of commercial opportunities moves an accountant away from integrity,
objectivity and professional behaviour in order to achieve commercial success. Entrepreneurship can lead
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6 Ethics and Governance
professional accountants to place more importance on increasing their personal wealth and influence than
on notions of public service.
Accountants are often in a position of power that can create an ‘ethics versus profits’ dilemma. Examples
of accountants pursuing self-interested outcomes at the expense of their ethical or professional standards
have been linked to the corporate collapses of the early 2000s, and the failures of organisations, such as
Lehman Brothers in the Global Financial Crisis (GFC) of 2008–2009. In these cases of systemic failure, it
was clearly demonstrated in all of the official reports by the US Congress, UK parliament and others that
not only had there been governance failures within the entities, but also all of the associated professionals
and regulators had some responsibility in allowing the failures to develop into a crisis (UK HCTR 2009;
US FCIC 2011).
Members of a profession will at times face conflicts between their own self-interest, the public interest,
and their responsibilities to the profession. Examples 1.2 and 1.3 describe real-world cases of conflicting
interests.
EXAMPLE 1.2
Excessive Fees
Liquidators John Sheahan and Ian Lock were ordered by a court to pay back $1.9 million plus interest
to companies they had been involved in liquidating after a court agreed that the fees charged by the two
liquidators were excessive.
The corporate regulator, the Australian Securities and Investments Commission (ASIC), took action
against the liquidators because the fees they were charging reduced the amount that was available to pay
the various creditors of the companies concerned.
The case concerned the liquidations of three companies. It was found that Sheahan and Lock had
charged more than they should have and spent more time than necessary on the jobs.
This meant that creditors of the businesses involved would be getting reduced returns as a result of the
funds that were claimed by the liquidators as remuneration.
A media release from the ASIC noted that the court slashed $1.9 million from the fees charged by the
liquidators. ‘Remuneration was fixed at $3.9 million compared to the $5.8 million sought by the liquidators,
a reduction of $1.9 million (33%),’ ASIC said.
‘To commence the process of determining the remuneration claim, His Honour stated that the charge
rates were excessive and ruled that the partner and manager rates were to be discounted by 20% and
the senior manager rates discounted by 10%. Other charge rates were not to be discounted.’
The insolvency practice told media representatives that it would review the outcome and decide whether
to appeal.
Source: Zuchetti, A 2019, ‘Liquidators ordered to repaid $1.9m plus interest’, www.mybusiness.com.au/management/5906liquidators-ordered-to-repay-1-9m-plus-interest; ASIC 2019, ‘Federal Court fixes liquidators’ remuneration for winding
up three Adelaide companies and orders them to repay $1.9m plus interest and ASIC’s costs’, https://asic.gov.au/aboutasic/news-centre/find-a-media-release/2019-releases/19-140mr-federal-court-fixes-liquidators-remuneration-for-windingup-three-adelaide-companies-and-orders-them-to-repay-19m-plus-interest-and-asic-s-costs.
EXAMPLE 1.3
In the Interests of the Client?
Gold Coast accountant Jenan Oslem Thorne will not provide financial services for three years after
Australia’s corporate regulator found she failed to prioritise client interests when giving advice.
Mrs Thorne entered into an enforceable undertaking with the ASIC when the regulator reviewed advice
that she had provided during an investigation into Trent Properties Group Pty Ltd.
ASIC found that Mrs Thorne was receiving referrals from Park Trent regarding the establishment of
self-managed superannuation funds (SMSF) and that Mrs Thorne had advised some clients to establish
self-managed funds without considering their circumstances.
‘ASIC found that Mrs Thorne hadn’t properly considered her clients’ existing superannuation arrangements or explored why they were interested in investing in direct residential property through an SMSF,’
an ASIC media release said. ‘When recommending SMSFs to some of her clients, she had inappropriately
scoped advice by excluding insurance and retirement planning.’
SMSF strategies were not properly stressed tested, according to the corporate regulator, and recommendations were made to clients without considering whether the strategy would increase retirement
benefits to clients. Mrs Thorne also recommended clients with self-managed funds use her accounting
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MODULE 1 Accounting and Society 7
practice to do their annual accounts and tax returns. ASIC concluded that Mrs Thorne recommended the
use of her services to ‘create extra revenue for herself’.
ASIC said that financial advisers had a best-interests duty with which they need comply and that there
must be an analysis of whether a self-managed fund was the best option for a client reflecting on their
retirement plans.
Source: ASIC 2019, ‘Court enforceable undertaking prevents Gold Coast accountant from providing financial services’, https://asic.gov.au/about-asic/news-centre/find-a-media-release/2019-releases/19-034mr-court-enforceableundertaking-prevents-gold-coast-accountant-from-providing-financial-services.
1.4 WHAT IS A PROFESSION?
A profession is defined in the Oxford Dictionary as an occupational area or vocation that ‘involves
prolonged training and a formal qualification’.
A profession is based on a high level of competence and skills in a given area, which are learnt through
specialised training and maintained by continuing professional development. Members of professions are
expected to behave ethically and in the best interests of society. There is a difference between the concept of
a ‘profession’ as defined by the established professional associations, which carry many obligations and
attributes and the wider reference to somebody being professional, which simply means they complete
their work with dedication and skill (attributes to be highly valued in any occupation).
Professions focus on intellectual or administrative skills, rather than mechanical or physical actions.
Further characteristics defining the professions relate to the critical nature of their work and the esoteric
knowledge required to perform it to a high standard — for example, surgery, corporate litigation or audit.
However, there is an almost universal process of professionalisation occurring across occupations as
diverse as financial advisers, project managers, physiotherapists, and among service occupations and
manual trades such as builders and electricians. Many professions and occupations have established
professional bodies and codes of conduct. The efforts of these occupations to raise their standards, and
to invest in training, education and quality standards must be respected. This raises the bar for the established professions, including accounting, which must demonstrate its high-level commitment to integrity
and service.
There are key attributes which, combined as a group, provide valuable guidance in recognising the
existence of a profession (elements of these attributes were originally derived from Greenwood (1957), and
have since been developed further). The existence of these eight attributes tends to confirm the existence
of a profession:
1. systematic body of theory and knowledge
2. extensive education process for its members
3. ideal of service to the community
4. high degree of autonomy and independence
5. code of ethics for its members
6. distinctive ethos or culture
7. application of professional judgment
8. existence of a governing body.
Later in this module we will examine in more detail each of the attributes of a profession as they apply
to the accounting profession.
It must be noted, however, that there is no clear distinction between an occupation and a profession.
It is suggested that there is a continuum of the degree to which these attributes are displayed so that
professionals are only distinguished from non-professionals by a higher level of standards
Another feature of a profession is that it often leads to greater status and wealth for its members. This
is often a result of the members’ specialised skills and the level of monopoly control. Monopoly control
describes the situation where members of the profession control who is allowed to work in the industry
by establishing licensing rules and regulations. This creates protection against competition. An example
of this exclusivity is the requirement under the Corporations Act 2001 (Cwlth) where a company auditor
must be a member of a professional accounting body (such as CPA Australia).
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8 Ethics and Governance
Early authors argued that professions exist primarily to serve society, and this view persists today. In
this view, often called the ‘service ideal’, it is accepted that professions should both serve society and do
so in part by ensuring they act in the public interest. Indeed one model (Brourard et al. 2017) suggests
that professions exist only as a result of an implied social contract. In exchange for promising to use
their expert knowledge and skills in the public interest or for social good, professions are afforded certain
benefits including self-regulation, autonomy, market control and economic rewards. This is shown in
figure 1.2.
FIGURE 1.2
Social contract between a profession and society
promises
benefits
exchanges
Knowledge
Skills
Expertise
Competencies
Values
Norms
Behaviours
Public interest
Professional judgment
Activities
Stereotypes
Privileges
Self-regulation
Associational control
Autonomy
Power
Exclusive rights
Occupational control
Control over market
Reputation
Social status
Economic rewards
Image
context
Source: Brourard, F, Merriddee, B, Durocher, S, Burocher Neison, L 2017, ‘Professional accountants’ identity formation: An
integrative framework’, Journal of Business Ethics, vol. 142, iss. 2, pp. 225–238.
However, when this social contract is broken, some of these benefits may be removed or modified. For
example, laws may change when the community, through its political representatives, believes that certain
functions need to be more tightly regulated.
Consider the change that brought auditing standards and auditing standard setting under the purview of
the FRC in 2004. The community, through its representatives elected to the Commonwealth Parliament,
decided that additional regulation of the auditing cohort of the accounting profession was necessary as a
result of the various corporate collapses in Australia and elsewhere in the early 2000s. The profession has
worked under a revised regime for setting auditing standards since that time.
QUESTION 1.2
Refer back to examples 1.2 and 1.3. For each example, explain how the accountant breached their
professional obligations and state the consequences of their actions. Use the main concepts from
figure 1.2 in your explanation.
SELF-REGULATION
Most of the time, professions are given permission to provide services to the public through some
regulatory process. For example, in many countries only doctors of medicine are allowed, by law, to
prescribe certain drugs.
Once accorded the relevant permissions, it is common for a profession to have a substantial degree of
independence or autonomy. This means they have a greater level of authority to set their own rules and
regulations and have less detailed government regulation.
The independence, or autonomy, to self-regulate commonly extends to membership and membership
rules of a profession. Professional bodies set the education requirements, professional ethical standards and disciplinary processes (which can be in addition to legal processes) for the members of
their profession.
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Autonomy allows members of a profession to be judged by their informed peers, rather than by regulators
whose knowledge is inevitably more limited and may have a bias resulting from less experience. Autonomy
also enables internal penalties, or sanctions, for matters that a legal process might ignore or not be able to
identify (e.g. ethical breaches of a professional code of conduct that are not legal breaches).
Professions have an extra-legal role in regulating their members. Extra-legal means regulations in
addition to what is prescribed in statute law or common law. It is another way individuals or groups are
regulated. Professions set certain expectations of conduct in constitutions and by-laws which are enforced
by a disciplinary process. A member found to have engaged in conduct that brings the profession into
disrepute can have a range of penalties imposed against them. The most severe of these is forfeiture of, or
expulsion from, the membership of a professional organisation. Outcomes of disciplinary action will often
include publication of the member’s name and a summary of the misconduct that occurred.
.......................................................................................................................................................................................
CONSIDER THIS
Why do you think it may be appropriate for a profession to publish the name of an accountant who has breached the
rules of a professional organisation such as CPA Australia?
FROM SELF-REGULATION TO A CO-REGULATORY PROCESS
Members provide services to society in their field of expertise and society benefits from the service
provided. Society trusts the profession to act in its best interest and values the service provided. There
is a potential negative outcome from this autonomy if the profession fails to properly demonstrate selfcontrol and self-regulation, and does not hold its members to account when they act inappropriately. If
members of a profession act in an unethical way, they are seen not to be acting in the best interest of
society. If this is allowed to continue through lack of self-regulation, trust in the profession will be eroded
and the value and the status of the profession will be destroyed.
Due to a large number of corporate failures and the poor conduct of some accountants, this erosion of
trust has occurred in the accounting profession. As a result, some of the authority to self-regulate has been
removed from the profession. Regulations from external sources are also in place, so the profession has
moved from a situation of self-regulation to co-regulation, with regulation shared between the profession
and external sources. Examples of co-regulation include:
• the FRC, which is an oversight body for accounting and auditing standard setters
• the Corporations Act, which gives auditing and accounting standards the force of law
• the Australian Securities and Investments Commission Act 2001 (Cwlth), which establishes the
Companies Auditors Disciplinary Board
• the Tax Practitioners Board (TPB), which is the registering authority for professionals providing taxation
services of varying levels of complexity
• professional bodies such as CPA Australia.
Each organisation plays a part in monitoring compliance of accounting professionals with ethical
standards and the law.
1.5 WHAT IS A PROFESSIONAL?
The term ‘professional’ refers to the members of a profession and much of the previous discussion about
professions is directly relevant to this question. A professional is a person who has a significant level
of training and a high level of competence and skills in a specific area of knowledge. Professionals
behave in an ethical and appropriate manner, and apply their skill and judgment in areas of importance.
The process of becoming a professional is sometimes described as the development from a technician
(i.e. someone who has technical knowledge about how to perform specific tasks in a given area) to
someone who uses their knowledge and experience in that area to make judgments of importance to the
public interest. The description of a profession that has been used so far in this module is often called
the traditional or functional view of professionalism. As discussed, professions are recognised as offering
important advantages to society by undertaking complex tasks and functions on its behalf. In return, the
professions are accorded a privileged position in society.
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10 Ethics and Governance
1.6 THE ACCOUNTING PROFESSION — THE
‘TRADITIONAL’ VIEW AND THE ‘MARKET
CONTROL’ VIEW
There are two contrasting views of the accounting profession.
• The traditional view sees the accounting profession as demonstrating a range of attributes that are
focused on serving society. The professional accountant acts for the public interest, rather than selfinterest, and can demonstrate skill and judgment in their area of expertise. Important attributes of
the profession include a systematic body of knowledge, an extensive education process, a code of
ethics, an ethos or culture, and a governing body. This could be described as the ideal view of the
accounting profession.
• The market control view is more critical and suggests that professional accountants are self-interested
and less concerned with the broader public interest than with their own careers. The accounting
profession, according to this view, has acted to create a monopoly in order to ensure only certain people
(members of the profession) can work in this area. This helps generate greater financial returns as well
as building status and prestige in the community.
Not everybody believes professions are necessarily so valuable — and for some, the concept of the
service ideal has often been replaced by visible greed. One common perception is that professionals are
self-serving monopolists whose professional bodies exist principally to maintain membership exclusivity.
Denial of entry of non-members into an industry or occupation maintains the monopoly.
An extreme example of self-interest is outlined in example 1.4.
EXAMPLE 1.4
Self-Interest
Andersen (previously Arthur Andersen, one of the world’s largest professional accounting firms) was the
auditor of HIH which was, until its failure, Australia’s largest insurance company. Its failure was rapid and
spectacular and took place at about the same time Enron failed in the US in 2001/2002. Arthur Andersen
audited Enron and WorldCom both of whom experienced major bankruptcies, despite clean audit reports.
As a result of a court case against Andersen’s role in the Enron failure, Andersen itself was put out of
business, despite the shell company winning the case on appeal. These three cases of HIH, Enron and
WorldCom were the most graphic illustrations of corporate failure in this period, and Arthur Anderson
featured in each of them (Jeter 2003; McLean & Elkind 2004; Westfield 2003).
In 2006, Allan noted in the Deakin Law Review that:
The independence of Andersen was also highly questionable. Three former partners of the firm sat on
the HIH board. One, who was the recipient of continuing benefits from Andersen, was made chairman
and was appointed to the audit committee only 17 months after his retirement. Another, who had been
the engagement partner, was made chief financial officer only the day after his resignation from the
firm. The third was appointed to the board only five months after his retirement having ‘played a
significant role in the audit of HIH for 25 years’ (Allan 2006, p. 144).
Examples such as this have a highly negative impact on the reputation of the accounting profession.
Therefore, it is not surprising that ‘images of altruism, ethical service and self-regulation were supplanted
by a portrayal of professions as self-interested collectives’ (West 2003, p. 21).
1.7 TRUST AND PROFESSIONS
Society recognises, or perhaps more correctly demands, that professions be especially equipped to work
with complex matters of economic and social significance. Society expects great individual capability
and the application of professional ethics from professionals as they make complex judgments that affect
individuals, entire economies and societies.
Ultimately, the way the public regards a particular profession will control the rights granted to
the profession and the professionals working within it. Public trust regarding any profession is vital. If
a profession loses credibility in the eyes of the public, the consequences can be severe for the public, the
profession and the members of the profession.
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After the early 2000s collapses of Enron, WorldCom and HIH Insurance, and the demise of the global
accounting firm Arthur Andersen, the accounting profession worldwide experienced the effects of a
credibility crisis. International bank failures during the GFC also caused doubt about the credibility of
accounting standards and the reliability of the professional work of accountants. Institutional failure,
business collapses and widespread doubt about the integrity of financial information hurt all levels
of society.
Similar issues of trust have arisen in various parliamentary inquiries related to the provision of financial
services advice involving incentive-based remuneration. The Hayne Royal Commission received evidence
that suggested some advisers sought to better their own positions by selling products that increased their
commissions without great benefit for their clients (Hayne 2019). That report and subsequent analysis
caused people to reflect on the nature of ethical and professional behaviour in the context of financial
services, and in the context of providing services to vulnerable people.
For more information on the Hayne report, please see reading 1.1.
.......................................................................................................................................................................................
CONSIDER THIS
What actions should a profession take to ensure it preserves its relevance, credibility and the trust of the community?
1.8 ATTRIBUTES OF A PROFESSION
In this section we demonstrate how the accounting profession meets the eight traditional attributes of a
profession that were identified earlier:
1. systematic body of theory and knowledge
2. extensive education process for its members
3. ideal of service to the community
4. high degree of autonomy and independence
5. code of ethics for its members
6. distinctive ethos or culture
7. application of professional judgment
8. existence of a governing body (Greenwood 1957).
.......................................................................................................................................................................................
CONSIDER THIS
Review Greenwood’s eight attributes of a profession. In light of the discussion so far and your professional
experiences, would you suggest adding any additional attributes?
A SYSTEMATIC BODY OF THEORY AND KNOWLEDGE
It is sometimes contended that the main difference between an occupational group that is a profession
and another occupational group not recognised as a profession lies in the element of superior skill. This
contention does not always withstand scrutiny, as many occupations require high levels of manual skill
but make no claim to professional status. Much more important than the possession of skills is the fact
that the entire range of skills and expertise should relate to, and be supported by, a well-founded body of
knowledge. Thus, theory construction by means of systematic research becomes an essential basis for the
development of a profession and for professional practice.
The educational process for accountants is one of lifelong learning that commences with the first study
of accounting. The International Federation of Accountants (IFAC) has issued International Education
Standards that outline the core competencies all aspiring accountants must satisfy in order to be recognised
as a member of the profession, and of a professional body.
All IFAC member bodies (including CPA Australia) must abide by the requirements in these standards
when designing the content and assessment of their education programs. The aim of the standards is to
ensure an equivalent level of competence and knowledge for all members of the accounting profession.
The standards cover technical knowledge, soft skills and professional competence, and they provide a
framework for professional bodies to assure the quality of their education programs.
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12 Ethics and Governance
QUESTION 1.3
Identify the relevant standard setting body within IFAC that is responsible for specifying the body
of knowledge required by professional accountants. Which documents contain this knowledge?
AN EXTENSIVE EDUCATION PROCESS
Membership of a professional body ensures, in principle, that entrants to that profession have acquired an
understanding of the theory and practice of the profession. Entrants to the profession have already acquired
knowledge and skills that are not generally obtained or understood by the general public.
Importantly, their knowledge and skills will be further enhanced by the accumulation of knowledge and
experience through mentoring, professional development and continuing education programs. Throughout
their careers, all professionals must maintain their knowledge and skills.
As part of the commitment to lifelong learning for the accounting profession, and to ensure all members
possess current knowledge and skills, IFAC has issued a standard prescribing the requirements for ongoing
professional development. All CPA Australia members must undertake ongoing professional development
throughout their careers.
AN IDEAL OF SERVICE TO THE COMMUNITY
Wilensky (1964, p. 140) referred to the importance of the service ideal, which he considered to be ‘the
pivot around which the moral claim to professional status revolves’.
How this service ideal is achieved by accountants is described by Willmott:
Accounting is perceived to present information in a reliable and comparable form by quantifying and
reporting the basic facts of economic life, thereby monitoring past performance and facilitating rational,
efficient decision making in respect of the generation and allocation of resources. In performing this role,
accounting is widely understood to serve the public interest (Willmott 1990, p.315).
According to Buckley (1978), society grants the professions monopoly power over professional affairs
and the power to use this monopoly power as they see fit, as long as the power is used in the public interest.
Any profession that deliberately and consistently breaches this trust does so at its own risk. This trust is an
important part of the philosophical notion of a social contract. As Wilensky (1964, p. 140) observes, ‘any
profession that abandons the service ideal will very quickly lose the moral claim to professional status’.
Continued erosion of public trust by unethical behaviour may lead ultimately to extreme governmental
intervention in the profession’s affairs, with consequent reduction of autonomy, authority and reputation.
Therefore, each member of a profession has a responsibility, and an obligation, to behave in a manner that
maintains the reputation of the profession.
The APES 110 Code of ethics for professional accountants (2018) published by the Accounting
Professional and Ethical Standards Board (APESB) specifies the fundamental principles of acceptable
professional conduct for professional accountants. These are reviewed in detail in module 2.
To better understand the service ideal, we examine it from three perspectives:
• the wellbeing of society
• the pursuit of excellence
• community service.
The Wellbeing of Society
Accountants contribute to the wellbeing of society by preparing and attesting information that ensures
the efficient and orderly functioning of business, not-for-profit and government enterprises. Additionally,
accountants provide information that facilitates better decision making for individuals, business and
government. Thus, financial information is vital for advancing the interests of parties at all levels, which
ultimately results in the betterment of society.
The Pursuit of Excellence
Here the focus is the performance of the professional. The individual accountant accepts responsibility for
maintaining and updating their knowledge and skills, and applying their skills and competence with due
professional care in the best interests of society.
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MODULE 1 Accounting and Society 13
Community Service
Many accountants offer their time and skills free of charge to the community. This is sometimes described
as pro bono, a Latin term meaning ‘for the good’, which indicates the provision of unpaid work for the
public good. Various kinds of pro bono work may include:
• membership of finance committees for church groups, charities and schools
• providing financial counselling and other advice to people referred by community welfare groups
• holding honorary positions on hospital and university boards.
True professionals bring the same care and skill to volunteer work as they bring to assignments they are
paid for. Note that as a member of the accounting profession, an accountant is held to the same level of
responsibility for all their work, whether it is paid or unpaid.
.......................................................................................................................................................................................
CONSIDER THIS
Consider where you could provide service to the community once you have obtained your membership of CPA
Australia. Identify what benefits this would provide to you as an accountant and to the organisation you are supporting.
Are there any specific considerations that you should have with respect to the provision of that service?
QUESTION 1.4
Discuss whether acts of public service are considered to be purely political actions designed to
maintain the profession’s status in the eyes of the community.
A HIGH DEGREE OF AUTONOMY AND INDEPENDENCE
As discussed earlier in this module, as part of the trust relationship between the community and the
professions, it is common for professions to be allowed a substantial degree of autonomy and independence
from government interaction and control. This is referred to as the self-regulatory aspect of professions
that, for the accounting profession, has now become a co-regulatory situation. The degree to which this
autonomy continues is dependent on the consistent demonstration of professional and ethical standards by
members of the profession and by the profession generally.
Many professions, including accounting, have endured numerous significant examples of unprofessional
conduct by their members. Earlier, we listed examples of corporate failures that involved some degree of
poor conduct by accounting professionals. As a result of these failures, the accounting profession is less
free to self-regulate than it used to be, and now co-regulates in combination with external authorities. An
example of this change is outlined in example 1.5, which describes how the boards that previously created
Australian Accounting Standards now report to a government body, not to the professional accounting
bodies in Australia.
EXAMPLE 1.5
Co-Regulation of the Accounting Profession
In Australia, accounting standards are developed by the Australian Accounting Standards Board (AASB)
and auditing standards are developed by the Auditing and Assurance Standards Board (AUASB). Originally, these boards were created and controlled by the professional accounting bodies in Australia. There
are three major professional accounting bodies in Australia: CPA Australia; the Chartered Accountants
Australia and New Zealand (CAANZ) (previously the Institute of Chartered Accountants (ICAA); and the
Institute of Public Accountants (IPA) (formerly known as the National Institute of Accountants).
Changes in laws at a Commonwealth level resulted in the professional accounting bodies giving up
full control over the standard setting processes that were previously managed by the profession through
the Australian Accounting Research Foundation (AARF), a body funded by CPA Australia and the then
Institute of Chartered Accountants. The AARF played an important role in the design and promulgation
of guidance for the accounting profession. Now, AASB and AUASB both report to the FRC, which is a
government body. This has been the case since the early 2000s when the audit standard setting function
was transferred to a government body. While the professional bodies have a number of their members on
the AASB and AUASB boards, they no longer have the complete regulatory control they had previously.
This has been a natural evolution of accounting standard setting, where a stronger regulatory framework
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14 Ethics and Governance
has been required. The professional accounting bodies are still very involved, but their involvement is
tempered by overarching regulation and FRC control.
Individual member autonomy is closely related to the concepts of professional judgment, adherence to
a code of professional conduct and professional independence.
The member must be allowed to use their professional judgment free from the direction or influence of
others, and detached from the risk of financial gain (or loss) as a result of the advice provided. The member
must also be free from fear of reprisals. In other words, the professional person’s judgment should be
autonomous in the literal sense of the term (i.e. governed by their own professional rules and laws and not
influenced by inappropriate outside interests). Autonomy, in this sense, implies a self-principled, ethical
and responsible approach by the member.
For a professional accountant in public practice, the specific attribute of independence becomes more
important in relation to the concepts of objectivity and integrity. At times the accountant may be torn
between meeting the requirements of the client to report in a given way and maintaining their own ethical
compass and professional obligations.
The ethics of the professional accountant can be tested in these circumstances, and maintaining
independence and autonomy from the client will help the professional accountant ensure the most
appropriate position is adopted.
Co-Regulation and Professional Discipline
As part of maintaining autonomy and independence, the profession is expected to regulate itself in
combination with external authorities. Co-regulation promotes a consistently high level of professional
practice in the public interest and is important to maintaining the profession’s esteem.
A complex set of regulatory structures and practices have been developed around the public accounting
profession. These regulatory structures and practices attempt to define the technical and ethical responsibilities that accountants owe to their employers, clients, third parties and the public.
The regulatory structures of CPA Australia include a:
• system of accreditation for accounting degree programs to ensure that the relevant body of knowledge
is acquired by future members
• membership qualification process by way of examination and required practical experience
• requirement for high levels of continuing professional education
• code of ethics that must be complied with
• disciplinary process to address member misconduct.
A brief overview of the code of ethics is provided in the following commentary. Later in this module,
we discuss the role of the APESB and the disciplinary procedures designed to enforce compliance with
accounting and auditing standards.
A CODE OF ETHICS FOR MEMBERS
Codes of professional ethics establish expected standards of behaviour and the need for members to act in
the public interest.
The APES 110 Code of Ethics for Professional Accountants (APESB 2018), various other Accounting
Professional and Ethical Standards (APES) statements and the Constitution of CPA Australia provide
guidance and a disciplinary framework for members of CPA Australia. Relevant legislation, such as
corporate law and accounting and audit standards regulation, also provide a framework that members
of CPA Australia must follow.
Professional ethics in its simplest form is behaviour that is consistent with the APESB Code of
Ethics, and behaviour that contravenes the Code is considered unprofessional. The Code attempts to
deter unethical behaviour or, alternatively, promote desirable behaviour by stipulating acceptable and
unacceptable conduct.
As part of working in a global market, we find that in different cultures and nations, different behaviours
are seen as acceptable or unacceptable. This raises challenges for professional accountants, in fact all
professionals, because there is a need to be true to the ethical guidelines of a profession without causing
others to feel that their behaviour is unethical. An example of this is the payment of bribes, which in some
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MODULE 1 Accounting and Society 15
countries is seen as unethical and corrupt, but in others is a part of business dealings that is sometimes
tolerated (albeit a part of business dealings that invariably leads to the undermining of the economies
in which it takes place, and to inefficiency and nepotism replacing business dealings based on quality,
efficiency and capability).
A DISTINCTIVE ETHOS OR CULTURE
The ethos or culture of a profession consists of its values, norms and symbols. In the first instance, values
are ideas that individuals, groups of individuals or entire communities believe are important. These ideas
can be embedded in documents such as constitutions so that they are core values or ideas that are observed
by people, and which may also be known as conventions. That observance of certain values — such
as representative democracy, for example — means that people in Australia get to vote in elections at
Commonwealth, state, territory or local government level. It is accepted that a government is elected when
the rules contained in the constitution and any other laws that govern elections have been complied with
by all involved in the conduct of the election.
The norms of a professional group comprise both formal and informal characteristics. New members
become familiar with the professional culture in a variety of ways. Creating a culture and a sense of
belonging are very important in maintaining a professional organisation that is kept vital by new and
interested membership — a key part of the ongoing value of the profession itself.
Symbols of a profession include its insignia, emblems, certification and titles (e.g. ASA, CPA or FCPA).
Culture and ethos stem from formal history, significant milestones, jargon, stereotypes and folklore. They
also includes dress codes. For example, when you think of professions such as law, the immediate image
that comes to mind probably includes a gown and a wig and symbols may include scales. For medicine,
the Hippocratic Oath and the Rod of Asclepius or the Caduceus may spring to mind.
To succeed in their chosen profession, a new member needs to learn about the culture and ethos of the
profession, and to become part of the culture and ethos. A key to evolutionary growth isthat new members
must contribute to the ethos and the culture of the profession to ensure change happens in ways that are
desirable for the community and the profession.
For CPA Australia members our ethos has the word ‘integrity’ as its foundation.
.......................................................................................................................................................................................
CONSIDER THIS
In light of the implied social contract under which professions exist and the accounting profession’s obligation to
serve in the public interest, what do you think CPA Australia’s vision and purpose should be? Locate the vision and
purpose on CPA Australia’s website — are they as you thought they would be?
APPLICATION OF PROFESSIONAL JUDGMENT
Becker (1982) argues that professional judgment is the single most important attribute that differentiates
professionals from non-professionals. The acquisition of knowledge through a formal educational process,
important though that is, is not sufficient to identify a person as a professional. According to Becker, the
key is the ability to diagnose and solve complex, unstructured values-based problems of the kind that arise
in professional practice.
Since many non-professional occupations insist on practical experience, and since problem solving is by
no means absent from those occupations, it is important to try to understand what distinguishes professional
judgment from decisions involving technical judgments only.
A major difference, as Schön (1983, p. 17), expresses it, is that professional people must have an
‘awareness of the uncertainty, complexity, instability, uniqueness, and value conflict’ that surround many
of the problems they tackle in practice. This reference to value conflict identifies that complex social values
can regularly apply to decisions.
Professionals must choose the outcome that professionally best meets the social ideal of professions,
rather than merely the best outcome for the client at that moment. It is certain that professionals will
make many technical judgments based on technical skills. However, it’s expected that professionals can
also judge values and make judgments regarding values (based on professional ethical wisdom) that
distinguishes the work of a professional within a profession.
To emphasise the previous point, Schön also stated that professionals are required to develop competency
in professional judgment, artistry and intuition. These competencies are required not only in applying
knowledge and skills to problem solving, but also (and Schön would argue, more importantly) to finding
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16 Ethics and Governance
and defining the right problem to be solved. The emphasis on problem setting rather than on problem
solving, in turn, requires professionals to communicate skilfully with their clients and/or employers in
order to identify and solve the right problems. The complexity of understanding the nature of problems may
not seem obvious at first, but this understanding is an essential component in gaining the wisdom required
to make values-based professional judgments. The exercise of professional judgment in the accounting
profession is important for all accountants, irrespective of their work environment or geographic location.
One area of concern for professionals is the distinction between a judgment made in error (that is, a
genuine mistake) and a negligently formed judgment.
Many interesting questions regarding the professional judgment of accountants have occurred in the
area of auditing. This is because judgment, and negligence in respect of judgment, have been tested in the
courts, proving the ongoing social impact of the judgments of auditors.
Auditing is based on judgment in almost every fundamental dimension of the process. Some of the key
judgments that auditors must make include:
• identifying those charged with governance in a reporting entity
• deciding whether reasonable assurance or limited assurance is possible
• ensuring that the budget for the audit is sufficient
• deciding on an audit plan — including details such as whether, in any area, sufficient appropriate audit
evidence has been identified and whether any required additional procedures have been undertaken
• deciding whether the evaluation of the results is appropriate, ensuring that the conclusions are soundly
based on the evidence examined and that appropriate action has been taken. It is also important to
consider whether the appropriate level of management has been informed and an appropriate opinion
expressed to the relevant authority or, where applicable, a modified audit report is required.
Accounting is a profession constantly involving the exercise of judgment. West (2003, p. 195) suggests
that without judgment, accounting becomes nothing more than a book of rules for compliance. Instead
of providing a useful and genuine service, accounting may become an occupational group that depends
upon the imposition of regulatory fiat where external regulations are created that require people to use
accounting services (e.g. requirements for external audits).
QUESTION 1.5
Discuss four situations where accountants may apply professional judgment in the course of their
work irrespective of the environment in which they work.
QUESTION 1.6
CPA Australia has been discussing the impact of artificial intelligence (AI) on the accounting profession. Discuss the extent to which AI is predicted to affect professional judgment.
(www.cpaaustralia.com.au/podcast/artificial-intelligence-and-the-future-of-accounting)
THE EXISTENCE OF A GOVERNING BODY
A profession must have a governing body that has been drawn from the membership on a fully democratic
basis. The governing body has the responsibility for ensuring that the attributes listed earlier are achieved
and maintained, and that the professional body and the profession are successful.
The governing body of a profession, therefore, has an important enabling role and should:
• speak for the profession as a whole, particularly on matters of public policy that adversely affect the
profession’s independence and autonomy
• ensure that those who enter the profession have the requisite standard of education and that those
practitioners already within the profession continue to keep themselves up to date with developments in
accounting theory and practice
• encourage the setting and monitoring of high standards of professional conduct
• apply disciplinary sanctions if standards of professional conduct are not observed. The power to discipline requires the governing body to have the power to control its members’ activities. Any breach of
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MODULE 1 Accounting and Society 17
professional conduct is judged and acted on by professional peers without public interference, although
members who may have acted illegally may face public prosecution in the courts
• ensure high standards of performance and conformance by the professional body itself — including
establishing policies, strategies and appropriate codes of conduct within the organisation.
The governing body must be credible and effective in the eyes of both the members and the public. Even
though the attributes of a profession may be clearly evident, the community’s view about whether or not a
profession deserves to be regarded as a profession is shaped to a significant extent by how the profession
(and its members) actually behave. The accounting profession is governed by IFAC.
1.9 THE PROFESSION’S REGULATORY PROCESS
ACCOUNTING PROFESSIONAL AND ETHICAL
STANDARDS BOARD
APESB is an independent body that sets the professional standards for accountants. APESB was the result
of an initiative of CPA Australia and CAANZ. The roles of the APESB are discussed in detail below.
Background
Earlier we highlighted that a high degree of autonomy is an important characteristic of a profession, and
noted how this attribute has been challenged by the regulators with the removal from the profession of
the powers to set accounting and auditing standards. As we have seen, these powers now reside with the
AASB and the AUASB. These two boards in turn report to the FRC.
In regard to auditing standards, the CLERP 9 legislation (Corporate Law Economic Reform Program
(Audit Reform and Corporate Disclosure) Act 2004 (Cwlth)) reconstituted the AUASB as a body corporate
under the Australian Securities and Investments Commission Act 2001 (Cwlth). Consequently, the AUASB
reports to the FRC and not to the professional accounting bodies.
Auditing standards have the force of law under the Corporations Act, which means registered auditors
have a legal duty to comply with auditing standards issued by the AUASB. The AUASB’s power
to approve legally enforceable standards means that all references to ethical requirements in auditing
standards will attract legal status. However, the AUASB has acknowledged that, while this will result in
professional standards having the force of law, it will not reduce or limit the profession’s own disciplinary
activities.
Once professional standards acquired the force of law for auditors, the profession sought a more
rigorous and transparent process for setting ethical requirements. On 4 November 2005, CPA Australia
and the ICAA announced the establishment of the APESB, an independent ethical standards board to
review and set the code of ethics and professional standards. The formation of the APESB effectively
transferred the setting of professional and ethical standards from the professional accounting bodies to an
independent body.
CPA Australia, CAANZ and the IPA are all members of the APESB. Members of these three
professional associations are required to abide by APESB standards.
The profession acknowledges that, in order to increase public confidence, it needs to open the
professional standard-setting process to greater public scrutiny. While the standards previously released
by CPA Australia were of a high standard and enforced through appropriate due processes, the profession
has an ongoing interest in improving the public’s perception of its professional standards. Any appearance
of self-interest should be removed and the standards should be written by an independent board.
The APESB comprises a technical board and a secretariat to enable it to fulfil this role. The technical
board consists of eight members, including two members from CPA Australia. It comprises representatives
from the public sector, corporate sector, audit profession, academia and the general public.
The APESB fulfils its role by:
• reviewing the professional and ethical standards on a yearly cycle, and monitoring the needs of the
accounting profession and the public for areas requiring new or updated professional and ethical
standards
• reviewing the implementation of new and amended professional and ethical standards within six months
of issue
• referring matters to the secretariat for research, direction and amendment
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18 Ethics and Governance
• seeking comment on exposure drafts for proposed standards from the public, the professional bodies
and their members
• monitoring the effectiveness of professional and ethical standards.
QUESTION 1.7
Identify the precise wording of the ‘force of law’ provisions (s. 296, s. 307A) for accounting and
auditing standards in the Corporations Act.
Refer to: www.legislation.gov.au/Details/C2019C00216.
THE QUALITY ASSURANCE PROCESS
Every profession is concerned about the quality of its services, and the accounting profession is no
exception. The integrity of information provided by accountants to their immediate employers, clients
and other stakeholders is enhanced through the profession’s quality assurance process. To help assure
quality outputs, the profession and the regulators have developed a multi-level regulatory framework
that encompasses many of the activities of private and public sector organisations. These activities are
described below.
Standard Setting
The institutional arrangements for standard setting involve the FRC with oversight responsibility for the
AASB, which deals with accounting standard setting in the private and public sector, and the AUASB,
which deals with the setting of auditing standards.
Conformity with Standards
Issued by the APESB, APES 205 Conformity with Accounting Standards and APES 210 Conformity with
Auditing and Assurance Standards are mandatory statements of responsibilities for members involved in
the preparation, presentation or audit of financial reports.
Practice Reviews
To hold a Certificate of Public Practice, members must demonstrate compliance with quality control
standards by annually providing a signed assurance that the established quality control requirements
are being met and by undergoing a practice review. Reviewers appointed by CPA Australia visit public
accounting firms and meet with Certified Practising Accountants (CPAs) who are partners or principals of
these firms. The reviews occur on a five-year cyclical basis. If the findings of the review are unsatisfactory,
the practitioner is required to take remedial action within an agreed timeframe. Serious deficiencies will
result in the instigation of disciplinary procedures.
Accounting Firm Regulation
Each public practice entity adopts policies and procedures to ensure that practising accountants adhere
to professional standards. Corporate failures and accounting scandals over the two decades have often
prompted accounting firms to be more vigilant about their procedures of quality control and independence.
In order to facilitate this, the APESB issued APES 320 Quality Control for Firms.
APES 320 establishes the basic principles of and provides guidance for a system of quality control
that provides reasonable assurance that a firm and its personnel comply with professional and regulatory
requirements. Under this statement, the elements of a system of quality control include policies and
procedures addressing the following.
• Leadership responsibilities for quality within the firm — policies and procedures to promote an internal
culture that recognises quality is essential in performing engagements.
• Ethical requirements — policies and procedures to provide reasonable assurance that the firm and its
personnel comply with relevant ethical requirements as contained in the profession’s code of ethics.
• Acceptance and continuance of client relationships and specific engagements — policies and procedures
to ensure that it will only undertake or continue with engagements where it has considered the integrity
of the client, is competent to perform the engagement and can comply with the ethical requirements.
• Human resources — policies and procedures to ensure there are sufficient personnel with the capabilities, competence and commitment to the ethical principles needed to perform engagements in
accordance with professional standards and regulatory and legal requirements.
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MODULE 1 Accounting and Society 19
• Engagement performance — policies and procedures to provide reasonable assurance that engagements
are performed in accordance with professional standards and regulatory and legal requirements.
• Monitoring — policies and procedures necessary for ongoing evaluation of the firm’s system of quality
control, including a periodic inspection of completed engagements and documentation.
.......................................................................................................................................................................................
CONSIDER THIS
Think about the organisations where you have worked or currently work. What documentation is used to assure and
control the quality of the organisation’s outputs?
QUESTION 1.8
A merger is being finalised between your public practice and a firm that provides bookkeeping
services. As the partner in charge of quality control, you have not quite finalised your due diligence
on the policies and procedures designed to provide reasonable assurance that the firm and its
personnel comply with relevant ethical requirements.
You are confident that the bookkeeping firm’s policies and procedures are robust, but you have
not yet completed a review of them. You nevertheless assume that there are no issues, as the firm
being acquired only provides bookkeeping services.
A few months after the merger is completed, you receive a phone call from one of your clients.
Your client is concerned because an employee of your firm who performs bookkeeping services
has an interest in a business that is one of their major competitors.
Your client is particularly disturbed because they are in the middle of extremely confidential
business negotiations. The client wants guarantees that your employee will not have access to
any confidential information. You agree to investigate your client’s concerns (Sexton 2009).
Identify and describe the quality assurance and ethical issues arising from this scenario.
PROFESSIONAL DISCIPLINE
Professional and ethical standards aim to ensure that members of the accounting profession work to
the highest level of professionalism, providing a quality of service that achieves credibility among the
general public and gains their confidence. Members often face personal, financial and other pressures
that threaten their integrity and test their judgment. Unfortunately, in response to such pressures, some
members prioritise self-gain and overlook their duty to protect the interests of third parties and the
trust bestowed upon members by the public. It should be noted that no profession is totally free of
unscrupulous members.
Joining CPA Australia means committing to upholding the reputation of the CPA designation by
adhering to the obligations spelt out in CPA Australia’s Constitution and By-Laws, the Code of
Professional Conduct and applicable regulations. To ensure all members uphold these standards, CPA
Australia has a formal process that enables complaints about members to be heard and evaluated and,
where appropriate, disciplinary actions to be taken.
Investigations and disciplinary processes are guided by the principles of procedural fairness (the right
for a member to put forward their case), confidentiality, independence and the right to appeal.
CPA Australia has undertaken to act in the public interest and has an obligation to ensure that complaints
about members are investigated thoroughly, in an impartial and timely manner, at all times striving to
preserve the rights of members while acknowledging the public interest concerns of complainants.
Investigation and disciplinary procedures form an essential adjunct to the Code of Professional Conduct.
CPA Australia has placed due importance on the area of co-regulation and professional discipline by
establishing an elaborate set of rules and procedures to handle disciplinary matters.
Regulation of Member Conduct
The specific procedures for regulation are identified in:
• Clauses 39–43 in the Constitution of CPA Australia Ltd (effective 14 May 2019)
• Part 5 of the By-Laws of CPA Australia Ltd (effective 1 April 2019).
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20 Ethics and Governance
QUESTION 1.9
Read clauses 39–43 of the current Constitution and Part 5 of the current By-laws. You can access
these documents via the following links.
• www.cpaaustralia.com.au/about-us/our-organisation/our-constitution
• www.cpaaustralia.com.au/about-us/our-organisation/our-bylaws
The process for dealing with member conduct is started when a complaint is made. A complaint may be
raised by any person including members of the public, members of CPA Australia or the General Manager
Professional Conduct (MPC) of CPA Australia.
Types of complaint identified in the Constitution of CPA Australia (clause 39) include:
• obtaining admission as a Member by improper means
• breaching the Constitution, By-laws or Code of Professional Conduct
• dishonourable practice or conduct that is derogatory to CPA members
• failing to observe a proper standard of professional care, skill or competence
• becoming insolvent
• being found to have acted dishonestly in any civil proceedings.
The complainant should first attempt to resolve the matter directly with the CPA Australia member.
Where this initial resolution attempt is unsuccessful, the complainant must lodge a written complaint
providing all necessary details, supported by documentary evidence.
All complaints are reviewed by the MPC. The MPC will determine whether the complaint is relevant
and, if it is, a file will be opened to address the issue. The complaint will be allocated to a Professional
Conduct Officer (PCO).
The PCO will contact the member against whom the complaint has been made and provide details of
the nature of the issue. The member will be asked to provide an explanation.
Once the PCO has completed the investigation, a report will be given to the MPC to enable a
recommendation to the Chief Executive Officer (CEO) of CPA Australia as to whether there is a case
to answer.
The CEO must determine whether there is a case to answer based on the MPC’s recommendation and
any relevant external advice. If the member is assessed as having a case to answer, the CEO must refer
the complaint to either the Disciplinary Tribunal or to a One Person Tribunal (OPT), depending on the
circumstances.
The member and complainant will be notified by the MPC that there is a case to answer and the MPC
will refer the case to an investigating case manager (ICM). The ICM will prepare written particulars of the
case and present the complaint at the hearing that will be conducted.
After the hearing of the case, a determination (decision) will be made and the member and complainant
will be advised of the outcome.
Penalties and Appeals
The findings and decisions of the Disciplinary Committee are published on CPA Australia’s website. The
Constitution of CPA Australia (clause 39(b)) specifies that penalties that can be imposed include:
• forfeiture of membership
• suspension of membership for five years or less
• a fine
• a severe reprimand
• cancellation or suspension of any certificate, privilege, right or benefit available to the member
• restricting the member from using the CPA designation and/or ordering the member to remove any CPA
Australia signage and the designation from advertising materials and office premises
• lowering the member’s status and/or removing any specialist designation
• directing the member to undertake additional hours of professional development
• a direction to undertake such quality assurance as may be prescribed.
It should be noted that the formal complaints process does not investigate issues relating to fees. Fees
charged by members are a commercial matter between members and their clients. However, the complaints
process will consider cases where members are in breach of their professional obligations, such as those
included in APES 110 Code of Ethics for Professional Accountants and other APES standards. Where
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MODULE 1 Accounting and Society 21
the client’s concern relates to the size of the fee, the client may consider contacting an organisation that
mediates commercial disputes. There is usually a cost involved in using mediation services.
QUESTION 1.10
Locate CPA Australia’s Disciplinary Hearing Outcome reports. Is the member’s name always
published?
SUMMARY
The accounting profession is integral to the process of ensuring people have access to accurate and useful
financial information upon which to base their decisions. These decisions often relate to the allocation of
resources and have important consequences for society. To make appropriate decisions about the analysis
and presentation of information, the professional accountant needs to clearly understand what information
serves the public interest and to ensure this — rather than any sense of self-interest — guides their
professional conduct. Ultimately, the accounting profession will only retain its integrity and authority
by serving the wider public interest.
A profession such as accounting has a series of features that distinguish it from other occupations.
These include a specific body of knowledge obtained through formal qualifications from tertiary education
institutions and regular continuing professional development courses conducted by accounting bodies or
commercial training providers. A profession has as a core ideal the notion of service to the community. A
profession will typically have a code of ethics (for example, APES 110), a culture in which the exercise
of professional judgemnt is important and a governing body (for example, IFAC).
Professions often exhibit a high level of autonomy and self-regulation. In the case of accounting, a degree
of external regulation has been imposed in response to various failings in some parts of the profession.
This co-regulatory approach means that in addition to the self-regulation undertaken by the peak bodies
of the profession, legislation and external regulators also have a degree of power over the conduct of the
profession and its members.
As a professional accountancy organisation, CPA Australia has a constitution and disciplinary rules that
set down what the profession expects of its members. Members who are the subject of public complaints,
for example, may be subject to disciplinary action. This may result in penalties, including forfeiture of
membership, fines, additional professional development or a reprimand.
The key points covered in part A of this module, and the learning objective they align to, are as follows.
KEY POINTS
1.1 Describe the nature and attributes of a profession.
• Professions exist because of an implied social contract.
• A profession generally has an overarching responsibility to operate in the public interest.
• A profession has a code of ethics and other guidance that establishes acceptable norms for
professionals practising in a specific discipline.
• A profession is established and defined by a set of specific attributes.
1. A systematic body of theory and knowledge — a profession has a specialised, unique body of
knowledge, skills and competencies that members of the profession must possess.
2. An extensive education process for its members — professionals must obtain the profession’s
body of knowledge, often initially through university education, and engage in formal continuing
professional development throughout their professional lives.
3. Ideal of service to the community — an implied social contract exists between a profession and
society based on the core notion that the profession will act in the public interest.
4. High degree of autonomy and independence — society grants professions considerable
autonomy and independence in return for consistently demonstrating that they are acting in
accordance with their professional and ethical standards and in the best interests of society.
5. A code of ethics — members of a profession are required to practise in accordance with a formal
code of ethics that establishes principles for good conduct.
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22 Ethics and Governance
6. Distinctive ethos or culture — a profession adopts a set of values that are expressed in
behaviours, documents and symbols that together form and reinforce the profession’s ethos
and culture.
7. Application of professional judgment — a profession is distinguished by the regular use of
judgment, rather than mere application of rules, to make decisions on situations and problems
that involve uncertainty and competing interests.
8. Existence of a governing body — professions maintain a peak body that brings members
together, establishes professional standards of conduct, assures the quality of the profession
and disciplines its members.
1.2 Explain the co-regulatory processes of the accounting profession.
• Society grants professions a high degree of autonomy and independence in return for acting in the
best interests of the society as a whole.
• When professions fail to act in the best interests of society, society responds by imposing external
regulation.
• A series of unexpected corporate failings in the early 2000s prompted regulators to increase
external oversight of the accounting profession.
• The mix of external regulation and self-regulation is known as ‘co-regulation’.
• External regulation of the accounting profession in Australia includes legislation such as the
Corporations Act, regulatory bodies such as ASIC and the ATO, and organisations such as the
FRC, which oversees the AASB’s and AUASB’s work on setting accounting and auditing standards,
respectively. These standards have the force of law.
• Self-regulation of the accounting profession in Australia includes the professional accounting
organisations (CPA Australia, Chartered Accountants Australia and New Zealand, and the Institute
of Public Accountants), and their set of membership rules, ethical standards, educational requirements and disciplinary processes.
• In a co-regulatory environment, government regulators and professional bodies interact to ensure
that professionals working in specific areas follow the relevant ethical standards and laws.
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MODULE 1 Accounting and Society 23
PART B: INTERACTION WITH SOCIETY
INTRODUCTION
As described in part A, much of what characterises a profession is the way it interacts with society.
Professions enjoy various privileges in return for acting in the public interest.
This part of the module looks in more detail at the professional relationships between accountants
and various stakeholders. In particular, the different roles accountants may fill within a variety of
work environments strongly influence the way in which accountants create value for themselves, their
organisations and society as a whole.
The core value created by accountants is their support of high-quality decisions by providing relevant
and useful information to decision-makers. It is in return for this value that society confers on accountants
professional status and the accompanying benefits. Accordingly, society scrutinises the conduct of the
profession and where it is has been found to fail, increased regulation and oversight has been introduced.
To ensure professional conduct, accountants must combine their technical accounting skills with
skills across a broad range of areas — sometimes collectively referred to as ‘soft skills’ — such as
communication, negotiation, persuasion and leadership skills. To support this, the profession requires
accountants to undertake formal continuous professional development throughout their careers.
1.10 ACCOUNTING ROLES, ACTIVITIES
AND RELATIONSHIPS
RELATIONSHIPS AND ROLES
Accountants are found in an ever-increasing number of roles and relationships in society. The key
professional relationships that accountants have are with employers, clients, regulators, employees (if
business owners or managers) and their peers. These relationships are shown in figure 1.3.
FIGURE 1.3
Accountants’ key professional relationships
Employers
Clients
Employees
Accountant
Peers
Regulators
Peers include work colleagues, accountants in professional networks and other accountants who work
for the same client in a different aspect of accounting. Maintaining good-quality professional relationships
is an essential part of being a successful professional accountant.
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24 Ethics and Governance
Many factors influence how an individual will behave in their workplace. These factors include culture,
standards and ethical evaluations. Other variables that have an impact on an accountant include:
• personal moral development
• family influences and personal relationships, including those at work
• the organisational level (business structure and relationships with superiors and subordinates, etc.)
• laws and regulations
• professional aspects (including professional expectations and professional ethics).
These all have an impact on the way problems and issues are dealt with by an individual in the workplace.
A threat to, or excessive pressure on, any of these areas has the potential to result in unprofessional conduct.
ACCOUNTING WORK ENVIRONMENTS
Examples of accounting work environments are shown in table 1.2.
TABLE 1.2
Types of accounting work environments
Work environment
Examples
Public practice
Public practitioner
Big Four accounting firm
Second-tier accounting firm
Small partnerships and sole practitioners
Private or business sector
Professional accountant in business
Large companies — privately held or publicly listed
Small and medium enterprises (SMEs)
Start-ups
Public sector
Government departments
Public entities (e.g. hospitals)
Financial advice
High wealth individuals
Business organisations
Trusts and foundations
Not-for-profit sector
Charities
Sporting and cultural associations
Source: CPA Australia 2015.
CPAs must be equipped with a range of skills to function as business leaders. Further, professional
capabilities are mobile, enabling accountants to work in different geographic locations, various work
environments and online. Each of the environments listed in table 1.2 is discussed in more detail in the
following sections.
Public Practice Environment
Public practice refers to professional accountants who offer accounting services to businesses and
the public. The public practice environment can be grouped into three types of firms and practices. These
are summarised in table 1.3.
TABLE 1.3
Sub-types of the public practice environment
Big Four accounting firms
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The ‘Big Four’, as they are known, are the four largest international
professional public practice firms that offer services in accountancy and
professional services in Australia and the world.
These firms are PwC (PricewaterhouseCoopers), Deloitte, EY (Ernst &
Young) and KPMG. The revenues of these firms have been reported to be
in the tens of billions. A significant but decreasing service line for the four
largest firms in the world is audit and assurance. These companies audit a
majority of the listed entities in Australia and overseas.
Their work often involves dealing with complex transactions that take
place across borders.
(continued)
MODULE 1 Accounting and Society 25
TABLE 1.3
(continued)
Second-tier accounting firms
Mid-tier public practice firms operate on a smaller scale than the Big Four.
They generally have a number of offices in capital cities and large regional
centres, together with some level of international engagement, generally
through alliances or network affiliations.
Examples of these firms are Findex, BDO, Grant Thornton and
Pitcher Partners.
Small practices and sole practice
operations
This level of public practice includes the smaller accounting practices
with one professional accountant as practitioner or a team of professional
accountants and support staff.
Smaller accounting firms tend to be used by small and medium
enterprises (SMEs), which often have no statutory audit requirements.
Accordingly, these practices usually undertake compliance work that
is less related to audit (e.g. tax returns, standard accounting), and
increasingly business and IT advisory work.
Roles in Public Practice
While Big Four firms, and to some extent mid-tier firms, offer services that include consulting and legal
divisions, the range of accounting activities for an accountant in public practice is similar, irrespective of
the size of the practice.
The types of roles within public practice work environments include those shown in table 1.4.
TABLE 1.4
Public practice roles
Area
Activity
Assurance and audit
Financial statement attestation, in which the firm examines and attests to a company’s
financial statements. Other assurance services including assessing procedures and
controls relating to privacy and confidentiality, performance measurements, systems
reliability, information security and outsourced process controls.
Financial management
Covers performance management, corporate governance, stakeholder relations, risk, as
well as the traditional financial controls.
Taxation services
Covers company and individual taxation, fringe benefits tax (FBT), goods and services
tax (GST), capital gains tax (CGT) and international tax issues.
Forensic accounting
Specialised area that involves engagement for legal issues including fraud, disputes
or litigation.
Insolvency
Specialised area that involves engagements in personal insolvencies (bankruptcies) and
corporate insolvencies (administrations, liquidations and receiverships).
Internal audit services
Systematic, disciplined approach to evaluating and enhancing risk management, control
and governance processes.
Business advising
Assisting business managers to more successfully achieve value. The tasks involved
are varied, often reflecting that businesses have internally recognised weaknesses, or
have identified that objective external evaluations and contributions can be valuable.
Business advising can also extend to advice on business re-engineering, restructuring,
takeovers and mergers.
Source: CPA Australia 2015.
Accountants as External Advisers to SMEs
It is important to note that often, in very small SMEs, no accountants will be employed internally and
there is total reliance on an external public accounting practice to perform all accounting functions.
Research commissioned by CPA Australia in 2005 found that accountants from public practice provided
a wide range of services as advisers to the SME sector. The survey reported that 97% of SMEs purchase
accounting services (i.e. taxation advice and financial statement preparation) from an external accountant
(CPA Australia 2005).
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26 Ethics and Governance
Five years later, and at an international level, IFAC (2010) found the same general trend. IFAC also
clarified that it is important for external accountants (small to medium practices) to recognise the real
opportunities that exist in the greater provision of profit-oriented business advice rather than accepting the
current overwhelming dominance of compliance advice. These opportunities benefit the businesses being
advised and help to grow the accounting practice.
The following summary explains how IFAC (2010) discusses the issue.
• Researchers identified that some owner-managers want to ‘go it alone’ rather than expose their problems
to outsiders, depicting this as a ‘fortress enterprise’ mentality. Owners displaying this attitude wanted
to hide their weaknesses and typically they would justify their approach by saying that outside advice
was irrelevant or poor. As they were not using outside advice anyway — how would they know?
• Other researchers have pointed out that the ‘range and quality of advice available’ in relation to business
advising from external advisers is growing. This has been a derivative of the work of external advisers
helping SMEs to meet regulatory requirements and can be seen in the increased number of advisers and
the increasing advisory skills in relation to ‘regulatory and day-to-day and strategic challenges’.
• It is apparent that SMEs do require external advice because many smaller entities (much smaller than
André Rieu in reading 1.2 for example) will have no internal accounting staff. Much advice has been in
relation to meeting regulatory requirements but demand is also evident in relation to business monitoring
and quality control. Importantly, IFAC states that ‘this is not merely confined to financial compliance’.
While it is clear that a compliance bias has continued, external advice and support have been sought
from accountants (as general business advisers) in relation to ‘employment, health and safety and
environmental regulations’.
Further research on the scope of work done by small and medium practices (SMPs) for small businesses
was released in 2016 by IFAC in the form of a global SMP (small-to-medium practice) survey. According
to the survey, 84% of SMP respondents provided business or consulting services to clients with the
most common services being tax planning (52%); corporate advisory services (45%) that encompasses
transaction, due diligence and financing advice; and management accounting (41%) that includes planning
and risk management (IFAC 2016a).
IFAC published a 56-page literature review on accountants and their roles in small to medium
practices in 2016. That review noted that accountants from SMPs provided a wide range of business
services. These business services include acquisition, succession, financial management, business strategy,
tax planning, cash-flow advice, financing advice and debt administration, business valuation, forensic
accounting, bankruptcy, costing and pricing, financial planning and budgeting, human resources, pensions,
remuneration schemes and payroll, environmental sustainability, IT services, secretariat, training and skill
development, and risk management (IFAC 2016b).
QUESTION 1.11
Why have SMEs not relied in the past on their external accountants for business advisory services?
Comment on whether this might now be changing or if this needs to change.
Private or Business Sector Environment
Professional accountants in business (PAIB) are employed by private sector businesses in varying roles.
The scale of a business’s operations will determine the professional accountants’ roles.
PAIB Employed in Large Businesses
Many professional accountants work in large corporations, often in specialised roles in accounting and
related areas. Some of these roles are listed in table 1.5.
During their career a professional accountant may remain in a particular role or may move through
various functional roles and then on to management levels within the finance area. Often, professional
accountants move into general management roles as a result of the wide capabilities and skills they acquire
during their career. Professional accountants are also often found on the boards of companies as directors
or company secretaries. Even with changes in the roles performed and challenges faced, which generally
become more complex as more senior roles are accepted, a CPA must continue to maintain the service
ideal and continue to comply with professional ethical requirements.
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MODULE 1 Accounting and Society 27
TABLE 1.5
PAIB roles in large businesses
Role
Responsibilities
Board member
Elected to the board of directors to oversee the activities of the
company or organisation.
Finance director or chief financial officer
Formulation, management and review of the financial and strategic
direction of the company or corporate group.
Financial accountant
Preparation of general purpose financial reports, the annual report
and special purpose financial reports as required. May supervise a
team of accountants.
Treasury accountant
Management of treasury functions of the organisation in order
to ensure sufficient cash flow and the effective use of financial
instruments.
Risk manager
Quality and risk management responsibility for the business.
Strategic management accountant
Preparation of budgets and forecasts, costing, performance
measures for analysing and improving organisational performance.
Internal auditor
Review of internal controls, information and business processes.
Human resources accountant
Remuneration and payroll-related functions.
Company secretary
Reporting and regulatory compliance and ensuring, with the chair,
the efficient functioning of the board of directors.
Source: CPA Australia 2015.
PAIB in Small and Medium Enterprises (SMEs)
Small- and medium-size enterprises (SMEs) vary significantly in their size, number of employees, direct
ownership control and geographic dispersion of resources.
So what is an SME? IFAC defines SMEs as follows.
Entities considered to be of a small and medium size by reference to quantitative (for example assets,
turnover/employees) and/or qualitative characteristics (for example, concentration of ownership and
management on a small number of individuals). What constitutes an SME differs depending on the country
(IFAC 2010, p. 10).
The accounting functions within an SME are broadly the same as in a large business environment.
However, an SME-employed accountant may have to complete more detailed work because there will be
fewer (if any) support staff. Also, the number of areas they need to cover may be wider but have less
complexity compared to a large business environment.
At the same time, because they will know the business and typically be very close to the ownership
(in fact, may even be an owner) and senior management, the professional accountant in an SME will also
often be involved in a range of business decision activities.
An example of the differences in the roles performed by a professional accountant in a large business
compared to an SME is as follows.
• A large business may engage a management accountant whose sole responsibility is budgeting,
forecasting and reporting actual results compared to budget for one of its areas of operation.
• An SME may engage a finance manager who is responsible for their end-to-end accounting and finance
function — with responsibility for every function from petty cash to monthly reporting to the directors.
IFAC Research
The PAIB Committee of IFAC ‘provides leadership and guidance on relevant issues pertaining to
professional accountants in business and the business environments in which they work’ (IFAC 2013).
The PAIB Committee in 2005 developed an information paper titled The Roles and Domain of the
Professional Accountant in Business. This paper provides a description of the contemporary roles that
are PAIB.
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28 Ethics and Governance
The PAIB Committee described PAIB roles as:
implementing and maintaining operational and fiduciary controls, providing analytical support for strategic
planning and decision making, ensuring that effective risk management processes are in place, and assisting
management in setting the tone for ethical practices (IFAC 2005, p. 1).
The PAIB Committee paper provides a description of activities listed in table 1.6.
TABLE 1.6
PAIB Committee description of PAIB activities
Activity
Examples
Value
Generation or creation of value through effective use of resources, through
understanding the drivers of value and innovation.
Information
Creating, providing, analysing and interpreting information for management to
formulate strategy, plan, control and make decisions.
Measurement
Developing appropriate measurement tools and accurately measuring performance.
Communication
Communicating financial reports and interacting with stakeholders so they can
understand the business and make informed choices.
Costing
Accurate costings of products and services.
Control
Financial control, budgeting and forecasting, and the reduction of waste through
process analysis.
Risk
Managing risk and providing business assurance.
Source: Adapted from The Roles and Domain of the Professional Accountant in Business, Professional Accountants in Business
Committee, p. 4, IFAC in 2005 and is used with permission of IFAC, accessed October 2015, www.ifac.org/publicationsresources/roles-and-domain-professional-accountant-business.
We can link these IFAC activities to the roles identified earlier and the different sizes of private sector
businesses. For example, the measurement activity in a large business may be a management accountant
measuring the performance of international freight supplier contracts. In a small business, the measurement
activity may be the financial controller determining a breakeven sales figure.
In 2008, the PAIB Committee released another information paper titled The Crucial Roles of Professional Accountants in Business in Mid-sized Enterprises (IFAC 2008). Understanding the role of
accounting in these enterprises is vital for the success of the enterprises and of economies reliant on
such enterprises.
For the paper, IFAC interviewed various accountants in mid-sized enterprises (MEs). The MEs were
chosen because they all had employed accountants, so the multi-dimensional role of the professional
accountant as an employee could be explored. The report summarises the interviews as follows.
Generating Value
The PAIBs featured in this report have identified numerous responsibilities that directly affect the current
and future success of the mid-sized enterprises in which they work . . .
Their most prevalent duties hinge on helping their companies to generate value by:
• establishing a common ‘performance language’ throughout the company so that everyone’s activities
are aligned with the vision and goals leadership has set;
• upholding business integrity;
• creating, implementing and improving management information systems to bolster strategy, planning,
•
•
•
•
decision making, execution and control activities;
managing costs through rigorous planning, budgeting, forecasting and process improvement efforts;
managing risk and handling business assurance;
measuring and managing performance; and
communicating financial and other performance information to internal and external stakeholders,
including regulatory authorities, lenders, bankers and investors in a manner that fosters trust (IFAC
2008, p. 6).
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MODULE 1 Accounting and Society 29
The report continues with specific observations about the importance of continuing self-development
by the employed accountants — especially regarding communication.
Other reports and studies by IFAC underscore the importance of the role played by PAIB in business
performance and the need for further training to be made available to these professionals. A report
published by IFAC in 2018, The Role of the Finance Function in Enterprise Performance Management,
highlighted the need to ensure that PAIB were treated as more than individuals who form one part of
a financial reporting chain within an entity. The report argued that the PAIB needed to be promoted
and advanced as a contributor to business performance and value creation. A way of encouraging this,
according to IFAC (2018), is to create an environment where knowledge is acquired in a series of
areas including:
• an organisation’s operating environment and business model
• strategic and operational planning, budgeting and forecasting
• lean operational management, including quality management principles, continuous process improvement and optimisation (all of which can also be applied to finance as well as to operations)
• finance fundamentals including core processes, systems and technology
• integrated thinking and reporting
• organisational management including culture, change and behaviour.
There is a greater awareness of the value PAIB are able to bring to the overall workplace outside of
the compliance and storytelling function that they have traditionally fulfilled within the entities for which
they work.
.......................................................................................................................................................................................
CONSIDER THIS
What are the ways in which you add value in your workplace? Reflect on each instance and note how your actions
or ideas made you and others feel.
QUESTION 1.12
Refer to reading 1.2. How did Roel van Veggel add value to André Rieu’s business?
Public Sector Environment
The public sector includes a wide range of government and regulatory bodies. It includes the federal
government and lower levels including state, territory and local government. Where governments provide
for-profit services, they often set up particular entities called government business enterprises (GBEs)
or state-owned enterprises (SOEs). Governments are characterised by the breadth of their powers in
comparison with the private sector, such as the ability to establish and enforce legal requirements.
Qualified accounting professionals can build successful careers in the public sector because governments
and their agencies require economic, financial, accounting and audit staff for their operations. Often people
are drawn to the government sector because of the potential for greater work–life balance, training and
development and career progression and because they wish to make a difference.
Over recent years there have been significant cultural changes with a shift towards a more corporate
model of best practice and ‘value for money’ approaches. As in the private sector, the public sector highly
values commercial know-how, analytical thinking and leadership and stakeholder management abilities.
Accounting roles within the public sector are quite similar to those in the private and business sector,
with the requirement for financial reporting, internal audit, risk management and strategic management
accounting of key importance.
Financial Advice Environment
Accountants are often called upon to offer financial advice to clients, who include high net worth
individuals, businesses or other entities such as trusts or foundations. As accountants are knowledgeable
and skilled about financial matters, and are able to interpret complex financial information, it is natural
that clients call upon them for investment or other financial advice beyond their normal accounting duties.
However, offering financial advice has significant risks and responsibilities that must be recognised.
Providing financial advice takes a critical step away from assessing compliance within a body of rules
and frameworks to actually taking complex decisions regarding the best means of financial performance.
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30 Ethics and Governance
Additional regulatory and educational obligations have been imposed on accounting professionals
engaged in the provision of financial advice through the imposition of education standards created by
the Financial Adviser Standards and Ethics Authority (FASEA). FASEA has issued a Code of Ethics for
financial advisers and has also provided a legislative instrument and explanatory statement that explain
their 12-point ethical code.
FASEA is responsible for promulgating the education requirement for licencing as a financial advisor.
From 1 January 2019 these new requirements replace ASIC’s RG 146, with existing licence holders
required to transition to the new requirements by 1 January 2024. For more information please refer to
FASEA’s website (fasea.gov.au).
The risks involved in offering financial advice are many. It is vital to remember Adam Smith’s words:
this is ‘other people’s money’. That is, any risks involved in the proposed investment strategy are borne by
the client, not the adviser. Moreover, if, as a financial adviser, the accountant becomes too close to certain
investment funds, this poses the risk of the adviser acting out of self-interest rather than the client’s interest.
The financial advice industry has been associated with these dilemmas on many occasions, which has led
to a number of government inquiries into the financial advice industry both in Australia and overseas,
including a comprehensive examination of the current cost, quality, safety and availability of financial
services, products and capital for users, in the Australian Government’s Financial System Inquiry Final
Report (2014) and the recent Royal commission that resulted in the Hayne Report.
The dilemmas of self-interest conflicting with public service are most serious in the field of financial
advice. The occupation of financial adviser has expanded considerably in recent decades as more people
have accumulated wealth that they wish to invest wisely. Since accountants have extensive financial skills
and knowledge, some accountants have been drawn into providing financial advice, often at the request of
their clients.
Regrettably, internationally there has been a series of scandals involving widespread selling of inappropriate investment products, charging unacceptably high fees, and sometimes corrupt practices. This has
not only occurred with individual financial advisers, but with financial advisers working for the insurance
industry in the UK, and the major banks in Australia.
Clearly the role of financial adviser carries significant responsibilities and risks beyond those normally
encountered in the accounting profession. It is essential for any accountant engaging in financial advice to
be fully aware of the responsibilities and risks involved, and to maintain a sense of objectivity regarding
the best interests of the client receiving the advice.
Not-for-Profit Sector Environment
Not-for-profit entities (NFPs) are generally defined as legal or social entities formed for the purpose of
producing goods or services, and whose status does not permit them to be a source of income, profit or
financial gain for the individuals or organisations that establish, control or finance them.
NFPs can vary in size from very large charitable institutions to local sports clubs. The principal sources
of income for their operations are usually receipts from members and supporters, grants, donations and
fundraising. Some NFPs also supplement revenue with trading activities. Although generating profit
from trading is not their core purpose, NFPs require sound financial management to ensure that they
are sustainable, can demonstrate positive social impact and can continue to meet their objectives and
reporting obligations.
The NFP sector, sometimes called the community or third sector, is diverse and growing. In Australia,
the NFP sector encompasses 600 000 organisations contributing an estimated AUD$43 billion, making it
larger than the communications industry, agriculture or tourism (Office for the Not-for-Profit Sector 2013).
A report published in May 2019 by the Australian Charities and Not-for-profits Commission (ACNC 2019)
revealed that there were more than 57 500 registered with the charities regulator. According to the report,
most charities — about 65% — are small and have revenue up to $250 000 while other charities may obtain
several millions in fundraising (ACNC 2019).
As the complexity of tendering and accountability requirements grow in this sector, so does the need
for professionally qualified staff to enhance efficiency and effectiveness.
Keeping the organisation in good financial shape, meeting the reporting requirements of a myriad
of stakeholders, understanding the grants process, constructing and monitoring budgets, tendering for
outsourced government services, diversifying revenue streams through new models of investment and
social enterprise and meeting best practice volunteer management are all part of the daily mix for an
accounting professional working in the NFP environment.
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MODULE 1 Accounting and Society 31
1.11 SOCIAL IMPACT OF ACCOUNTING
It might be argued that all professions, because of their accumulation of relevant capabilities, have a duty
to use those capabilities to improve and enhance society. We can call this a positive (or active rather than
passive) social impact. Does accounting have a positive social impact? Can that impact be negative in some
circumstances? Is it possible that accounting may even change society?
One aspect of accounting is the important role of reporting to investors, owners, management and other
users. This reporting may be designed principally to inform users about events that occurred in the past, by
way of annual, half-yearly and quarterly reports, and some types of historical reports within organisations.
Some people might think that this reactive information is passive. However, as a result of this historical
accounting information (created under applicable accounting standards), investors, governments, managers
and other stakeholders make decisions with significant social consequences. Reporting, which is reactive
in respect of events, is the active foundation for a variety of outcomes — and these outcomes actively
change social circumstances and entire societies. An example of this may be the preparation of the halfyearly results for a publicly listed company. If the results are poor, there is an obligation for the company
to announce this to the public. Investors may then choose not to go ahead with a plan to purchase shares
in the company. If financial results for a large number of companies are poor, society may interpret this as
a sign that the economy is failing.
Examples such as these show that implementing accounting systems and their constructs have a forceful
social impact and social and economic consequences, so accountants need to understand and apply
their professional capabilities to achieve appropriate reporting in each circumstance. These professional
capabilities include relevant technical knowledge, soft (sometimes called social or interpersonal) skills and
extensive experience to avoid adverse consequences due to poor or inaccurate reporting.
Beyond reporting about the past, accounting is commonly used within organisations to provide
information to support managers in decision making. Such information is future-oriented and is designed
to facilitate, support and even to cause change. For example, a strategic management accountant designing
information to support a new manufacturing plant is change-focused, as is an accounting regulator working
on new laws or new accounting standards designed to create changes.
If the reporting is right, then the social impact, arguably, will be good, as markets and decisionmakers are informed appropriately. If the reporting is wrong, then the social impact will almost certainly
be negative.
Arguably, even perceptions about accounting can create significant social impact — so communications
regarding accounting need to be professional and balanced.
Accounting is increasingly recognised internationally and nationally as creating changes to society,
affecting individuals, business entities and regulatory agencies (including governments). The professional
accountant must always be aware of their ethical obligations and the reliance society places on the
information they provide.
SOCIAL IMPACT EXAMPLE — DEPRECIATION
AND BEHAVIOUR
A powerful example of how accounting has a social impact is shown by looking at how assets are
depreciated.
People who are not familiar with accounting may see depreciation as a technically accurate adjustment
to reflect the decline in values of non-current assets. However, in reality there is a broad scope for choice
in depreciation methods.
The depreciation method and estimated residual life or productive capacity will have an impact on
several measures, including reported profits and asset balances, and therefore remuneration and bonus
plans that are linked to profits or return on investment.
Impacts of Higher Levels of Depreciation
• In the short term, higher depreciation levels will mean lower profits and lower asset levels.
• In the longer term, there will be a rise in profits with lower assets levels. This may lead to a lower
measurement base for a manager against which future performance is measured — this will show a
greater percentage improvement and is likely to lead to higher long-term bonuses. Lower asset levels
will also lead to a higher return on assets.
• Lenders may be nervous due to lower profit levels and asset values that may be used as security.
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32 Ethics and Governance
• Owners with a short-term approach may be frustrated by lower profits and consider selling their
investment. This may lead to a decline in the share price.
Impacts of Lower Levels of Depreciation
• Lower depreciation levels will lead to higher profits and higher asset levels, which may be the source
of short-term rewards for managers.
• Lenders and owners may have greater confidence levels in the organisation because of higher profits
and asset values.
• It may reduce investments in assets in the future, as assets are assumed to have a longer lifespan than is
actually the case. This may hinder the organisation’s competitiveness.
• When assets reach the end of their useful life and are scrapped or sold, there may be large write-offs if
the written-down value of the asset is higher than its disposal value.
From these points, we can conclude that the choice of depreciation method and residual life of the asset
is not a value-free or technical choice, but one that may have a significant impact on different people.
Because the different outcomes may have positive or negative effects, they have a social and behavioural
impact on accountants, managers and users of financial reports, including lenders, owners and the broader
community. This may create a situation where an accountant is pressured to report an artificial result.
Accounting is often perceived as neutral — a set of black and white tasks performed in a mechanical
manner — but this understates its influence. Rather, the activities of accountants and the use of accounting
information, including the decisions that are made based on the outputs of accountants, have a decisive
impact on the social functioning of individuals, groups and entities. The impact is far wider than at first
might be apparent.
It is important for accountants to understand the potentially broad social impact of accounting at the
micro and the macro level. At the macro level, this extends to all types of business, public organisations
and social institutions, and society generally. At the micro level, we must understand the potential
impact that accounting can achieve on the motivation and behaviour of managers and employees within
an organisation.
The motivational effects of performance measurement are discussed in more detail in the ‘Strategic
Management Accounting’ subject of the CPA Program.
At a macro level, ASIC reviews financial statements on an annual basis and raises concerns with
companies as issues arise. Issues related to the impairment of assets appear regularly on the corporate
regulator’s accounting watchlist, one of which is outlined in example 1.6.
EXAMPLE 1.6
ASIC’s Power
In its 2018–19 Annual Report, ASIC raised concerns about the value of assets in Myer Limited’s
financial report for the full-year ended 29 July 2017. These concerns included the reasonableness and
supportability of the cash flow forecasts used in testing the assets for impairment.
After ASIC raised these concerns, Myer announced its decision to write down the value of its goodwill
and brand name intangible assets by $515 million in its half-year financial report. Myer stated that this
write-down in the value of its assets reflected its adoption of lower cash flow forecasts, as well as the
deterioration in trading during the first half of the 2018 financial year.
The impairment of non-financial assets remains a focus in ASIC’s surveillance of financial reports.
Source: ASIC 2018, ‘Annual Report 2017–18’, p. 78, https://download.asic.gov.au/media/4922570/annual-report-2017-18published-31-october-2018-full.pdf.
ASIC also has an Audit Inspection Program under which it looks at a selection of audits of the financial
reports of public interest entities. Part of the 2017–2018 report is included in example 1.7.
EXAMPLE 1.7
Audit Deficiencies
We reviewed key audit areas in audit files at the largest six firms. In our view, in 20% of the key audit
areas that we reviewed, auditors did not obtain reasonable assurance that the financial report as a
whole was free of material misstatement. This compares to 23% in the previous 18-month period ended
31 December 2016 and represents a welcome reduction in the level of findings for the largest six firms.
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MODULE 1 Accounting and Society 33
However, in our view, in 24% of the total 347 key audit areas that we reviewed across 98 audit files
at firms of all sizes covered by our inspections, auditors did not obtain reasonable assurance that the
financial report as a whole was free of material misstatement. This compares to 25% of 390 key audit
areas in the previous 18-month period ended 31 December 2016: see Section A.
Findings from our audit inspection program do not necessarily mean that the financial reports audited
were materially misstated. Rather, in our view, the auditor did not have a sufficient basis to support their
opinion on the financial report.
Source: ASIC 2019, ‘Audit inspection program report for 2017–18’, p. 4, https://download.asic.gov.au/media/4990650/
rep607-published-24-january-2019.pdf.
............................................................................................................................................................................
CONSIDER THIS
Reflect on the role a regulator plays in the surveillance of financial statements and audits. Do you think that
this has an impact on the actions of accountants and auditors? Would it have an impact on your actions as
an accountant or auditor?
1.12 CREDIBILITY OF THE PROFESSION
For accounting to continue to be regarded as a profession, it is important that it is perceived to provide a
public service and contribute to effective governance of organisations, large and small, public and private.
Our technical actions and behaviours as accountants are under scrutiny. The way we act and the work we
perform have a significant impact on organisations and society. As such, when we fail to perform our work
to an adequate standard and organisations experience trouble and distress, the credibility of the profession
is called into question.
CREDIBILITY UNDER CHALLENGE
Some authors argue that the credibility of the profession has declined because of several factors including
accuracy of financial reporting, corporate failures, auditor independence and a lack of audit quality. For
example, Brewster (2003) documents the loss of trust in the accounting profession during 2001 and 2002
in How the Accounting Profession Forfeited a Public Trust and this study was updated by Carnegie and
Napier (2010) who examined the stereotypes used to portray accountants, and found a movement toward
a more negative stereotype.
Accountants and auditors who have not performed their roles effectively are seen as responsible for
the failures and inaccuracies that have led to the decline in credibility. The view is that the accounting
profession did not fulfil its service ideal role as it did not prevent these situations by giving appropriate
advice to managers and/or making appropriate disclosures.
Following the many corporate collapses of the late 1980s, the market collapse of October 1987 (Black
Monday), the corporate collapses in the early 2000s and the GFC in 2008 and 2009, many efforts were
made to make accounting standards more consistent — and these efforts continue today.
KEY ISSUES CAUSING REDUCED CREDIBILITY
Other core problems affecting the credibility of the profession are outlined below. These were highlighted
during the corporate failures of the early 2000s as well as during the GFC.
Creative Accounting
‘Creative accounting’ means using the choices available to present information in ways that do not clearly
represent reality, and which provide a distorted and often favourable view of the organisation.
Many accounting issues from the 1980s remain unresolved, including practices such as capitalisation
of interest expenditure, financial instrument valuation and risk management, formation expenditure being
treated as an asset, mining exploration expenses regularly being capitalised and related party transactions.
The words of Chambers, writing in 1973, are still current:
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If due to the optional accounting rules available to them, the company managers and directors are
able to conceal the drift (in financial position), shareholders and creditors will continue to support,
and support with new money, companies that are weaker than their accounts represent them to be
(Chambers 1973, p. 166).
34 Ethics and Governance
Chambers could just as easily have been writing about corporate collapses that took place in the 1980s,
the 2000s or about the valuation of sub-prime debt and complex financial instruments from 2007 to 2009.
Poor Audit Quality
Poor audit quality refers to the perceived inability of auditors to identify a company in distress prior
to collapse.
The GFC also saw auditors become subject to increased scrutiny (Durkin & Eyers 2009; Eyers 2009).
GFC corporate failures have demonstrated valuation failures especially in relation to financial instruments
and these valuation failures have raised questions about the role and value of auditing (Sikka 2009; Sikka,
Filling & Liew 2009; Woods et al. 2009).
In view of the massive financial bail-outs of many prominent corporations around the globe, Sikka
observed that:
Many financial enterprises have sought state support within a short period of time of receiving unqualified audit opinions. This raises questions about the value of company audits, auditor independence
and quality of audit work, economic incentives for good audits and the knowledge base of auditors
(Sikka 2009, p. 868).
Lack of Auditor Independence
Another issue is lack of auditor independence, where conflicted auditors do not act in the public interest.
Sikka, Filling and Liew (2009), for example, expressed a perennial view of the basic auditing model,
that is, it is ‘flawed since it makes auditors financially dependent on companies’. Consequently, according
to Sikka’s view, auditors will not give objective independent professional judgments because their incomes
depend on the survival of the audit ‘target’. Example 2.13 in module 2, ‘Arthur Andersen’, explores this
issue in detail.
Financial Accounting Distortions
Accounting has played a role in triggering financial distress, especially with mark-to-market techniques
that reduce asset values, and may lead to breach of banking covenants or even default.
It has been proposed that the GFC was at least in part caused by ineffective accounting standards for
complex financial instruments. The role of risk, along with the failure of the various decision-makers to
understand risk and the true nature of ‘complex financial instruments’, has also been a key factor. The fact
that accounting standards did not help has been a matter of professional concern for accountants.
It is worth noting that IFAC commissioned a study in 2002 to look at the loss of credibility in financial
reporting and approaches to resolving the problem.
Critical matters that were identified in the study include:
•
•
•
•
the payment of incentives that encourage the manipulation or misstatement of information
lack of actual or perceived auditor independence
lack of audit effectiveness both through lack of skill or deliberate action
too much flexibility and loopholes in reporting practices (IFAC 2003).
QUESTION 1.13
Outline reasons why the four key issues identified by IFAC (2003) could reduce the profession’s
credibility. What strategies may be useful for reducing or eliminating these problems in future?
Example 1.8 details a case in which a company auditor has successfully identified fraud in an
organisation’s financial records and reported the matter to the regulators.
EXAMPLE 1.8
Armistead Convicted for Accounting Fraud and Misleading an Auditor
Victorian accountant Wayne Allan Armistead was convicted and sentenced on charges related to
accounting fraud in the financial records of Calvary Health Care ACT Ltd by the ACT Magistrate’s Court
that resulted in a company recording a fake profit.
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MODULE 1 Accounting and Society 35
Mr Armistead pleaded guilty to two charges of ‘causing false entries to be recorded in the financial
records’ of Calvary Health Care as well as providing false information to the company auditor.
The charges, which were laid by the Australian Securities and Investments Commission, related to 28
false entries that were made in the accounts of the company that resulted in the misstatement of revenue
for the financial statements in the 2012–2013 and 2013–2014 financial years.
Mr Armistead also provided information about the company to the company auditor between 30 July
2014 and 1 August 2014 that he knew was false.
The fiddling of the company books by Mr Armistead resulted in the company reporting ‘earnings of
$1.925 million in the 30 June 2014 financial report’, a media release issued by the Australian Securities
and Investments Commission said. ‘Once the entries were readjusted to reflect the true financial position,
Calvary Health Care ACT Ltd reported a loss of $9.451 million.’
Mr Armistead was sentenced to a $1000 good behaviour bond for two years and fined $3000 for the
making of false entries into the company accounts. He also copped a further good behaviour bond for
two years and was fined $2000 for lying to the company auditor about the accounts.
The corporate regulator had Mr Armistead’s behaviour brought to their attention by the company
auditor and the matter was prosecuted by the Commonwealth Department of Public Prosecutions.
Source: ASIC 2019, ‘Former chief financial officer convicted of causing false records and providing false information
to company auditor’, https://asic.gov.au/about-asic/news-centre/find-a-media-release/2019-releases/19-037mr-former-chieffinancial-officer-convicted-of-causing-false-records-and-providing-false-information-to-company-auditor.
As we look at corporate failures over the last 30 years, it appears that too often the independence
and professional ethics of accountants failed. Instead, professionals left behind their standards in the
hope of becoming part of an economic revolution related to booming share market growth. The decade
beginning with the failures of 2001 to 2002 has seen the profession come under scrutiny to an extent never
previously seen.
The credibility of accounting as a profession of value has been very much ‘on the line’. Arguably, there
has been a diminution of public trust in the profession’s service ideal and a reduction in its former degree of
autonomy and independence. We now consider the response of the professions and government to restore
credibility to financial accounting, auditing and the accounting profession itself.
RESTORING CREDIBILITY TO ACCOUNTING
Pressure from governments, the investor community, professional accounting bodies and others have
resulted in a number of measures aimed at reducing the likelihood and severity of the corporate failures
that have occurred in recent times. Examples are given below.
• Establishment of the FRC. As detailed earlier, the AASB and the AUASB are no longer controlled only
by the professional accounting bodies. They are controlled by the FRC, a government body set up to
oversee the effectiveness of financial reporting.
• Accounting standards are backed by law. Accounting standards are externally created and enforced by
regulations, meaning non-compliance by a professional accountant can mean both disciplinary action
from their professional body and legal penalties.
• Auditors must apply the code of ethics. The APES 110 Code of Ethics for Professional Accountants also
has legislative application to auditors.
• FRC responsible for auditor independence. The FRC now has direct responsibility for monitoring the
effectiveness of auditor independence. This reduction in autonomy is likely to lead to greater comfort in
the community and less opportunity for abuse by auditors. As a result, this change should help to restore
and maintain professional auditor credibility in the future.
• Enhanced regulation. Laws, regulations and guidance have also been developed globally, including the
Sarbanes–Oxley Act 2002 in the US, COSO 2004 and the extensive process leading to the CLERP 9
Act in Australia.
• Adoption of international standards. Since 2004, many countries have adopted, or are in the process of
adopting, common international standards on accounting, auditing and professional ethics.
• The reduction of the profession’s autonomy (in terms of setting its own rules and guidelines) is one
change that is leading to restored credibility, as externally enforced legislation and rules provides greater
protection and comfort to users of accounting information and society in general.
Individual accounting bodies, such as CPA Australia, have also been active with various initiatives
in support of improved financial reporting, enhanced auditing standards and more effective governance.
The Corporate Governance Council of the Australian Securities Exchange (ASX), the Organisation for
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36 Ethics and Governance
Economic Cooperation and Development (OECD) and the UK Financial Reporting Council have also
undertaken much work. These institutions and their work is covered in module 3.
To restore credibility the underlying problems must be identified, and practical measures put in place
to reduce or eliminate them. The measures described above aim to reduce the likelihood of past issues
being repeated.
If these aims are met, they will help alleviate society’s concerns and provide reassurance that these
issues will not happen again. Success will require the utmost application of all the relevant professional
capabilities that a professional accountant must possess.
1.13 CAPABILITY CONSIDERATIONS
So far, we have been discussing the broader accounting profession, what it means to be a professional
and the issues the profession has been facing. Professional accountants are expected to understand their
professional responsibilities and apply themselves diligently to achieve and maintain these standards. As
such, they have a role to play in improving the credibility of the profession, ensuring the public interest is
served, and making sure clients, employers and the broader community benefit from their skills, knowledge
and decision making.
The CPA Program is a large component of developing technical knowledge to attain professional status.
However, it is also important to develop a broader range of skills. The pathway to becoming a CPA
includes professional mentoring and achieving rigorous technical knowledge requirements, combined with
broader business knowledge and soft skills including communication and leadership. Managing oneself is
fundamental to successfully achieving professional status, and so personal effectiveness becomes another
foundation for a successful career.
BUSINESS LEADERSHIP CAPABILITIES
Professional accountants are well-placed to attain leadership roles within society. These leadership roles
may be as a partner in a professional practice, chief financial officer of a large enterprise or on the board
of a company or not-for-profit organisation.
Leaders are required to develop the strategy, drive change and align the organisation’s structure,
resources and culture with the strategy. Leadership requires vision, energy and drive from the professional
accountant, the desire to be strategic and to be a key contributor to the improvement and strategic growth
of the organisation. As business leaders, and as professionals, accountants must exercise a high degree of
competence and due care, and have a professional obligation to service ideals.
We discussed earlier that professional competence requires not only strong technical accounting skills,
knowledge and experience, but also the desire to actively enhance our professional expertise and insights
through the acquisition of diverse new skills, knowledge and experience. As the professional accountant
enhances their skills, knowledge and experience, they enhance what they can offer society, and in particular
their readiness to be leaders in society.
The skills, knowledge and experience of a professional accountant can be broken into the two key
categories of technical skills and soft skills. Both are vitally important and it is a mistake to concentrate on
one at the expense of the other. Professional capabilities are not simply skills, knowledge nor experience
on their own. Rather, professional capabilities arise over a relatively long timeframe through the steady
accumulation of all the relevant skills, knowledge and experience. There is no clear definition of when we
become professional, but arguably an individual can be regarded as professional when that individual has
sufficient capabilities to make complex and difficult professional judgments and effectively advise others
in respect of those judgments.
TECHNICAL SKILLS, KNOWLEDGE AND EXPERIENCE
From your study and employment, you will have a good understanding of the technical skills, knowledge
and experience (TSKE) that relate to general accounting activities, including:
• financial reporting
• taxation
• finance and financial analysis
• management accounting
• relevant IT and technical communications knowledge
• an understanding of regulations, laws and company structures.
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MODULE 1 Accounting and Society 37
The degree of TSKE required varies according to the tasks being undertaken by the accountant. For
example, an accountant functioning as a company secretary (called ‘public officer’ in some jurisdictions)
for a publicly listed entity must have a strong awareness of financial reporting requirements and the local
stock exchange listing rules.
Some accountants will have TSKE regarding internal audit, external audit and forensic accounting.
Technical requirements will depend on the field of work and the level of detailed skills and
knowledge required.
SOFT SKILLS, KNOWLEDGE AND EXPERIENCE
CPAs must also possess extensive soft skills, knowledge and experience (SSKE). SSKE is primarily (some
might say is all) about people and related issues. More specifically, professional accountants need welldeveloped social skills and capabilities, including the ability to:
• listen
• understand complex and difficult issues and their role in the decisions and information needs of others
• communicate effectively (both verbally and in writing)
• discuss and debate without hostility — a vital aspect of interpersonal skills
• persuade and convince based on logical and reasonable argument — another vital aspect of interpersonal
skills and an important part of leadership
• manage time
• meet deadlines
• build and improve capabilities.
TSKE AND SSKE — CAREER PERSPECTIVES
CPAs are subject to formal continuous professional development (CPD) learning requirements. CPA
Australia recognises both TSKE and SSKE activities as satisfying CPD requirements, acknowledging that
lifelong learning for both activities is vital for professional accountants.
Professional career progression, advancement and promotion within employment, along with higher
status in the profession (as a person becomes a CPA and then an FCPA), are all functions of demonstrated
improvement in TSKE and SSKE capabilities.
Staff from the University of North Carolina (Blanthorne, Bhamornsiri & Guinn 2005) reported that
TSKE are relatively more important in the early years of professional accountants’ actual careers but,
as time passes, and TSKE and SSKE improve and as some CPAs move to partnership (and/or senior
management) level, SSKE becomes relatively more important in career progression.
In fact, Blanthorne, Bhamornsiri and Guinn (2005) found that CPA firms, when selecting candidates for
early career promotions, regarded technical skills of candidates as the most important evaluation criterion
(ranked first on a list of six ranked appointment criteria). However, when seeking promotion later in their
careers (promotion to partnership level), the research found that technical skills moved to fifth place in the
six items.
Further, the ‘interpersonal’ soft skill moved from its previous third place (for early career appointments)
to first place, with leadership in second place and communication in third place for partner appointments.
This demonstrates that accountants need to have a strong foundation of technical skill, but that building
relationships, interacting with staff and clients, and leadership skills are required to further their careers.
.......................................................................................................................................................................................
CONSIDER THIS
Continuing professional development is a CPA Australia requirement. It is easy to focus on technical skills but at this
stage in your career are there any soft skills that you will need to work on?
QUESTION 1.14
Reading 1.3, ‘How “soft skills” can boost your career’, was released in 2005 and is still relevant. It is
valuable in further discussing attributes of soft skills and how these can be important in successful
career development. You should study this now.
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38 Ethics and Governance
SUMMARY
Accountants operate in different sectors. They are relied upon by entities in the private, public and notfor-profit sectors to provide advice on financial and compliance matters, but that is not the only work
accountants are either skilled at or capable of doing. IFAC has long recognised that there are different
streams to accounting. Through its Knowledge Gateway, IFAC provides extensive guidance on many topics
including audit and assurance, governance, sustainability and ethics.
These roles place an inherent obligation on professional accountants to consider stakeholders affected
by their work. One example of this is the preparation of financial statements. There are many stakeholders
that may wish to use financial statements. For example, governments, regulators, shareholders, potential
investors, suppliers, creditors and analysts are all users of financial statements. It is important that financial
statements are prepared in accordance with acceptable standards so that they provide accurate and complete
information in an understandable format.
There are also legal obligations that require accountants to ensure that they act in the public interest rather
than self-interest. For example, there have been numerous instances of distress caused to clients when
accounting professionals acting as advisers put their financial self-interest before the future retirement
benefits being sought by a client. Accountants and other financial advisers are routinely the subject of
enforcement action as a result of regulators expressing concern about their conduct. This has the potential
to do damage to the profession as a whole. Indeed, failings in some areas of professional practice have led
to co-regulation of the accounting profession, whereby external regulation and oversight has been imposed.
During an accountant’s career, there is a clear pattern of growth in skills and knowledge. Early in careers
the focus is on technical skills and personal skills such as time management. Later in careers interpersonal
skills such as communication and negotiation need to be acquired as accountants increasingly interact with
clients and take on leadership roles.
The key points covered in part B of this module, and the learning objective they align to, are
listed below.
KEY POINTS
1.1 Differentiate the roles, relationships and activities of accountants.
• The precise role and activities undertaken by an accountant are largely determined by their work
environment, which may be in public practice, in the private or business sector, in the public sector,
as financial advisers or in the not-for-profit sector.
• Accountants have professional relationships with employers, clients, regulators, employees and
peers. These relationships vary depending on the sector the accountant works in and the nature of
their role. For example, accountants in public companies will engage with management, boards of
directors, employees, investors and suppliers amongst others.
• In each instance, regardless of the specific roles, activities or relationships attached to an
accountant’s work, they are obliged to work in accordance with their code of ethics and other
professional and legal standards.
1.2 Evaluate the challenges faced by the accounting profession in the global context.
• Accounting is a global profession and bodies such as the International Federation of Accountants
have sought to develop and, through member organisations, promote implementation and compliance with global guidance.
• There is a need to build and maintain the credibility of the profession through co-regulatory
processes.
• It is the role of IFAC to ensure that uniform guidance is developed in a range of elements of the
accounting discipline, so that the profession, across the world, has a base level of uniform guidance
on which to draw.
• Several factors, including lack of auditor independence and skill, incentives to misstate financial
information and too much flexibility in reporting practices, have resulted in a reduction of the
credibility in the account profession.
• Several strategies have been put forward to restore credibility. These include appointment of
auditors by an independent body and heavier penalties for non-compliance.
1.3 Explain the importance of soft and technical skills required of accountants.
• Accountants require a mix of technical, interpersonal and organisational skills.
• Early in an accountant’s career the focus is on technical skills.
• As an accountant’s career progresses, and they need to interact more with clients and may start to
manage staff, the development of interpersonal and organisational skills becomes more important.
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MODULE 1 Accounting and Society 39
• Interpersonal and organisational skills are often referred to as ’soft skills’ and cover areas such as
communication, persuasion, negotiation and leadership.
• Accountants continue to develop knowledge, skills and competencies throughout their working
lives through professional experience and continuing professional development activities.
REVIEW
This module explored what it means to be a professional accountant and the need to combine technical,
interpersonal and organisational skills with a commitment to the ethos and core values of the profession
in order to properly fulfil the demands and obligations of their role.
A recurring theme throughout this module has been the overarching obligation of the professional
accountant to put the public interest ahead of self-interest. This obligation guides the conduct of the
accounting profession in its work to provide useful information to support high-quality decision making.
Accountants must be capable of making professional ethical choices in complex circumstances that often
involve competing interests and degrees of uncertainty.
The accounting profession has been confronted with various challenges over the past few decades. This
module covered the responsibility that the accounting profession, in general, and professional accounting
organisations, in particular, have to respond to these challenges and ensure that society places value on and
benefits from the work of accounting professionals.
The core attributes of a profession represent and reflect both the value it creates and the way society
recognises this value. One core attribute is the privilege to self-regulate. CPA Australia has procedures
in place to ensure its members meet the required standards of professional conduct and the measures to
monitor and manage members’ conduct. Members can be subject to disciplinary action if allegations of
misconduct are proven against them and, in some cases, members may be struck off the membership
register. At present, accounting is co-regulatory, with external oversight imposed on the profession.
Professional accountants must be enquiring, innovative, measured and courageous in making ethically
sound, balanced professional judgments. To preserve the integrity of the profession and the trust of society,
acting in the public (rather than self) interest should be a fundamental goal of professional accountants.
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Sikka, P, Filling, S & Liew, P 2009, ‘The audit crunch: Reforming auditing’, Managerial Auditing Journal, vol. 24, no. 2,
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MODULE 1 Accounting and Society 41
MODULE 2
ETHICS
LEARNING OBJECTIVES
After completing this module, you should be able to:
2.1 explain the concept of professional and business ethics
2.2 discuss the key philosophical approaches to ethics and how these impact on the professional’s ethical
decision making
2.3 apply APES 110 Code of Ethics for Professional Accountants (including Independence Standards)
2.4 analyse and resolve ethical dilemmas in accounting
2.5 apply ethical decision-making models
2.6 discuss the impact of decision making and actions on society.
ASSUMED KNOWLEDGE
Candidates will have completed module 1.
LEARNING RESOURCES
Each of these resources is available on the APESB website at www.apesb.org.au. Candidates are encouraged
to download their own copy and read the guidance in full. Printing whole documents should not be necessary
except where you want to specifically focus on parts that will be examinable as noted throughout the text.
• APES 110 Code of Ethics for Professional Accountants (including Independence Standards) (APESB 2018)
• APES 230 Financial Planning Services (APESB 2013)
• APES GN 40 Ethical Conflicts in the Workplace—Considerations for Accountants in Business (APESB 2015)
PREVIEW
In module 1, we discussed what it means to be a professional accountant. We now extend this discussion to
examine the practical implications of professional ethics, based on the notions of the service ideal and the
public interest. Professional ethics extends beyond compliance with written codes and laws to also include
the ethical commitment of the professional person to act in the best interests of society.
Written codes and relevant rules establish the expectation and provide the principles for ethical
conduct. However, in practice many situations that involve ethical issues cannot be resolved by the simple
application of rules. Rather, the situation must be analysed from an ethics perspective to reach an ethical
decision. In this module, we discuss the notion of professional ethics and the analytical tools that guide
accountants and help them resolve ethical problems and dilemmas. These tools include a code of ethics
for professional accountants, philosophical theories of ethics and ethical decision-making frameworks.
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PART A: PROFESSIONAL ETHICS
INTRODUCTION
Ethics essentially deals with what is ‘right’ and ‘wrong’ and how people should act when faced with a
particular situation. The Chambers Dictionary defines ethics as ‘a code of behaviour considered correct’.
Professional ethics is the application of ethical principles or frameworks by professionals who have
an obligation to act in the interests of those who rely on their services as well as in the best interests
of the public. Ethical principles include integrity, objectivity, professional competence and due care,
confidentiality and professional behaviour. By acting ethically, professionals maintain the credibility of
the profession.
Any professional ethics framework adopted must be understood by members of the profession so that it
forms the basis for sound and consistent ethical behaviour. Later in this module, we will explore APES 110
Code of Ethics for Professional Accountants, the professional ethics framework issued by the Accounting
Professional Ethical Standards Board (APESB 2018).
The ethical responsibilities of a professional accountant include:
• the exercise of reasonable skills and diligence
• adherence to a professional code of ethics and standards
• the cautious application of relevant knowledge and experience
• professional scepticism to ensure that any observed discrepancies are properly followed up and
investigated.
A professional accountant is objective, takes full responsibility for the tasks they are entrusted to do,
adopts proper planning and control procedures, and possesses the integrity to maintain a professional
approach to work.
.......................................................................................................................................................................................
CONSIDER THIS
Reflect on what you understand to be the meaning of ethics at this point of your reading in the module. Write a note
somewhere. Come back to it at the conclusion of the module to see whether you would change what you have
written.
2.1 IMPACT OF ETHICAL OR UNETHICAL DECISIONS
APES 110 (para. 200.2) outlines the role of members in business as:
Investors, creditors, employing organisations and other sectors of the business community, as well as
governments and the general public, might rely on the work of Members in Business. Members in Business
might be solely or jointly responsible for the preparation and reporting of financial and other information,
on which both their employing organisations and third parties might rely. They might also be responsible
for providing effective financial management and competent advice on a variety of business-related matters.
In many cases, the information provided will be the result of decisions that members make when
compiling or preparing the information.
The discussion of ethical issues is not a theoretical pursuit. Decisions have an effect on others and
ourselves, and can be beneficial or may cause significant harm. For example, ethical reporting of a poor
financial position may lead to the failure of an organisation. Stakeholders may lose confidence in an
organisation. Jobs may be lost. Creditors and suppliers may lose monies owed to them as a result of an
entity trading when it should have ceased plunging itself further into debt. Despite this, ethical action is
still desirable as it is likely to limit losses and lead to faster resolution of issues. It also respects the rights of
all stakeholders involved to know the true state of affairs, despite the negative outcomes for stakeholders.
Consider the role played by incentive payments for advisers encouraged to sell more financial products
to customers. Some advisers sold products they knew were unsuitable for clients or generated fraudulent
documents in order to get commissions. Customers later complained because the cost of poor adviser
behaviour was financial hardship for the customer and also the financial institution. There were, for
example, financial advisers who lost their jobs and regulatory registration because they failed to behave
ethically while trying to meet performance criteria set by their institutions. The behaviour of individual
or groups of advisers, which was outlined in detail during the royal commission into the financial
services sector, led to banks establishing remediation schemes to compensate customers for lost funds and
financial distress.
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MODULE 2 Ethics 43
Another example of the way in which some entities behave that impacts on the broader community
is the failure of companies to report correctly in accordance with accounting standards. The Australian
Securities and Investments Commission (ASIC) conducts financial reporting surveillance and seeks
financial statement amendments from entities that failed to properly apply a particular accounting standard.
Accounting standards exist as a generally accepted set of principles for the preparation and presentation
of financial statements. Breaches of accounting standards result in a set of financial statements that a user,
irrespective of the stakeholder group to which they belong, may be misled. In circumstances where the
financial statements are relied on by an investor or other stakeholder, this can lead to incorrect judgments
being made about the governance of the entity or poor decisions about continuing investment in a business.
The regulator is empowered to request correction of the financial statements and, at times, court action can
be taken to penalise companies that have transgressed.
The impact of unethical decisions can be considered in relation to the whole profession and at the
individual level as well. The two levels are connected because the ethical failings of individual accountants
(who may suffer personal consequences as a result) also affect the overall profession, which suffers reduced
credibility and increased restrictions on its ability to act autonomously and to self-regulate.
Decisions that are not in line with accounting professional standards and legal obligations can result in
loss of membership, fines and even imprisonment. Therefore, it is important for professional accountants
to carefully assess decisions when faced with ethical choices to ensure the decisions they make are
satisfactory, both to other stakeholders and to themselves. Further examples are presented at the end of
this module.
A benefit of applying the frameworks that we will be describing in this module is that it helps us focus
not only on ourselves, but also on others who will be affected by our decisions. These frameworks can
guide the professional accountant to the most ethical decision, even when the most suitable option is not
readily apparent.
It is also appropriate to highlight the dilemma faced by managers who deal with the consequences of
unethical conduct by employees, contractors and others who are connected with the business. One model of
resolution that is worth noting was promoted by the late Doctor Rushworth Kidder, an ethicist (Christenson
1996). Doctor Kidder outlined a series of approaches to deal with ethical dilemmas in different parts of
life. These involved understanding that not all decisions by employers and others in authority relate to
things that are good or bad. The most challenging ethical dilemmas that a manager may face can be related
to deciding what to do when two outcomes can be deemed right. The Kidder approach is discussed in the
following section.
2.2 ETHICS — AN OVERVIEW
So far in this subject we have looked at a variety of activities and attributes that are relevant to professional
accountants. We have identified that accounting has an impact on society and that accountants are actively
involved in creating social outcomes and social change. To be professional, the activities of accountants
need to be pursued appropriately and, where deliberate social outcomes are intended, they must also be
pursued in an appropriate manner.
By what standard is appropriate behaviour to be measured? According to whose judgments or
assessments? Every individual is different and will form their own ethical assessment in a given situation.
However, ethics is subjective, cast from personal upbringing and experience and from personal views on
philosophies of life, religion and similar concepts.
Therefore, one person’s ethical code may judge an action to be ethical, but another’s may not. To get a
more definitive understanding of ethics, we need to delve further to contemplate ‘What exactly is ethics?’
and ‘How does ethics relate to professional ethics?’
Sociologist Raymond Baumhart conducted a survey of business people in the early 1970s by asking
them ‘What does ethics mean to you?’ Some of the responses he obtained were:
• Ethics has to do with what my feelings tell me is right or wrong.
• Ethics has to do with my religious beliefs.
• Being ethical is doing what the law requires.
• Ethics consists of the standards of behaviour our society accepts (Baumhart, cited in
Mitchell 2003, p. 8).
However, simply equating ethics with feelings, religious beliefs, following laws and social behaviour
fails to identify an important aspect of ethics. Ethics needs to have a systematic process to create a coherent
and consistent approach to resolving issues. Undertaking actions based on one’s feelings of right or
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44 Ethics and Governance
wrong is arguably a good approach — but, without any systematic support or structured approach to
making ethical decisions, relying on feelings is neither convincing nor consistent. We recommend using
a systematic approach to resolve ethical issues, and in this module we introduce structured approaches to
resolving ethical issues that provide an alternative to a more instinctive approach. It is beyond the scope
of this module to discuss the differences and similarities of ‘ethics’ and ‘morals’. In many circumstances,
the two terms can be used interchangeably.
There is a difference between following laws and acting ethically. Just because you are complying with
the law does not mean you are acting ethically. An example of this situation can be seen in example 2.1,
which examines the actions of the company James Hardie in dealing with its asbestos liabilities.
EXAMPLE 2.1
James Hardie Industries NV
In February 2007 ASIC commenced civil penalty proceedings against a number of former directors of
James Hardie Industries Ltd (JHIL). This was in relation to disclosures by James Hardie in respect to the
adequacy of the funding of the Medical Research and Compensation Foundation (MRCF) for victims of
asbestos-related diseases (ASIC 2007).
Prior to ASIC commencing its proceedings, the Special Commission of Inquiry into the MRCF released a
report in September 2004. Commissioner Jackson QC raised serious issues about corporate governance
and disclosure, and particular concerns about potential breaches of the Corporations Act. In the Report
of the Special Commission (Jackson 2004), Commissioner Jackson stated:
There was no legal obligation for JHIL [emphasis in original] to provide greater funding to the
Foundation, but it was aware – indeed, very aware because it had made extensive efforts to
identify and target those who might be “stakeholders”, or were regarded as having influence with
“stakeholders” – that if it were perceived as not having made adequate provision for the future
asbestos liabilities of its former subsidiaries there would be a wave of adverse public opinion which
might well result in action being taken by the Commonwealth or State governments (on whom much
of the cost of such asbestos victims would be thrown) to legislate to make other companies in the
Group liable … (para. 1.8).
The James Hardie Group has also indicated . . . (including that it is under no legal obligation to do
so), that it is prepared to fund the future asbestos liabilities. In my opinion it is right that it should do
so (para. 1.23).
Source: Extract from © State of New South Wales
It is useful to consider the circumstances underlying the James Hardie case in the context of the work
of the late Dr Rushworth Kidder. Dr Kidder offered a different way of looking at ethical dilemmas in
circumstances where managers, parents and others struggled to identify the best course of action. The
Kidder philosophy identified four types of ethical dilemmas. These types were:
(1) Truth versus loyalty. You are a child. Your best friend has broken a window at school and has confessed
to you in confidence. The principal asks you if you know who did it. Do you tell the truth or evade the
question and remain loyal to your friend?
(2) Individual versus group. In wartime, a downed pilot is being hidden by the residents of a village
occupied by enemy soldiers. The soldiers will shoot one village resident every hour until the pilot
is surrendered. You are the mayor. Whose life do you save?
(3) Short-term versus long-term. You are a single parent with two small children. To qualify for a much
better position at work, you need an MBA which will require at least two years of classes and study
on nights and weekends. Where do you devote your time?
(4) Justice versus mercy. Your office manager confesses to you that she has been stealing money from the
office account to buy medicine for her ailing father. Her father has died, and she offers you a check
from the insurance proceeds to pay you back. After you cash the check, do you fire her or forgive her?
(Christenson & Burke 1996)
The categories put forward by Dr Kidder test what individuals believe is important in a specific situation.
These are not easy decisions. Consider the last category referring to the concept of ‘justice versus mercy’.
Terminating the employee for her conduct could be justified because the employee had been stealing funds
from the company, but is a more merciful approach, understanding the situation the employee was facing,
more appropriate here? Would the James Hardie case fall into the fourth category of justice versus mercy?
There was no obligation on the company to pay funds into a Foundation but is it right (morally correct)
that it did so?
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MODULE 2 Ethics 45
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CONSIDER THIS
Consider the four categories of ethical dilemma described by Dr Kidder and identify a situation in your professional
and personal life in which you have confronted similar challenges. Reflect on how the issue was resolved and whether
you believe it was resolved in an appropriate way.
2.3 ETHICAL CHALLENGES WITHIN THE
ACCOUNTING PROFESSION
Accountants face many difficult ethical situations. It is important to understand that ethical dilemmas can
arise throughout your daily professional life; they do not necessarily involve large-scale activities, but
can be simple events or decisions that at first glance do not appear unusual. As accounting work often
involves decisions about money and other resources, people will often have strong motivations to act in
their own self-interest. This can lead to pressure on the accountant and may make it difficult to act in an
objective manner.
The current environment of continuous and rapid change, combined with the complexity of accounting
work, provides many challenges for accountants. This creates many types of pressures that are compounded
by the requirement to comply with deadlines. Such pressures may create the risk that integrity or
competence will be subordinated to expedience.
ETHICAL CHALLENGES FACED BY MEMBERS IN PRACTICE
AND IN BUSINESS
Various surveys have been published in recent years asking accountants what they believed to be the most
frequent ethical issues they have confronted through work. The International Federation of Accountants
(IFAC) published the results of a survey of Australian practitioners conducted by Dr Cristina Neesham
and Associate Professor Eva Tsahuridu. The research team involved in this study, which was funded by a
CPA Australia, surveyed 238 accounting professionals the worked in either practice or business. The most
frequent ethical issue that practitioners in business or public practice encounter is misleading reporting with
40.88% of the sample citing this as a prominent ethical concern. Fraud and tax evasion are in second place
with 13.87% of the sample highlighting this issue. Misuse of funds and insider trading are encountered
less frequently with 1.46% of the sample reporting occurrences of both of these types of ethical challenges.
These results are shown in figure 2.1.
FIGURE 2.1
Most frequent ethical issues encountered by accountants
Issue
Misleading reporting
40.88%
Fraud/Tax evasion
13.87%
11.68%
Lack of transparency in accounting decisions
Breach of confidentiality
8.03%
7.30%
Misrepresentation of expertise/Cheating
Overcharge of fees to client/Overservicing
6.57%
Bribery
4.38%
Favouritism or bias
2.19%
Cover-up of accounting errors
2.19%
Misuse of funds
1.46%
Insider trading
1.46%
0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
Source: Neesham, C & Tsahuridu, E 2018, ‘Assessing and improving professional accountants’ ethical capability’, IFAC,
www.ifac.org/global-knowledge-gateway/ethics/discussion/assessing-and-improving-professional-accountants-ethical.
The research identified three key reasons why misconduct occurred within organisations, as shown in
figure 2.2. These were: pressures from clients (21.43%), conflicts of interest (18.91%) and pressure from
corporate management or a board of directors (17.65%).
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46 Ethics and Governance
Reasons for misconduct
FIGURE 2.2
Cause
Pressure from client
21.43%
Conflict of interests
18.91%
17.65%
Pressure from management/board
42.02%
Other/Not stated
0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
Source: Neesham, C & Tsahuridu, E 2018, ‘Assessing and improving professional accountants’ ethical capability’, IFAC,
www.ifac.org/global-knowledge-gateway/ethics/discussion/assessing-and-improving-professional-accountants-ethical.
The survey results detailed the most frequent responses of accountants to situations in which they
encounter ethical challenges. As shown in figure 2.3, accountants who report resisting pressure or saying
‘no’ made up 29.66% of the sample surveyed. Other strategies included the seeking of advice (16.35%),
educating fellow professionals (14.07%) and educating clients (11.79%).
Accountants responses to ethical challenges
FIGURE 2.3
Action
Resisted pressure/Said ‘no’
29.66%
Sought advice
16.35%
14.07%
Educated fellow professionals
Educated client
11.79%
Reported issue to management
11.79%
Documented events in writing
10.27%
Resigned
3.80%
Admitted mistake
1.52%
Compromised within legal limits
0.76%
0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
Source: Neesham, C & Tsahuridu, E 2018, ‘Assessing and improving professional accountants’ ethical capability’, IFAC,
www.ifac.org/global-knowledge-gateway/ethics/discussion/assessing-and-improving-professional-accountants-ethical.
The research provides evidence that accountants encounter ethical challenges on a daily basis and an
examination of ethical and philosophical issues is not merely an academic exercise. Professionals must
ensure that they behave in a manner that is appropriate, irrespective of the context in which they work.
.......................................................................................................................................................................................
CONSIDER THIS
Visit the IFAC website and read the article in which the preceding survey results are published. Reflect on any
other issues you feel are of interest or that provoke further thought on your part. (www.ifac.org/global-knowledgegateway/ethics/discussion/assessing-and-improving-professional-accountants-ethical)
Examples 2.2 and 2.3 illustrate various situations encountered by professional accountants that highlight
the complexity of conflicts and choices that accountants face daily in their professional lives.
QUESTION 2.1
Read examples 2.2 and 2.3 and complete the following.
(a) Briefly summarise the ethical dilemmas that Gil and Jane face.
(b) For each of these dilemmas, state which of Kidder’s four categories summarises the problem.
(c) Describe two courses of action that each accountant may take.
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MODULE 2 Ethics 47
EXAMPLE 2.2
Keep on Trucking
An entrepreneurial spirit, Jack Davis had moved out of his parents’ home at the age of 20, and into their
garage. He had successfully lobbied the local council to have the garage re-designated as a subplot of
his parents’ house, and hence a separate address: ‘303a’. As the area had mixed zoning, Jack began to
start a number of businesses. A voracious consumer of social media and online material, he was quick to
know what businesses might become fashionable, and set about creating low-cost start-ups, gathering
the requisite rights, and then selling them on.
Having gained sufficient capital in these ventures, Jack began his own ‘bricks and mortar’ business,
a Texas BBQ restaurant that would be delivered solely via food trucks. He refitted the unzoned ‘303a’
address as a smokehouse kitchen and bought two ageing trucks. Running a comprehensive social media
promotion for the business, Jack soon attracted investment, and decided to grow the business and seek
partnerships. Gil White, a friend who had recently completed his CPA, bought one of three 20% stakes in
the business and took over finance and accounting for the business.
Over the next six months the business expanded; Jack and Gil bought and refitted three more trucks
and took on several employees. At the end of this period, Jack prepared a memorandum for the partners,
recommending that they sell the business, as interest was high and they could probably net a considerable
profit. Gil was a little surprised, as the business seemed to be growing healthily. He asked Jack if it was
the best time to sell, and whether perhaps they should hang on to the business for another year or so.
Jack revealed that he’d heard rumours that there were plans to restrict the movements of food trucks,
heavily pushed by local restaurant owners who were feeling the pinch of the competition. This would likely
impact on the company’s viability in its expanded state. Gil realised that Jack was probably right, and that
exiting the business was the prudent move. Jack asked Gil to prepare the projected estimates in order to
begin the process of courting buyers. Gil pointed out that the estimates would depend heavily on whether
the council restricted food truck operations. Jack asked Gil to make no mention of the council plans, as
nothing was yet official, and few people were aware of the rumours. Jack had been closely monitoring local
government planning since having the garage re-designated. Furthermore, if they projected a downturn
in revenue then they would likely make a severe loss on the sale.
EXAMPLE 2.3
Sustainable Distribution
Dwyer worked as an auditor for several companies, but one source of regular work was a timber
decking business, Sustainable Solutions, an intergenerational family business now managed by two high
school friends. Jane also worked as a personal accountant for the two managers. A married couple,
Joe and Debbie Frazer, ran the company together after Joe’s father had retired from the position, until
Debbie largely retired to raise their two children. After steadily growing the business over more than a
decade, Joe and Debbie separated due to growing marital difficulties. In the following year Joe decided
to significantly expand the business, proposing the acquisition of a second distribution centre and to
expand the company’s fleet of light trucks, and sought Jane’s assistance in signing off on the proposal.
Jane looked at Joe’s projected estimates, and was not convinced. The proposal required significant
outlay on infrastructure, much of which would be borrowed against the value of the business. While
Sustainable Solutions maintained a constant client base, it was not clear that they could expand this
base proportionally to Joe’s proposed business expansion. Jane suspected that the move was intended to
embed Sustainable Solution’s current revenue in the new venture for the foreseeable future. She suspected
that Joe probably feared that a divorce may be imminent, involving a subsequent division of assets. By
taking on this debt, Joe could probably delay any division of revenue or company assets with Debbie.
Jane felt she had a duty to Debbie as much as Joe.
2.4 THE ACCOUNTING WORK ENVIRONMENT
Today’s accountants are critical thinkers and articulate professionals respected for their technical and
professional competence. The work undertaken by professional accountants is diverse, challenging
and intellectually stimulating. This reflects the complex and often rapidly changing environments that
accountants work in. These environments are typically shaped by factors such as new and evolving
technologies, changing market conditions, legislative and regulatory developments, and the needs of a
diverse range of parties engaged in making resource-allocation decisions and accountability evaluations.
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48 Ethics and Governance
The kinds of characteristics needed for success, in addition to a comprehensive knowledge of accounting
and finance, are problem solving, strategic thinking, ethical behaviour and a mastery of interpersonal
relationships. Accountants are often trusted advisers to executive management. As such, they are behind
nearly all business decisions — local, national and international.
Like most professionals, accountants work in an environment of high expectations and rewards.
However, rewards are often associated with responsibility and occasionally with extreme pressure. The
complexity of the work environment and the demands of a dynamic regulatory regime sometimes create
conditions that make it difficult for accountants to operate effectively.
SUMMARY
The decisions made by professional accountants have consequences for themselves, the profession and
society. In this part of the module, we have described professional ethics as the application of ethical
principles and frameworks by professionals to guide their own behaviours. Ethical decisions are those
that support the overall objective of serving the interests of society. Unethical decisions undermine
the credibility of the entire profession and increase the likelihood that external regulators will impose
restrictions on the profession’s ability to act autonomously and self-regulate. For individuals engaging
in unethical conduct, consequences can include fines, loss of membership of the professional accounting
body and even imprisonment.
A career in the accounting profession will inevitably involve dealing with many ethical issues.
Key sources of pressure to act contrary to professional ethics include clients, corporate management
(e.g. the board of directors) and conflicts of interest. The most frequently encountered ethical issues revolve
around misleading reporting, fraud, tax evasion, lack of transparency and breaches of confidentiality.
Mere compliance with legal requirements does not ensure ethical behaviour. The use of a set of principles
provides the accountant with a clear and coherent basis for thoughts and actions, and a decision-making
framework guides the accountant to an ethical decision, even when uncertainty and conflicting interests
are involved.
To help with this, the next section provides a detailed overview of ethical theories, which is followed by a
practical examination of APES 110 Code of Ethics for Professional Accountants (including Independence
Standards).
While some of this discussion is quite theoretical, it is important for you to develop a clear
philosophy and understand your own ethical thoughts and approaches. You should consider each
theory carefully and identify which most closely aligns with your own view of what is ethical.
The key points covered in this part, and the learning objective they align to, are listed below.
KEY POINTS
2.1 Explain the concept of professional and business ethics.
• Professional ethics is the use of principles and frameworks to guide decisions and behaviours that
accord with the interests of clients and society and reflect the expectations of the profession.
• In the professional context, ethical principles include integrity, objectivity, professional competence
and due care, confidentiality and professional behaviour.
• Decisions relating to ethics are often complex, involving conflicting interests and uncertainty.
• Research suggests people have varying personal definitions of ethics. Similarly, ethicists offer
different conceptions of ethics and what constitutes an ethical dilemma.
• A set of ethical principles provides a coherent and consistent basis for decisions and actions and
thus is more useful in the professional context than reliance on personal feelings, religious beliefs
or social norms.
• CPA Australia funded research that found that accountants regularly confront serious ethical issues
but have established strategies and actions to deal with them.
• Ethical challenges facing accountants include conflicts of interest and pressure from clients
and corporate management. The most frequently encountered ethical issues involve misleading
reporting, fraud, tax evasion, transparency and confidentiality.
2.6 Discuss the impact of decision making and actions on society.
• The decisions that accountants make and those that are made by others based on information
provided by accountants often have significant consequences for stakeholders.
• Ethical financial reporting provides all stakeholders with true information relating to an entity’s
financial position and performance, enabling stakeholders to make properly informed decisions.
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MODULE 2 Ethics 49
• Unethical financial reporting misleads some stakeholders, leading to decisions different from those
that would be made with the true information.
• Both ethical and unethical reporting can have positive and negative consequences for various
stakeholders and the entity itself.
• Ethical financial advice puts the client’s interests ahead of the adviser’s interests. Unethical financial
advice may benefit the adviser at the expense of the client’s interests.
• Decision making by professional accountants that does not accord with the profession’s ethical
standards impacts negatively on the profession as a whole and on society’s trust in the profession.
This may result in increased external regulation.
• On an individual level, accountants that breach ethical standards may face penalties and lose their
membership of their accounting body.
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50 Ethics and Governance
PART B: ETHICAL THEORIES
INTRODUCTION
Theories are models constructed by thinkers that present one way of explaining certain kinds of phenomenon. Ethics comes under the general category of theories known as philosophy. Some categorise
ethics as moral philosophy.
There are differences between the ways in which ethics are considered in Western and Eastern cultures.
The Western approach to ethical theory tends to orient itself around the objective of finding the truth in a
situation. Western ethical theories are predominantly discussed in this subject but it is important to note
that cultural traditions, customs and religious beliefs may govern how people behave.
Eisenbeiss (2012) describes the different cultural traditions that must be considered when examining the
different principles and backgrounds that constitute Western and Eastern philosophies using the example
of leadership (see figure 2.4). Eisenbeiss states that Western theories in the area of ethics and leadership
have their historical roots in the work by ancient theorists or ethicists such as Plato and Aristotle. Eastern
traditions have their historical roots in Confucianism, which has an emphasis on social order, responsibility,
reverence for a family. More modern authors in the Western traditions of ethics and leadership are Kant,
Rawls and Jonas with Tagore being a more current philosopher in the Eastern tradition.
It should also be noted that religions play a large part in the way individuals and groups engage with each
other. Religions in the Western tradition that have shaped various aspects of thought include Christianity,
Judaism and Islam. Islam is classified as a Western religion by Robinson and Rodrigues (2006; cited in
Eisenbeiss 2012) because it has its origins in the Abrahamic tradition. Each of the Abrahamic faiths has
its own traditions.
FIGURE 2.4
Religious traditions
Moral philosophy
World religions
Ancient
Modern
Western tradition
Eastern tradition
Plato, Aristotle
Kant, Rawls, Jonas
Confucianism
Tagore
Christianity, Judaism, Islama
Buddhism, Hinduism, Sikhism,
Shinto, Daoism and Jainism
a Islam is classified as a Western religion due to its Abrahamic roots but is predominantly practised in Northern Africa and
Eastern regions of the world (Robinson and Rodrigues, 2006).
Source: Eisenbeiss, SA 2012, ‘Re-thinking ethical leadership: An interdisciplinary integrative approach’, The Leadership Quarterly,
vol. 23, no. 5, pp. 791–808. http://dx.doi.org/10.1016/j.leaqua.2012.03.001.
It is important to understand that there are other sources of ethical guidance, but that this part of
module 2 focuses on sources of Western ethical thought. In Western ethics, ethical theories are attempts to
either explain human behaviour as it is, which is called descriptive ethics, or provide a framework for how
people should behave, which is called normative ethics. One way of thinking about these approaches is
that any descriptive theory of ethical behaviour explains existing behaviour without necessarily seeking to
change it while normative ethical theories set norms for behaviour. In this course, the focus is on normative
theories of ethics.
2.5 NORMATIVE THEORIES
Normative theories of ethics propose principles that distinguish right from wrong by establishing a norm
or standard of correct behaviour that should be followed at all times. The awareness and application of
such theories provide two key functions. First, they provide a framework for judging the rightness of an
act or decision after the event has occurred, and secondly, they provide a framework for decision making to
resolve ethical problems. Applying different ethical theories involves examining the situation or dilemma
from multiple perspectives.
Normative ethics are split into two specific categories: ethics of conduct and ethics of character.
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MODULE 2 Ethics 51
ETHICS OF CHARACTER
Ethics of character is also called virtue ethics. This is an area of ethical theory that calls upon people to
examine the various traits of individuals in order to determine whether they have behaved in a manner that
is wrong, based on that particular assessment. It has its origins in the thinking put forward by theorists
such as Aristotle. We will examine ethics of character in further detail later in this part of the module.
ETHICS OF CONDUCT
Ethics of conduct can be split into two prominent categories: teleological (or consequential) and
deontological (or non-consequential or duty-based). These two categories and the types of theories that
are classified within these categories are discussed in the following sections, but the key schools of thought
may be briefly summarised as follows.
• Teleological theories centre around the need for individuals and groups to consider the consequences
of actions. The ends justify the means. Two major theories in this category take alternative perspectives
on the object of the consequences/benefits.
– Egoism: focuses on taking actions that result in the best consequences for the individual taking the
action/making the decision.
– Utilitarianism: focuses on taking actions/making decisions that will result in the greatest good for the
greatest number of people, including possibly, but not necessarily, the person making the decision.
• Deontological theories centre round the need for individuals and groups to consider the intent of actions.
Some actions will never be justified despite potentially positive consequences and conversely some
actions may be justified despite the potentially negative consequences. Two major theories in this
category take alternative perspectives on what constitutes appropriate intentions.
– Rights: focuses on taking actions that intend to recognise the rights of the parties involved
– Justice: focuses on taking actions that intend to be fair and equitable to the parties involved.
Figure 2.5 illustrates the theories that fit into these two categories and two other key areas of moral
philosophy (ethics) — descriptive ethics and ethics of character.
FIGURE 2.5
Theories of ethics
Normative ethics
Ethics of conduct
Teleological
(Consequential)
theories
Egoism
Utilitarianism
Descriptive ethics
Ethics of character
Deontological
(Non-consequential)
theories
Duties
Virtue ethics
Rights and justice
2.6 TELEOLOGICAL (CONSEQUENTIAL) THEORIES
Teleological theories determine right from wrong or good from bad, based solely on the results or
consequences of the decision or action. As teleological theories evaluate the impact of decisions or actions
on outcomes, they are termed ‘consequential’. Generally, if the benefits of a proposed action outweigh the
costs, the decision or action is considered ethically correct. Conversely, if the harms outweigh the benefits,
the decision or action is considered ethically wrong. The terms ‘benefits’ and ‘costs’, used for the purpose
of weighing up consequences, include both tangible and psychological outcomes. Benefits may therefore
include pleasure, health, life, satisfaction, knowledge and happiness. Likewise, costs may include pain,
sickness, death, dissatisfaction, ignorance and unhappiness.
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52 Ethics and Governance
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CONSIDER THIS
From whose perspective should the consequences of a decision or action be evaluated? Do you think evaluation
should be based on the consequences for the decision maker or for those who are affected by the decision?
There is no correct answer to these questions. Rather, these different approaches are represented by two
traditional teleological theories: egoism and utilitarianism. In brief, egoism evaluates the rightness of an
action from the perspective of the decision maker (self) whereas utilitarianism evaluates the rightness
of an action based on consequences for others. Because each person is a product of a number of
factors including education, culture and background, different individuals may choose to apply these
approaches differently. Remember that these theories are conceptual approaches to how we ‘ought to’
behave, not how we do behave. When it comes to making decisions, people are likely to make a decision
based on a mix of different types of ethical approaches, and their approach may also depend on the
particular situation.
EGOISM
An ethical egoist approach describes the idea that it is right for a person to pursue an action in their own
self-interest, assuming that everyone else is entitled to act in their own self-interest as well. As stated
previously, this is an ethical theory so, in reality, people are more likely to have a mix of different ethical
approaches. In this respect, ethical egoism is different from psychological egoism, which describes how
people tend to behave, without implying an ethical judgment about how they should behave.
Ethical egoists evaluate the rightness of a proposed action by choosing a course of action that maximises
the net positive benefits to themselves. An example of egoism would be a company that only releases
information or clarifies issues when it is in the company’s self-interest for the information to be released.
Such companies display ethical egoism when they support this behaviour as an appropriate general rule.
Based on the assumption that human beings tend to act in a way that brings them some form of happiness
or avoids some form of unhappiness, ethical egoism contends that this reality should be accepted as a
social norm.
The term ‘happiness’ has a number of connotations, but the characteristics of happiness generally include
a feeling of joy or delight, satisfaction or peace of mind, and the sense of achieving one’s goals or desires.
Correspondingly, unhappiness may be defined as a feeling of pain or sadness, frustration and the sense of
failure in achieving one’s goals or desires. Although this module refers to an egoist as a single person, the
term ‘egoist’ can also refer to a group of people or an organisation.
One difficulty with egoism is that acts of self-interest are commonly misunderstood as acts of selfishness.
According to this view, egoists are people who demonstrate a lack of concern for the well-being of
others and will justify questionable acts such as discrimination or dishonesty if they promote self-interest.
However, self-interest may also include concern for the well-being of others, and can sometimes contradict
selfishness. We use the term enlightened self-interest precisely to highlight situations where acting
selfishly may not be in our own self-interest.
EXAMPLE 2.4
Egoism and Providing a Professional Opinion
Consider an accountant who is asked by a client for a professional opinion. Suppose that the opinion
would be to the detriment of the client, who has threatened to seek the services of another professional
accountant if the news is not favourable.
According to ethical egoism, the accountant should provide full and accurate advice and allow the client
to employ the professional adviser of their choosing. It is not in the accountant’s long-term interest, nor in
the interests of those who rely on their advice, to offer less than frank or full advice. Overall, the pursuit of
self-interest will generally promote one’s well-being, but selfishness tends to ignore the interests of others
when they ought not to be ignored. Therefore, ethical egoism contends that the pursuit of self-interest
should not knowingly come at the expense of one’s well-being or that of others.
Ethical egoism also contends that the pursuit of self-interest should be constrained by the law and the
conventions of fair play. Rules and legal systems exist to resolve conflict. It is, therefore, in the interests of
all parties to obey and accept the decision of arbitration systems because, without them, chaos will result.
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MODULE 2 Ethics 53
Thus, self-interest is not allowed to function unbridled by the law or the dictates of what is considered fair
competition. We can refer to this as restricted egoism.
Restricted egoism can be seen as an ethically more acceptable form of egoism. It sanctions corporate
self-interest and encourages competition to the extent that it leads to the maximisation of utility and is in
the interests of society as a whole.
UTILITARIANISM
According to the utilitarian (or utility) principle, determining good from bad, or right from wrong, is an
act or decision that produces the greatest benefit or pleasure for the greatest number of people. Similarly, if
harm is inevitable, the right course of action is the one that minimises harm or pain to the greatest number
of people. Under utilitarianism, pleasure and pain may be both mental and physical. As noted in the earlier
example, one of the problems that may arise is that an action that generates great benefit for many people
may also come at the cost or harm to smaller minority groups. This dilemma is often faced by governments,
but is also faced by organisations, which often need to make decisions that may benefit most employees
but may also have a negative impact on a few employees.
The utilitarian principle is attractive because it is easy to understand and provides a systematic approach
to problem resolution. Applying this principle to judgment, decision making and problem solving is a
process that relies on five basic steps.
1. Identify and articulate the ethical problem(s).
2. Identify all available courses of action that will resolve the situation.
3. Determine the foreseeable costs and benefits (short and long term) associated with each option.
4. Compare and weigh the ratio of good and bad outcomes associated with each option.
5. Select the option that will produce the greatest benefit for the greatest number of people.
While the process is conceptually simple, in certain circumstances it may lead to very complex
calculations.
A utilitarian analysis should be distinguished from a cost–benefit analysis that is normally applied in
business decisions. A cost–benefit analysis in business is generally weighed up in economic terms and
only as it relates to the decision maker and the employing organisation.
EXAMPLE 2.5
Cost–benefit Analysis by Ford
In America, in the 1970s, the Ford Motor Company reacted to safety concerns regarding its Pinto car by
conducting a cost–benefit analysis to determine whether the company should fix the apparently unsafe
placement of the petrol tank. Ford decided not to repair the cars because its cost–benefit analysis revealed
that the cost of fixing the cars was higher than that of paying damages for death and injury arising from
the design fault. Needless to say, Ford was ordered by the court to pay damages for negligent behaviour.
The cost of the damages order imposed by the court far exceeded the cost of repairing the cars.
TABLE 2.1
Ford Pinto cost–benefit analysis
Benefits
Savings
180 burn deaths, 180 serious burn injuries, 2100 burned vehicles
Unit
$200 000 per death, $67 000 per injury, $700 per vehicle
Total benefit
180 × ($200 000) + 180 × ($67 000) + 2100 × ($700) = $49.5 million
Costs
Sales
11 million cars, 1.5 million light trucks
Unit cost
$11 per car, $11 per truck
Total cost
11 000 000 × ($11) + 1 500 000 × ($11) = $137 million
Source: Hoffman WM 1982, ‘The Ford Pinto’, Business Ethics: Readings and Cases in Corporate Morality, McGraw-Hill
Book Company, New York, pp. 412–20.
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54 Ethics and Governance
The application of the utilitarian principle considers the costs and benefits for all who are affected by the
proposed decision or action (not just the decision maker), and measures outcomes both in economic and
psychological terms. If executive management at the Ford Motor Company had undertaken a utilitarian
analysis, it may well have arrived at a different decision. Rather than a short-term and narrow economic
analysis of costs, management would have given due consideration to the safety concerns of its customers
as well as the long-term market reaction to a seemingly callous decision.
Utilitarian theory has a much wider application than that of the impact on the immediate group, or a
group whose interests are immediately identifiable, which is arguably an ethical judgment based on the
theory of egoism. Most importantly, however, the application of the utilitarian principle should not be
reduced to a simple economic cost–benefit analysis measured in dollars and cents.
Although it appears simple and widely applicable, utilitarianism is subject to four main limitations.
1. Measuring and assigning a numerical value to consequences is difficult and subjective, particularly
when dealing with non-economic outcomes. How should non-economic outcomes such as pleasure,
pain, health or improved personal rights be measured?
2. Identifying all stakeholders potentially affected by a decision or action and the ability to reliably predict
future outcomes is an uncertain and difficult process. Balancing risks against benefits is a perpetual
problem for which there is no easy solution. The risks include failing to identify the impact of any
decisions on all stakeholders and whether all consequences have been identified and examined.
3. Utilitarianism focuses on the results of proposed action and not the motivation, intention or character
of the action itself. Consequently, a questionable act may be justified on utilitarian grounds because it
brings greatest happiness to the majority, even if it disregards the minority that may also be affected by
the act. Therefore, it is concerned with total happiness and may ignore the individual or the minority,
and is indifferent to the distribution of benefits.
4. In business, utilitarian arguments are often relied on to justify a board’s decision to close down a lossmaking segment of the business so the entity can continue financially. That is, the benefit of maintaining
the entire business and its stakeholders outweighs ethical reasons to maintain the loss-making segment.
In this case, a utilitarian judgment may lead to terminating the services of employees in this segment.
Critics, however, contend that actions such as this ignore other factors (e.g. community interests or the
interests of the particular employees whose employment was discontinued).
The key differences between ethical egoism and utilitarianism are highlighted in table 2.2.
TABLE 2.2
Differences between ethical egoism and utilitarianism
Theory
Ethical egoism (including
restricted egoism)
Utilitarianism
Type of theory
Normative theory
Normative theory
Proposes how one ought to behave.
Proposes how one ought to behave.
Guiding principle
Maximises net positive benefits to oneself.
Maximises net positive benefits to the
greatest number of people.
Stakeholders
Pursuit of self-interest should not come at
the expense of others.
Produces the best overall consequences for
everyone concerned.
Pursuit of happiness is constrained by
the law and the conventions of fair play
(restricted egoism).
Greatest happiness rule may come at the
cost of a minority.
Source: CPA Australia 2015.
QUESTION 2.2
A candidate in the CPA program is explaining to a friend the concept of utilitarianism. In doing
so, the candidate defines utilitarianism as ‘an action that provides me with the greatest amount of
measurable monetary rewards over costs’.
Identify the problem(s) with this definition.
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2.7 DEONTOLOGICAL THEORIES (DUTY BASED)
We now turn our attention to the main deontological theories. In contrast to teleology, a deontologist asserts
that there are more important considerations than outcomes. In fact, it is the intention behind the act itself
that is more important than the results of the act. To do justice to the complexities of professional life, it
is important to acknowledge that ethical decisions may be evaluated using a variety of criteria, and that
giving priority to consequences is only one criterion among others.
According to German philosopher Immanuel Kant (1724–1804), persons of goodwill are motivated by
a sense of duty to do the right thing. Therefore, what is important to a deontologist is the intention to do
the ‘right thing’, or the motivation to behave in an appropriate manner in accordance with a sense of duty.
Take the example of telling a lie. Some look to the consequences that are likely to flow from telling a
lie (a consequential analysis), whereas a deontologist would argue that it is always wrong to lie, whatever
the outcome(s).
MOTIVE
Deontology advocates that the motive is far more important than the action itself or its consequences.
Self-interest or emotion, rather than a sense of duty, are not appropriate motives for an ethical act. The
overriding value that guides duties, in Kant’s view, is respect for the human dignity of all involved.
Although the good consequences that result from an act may be the same regardless of its motive, it is
the desire to do the right thing for its own sake that makes it an ethical act and distinguishes it from an act
of selfishness. Therefore, actions are right, not because of their benefits but because of the nature of the
actions or the rules from which they derive.
There are two major concepts in relation to which duties may be examined: rights and justice.
RIGHTS
An ethical theory of rights contends that a good or correct decision is one that respects the rights of others.
Conversely, a decision is considered wrong if it violates the rights of a person or organisation.
A right is an entitlement that a person may have by virtue of a particular characteristic, role or condition
that defines them. For example, it is generally recognised that each person has a right to liberty, and
therefore no one should be enslaved.
While rights are not to be confused with duties or obligations, there is a close correlation between
a person’s rights and the duty or obligation of another not to interfere with or abuse these rights. In
accounting, a client can expect to have their right to confidentiality protected by their accountant, who
has a duty not to breach this right unless the need to serve the public interest supersedes it. A decision will
be considered ethical if the resulting actions do not offend the rights of anyone affected by that decision.
Legal and Contractual Rights
Among the many types of rights that exist, legal rights are particularly important for the accounting
profession. Legal rights, namely those rights that are defined and enforced by the legal system, prescribe
both what people are entitled to and what duties others have to protect those entitlements. Contractual rights
(also called special rights) arise out of agreements and relationships between individuals. An accountant
has a contractual duty, for example, to provide professional services that the client has a contractual right
to receive (refer back to example 1.1, A Costly Error, for an example of this right). To do otherwise may
demonstrate a wrongful act on the part of the accountant. There is also the need to consider contractual
rights and obligations that relate to general employment.
EXAMPLE 2.6
Whistleblower Committed for Trial
The case of the whistleblower, former army lawyer David McBride, illustrates the tension between an
employment agreement where staff are obliged to keep matters confidential — effectively secret — and
the publicising or leaking of sensitive military information. The McBride leak manifested itself in the form
of a television report and a series of articles on the website of national broadcaster, the ABC. McBride
was committed for trial at the time of writing.
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56 Ethics and Governance
............................................................................................................................................................................
CONSIDER THIS
Read the article by Samantha Maiden in The New Daily online entitled ‘Whistleblower at centre of ABC raid
stands by Afghan leaks’ (Maiden 2019) and consider in your own mind what circumstances you believe give
grounds for an employee, consultant or employer to break the terms of a contract.
Human Rights
Human rights, on the other hand, are more fundamental to society and relationships, and are the key to
maintaining social order. They are natural rights that apply to all people simply because they are human
beings. Some commonly recognised human rights are the:
• right to life
• freedom of choice
• right to the truth
• right to privacy
• freedom of speech.
One limitation of the rights principle is its inability to address conflicting rights and obligations. What
should one do when respecting one person’s rights contravenes the rights of another? Which rights should
be given preference? In Western societies, the right to free speech is often considered a fundamental human
right that should be respected. But what if allowing one person to express their views brings harm to
another? An important weakness of the rights principle is that it provides little guidance on how to prioritise
among different rights. A solution to this problem may be examining the freedoms and interests at stake
and deciding which one of all those considered is more essential to human dignity.
JUSTICE
Under principles of justice, an ethical decision is one that produces: (1) the fairest process by which any
person in a particular situation should be treated by others (procedural justice); or (2) the fairest distribution
of benefits and burdens among members of a group or community (distributive justice). Therefore, justice
theory is concerned with issues of fairness and equality.
Considering distributive justice, while it is generally unethical or unjust to have an unfair distribution
of benefits and burdens, there are different ways of deciding on what basis a fair distribution should be
conducted.
• Should each person receive an equal share? (equality principle)
• Should each person be rewarded for their individual effort or ability? (merit principle)
• Should each person receive a share based on need rather than ability? (needs principle)
EXAMPLE 2.7
Equality
Ravi and Delfina perform the same job functions to the same level. Distributive justice then commands that
they should receive equal benefits. Injustice occurs when Ravi receives more benefit because of irrelevant
concerns such as gender or race. However, if Ravi is more talented and works harder, the justice principle
dictates that Ravi should receive more. Therefore, justice is a function of contributions and rewards.
This example highlights a significant justice issue that exists in relation to the gender gap, where men
often receive higher wages than women for equivalent roles.
The principle of equality can be discussed in significantly different ways. Aristotle argued that fairness
does not mean treating everyone the same but acknowledging individual differences and allocating
resources to reflect these differences. In applying his account of fairness to workers with disabilities,
for example, treating equals equally and treating those who are unequal differently or unequally requires
that special provisions should be made for disabled workers to access and enjoy the use of workplace
facilities just as others do. Another qualified approach to equality is the difference principle (Rawls 1971),
which allows for unequal distribution of resources only in circumstances where this distribution works to
everyone’s advantage, including those placed in an inferior position by the inequality that results.
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MODULE 2 Ethics 57
Irrespective of the nuances involved, according to the principle of distributive justice, an ethical decision
is one that results in a fair and equal distribution of benefits and burdens.
2.8 VIRTUE ETHICS
The previous discussion on normative theories of ethics described what a person should do based on either
consequences (teleology) or duty (deontology). Critics have challenged the notion of what one should
do according to principles of correct behaviour and argue that there is a more important issue, namely,
what people should be. If the guiding principle of right and wrong is external to the self, as is the case
with normative theories of ethics, then it lessens individual responsibility because it shifts the burden of
having to make decisions from oneself to an external authority — be it a community, a principle or an
abstract rule.
According to Melé (2005), determining what is right according to a set of duties or by systematically
analysing the consequences of an action may not motivate appropriate behaviour. Consistent ethical
behaviour is more likely to be the result of values such as integrity and good character. According to
this view, ethical character is seen to be more important than the right action. This branch of ethics is
known as ‘virtue ethics’. Its focus is to understand and develop virtues that make us better people.
Virtues may be defined as attitudes, dispositions or traits of character that enable us to do what is
ethically desirable, and which, through consistent practice, become habitual acts. Virtues (e.g. courage,
courtesy, compassion, generosity, fairness, fidelity, friendliness, honesty, integrity, prudence and selfcontrol) develop dispositions that favour ethical behaviour. Virtues are not natural or inborn but rather
they are developed through learning and practice.
Students acquire virtues or ethically ‘good’ habits by behaving ethically in context, much in the same
way as athletes or musicians gain the ability to perform. Through practice, students can learn to be
courageous and compassionate. Once they have been learned, these virtues are internalised and become
a character trait. Virtuous behaviour then becomes a natural reaction — usually referred to as ‘second
nature’. In other words, once acquired, virtues predispose us to act ethically.
The concept of virtue ethics is arguably more applicable to the role of professional accountants than
are the traditional normative theories of ethics. The responsibilities and expectations of a professional
accountant and the principles of professional conduct are outlined in the Code of Ethics for Professional
Accountants.
Principles of professional conduct such as integrity, objectivity and competence (as outlined in the Code
of Ethics for Professional Accountants) are not unlike the virtues described above. Doucet and Ruland
(1994), for instance, identify three virtues of particular relevance for accountants, which are necessary to
enable them to fulfil their professional responsibilities. These are expertise, courage and integrity:
In essence to have expertise means that the accountant knows what the rules and principles are … Courage
is necessary to resist client or competitive pressures … Integrity entails the disposition to do the right and
just action without regard to personal gain or advantage (Doucet & Ruland 1994).
A limitation of virtue ethics is that it does not always provide guidance when a person is faced with a
genuine ethical dilemma. Unlike traditional theories of ethics that emphasise a ‘right’ action, virtue ethics
emphasises the personal attributes that an ethical person should possess. However, it does not necessarily
make clear what one should do in a specific conflict situation.
MORAL AGENCY
A moral agent is a decision maker who has the ability to make moral judgments based on some notion of
right and wrong and is held accountable for these actions. Accountants are a class of professional that may
be regarded as being moral agents. They have a framework of ethics and are trained in the requirements
of their profession. They are capable of being held accountable for their actions and are less likely to be
able to claim that they lack an understanding or avoid responsibility.
Consider the various areas of guidance accountants use in everyday practice. Accountants understand
that financial statements are meant to be prepared in accordance with accounting standards. There is no
manner in which an accountant can claim to not know that accounting standards should apply. Auditors
know that auditing standards should be applied in the engagements they undertake. Accountants who are
liquidators also understand that there are legal and regulatory constraints on what they are able to do in
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58 Ethics and Governance
the circumstances of an administration or receivership. The theory of moral agency should lead a person
applying it to conclude that each practitioner in each of these areas is in a position to understand their
obligations under ethical and legal frameworks and do what is regarded as the right thing.
This theory of moral agency is applied in practice by professional accounting bodies such as CPA
Australia through the enforcement of disciplinary processes and guidelines, particularly in circumstances
where the practitioner knows or should know the technical and legal frameworks under which they are
conducting work for a client or an employer.
QUESTION 2.3
Refer back to the Jack and Jane in examples 2.2 and 2.3. Each is acting from a particular ethical
perspective. For each, identify the ethical theory that they as moral agents could use to justify
their actions.
SUMMARY
We have now considered a broad range of ethical viewpoints, from those that focus on self-interest to those
that are linked to intention and motivation rather than outcomes.
From this discussion you should be aware that two people may come to very different answers about
what is ethical in a particular situation. You should also have a clearer understanding of your own ethical
philosophy. It is also useful to understand how other people may be making their decisions.
In the next section, we move away from the theoretical aspects of ethics to review APES 110, which
outlines the ethical principles guiding the behaviour of professional accountants.
The key points covered in this part, and the learning objective they align to, are listed below.
KEY POINTS
2.2 Discuss the key philosophical approaches to ethics and how these impact on the professional’s
ethical decision making.
• Normative theories set down principles that establish a norm for behaviour. These theories provide
a framework for judging right from wrong or good from bad.
• There are two categories of normative theories: teleological (or consequential) and deontological (or
duty based).
• Two theories in the teleological category are egoism and utilitarianism.
• Egoism has at the centre of its ethical approach that a person is right to pursue actions in their own
self-interest.
• Utilitarianism is a theory that gives primacy to actions which serve the greater good of a majority of
people, even though a minority may be adversely affected by decisions.
• Deontological theories are duty based and a central theorist in the deontological school of thought
is Kant. Two key theories in the deontological category are duties, and rights and justice.
• Virtue ethics, another ethical theory, comes from the tradition of Aristotle and centres around how a
person should be rather than what a person should do.
• Each of these philosophical standpoints is a way of viewing problems people confront each day. Each
philosophical approach offers a different perspective about how people should deal with dilemmas.
Professional ethics are built on principles that are drawn from general ethical theories.
• Professional accountants, in their role as moral agents, may use any one of these ethical theories
when making decisions involving ethical dilemmas, and be held accountable for their decisions.
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MODULE 2 Ethics 59
PART C: APES 110 CODE OF ETHICS FOR
PROFESSIONAL ACCOUNTANTS
(INCLUDING INDEPENDENCE STANDARDS)
INTRODUCTION
In this section, we discuss the APES 110 Code of Ethics for Professional Accountants (including
Independence Standards) (APESB 2018), as at November 2018. It is referred to as the APES 110 because
it includes of amendments that have been made to the standard over time. It may also be referred to as
APES 110, the APESB Code of Ethics or ‘the Code’. The most recently issued version of the APESB
Code of Ethics can be found on the APESB website under ‘APES 100 Code of Ethics — effective from
1 January 2020’ at: www.apesb.org.au/page.php?id=12.
Candidates are not expected to print out the entire APESB Code of Ethics, although it may be
helpful to print sections that are referenced and/or discussed in the study guide. Unless specifically
noted, only the content in the study guide is examinable. You should, however, ensure that you
download a copy of the Code of Ethics so that you can refer to it during study.
The International Ethics Standards Board for Accountants (IESBA) develops and issues the Code of
Ethics for Professional Accountants. CPA Australia is a member body of the International Federation
of Accountants (IFAC) and, as such, cannot apply less stringent standards than those stated in the
IESBA Code.
The APESB, which issues the ethical and professional standards for CPA Australia, released the APESB
Code of Ethics, which incorporates the IESBA Code and was initially operative from 1 July 2006. The
current version of the APESB Code of Ethics was issued in November 2018. Australian-specific ethical
requirements that have been inserted into the APESB Code of Ethics are denoted with an ‘AUST’ prefix.
It is important to be aware of the hierarchy of ethical pronouncements issued by the APESB. Figure 2.6
illustrates the hierarchy, which is has at its apex the Code of Ethics that is supported by standards covering
specific topics, and guidance notes. The Code sets down the foundation principles on which other APESB
guidance is based.
Under paragraph R1.2 of the APESB Code of Ethics, ‘all Members in Australia shall comply with
APES 110 including when providing Professional Services in an honorary capacity’. Under paragraph
R1.3 of the Code, ‘all Members practising outside of Australia shall comply with APES 110 to the extent
to which they are not prevented from so doing by specific requirements of local laws and/or regulations’.
CPA Australia members must comply with the APESB Code of Ethics.
The APESB Code of Ethics expresses the distinguishing mark of the accounting profession, which
is its acceptance of the responsibility to act in the public interest. The Code highlights the fundamental
principles that apply to all aspects of a professional accountant’s work, and also provides guidance for
resolving conflicts of interest and other ethical situations that may arise from time to time.
To further clarify what it means to act in the public interest and, more explicitly, to outline the
members’ obligations that stem from this responsibility, the ‘Responding to Non-Compliance with Laws
and Regulations’ (NOCLAR) requirements were added in the APESB Code of Ethics in May 2017 and
became effective on 1 January 2018. NOCLAR allows members to report to an appropriate authority
an actual or suspected non-compliance with laws and regulations by a client or employer, when such a
disclosure is in the public interest, without breaching the duty of confidentiality. It provides proportional
requirements for members to follow depending on the professional activity or service they provide,
and clarifies that withdrawing from the engagement and professional relationship or resigning from
the employing organisation are not substitutes for the other actions that are required under NOCLAR.
Provisions related to NOCLAR are discussed further in this section.
By joining a profession, members agree to uphold its high ethical standards. The proper fulfilment of
the role of an accountant involves discharging one’s professional work responsibilities while ensuring
compliance with all the obligations included in the Code.
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60 Ethics and Governance
FIGURE 2.6
Structure of APESB pronouncements
Due process and working procedures
APES 110: Code of Ethics for
Professional Accountants
(including Independence
Standards)
APESB Standards
Conceptual Framework
• Principles based
• Mandatory for professional accountants
Standards
Members in
Public Practice
All Members
APES 300
series
• Introduces principles
• Mandatory requirements in bold-type
Members
in Business
APES 400
series
APES 200
Series
• Guidance and/or explanation in regular type
Guidance notes
• Do not introduce new principles
• Guidance on a specific matter on which
the principles are already stated in a
Standard
• Guidance is only in regular type
Guidance notes
Members in
Public Practice
All Members
APES GN 30
series
Members
in Business
APES GN 40
series
APES GN 20
Series
Source:APESB 2018, APES 110 Code of Ethics for Professional Accountants (including Independence Standards), APESB,
Melbourne, www.apesb.org.au/uploads/standards/apesb_standards/ 23072019020747_APES_110_Restructured_Code_Nov_
2018.pdf.
2.9 THE PUBLIC INTEREST — ETHICS IN PRACTICE
A distinguishing feature of a profession is its commitment to promote and preserve the public interest even
if it comes at the expense of its members’, and its own self-interest. IFAC has defined public interest as
‘the sum of the benefits that citizens receive from the services provided by the accountancy profession,
incorporating the effects of all regulatory measures designed to ensure the quality and provision of such
services’ (IFAC 2010).
IFAC defines ‘interest’ as the ‘responsibilities that professional accountants have to society’. Examples
of these responsibilities include the following.
• Providing sound financial and business reporting to stakeholders, investors, and all parties in the
marketplace directly or indirectly impacted by that reporting;
• Facilitating the comparability of financial reporting and auditing across different jurisdictions;
• Requiring that accounting professionals apply high standards of ethical behaviour and professional
judgment;
• Specifying appropriate educational requirements and qualifications for professional accountants; and
• Providing professional accountants in business with the knowledge, judgment and means to contribute
to sound corporate governance and performance management for the organizations they serve
(IFAC 2010).
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MODULE 2 Ethics 61
Safeguarding the public interest is an overriding responsibility that underpins all professional duties and
obligation. Members have a duty to a number of stakeholders, including clients, employers, shareholders
and the accounting community. For example, in preparing financial reports for a client, accountants have
a responsibility to the financial institutions from which client companies obtain finance. They also have a
responsibility to the client, who provides remuneration in return for diligent and competent service, and
to shareholders, who invest their trust in the external financial reports of the client company.
In cases where the accountant has obligations to more than one stakeholder, the question arises of to
whom the accountant owes their primary loyalty. In public practice, it is tempting to assume that the
accountant–client relationship is central to the function of accounting. In this view, no one else matters but
the client. Similarly, in the accountant–employer relationship, it may be presumed that accountants owe
their primary loyalty to their employers. Both views are incorrect.
The accountant’s primary duty is not to the client or the employer, but to the public. Therefore, emphasis
on the public interest extends to interests beyond the needs of an individual client or employer. In general,
it is assumed that the accountant is obligated to advance the interests of their client or employer, so long
as this does not conflict with the obligation to safeguard the public interest.
In addition to defining their obligations under the public interest, members of the accounting profession
must also understand what it means to serve the public interest. This encompasses the pursuit of excellence
for the benefit of others and includes integrity, objectivity, independence, confidentiality, adherence to
technical and professional standards, competence and due care, and ethical behaviour.
Consequently, serving the public interest relies on professional behaviour, underpinned by adherence
to the fundamental principles of professional conduct and a conceptual framework approach to applying
those principles. As a result, the Code of Ethics is relevant to all professional accountants. By applying the
Code of Ethics, professional accountants will be acting in the public interest.
2.10 THE APESB CODE OF ETHICS (APES 110)
The Code of Ethics is divided into four parts.
• Part 1 sets out the requirement for members to comply with the code, lists the fundamental principles
that members must comply with and provides a conceptual framework that members can use to ensure
that they comply with the principles.
• Part 2 sets out how the conceptual framework applies to members in business.
• Part 3 sets out how the conceptual framework applies to members in public practice.
• Part 4 sets out the independence requirements for members engaging in audit, review and assurance
activities.
These parts are preceded by a Guide to the Code that has the purpose of highlighting how the Code
of Ethics should be read and used. Members need to ensure they understand the rationale underlying the
Code of Ethics.
QUESTION 2.4
Watch this IFAC recorded webinar introducing the new Code of Ethics and why the revisions made
to the standard exist. It is critical that all members understand the context of the Code of Ethics
and how it is intended to operate.
Watch the video: https://youtu.be/x5QWAiUemEY.
Imagine you are required to explain the Code to a new recruit in an office after watching the
webinar. (You may also need to refer to paragraphs 4, 11–15 in the Guide to the Code at the start of
APES 110.) Consider how you would describe:
(a) the purpose and importance of the Code
(b) the members to whom the Code applies
(c) whether the Code applies to members working in not-for-profit organisations
(d) the purpose of the letters R and A throughout the Code in various paragraphs
(e) the difference in interpretation and application of clauses in the Code that contain the words
‘shall’, ‘may’ and ‘might’.
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62 Ethics and Governance
PART 1 OF THE CODE — FUNDAMENTAL PRINCIPLES AND
CONCEPTUAL FRAMEWORK
The first part of the Code introduces members to the five fundamental principles of the Code of Ethics
and the conceptual framework which sets out a framework for resolving ethical issues. The principles
deal with the fundamentals of ethical behaviour expected of members irrespective of where they practice
and the conceptual framework deals with how a member should consider resolving any ethical challenges
they confront.
Fundamental Principles (ss. 110–115)
The five fundamental principles are: integrity, objectivity, professional competence and due care, confidentiality and professional behaviour (see figure 2.7). The fundamental principles should be regarded
as the minimum standard of ethical behaviour for a professional accountant. They are also to be used as
ethical outcomes in the resolution of ethical and professional dilemmas.
FIGURE 2.7
The fundamental principles and where they are mentioned in the Code of Ethics
Integrity
(s. 111)
Objectivity
(s. 112)
Confidentiality
(s. 114)
Professional competence
and due care
(s. 113)
Professional behaviour
(s. 115)
QUESTION 2.5
Access APES 110 and use your reading of section 110 to complete this question.
Each of the fundamental principles has a definition in paragraph 110.1 A1. Add the definitions to
table 2.3.
TABLE 2.3
Fundamental principles
Definition
Integrity
Objectivity
Professional competence and due care
Confidentiality
Professional behaviour
A more detailed discussion of each principle follows.
Integrity (s. 111)
Integrity is the motto of CPA Australia. According to Windal, ‘integrity is an element of character and is
essential to the maintenance of public trust’ (1990, p. 26). Integrity in accounting is centred on concepts
such as trust, honesty, and honourable and reliable behaviour. Integrity requires strength of character and
the courage to pursue one’s convictions, otherwise good intentions may not be sufficient.
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MODULE 2 Ethics 63
As integrity is intrinsically linked with trust, the APESB Code of Ethics imposes an obligation on
accountants to be straightforward and honest in professional and business relationships (para. R111.1).
This means that accountants:
... shall not knowingly be associated with reports, returns, communications or other information where the
Member believes that the information:
(a) Contains a materially false or misleading statement;
(b) Contains statements or information provided recklessly; or
(c) Omits or obscures required information required where such omission or obscurity would be
misleading (para. R111.2).
EXAMPLE 2.8
Moral Courage
Michael Woodford, the CEO of Olympus, blew the whistle on an enormous USD$1.7 billion fraud, knowing
that this would cause personal hardship to himself. Instead of being rewarded, he was sacked and ended
up fearing for his life. Despite this, Woodford insists that he would take the same action again. However,
he also suggested that, based on his experience, he understood how hard it would be for a more junior
employee with responsibilities such as a family or mortgage to take the risk of disclosing problems to an
employer (Dugdale 2012).
Objectivity (s. 112)
Objectivity refers to the state or quality of being true, outside of any individual feelings or interpretations.
Accountants may be exposed to numerous situations that may impair their objectivity in the application of
professional judgment. For example, a member in business may feel pressure from a supervisor to overlook
an accounting irregularity. Similarly, a member in public practice may feel the need to support a client’s
questionable assertions to secure ongoing fees. In such circumstances, accountants may subordinate
the interests of the public to those of the client or themselves, or compromise one client’s interest
over another’s.
Flowing from these examples are three obligations that are founded on the principle of objectivity:
accountants should be impartial, honest and free from conflicts of interest. Consequently, accountants
have a duty to avoid relationships or other situations that may ‘compromise [their] professional or business
judgement because of bias, conflict of interest or undue influence of others’ (para. R112.1).
There are many circumstances that have the potential to compromise a member’s objectivity, such as
acquiring a financial interest in a client, formal or informal relationships with executive management, or
receiving excessive fees from a single client.
Related party transactions can compromise objectivity because of a lack of independence. Such
transactions arise whenever an organisation, or a member within an organisation, deals with others who
cannot be seen as independent. Examples include a company awarding a contract to a supplier company
in which the finance director has a significant shareholding, or a board deciding to send offshore some
functions of a business to an entity owned by a board member.
The highest risk arising from related party transactions is that they may not be at arm’s length. An arm’s
length transaction is one in which both parties act in their own interests (e.g. to maximise returns), without
pressure or duress from the other party or a third party. To do this effectively, it is important to keep the
other party at a distance, or at arm’s length — and not engage in relationships that interfere with each
party’s independent interests. Because they may not be at arm’s length, failure to disclose or report related
party transactions may lead to distorted representations of an organisation’s financial situation and hide
dealings that benefit other parties to the detriment of the organisation.
Professional Competence and Due Care (s. 113)
Professional competence and due care involve two distinct obligations. The first obligation is to ‘Attain
and maintain professional knowledge and skill at the level required to ensure that a client or employing
organisation receives competent Professional Activities, based on current technical and professional
standards and relevant legislation’ (para. R113.1 (a)). The second obligation is to ‘Act diligently in
accordance with applicable technical and professional standards’ (para. R113.1 (b)).
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64 Ethics and Governance
Having professional competence requires both acquiring and maintaining professional competence.
It is normally acquired by completing an accredited university accounting degree and a professional
development program such as the CPA Program. Once CPA status is acquired, professional competence is
normally maintained by keeping up to date with relevant technical, professional and business developments
(para. 113.1 A2).
Due care encompasses the responsibility to ‘act in accordance with the requirements of an assignment,
carefully, thoroughly and on a timely basis’ (para. 113.1 A3). In addition to producing credible and accurate
reports, members should not accept jobs or tasks unless they possess the requisite skill to perform the
task properly. Supervisors have a corresponding duty to ensure that those working under their authority
have appropriate training and supervision (para. R113.2). Due diligence and appropriate supervision
are critical to the work of accountants, particularly during busy and stressful times. Under the strain
of a heavy workload, attention to detail may be overlooked in favour of meeting deadlines and errors
can occur.
Due care also imposes a condition of compliance with relevant technical and professional requirements.
Such requirements include accounting and auditing standards and other statutory regulations such as
taxation laws.
Confidentiality (s. 114)
A professional accountant should respect the confidentiality of information acquired as a result of
professional and business relationships and should not disclose any such information to third parties
without proper and specific authority, unless there is a legal or professional right or duty to disclose it.
Clients and employers have a right to expect that accountants will not reveal anything about their
personal or business affairs. Accountants must also refrain from using confidential information to their
‘personal advantage . . . or the advantage of a third party’ (para. R114.1 (e)).
Accountants should maintain confidentiality in all circumstances, including discussions with prospective clients and employers, and in social situations, particularly where long-term collaborations with
associates or related parties might result in accountants being less alert to the possibility that they may
be inadvertently indiscreet.
The duty of confidentiality extends to all members, including those within employing firms or organisations (para. R114.1 (b)), as well as prospective clients or employers (para. R114.1 (c)). Furthermore,
the duty of confidentiality does not end with the termination of the professional — client or professional — employer relationship. The duty continues even after such relationships have been terminated
(paras. R114.1 (f), R114.2).
Generally, the duty of confidentiality is relieved only when disclosure is required by law, or there is a
professional duty or right to disclose. The following, listed in paragraph 114.1 A1, are the circumstances
when disclosure of confidential information may be appropriate.
(a) Disclosure is required by law, for example:
(i) Production of documents or other provision of evidence in the course of legal proceedings; or
(ii) Disclosure to the appropriate public authorities of infringements of the law that come to light;
(b) Disclosure is permitted by law and is authorised by the client or the employing organisation; and
(c) There is a professional duty or right to disclose, when not prohibited by law:
(i) To comply with the quality review of a Professional Body;
(ii) To respond to an inquiry or investigation by a professional or regulatory body;
(iii) To protect the professional interests of a Member in legal proceedings; or
(iv) To comply with technical and professional standards, including ethics requirements.
Paragraph AUST 114.1 A1.1 states that:
The circumstances described in paragraph 114.1 A1 do not take into account Australian legal and regulatory
requirements. A Member considering disclosing confidential information about a client or employer
without their consent is advised to first obtain legal advice.
Professional Behaviour (s. 115)
A professional accountant must ‘comply with relevant laws and regulations and avoid any conduct that the
Member knows or should know might discredit the profession’ (para. R115.1).
Therefore, in addition to their duty to clients, employers and the public, which comes with a
commitment to act in the public interest, accountants also have a responsibility to the accounting profession
and fellow members. They must act in a way that promotes the good reputation of the profession and
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their colleagues. This includes avoiding exaggerated claims about the services offered, qualifications or
experience, and avoiding disparaging references or unsubstantiated comparisons to the work of others
(para. R115.2).
QUESTION 2.6
Each statement in table 2.4 is aligned to one of the fundamental principles. Identify the principle
and add it next to the statement in the column on the right.
TABLE 2.4
Statements aligned with principles
Statement
This fundamental principle deals with implicit fair dealing and truthfulness.
Members are obliged to ensure their professional judgment is not compromised due to undue influence by others.
A member is required to ensure they act diligently and in accordance with
professional standards that apply to their work.
A member needs to be conscious about inadvertent disclosure of client
information.
A member should not associate themselves with documents where the
member believes the content is materially false
Conduct that a reasonable and informed third party would be likely to
conclude adversely affects the good reputation of the profession is conduct
that is or may be defined as conduct discrediting the profession.
Information acquired as a result of working on an engagement shall not be
disclosed unless there is a legal or professional duty to do so.
It may be a breach of a principle if a member associates themselves with
statements or information that was provided recklessly.
Members shall avoid conduct that they know may discredit the profession.
A member shall make clients or employers aware of any limitations of the
services a member is providing.
Members should not be involved with the publication of information where
the presentation of information omits or obscures the true substance of
a situation.
Members shall not mislead clients or potential clients with claims that
misrepresent their actual qualifications or experience.
Proper authorisation shall be obtained before certain kinds of information are
shared with parties that are not involved in an engagement within a company
or professional practice.
A member shall disassociate themselves from information that is false,
provided recklessly or omits information that might otherwise lead a reader
to interpret a situation differently if a full and clear account of a situation
was presented.
Ending a relationship between a client or employing organisation does not
mean that a member is free to share information with other parties or on
social media.
Disparaging references or unsubstantiated comparisons to the work of others
shall not be made by a member.
A member shall take necessary measures to ensure people working under
their authority are properly supervised and trained.
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66 Ethics and Governance
Principle
A member shall not undertake a professional engagement if there is a
situation or relationship that may unduly influence the member’s exercise
of professional judgment if they were to engage in that activity.
Information acquired as a result of professional and business relationships
shall not be used for the personal advantage of the member or the advantage
of a third party.
Members have a professional duty or right to disclose information where not
prohibited by law to comply with quality reviews conducted by CPA Australia
or responding to an inquiry or investigation by CPA Australia.
The fundamental principles form the foundation of the Code of Ethics and are to be applied by all
members irrespective of the context in which they work. Specific guidance on how members who are
accountants in business or accountants in practice appear later in the module. Consider the issues related
to fundamental principles in the context of the Scott London case study which follows below.
EXAMPLE 2.9
Scott London, Former Senior Partner (Audit) at KPMG Los Angeles
On 11 April 2013, Scott London (London), a former senior audit partner at KPMG Los Angeles who had
worked at KPMG for nearly 30 years, was charged by the FBI with insider trading. On the same day, the US
Securities and Exchange Commission (SEC) filed civil charges against London (SEC 2013a). The director
of the SEC’s office in Los Angeles stated: ‘As a leader at a major accounting firm, London’s conduct was
an egregious violation of his ethical and professional duties’ (SEC 2013a).
As a result of his position, London had access to highly sensitive and confidential information regarding
upcoming earnings announcements about KPMG clients before that information was disclosed to the
public. For over two years, London illegally provided this confidential information to his close friend Bryan
Shaw, who made over USD$1 million profit by using the information to trade securities. In exchange, Shaw
gave London thousands of dollars in cash, a Rolex watch and concert tickets (FBI 2013).
On 1 July 2013, London pleaded guilty to insider trading and admitted to disclosing confidential
information to Shaw. On 27 September 2013, London was banned by the SEC from auditing public
companies and ‘denied the privilege of appearing or practicing before the Commission as an accountant’
(SEC 2013b, p. 9).
On 24 April 2014, London was sentenced to 14 months in jail, commencing in July 2014, and ordered
to pay a $100,000 fine. After being sentenced, London said ‘I had to plead guilty. The impacts on the
profession and on KPMG could have led to even further damage if there had been a long investigation
and court case. It doesn’t take long for bad public perception about accounting firms, like what happened
to Arthur Andersen in 2002. So I want to do as much as I can to set things right. What I did was
clearly wrong, and I take full responsibility. However, this is a subject matter that unfortunately may be
very prevalent with people who have access to confidential information, but it’s difficult to catch people
doing it. Even seemingly innocuous conversations with a good friend can lead a person to be tempted
and think they won’t get caught. I hope that my story can help prevent others from crossing the line’
(O’Bannon 2014).
QUESTION 2.7
(a) Who were the stakeholders (individuals or groups who have a stake in what happens), and how
were they affected by the actions of Scott London?
(b) Did London breach any of the fundamental principles of professional conduct contained in the
Code of Ethics? If so, state those principles and explain why you think they have been breached.
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MODULE 2 Ethics 67
THE CONCEPTUAL FRAMEWORK (s. 120)
The conceptual framework approach, which relies on the application of key principles for decision making,
differs from rule-based codes, which require adherence to a set of specific rules in terms of the specific
actions that should or should not be taken. The problem with a code that is entirely rules-based is that it
becomes too prescriptive and too voluminous to be of practical use. Excessive prescription causes ethical
decision making to focus too much on whether the rule permits or prohibits a particular treatment or
behaviour, rather than using ethical judgment to determine whether a fundamental principle is protected.
For a principles-based code to be effective, it is useful to take a blended approach containing a mix of
broad principles and more specific guidance that is specific to areas of an accountants’ work and certain
tasks which together show how the conceptual framework applies in specific situations.
The conceptual framework (outlined in APES 110) that members are required to consider when
determining whether there are any threats to the fundamental principles is made up of three steps.
(a) Identify threats to compliance with the fundamental principles;
(b) Evaluate the threats identified; and
(c) Address the threats by eliminating or reducing them to an Acceptable Level (para. 120.2).
Members need to identify, evaluate and respond to any identified threat that may compromise compliance with the fundamental principles. If the identified threats are significant, members must address them
by eliminating them or reduce them to an acceptable level, so that compliance is no longer compromised.
If accountants are unable to implement appropriate safeguards, they should either decline or discontinue
the specific professional service involved, or consider resigning from the client or employer. Figure 2.8
illustrates the conceptual framework approach.
FIGURE 2.8
The conceptual framework approach
Threat identified
Is the threat to
fundamental principles
significant?
No
No further action
Yes
Implement safeguard(s)
Is threat
mitigated to an
acceptable level?
Yes
No
Decline or discontinue
service, client or employer
Source: Delaportes et al. 2005, Ethics, Governance and Accountability: A Professional Perspective, John Wiley & Sons, Milton,
Queensland.
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68 Ethics and Governance
QUESTION 2.8
Read the following APES 110 paragraphs.
• R120.5–120.5 A4
• R120.9–120.9 A2
• R200.5 A3
Note the ways in which these requirements may have an impact on judgments members make
when they evaluate any challenges they face in their day-to-day work as a professional accountant.
Identifying Threats (para. R120.6)
Threats to the fundamental principles may be created by a broad range of relationships and circumstances. The first step in the conceptual framework is to identify such threats. Such a circumstance or
relationship may create more than one threat, and a threat may affect compliance with more than one
fundamental principle (para. R120.6 A4). APES 110 defines five categories of threat which are detailed in
paragraph 120.6 A3.
QUESTION 2.9
Read paragraph 120.6 A3 carefully and name the threat that matches the definition given in
table 2.5.
TABLE 2.5
Threat categories
Definition
Threat
The threat that a Member will be deterred from acting objectively because
of actual or perceived pressures, including attempts to exercise undue
influence over the Member.
The threat that a Member will promote a client’s or employing organisation’s position to the point that the Member’s objectivity is compromised.
The threat that a Member will not appropriately evaluate the results of a
previous judgement made, or an activity performed by the Member, or by
another individual within the Member’s Firm or employing organisation,
on which the Member will rely when forming a judgement as part of
performing a current activity.
The threat that a financial or other interest will inappropriately influence a
Member’s judgement or behaviour.
The threat that, due to a long or close relationship with a client or
employing organisation, a Member will be too sympathetic to their interests
or too accepting of their work.
Source: APESB 2018, APES 110 Code of Ethics for Professional Accountants (including Independence Standards),
www.apesb.org.au/uploads/standards/apesb_standards/23072019020747_APES_110_Restructured_Code_Nov_2018.pdf.
Example 2.10 illustrates the conceptual framework approach to compliance with the fundamental
principles of professional conduct.
EXAMPLE 2.10
Intimidation — a Threat to the Fundamental Principles
An intimidation threat to the accountant’s objectivity or competence and due care may arise where the
accountant is pressured (or motivated by the possibility of personal gain) into being associated with
misleading information.
The accountant must evaluate the significance of such a threat and, if the threat is other than clearly
insignificant, safeguards should be considered and applied as necessary to reduce the threat to an
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MODULE 2 Ethics 69
acceptable level. One relevant safeguard includes consultation with superiors within the employing
organisation (such as the audit committee or other body responsible for governance), or with a relevant
professional body. If the threat cannot be mitigated to an acceptable level, the accountant should consider
discontinuing their service for the employer.
The specific nature of each threat will depend on the particular circumstances or relationships in which
it arises, and some may be difficult to categorise.
QUESTION 2.10
Categorise each of the threats in table 2.6 according to APES 110’s five categories.
Intimidation
Familiarity
Advocacy
Circumstance
Self-review
Examples of threats — accountants in business and accountants in public practice
Self-interest
TABLE 2.6
Members in Business
A Member holding a financial interest in, or receiving a loan or guarantee from
the employing organisation.
An individual attempting to influence the decision making process of the
Member, for example with regard to the awarding of contracts or the
application of an accounting principle.
✓
A Member determining the appropriate accounting treatment for a business
combination after performing the feasibility study supporting the purchase
decision.
A Member having the opportunity to manipulate information in a prospectus in
order to obtain favourable financing.
A Member being responsible for the financial reporting of the employing
organisation when an immediate or close family member employed by
the organisation makes decisions that affect the financial reporting of the
organisation.
✓
A Member having a long association with individuals influencing business
decisions.
A Member or immediate or close family member facing the threat of dismissal
or replacement over a disagreement about:
• The application of an accounting principle
• The way in which financial information is to be reported.
A Member being offered a gift or special treatment from a supplier of the
employing organisation.
A Member participating in incentive compensation arrangements offered by
the employing organisation.
A Member having access to corporate assets for personal use.
Members in public practice
A Member being threatened with dismissal from a client engagement or the
Firm because of a disagreement about a professional matter.
A director or officer of the client, or an employee in a position to exert
significant influence over the subject matter of the engagement, having
recently served as the engagement partner.
An audit team member having a long association with the audit client.
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70 Ethics and Governance
✓
✓
A Member quoting a low fee to obtain a new engagement and the fee is so low
that it might be difficult to perform the professional service in accordance with
applicable technical and professional standards for that price.
A Member having prepared the original data used to generate records that are
the subject matter of the assurance engagement.
✓
A Member acting as an advocate on behalf of a client in litigation or disputes
with third parties.
A Member having a close or immediate Family member who is a director or
officer of the client.
A Member being informed that a planned promotion will not occur unless the
Member agrees with an inappropriate accounting treatment.
A Member having accepted a significant gift from a client and being
threatened that acceptance of this gift will be made public.
A Member issuing an assurance report on the effectiveness of the operation of
financial systems after implementing the systems.
A Member lobbying in favour of legislation on behalf of a client.
✓
A Member having access to confidential information that might be used for
personal gain.
A Member promoting the interests of, or shares in, a client.
A Member having a direct financial interest in a client.
✓
A Member feeling pressured to agree with the judgement of a client because
the client has more expertise on the matter in question.
✓
A Member discovering a significant error when evaluating the results of a
previous professional service performed by a member of the Member’s firm.
A Member having a close business relationship with a client.
✓
Source:APESB 2018, APES 110 Code of Ethics for Professional Accountants (including Independence Standards), APESB,
Melbourne, www.apesb.org.au/uploads/standards/apesb_standards/23072019020747_APES_110_Restructured_Code_Nov_
2018.pdf.
Evaluating Threats (para. R120.7)
Once a threat has been identified, members need to evaluate the threat to determine whether a threat is
at an acceptable level. APES 110 states that ‘An acceptable level is the level at which a Member using
the reasonable and informed third party test would likely conclude that the Member complies with the
fundamental principles’ (para. 120.7 A1). In other words, the standard requires members to determine
whether the facts or the circumstances with which they are confronted compromise their ability to meet
the fundamental principles set down in the Code.
Paragraph 120.8 A1 of the Code states that qualitative as well as quantitative factors must be considered
when evaluating a threat or the combined impact of threats. This will depend on the circumstances
confronted by a member, group of members or organisation that employs members bound by the Code.
There may also be specific pieces of guidance that entities themselves produce that assist with dealing
with specific threats to fundamental principles. The forms of guidance relevant to evaluating the threat
level (para. 120.8 A2) include:
• Corporate governance requirements.
• Educational, training and experience requirements for the profession.
• Effective complaint systems which enable the Member and the general public to draw attention to
unethical behaviour.
• An explicitly stated duty to report breaches of ethics requirements.
• Professional or regulatory procedures.
Parts 2 and 3 of the Code contain specific considerations for accountants in business and in practice to
use when evaluating threats. These are summarised in table 2.7.
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MODULE 2 Ethics 71
TABLE 2.7
Considerations for evaluating threats
Members in Business
Members in Practice
A member in business will need to evaluate threats
in the context of the engagement or task being
undertaken.
Threats to fundamental principles will need to be
evaluated with reference to the client and its operating
environment and the firm (professional practice) and its
operating environment. Threat evaluation will also be
impacted by the nature of scope of service involved.
Assessments of threats will be impacted by the work
environment and factors to be considered may include
the following.
• Leadership that stresses the importance of ethical
behaviour and the expectation that employees will
act in an ethical manner.
• Policies and procedures to empower and encourage
employees to communicate ethics issues that
concern them to senior levels of management
without fear of retribution.
• Policies and procedures to implement and monitor
the quality of employee performance.
• Systems of corporate oversight or other oversight
structures and strong internal controls.
• Recruitment procedures emphasising the
importance of employing high calibre competent
personnel.
• Timely communication of policies and procedures,
including any changes to them, to all employees,
and appropriate training and education on such
policies and procedures.
• Ethics and code of conduct policies.
Evaluation of threats by members in public practice
will be dependent in part on the operating environment
of the client and whether they are an audit client, an
assurance client or a non-assurance.
The client’s governance structure and cultural tone
may promote compliance with fundamental principles.
Factors that may be considered include the following.
• The client requires appropriate individuals other than
management to ratify or approve the appointment of a
Firm to perform an engagement.
• The client has competent employees with experience
and seniority to make managerial decisions.
• The client has implemented internal procedures
that facilitate objective choices in tendering nonassurance engagements.
• The client has a corporate governance structure that
provides appropriate oversight and communications
regarding the Firm’s services.
Evaluation of threats also need to take place in
the context of the professional firm’s operating
environment. A member in practice may consider
the following factors when evaluating threats to
fundamental principles.
• Leadership of the Firm that promotes compliance
with the fundamental principles and establishes the
expectation that assurance team members will act in
the public interest.
• Policies or procedures for establishing and monitoring
compliance with the fundamental principles by all
personnel.
• Compensation, performance appraisal and
disciplinary policies and procedures that promote
compliance with the fundamental principles.
• Management of the reliance on revenue received from
a single client.
• The Engagement Partner having authority within the
firm for decisions concerning compliance with the
fundamental principles, including decisions about
accepting or providing services to a client.
• Educational, training and experience requirements.
• Processes to facilitate and address internal and
external concerns or complaints.
A member may need to reconsider threats to
fundamental principles when new information arises
that could impact the level of a threat or whether
safeguards could address the threat appropriately.
Examples of new information or changes in facts and
circumstances that might have an impact on threat
levels include:
• When the scope of a Professional Service
is expanded.
• When the client becomes a Listed Entity or acquires
another business unit
• When the Firm merges with another Firm.
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72 Ethics and Governance
• When the Member in Public Practice is jointly
engaged by two clients and a dispute emerges
between the two clients.
• When there is a change in the Member in Public
Practice’s personal or Immediate Family relationships.
Members may need to seek legal advice if they
believe unethical behaviour has and will continue to
occur within their employing organisation.
Source: APESB 2018, APES 110 Code of Ethics for Professional Accountants (including Independence Standards), APESB, Melbourne, www.apesb.org.au/uploads/standards/apesb_standards/23072019020747_APES_110_Restructured_Code_Nov_2018.pdf.
Identification and evaluation are the first two steps in the process for dealing with threats to the
fundamental principles. A threat that is evaluated as not being at an acceptable level needs to be addressed.
This is the third step in applying the conceptual framework.
Addressing Threats (para. R120.10)
Members need to consider how to address the threats that have been identified as not at an acceptable level.
The Code refers to the process of addressing threats in the context of eliminating them or reducing them
to an acceptable level (para. R120.10).
Threats should be addressed by either:
(a) Eliminating the circumstances, including interests or relationships, that are creating the threats;
(b) Applying safeguards, where available and capable of being applied, to reduce the threats to an
Acceptable Level; or
(c) Declining or ending the specific Professional Activity (para. R120.10).
It should be noted that, if members are unable to eliminate the circumstances that gave rise to the threat
or find that safeguards will not bring the threat down to an acceptable level, the only option left is to decline
to engage in or to end a particular professional activity (para. 120.10 A1).
The safeguards to eliminate or reduce threats to the fundamental principles of professional conduct
generally fall into two broad categories: institutional safeguards, and safeguards in the work environment.
It should be noted that the standard tailors specific guidance for matters such as independence issues
(particularly relevant in the circumstances of audit and assurance engagements) and guidance related to
the way in which threats can be dealt with in a business or accounting practice environment.
The independence standards form Parts 4A and B of the Code while issues of specific relevance to
professional accountants in business are covered in Part 2, and public practice accountants will find
guidance in Part 3.
Examples of the kinds of safeguards that could be applied include:
1. Institutional safeguards created by the profession, legislation or regulation:
– educational, training and experience requirements for entry into the profession
– continuing professional development requirements
– corporate governance regulations
– professional standards
– professional or regulatory monitoring and disciplinary procedures.
2. Safeguards particular to the work environment:
– corporate oversight structures, strong internal controls, ethics and conduct programs and appropriate
disciplinary processes
– recruitment of high-calibre, competent staff and leadership that stresses ethical behaviour
– empowering and encouraging employees to communicate ethical issues to senior management,
without fear of retribution.
Some safeguards help to identify and deter unethical behaviour and apply across both categories. These
include effective, well-publicised policies that outline required behaviours, as well as disciplinary and
complaints systems that enable colleagues, employers, accountants or the public to draw attention to
unprofessional or unethical behaviour.
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MODULE 2 Ethics 73
Documentation and Advice
In applying the three steps of the conceptual framework, members are encouraged to document the process
and outcomes (para. 110.2 A3) and to consider consulting others (para. 110.2 A2) including:
• others within the firm or employing organisation
• those charged with governance
• a professional body
• a regulatory body
• legal counsel.
PARTS 2 AND 3 OF THE CODE — APPLYING THE CODE TO
MEMBERS IN BUSINESS AND PUBLIC PRACTICE
Part 1 of the code provides a theoretical overview of the fundamental principles and the conceptual
framework. Parts 2 and 3 of the code provide specific guidance for selected circumstances members in
business or public practice may encounter that pose threats to the fundamental principles. Part 2 of the
code deals with seven common situations that members in business may need to deal with and Part 3 deals
with seven common situations faced by members in public practice. These situations are listed in table 2.8
below and examined in more detail in the material that follows. Note that there are four topics in common
and these will be addressed together at the start of the material. Other topics will follow.
TABLE 2.8
Code of Ethics Parts 2 and 3
Part 2: Members in Business
Part 3: Members in Public Practice
Section
Topic
Section
Topic
210
Conflicts of interest
310
Conflicts of interest
220
Preparation and presentation of information
320
Professional appointments
230
Acting with sufficient expertise
321
Second opinions
240
Financial interests, compensation and
incentives linked to financial reporting and
decision making
330
Fees and other types of remuneration
250
Inducements, including gifts and hospitality
340
Inducements, including gifts and hospitality
260
Responding to non-compliance with laws
and regulations
350
Custody of client assets
270
Pressure to breach the fundamental
principles
360
Responding to non-compliance with laws
and regulations
Conflicts of Interest (ss. 210, 310)
These sections cover the area of conflicts of interest in the case of both members in business and in public
practice. The Code requires individuals to not allow a conflict of interest to compromise their judgment
when involved in professional activities or engagements. The Code sets down examples in both cases that
may give rise of conflicts of interest. These appear in table 2.9.
TABLE 2.9
Circumstances that may create a conflict of interest
Members in Business (para. 210.4 A1)
Members in Practice (para. 310.4 A1)
• Serving in a management or governance position
• Providing a transaction advisory service to a client
for two employing organisations and acquiring
confidential information from one organisation that
might be used by the Member to the advantage or
disadvantage of the other organisation.
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74 Ethics and Governance
seeking to acquire an Audit Client, where the Firm
has obtained confidential information during the
course of the audit that might be relevant to the
transaction.
• Undertaking a Professional Activity for each of two
parties in a partnership, where both parties are
employing the Member to assist them to dissolve
their partnership.
• Preparing financial information for certain members
of management of the Member’s employing
organisation who are seeking to undertake a
management buy-out.
• Being responsible for selecting a vendor for the
employing organisation When an immediate Family
Member of the Member might benefit financially from
the transaction.
• Serving in a governance capacity in an employing
organisation that is approving certain investments
for the company where one of those investments will
increase the value of the investment portfolio of the
Member or an Immediate Family Member.
• Providing advice to two clients at the same time
•
•
•
•
•
•
•
•
where the clients are competing to acquire the same
company and the advice might be relevant to the
parties’ competitive positions.
Providing services to a seller and a buyer in relation
to the same transaction.
Preparing valuations of assets for two parties who
are in an adversarial position with respect to the
assets.
Representing two clients in the same matter who
are in a legal dispute with each other, such as
during divorce proceedings, or the dissolution of a
partnership.
In relation to a license agreement, providing an
assurance report for a licensor on the royalties due
while advising the licensee on the amounts payable.
Advising a client to invest in a business in which,
for example, the spouse of the Member in Public
Practice has a Financial Interest.
Providing strategic advice to a client on its
competitive position while having a joint venture or
similar interest with a major competitor of the client.
Advising a client on acquiring a business which the
Firm is also interested in acquiring.
Advising a client on buying a product or service while
having a royalty or commission agreement with a
potential seller of that product or service.
Source: APESB 2018, APES 110 Code of Ethics for Professional Accountants (including Independence Standards), APESB, Melbourne, www.apesb.org.au/uploads/standards/apesb_standards/23072019020747_APES_110_Restructured_Code_Nov_2018.pdf.
The more direct the connection between the professional activity and a conflict of interest, the more
likely it is that there is no way of ensuring a risk is kept to an acceptable level. There is a need for businesses
and professional practices to ensure that they identify potential conflicts and decide on the best way to deal
with them. It is necessary in the cases of members in either business or public practice to ensure they review
all business engagements to assess them for any potential conflicts. Members in practice, in particular,
need to ensure they evaluate the nature of interests and relationships that exist between the various parties
involved, and whether there are implications of any service offering that is being considered.
There is a need to ensure that a conflict of interest is properly dealt with by putting in place safeguards
that may assist in mitigating or reducing threats to the fundamental principles to an acceptable level.
Safeguards that may be applied in business and practice in the context of minimising or preventing conflicts
of interests are presented in table 2.10.
TABLE 2.10
Conflict of interest safeguards
Members in Business
(paras. 210.7 A2–210.7 A3, 210.9 A1)
Members in Practice
(paras. 310.8 A2–310.8 A3)
• Restructuring or segregating certain responsibilities
In the case of confidential client information that may
be a concern when dealing with clients in similar
industries, for example, the Code suggests measures
such as the following.
• The existence of separate practice areas for
specialty functions within the Firm, which might
act as a barrier to the passing of confidential client
information between practice areas.
• Policies and procedures to limit access to client files.
• Confidentiality agreements signed by personnel and
partners of the Firm.
and duties.
• Obtaining appropriate oversight, for example, acting
under the supervision of an executive or
non-executive Director.
• Withdrawing from the decision making process
related to the matter giving rise to the conflict
of interest.
• Consulting with third parties, such as a professional
body, legal counsel or another Member.
(continued)
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MODULE 2 Ethics 75
TABLE 2.10
(continued)
Members in Business
(paras. 210.7 A2–210.7 A3, 210.9 A1)
Members in Practice
(paras. 310.8 A2–310.8 A3)
• Separation of confidential information physically and
electronically.
• Specific and dedicated training and communication.
Safeguards to address conflicts of interest more
generally include the following.
• Having separate Engagement Teams who are
provided with clear policies and procedures on
maintaining confidentiality.
• Having an appropriate reviewer, who is not involved
in providing the service or otherwise affected by
the conflict, review the work performed to assess
whether the key judgements and conclusions are
appropriate.
Source: APESB 2018, APES 110 Code of Ethics for Professional Accountants (including Independence Standards), APESB, Melbourne, www.apesb.org.au/uploads/standards/apesb_standards/23072019020747_APES_110_Restructured_Code_Nov_2018.pdf.
QUESTION 2.11
Francis is a member working in a practice that specialises in the provision of financial advice.
Toby and Francis are both directors and they are both engaged in providing financial advice to
clients. Francis and Toby discussed investment strategies appropriate for a new client that involved
property investments and Toby disclosed that he has interests in a property investment firm while
Francis has no shares or ownership in such an entity.
Determine the potential conflict that exists in this situation and suggest a strategy to reduce the
threat to fundamental principles to an acceptable level.
QUESTION 2.12
Celia is a director of a company that is a local uniform manufacturer but she is also on the
management committee of a local community group which has launched its annual fundraising
drive. Celia has mentioned the fundraising initiative to her board colleagues and suggested that
the business could benefit from being associated with a group that has an objective to help the
needy in the same area in which the company has its factory and corporate offices. Celia is an
accountant and has disclosed her interest as a member of the management committee.
The board of the uniform manufacturing company is considering the request. How should the
board deal with Celia’s suggestion?
QUESTION 2.13
You have been asked to audit Toytown Pty Ltd’s half-year financial statements.
• The company was last audited by Smith, Jones & Associates, which resigned as the auditor as a
result of the retirement of the only registered company auditor within the practice.
• For the last three years, Toytown has engaged Ace Tax Services, a firm of local CPAs, to prepare
corporate income tax returns and wishes this arrangement to continue.
Are you required by the APESB Code of Ethics to contact or obtain professional clearance from
each of the above accounting firms before accepting the appointment as auditor of the half-year
financial statements?
dP
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76 Ethics and Governance
Remuneration, Incentives, Fees and other Forms of Payment
Financial considerations that are improperly managed in both business and public practice can lead to
threats to fundamental principles set down in the Code. Members in business (paras. 240.1–240.4 A4)
and members in public practice (paras. 330.1–330.6 A1) have specific guidance about how to deal with
threats that might arise. In both circumstances there is the possibility of a self-interest threat that can arise
if situations are not properly managed. Self-interest threats can arise in several ways if financial affairs are
compromised in some form. Table 2.11 outlines these in some detail.
TABLE 2.11
Circumstances that create a self-interest threat
Members in Business (para, 240.3 A2)
Members in Practice
A self-interest threat exists when a Member:
Level of fees (para. 330.3 A2):
Level of fees may impact on a Member’s ability
to perform services to appropriate professional
standards. If a fee quoted is too low if may be difficult
for the Member to perform a service in accordance
with technical and Professional Standards.
• Has a motive and opportunity to manipulate pricesensitive information in order to gain financially.
• Holds a Direct or Indirect Financial Interest in
the employing organisation and the value of that
Financial Interest might be directly affected by
decisions made by the Member.
• Is eligible for a profit-related bonus and the value of
that bonus might be directly affected by decisions
made by the Member.
• Holds, directly or indirectly, deferred bonus share
rights or share options in the employing organisation,
the value of which might be affected by decisions
made by the Member.
• Participates in compensation arrangements which
provide incentives to achieve targets or to support
efforts to maximise the value of the employing
organisation’s shares. An example of such an
arrangement might be through participation
in incentive plans which are linked to certain
performance conditions being met.
Contingent fees (paras. 330.4 A1, AUST R330.4.1):
Contingent fees are dependent on an outcome and
these may create a self-interest threat in circumstances
where a practitioner may not be objective in the
delivery of professional services. The Code prohibits
contingent fees in the following types of services:
forensic accounting, valuation, insolvency, reporting
on prospective financial information, due diligence
committee participation.
Referral fees (para. 330.5 A1):
Referral fees may lead to a self-interest threat,
especially in circumstances where fees are:
• paid to another Member in Public Practice for
the purposes of obtaining new client work when
the client continues as a client of the Existing
Accountant but requires specialist services not
offered by that accountant
• a fee received for referring a continuing client to
another Member in Public Practice or other expert
where the Existing Accountant does not provide the
specific Professional Service required by the client.
• a commission received from a third party (for
example, a software vendor) in connection with the
sale of goods or services to a client.
Source: APESB 2018, APES 110 Code of Ethics for Professional Accountants (including Independence Standards), APESB, Melbourne, www.apesb.org.au/uploads/standards/apesb_standards/23072019020747_APES_110_Restructured_Code_Nov_2018.pdf.
The Code requires members to evaluate the threats once they are identified as required by the conceptual
framework. Each member will have a slightly different way of evaluating threats and different ways of
implementing safeguards to avoid contravening the fundamental principles set down in APES 110. These
are outlined in table 2.12.
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MODULE 2 Ethics 77
TABLE 2.12
Safeguards to prevent self-interest threats
Members in Business (para. 240.3 A3)
While the points that appear below are a part of
the evaluation of threats in a business setting, they
can also be regarded as safeguards which may
restrict behaviour that is contrary to the fundamental
principles.
• Policies and procedures for a committee
independent of management to determine the level
or form of senior management remuneration.
• In accordance with any internal policies, disclosure
to those charged with governance of:
– all relevant interests
– any plans to exercise entitlements or trade in
relevant shares.
• Internal and external audit procedures that are
specific to address issues that give rise to the
financial interest.
Members in Practice (s. 330)
Fees (para. 330.3 A4):
• Adjusting the level of fees or the scope of the
engagement.
• Having an appropriate reviewer review the work
performed.
Contingent fees (para. 330.4 A3):
• Having an appropriate reviewer who was not
involved in performing the non-assurance service
review the work performed by the Member in Public
Practice.
• Obtaining an advance written agreement with the
client on the basis of remuneration.
Referral fees (para. 330.5 A2):
• Obtaining an advance agreement from the client for
commission arrangements in connection with the
sale by another party of goods or services to the
client might address a self-interest threat.
• Disclosing to clients any referral fees or commission
arrangements paid to, or received from, another
Member in Public Practice or third party for
recommending services or products might address a
self-interest threat.
Source: APESB 2018, APES 110 Code of Ethics for Professional Accountants (including Independence Standards), APESB, Melbourne, www.apesb.org.au/uploads/standards/apesb_standards/23072019020747_APES_110_Restructured_Code_Nov_2018.pdf.
Commissions and Soft-Dollar Benefits
Financial advisers have an important role to play in helping clients achieve their financial objectives such
as wealth accumulation and retirement planning. To do this, advisers must provide high-quality, objective,
expert advice.
Accountants in public practice who provide financial advice must be able to recognise potential threats
created by personal and business relationships. Those who provide financial advice (which generally
includes advice on financial products such as shares, managed funds, master funds and life insurance)
must follow the provisions of APES 230 Financial Planning Services.
Receiving remuneration in the form of commissions and other financial benefits might threaten a member’s objectivity. Commissions create potential self-interest threats to objectivity. Therefore, accountants
should adopt a fee-for-service approach, as this approach is seen as consistent with the principle of
professional independence.
At a minimum, where a member accepts commissions or other incentives, the member must fully and
clearly disclose to the client the nature and extent of such fees. In addition to commissions, soft-dollar
benefits received from third parties create conflicts that can potentially undermine independent advice.
Soft-dollar benefits include all monetary and non-monetary benefits received from a third party, such as
fund managers, for the sale or recommendation of certain products. Remuneration in the form of softdollar benefits has the potential to influence an adviser’s recommendations to clients, or at least give the
impression of such influence.
CPA Australia, through APES 230, has accordingly banned a wide range of benefits, gifts or other
incentives (including soft-dollar benefits), including commissions based on sales volumes, preferential
commissions linked to in-house financial products, free or subsidised office equipment, computers or
software, and gifts over $300 in value.
.......................................................................................................................................................................................
CONSIDER THIS
Turn to s. 240 as it relates to members in business and s. 330, which covers the topics of fees for members in public
practice. Take note of the provisions related to the evaluation of threats and reflect on why those differences exist.
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78 Ethics and Governance
Inducements, Including Gifts and Hospitality (ss. 250, 340)
Inducements are defined in paragraph 250.4 A1 as being objects, situations or actions that are used as a
means to influence another individual’s behaviour. The code describes inducements as ranging from acts
of hospitality to acts that end in noncompliance with the legal and regulatory pronouncements that are in
force in a jurisdiction. Various forms of inducements exist and they may take the form of gifts, hospitality,
entertainment, political or charitable donations, appeals to friendship and loyalty, employment or other
commercial opportunities, and preferential treatment, rights or privileges.
The Code points to rules and laws that operate in jurisdictions that prohibit the offer or acceptance of
inducements. These laws are typically related to bribery and corruption. Members are obliged under the
Code to understand relevant regulations and ensure compliance. The Code offers a series of examples of
different threats that may exist in the provision of inducements, even if there is no intent on the part of the
person offering hospitality, for example, to influence behaviour.
Paragraph 340.11 A3 states that there are situations where an inducement may create a threat in the
context of public practice. A self-interest threat may be created in circumstances where a member in public
practice who is providing corporate finance services to a client is offered hospitality by a prospective
acquirer of the client. Familiarity threats may arise if an existing or prospective client is regularly taken to
sporting events. An intimidation threat could exist if a member in public practice accepted hospitality of a
kind that could be seen as inappropriate by the broader community if it was publicised.
Table 2.13 lists the key indicators that determine whether inducements are likely to cause a threat to
fundamental principles. That is, is the intent of the inducement (actual or perceived) to influence the
behaviour of the recipient or other individual?
TABLE 2.13
Factors to consider
Members in Business (para. 250.9 A3)
Members in Practice (para. 340.9 A3)
• The nature, frequency, value and cumulative effect of
• The nature, frequency, value and cumulative effect of
the Inducement.
• Timing of when the Inducement is offered relative to
any action or decision that it might influence.
• Whether the Inducement is a customary or cultural
practice in the circumstances, for example, offering
a gift on the occasion of a religious holiday or
wedding.
the Inducement.
• Timing of when the Inducement is offered relative to
any action or decision that it might influence.
• Whether the Inducement is a customary or cultural
practice in the circumstances, for example, offering
a gift on the occasion of a religious holiday or
wedding.
• Whether the Inducement is an ancillary part of
• Whether the Inducement is an ancillary part of
a Professional Activity, for example, offering or
accepting lunch in connection with a business
meeting.
a professional service, for example, offering or
accepting lunch in connection with a business
meeting.
• Whether the offer of the Inducement is limited to an
individual recipient or available to a broader group.
The broader group might be internal or external to
the employing organisation, such as other customers
or vendors.
• The roles and positions of the individuals offering or
being offered the Inducement.
• Whether the Member knows, or has reason to
believe, that accepting the Inducement would breach
the policies and procedures of the counterparty’s
employing organisation.
• The degree of transparency with which the
Inducement is offered.
• Whether the offer of the Inducement is limited to an
individual recipient or available to a broader group.
The broader group might be internal or external to
the firm, such as other suppliers to the client.
• The roles and positions of the individuals at the
firm or the client offering or being offered the
Inducement.
• Whether the Member in public practice knows, or
has reason to believe, that accepting the Inducement
would breach the policies and procedures of the
client.
• The degree of transparency with which the
Inducement is offered.
(continued)
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MODULE 2 Ethics 79
TABLE 2.13
(continued)
Members in Business (para. 250.9 A3)
Members in Practice (para. 340.9 A3)
• Whether the Inducement was required or requested
• Whether the Inducement was required or requested
by the recipient.
• The known previous behaviour or reputation of the
offeror.
by the recipient.
• The known previous behaviour or reputation of the
offeror.
Source: APESB 2018, APES 110 Code of Ethics for Professional Accountants (including Independence Standards), APESB, Melbourne, www.apesb.org.au/uploads/standards/apesb_standards/23072019020747_APES_110_Restructured_Code_Nov_2018.pdf.
There are some safeguards that can be used to ensure that any threat to fundamental principles from
inducements irrespective of their nature is either eliminated or reduced to an acceptable level. These are
outlined in table 2.14.
TABLE 2.14
Safeguards related to inducements
Members in Business (para. 250.11 A6)
Members in Practice (para. 340.11 A6)
• Being transparent with senior management or
• Being transparent with senior management of the
Those Charged with Governance of the employing
organisation of the Member or of the counterparty
about offering or accepting an Inducement.
• Registering the Inducement in a log maintained by
the employing organisation of the Member or the
counterparty.
Firm or of the client about offering or accepting an
Inducement.
• Registering the Inducement in a log monitored by
senior management of the firm, another individual
responsible for the Firm’s ethics compliance or
maintained by the client.
• Having an appropriate reviewer, who is not otherwise
• Having an appropriate reviewer, who is not otherwise
involved in undertaking the Professional Activity,
review any work performed or decisions made by the
Member with respect to the individual or organisation
from which the Member accepted the Inducement.
involved in providing the Professional Service, review
any work performed or decisions made by the
Member in Public Practice with respect to the client
from which the Member accepted the Inducement.
• Donating the Inducement to charity after receipt and
appropriately disclosing the donation, for example,
to Those Charged with Governance or the individual
who offered the Inducement.
• Reimbursing the cost of the Inducement, such as
hospitality, received.
• As soon as possible, returning the Inducement, such
as a gift, after it was initially accepted.
• Donating the Inducement to charity after receipt and
appropriately disclosing the donation, for example, to
a member of senior management of the Firm or the
individual who offered the inducement.
• Reimbursing the cost of the Inducement, such as
hospitality, received.
• As soon as possible, returning the Inducement, such
as a gift, after it was initially accepted.
Source: APESB 2018, APES 110 Code of Ethics for Professional Accountants (including Independence Standards), APESB, Melbourne, www.apesb.org.au/uploads/standards/apesb_standards/23072019020747_APES_110_Restructured_Code_Nov_2018.pdf.
QUESTION 2.14
Toby is working with an accounting firm providing consulting services to a manufacturing client
who repeatedly offers him hospitality at the football, tennis and the cricket. The output from his
consulting services is a report that needs to be seen as independent when it is completed and
lodged with a regulator.
Describe what Toby’s response should be to the client when a representative approaches him
with an offer of hospitality at sporting events. Name the threat and fundamental principle involved.
dP f_Folio:80
80 Ethics and Governance
QUESTION 2.15
Muscle Adventures Ltd is looking for a new contractor to supply its photocopiers and associated
supplies. The company’s purchasing officer, Peter, a CPA, has a key role in organising the tender
and deciding on the successful party. He has been invited out to lunch and dinner by a company
that is considering tendering for services.
What kind of threat does this invitation pose to Peter given his role in the tendering process?
Responding to Non-compliance with Laws and Regulations (ss. 260, 360)
Members in business and in public practice may encounter or be made aware of actual or suspected
non-compliance with laws and regulations when carrying out professional activities. Members in public
practice may find non-compliance in activities undertaken by their clients while members in business
may encounter non-compliance within their own company and in the activities of companies with which
they engage.
Non-compliance in the following areas is covered by this part of the standard.
(a) Laws and regulations generally recognised to have a direct effect on the determination of material
amounts and disclosures in the employing organisation’s/client’s Financial Statements; and
(b) Other laws and regulations that do not have a direct effect on the determination of the amounts and
disclosures in the employing organisation’s/client’s Financial Statements, but compliance with which
might be fundamental to the operating aspects of the employing organisation’s/client’s business, to its
ability to continue its business, or to avoid material penalties (paras. 260.3, 360.3).
NOCLAR deals with how members must respond when they encounter or are made aware of noncompliance or suspected non-compliance with laws and regulations in the course of carrying out
professional activities, to ensure that they act in the public interest.
If there are laws or regulations that specify how members should deal with non-compliance or suspected
non-compliance, members have the responsibility to be aware of and comply with them.
NOCLAR provides a framework for accountants in business so that they can fulfil their responsibility
to act in the public interest when responding to non-compliance:
(a) To comply with the fundamental principles of integrity and professional behaviour;
(b) By alerting management or, where appropriate, Those Charged with Governance of the employing
organisation/client, to seek to:
(i) Enable them to rectify, remediate or mitigate the consequences of the identified or suspected
NOCLAR; or
(ii) Deter the commission of the NOCLAR where it has not yet occurred; and
(c) To take such further action as appropriate in the public interest (paras. 260.4, 360.4).
Laws and regulations that are fundamental to the operations of the employing organisation or lead to
material penalties vary for each entity and context, and generally include:
•
•
•
•
•
•
•
•
Fraud, corruption and bribery.
Money laundering, terrorist financing and proceeds of crime.
Securities markets and trading.
Banking and other financial products and services.
Data protection.
Tax and pension liabilities and payments.
Environmental protection.
Public health and safety (paras. 260.5 A2, 360.5 A2).
The illustration in figure 2.9 provides an example of how the NOCLAR regime works. Notice that the
graphic has on the right-hand side a solid navy bar with the word ‘documentation’. It is critical to ensure
that details of all considerations are documented because the notes and records may be required later if
litigation becomes involved.
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MODULE 2 Ethics 81
FIGURE 2.9
Applying the NOCLAR regime
Obtain an understanding of the matter
Determine whether further action is needed
Documentation
Address the matter
Determine whether to disclose the matter to an appropriate authority
NOCLAR provides a different and proportionate approach for senior accountants in business and
for accountants other than those in senior positions. Accountants in business must consider established
protocols and procedures, such as ethics and whistleblowing policies, when determining how to respond
to non-compliance with laws and regulations. There are core obligations that need to be followed by senior
accountants in business and also senior accountants in practice. These are set down in sequence.
Senior Members in Business (paras. 260.11 A1–260.18 A2)
Senior members are ‘Directors, Officers or senior employees’ who are ‘able to exert significant influence
over, and make decisions regarding’ the employing organisation’s resources. Their roles, positions and
influence create the expectation that they will ‘take whatever action is appropriate in the public interest
to respond to NOCLAR or suspected NOCLAR than other Members within the employing organisation’
(para. 260.11 A1).
Senior accountants or senior members in business must (paras. R260.12–R260.23):
• obtain an understanding of the matter, including its nature and circumstances, the relevant laws and
regulations, and potential consequences for the employing organisation and its stakeholders; as well as
apply knowledge, professional judgment and expertise
• address the matter:
– discuss the non-compliance or suspected non-compliance with the immediate superior, or the next
hierarchical level if the immediate superior seems to be involved in it
– communicate with those charged with governance, comply with laws and regulations, rectify,
remediate or mitigate the consequences of the non-compliance, reduce risk of reoccurrence, and
deter the non-compliance from happening, if it has not already occurred
– the member must also determine whether the non-compliance needs to be communicated with the
external auditor, if any
• determine whether further action is needed:
– assess the response from superiors and those charged with governance
– determine if further action is needed in the public interest by considering factors such as the legal and
regulatory framework, the urgency and pervasiveness of the matter, confidence in the integrity of the
superiors and those charged with governance, the possibility of recurrence, evidence of substantial
harm to stakeholders, etc.
– take into account whether a reasonable and informed third party, weighing all the specific facts
and circumstances available at the time, would be likely to conclude that the member has acted
appropriately in the public interest
• determine whether to disclose the matter to an appropriate authority:
– making a disclosure to an appropriate authority is not allowed if it is contrary to law or regulation;
in all other cases, the senior member must determine whether to disclose to an appropriate authority
by considering the actual or potential harm to stakeholders. Senior accountants may determine that
disclosure to an authority is appropriate in cases such as bribery, harmful products, tax evasion,
systemic risk to the financial markets, etc.
Pdf_Folio:82
82 Ethics and Governance
– determine whether an appropriate authority exists, there are adequate protections from civil, criminal
or professional liability or retaliation, and there is potential for threats to safety
• document details of the matter, judgments and decisions made, responses from management and those
charged with governance, etc.
Accountants other than Senior Members (paras. R260.24, R260.26)
Accountants in business who are not in senior positions are required to obtain an understanding of the
matter and apply knowledge, professional judgment and expertise. They are also required to inform their
immediate superior about the non-compliance or suspected non-compliance, or the next hierarchical level
if the immediate superior seems to be involved in it.
In exceptional circumstances, the member may decide to disclose the non-compliance to an appropriate
authority. If a disclosure is made to an appropriate authority in line with the requirements of section 260,
this will not be considered a breach of the duty of confidentiality.
Disclosure of non-compliance with laws and regulations to an appropriate authority may be a complex
and difficult judgment. The Code of Ethics suggests that members in business may consider consulting on
a confidential basis within the employing organisation, obtain legal advice to understand options and the
professional or legal implications of taking any particular course of action; or consult a professional body.
However, in relation to disclosure of confidential information when not required by law or regulation,
the Australian-specific guidance requires accountants to seek advice before disclosing confidential
information about a client or employer without consent.
NOCLAR for Members in Public Practice
APES 110 has guidance that differs for audits and professional services other than audits. Public
practitioners who identify or suspect non-compliance must apply the guidance in a timely manner,
they must:
• obtain an understanding of the matter
• address the matter
• determine whether further action is needed
• document details of the matter.
QUESTION 2.16
Read the relevant parts of section 360 and complete the following.
(a) Fill in the missing items in table 2.15.
TABLE 2.15
Guidance for managing non-compliance
Steps for audits (paras. R360.10–360.28 A1)
Steps for professional services other than
audits (paras. R360.29–360.40 A1)
1.
1. Obtain an understanding of the matter
2. Address the matter
2.
3.
3. Communicate with the entity’s external auditor
4. Document the steps and outcomes
4.
5.
(b) What difference does the presence or possibility of an ‘imminent breach’ make to the process?
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MODULE 2 Ethics 83
EXAMPLE 2.11
DDV Accounting
DDV Accounting offers accounting services to a number of small and medium enterprises. Over the past
five years it has managed the payroll for some restaurant chains and corner stores. One of its clients was
the fast-food chain Yummy Tummy. Three years ago, Yummy Tummy was audited by the relevant regulator
and found to have been underpaying its casual employees by thousands of dollars and non-compliant
with the relevant labour and employment conditions laws. DDV Accounting was informed by the regulator
and provided with information about the legal labour rates and conditions that apply in the jurisdiction.
Kath Omany, a CPA, has been working for DDV Accounting for four years. She has been responsible
for the services provided to Yummy Tummy for three and a half years. These services include managing
the chain’s payroll for its 287 employees. Kath is aware that the amounts paid to at least half of those
employees are well below the legal requirements. She became aware of this when she started providing
services to Yummy Tummy. She has not done anything about it because she did not, and does not, think
that the decisions made by her clients are her business. She believes that she is only obligated to complete
tasks requested by the client.
QUESTION 2.17
How would you advise Kath?
QUESTION 2.18
In your jurisdiction there is no legal requirement to keep client confidentiality under a relevant law
or regulation. However, in your professional services contract and terms of engagement there is a
confidentiality clause. Considering this, answer the following questions.
• Are you required to do anything if you identify or suspect a non-compliance with laws and
regulations?
• Are you protected if you do not comply with the confidentiality clause in your client contract and
terms of engagement?
The following sections deal with the topics that are specific to members in business.
Preparation and Presentation of Information (s. 220)
Closely related to the issue of conflicts of interest is earnings and balance sheet management. Earnings
and balance sheet management consists of actions that deliberately increase or decrease reported earnings,
assets or liabilities in order to achieve a preferred outcome. The management of a company may, for
example, favour the adoption of such practices in order to mislead shareholders and other stakeholders
about the underlying economic performance of the company or to influence contractual outcomes that
depend on the published accounting information.
Accountants in business who are involved in preparing and reporting information must ensure that they:
(a) Prepare or present the information in accordance with a relevant reporting framework, where
applicable;
(b) Prepare or present the information in a manner that is intended neither to mislead, nor to influence
contractual or regulatory outcomes inappropriately;
(c) Exercise professional judgement to:
(i) Represent the facts accurately and completely in all material respects;
(ii) Describe clearly the true nature of business transactions or activities; and
(iii) Classify and record information in a timely and proper manner; and
(d) Not omit anything with the intention of rendering the information misleading or of influencing
contractual or regulatory outcomes inappropriately (para. R220.4).
Accountants in business can be pressured to prepare or report information in a misleading way or to
become associated with misleading information through the actions of others. Safeguards to address such
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84 Ethics and Governance
threats or reduce them to an acceptable level include ‘consultation with superiors within the employing
organisation, the audit committee or Those Charged with Governance of the organisation, or with a relevant
Professional Body’.
A member may decide to refuse to be associated with information that is misleading if attempts to
deal with various individuals within the corporate hierarchy fail (para. R220.9). Application guidance
in paragraph 220.9 A1 states that ‘it might be appropriate for a Member to resign from the employing
organisation’ depending on the circumstances. The Code also provides guidance for accountants to
document all of the relevant issues, facts, communication with parties involved in the discussions over
reporting issues and what courses of action were considered (para. 220.10 A1).
Reporting with Integrity
The motto of CPA Australia is ‘integrity’. Accountants have long been trusted as those who assure the
community of reliable and accurate financial information. The wider community relies heavily on the work
performed by accountants. People who use the services provided by accountants, particularly decision
makers relying upon financial statements, expect accountants to be highly competent and objective.
Therefore, those who work in the field of accounting must not only be well qualified but also must possess
a high degree of integrity.
The Institute of Chartered Accountants in England and Wales (ICAEW 2007) developed a framework for reporting with integrity. While integrity is often associated with the ethics of the individual,
according to this framework, reporting with integrity is a joint endeavour of individuals, organisations and
the profession.
A person with integrity will then demonstrate desirable behavioural attributes that are associated with
integrity, such as being honest and compliant with the relevant laws and regulations. Overall integrity in
reporting is underpinned by ethical values such as honesty, motives such as fairness, a commitment to users,
and qualities such as scepticism and diligence. Reporting with integrity relies on all entities (e.g. audit
firms) to take steps to promote integrity through leadership, strategy, policies, information and culture.
EXAMPLE 2.12
Fortex
In the early nineties New Zealand meat processor Fortex failed owing more than $130m to creditors and
another $30m to farmers. The managing director was jailed for 6.5 years and the financial controller for
4 years (although this was later reduced on appeal). Both showed a distinct lack of integrity and were
convicted of fraud for:
• classifying $20m of loans as income
• overvaluing inventory by $25 by reclassifying lamb flaps as French cutlets
• recording $5m of false sales.
Source: Information from Hutching, C 2017, ‘Fortex boss spills beans about jail and return to business’, accessed August
2019, www.stuff.co.nz/business/97120854/fortex-boss-spills-beans-about-jail-time-and-return-to-business.
QUESTION 2.19
Explain why integrity is an essential attribute of the profession.
Acting with Sufficient Expertise (s. 230)
The requirement to act with sufficient expertise is linked closely to the fundamental principle of professional competence and due care. A member shall ‘only undertake significant tasks for which the Member
has, or can obtain, sufficient training or experience’ (para. 230.3 A1). Furthermore, ‘A Member shall
not intentionally mislead an employing organisation as to the level of expertise or experience possessed’
(para. R230.3).
Potential threats include having insufficient time to properly perform or complete relevant duties, and
having insufficient experience, training and/or education (para. 230.3 A2). Safeguards include obtaining
additional training, ensuring that there is adequate time available for performing the relevant duties, and
obtaining assistance from someone with the necessary expertise (para. 230.3 A4).
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MODULE 2 Ethics 85
QUESTION 2.20
James Chan is a sole practitioner specialising in audit services. James has become interested in
assurance services for the elderly. He recently attended a presentation on care services for the
elderly and believes that this new assurance service will differentiate him from other practitioners
in the area and, therefore, offers a means to attract more clients.
James has placed a series of advertisements in the local press. The advertisements state that he
can provide expert reports to assure family members that proper care is provided to elderly family
members who are no longer totally independent.
Although James has no previous experience or training in this area, he believes that he can carry
out the work using traditional audit skills.
(a) What is the threat here and which principles are threatened?
(b) Advise James on how to address this threat.
Pressure to Breach Fundamental Principles (s. 270)
Intimidation is the last of the threats to be examined in this section. Intimidation can take the form of
pressure related to any of the threats that have been covered. For example pressure to act without sufficient
expertise or pressure to influence the preparation or presentation of financial statements.
QUESTION 2.21
Please read s. 270 of APES 110 and answer these questions.
A senior manager is pressuring you (a junior accountant) to pay invoices for expenses that she
has signed off on but that you know are not work related.
(a) What type of threat is this?
(b) What should you do?
The following sections deal with the topics that are specific to members in public practice.
Professional Appointments (s. 320)
When a member in public practice is approached by a potential client, acceptance of the client should
not be granted automatically. The member must consider a number of issues before accepting a new
client. In particular, they must consider ‘whether acceptance would create any threats to compliance
with the fundamental principles’. For example, ‘client involvement in illegal activities (such as money
laundering), dishonesty, questionable financial reporting practices or other unethical behaviour’ could
threaten a member’s compliance with integrity and professional behaviour (para. 320.3 A1). Likewise,
a member may be approached by a potential client to undertake tasks for which the member has neither
experience nor knowledge. In this circumstance, a self-interest threat to professional competence and due
care arises because the member does not possess the competencies necessary to properly carry out the
engagement (para. 320.3 A3).
The Code of Ethics outlines factors to take into account when evaluating a threat. These include:
• acquiring an appropriate understanding of the nature of the client’s business, the complexity of its
operations, the specific requirements of the engagement and the purpose, nature and scope of the work
to be performed
• acquiring knowledge of relevant industries or subject matters
• possessing or obtaining experience with relevant regulatory or reporting requirements
• assigning sufficient staff with the necessary competencies
• using experts where necessary
• agreeing on a realistic time frame for the performance of the engagement
• complying with quality control policies and procedures designed to provide reasonable assurance that
specific engagements are accepted only when they can be performed competently (paras. 320.3 A2,
320.3 A4–320.3 A5).
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86 Ethics and Governance
Communication
It has long been considered a matter of etiquette for a proposed successor to communicate with their
predecessor before accepting a professional appointment. This communication provides the proposed
successor accountant with the opportunity to identify whether there are professional reasons why the
appointment should not be accepted. For example, reasons could include intimidation threats where the
predecessor was placed under undue pressure to act in a way that was illegal and/or unethical.
In the case of an audit of financial statements, paragraph R320.8 requires that a member requests:
. . . the Existing or Predecessor Accountant to provide known information regarding any facts or other
information of which, in the Existing or Predecessor Accountant’s opinion, the Member needs to be aware
before deciding whether to accept the engagement. Except for the circumstances involving NOCLAR or
suspected NOCLAR set out in paragraphs R360.21 and R360.22:
(a) If the client consents to the Existing or Predecessor Accountant disclosing any such facts or other
information, the Existing or Predecessor Accountant shall provide the information honestly and
unambiguously; and
(b) If the client fails or refuses to grant the Existing or Predecessor Accountant permission to discuss
the client’s affairs with the Member in Public Practice, the Existing or Predecessor Accountant shall
disclose this fact to the Member, who shall carefully consider such failure or refusal when determining
whether to accept the appointment.
Similarly, there may be a threat to professional competence and due care if an accountant accepts the
engagement before knowing all the facts regarding the client’s business. Thus, the matter becomes one of
competence, integrity and objectivity.
One problem inhibiting effective communication is that existing accountants are bound by the principle
of confidentiality. The extent to which the existing accountant can and should discuss the affairs of a
client with a proposed successor will ultimately depend on whether the client has granted permission
to do so, as well as the legal or ethical requirements relating to such communications and disclosure.
Circumstances where disclosure of confidential information is required or may otherwise be appropriate
are set out in an earlier section of the framework on confidentiality. Generally, a member will need to
obtain the client’s permission, preferably in writing, to communicate with the existing or predecessor
accountant (para. R320.7). The existing or predecessor accountant must provide information ‘honestly
and unambiguously’ (para. 320.5 A1) and should do so only with the client’s permission (para. 320.7 A1)
or under the circumstances set out in paragraph 114.1 A1 (para. 320.7 A2).
Referrals
Referrals occur when a client requires specialist advice in an area that is beyond the competence of their
existing accountant. In this case, the member or the client should engage another accountant with the
required expertise. A referral should not be seen as an invitation for the accountant who has received the
referred special assignment to ‘take over’ the client. The established relationship between the referring
accountant and the client is maintained.
The underlying issue with referrals is one of professional competence. Knowing the extent of one’s
own skills and when the skills of a more qualified expert are required is closely linked to the principle of
professional competence.
Second Opinions (s. 321)
Seeking a second opinion is common in many professions. In an accounting setting, problems may arise
when a client who is dissatisfied with the original opinion on an accounting transaction seeks alternative
opinions from other accountants. This practice, colloquially referred to as ‘opinion shopping’, occurs when
the client seeks alternative opinions until they succeed in obtaining an opinion favourable to their position.
When this occurs, the client may use this opinion to place pressure on the existing accountant to adopt the
alternative opinion favourable to the client or risk losing the client.
When a member is asked to provide a second opinion, the member should seek permission from the
client to contact the existing accountant and discuss the transaction in question to ensure that the member
provides a fully informed second opinion If the client refuses the member permission to communicate
with the existing accountant, the member should consider whether it is appropriate to provide a second
opinion (para. R321.4). In providing a second opinion, as safeguards, the member should clearly inform
the client about limitations surrounding any opinion and also provide the existing accountant with a copy
of the opinion (para. 321.3 A3).
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MODULE 2 Ethics 87
Custody of Client Assets (s. 350)
Unless permitted by law, accountants should not assume custody of client monies or other assets. Where
an accountant has been entrusted with money, they should make sure this is kept separate from other assets
and should only be used for its intended purpose (para. R350.3).
QUESTION 2.22
Using your understanding of the Code as it presently stands, answer the following.
• Does the Code of Ethics require a member in business to actively look for any noncompliance
with laws and regulations in the employing organisation?
• Does it require accountants to know laws and regulations that are not related to their role and
responsibilities?
PART 4 OF THE CODE — APPLYING THE CONCEPTUAL
FRAMEWORK IN THE CONTEXT OF AUDIT, REVIEW AND
ASSURANCE ENGAGEMENTS
Audit, review and assurance engagements receive individual, special treatment in the Code because of the
need to ensure that these engagements are conducted in an environment where auditors and other assurance
professionals provide independent perspectives on a set of facts. The area of audit independence is taken
seriously by the profession and all members are expected to understand the underlying principles that drive
the need to ensure any audit, review or assurance report or opinion is seen as being done by professionals
who are independent of the client.
Independence is a fundamental component of complying with the fundamental principles of integrity
and objectivity. The conceptual framework in APES 110 requires members involved in audit, review and
assurance engagements to ensure that any threats to independence are either eliminated or reduced to an
acceptable level using safeguards as outlined in the previous section. There are circumstances in which
specific threats can only be dealt with by declining or withdrawing from a particular professional activity
or engagement.
Definition of Independence
The Code defines independence as being linked to both objectivity and integrity. It compises:
(a) Independence of mind – the state of mind that permits the expression of a conclusion without being
affected by influences that compromise professional judgement, thereby allowing an individual to act
with integrity, and exercise objectivity and professional scepticism.
(b) Independence in appearance – the avoidance of facts and circumstances that are so significant that a
reasonable and informed third party would be likely to conclude that a Firm’s or an Audit or Assurance
Team member’s integrity, objectivity or professional scepticism has been compromised (para. 290.6).
The Code of Ethics treats independence as a significant concern for accountants and there are two
sections in the Code that deal with independence in the context of specific engagements.
Part 4A deals with independence of audit and review engagements while Part 4B deals with independence in the context of assurance engagements other than audit and review engagements. While you are
not expected to know this section in detail for examination purposes, it is important that you understand
the underlying principles embedded within these two sections of the Code of Ethics.
Parts 4A and 4B of the Code are comprehensive in their coverage of a range of independence-related
matters. It is not a requirement to print the whole section on independence. Parts 4A and 4B cover the
topics that appear in table 2.16.
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88 Ethics and Governance
TABLE 2.16
Independence topics for public practice
Part 4A: Audit and review engagements
Part 4B: Engagements other than audit and review
engagements
Section
Topic
Section
Topic
410
Fees
905
Fees
411
Compensation and evaluation policies
906
Gifts and hospitality
420
Gifts and hospitality
907
Actual or threatened litigation
430
Actual or threatened litigation
910
Financial interests
510
Financial interests
911
Loans and guarantees
511
Loans and guarantees
920
Business relationships
520
Business relationships
921
Family and personal relationships
521
Family and personal relationships
922
Recent service with an assurance client
522
Recent service with an audit client
923
Serving as a director or officer of an
assurance client
523
Serving as a director or officer of an audit
client
924
Employment with an assurance client
524
Employment with an audit client
940
Long association of personnel with an
assurance client
525
Temporary personnel assignments
950
Provision of non-assurance services to
assurance clients other than audit and
review engagement clients
540
Long association of personnel (including
partner rotation) with an audit client
990
Reports that include a restriction on use
and distribution (assurance engagements
other than audit and review engagements)
600
Provision of non-assurance services to an
audit client
601
Accounting and bookkeeping services
602
Administration services
603
Valuation services
604
Tax services
605
Internal audit services
606
Information technology/systems services
607
Litigation support services
608
Legal services
609
Recruiting services
610
Corporate finance services
800
Report on special purpose financial
statements that include a restriction on
use and distribution (audit and review
engagements)
Special Purpose Financial Statements (ss. 800, 990)
There is a substantial section in the Code that contains guidance applicable for members who are dealing
with special purpose financial statements. Special purpose financial statements are typically prepared
in accordance with a specific request rather than in full compliance with all accounting standards. The
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MODULE 2 Ethics 89
provisions (ss. 800, 990) modify the rest of the provisions in Parts 4A and 4B. At this point, it is sufficient
to understand that reports that are ’special purpose’ need to be stated as such and that the intended users
of the reports need to be told about modified independence requirements that may apply. There is also a
need for users to be told what the limitations of the report may be and that they agree to the application of
any modifications to independence requirements.
Audit and Review Engagements
Independence
Independence is especially relevant to members in public practice who provide audit and review services.
Auditor independence is critical to the credibility and reliability of an auditor’s reports and public
perceptions of the profession. In fact, financial reports audited by accountants may appear to lack integrity
if the professionals involved have failed to maintain independence.
The concept of independence is so important and ingrained that it is often regarded as the cornerstone on
which much of the ethics particular to the audit profession is built. The entire rationale for the profession
of public accounting rests on the foundation of integrity, of which independence is an important part.
Cottell and Perlin (1990) remind us that independence should be considered of utmost importance if the
profession is to maintain the confidence of the public.
Debate about [independence] … will continue if the profession is to be viable, for such a debate is an
indicator of ethical health … Perhaps the greatest danger to the profession lies in potential apathy toward
independence. If the public and its representatives were ever to perceive that independence was a sham, the
profession would likely be swept away like a sand castle before the tides (Cottell & Perlin 1990, p. 40).
In general, independence is equated with an attitude of objectivity (no bias, impartiality) and integrity
(honesty). This means adherence to the principles of integrity and objectivity is possible when independence is achieved. According to this relationship, being independent, both in appearance and reality, will
assist in satisfying the principles of integrity and objectivity. Conversely, a breach of integrity or objectivity
may result when independence is lost.
QUESTION 2.23
Make a note of the definition of independence as it appears in APES 110 and write down the
fundamental principles with which independence is closely associated.
Being independent means that one is not only unbiased, impartial and objective but is also perceived
to be that way by third parties. Independence in appearance is the avoidance of facts and circumstances
where a reasonable and informed third party, having knowledge of all relevant information, including
any safeguards applied, would reasonably conclude that the accountant’s integrity or objectivity has
been compromised. While independence is applicable to all accounting professionals, independence is
especially important for members in public practice.
The rules pertaining to independence for members in public practice who perform audits are detailed
and technical. There are a large number of areas in which independence threats can emerge. CPA Australia
has produced a checklist (figure 2.10) to assist in determining whether the firm in which they are employed
complies with the independence rules, regulations and interpretations of CPA Australia and relevant
statutory bodies. Have another look at the list of topics in table 2.16. You will notice that the checklist
in figure 2.10 is a concise summary of the key areas that the ethical standard covers and appear in
table 2.16. The checklist is one method used to check whether employees comply with the guidance set
down in APES 110.
QUESTION 2.24
Reflect on each of the questions in the checklist in figure 2.10 and note which of the fundamental
principles you believe are breached by a member if they fail to respond in the negative to those
questions in the form.
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90 Ethics and Governance
FIGURE 2.10
Independence checklist for employees
Name of employee:
Office:
Completion of this form provides data for determining that the practice is complying with the
independence rules, regulations and interpretations of CPA Australia and relevant statutory bodies.
Yes† No
❑
❑ Do you have a direct or indirect material financial interest in a client or its subsidiaries/
affiliates?
❑
❑ Do you have a financial interest in any major competitors, investees or affiliates of a client?
❑
❑ Do you have any outside business relationship with a client or an officer, director or principal
shareholder having the objective of financial gain?
❑
❑ Do you owe any client any amount, except as a normal customer, or in respect of a home loan
under normal lending conditions?
❑
❑ Do you have the authority to sign cheques for a client, or make electronic payments on their
behalf?
❑
❑ Are you connected with a client as a promoter, underwriter or voting trustee, director, officer
or in any capacity equivalent to a member of management or an employee?
❑
❑ Do you serve as a director, trustee, officer or employee of a client?
❑
❑ Has your spouse or minor child been employed by a client?
❑
❑ Has anyone in your family been employed in any managerial position by a client?
❑
❑ Are any billings delinquent for clients that are your responsibility?
❑
❑ Have you received any benefits such as gifts or hospitality from a client, that are not
commensurate with normal courtesies of social life?
❑
❑ Are there any other independence issues that you believe are relevant to disclose?
I have read the Independence Policy of the practice, and professional standards related to independence,
and I believe I understand them. I am in compliance except for the matters listed below.
Arrangements made to dispose of above exceptions to comply with policies:
†
Note: If you answered ‘YES’ to any of the answers above, please also complete the Professional
Independence Resolution Memorandum.
Signature of employee:
Date:
Signature of employer:
Date:
Source: CPA Australia 2015, ‘Independence checklist for employees’, CPA Australia, accessed August 2018, www.cpaaustralia.
com.au/~/media/corporate/allfiles/document/professional-resources/practice-management/independence-checklist-for-employees.
doc.
Specific Areas of Concern for Audit and Review Engagements
Part 4A of the Code sets down ways in which members in practice are able to manage independence threats.
Table 2.17 covers the most common threats and the way in which the Code asks members in practice to
deal with them.
TABLE 2.17
Common threats to independence and relevant safeguards — audit and review
engagements
Circumstance
Section
Threat(s)
Safeguard(s)
Fees — large amounts in
fees from a specific client
410
Self-interest
or
intimidation
Fee dependence on specific clients can be reduced
by growing the client base.
Compensation and
evaluation policies —
selling non-assurance
services
411
Self-interest
Revising the compensation plan for the audit team
member that has a selling obligation.
Gifts and hospitality
420
Removing the individuals from the audit team.
Self-interest,
familiarity or
intimidation
Audit team members shall not accept gifts and
hospitality unless they are trivial and inconsequential.
(continued)
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MODULE 2 Ethics 91
TABLE 2.17
(continued)
Circumstance
Section
Threat(s)
Safeguard(s)
Actual or threatened
litigation
430
Self-interest
and
intimidation
Removal of any audit team member that may be
involved in the litigation may eliminate threats.
A safeguard that could address these threats is for
work to be reviewed by an appropriate individual.
Financial interest in client
510
Self-interest
Evaluation of the role of the person holding the
financial interest, the materiality and type of financial
interest.
Loans and guarantees
511
Self-interest
Audit team members shall not accept loans or
guarantees from banks or institutions that are not
made under normal lending procedures, terms or
conditions.
Firms or networks firms can use a safeguard of having
work reviewed by an appropriate reviewer who is
not working for the firm or network firm that is the
beneficiary of the loan.
Close business
relationships with clients
520
Self-interest
and
intimidation
In circumstances where the interest is material, no
safeguard can reduce the threat to an acceptable
level.
A family and personal
relationship between a
member of the audit team
and an officer of the client
521
Self-interest,
familiarity and
intimidation
A wide spectrum of safeguards is available in this
section.
Recent service with an
audit client
522
Self-interest,
familiarity and
intimidation
A wide spectrum of safeguards is available in this
section.
Serving as a director or
officer of an audit client
523
Self-review
and
self-interest
The Code prohibits involvement on company boards
or the appointment as a company secretary.
Employment with an audit
client — former partner of
team member joins an
audit client.
524
Self-interest,
familiarity or
intimidation
Modification of an audit plan.
Temporary personnel
assignments —
secondment or loaning of
audit personnel
525
Appoint audit team members who have a similar level
of experience and the former audit team member.
A review of the former audit team members work by a
suitable individual.
Self-review,
advocacy or
familiarity
Conducting an additional review of the work
performed by the loaned personnel might address a
self-review threat.
Not including the loaned personnel as an audit team
member might address a familiarity or advocacy
threat.
Not giving the loaned personnel audit responsibility for
any function or activity that the personnel performed
during the loaned personnel assignment might
address a self-review threat.
Long association
of personnel
540
Familiarity or
self-interest
Changing the role of the individual on the audit team
or the nature and extent of the tasks the individual
performs.
Having an appropriate reviewer who was not an audit
team member review the work of the individual.
Performing regular independent internal or external
quality reviews of the engagement.
Source: CPA Australia 2015.
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92 Ethics and Governance
Provision of Non-Assurance Services to an Audit Client (ss. 600–610)
The provision of non-assurance services (which include all services that do not constitute assurance or
audit services) to audit clients is an activity that often provides additional value for an audit client. Audit
clients benefit from the non-assurance services provided by their audit firms, which have an intimate
understanding of the client’s business.
However, the provision of non-assurance services to an audit client may also create real or perceived
threats to independence They can also create self-review, self-interest and advocacy threats. For example,
when a client asks its audit firm to prepare the original books of entry, a self-review threat is created
because the audit team is placed in a position where it will audit its own work. In this situation, the auditor
theoretically can alleviate this self-review threat by making arrangements so that the personnel providing
accounting services do not participate in the assurance engagement.
In all circumstances, before accepting an engagement to provide a non-assurance service to an
audit client, paragraph R600.4 of the Code requires the firm to determine whether there is a threat to
independence posed by the proposed service offering.
QUESTION 2.25
Based on your reading so far, reflect on why you think the accounting professional believes certain
non-audit services create a threat to independence.
Assurance Engagements
Assurance services are related to services provided by members that provide users of specific reports or
information with confidence that the information is accurate. There is a similar framework in place for
dealing with threats to the fundamental principles in the Code. Firms conducting assurance engagements
are required to be independent and they are required to apply the conceptual framework set out in section
120 of the Code. Firms must identify, evaluate and address or treat independence threats in a similar fashion
to other threats described in the Code. Table 2.18 outlines some of the common threats and safeguards.
TABLE 2.18
Threats to independence and safeguards — assurance engagements
Circumstance
Section
Threat(s)
Safeguard(s)
Fees
905
Self-interest or
intimidation
Increasing the client base of the partner to reduce
dependence on the assurance client.
Having an appropriate reviewer who was not an
assurance team member review the work.
Gifts and hospitality
906
Self-interest,
familiarity or
intimidation
The requirements in section 340 for members in
practice should be considered in the context of
gifts and hospitality.
Actual or threatened
litigation
907
Self-interest or
intimidation
Members should consider materiality of litigation
and whether the litigation relates to prior assurance
engagements.
Removing a staff member from the assurance team
may assist in dealing with threats.
Financial interests
910
Self-interest
Various safeguards and measures are outlined in
the Code for different kinds of financial interests.
Loans and guarantees
911
Self-interest
Work done by people who have loans or
guarantees can be reviewed by an appropriate
reviewer who is not a member of the assurance
team from a network firm that is not the beneficiary
of the loan.
(continued)
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MODULE 2 Ethics 93
TABLE 2.18
(continued)
Circumstance
Section
Threat(s)
Safeguard(s)
Business relationships
920
Self-interest or
intimidation
Eliminating or reducing the size of the transaction
involving the assurance team member.
Removing the individual from the assurance team.
Family and personal
relationships
921
Self-interest,
intimidation or
familiarity
Restructure activities so that an assurance
team member is not dealing with issues that are
the responsibility of the person with whom an
assurance team member has a close relationship.
Recent service with an
assurance client
922
Self-interest,
self-review or
familiarity
The assurance team should not include someone
who was employed as a director or officer of the
client.
A safeguard may be a review by an appropriate
reviewer of work performed by an assurance team
member.
Serving as a director or
officer of an assurance
client
923
Employment with an
assurance client
924
Self-review and
self-interest
The Code prohibits serving as a director or officer.
Self-interest,
familiarity or
intimidation
Making arrangements such that the individual is
not entitled to any benefits or payments from the
firm, unless made in accordance with fixed predeterminedarrangements.
Guidance is provided in the code regarding
the provision of non-assurance services to an
assurance client in the context of company
secretarial work or appointment.
Making arrangements such that any amount owed
to the individual is not material to the firm.
Modifying the plan for the assurance engagement.
Assigning to the assurance team individuals who
have sufficient experience relative to the individual
who has joined the client.
Having an appropriate reviewer review the work of
the former assurance team member.
Long association of
personnel with an
assurance client
940
Familiarity or
self-interest
Changing the role of the individual on the
assurance team or the nature and extent of the
tasks the individual performs.
Having an appropriate reviewer who was not an
assurance team member review the work of the
individual.
Performing regular independent internal or external
quality reviews of the engagement.
Provision of non-assurance
services to assurance
clients other than audit
and review engagement
clients
950
Various
The Code provides guidance to members that
relate to the provision of non-assurance services to
clients.
It is for the firm concerned to review all of the nonassurance engagements.
Source: CPA Australia 2015.
It is essential to read section 950 in its entirety so that you fully understand the ramifications of the
provision of certain non-assurance services where a practice is providing assurance services to a client.
Example 2.13 shows the problems relating to providing non-audit services to audit clients and a
preoccupation with profit.
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94 Ethics and Governance
EXAMPLE 2.13
Arthur Andersen
Throughout the 1990s, accounting firms, including Arthur Andersen, offered consulting services along
with traditional auditing services, and discovered that consulting work was often more profitable. Critics
argue that the two services are incompatible as auditors verify and communicate to users the accuracy of
company reports, but, as the auditors were providing consulting services, they would be checking their
own work. Auditors must be independent of their clients, and consulting enmeshes them in their clients’
business in ways that compromise independence (Aronson 2002).
During the 1990s the firm separated into two units, Arthur Andersen and Andersen Consulting (known as
Andersen Worldwide). In 1996, Steve Samek ‘became the firm’s world-wide head of auditing, with indirect
responsibility for 40 000 people’. In the spring of 1998, he headed Arthur Andersen’s US operations, which
accounted for about half of the firm’s revenue. Mr Samek gave rousing speeches designed to inspire the
auditors to sell to their clients everything from tax services to consulting work (Brown & Dugan 2002).
Meanwhile, Andersen Consulting more than doubled its revenue to USD$3.1 billion, ‘bringing in 58%
of the overall firm’s revenues, and subsidizing the accountants to the tune of about $150 million a year’.
In 1997, Andersen Consulting partners ‘voted unanimously to split off entirely’ (Brown & Dugan 2002) and
changed its name to Accenture.
Arthur Andersen and Enron
According to reports, Enron paid Arthur Andersen USD$52 million in 2000. More than 50% (USD$27 million) came from consulting services. Consequently, traditional auditing services, compared to consulting,
became less and less profitable and, unfortunately, seemingly less and less important to the firm.
Embroiled in the multi-billion-dollar bankruptcy of Enron, Arthur Andersen shared with its client the
accusation of not fully disclosing Enron’s financial position to investors. In the lead-up to pending
enquiries, Arthur Andersen destroyed (by shredding) a significant number of documents relating to the
Enron audit.
On 15 June 2002, Arthur Andersen was convicted of obstruction of justice for shredding documents
related to its audit of Enron. The firm ultimately lost its right to practice.
Arthur Andersen’s greatest foe was not the courts, but market forces and public perceptions (Simpson
2002). This included the termination of merger talks between Arthur Andersen and another major
accounting firm. Clients terminated their relationship with Arthur Andersen and many employees resigned.
The market and public imposed the ultimate penalty on Arthur Andersen, hastening its implosion in 2001
(Simpson 2002). On 31 May 2005, the Supreme Court of the United States unanimously overturned Arthur
Andersen’s conviction, due to flaws in the jury instructions. By this time it was too late for Arthur Andersen.
QUESTION 2.26
(a) Describe Arthur Andersen’s organisational culture and explain how the firm’s culture may have
contributed to its downfall.
(b) Explain why the provision of non-auditing services to an audit client may compromise the
auditor’s independence. In your answer, list two threats to the audit and explain why they are
threats.
(c) List the safeguards that Arthur Andersen might have employed to reduce the threat to an
acceptable level.
(d) Explain how Arthur Andersen failed to act according to the public interest principle.
2.11 EXAMPLES OF ETHICAL FAILURES
BY ACCOUNTANTS
This section highlights examples of accountants in business and public practice who have failed to comply
with the fundamental principles of the Code. These examples are available at: www.cpaaustralia.com
.au/about-us/member-conduct-and-discipline/outcome-of-disciplinary-hearings.
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EXAMPLE 2.14
Sonya Denise Causer (August 2010)
Member in Business (Integrity, Professional behaviour)
On 19 August 2010, Sonya Denise Causer, aged 39 years, was sentenced in the Supreme Court of Victoria
after pleading guilty to stealing $19 million from her previous employer, Clive Peeters Ltd. Causer was
sentenced to eight years’ jail with a non-parole period of five years (i.e. she must serve a minimum five
years). Approximately $16 million of the funds stolen have been recovered. The fraud was detected by a
routine audit.
In March 2006, Causer commenced employment as a Senior Financial Accountant with Clive Peeters,
a publicly listed whitegoods and electrical retailer. Between July 2007 and July 2009, Causer deceptively
recorded in the company’s electronic accounts 125 individual payments totalling $19 million, with the
funds paid to eight bank accounts controlled by Causer. Causer would alter the payee details for a
particular transaction, substituting the number of a bank account she controlled in place of the genuine
bank account. To conceal the thefts, Causer manipulated the online banking records, general ledger and
management reporting.
On 14 September 2011 the CPA Australia Disciplinary Tribunal imposed the following penalties and
costs against Causer:
• forfeiture of Accountantship
• non-eligibility for readmission for 30 years
• a fine of $100 000
• costs of $464 (CPA 2011).
Source: Adapted from R v. Causer 2010, VSC 341 2010, Supreme Court of Victoria, 19 August; Butler, B 2010, ‘ITL
revises hire policy after fake CV’, The Age, 14 August 2010, ‘CPA Australia Member Discipline outcome “Sonya Causer”
14 September 2011’, accessed October 2015, www.cpaaustralia.com.au/~/media/Corporate/AllFiles/Document/about/aboutmember-conduct/mdh-sonya-causer-2011.pdf.
EXAMPLE 2.15
Trevor Neil Thomson (May 2010)
Member in Public Practice (Integrity, Objectivity, Professional Behaviour)
On 13 May 2010, Trevor Neil Thomson, a Perth accountant, was sentenced in the Supreme Court of
Western Australia after pleading guilty to having conspired with others to evade paying approximately
$27 million in tax. Thomson was sentenced to 13 months’ jail. Judge McKechnie said, ‘The Australian
Income Tax Assessment scheme depends upon the honesty of all involved. It particularly depends on the
honesty of thousands of tax agents who assist their clients to meet their lawful obligations. Your actions
are a blight on thousands of honest accountants. You were an accountant trusted not only by your clients
but also by the tax office to be scrupulous in your dealings at all times’.
The Executive Director of the Australian Crime Commission, Michael Outram, said, ‘Through the use of
false documents, Mr Thomson deliberately attempted to hide profits generated by his clients’ businesses
and knowingly misled the Australian Government, to ensure his clients did not pay their required tax’.
Source: Adapted from R v. Thomson 2010, Sentencing remarks of McKechnie, J. 2010, Supreme Court of Western
Australia, 13 May (WASC INS 172 of 2009); ABC News 2010, ‘Jail for $30M fraud’, 13 May, accessed October 2019,
www.abc.net.au/news/2010-05-13/jail-for-30m-fraud/434568.
EXAMPLE 2.16
Warren Sinnott (June 2014)
Member in Public Practice (Objectivity, Professional Competence and Due Care,
Professional Behaviour)
Warren Sinnott, a member of CPA Australia, was the lead auditor responsible for the audits of companies
in the Banksia group of companies (Banksia) for the accounting periods between 31 December 2008 and
30 June 2012. Sinnott signed unqualified audit opinions in respect of Banksia.
Banksia was based in regional Victoria and was involved in raising money from the public by issuing
debentures and lending the funds raised to third-party borrowers for property investment and development
purposes. Banksia was able to raise approximately $663 million from 15 000 investors by 25 October
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96 Ethics and Governance
2012. On that date Banksia was placed into receivership following concerns that it was insolvent or likely
to become insolvent.
ASIC found that Sinnott did not conduct the audits in accordance with the Australian Auditing Standards.
In relation to each audit ASIC formed the view that Sinnott failed, among other things, to:
• perform sufficient audit procedures in relation to loan receivables and obtain sufficient appropriate audit
evidence to reduce the risk of material misstatement of loan receivables to an acceptably low level
• display an appropriate level of professional scepticism when auditing the valuation of, and provision for,
impairment of loans receivable, and adequately document his conclusion about the reasonableness of
the provision for impairment
• remain alert through the audits that the risk of the potential impairment of loan receivables may cast
doubt over Banksia’s ability to continue as a going concern
• take responsibility for the overall quality of the audit and provide an appropriate level of supervision and
review
• appropriately conclude that he had obtained reasonable assurance to form an appropriate opinion on
the financial report.
On 11 June 2014, ASIC accepted an undertaking from Warren Sinnott, a registered company auditor,
that he would not practise as an auditor for five years.
Source: Adapted from ASIC 2014, ‘14-127MR ASIC suspends former Banksia auditor for five years’, accessed
June 2014, https://asic.gov.au/about-asic/news-centre/find-a-media-release/2014-releases/14-127mr-asic-suspends-formerbanksia-auditor-for-five-years.
SUMMARY
APES 110 Code of Ethics for Professional Accountants (including Independence Standards) is the ethical
framework for members of the accounting profession. The Code of Ethics:
• outlines fundamental principles of ethical professional behaviour
• lists the key threats to fundamental principles
• provides instances of guidance for specific common circumstances
• includes a conceptual framework that sets down a process by which members should deal with ethical
dilemmas that emerge throughout their professional and personal lives.
The inclusion of a conceptual framework avoids the need for volumes of rules to try to accommodate
every possible ethical issue that may arise.
Independence, which is defined as being both independence of mind and independence in appearance, is
handled in Parts 4A and 4B of the Code as it impacts on audit and review engagements and other assurance
engagements respectively. This guidance is provided to ensure that members in practice are able to resolve
possible threats to the fundamental principles of integrity and objectivity. An independent perspective on a
set of financial statements, or a specific set of facts in the case of an assurance project, is what the member
in practice is being paid to provide. Breaches of the fundamental principles can lead to the work done by
members in public being perceived to be compromised.
The key points covered in this part, and the learning objective they align to, are listed below.
KEY POINTS
2.3 Apply APES 110 Code of Ethics for Professional Accountants (including Independence
Standards).
• APES 110 is the ethical standard for accounting professionals in Australia.
• APES 110 is based on the international equivalent code that is issued by the International Federation
of Accountants
• By applying the Code of Ethics to their decisions and actions, professional accountants will be acting
in the public interest
• The Guide at the beginning of APES 110 instructs the professional accountant how the Code should
be read and used.
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• Part 1 of APES 110 reflects the profession’s recognition of its public interest responsibility, setting
out five fundamental principles for ethical conduct: integrity; objectivity; professional competence
and due care; confidentiality; and professional behaviour.
• Part 1 of APES 110 also includes a conceptual framework that provides a process for making ethical
decisions in any situation. The conceptual framework is made up of three steps: identifying threats,
evaluating threats, and addressing threats.
• Parts 2 and 3 of APES 110 set out ethical requirements for members in business and members in
public practice respectively, including guidance and safeguards to apply to specific circumstances
that members may commonly face.
• Part 2 of APES 110 provides guidance on ethical issues facing members in business related to:
conflicts of interest; preparation and presentation of information; acting with sufficient expertise;
financial interests, compensation and incentives linked to financial reporting and decision making;
inducements; responding to NOCLAR; and pressure to breach the fundamental principles.
• Part 3 of APES 110 provides guidance on ethical issues facing members in public practice related
to: conflicts of interest; professional appointments; second opinions; fees and other types of
remuneration; inducements; custody of client assets; and responding to NOCLAR.
• Parts 4A and 4B of APES 110 deal with the requirement for independence in audit, review and other
assurance engagements where a client is seeking an independent perspective.
• Special purpose reports may be subject to modified independence requirements. Users of the reports
must be told about those modifications.
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98 Ethics and Governance
PART D: ETHICAL DECISION MAKING
INTRODUCTION
Ethical frameworks and ethical standards do not exist in a vacuum. They are intended to be applied or
used as guidance for those seeking a way to make decisions in complex or challenging circumstances.
Figure 2.11 highlights the various factors that influence decision making. Most decisions are influenced
predominantly by an individual’s cognitive processes (the reasoning used in making a decision). However, other factors also have an influence. Additional individual variables such as situational variables
(e.g. societal, professional and organisational) interact with the cognitive component to determine how an
individual is likely to behave in response to an ethical dilemma.
We can see from figure 2.11 that, although we attempt to take a disciplined and rational approach to
decision making, it is strongly affected by many things. The more we are aware of these influences, the
more we consider them as part of the decision-making process, to make sure they do not have a negative
effect. In the centre we have our individual influences, which will include our character and past experience,
and these will then be strongly influenced by the organisation we are working within.
In general, the intensity with which these variables affect decision making is directly related to their
proximity to the individual, as appears in figure 2.11. For example, organisational values exert a more
intense influence on decision making than do professional values. Understanding these influences will
help professional accountants identify factors that may impact on their ethical decision making.
FIGURE 2.11
Influences on an individual’s decision
Societal
Professional
DECISION
Stress
Law
Culture
Individual
Cognitive
development
Moral development
Ethical courage
Corporate
culture
PROBLEM
Organisational
Codes
Significant others
Policies
Code of ethics
Source: CPA Australia 2015.
Decision making is the thought process necessary to select a course of action to achieve a desired result
from among two or more options. Put more simply, it involves making a purposeful choice from a set of
alternatives. Decision making with ethical implications is simply another form of problem solving. The
chief difference between decision making and ethical decision making is the consideration of ethical values
and implications in the selection of an appropriate alternative.
Therefore, ethical decision making is defined as reaching a responsible decision after taking into
consideration the general ethical beliefs of the individual, the ethical implications of a course of action,
and the norms and rules pertaining to the circumstances of the situation.
Example 2.17 highlights the issues involved in making an ethical decision. The rest of this module
examines the inputs to ethical decision making in greater detail and then examines several ethical decisionmaking models.
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EXAMPLE 2.17
Whistleblowing
When accountants believe or suspect that unethical or illegal behaviour is occurring, they may be put
in a difficult position. Whistleblowing describes the action of bringing these concerns to the attention of
appropriate people. Whistleblowing should be seen as beneficial to the organisation as it helps identify
fraud and inappropriate behaviours and actions. However, it seems that in many organisations, managers
view whistleblowing ‘as a risk generator rather than an element of the risk management infrastructure’
(Tsahuridu 2011, p. 56). Rather than being a faithful servant, the whistleblower is perceived to be ‘against
the organisation’ and disloyal.
The Code of Ethics and its NOCLAR sections deal with how members should respond to noncompliance with laws and regulations so that they act in the public interest.
............................................................................................................................................................................
CONSIDER THIS
Reflect on what role a member of CPA Australia may have in helping another professional deal with the question
of disclosing unethical or illegal behaviour.
2.12 FACTORS INFLUENCING DECISION MAKING
Decision making is a function of individual characteristics and the environment in which the decision
maker works and lives. Rational decision making is, therefore, constrained by a number of organisational,
psychological and environmental factors.
Undertaking an analysis of the factors affecting decision making provides a better understanding of
how and why decisions are made. If such factors are recognised and understood, the decision maker may
take particular care when making decisions with ethical implications, and also appreciate the impact any
decision will have on the decision maker and other stakeholders.
The factors that influence ethical decision making can be classified into four broad categories (see
figure 2.11) that are introduced in order of their likely influence on decision making. Despite some
interrelated dependencies between the categories, these factors may be characterised as individual,
organisational, professional and societal.
INDIVIDUAL FACTORS
Arguably, the factor having most influence on a person’s decision making is their cognitive ability to judge
the ethical rightness of a situation. People have different levels of moral development. Some people are
selfish and may only act in the right way out of fear of punishment, rather than because it is the right thing to
do. Others (who are self-interested) may act appropriately in order to gain additional benefits from others.
Others may act in a particular way to gain approval from other people they see as significant to them.
Obeying the law and the rules also motivates many people, without much thought as to whether those
laws and rules are appropriate. Meanwhile, others may focus on acting based on intentions to do the right
thing — regardless of external factors such as peer approval or legal rules (Kohlberg 1981).
From this, we can summarise that people at different levels of moral development have varying capacities
to judge what is ethically right and so may react differently to a similar situation. Therefore, the higher a
person’s moral development, the less dependent that person is on outside influences and, hence, the more
that person is likely to behave autonomously and ethically.
Another factor influencing a person’s decision making is their development of ethical courage. Ethical
courage is the level of courage a person demonstrates in order to make difficult decisions and act upon these
decisions. Acting with courage means being straightforward and honest in all professional and business
relationships. Accountants face difficult situations and often have to make decisions, requiring them to
choose between the competing interests of clients, employers and the public.
A junior or recently qualified accountant may not be in a position to act with courage when faced with an
ethical situation due to a fear of superiors or the possible loss of employment. However, a more experienced
accountant may not hold such fears and will not be intimidated by demands from other people. The ability
to act with courage can be developed over time.
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100 Ethics and Governance
The Code of Ethics covers the responsibilities of an experienced member in a business, particularly
in areas where the member has the ability to impact on decisions where honesty and transparency in a
company’s dealings with the broader marketplace.
ORGANISATIONAL FACTORS
Corporate culture is defined as patterns and rules that govern the behaviour of an organisation and its
employees. Corporate culture defines acceptable behaviour within an organisation. The culture of an
organisation may be formally expressed in the form of written policies and codes of ethics or may be
informally expressed through the words and actions of significant others.
A culture that lacks written policies and codes of ethics and accepts dishonesty and unethical conduct
may have a strong influence on a person’s ethical decision making. They may feel compelled to go along
with what is being done for fear of being excluded from the group.
In the 1960s the social psychology experiments of Solomon Ash, Stanley Milgram and Philip Zimbardo,
which investigated the effects of conformity, obedience to authority, assigned roles and situational
environments on our behaviour, showed how much our actions are influenced by the people, the authority
structures and the environment surrounding us. Similarly, organisational research finds that even honest
employees will behave in deviant ways if their environment, or management, encourages it. Pressure
to conform, excessive performance demands and unfair treatment have all been found to contribute to
organisational misconduct (Litsky, Eddlestone & Kidder 2006).
Unsupportive management styles and organisational cultures as well as hierarchical structures that are
not open to upwards communication can also lead to employee silence on issues such as supervisor
and colleague competence, dysfunctional organisational processes and working conditions. Fear of poor
treatment, negative labelling and distrust by colleagues as well as feelings of futility can prevent employees
notifying management of these problems, resulting in inefficiency, employee apathy and high turnover,
at considerable costs to the organisation (Milliken, Morrison & Hewlin 2003). This can be offset by
ensuring rules and procedures are perceived as fair and by managers establishing trusting relationships with employees, including them in decision-making processes, setting measurable and attainable
goals, offering consistent performance evaluation, leading by example and creating ethical climates
(Litsky et al. 2006).
Top-tier management is considered the most influential factor in setting organisational values, which
in turn determines the culture that influences accountants’ behaviour. The actions and decisions of
management have a significant contribution to the culture and ethical approach of an organisation.
Schein (2004) identifies six areas in which such actions and decisions are most relevant.
•
•
•
•
•
•
What leaders pay attention to, measure, and control on a regular basis.
How leaders react to critical incidents and organizational crises.
How leaders allocate resources.
Deliberate role modelling, teaching, and coaching.
How leaders allocate rewards and status.
How leaders recruit, select, promote, and excommunicate.
There is a direct and positive relationship between the strength of the organisation’s culture and the
extent of that culture’s influence on ethical behaviour. A strong culture is likely to have more influence
on people’s daily decisions than a weak one. If the culture is strong and supports high ethical standards, it
should have a powerful and positive influence on employees’ behaviour. Conversely, a weak ethical culture
tends to have a negative influence on employees’ behaviour.
.......................................................................................................................................................................................
CONSIDER THIS
Commissioner Kenneth Hayne referred to a culture of greed causing problems in the financial services sector. His
observations related to behaviours that were related to bankers, financial planners, brokers and other intermediaries
adopting a ‘whatever it takes’ approach to getting commissions or bonuses for selling financial products to customers.
Reflect on the issues you believe Commissioner Hayne’s observation raises from an ethical standpoint?
Ethical climates, or cultures, have been found to affect various organisational outcomes (Simha &
Cullen 2012).
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• Instrumental climates where egoistic, opportunistic behaviour predominates, have been associated with
low job satisfaction for employees and managers, low employee commitment and high turnover, low
moral reasoning, unethical behaviour, organisational misconduct and bullying.
• Principal-based climates where rules and regulations are faithfully adhered to.
• Benevolent climates where decisions are made mindful of the interests and needs of all affected
organisational accountants, perform considerably better on these measures.
Benevolent climates generally perform the best.
Generally, the more ethical the culture of an organisation, the more ethical employee behaviour is likely
to be. While the ethical culture of an organisation might be formally expressed in the form of written
policies and a code of ethics, its effectiveness is subject to the actions of management.
If top management aims to develop an ethical culture based on the principles of the organisation’s code of
ethics, there must be consistency between the words and behaviour of top management and the behavioural
expectations of the code. In this way, the code of ethics and the ethical culture are congruent.
The major limitation in achieving acceptance of the code by employees is the belief that the code is
merely rhetoric and serves as a public relations document. To this end, codes are only as good as the
commitment made by management.
In addition to the benefits that are derived from ethical behaviour, an ethical culture may also enhance
a company’s productivity. In a survey on business ethics administered to over 15 000 professionals, 80%
of respondents said they would work harder for an ethically run company and 75% said that they would
leave the company if it was violating their core ethical principles (Dent 2009).
EXAMPLE 2.18
Poor Ethical Cultures Cause Significant Trouble
The link between leadership and culture has been examined by Sims (2000), Sims and Brinkmann
(2002, 2003) and Dellaportas, Cooper and Braica (2007). These authors demonstrate how mismanaging
organisational culture can have devastating effects.
Sims and Brinkmann (2002) examined the case of Salomon Brothers and the role played by
John Gutfreund, the CEO of the investment banking division at Salomon Inc., at the time of its bond trading
scandal in 1991. The authors link Gutfreund’s irresponsible leadership style to a win-at-all-costs culture at
the bank, which led to the unethical and illegal behaviour of its accountants. Sims (2000) describes how
Warren Buffett, after displacing John Gutfreund as the CEO, successfully changed the culture at Salomon
Brothers following the bond fiasco. However, Gutfreund’s style was so ingrained in the culture of Salomon
that simply removing Gutfreund was not enough.
Further steps were necessary to turn the culture away from a short-term win-at-all-costs attitude to that
of responsible corporate citizenship. Changes to the firm’s compensation system proved to be the most
difficult for Buffett to manipulate. Salomon lost many of its best performing accountants and the remaining
employees had to be assured that their positions were safe.
Sims and Brinkmann (2003) conducted a similar analysis on the Enron failure and the results were
comparable to those of the Salomon Brothers case. The authors had no reservations in blaming the top
executives for the unethical behaviour that took place within the company, which eventually brought down
one of the world’s largest and seemingly most successful organisations. The authors conclude that ‘in
retrospect, the leadership of Enron almost certainly dictated the company’s outcome through their own
actions by providing perfect conditions for unethical behaviour’ (Sims & Brinkmann 2003, p. 250).
Dellaportas et al. (2007) considered the case of the National Australia Bank, in which four rogue
traders incurred and concealed losses of AUD$360 million (one of Australia’s largest banking losses
due to deception). The bank recruited traders who had a reputation for creating outstanding profits
and encouraged risk-taking beyond prescribed limits, suggesting a profit-driven culture. However, it was
management’s abrogation of responsibilities that contributed to the problem. Issues, when they arose,
were ignored or deferred by management and, in so doing, management neglected its responsibility for
rectifying the identified problems. It was this leadership style that reduced the likelihood of detecting and
dealing with rogue behaviour.
............................................................................................................................................................................
CONSIDER THIS
Make a list of rules and regulations that exist in your place of employment, or an organisation you are familiar
with, and classify each item as explicit or implicit. Explicit rules are formal rules, such as those found in company
policy or codes of ethics, and implicit rules are those recognised and accepted by a large majority of your
colleagues but not formally expressed in company documents. Then consider how each item affects your
behaviour.
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EXAMPLE 2.19
Omega Finance
Omega Finance is a prominent accounting, auditing and financial advice company, frequently advertising
on television, social media and radio, emphasising their ability to offer solutions, ‘whatever the problem,
big or small’. Upon successfully gaining employment there shortly after gaining his CPA certification, Jerry
Black was surprised to find that for such a high-profile company, the number of employees was small.
After a few months working on individual and small business tax problems, he was reassigned to their
‘consultation and referrals’ department. It was explained to him that, due to the varied nature of the clients
that came to them, it was frequently necessary to refer them to a more specialised firm, in order to ensure
compliance with the Code of Ethics.
When jobs came in that were beyond the expertise of Omega’s own accountants, they were sent to the
referrals department with a synopsis of the relevant details and the kind of expertise required, and it was
the job of referrals to recommend an appropriate specialist and forward the account to them. Jerry was
surprised at the volume of referrals that came across his desk—it was clearly a substantial proportion of
the clients processed by the company. Furthermore, being new to the field, it was difficult to recommend
appropriate specialists for the referrals. Jerry had been reassured that his supervisor could help in this
regard, and so he frequently sought advice on appropriate referrals.
After a while, he noticed that the same names frequently came up in his supervisor’s recommendations,
though there were alternative companies that may have been better suited. He pointed this out, but
his supervisor simply told him that they had good working relationships with these companies, and
that it streamlined the process both for Omega and for their clients. Omega was transparent about the
referral commissions, or fees, received from the specialists to whom it referred these cases, and it was a
standardised rate, yet the sheer volume of referrals must have made the total commissions or fees received
from these companies sizeable. Jerry noticed also that following his query his caseload increased,
explained by management as due to an overall growth in client numbers, but Jerry had heard similar
stories from other employees. It was suspected that this was an informal punitive measure to discourage
employees from questioning managerial decisions and to restrict both their discretion and autonomy. One
consequence of this increase was a further reduction in the ability to examine alternative specialist options,
and the necessity to increase referrals to those companies already receiving considerable business
from Omega.
QUESTION 2.27
What is the effect of the culture at Omega Finance on the individual ethical decisions of the
employees such as Jerry? Can you think of any possible violations of the Code of Ethics these
decisions may present?
QUESTION 2.28
What reasons or factors can you think of that may cause an employee to compromise their personal
ethics in a corporate environment?
PROFESSIONAL FACTORS
In addition to individual and organisational factors influencing ethical decision making, accountants are
also influenced by their accountantship of a profession. We have already described the Code of Ethics in
detail and how accountants must follow the Code, which unites accountants by having a common set of
values and standards of behaviour.
The extent of the influence on decision making is dependent on the effectiveness of the Code. According
to the Code, accountants in business may hold a senior position.
The more senior the position of a Member, the greater will be the ability and opportunity to access
information, and to influence policies, decisions made and actions taken by others involved with the
employing organisation . . . Members are expected to encourage and promote an ethics-based culture in
the organisation (para. 200.5 A3).
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QUESTION 2.29
Why should accountants in business be accountable to a higher authority such as the professional
accounting bodies?
SOCIETAL FACTORS
Societal factors that influence decision making generally relate to the world we live in. These include the
laws that govern our behaviour and culture, which reflect the attitudes and values of the community.
Laws and Regulations
Laws and regulations are rules, established by the community through the legislature, that prohibit certain
actions. Laws are generally a reflection of societal attitudes, so for most people they will have minimal
impact on ethical behaviour other than maintaining order and resolving disputes when they arise.
QUESTION 2.30
Discuss whether decisions that are compliant with the law will always result in ethical decisions.
Culture
Understanding the culture of the community in which an organisation is operating is an essential first step
in identifying the effects that the attitudes and values of the community may have on how decisions are
made. Cultural values play an important role in the way business is conducted and in determining people’s
perceptions about what is important and what is not.
In ethics, cultural values have a major influence in determining what is considered proper and ethical
in a particular society. Ethical relativism holds that ethical behaviour is relative to the norms of one’s
culture. That is, whether an action is right or wrong depends on the ethical norms of the society in which
it is practised. If ethical relativism is accepted, the rightness or wrongness of an act depends on a society’s
norms and any act inconsistent with those norms is ethically wrong. Alternatively, an ethical act is one that
is consistent with the norms of society. Therefore, a person with good ethical intentions will be influenced
to act in accordance with society’s norms. A common saying describing the practice of relativism is ‘When
in Rome, do as the Romans do’.
Relativism is premised on the belief that there is no single ethical standard. While this is the major
premise of relativism, it is also the cause of its major criticism: there is no universal standard of right and
wrong that can be applied to all people at all times. In this sense, no guidance on accepted behaviour is
provided when there are divergent opinions within society or across societies. The same action may be
ethical in one society but unethical in another.
This is particularly important in multicultural societies and multinational companies where cultural
practices can directly or indirectly influence respective business behaviour, giving rise to possible conflicts
of opinion and ethical values. For the ethical relativist, there is no universal standard of right or wrong but
only the standard of a particular society. Therefore, unlike normative theories of ethics, there is no common
framework for resolving ethical dilemmas across different societies.
.......................................................................................................................................................................................
CONSIDER THIS
Identify an issue you have seen reported in the media that relates to differing cultural values as they relate to the
conduct or freedom of individuals. What, if any, are the risks in taking a relativist approach to an ethical or philosophical
debate?
QUESTION 2.31
You are an employee of a company operating in a culture where bribery is commonplace. You have
been offered a gift, but no favours have been sought. Returning the gift will offend the donor. What
should you do?
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However, we can recognise that different people, and different cultures, hold different values, and that
many of these are valid, without accepting that any value is equally valid to other values. Related to the
notion of cultural relativism is cultural diversity — observations of the different values embraced by
different cultures.
One of the most widely cited studies of cultural differences was by Geert Hofstede (1980), who
measured differences in values held by employees in IBM offices around the world to study the way
organisational culture varied from country to country. Sorting these differences along five dimensions
— masculinity/femininity, individualism/collectivism, high/low uncertainty avoidance, high/low power
distance and short-/long-term perspective — this research has been a significant resource for organisational
studies, as many items have clear relevance for organisational decision making.
A company culture that is high in power distance, for instance, will likely employ a hierarchical structure
and top-down decisionmaking process, and the questioning or feedback of subordinates is less likely
to be encouraged than in a company culture that is low in power distance. An organisational culture
that has low uncertainty avoidance is likely to tolerate higher levels of risk and seek fewer assurances
than one that is high in uncertainty avoidance. Since Hofstede, other studies, such as the World Values
Survey and the Global Leadership and Organizational Behaviour Effectiveness (GLOBE) study, have
measured differences in values between countries both among their general populations and within
business organisations.
2.13 ETHICAL DECISION-MAKING MODELS
Probably the most widely employed approach to decision making in practice is to rely on personal
insight, intuition, judgment and experience. Rather than rationally searching for the best alternative,
decision makers often select alternatives that are merely satisfactory or adequate. Because of this tendency,
people will seek easily understood decision-making rules rather than attempting to find the best or
optimal outcome.
This can lead to simplistic approaches to decision making that are often called heuristic approaches.
The term heuristics is used to describe a set of decision-making rules or approaches based on past
experience, intuition or mental short-cuts. Decision rules are a convenient way of reducing the number
of alternatives that must be evaluated. However, the problem with this approach is that it is limited to the
individual’s background, previous experience, memory, knowledge and perceptions.
.......................................................................................................................................................................................
CONSIDER THIS
While decisions based on past experience could lead to consistency, what dangers can you identify in this approach
for individuals, groups, companies or firms?
Often, the decision maker may not have a sufficient knowledge base to make proper decisions,
particularly when faced with new and difficult situations. Although decision making that relies on the
application of decision rules may be justified on practical grounds, it might not be adequate from an ethical
point of view. Some situations may require a more systematic approach to problem resolution.
A more systematic approach is to use structured methods of decision making that help reduce the
potential for inappropriate and inconsistent decision-making processes and outcomes. These models are
often based on normative ethical theories and ask probing questions to help identify the underlying ethical
issues, as well as the outcomes that various choices will have on different stakeholders. This helps avoid the
problem of forgetting to consider the ramifications of a particular course of action or ignoring a minority
interest group.
We have already outlined the conceptual framework in the Code of Ethics. In this section we outline:
• the decision-making model that can be applied to the conceptual framework
• two additional models:
– the philosophical model
– the American Accounting Association model.
Each of these models is designed to help accountants make well-reasoned ethical decisions. A detailed
discussion of all ethical decision-making models is beyond the scope of this module.
The decision-making models will not guarantee the correct or ethical decision, but they reduce the
possibility of an incorrect or inappropriate decision being made. A decision-making model is likely to
lead to a more systematic analysis and comprehensible judgment, clearer reasons and a justifiable and
more defensible decision than would have otherwise been the case.
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Decision-making models also assist accountants in exercising proper judgment when faced with difficult
or complex situations. This strengthens the ability of accountants to act in the public interest, since our
decision-making process is carried out with integrity and objectivity.
There is no perfect or correct model to use. It is not unusual to use one or more ethical decisionmaking models when assessing ethical situations so as to gain different perspectives on the same situation.
Ultimately, it is up to the accountant to assess the suitability of the various frameworks. We recommend
referring to a range of models and selecting one or more that are most useful in the circumstances.
APES GN 40 ETHICAL CONFLICTS IN THE WORKPLACE —
CONSIDERATIONS FOR ACCOUNTANTS IN BUSINESS
In October 2015 the APESB issued a revised edition of APES GN 40 which gives members in business
guidance on:
• fundamental responsibilities of the Member in Business when dealing with ethical conflicts in the
workplace;
• the application of the conceptual framework in the Code to identify, evaluate and address ethical issues;
• specific circumstances such as dealing with conflicts of interest, reporting of information, acting with
sufficient expertise, financial interests and inducements; and
• the disclosure of confidential information of an Employer to a third party and whistleblowing (para. 1.1).
Paragraph 4.2 of the guidance note outlines a structured approach to ethical decision making which
mirrors the conceptual framework in the Code of Ethics. The steps in the approach are:
i.
ii.
iii.
iv.
v.
vi.
vii.
viii.
ix.
x.
xi.
xii.
Gather the facts and identify the problem or threat;
Identify the fundamental principles involved;
Identify the affected parties;
Determine whether established organisational procedures and conflict resolution resources exist to
address the threat to compliance with the fundamental principles;
Identify the relevant parties who should be involved in the conflict resolution process;
Discuss the ethical issue and the conflict with the relevant parties, and in accordance with the prescribed
procedures evaluate the significance of the threats identified and safeguards available;
Consider courses of action and associated consequences;
Consider whether to consult confidentially with external advisers such as an independent adviser, legal
advisor and/or the Professional Body to which the Member belongs;
Consider whether to consult Those Charged with Governance;
Decide on an appropriate course of action;
Document all enquiries and conclusions reached; and
Implement the appropriate course of action. In the event that the Member believes that the threat to
compliance with the fundamental principles has not been satisfactorily resolved, the Member should
determine whether it is appropriate to resign.
The guidance note includes a flowchart that illustrates the steps. There are several things to notice about
this process as it is set down in the guidance note. It looks at the way in which a member investigating a
complaint or a potential breach of standards ought to undertake the fact finding process to determine what
had occurred and what the appropriate way may be to address the issue. It is another illustration of a way
in which ethical issues can be dealt with.
GN 40 also includes 21 case studies incorporating examples from commercial, public and not-forprofit sectors where professional accountants in business encounter ethical conflicts in their workplace
that require application of the fundamental principles of the Code of Ethics.
QUESTION 2.32
Download a copy of GN 40 from the APESB website and complete the following.
(a) Read section 4.2.
(b) Select two case studies that appear in section 13 of GN 40.
(c) Apply the structured approach to the case study.
A solution is not provided for this question, so please self-assess your answer to (c) by comparing
your analysis of the case study to that given in GN 40.
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PHILOSOPHICAL MODEL OF ETHICAL DECISION MAKING
The second model to be discussed is the Philosophical model of decision making. By applying a
philosophical model of ethical decision making, ethical theories are no longer abstract concepts but
questions of ethical analysis.
The philosophical ethical decision-making model presents a combination of the normative ethical
principles derived from the theories of egoism, utilitarianism, and rights and justice in the form of specific
questions rather than abstract principles. For each alternative course of action, answers to the following
questions should be established.
1. Do the benefits outweigh the harms to oneself?
2. Do the benefits outweigh the harms to others?
3. Are the rights of individual stakeholders considered and respected?
4. Are the benefits and burdens justly distributed?
For example, consider a situation where a private business has a small number of significant external
investors and a large level of debt funding. The business has experienced some difficulty and the accountant
in the business has been asked to ‘produce’ the right figures (in effect, manipulate them, to create the
appearance of better results). These results are to be distributed to the external lenders and investors. The
accountant is advised that a bonus is on offer for achieving strong results, but that ‘there will be significant
trouble if we fail to satisfy these stakeholders’.
The accountant can evaluate the situation by considering potential courses of action, which include
complying with the request or refusing to comply.
For Question 1 we see that the immediate financial benefits of complying with the unethical request will
be greater than refusing. Harm to oneself may come from doing the right thing, although there would also
be long-term harm in terms of loss of integrity by complying with the request.
Considering Question 2, we see that the benefits of honest reporting would be linked to the external
investors and lenders who receive accurate information and may be able to protect their investments,
whereas harm will probably come to the owners of the company as the financial results may lead to action
being taken against them.
In relation to Questions 3 and 4, deceiving the external funding providers is disrespectful of their rights,
and leads to an unfair distribution of benefits and burdens. All of these factors can then be weighed as the
accountant makes the decision.
The overall objective of the philosophical approach is to provide a framework within which ethical
issues can be identified, analysed and resolved. The strength of this approach lies in the application of
multiple theories to an ethical dilemma, rather than a single theory. Each normative theory of ethics is
subject to inherent limitations. Therefore, adopting multiple ethical theories will overcome the limitations
of individual theories. In this model, the ideal course of action is one that satisfies all four principles:
one that is just, balances the benefits and harms to oneself and to others, and respects the rights of others
and maximises both the net benefit to self, and the net benefit to stakeholders. Striving to satisfy all four
principles will be difficult, but attempting to do so is more likely to result in the best decision overall.
QUESTION 2.33
Alpha Ltd, a clothing manufacturer in Australia, has decided to outsource its clothing production
to a supplier in Bangladesh to take advantage of the relative strength of the Australian dollar and
lower operating costs.
The company identified a supplier, called Delta Ltd, which was capable of providing this work.
Delta Ltd had offered to do the work at a lower price than other competitors, and a review of the
work quality indicated that it was at a comparable and suitable level.
During a visit to the production factory, the Australian management team observed the working
arrangements, how the factory was set up, and discussed working conditions with local employees.
They noticed and were advised of potential work safety problems in relation to noise, fire and
ventilation. However, the managers of Delta Ltd explained that the factory was a typical example in
Bangladesh and that it was compliant with all relevant laws.
Using the philosophical model of ethical decision making, recommend whether Alpha Ltd should
work with Delta Ltd.
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EXAMPLE 2.20
DIGFX
DIGFX is an emerging 3D printing business. Having marshalled its initial finances successfully through
crowd sourcing, seeking investor finance and incorporating was a logical step. The main change required
by the transition from a small business to incorporated entity was to effect transparent financial reporting.
Jaqueline Chan found herself in her first full-time employment as DIGFX’s in-house accountant,
overviewing and finalising its accounts for the financial year and its projected estimated for the coming
financial year. This was part of a company-wide report to be disseminated to shareholders at the
AGM. While checking the projected estimates, however, Jaqueline noticed that DIGFX had included a
prospective deal with NovaTech, a biomedical supplies company researching new ways to manufacture
cardiac valves. Jacqueline was sure that she had overheard conversations regarding the deal, and that
it had been successfully made some weeks earlier. The deal guaranteed DIGFX a new revenue stream
from orders above those generated by their current clients. She brought this up with the company’s CFO,
Paul O’Brien, who passed it off lightly, saying that the deal was still being finalised, and that passing
the expected revenue into the next year’s expected revenue would release the pressure on the accounts
section to process the paperwork before the end of financial year, in which was in a week.
Jacqueline returned to preparing the report, but was concerned that shifting the expected revenue from
NovaTech to the coming financial year may violate tax law. Researching the matter further, she found her
suspicions confirmed: that even if the revenue from the deal had not as yet found its way into DIGFX’s
accounts, the deal’s confirmation required that the revenue generated be noted in the current report. She
emailed Paul to that effect, to ensure that she had covered all bases. Paul again thanked her for her
thoroughness and expressed interest in her findings, suggesting a meeting to discuss it further. Feeling
gratified that her efforts had been appreciated, Jacqueline was keen to meet soon enough to finalise the
accounts for the AGM report. Given time pressures, Paul suggested a working lunch.
Over lunch, Paul explained that they were in a bit of a bind. The 3D printing scene was one that
quickly evolved, and the deal with NovaTech guaranteed DIGFX the resources to properly update their
inventory to deal with the project they were taking on, so long as it was largely untaxed. The problem
was that if the revenue was counted in the current financial year, it would be heavily taxed. In the coming
financial year, however, the revenue could be offset against the cost of the upgraded printers, reducing
the taxable return on investment. Shifting the profits a year ahead would strongly affect DIGFX’s viability,
and hence the tenure of Jacqueline’s position. Furthermore, the contract had been kept word of mouth,
so there was (as yet) no written document to demonstrate that it had already been confirmed, and the
revenue guaranteed.
QUESTION 2.34
Apply the philosophical model of ethical decision making to the scenario. What would you do if you
were Jacqueline?
AMERICAN ACCOUNTING ASSOCIATION MODEL
The third model to be examined is the American Accounting Association model. Langenderfer and
Rockness (1990) developed a seven-step ethical decision-making model based on the process of conventional decision making. The model was adopted by the American Accounting Association (AAA) in a
publication designed to provide instructors with a comprehensive resource for teaching ethics in accounting
and is commonly known as the AAA model.
The purpose of the seven-step model is to develop a systematic approach to making decisions that can be
used in any situation with ethical implications. The advantage of the AAA model is the ethical awareness
it creates by giving particular attention to stakeholders and ethical issues.
The seven steps of the model are as follows.
1. What are the facts of the case? Pertinent information must be determined in order to identify the
problem.
2. What are the ethical issues in the case? This question involves a two-part process. Firstly, the primary
stakeholders are identified and, secondly, the ethical issues are clearly defined. Identifying and labelling
ethical conflicts and the competing interests of those affected by the dilemma are important stages in
the resolution process.
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3. What are the norms, principles and values related to the case? The norms, principles and values
relating to all stakeholders at all levels, including corporations, individuals and accountants, should be
identified. Generally, norms, principles and values are standards, rules and beliefs that guide acceptable
and ethically ‘good’ conduct. Examples of principles include integrity and respect for individuals.
4. What are the alternative courses of action? The major alternative courses of action that will resolve the
problem should be identified, including alternatives that may involve compromise.
5. What is the best course of action that is consistent with the norms, principles and values identified
in Step 3? At this point, all alternatives are considered in light of the norms, principles and values
identified in Step 3. One purpose of this process is to determine whether any norm, principle or value
(or a combination of them) is so persuasive that resolution is obvious. For example, protecting the
environment is important to avoid permanent damage and to respect the rights of the communities who
rely on the environment for survival.
6. What are the consequences of each possible course of action? Each course of action should be evaluated
with respect to its norms, principles and values, from both short- and long-term perspectives, and for
its positive and negative consequences.
7. What is the decision? The consequences should be balanced against the primary norms, principles and
values, and an appropriate option should be selected.
A comparison of the AAA model with the Code of Ethics framework shows that they are consistent
with each other. However, the Code attributes greater emphasis to the fundamental principles, threats and
safeguards. The AAA model is a model of ethical decision making applicable to all settings and not specific
to accounting.
.......................................................................................................................................................................................
CONSIDER THIS
Visit the IFAC website, register if you do not already have access to the resources and work through two of the case
studies that are available in the ethics education toolkit available at the link below. These case studies will help you
understand the model outlined above.
You can access the materials required for this activity by visiting: www.ifac.org/publications-resources/iaesbethics-education-toolkit-study-guides.
Example 2.21 illustrates the AAA ethical decision-making model.
EXAMPLE 2.21
An Asset by any other Name
Until recently, Booker Manufacturing Company had been a family business. Booker manufactured small
machines and household equipment as its primary product line. Recently, the company was bought by
a large equipment firm that wished to expand its product line into household equipment. The financial
director of Booker, Paul Davis, CPA, had been asked to stay on in his position. In the future, however, Paul
Davis would report to both the CEO of the Booker subsidiary and the CEO of the parent company. Paul
had a close relationship with the Booker CEO, but he realised that he would have to prove himself to the
CEO of the parent company.
In preparation for the acquisition, Davis was asked to supply the parent company with a list of Booker’s
fixed assets, their date of acquisition, the original cost and the accumulated depreciation, all on an
individual asset basis. In general, the fixed assets were relatively old and, therefore, the book values
were substantially lower than the original costs. Davis assumed that the parent company needed this
information to determine the fair market values of these assets in order to arrive at an estimated purchase
price for Booker. Eventually, the fair market values assigned to the fixed (i.e. non-current) assets would
be used in the consolidated financial statements. These values would be used to determine the portion
of the purchase price that should be allocated to goodwill.
When Davis was shown the consolidated balance sheet, as at the date of acquisition on 13 April 2019
he noted that Booker’s tangible fixed assets were assigned a fair market value. Davis agreed with that
value. The excess purchase price above the fair market value of the assets was included as goodwill. This
amounted to $450 000. During late May and early June of 2019 the parent company’s auditors spent time
at Booker. Their purpose was to become familiar with the operations and to conduct a full scale audit.
They would publish their opinion on the consolidated financial statement for the financial year ending
30 June 2019.
Shortly after the audit was completed, Davis received a copy of the consolidated financial statements
and was surprised to note that the goodwill amount of $450 000 was not shown as such but had been
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used to raise the asset values. Most of these assets were quite old and not as efficient as the
new machines because current technology had improved considerably since the assets had been
acquired. To add to his concern, Davis noted that the auditors had given an unqualified opinion on the
financial year-end statements.
Davis is aware that the company policy was to amortise goodwill over 20 years. However, assets are
depreciated over five to 10 years. He was aware that the company’s contract with its labour unions was
soon to be renegotiated and he wondered if the higher asset values, with a much faster write-off than over
20 years, were a relevant factor in preparing the figures for the negotiation. He learned that the company
might sell some of its assets owing to an expansion of product lines. A higher book value would most
likely result in a recognised loss at the time of sale.
The more Davis thought about the treatment of the Booker company assets, the more upset he became.
He felt that the parent company deliberately ‘cooked the books’ (misrepresented the accounts) and that
the auditors were either a party to it or did not do a sufficiently careful audit of the Booker company assets.
Source: Langenderfer, HQ & Rockness, JW 1990, ‘Ethics in the Accounting Curriculum: Cases and Readings’, American
Accounting Association, Sarasota, Florida.
QUESTION 2.35
What are the ethical issues in this context? What should Davis do? Use the American Accounting
Association (AAA) ethical decision-making framework in analysing this case.
EXAMPLE 2.22
Chain of Command
Jenna worked as an in-house accountant for a superannuation fund, Millennial Funds, and was part of a
team preparing estimated dividends over the coming financial year as part of the company’s prospectus.
While estimating the revenue to be raised via its investments, she noticed considerable investment in a
proposed coal mine in Queensland, the Deep Vein mine. She found this odd, as she knew Millennial had a
policy of diversified investment, and particular in limiting fossil fuel investment. Jenna knew that the coal
prices factored into the projected profitability of the proposed mine could not be guaranteed. Millennial’s
CFO had publicly stated that it planned to move to an investment distribution that capped investment
in fossil fuels at 20% of its portfolio. This new mine investment would place its investment in coal alone
above that 20% threshold.
Jenna revised the projected estimate in line with a more conservative ongoing value of coal. When
she submitted her revisions, the document was returned to her by her manager, pointing out what they
considered to be an error — her revised estimate of the mine’s projected revenues. She forwarded her
workings on the topic, but was sent a curt reply to use the value initially supplied by Deep Vein. The
superannuation market was competitive and Millennial couldn’t afford to lose accountants to their rivals.
Furthermore, Jenna’s performance review would be coming at the end of the year, and it would not help
that process if she’d been found to be unhelpful in these essential matters.
QUESTION 2.36
Apply the American Accounting Association model to this scenario. What action would you
recommend in this situation?
SUMMARY
Ethical theories and principles provide useful tools to resolve dilemmas that arise in practice or in work
places. It is important to recognise, however, that decision making occurs in the context of numerous
individual, organisational, professional and societal influences. Generally, individual and organisational
factors can have a more intense influence on decision making than professional factors. The better a
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professional understands these influences, the better they can take into consideration their potential effects
on decision making and ensure their decisions reflect the ethical standards of the profession.
Ethical frameworks and decision-making models are useful tools for individuals and groups to analyse
situations that involve ethical dilemmas and to make decisions that successfully deal with the tensions
between competing interests.
APESB’s APES 110 Code of Ethics for Professional Accountants (including Independence Standards)
includes a conceptual framework that provides a structured approach to dealing with ethical issues that
arise in the work of the professional accountant. APESB has also issued a guidance note known as
GN 40 that reflects the approach in the conceptual framework. GN 40 provides a method to enable a
member to methodically analyse and deal with ethical conflicts in the workplace. A series of case studies
in the guidance note provide further assistance to members in business.
A philosophical model of ethical decision making brings together multiple ethical theories and thus
provides a way to identify, analyse and resolve ethical issues in a way that is just, balances the benefits
and harms to oneself and others, and respects the rights of each stakeholder.
The American Accounting Association issued a decision-making model for use in any ethical situation.
It is consistent with the conceptual framework in APES 110, but is also applicable beyond the professional
accounting context.
The key points covered in this part, and the learning objective they align to, are listed below.
KEY POINTS
2.4 Analyse and resolve ethical dilemmas in accounting.
• Professional accountants routinely confront ethical dilemmas in their work, including where they
detect non-compliance with laws and regulations, receive or are approached with inducements, or
observe wilful misleading and deceptive statements being made by management or a client.
• People commonly rely on personal insight, intuition, judgment and experience to make decisions,
but this approach is limited and may result in decisions that are less than optimal.
• A systematic approach to decision making, based on decision-making models that incorporate structured processes is more likely to result in ethical decisions that properly consider all
relevant factors.
2.5 Apply ethical decision-making models.
• The APES 110 Code of Ethics includes a conceptual framework that provides a decision-making
model. This approach is mirrored in APES GN 40, which provides members with a framework to be
used when ethical conflicts arise.
• The philosophical model of decision making combines various ethical perspectives. The philosophical model requires the professional accountant to specifically consider the benefits and harms
to oneself; the benefits and harms to others; the rights of individual stakeholders; and the just
distribution of benefits and burdens.
• The American Accounting Association provides its own model of decision making. It is a seven-step
model that focuses on stakeholders and ethical issues and is broadly applicable to ethical issues,
not only the accounting context.
• The American Accounting Association model and the Code of Ethics framework are consistent with
one another, but the Code is more specific to the professional accounting context and emphasises
fundamental principles, threats and safeguards.
REVIEW
Professional ethics requires the application of a set of principles or a framework to make decisions and
take actions that are in the best interests of the public, in accordance with the professional ideal to serve
society. APES 110 Code of Ethics for Professional Accountants (including Independence Standards) sets
out five fundamental principles for the ethical conduct of professional accountants: integrity; objectivity;
professional competence and due care; confidentiality; and professional behaviour. APES 110 also
includes a conceptual framework that provides a structured decision-making approach to deal with any
ethical dilemma that may confront an accountant in their professional life. In addition, specific guidance to
identify and safeguard against threats is included for members in business and members in public practice.
Finally, independence requirements are set out for accountants who engage in audit, review and other
assurance engagements.
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The professional accountant needs to be aware of influences at a personal, organisational, professional
and societal level that may impact on their decision-making process. It can be helpful to use a variety of
ethical theories and perspectives to identify and resolve ethical issues. This module introduced the different
orientations of teleology, deontology and virtue ethics.
Key sources of ethical dilemmas facing accountants are conflicts of interest; professional appointments;
preparation and presentation of information; acting with sufficient expertise; second opinions; financial
interests, compensation and incentives linked to financial reporting and decision making; fees and
remuneration; inducements; custody of client assets; responding to NOCLAR; and pressure to breach
the fundamental principles.
Ethical frameworks and principles help accountants to address such dilemmas in a coherent and
consistent way, reducing the risk of choosing sub-optimal outcomes.
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Kohlberg, L 1981, ‘The philosophy of moral development: Moral stages and the idea of justice’, Essays in Moral Development,
vol. 1, Harper & Row, New York.
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Langenderfer, HQ & Rockness, JW 1990, ‘Ethics in the Accounting Curriculum: Cases and Readings’, American Accounting
Association, Sarasota, Florida.
Litsky, B, Eddlestone KA & Kidder DL 2006, ‘The good, the bad, and the misguided: How managers inadvertently encourage
deviant behaviours’, Academy of Management Perspectives, vol. 20, no. 1, pp. 91–101.
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https://thenewdaily.com.au/news/national/2019/06/05/abc-raid-david-mcbride.
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PressRelease/1365171514600#.U5r0_3l-_rc.
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Commission, 27 September, accessed October 2015, www.sec.gov/litigation/admin/2013/34-70549.pdf.
Simha, A & Cullen JB 2012, ‘Ethical climates and their effects on organizational outcomes: Implications from the past and
prophecies for the future’, Academy of Management Perspectives, vol. 25, no. 4, pp. 20–34.
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Sims, RR 2000, ‘Changing an organisation’s culture under new leadership’, Journal of Business Ethics, vol. 25, pp. 65–78.
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Business Ethics, vol. 35, pp. 327–29.
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and Democratic Values, International Whistleblowing Research Network, London, pp. 56–60.
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ETHICS WEBSITES
USEFUL WEBSITES ON PROFESSIONAL AND BUSINESS ETHICS
• Accounting Professional & Ethical Standards Board, accessed September 2015, www.apesb.org.au
• The Ethics Centre, accessed September 2015, www.ethics.org.au
• International Federation of Accountants, www.ifac.org/system/files/publications/files/IAESB-EthicsEducation-Toolkit-Introduction.pdf
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MODULE 2 Ethics 113
MODULE 3
GOVERNANCE
CONCEPTS
LEARNING OBJECTIVES
After completing this module, you should be able to:
3.1 describe corporate governance and explain why it is important
3.2 evaluate the importance of the key elements of the corporate governance framework
3.3 describe the nature of corporations and the division of corporate powers
3.4 discuss agency theory and how it is used to understand corporate behaviour
3.5 discuss the key features of corporate structure
3.6 examine the characteristics and duties of directors and other officers
3.7 explain the various international approaches to corporate governance
3.8 analyse how robust governance is relevant to public sector and non-corporate entities
3.9 interpret and apply codes and principles of corporate governance.
ASSUMED KNOWLEDGE
No specialised knowledge is assumed for this module.
LEARNING RESOURCES
The following resources will be referred to or are included in this module.
• Corporate Governance Principles and Recommendations, 4th edition, ASX Corporate Governance Council,
2019, www.asx.com.au/documents/regulation/cgc-principles-and-recommendations-fourth-edn.pdf
• The UK Corporate Governance Code, Financial Reporting Council, 2018, www.frc.org.uk/getattachment/
88bd8c45-50ea-4841-95b0-d2f4f48069a2/2018-UK-Corporate-Governance-Code-FINAL.pdf
• G20/OECD Principles of Corporate Governance, OECD, 2015, www.oecd.org/daf/ca/Corporate-GovernancePrinciples-ENG.pdf
• OECD Corporate Governance Factbook, OECD, 2019, www.oecd.org/corporate/Corporate-GovernanceFactbook.pdf
• Corporations Act 2001 (Cwlth), www.legislation.gov.au/Details/C2019C00216
PREVIEW
Governance is the system that is put in place to operate and control an organisation. With the advent of
the corporate structure, the resulting agency relationship between the company (or its owners) and those
who act on its behalf, and a spate of reasonably recent corporate failures, a form of governance known as
‘corporate governance’ has evolved.
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Part A of this module examines the nature and structure of corporations, the characteristics and duties
of directors and other officers, the division of power between owners and directors within a company and
what, theoretically, this division of power means for the governance of an organisation.
Part B of this module defines and discusses the importance of corporate governance and looks at the
key elements of a corporate governance framework that are common to most organisations.
Part C looks at the history of and differing international perspectives on corporate governance.
Part D examines the content and application of various corporate governance codes and principles.
Finally, part E examines governance in the small- and medium-sized enterprises (SME), and the
not-for-profit and public sectors.
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MODULE 3 Governance Concepts 115
PART A: CORPORATIONS
INTRODUCTION
As organisations have grown, their activities have become more complex and the demand for capital has
increased, new forms of business structures have arisen. One of these structures is the corporation. A
corporation is separate from its owners; it is a distinct legal entity with most of the same legal rights as an
individual. In Australia, there are various forms of corporation, generally distinguished by size, liability,
and how they can raise capital.
By its very nature, in a corporation the owners of the capital are not the ones managing the day-to-day
operations of the business. This has the potential to lead to a misalignment of goals. In response, legislation
imposes various duties on those charged with the governance of the corporation.
This part of the module examines the key features of proprietary and public companies, the division of
power between owners and directors, the duties required of directors and a number of theories that help
explain and understand corporate governance.
3.1 KEY FEATURES OF CORPORATIONS
There are many legal forms for business associations. The public corporation is the legal form we are most
familiar with, as it is the legal form adopted by many of the largest business organisations.
Corporations are frequently at the heart of debate and discussion about corporate governance. As
‘fictional entities’ brought into existence through legal means (e.g. being registered under the Corporations
Act 2001 (Cwlth) (Corporations Act)), they give rise to a number of distinct advantages over other forms
of business organisation (such as sole traders or partnerships), including the following.
• Separate legal entity distinct from its owner. This results in the ability to hold and own property in the
name of the corporation, to sue and be sued, and to enter into contracts.
• Limited liability. This provides that the liability of the owners of a corporation is limited to the original
capital invested by owners. Other rules may be defined, such as ‘no liability’, where unpaid capital is
not at risk, and ‘unlimited liability’, where some corporations leave owners exposed beyond the amount
of invested capital.
• Perpetual succession. As an artifice of law, corporations do not have a finite life. Individuals (as a
biological fact) and trusts (as a legal requirement) have finite lives and a partnership legally terminates
and re-forms whenever a partner leaves or enters a partnership. Ownership by, and operations of,
corporations can theoretically last forever. A corporation ceases to exist only through formal legal
procedures that result in the corporation ‘winding up’.
In the 1960s, noted economist Milton Friedman argued that the primary responsibility of a corporation
is to maximise the wealth of its shareholders. However, increasingly this view has been challenged by
people who believe that an organisation should also consider the interests of a wider group of stakeholders
such as employees, customers and suppliers. This point of view is discussed further in module 5.
Corporations vary enormously in size, capitalisation, structure, the nature of their activities, number of
employees and other factors. They may be for-profit or not-for-profit (NFP), private or public, with no
liability, limited liability or unlimited liability, and listed or unlisted. Section 112 of the Corporations Act
lists the types of company that can be registered in Australia.
Table 3.1 provides examples of different types of corporations in Australia and other countries.
TABLE 3.1
Types of corporations
Ownership
Liability
Naming
Private/Proprietary (unlisted)
Limited by shares
Pty Ltd
Pvt Ltd
Ltd
Sdn Bhd
Corp/Inc.
PT
YK
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116 Ethics and Governance
Proprietary Limited (Australia)
Private Limited (India)
Limited (UK)
Sendirian Berhad (Malaysia)
Incorporated (US)
Perseroan Terbatas (Indonesia)
Yugen-Kaisha (Japan)
Public (listed or unlisted)
Unlimited with share capital
Pty
ULC
Proprietary (Australia)
Unlimited Liability (Canada/UK)
Limited by shares/
guarantee
Ltd
PLC
Bhd
Corp/Inc.
PT Tbk
KK
Limited (UK, Australia, India)
Public Limited Company (UK)
Berhad (Malaysia)
Incorporated (US)
Perseroan Terbuka (Indonesia)
Kabushiki-Kaisha (Japan)
Unlimited with share capital
ULC
Unlimited Liability (Australia/
Canada/UK)
No liability company
NL
No Liability (Australia)
Source: CPA Australia 2015.
PROPRIETARY COMPANIES
Proprietary companies are the most commonly registered company type in Australia. Shares are held
privately by no more than 50 non-employee members. A proprietary company is not allowed to do
anything that would require disclosure to investors, including, offering securities for issue or sale to
the public. Proprietary companies may however issue shares to existing shareholders, employees or
subsidiary companies. They may also issue shares or corporate bonds to sophisticated or professional
investors, and as small-scale issues of not more than $2m in any 12-month period to no more than
20 people. Should a proprietary company fail to follow any of these rules, the Australian Securities and
Investments Commission (ASIC) may force it to change to a public company. Proprietary companies are
further subdivided into large and small proprietary companies. The financial reporting obligations for large
proprietary companies are different to those of small proprietary companies
QUESTION 3.1
Refer to s. 45A of the Corporations Act for the rules used to differentiate between large and small
proprietary companies.
PUBLIC COMPANIES
A public company is defined as a company that is not a proprietary company. It will have more than 50
members and may issue securities to the public. Public companies may apply to list on the Australian
Securities Exchange (ASX).
PROPRIETARY VS PUBLIC COMPANIES
Compliance requirements come from a variety of sources including:
• the Companies Act 2001
• ASX listing requirements, www.asx.com.au/listings/listing-with-asx/listing-requirements.htm
• ASX listing rules, www.asx.com.au/regulation/rules/asx-listing-rules.htm.
These requirements are summarised in table 3.2. Note that there are specific requirements for companies
limited by guarantee which are not covered in this table.
The three components to an annual financial report are the financial statements, the notes to financial
statements, and the directors’ declaration.
Listed public companies must also comply with the ASX’s corporate governance principles and
recommendations which will be discussed in part D.
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MODULE 3 Governance Concepts 117
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118 Ethics and Governance
Yes, electronic or convertible
to hard copy, kept for
7 years and either in English
or a translation to be made
available upon request
(Part 2M.2)
No
Annual financial report and
directors report only in some
circumstances (ss. 292(2),
293, 294, 298(3))
Financial records
Ongoing disclosure
Reporting requirements
ASIC notification of
changes to members,
issuance or transfer
of shares
Only in certain circumstances (s. 301(2))
Auditor/Audit report
Yes (Part 2C.2)
Note that these do not need
to comply with accounting
standards (s. 296(1A)).
Optional (Part 2D.4)
Optional (Part 2D.4)
Company secretary
Yes (Part 2C.2)
Annual financial report
(s. 295) and directors report
(ss. 298, 299, 300(1)–(9))
No
Yes, electronic or
convertible to hard copy,
kept for 7 years and either
in English or a translation
to be made available upon
request (Part 2M.2)
Yes, but ASIC may provide
relief in appropriate cases
(ss. 301, 342(2)–(3),
Part 2M.4)
One (one) (s. 201A (1)-(1A))
One (one) (s. 201A (1)-(1A))
Minimum number of
directors (resident
in Australia)
Large proprietary
company
Small proprietary company
No
Financial report, auditor’s
report and directors’ report to
be presented at AGM (ss. 315,
317, and 250N)
Annual financial report (s. 295)
and directors report (ss. 298,
299, 300(1)–(13))
No
Yes, electronic or convertible
to hard copy, kept for 7
years and either in English
or a translation to be made
available upon request
(Part 2M.2)
Yes, including independence
requirements (ss. 301, 307,
308, Part 2M.4)
At least one who resides in
Australia (Part 2D.4)
Three (two) (s. 201A (2))
Public company
No
ASX Listing requirements — Chapter 4 and Chapter 5
which include submission of quarterly returns to ASX for
some companies (mining, oil and gas, and those without a
record of revenue or profit).
Submit annual and half yearly financial, directors and audit
reports to ASIC (s. 319)
Financial report, auditor’s report and directors’ report to be
presented at AGM (ss. 315, 317, and 250N)
Annual and half-year financial report (ss. 295, 302-306) and
directors report (ss. 298, 299, 299A, 300(1)–(13), 300A)
Yes (Chapter 6CA)
ASX Listing Rules — Chapter 3
Yes, electronic or convertible to hard copy, kept for 7 years
and either in English or a translation to be
made available upon request (Part 2M.2)
Yes, including independence and rotation requirements
(ss. 301, 307, 308, 309, Part 2M.4)
At least one who resides in Australia (Part 2D.4)
Three (two) (s. 201A (2))
Listed public company (disclosing entity)
Compliance requirements (unless specified otherwise, section references are to the Corporations Act)
Aspect of compliance
TABLE 3.2
Figure 3.1 illustrates how the level of regulation, reporting and disclosure vary depending on the type
of corporate structure.
FIGURE 3.1
Level of company regulation
Structure
Listed
company
Public
company
Large private
company
Small private
company
High
Low
Regulation
Source: CPA Australia 2015.
3.2 DIRECTORS AND OTHER OFFICERS
The Corporations Act sets out the eligibility criteria for directors and their duties. It also sets out the
requirements for company secretaries.
QUESTION 3.2
Find and list the eligibility criteria for directors in the Corporations Act. Use ASIC’s list of
eligibility criteria at https://asic.gov.au/for-business/running-a-company/company-officeholderduties/your-company-and-the-law/#can-anyone-be-an-officeholder to confirm your list.
DIRECTORS AND THEIR DUTIES
As noted in the previous discussion on corporations, incorporation brings specific corporate attributes,
including the benefits of limited liability, separate legal personality and perpetual succession. As corporations grow in size, there is also a separation of ownership and management. Over time, the legal duties
and responsibilities of directors have evolved to protect the interests of the owners, who are not able to
observe closely the daily management activities within a corporation.
In most jurisdictions, there is a core group of directors’ duties and responsibilities that have arisen from
either statute or case law. The key duties, which are considered in further detail next, are to:
• avoid conflicts of interest and where these exist, ensure they are appropriately declared and, as required
by law, otherwise managed correctly
• act in good faith in the best interests of the corporation
• exercise powers for proper purposes
• retain discretionary powers and avoid delegating the director’s responsibility
• act with care and diligence
• remain informed about the corporation’s operations
• prevent insolvent trading.
Additionally, directors must not use information they gain in the course of their duties improperly nor
use their position as a director improperly. It is also important that directors ensure they apply professional
scepticism as they deal with issues arising during their term as a director.
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MODULE 3 Governance Concepts 119
Duty to Avoid Conflict of Interest
Conflict of interest is an issue that often arises with respect to all types of agency. An agency relationship
exists when one person acts on behalf of another, for example directors act on behalf of shareholders. The
ever-present opportunities that would benefit the agent due to their position provide significant temptation.
Potential conflicts may be at the expense of the corporation, or may even be beneficial to the corporation.
That is, it is not necessary that there be fraud, dishonesty or loss to the corporation, as the corporation does
not have to suffer a detriment for the director to be in breach of their duty. An example of this is when
a contract is awarded to a supplier that is owned by one of the directors. It may still provide a benefit to
the organisation in terms of the best price and appropriate quality, but this does not remove the conflict of
interest for the particular director involved.
All agents, including directors, need to be aware of conflicts and must manage them correctly. As a
fundamental of good corporate governance compliance, directors need to fully understand that the law
requires that directors of larger corporations (including all public and listed corporations) must not be
involved in decisions where any actual or potential conflicts of interest are identified.
They can bypass this rule if they clearly advise the board of the conflict and also gain approval from
the remaining directors or from the shareholders or from corporate regulators. Failure to disclose to the
board or seek necessary shareholder approvals can result in civil liabilities, full obligations to compensate
persons (natural and corporate) who are harmed and even criminal prosecutions, including possible jail
and fines.
There are a number of examples of possible conflicts of interest to be aware of, including:
• relationships or circumstances that create conflicts of interest where no relevant gains to a director
may ever arise, but where the ability of the director to be regarded as independent is compromised by
relationships such as competing shareholdings, the interests of relatives or friends, and so on
• bribes, secret commissions and undisclosed benefits (e.g. in the awarding of a tender)
• misuse of corporation funds (e.g. for personal expenses)
• taking up corporate opportunities (e.g. purchasing land to on-sell to the corporation at a profit)
• using confidential information (e.g. to trade in the corporation’s shares)
• competing with the corporation (e.g. tendering for the same project)
• using a position in the corporation improperly (e.g. to secure a personal discount to the detriment of the
corporation).
It should be noted that accepting or being involved in secret commissions (which are often in the form
of bribes) is an offence in Australia under relevant criminal codes such as the Crimes Act 1958 (Cwlth).
This legal concept has legislative equivalents in most countries. Legislation for such actions often has a
wide reach, with citizens of a country being liable for prosecution for actions committed outside their
home country.
Duty to Act in Good Faith in the Corporation’s Best Interests
The duty to avoid conflicts of interest is matched with the corresponding demand to act in the best interests
of the corporation. Actions should be made in good faith, honestly and without fraud or collusion.
In many jurisdictions, the test for this is whether directors themselves believed their actions to be in the
best interests of the corporation. Directors who use good business judgment and behave honestly in a way
that a reasonable person in their position would act will satisfy the duty.
Duty to Exercise Powers for Proper Purpose
In addition to the need to act in the best interests of the corporation and avoid conflicts of interest, it is
essential for directors to act within their designated powers. The two main areas that must be satisfied are
that directors:
• act within their power
• do not abuse their powers.
It is important to note that action that is perceived to be in the best interests of the corporation is still
unacceptable if it goes beyond the authority given to a director. This duty to exercise powers for proper
purposes is usually linked to legislation, and the constitution of the corporation or its equivalent, which
outlines the authority of directors.
Possible breaches of this duty include making anti-competitive agreements that benefit the corporation
but are illegal (e.g. price-fixing). There are a number of situations where the issue of improper purpose
may arise, including defensive actions during hostile takeovers (that are focused on protecting the current
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120 Ethics and Governance
management team rather than getting the best deal for shareholders) and actions to destroy majority voting
power (where a small minority gains control of a corporation at the expense of the majority).
Nominee Directors
A difficult situation arises when powerful interest groups appoint nominee directors to a board. These
directors are appointed to represent third-party interests, such as a major shareholder, a class of shareholders or a holding corporation. However, this may put the nominee in a position where their loyalties
are divided between the conflicting interests of the nominator and the corporation. The nominee director
must always act in the best interests of the corporation and use their powers only for proper purposes when
making a decision as a director of a board.
Example 3.1 describes a case in which directors failed to act within their powers.
EXAMPLE 3.1
Advance Bank
Directors of Advance Bank Australia Ltd believed they were acting in the best interests of the corporation
in using the corporation’s funds in an election campaign to stop the nominees of FAI Insurances Ltd from
gaining a place on the board, and to return the current directors to the board.
The allegation was that the material sent to the shareholders included misleading and prejudicial material
that should not have been paid for by the corporation. The court decided that, although the directors acted
honestly and in good faith, they exceeded their power and used their power for an improper purpose. The
case highlights the position of directors who act beyond their power, however innocently (Advance Bank
Australia Ltd v. FAI Insurances Ltd (1987) 5 ACLC 725).
Duty to Retain Discretionary Powers
Directors generally have powers granted to them in legislation or a corporation’s constitution to delegate a
range of their functions. These include the power to manage the corporation, which is generally delegated
to executive directors and other senior officers. However, situations can occur where a director delegates
to another a power that the director should themselves have exercised. If the delegate’s action, or inaction,
subsequently causes the corporation to suffer loss, the director may be liable.
The board must not, without express authority from the corporation’s constitution or from statute,
delegate their discretion to act as directors to others. While the directors can engage employees and agents
to perform the ordinary business of the corporation, the directors must not let someone who is not a
director carry out their duties. In addition, as directors owe a fiduciary duty to the corporation to give
proper consideration when exercising their right to vote or act — they cannot simply accept the direction
of others as to how they will vote at board meetings.
Where a director has delegated powers to anybody (usually managers), the director (or the whole board
jointly and severally) remains responsible for the exercise of the power by the delegate, as if the director
had exercised the power themselves.
However, corporate legislation in various jurisdictions usually allows directors to escape this total
liability for every action by a manager to whom power is delegated. Delegates (i.e. managers) need to be
properly appointed by boards (of directors) using professionally acceptable procedures (as to competence,
qualifications, etc. of the manager).
Additionally, the board must carry out correct and ongoing oversight. Note, however, that the board
does not undertake day-to-day operational management, so a balanced approach is required. If these
two obligations are met, then boards can be comfortable that they will not be exposed to a vast array
of management-induced personal liabilities.
A word of caution is required however. From both the Centro case and the James Hardie case, to be
discussed shortly, a residual matter arising in discussion relates to the fact that some director’s duties and
tasks are simply ‘non-delegable’. This means that any attempt to delegate these ‘non-delegable’ functions
(to managers or to other fellow directors) will comprise inappropriate action by a director and will not deem
the director immune from liability. The obligation to report correctly to shareholders on major matters
affecting the finances of the corporation, which directors should do or be aware of, appear from the Centro
and James Hardie decisions to be ‘non-delegable’. These two cases are discussed later in the module in
example 3.3 and example 3.4 respectively.
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MODULE 3 Governance Concepts 121
Duty to Act with Care and Diligence
A director is expected to run a business aimed at making a profit and must, therefore, be in a position
to take risks to enhance the prospects of the enterprise. However, this risk taking should not be reckless
and must still be done in a sensible, prudent manner. The appropriate standard or test ‘is basically an
objective one in the sense that the question is what an ordinary person, with the knowledge and experience
of the [director], might be expected to have done in the circumstances if he was acting on his own behalf’
(ASC v. Gallagher (1993) ASCR 43).
There are two interesting situations where the standard of care may differ even between directors of the
same corporation.
• A director who also has professional qualifications (e.g. a CPA) and uses them in an executive capacity
(e.g. as a chief financial officer (CFO)) may be subject to a higher level of responsibility. In this sense,
these directors may have a higher standard of care than unqualified directors because of their higher
level of skills and the specific role they fulfil and for which they receive executive remuneration.
• Non-executive directors who are not involved in the business on a day-to-day basis are still required
to demonstrate a duty of care. However, the care, skill and diligence that a non-executive director may
be expected to exercise may not equate to that of an executive director who also holds professional
qualifications.
Business Judgment Rule (s. 180(2))
As a protection for directors the Corporations Act contains the business judgment rule. Effectively a
director can be said to have met their duty to act with care and diligence in respect of decisions that they
have made if they:
(a) make the judgment in good faith for a proper purpose; and
(b) do not have a material personal interest in the subject matter of the judgment; and
(c) inform themselves about the subject matter of the judgment to the extent they reasonably believe to be
appropriate; and
(d) rationally believe that the judgment is in the best interests of the corporation.
Duty to Remain Informed about Company Operations
To fulfil their duties, directors need to know what is happening within the company and in the environment
within which the company operates. Reading board papers is a crucial facet of this duty. Applying
professional scepticism and asking appropriate questions of company officers and auditors enable directors
to get the information that they require, make informed judgments and act accordingly.
Continuous Disclosure Regimes
A further responsibility of directors related to remaining informed about the operations of a listed company
is the regime of continuous disclosure that now applies to companies listed on major exchanges including
the ASX. This is to ensure that shareholders and other stakeholders are provided with high-quality
disclosures on the financial and operating results of the company. This includes any aspect of operations
that might impact upon the share price of the company or the market perception of the company. This also
involves matters such as governance, performance, investment and other issues relating to the company.
Shareholders and others can then make informed assessments concerning the progress of the company and
informed decisions regarding further investment.
Continuous disclosure does not only apply to significant financial or operating performance developments, but also to any development in the company that may affect the market for the company’s shares (e.g.
the possibility of a merger or takeover, a new product launch, entering an important new market). In recent
years, penalties imposed upon companies that have failed to disclose material issues have increased and
included significant fines and banning of directors.
Most of the corporate governance regimes around the world including the OECD Principles (2015),
Sarbanes–Oxley Act (2002) and EU Transparency Directive (2013) commit companies to disclosure as a
vital basis for the effective operation of all of the other mechanisms of governance and investment.
The United Nations Conference on Trade and Development (UNCTAD) has summarised these collected
guidelines into requirements on financial disclosures stating:
The quality of financial disclosure depends significantly on the robustness of the financial reporting
standards on the basis of which the financial information is prepared and reported. In most circumstances,
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122 Ethics and Governance
the financial reporting standards required for corporate reporting are contained in the generally accepted
accounting principles recognized in the country where the entity is domiciled … the board of directors could
enrich the usefulness of the disclosures on the financial and operating results of a company by providing
further explanation (UNCTAD 2006, pp. 3–4).
However, the requirement for continuous disclosure is not confined to financial information,
and includes any information that is expected to have a material effect on the price of securities. Further
explanation of the board becomes necessary in continuous disclosure regimes when a critical accounting
or material matter occurs that might have material impact on the financial and operating results of
the company.
Chapter 3 of the ASX Listing Rules (ASX 2014a) gives the following examples of information that
could be market sensitive:
•
•
•
•
•
•
•
•
•
a transaction that will lead to a significant change in the nature or scale of the entity’s activities;
a material mineral or hydrocarbon discovery;
a material acquisition or disposal;
the granting or withdrawal of a material licence;
the entry into, variation or termination of a material agreement;
becoming a plaintiff or defendant in a material law suit;
the fact that the entity’s earnings will be materially different from market expectations;
the appointment of a liquidator, administrator or receiver;
the commission of an event of default under, or other event entitling a financier to terminate, a material
financing facility;
• under-subscriptions or over-subscriptions to an issue of securities (a proposed issue of securities is
separately notifiable to ASX under Listing Rule 3.10.3);
• giving or receiving a notice of intention to make a takeover; and
• any rating applied by a rating agency to an entity or its securities and any change to such a rating.
While understanding the broad principles and necessity of continuous disclosure, boards and directors
are often challenged on exactly when disclosure is required. The ASX (2014a) advises:
Once an entity is or becomes aware of any information concerning it that a reasonable person would expect
to have a material effect on the price or value of the entity’s securities the entity must immediately tell ASX
that information (Listing Rule 3.1 (p. 301)).
A listed entity should have a written policy directed to ensuring that it complies with this obligation so
that all investors have equal and timely access to material information concerning the entity – including its
financial position, performance, ownership and governance (Corporate Governance Recommendation 5.1
(p. 21)).
In designing its disclosure policy, a listed entity should have regard to ASX Listing Rules Guidance Note 8
Continuous Disclosure: Listing Rules 3.1 – 3.1B and to the 10 principles set out in ASIC Regulatory
Guide 62 Better disclosure for investors.
Further advice offered by the ASX (2014b) regarding the immediacy of the need for disclosure includes
when and where the information originated (rumours abound and need to be countered carefully); the
forewarning the entity had of the information and the need to verify the bona fides of the information; and
the need for an announcement to be drawn up that is accurate, complete and not misleading.
Duty to Prevent Insolvent Trading
The Global Financial Crisis (GFC) of 2007 resulted in an economic meltdown with numerous publicised
corporate insolvencies and liquidations. This economic environment focused attention on directors’ duties
where a corporation is experiencing financial difficulties or, in a worst case scenario, has become insolvent.
While the laws relating to corporate insolvency and liquidations can be complex and contain important
technical differences across countries, the following summary covers the key issues under the Corporations
Act, from the point of view of directors.
A basic duty of directors under the Corporations Act is to ensure that a company can pay its debts. This
means that the directors must, at the time a debt is incurred, have reasonable grounds to believe that the
company will be able to pay its debts when they are due for payment. An insolvent company is one that
is unable to pay all its debts when they fall due. If a company becomes insolvent, the directors must not
allow it to incur further debts.
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MODULE 3 Governance Concepts 123
Serious penalties can be imposed on directors if they allow a company to trade while insolvent. It is
therefore very important that the directors are constantly aware of the company’s financial position — not
just at the end of the financial year when they sign off the company’s financial statements. Directors need
to pay careful attention to the declaration where they confirm whether or not, at the date of the declaration,
there are reasonable grounds to consider that the company will be able pay its debts as and when they fall
due and payable. In situations where the company is experiencing financial difficulty, it may be prudent
for directors to seek independent advice on their responsibilities.
In an effort to protect directors in their attempt to trade out of insolvency, the Corporations Act includes
a safe harbour provision (s. 588 GA). Under this provision directors who incur debts while insolvent are
protected if:
(a) at a particular time after the person starts to suspect the company may become or be insolvent, the
person starts developing one or more courses of action that are reasonably likely to lead to a better
outcome for the company; and
(b) the debt is incurred directly or indirectly in connection with any such course of action during the period
starting at that time, and ending at the earliest of any of the following times:
(i) if the person fails to take any such course of action within a reasonable period after that time –the
end of that reasonable period;
(ii) when the person ceases to take any such course of action;
(iii) when any such course of action ceases to be reasonably likely to lead to a better outcome for the
company;
(iv) the appointment of an administrator, or liquidator, of the company.
This provision also states that should a director rely on this defence, the burden of proof rests with
the director.
Unless the company can obtain sufficient finance or trade its way out of financial difficulty, the
options available to directors are to appoint a voluntary administrator or a liquidator. In a voluntary
administration, an independent and suitably qualified person will assume full control of the company to
try to work out a way to save either the company or the company’s business. If it isn’t possible to save
the company or its business, the aim is to administer the affairs of the company in a way that results in a
better return to creditors than they would have received if the company had instead been placed straight
into liquidation.
The purpose of liquidation of an insolvent company is to have an independent and suitably qualified
person (the liquidator) take control of the company so that its affairs can be wound up in an orderly and
fair way for the benefit of its creditors. There are also circumstances under which directors may find
themselves liable for insolvent trading and have judgments awarded against them. Example 3.2 presents
one such set of circumstances.
EXAMPLE 3.2
Mainzeal
A notable case in New Zealand, the Mainzeal case, is an example of a court deciding in February 2019 that
directors were liable for trading while insolvent and that the directors were to pay a penalty of $36 million.
Mainzeal was a construction company that was placed in the hands of liquidators in 2013 after it had built
up $110 million in debt to creditors. Former New Zealand Prime Minister, Dame Jenny Shipley, and other
directors were told they were to pay an amount capped at $6 million individually. The case illustrated the
need for directors to get proper legal advice as well as drawing attention to the fact that directors should
not use an auditor’s opinion that views the entity as a going concern as the sole basis for their assessment
for whether the entity is able to pay its debts as they fall due.
Source: Information from Dolor S 2019, ‘Mainzeal judgment highlights need for good corporate governance’, March,
New Zealand Lawyer, accessed October 2019, www.nzlawyermagazine.co.nz/news/mainzeal-judgment-highlights-need-forgood-corporate-governance-260950.aspx.
............................................................................................................................................................................
CONSIDER THIS
What are the issues that you would consider important if you were a director contemplating whether your entity
was a going concern?
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124 Ethics and Governance
EXAMPLES OF THE EXERCISE OF DIRECTORS’ DUTIES
Examples 3.3 and 3.4 illustrate important principles concerning the duty of care and diligence expected
of directors when they approve financial statements, and how problems may occur. Both cases reveal that
company directors cannot rely solely on the view of company executives and auditors but must exercise
their own judgment. While the courts may look to those with significant professional expertise such as
CFOs or CEOs for a more detailed understanding of corporate dilemmas, it is the duty of every company
director to have an understanding of the main issues in annual reports and corporate communications, and
these duties are not delegable to others.
EXAMPLE 3.3
Centro Case
The Centro case (ASIC v. Healey & Ors (2011) FCA 717) involved actions brought by the Australian
corporate regulator, ASIC, against certain executives and non-executive directors of the Centro group
of entities. The principal activities of the Centro group, the parent of which is listed on the ASX, involves
the ownership, management and development of shopping centres throughout Australia, New Zealand
and the United States, and the management of unlisted funds.
ASIC alleged that the defendants had contravened their statutory duties of care and diligence under the
Corporations Act in relation to their approval of the consolidated financial statements of the Centro group
for the year ended 30 June 2007. In particular, it was alleged that the consolidated financial statements
were incorrect as they incorrectly classified $1.5 billion of debt as non-current liabilities when in fact they
should have been classified as current liabilities.
Furthermore, it was alleged that the defendants had failed to disclose USD$1.75 billion of guarantees
as a material post balance date event in the financial statements of Centro. Centro’s auditor, PricewaterhouseCoopers, did not identify any such errors in the financial statements of Centro.
In June 2011, Justice Middleton of the Federal Court of Australia (FCA) held that each of the directors
had breached their duty of care and diligence in relation to the Centro group of entities and had
failed to take all reasonable steps to ensure compliance with the financial reporting obligations of the
Corporations Act.
The directors were also found to have approved the financial statements of Centro without receiving a
CEO/CFO declaration that complied with section 295A of the Corporations Act. The court held that each
director knew or should have known of the extent of the relevant entities’ borrowings and maturity profiles
as well as the post balance date guarantees.
Key lessons for directors arising out of the Centro case include the following matters.
Duty of Care
The Centro case emphasises the duty of care expected of public company directors when they approve
financial statements. The directors should apply their minds to the proposed financial statements,
including a careful review of how the financial analysis is presented and the clarity of the accompanying
directors’ report.
The directors should determine whether the information contained in these documents is consistent
with their knowledge of the company’s affairs and that they do not omit material matters known, or that
should have been known, to the directors.
The directors should know enough about basic accounting concepts to enable them to carry out their
responsibilities adequately. Furthermore, they should make appropriate inquiries if they are uncertain.
Reliance on Others
The Centro directors argued that the Corporations Act permits reasonable reliance on others in the
discharge of their duties, and that they reasonably relied on Centro’s management and the external auditor
to ensure that the financial statements complied with relevant accounting standards.
The court found that the directors may rely on others, including management and external advisors,
who prepare financial statements and advise on accounting standards. Such reliance can exclude
independently verifying the information on which the advice is based, provided that there is no cause
for suspicion or circumstances demanding critical attention.
However, directors cannot substitute reliance on advice for their own attention and examination of
important matters within the board’s responsibilities (i.e. the directors must approach their tasks with
an enquiring mind). Therefore, the directors’ failure is not excused even if others on whom they relied fell
into error.
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MODULE 3 Governance Concepts 125
Delegation
The obligation of directors to approve the financial statements, and to express an opinion as to their
compliance with accounting standards and that they give a true and fair view, rests with the directors and
is not able to be delegated to others. The court referred to the ‘core, irreducible requirement of directors
to be involved in the management of the Company’.
Information Flow
Directors have a duty to take into account information they receive from all sources when reviewing the
financial statements, including information about loan maturities provided in board papers. Having to deal
with complex and voluminous material is no excuse for failure to take sufficient care and responsibility.
The board can control the information it receives, so it can take steps to prevent information overload.
Over time, it is expected that directors will or should accumulate sufficient knowledge of what is contained
in regular board reports. Information provided to directors by management is assumed to be given to them
for a reason.
Financial Competence
Directors are required to have the financial literacy to understand basic accounting conventions and to
exercise proper diligence in reading the financial statements. Note that this does not mean that the director
should have a working knowledge of all the accounting standards.
While there are many matters a director must focus on, the financial statements are regarded as
one of the most important matters. For instance, directors should understand that financial statements
classify assets and liabilities as current and non-current, and directors should understand what these
concepts mean.
............................................................................................................................................................................
CONSIDER THIS
Do you agree with the idea that different directors within the same organisation may be held to have a different
standard of care based on their qualifications?
Example 3.4 further illustrates the importance of directors not relying on others to avoid their duty to
use care, skill and diligence in their dealings with and on behalf of the corporation.
EXAMPLE 3.4
James Hardie Case
The James Hardie Group is an industrial building-materials company with operations in Australia, the US,
New Zealand and the Philippines. Two subsidiaries of the James Hardie Group were exposed to major
liabilities associated with asbestos-related claims.
The group restructured itself to separate those subsidiaries from the group and established a foundation
to compensate the victims of asbestos-related diseases who had claims against the two subsidiaries.
February 2001
The board of James Hardie Industries Limited (the parent in the James Hardie Group) announced to the
ASX that the foundation had sufficient funds to meet all anticipated compensation claims. In fact, the
announcement was misleading because the foundation was underfunded by $1.5 billion.
2007
ASIC brought proceedings against the directors of James Hardie Industries Limited and certain officers
for failing to exercise due care and diligence in approving and releasing the ASX announcement.
May 2012
The High Court of Australia (ASIC v. Hellicar (2012) HCA 17) found that the directors of James Hardie
Industries Limited had breached their duties to act with due care and skill by approving the release of a
misleading announcement to the ASX concerning the funding arrangements for the asbestos liabilities.
It was held that none of the directors were entitled to abdicate responsibility (in relation to the misleading
ASX announcement) by delegating their duty to a fellow director or by pleading reliance on management
or expert advisers for the task of approving a draft of the ASX announcement.
Following the Centro and James Hardie cases, detailed in examples 3.3 and 3.4, there are some nondelegable duties and these apply to ‘business judgment’ decisions. While the area is unclear, it can be
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126 Ethics and Governance
stated with reasonable certainty that if matters are considered carefully by a director and on an informed
basis, it would seem that directors can delegate to others.
This would include the concept that non-executive directors delegate to appropriately qualified executive
directors with the expectation that personal liability is also ‘delegated’. If the matter is of major importance,
delegation may not be effective — just as it would not be if the delegate is, on an ongoing basis, objectively
considered not to be reliable and appropriate as a delegate.
From a regulatory perspective, several types of officers or agents deserve special mention. Other than
directors, a number of agents in a corporation play important roles in its governance. (Note that many of
these may also have the office of director, meaning that they hold two ‘offices’ — one as a director and
another as a skilled executive.) These ‘other offices’ include positions that are simply defined as offices
and other positions where responsibilities may have a significant impact on the corporation. Officers under
either approach include:
• CEO
• CFO
• company secretary
• legal counsel
• internal auditor.
Without a highly competent CEO who is committed to good governance, it would be difficult for good
governance practices to be effectively implemented. To enhance governance, some corporations are also
appointing chief operating officers, compliance officers, ethics officers and risk managers. The titles are
often somewhat meaningless on their own — the crucial issue on every occasion is for the board (and each
director) to establish the responsibilities and capabilities of these officers and to ensure that all delegations
to the officers are understood and properly documented.
The board needs to understand and take appropriate responsibility for the formal approval of all significant delegations and their documentation. Correct board policies and knowledge relating to systems and
procedures involving significant delegations is an important foundation of good corporate governance.
DIRECTOR INDEPENDENCE
It is crucial to appreciate the importance of independence in the role of directors. All independent directors
must be non-executive directors, but not all non-executive directors are independent. Sometimes people
confuse these two terms or use them interchangeably, but they are different.
The ASX Corporate Governance Council Recommendations (2019), which are now in their fourth
edition, provide the following commentary on independence and directors.
To describe a director as ‘independent’ carries with it a particular connotation that the director is not aligned
with the interests of management or a substantial holder and can and will bring an independent judgement
to bear on issues before the board.
It is an appellation that gives great comfort to security holders and not one that should be applied lightly.
A director of a listed entity should only be characterised and described as an independent director if he
or she is free of any interest, position or relationship that might influence, or reasonably be perceived to
influence, in a material respect their capacity to bring an independent judgement to bear on issues before
the board and to act in the best interests of the entity as a whole rather than in the interests of an individual
security holder or other party (ASX CGC 2019, p. 13).
The three categories of director are defined in table 3.3
TABLE 3.3
Categories of director
Category
Attributes
Executive directors
Work for the company and are never independent
Non-executive directors
Do not work in the organisation, but are not independent because of a particular
relationship
Independent non-executive
directors
Are free from influences that cause bias and exhibit the characteristics of
independence
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MODULE 3 Governance Concepts 127
The UK Corporate Governance Code (produced by the UK Financial Reporting Council (FRC) and
known as the FRC Code) provides the following items to help guide consideration of whether a director is
independent, by asking if the director:
• is or has been an employee of the company or group within the last five years;
• has, or has had within the last three years, a material business relationship with the company, either
•
•
•
•
•
directly or as a partner, shareholder, director or senior employee of a body that has such a relationship
with the company;
has received or receives additional remuneration from the company apart from a director’s fee,
participates in the company’s share option or a performance-related pay scheme, or is a member of
the company’s pension scheme
has close family ties with any of the company’s advisers, directors or senior employees;
holds cross-directorships or has significant links with other directors through involvement in other
companies or bodies;
represents a significant shareholder; or
has served on the board for more than nine years from the date of their first appointment (FRC 2018,
pp. 6–7).
Even if a director is not independent, it is important to appreciate the concept and to ensure decisions
are made as impartially (i.e. as independently) as possible. This obligation is actually required by law in
most jurisdictions.
The identification of non-executive and independent directors is important. In Australia, for example,
Recommendation 2.3 of the ASX Corporate Governance Council Corporate Governance Principles and
Recommendations (ASX Principles) states that ‘a listed entity should disclose the names of the directors
considered by the board to be independent directors’ (ASX CGC 2019). It also provides a checklist of
factors to consider when assessing a director’s independence. There are similarities between these factors
and those from the FRC Code discussed earlier.
In addition to this, certain committees should only have independent or at least non-executive members
on them, this will be discussed in part D. The ASX Corporate Governance Council recommendations also
deal with the need to periodically review the tenure of directors to ensure that they maintain independence.
The recommendations suggest that the relationships, experience and tenure of directors should be reviewed
periodically to ensure that directors that are classified as being independent are able to continue to be
classified as independent. The commentary on Recommendation 2.3 describes in some detail what the
Corporate Governance Council expects of directors.
QUESTION 3.3
a) Download the two sets of governance guidance from the ASX Corporate Governance Council
and the UK FRC as per the links below.
– www.asx.com.au/documents/regulation/cgc-principles-and-recommendations-fourthedn.pdf
– www.frc.org.uk/getattachment/88bd8c45-50ea-4841-95b0-d2f4f48069a2/2018-UKCorporate-Governance-Code-FINAL.PDF
b) Take notes on similarities and differences between the ASX’s Box 2.3 and Provision 10 of the
UK FRC Code.
c) What does the Corporate Governance Council state that a board should do in relation to directors
whose tenure is more than 10 years?
COMPANY SECRETARIES AND THEIR DUTIES
Company secretaries are individuals who fulfil a critical compliance role. A company secretary has the
responsibility for ensuring a company maintains all its compliance obligations with the corporate regulator.
This will include ensuring required documents are filed on time, fees for registration paid and changes to a
company register are made as required under the Corporations Act. These changes include new directors,
changes to addresses for serving notices as well as changes to shareholdings where relevant. A company
secretary must be at least 18 years of age and reside in Australia. Companies may have more than one
company secretary but at least one of the company secretaries must be resident in Australia.
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128 Ethics and Governance
QUESTION 3.4
The Small Business Guide in the Corporations Act (Volume 1, Chapter 1, Part 1.5, paragraph 5)
describes the responsibilities of a company secretary at the link below. Find the responsibilities as
described in the guide and ensure you note them.
See link at: www.legislation.gov.au/Details/C2019C00216/Html/Volume_1#_Toc13831317
3.3 NATURE OF CORPORATIONS AND DIVISION OF
CORPORATE POWERS
In a corporate structure the shareholders, board of directors, and the CEO share power. The powers of the
board and shareholders are detailed in the Corporations Act and, if it has one, a company’s constitution.
This includes the right of the board to delegate some of their powers to the CEO. The relationship between
these three ‘actors’ is known as an agency relationship. An agency relationship is created when one party
(the agent) assumes or is given responsibility for looking after the rights or interests of another party (the
principal). In a corporate structure, two such agency relationships exist; one between the shareholders (as
principals) and the board (as agents of the shareholders), and another between the board (as principals)
and the CEO (as an agent of the board). This is illustrated in the middle column of figure 3.2, which is
shown later in the module. The roles of each of these three actors and their powers and/or responsibilities
are described below.
SHAREHOLDER POWERS
Shareholders (or members, as they are referred to in the Corporations Act), are also given powers under the
Act. Generally, these powers include the power to appoint, remunerate and remove directors, call meetings,
call for and vote on resolutions, and seek redress from the courts.
Appointment of Directors
The Corporations Act states that directors can be appointed in two ways (ss. 201G, 201H):
• by resolution passed in a general meeting;
• by the directors of a company which is subject to confirmation by:
– a proprietary company via resolution within two months of the appointment; and
– a public company via resolution at the company’s next annual general meeting (AGM).
Once appointed (unless otherwise restricted), they can exercise all the powers conferred upon them by
the Corporations Act.
Remuneration
In public companies, shareholders generally approve the overall upper limit of (or increases to) director
remuneration. For listed companies, members at annual general meetings have the opportunity via
s. 250R(2) to adopt a company’s remuneration report, however, ‘this is advisory only and does not bind
the directors or the company’ (s. 250R (3)). Two successive ‘strikes’ (a ‘no’ vote of 25% or more to the
adoption of the remuneration report) gives members the opportunity to vote on a spill resolution. If the
resolution is passed by at least 50% of votes, all directors are forced to put themselves up for re-election
at a ‘spill meeting’, which must be held within 90 days of the spill resolution being passed (ss. 250U,
250V, 250W).
QUESTION 3.5
Find the sections from the Corporations Act listed in table 3.4 and fill in the other powers reserved
for shareholders.
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MODULE 3 Governance Concepts 129
TABLE 3.4
Shareholder powers
Section
Shareholder power
136
162
173(2)
201P
203D
208
234
246B
249D (1)
249N
251B
314 and 316A
327B and 329
BOARD POWERS
The Corporations Act (s. 198A) states that ‘the business of a company is to be managed by or under the
direction of the directors’. The board of directors (the board) is the body that oversees the activities of
an organisation.
It is preferable that the roles and responsibilities of the board be explicitly set out in a written charter
or constitution. A significant court case in Australia regarding what boards should do has received
international recognition in the Anglo-American corporate world. In AWA Ltd v. Daniels (1992) 10
ACLC 933, Rogers C J concluded that the role of the board in modern companies is to set policy and
organisational objectives (performance) and then ensure adequate controls and review procedures are in
place (conformance) to ensure effective implementation by management (performance).
However, Rogers C J observed that the board is not in place to actually run the business itself. That
part of the governance process is delegated to the CEO, although the board must remain informed and is
responsible for taking timely action where fundamental CEO failures arise. Rogers C J stated:
The board of a large public corporation cannot manage the corporation’s day-to-day business. That function
must by business necessity be left to the corporation’s executives. If the director of a large public corporation
were to be immersed in the details of day-to-day operations, the director would be incapable of taking more
abstract, important decisions at board level (AWA Ltd v. Daniels (1992) 10 ACLC 933, p. 1013).
Therefore, directors are entitled to rely on management to manage the daily operational activities of
the corporation. The board need not be informed of these details and will expect the paid managers to
run the corporation according to strategies and policies set by the board. However, the board cannot leave
everything to the managers, as the board also has an ongoing oversight responsibility.
The board must ensure appropriate procedures are in place for risk management and internal controls,
and it must also ensure that it is informed of anything untoward or inappropriate in the operation of those
procedures. Any major operational issues will also be brought to the attention of the board for appropriate
consideration and decision.
Despite these expectations, in many high-profile corporate collapses, it is apparent that the board was not
informed about key business decisions or simply chose to comply with management. For example, in the
case of a former prominent Australian company, HIH Insurance, it was apparent that the major takeover of
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130 Ethics and Governance
another company, FAI Insurance, was undertaken without rigorous debate at board level or due diligence
being carried out before the transaction was finalised.
The role of the board has become more onerous, making support mechanisms more important. These
include induction for new directors, relevant education and training for all directors and board evaluations.
Furthermore, to enable directors to properly carry out their legal and ethical duties, it is necessary for them
to be provided with expert advice (including legal and financial advice). Such advice should be objective
and as independent as possible. Professional accountants, along with other professional groups and other
experts, are important contributors to meeting these needs of boards.
The board is elected by shareholders and functions as their agent. Boards are expected to act for, on
behalf of or in the best interests of shareholders. Under Anglo–American law (which has been developed in
many Western countries), companies developed with the concept that shareholders are part of the company,
being the owners. Therefore, the primary duty of boards is to shareholders, with the duty to all other
stakeholders deriving from the directors’ duty to ‘act in good faith in the best interests of the company’
(Corporations Act, s. 181). Obviously, it is not possible to make all shareholders happy at all times, but if
the directors genuinely make decisions intended to be good for the general body of shareholders, then this
is satisfactory.
Alternative Board Structures and Relationships
Board structure and stakeholder representation may vary, especially in different countries. For example,
two-tier board structures are commonly required for large companies in some northern European countries.
The top tier comprises the supervisory board and the second tier is the management board, which may
have strong employee representation. In Japan, it is common for banks and finance providers to have
a relationship with boards that is much stronger and more influential than elsewhere. Traditionally this
provided a stable source of investment capital for Japanese companies, though the equity markets are now
growing in influence. As professional accountants, we must recognise and understand these differences.
CEO POWERS
The CEO is responsible for the ongoing operations of the organisation. The CEO is usually a director of
the board as well, and because of this, may also be called the managing director or MD. In this capacity, the
CEO is easily identified as an agent of the board, with carefully defined responsibilities to make a range
of operational decisions as delegated by the board.
The CEO effectively has two roles, board member and CEO, and potentially two identifiable agency
relationships arise — one with shareholders and another with the board. This duality results in a series of
governance rules and laws designed to control problems that can arise.
The CEO, in conjunction with the management team, is responsible for constructing the strategies and
the significant policies of the company. However, this will be the result of boardroom deliberations in
which the CEO, as a director, will participate. When the process is completed to the satisfaction of the
board, the board will formally approve these corporate strategies and policies. The task of implementing
corporate strategies and policies rests with the CEO and the management team.
The CEO must keep the board informed on key issues relating to the management of the company — for
example, through monthly management reports to the board. These reports should include information on
performance and key risks, and also exceptional/significant events (such as the loss of a key customer). The
CEO also works with the board (primarily the chair) and the company secretary to prepare the agenda for
board meetings and to ensure that appropriate background information accompanies the agenda to enable
the board to make the right decisions.
3.4 THEORIES OF CORPORATE GOVERNANCE
There are a number of theories that attempt to explain how the division of power/agency relationship within
the corporate structure will or should operate. A theory provides an understanding of how different people
or groups are likely to behave in the corporate environment. From this understanding, we can then design
governance systems to ensure the best outcomes. For example, if our underlying belief is that people are
selfish or egoists, we need to ensure there are appropriate rules and regulations in place to stop those people
from abusing their position to maximise their own wealth and status.
There are several theories that are presented in relation to the governance of entities and the behaviour
of managers and staff.
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Two of these theories (stewardship theory and agency theory) are examined in some detail in
this module. Three other theories (stakeholder theory, transaction cost theory, and corporate social
responsibility theory (CSR)) are discussed briefly at the end of this part of the module.
STEWARDSHIP THEORY
Stewardship theory suggests that people in power (the agents or stewards) will act for the benefit of those
who have engaged them. Stewardship theory sees appointed directors as ‘stewards’ who carefully look
after the resources they have been trusted with. Rather than directors and managers as agents who act
in their own self-interest, these stewards are expected to naturally act favourably on behalf of the owners
(Donaldson & Davis 1991). Executive self-interest is not expected to interrupt corporate goals and genuine
stakeholder outcomes. In this situation, financial reports provide a formal means for the directors to declare
their stewardship obligations to the owners.
While stewardship theory accepts that directors must also consider the interests of groups other than
shareholders (i.e. stakeholders such as employees, suppliers, customers), the primary duty of directors is
for the interests of shareholders. The boundaries of corporate governance under stewardship theory are
therefore defined by the relationship between directors and shareholders.
The interests of other stakeholders are assumed to be addressed by relevant laws outside the boundaries
of corporate governance, such as consumer protection or competition laws. A strength of stewardship
theory is that it perceives directors as professionals able to demonstrate their commitment to the company
and its shareholders in a virtuous and capable way without constant oversight. One criticism of this theory
is the assumptions that good stewards do exist and that these stewards will maintain their virtues over
extended periods of time.
AGENCY THEORY
Agency theory takes the alternative view and assumes people have a self-interested egoist approach.
Agency theory views corporate governance through the relationship between agents and principals. At
its broadest level, agency consists of giving power to individuals or groups to act on behalf of others.
Agents are permitted to act in place of, and to make decisions for and on behalf of, the principals and to
comply with the terms of the agency and the rules applying to them.
While agents are expected to act on behalf of the principal, agency theory differs from stewardship theory
because it suggests the agent may not naturally act in the best interests of the principal. The underlying
assumption of agency theory is that all parties are rational utility maximisers, which means agents may
pursue different goals from those of the principals. Therefore, potential for conflict arises and mechanisms
such as corporate governance must be in place to ensure the agent acts appropriately.
Agents must therefore be aware of the concepts and principles of good governance, and to comply with
the terms of the agency and the rules applying to them. Jensen and Meckling define agency and comment
on its central problem.
We define an agency relationship as a contract under which one or more persons (the principal(s)) engage
another person (the agent) to perform some service on their behalf, which involves delegating some decision
making authority to the agent. If both parties to the relationship are utility maximizers, there is good reason
to believe that the agent will not always act in the best interests of the principal (Jensen & Meckling 1976,
p. 308).
Two key assumptions underlie agency theory.
1. All individuals will act in their own self-interest. Therefore, where a potential conflict of interest exists
between principals and agents, agents will tend to act first in ways that will maximise their own personal
circumstances.
2. Agents are in a position of power as they have better access to, and control of, information (information
asymmetry) and the ability to make decisions. This allows them to further their own interests.
The key question to be resolved in any agency is: How do you align the interests of the principals and
agents, thereby modifying any self-serving and ill-informed behaviour of the agents in order to minimise
agency costs? Interest alignment, also called ‘goal congruence’, is a critically important aspect of good
governance. The costs of not achieving interest alignment can sometimes be catastrophic.
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132 Ethics and Governance
Specific examples of governance that address this issue that are discussed in this module include a
remuneration committee that sets management performance targets and rewards, and an audit committee
that focuses on ensuring financial information and internal controls are in order.
Most of the discussion in this module is directed at large corporations whose shares are sold on public
stock exchanges. The shareholders or owners are the principals and the managers of the corporation are
the agents. The concept of agency is particularly pertinent here due to the usually wide separation between
the owners and the board and other management. Nevertheless, the concept of agency is common in all
entities; small or large, public or private.
AGENCY ISSUES AND COSTS
Many corporate governance rules, regulations and principles are based on agency theory. For example,
directors have legal duties with which they must comply, such as a duty to act in the best interests of a
corporation. We therefore need to explore the agency issues and costs that arise when an agent acts in
a self-interested manner. This will help with understanding the intent of the rules, codes, principles and
guidance that we discuss later in this module.
Within corporations, shareholders are the principals and boards are their agents. Similarly another
principal or agent relationship arises when the board engages the CEO and other senior managers, and
delegates specific management powers. In this case, the board is the principal, and the CEO and managers
are the agents.
It is common practice for boards to delegate day-to-day operational powers to the CEO, but not extensive,
strategic decision-making powers. Boards need to carefully consider all delegations. Sir Adrian Cadbury
(CFACG 1992) has stated that there must be a ‘series of checks and balances’, and the freedom to delegate
broadly is implicitly limited by the system of checks and balances. A director cannot delegate and then
deny all responsibility. In module 1, we observed the importance of ‘professional judgment’. It is clear
that boards must understand good judgment, exercise sound judgment and act accordingly.
QUESTION 3.6
What is one major issue that arises from an agency relationship, where powers of control
are delegated?
Agency theory identifies three types of agency costs: monitoring costs, bonding costs and costs relating
to residual loss. These costs can arise as a result of:
• information asymmetry (where the agent has more information than the principal)
• poor communication
• poor understanding
• innocent and unintended self-interested behaviour by agents
• deliberate legal self-interested behaviour
• illegal self-interested behaviour by agents (e.g. fraud).
Monitoring Costs
Monitoring costs are incurred by principals because an agency relationship exists. Some monitoring costs
are compulsory, such as costs relating to annual reporting and external auditing. Other monitoring costs
are discretionary, such as the work required to construct and analyse activities according to a strategic or
balanced scorecard.
Bonding Costs
Bonding costs are costs incurred by the agent to demonstrate to the principal that they are goal
congruent. This may include voluntary restrictions on the agent’s behaviour or benefits to demonstrate
goal congruence, and are part of the explanation for the development of executive stock options and other
benefits that have significantly increased executive rewards in recent decades. An example of bonding
costs is provided later in example 3.5.
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Residual Loss
Residual loss is a cost incurred by the principal. Residual loss arises because, no matter how good the
monitoring and bonding efforts, the agent will inevitably make decisions that are not consistent with the
principal’s interests. Any loss, cost or underperformance arising from these decisions or actions by the
agent represents a residual loss of value to the principals. Some examples of residual loss are described next.
Excessive Non-financial Benefits
The over-consumption of perquisites (perks) relates to obtaining an excessive level of incidental benefits
in addition to income. Many directors and managers highly value these often prestigious benefits. In
contemporary business, this may include a company car, club membership, low-interest loans, prestigious
offices and furnishings. Such perks, paid for by the corporation, reduce both profitability and cash flow
available for distribution to shareholders.
Empire Building
Empire building refers to acts by management to increase their power and influence in a company for
reasons associated with personal satisfaction. Such personal aggrandisement or excess may have little or
no congruence with company profitability or success.
An example would be the recommendation to the board by a CEO that it should purchase a subsidiary.
Having a desire for growth, as is common in many corporations, the board may agree to the acquisition
without sufficient consideration. In fact, the board may not know that the real motivation driving the CEO
was the opportunity to enhance their own power and authority, and the prospect of additional financial
rewards in relation to additional responsibilities. Importantly, increased shareholder value was not a
key goal.
Risk Avoidance
Depending on how managers are remunerated, there may be little incentive for them to engage in risky
investments. The higher returns associated with risk might be actively sought by some shareholders who
have the ability to diversify their own risk through their portfolio of investments.
If managers are remunerated with fixed salary packages and do not participate in the higher returns, the
only rational approach for them is to minimise the downside risk (losses) that may affect their continued
employment. The organisation may therefore underachieve, with higher returns forgone, representing a
loss of value to the shareholders.
While risk avoidance can be a result of a lazy, self-seeking agent (the board or manager, depending on
the agency under consideration), it is a requirement that principals must properly instruct agents so that
the risk appetite of the corporation is structured according to the wishes of the owners. Agency is highly
dependent on communication, and failed communication may damage agency as much as, or more than,
self-seeking agents.
Differing Time Horizons
Managers often only have an interest in the firm for the duration of their employment. If managers are
to be rewarded on current-year profits alone, then those managers may only consider the current year as
being the relevant time frame. If managers anticipate leaving the firm or are approaching retirement, they
may seek to maximise gains based on those time frames.
The time frame is an important consideration when designing remuneration schemes. A well designed
scheme will provide management performance rewards that correlate the timing of management performance with the timing of shareholder performance expectations.
Example 3.5 provides an example of all three types of agency cost. Many costs may be conceptual rather
than dollar costs, and this is especially so for bonding costs.
EXAMPLE 3.5
Agency costs
Robert was the CEO of a large listed corporation. He had been in the position for many years. During his
tenure, a branch had opened near a popular seaside resort in Thailand. It was not profitable, but Robert
argued it was important and visited it several times each year. He would commonly take a holiday at the
same time at a nearby resort. The corporation would pay his hotel bills and travel costs.
Robert later retired and his position was advertised. Susan was interviewed by the board for the
position. Susan had sought extensive information about the corporation and had learned about Robert’s
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134 Ethics and Governance
regular travel and holidays. At the interview, without inappropriately referring to Robert, Susan advised the
board that:
• she would only travel with permission from the corporation chair
• if urgent travel was required without permission from the chair, she would provide a written report to
the board following the travel
• if the report was not accepted immediately, she would pay the travel costs personally without further
request to the corporation
• she would undertake a review of the efficiency of all overseas branches with a view to closing those
that were not profitable.
In example 3.5, Robert’s expenses are an example of residual loss. Susan’s behaviour demonstrates
voluntary restrictions accepted by Susan in order to show that she is bonded to the corporation. Restrictions
on freedoms are bonding costs borne by agents. In example 3.5, Susan will also bear a dollar cost if the
board does not approve the travel. Her willingness to undertake the overseas branch review is possibly
another bonding cost. Also, note that Susan has suggested extra duties to the chair. If performed, these
extra duties are a monitoring activity, the cost of which is borne by the principal.
Aside from self-interest, ineffective communication between principal and agent will result in residual
loss, as agents will not know or understand the principal’s goals — meaning that good goal congruence
will be highly unlikely.
When we consider remuneration issues, we might find that an agent who is highly bonded should be
remunerated more abundantly. The diminished residual loss and the reduced need to monitor a highly
bonded agent would seem to imply that the extra value available to the principal might, at least in part, be
made available as an extra reward to the good agent.
QUESTION 3.7
Describe key aspects of the principal and agent problems that exist within corporations and that
can result in loss of value for the shareholders.
OTHER GOVERNANCE THEORIES
There are some other theories relating to the behaviour of individuals, managers and others within or
engaging with entities. Some of the relevant theories including stakeholder theory, transaction cost theory,
and corporate social responsibility (CSR) theory are examined below.
Stakeholder Theory
This theory focuses on how managers in an entity, irrespective of its type, seek to manage their relationships
with all of their internal and external stakeholders. Internal stakeholders include the owners of an entity,
which can vary depending on entity structure or sector in which the entity operates, employees and
management. Each internal stakeholder group will require different responses from the entity in order
to fulfil their demands. It should be noted that shareholders may, at times, be seen as external stakeholders
even though they are owners of part of an entity.
External stakeholders are much broader. External stakeholders include customers, suppliers, creditors,
regulators and government. Each of these stakeholders has to be managed and satisfied in different ways.
It is worth noting that each stakeholder group does not have a relationship with the entity in a vacuum.
There may be competing interests that the entity must satisfy at the same time.
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CONSIDER THIS
What tensions do you believe exist when an entity in the financial services sector considers its obligations to
shareholders and also customers?
Transaction Cost Theory
Transaction cost theory, which is sometimes referred to as transaction cost economics, deals with the notion
of why firms or entities exist in markets and what the boundaries are within a marketplace. The theory has
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also been used to explain that behaviour of firms or entities and how they are managed. One theorist in
particular, Oliver E Williamson, focuses on the aspects of opportunism related to the behaviour of firms
or entities in a marketplace. He notes that internal governance within organisations may promote or create
a situation where individuals become opportunistic and seek to fulfil their own self-interest in ways that
may not be beneficial to the firm or entity as a whole. Williamson notes that entities need to have sanctions
as well as benefits in place for people who are in a position where they are exercising opportunism. A
recent example of this kind of phenomenon was the conduct of agents selling financial products on behalf
of banks, mortgage brokers or financial planning firms as revealed in the Royal Commission into abuses
into the financial services sector.
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CONSIDER THIS
What is the role of opportunism in a corporate context? In what contexts do you believe opportunism might
be harmful?
CSR Theory
CSR theory deals with the concept that an entity and those employed by it should engage in activities and
promote causes and initiatives that are seen as providing a social benefit to the community. It is said that
the individuals working within the entity are then engaged, not just on the work they do within the entity,
but also with the broader community. It is also a way in which an entity emphasises its support of various
community-based causes.
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CONSIDER THIS
Identify an entity and a charitable or social cause it has supported. What are the possible advantages or disadvantages
to the entity?
SUMMARY
Corporate law encompasses the body of law that regulates the operation of companies. In Australia, the
Corporations Act provides the framework of regulation for companies.
Corporate law defines company directors’ duties and sets out the rights of shareholders. Essential characteristics of corporate law include the consideration of the corporation as having the legal capacity and
powers of both an individual and a body corporate. This enables the corporation to act as an autonomous
entity. Limited liability means the shareholders’ liability is limited to the value of their shares in the
corporation, and direction of the company is delegated to a board of directors. Within the different types
of corporate structure permitted by corporate law, there is the freedom of directors to govern by pursuing
the best interests of the corporation. A range of duties are imposed on directors and other officers to act
on behalf of the company to ensure their duties are carried out in accordance with the best interests of the
company. The Corporations Act also includes two protective provisions for directors (business judgment,
safe harbour).
Shareholders are unable to directly intervene in management decisions, but have power to appoint and
remove directors and determine their remuneration.
A range of theories offer different perspectives on corporate behaviour. A common theme among these
theories is a focus on the interaction of different actors in a corporation and the importance of different
groups in the chain of decision making. These theories are a useful way of reflecting on a company’s
obligations to various groups and individuals and hence can be used as problem-solving tools in business.
They should not be thought of as only academic undertakings.
The key points covered in this part, and the learning objective they align to, are listed below.
KEY POINTS
3.3 Describe the nature of corporations and the division of corporate powers.
• Corporations are artificial persons that have most of the rights and obligations of real people.
• Companies are a separate legal entity from their owners.
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136 Ethics and Governance
• Most companies have limited liability, meaning their owners cannot be held responsible for the
company’s debts.
• There is a perpetuality of life in the case of companies.
• There are proprietary (or private) companies and public companies.
• Public companies may be unlisted or listed.
• Public companies are commonly limited by shares or limited by guarantee and there is also a category
of no liability company.
• Companies have directors who are responsible for the oversight of the business.
• Shareholders have a range of powers to appoint the board and vote on a range of motions at annual
general meetings, but can not directly intervene in management.
• Boards have specific powers under law.
3.4 Discuss agency theory and how it is used to understand corporate behaviour.
• Agency theory views corporate governance through the relationship between principals (generally
the shareholders) and agents (those that the shareholders appoint to act on their behalf).
• Agency consists of giving power to individuals or groups to act on behalf of others. Agents are
permitted to act in place of, and to make decisions for and on behalf of, the principals and to comply
with the terms of the agency and the rules applying to them.
• While agents are expected to act on behalf of the principal, agency theory suggests the agent may
not naturally act in the best interests of the principal. The underlying assumption of agency theory is
that all parties are rational utility maximisers, which means agents may pursue different goals from
those of the principals.
• Therefore, potential for conflict arises and mechanisms such as corporate governance must be in
place to ensure the agent acts appropriately. This is why auditors, for example, are engaged to
ensure that managers are presenting information that is truthful and fair when financial statements
are finalised.
• The costs of an agency relationship include monitoring, bonding and residual loss.
3.5 Discuss the key features of corporate structure.
• In a corporate structure the shareholders, board of directors and the CEO share power.
• The powers of the board and shareholders are detailed in the Corporations Act and a company’s
constitution.
• These powers include the right of the board to delegate some of their powers to the CEO.
• The relationships between shareholders and the board, and between the board and the CEO, are
known as agency relationships.
• In a corporate structure, two agency relationships exist: one between the shareholders (as principals)
and the board (as agents of the shareholders) and another between the board (as principals) and the
CEO (as an agent of the board).
3.6 Examine the characteristics and duties of directors and other officers.
• Directors need to ensure that they:
– avoid conflicts of interest and where these exist, ensure they are appropriately declared and, as
required by law, otherwise managed correctly
– act in good faith in the best interests of the corporation
– exercise powers for proper purposes
– retain discretionary powers and avoid delegating the director’s responsibility
– act with care and diligence
– remain informed about the corporation’s operations
– prevent insolvent trading
– do not use their position as a director or the information they gain in that capacity for improper
purposes.
• Company secretaries handle the compliance work for a company and this includes lodging regulatory
paperwork.
• Two protections are available for directors: safe harbour in relation to the duty to prevent insolvent
trading and business judgment in relation to the duty to act with care and diligence.
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PART B: CORPORATE GOVERNANCE
INTRODUCTION
The governance of enterprises has become a key concern in recent decades. Governance is the system
by which companies are directed and controlled, and accountability and transparency are assured.
While the concept is usually associated with corporate governance, that is the governance of large
listed corporations, similar governance principles should apply to all enterprises. Governance relates to
the responsibilities of the board of directors towards investors and other stakeholders, and involves setting
the objectives and direction of the company. Governance is distinct from management of the enterprise on
a daily basis, which is the job of full-time executives.
The governance of enterprises is broadly structured by the law, not just corporate law (or trust or other
relevant law) but also employment law, environmental law and so forth. It is the first duty of directors
to ensure that the enterprise operates within the law. However, beyond requiring a board of directors to
exercise certain duties such as the duty of care and diligence, corporations law gives considerable scope for
directors to make decisions in the best interests of the company. It is here where the skills of governance
become critical. Most important is the capacity to understand and interpret the strengths and weaknesses of
the enterprise, and how to direct the enterprise towards business success while maintaining accountability
and good relationships with all stakeholders. Good governance is a hallmark of enterprises that achieve
improving and sustainable performance even in changing and unpredictable environments.
The first section of this part of the module explains the need for good governance in some detail.
The need for governance arises when an individual, group or entity has responsibility to look after
the rights or interests of other individuals, groups or entities. As stated in part A those assuming such
responsibilities are called agents and those whose rights or interests are being looked after are the
principals. In an agency relationship, principals are represented by agents, and the principals give or
delegate to their agents the freedom or authority to make decisions on their behalf. Shareholders entrust
company directors to pursue the success of the company, citizens elect representatives to pursue their
democratic interests in government and, in voluntary associations, members elect a board to represent
their interests. To ensure this role is performed in a systematic way, we use a framework of corporate
governance, defined as follows.
Corporate governance is the system by which business corporations are directed and controlled (CFACG
1992, para. 2.5).
The second section of this part of the module examines the key elements of a corporate governance
framework, but we will briefly explain the basic principles here. ‘Direction’ refers to steering the
organisation towards its performance goals. ‘Control’ relates, at least in part, to ensuring compliance
with rules. We use the word ‘corporate’ to indicate that we are focusing on the governance of corporate
or business organisations. This may be a formal corporate structure (e.g. company) or a non-corporate
entity such as an NFP organisation (e.g. charity or government entity) or an incorporated association
(e.g. sporting club). Note that the term ‘corporate governance’ is, in practice, also used by non-corporate
entities. The important thing to grasp is that all entities acting on behalf of the rights or interests of others
need to respect basic principles of governance if they are to act with integrity, authority and accountability.
It is important not to focus solely on the compliance and regulatory aspects of governance, which must
always be balanced with a focus on pursuing an effective strategy and successfully achieving organisational
goals and objectives. As such, corporate governance extends to both conformance with all the necessary
rules for the proper conduct of the organisation, including compliance with external regulations and internal
organisational policies, and performance, with a focus on economic success. If an organisation is a not-forprofit entity, then its performance will relate to the economy, efficiency and effectiveness of its activities.
A large amount of discussion and effort in the governance area has focused on compliance rather than
performance. As a result, some people have argued that the term ‘corporate governance’ is limited and
solely focused on compliance, and that a different name, ‘enterprise governance’, is needed to describe
the broader focus on both conformance and performance. In this subject we take the perspective that this
is not necessary, and corporate governance is a broad enough term to capture both approaches.
Organisations need to demonstrate compliance and accountability to offer assurance to investors and
other stakeholders, and they need strategies to achieve higher performance if they are to offer the returns
and benefits that investors and stakeholders expect. Indeed, it is when accountability and strategy are well
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integrated that organisations perform most effectively. In the public and NFP sectors, similar standards of
accountability and performance are required even though the mission is to provide high quality public and
social services, and while there may not be shareholders to satisfy, there are many stakeholders who must
be considered.
We can therefore state the following important relationship.
Governance = conformance + performance
A more detailed explanation of corporate governance is provided by the Organisation for Economic
Co-operation and Development (OECD, p. 9).
Corporate governance involves a set of relationships between a company’s management, its board, its
shareholders and other stakeholders. Corporate governance also provides the structure through which the
objectives of the company are set, and the means of attaining those objectives and monitoring performance
are determined (OECD 2015).
The Ethics and Governance subject emphasises the conformance aspect of governance. Both performance and conformance are equally important, and performance aspects are covered in other subjects
of the CPA Program. However, it is important to appreciate the close relationship between strategy
and accountability: strategy without accountability may lead to recklessness, and accountability without
strategy may lead to paralysis (Clarke 2016).
3.5 IMPORTANCE OF GOVERNANCE
Good governance aims to ensure that organisations are properly run in the best interests of their
stakeholders, including the optimal performance of national and international economies. The ASX has
acknowledged in the fourth edition of the principles issued by its Corporate Governance Council that good
corporate governance promotes investor confidence ‘which is crucial to the ability of entities listed on the
ASIC to compete for capital’. The same point is made by the deputy secretary general of the OECD.
Rintaro Tamaki. Mr Tamaki told an audience in Milan, Italy, in December 2015 that corporate governance
did not exist in a vacuum and that it contributed to the financial wellbeing of all stakeholders.
[Corporate Governance] is a means to create market confidence and business integrity, which in turn
is essential for companies that need access to equity capital for long term investment. Under current
circumstances, it is particularly important to ensure access to equity capital for future oriented growth
companies to support investment as a powerful driver of growth and to balance any increase in leveraging.
For capital markets, it is a means to create the best possible conditions to allocate capital to its most effective
use. It is also about inclusiveness. Today, millions of households around the world have their savings in the
stock market, directly or indirectly (Tamaki 2015).
Mr Tamaki’s speech was delivered in the year that the OECD published an updated version of its
corporate governance guidelines. The preface to the OECD’s guidelines acknowledges that:
international flows of capital enable companies to access financing from a much larger pool of investors
… If companies and countries are to reap the full benefits of the global capital market, and if they are to
attract long-term ‘patient’ capital, corporate governance arrangements must be credible, well understood
across borders and adhere to internationally accepted principles (OECD 2015).
.......................................................................................................................................................................................
CONSIDER THIS
Identify areas in the accounting discipline where authoritative guidance emanates from a global organisation. What
are your views on global consistency in guidance? Under what circumstances could divergence from global guidance
be appropriate?
At an organisational level, the behavioural styles and business management practices of managers (and
other employees) or directors can result in outcomes that are not in the best interests of shareholders
and other stakeholders. These situations can range from relatively minor technical breaches of policies or
practices, to more serious cases where excessive risk taking or poor controls place the ongoing survival of
the organisation at risk.
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In extreme cases, public organisations may be run more as personal fiefdoms where personal greed is
put ahead of the interests of shareholders and other stakeholders. To reduce undesirable consequences
for shareholders and other stakeholders and to ensure personal accountability, organisations need an
appropriate system of checks and balances in the form of a corporate governance framework. This
framework emphasises both conformance and performance as vital elements of the way that companies
are run.
An organisation with good governance can instil confidence in its shareholders and other stakeholders.
For example, transparent disclosure policies are crucial for ensuring shareholders and lenders continue to
supply the finance required by organisations. The performance of individual organisations also contributes
to the enhanced performance of national economies, not just through their individual contributions, but also
through their role in fostering positive relationships with other organisations in the economy. Corporate
governance is also one of the criteria that foreign investors increasingly rely on when deciding in which
companies to invest.
It should be noted that while good governance can bring benefits to companies, it can also temper
growth. For example, strict governance policies and practices can lengthen the time to undertake mergers
and acquisitions due to the requirement to follow extensive due-diligence procedures. However, growth is
more valuable when it is durable through being built on solid foundations, rather than hastily pursued as
opportunities arise.
The ability of management to make quick decisions may be constrained by the need to observe proper
governance policies and practices. These risk-mitigation requirements contained within complianceoriented rules need to be understood. As was seen in the GFC, excessive risk-taking and ‘management
enthusiasm’ (often based on personal motivations) can result in devastating consequences for shareholders
and other stakeholders. In many ways, good governance is a balancing act between the two extremes of
unfettered excessive risk taking and overly restrictive decision making.
GOVERNANCE AND PERFORMANCE
With the emphasis on accountability embedded in popular definitions of governance, it is often forgotten
that good governance is also the route to enhanced performance. Governance allocates clear roles to the
board and to management, and a well-constituted and high-performance-oriented board can motivate and
encourage management to achieve greater corporate performance.
As Robert Tricker (1984) highlights, the management role is to run the business efficiently and
effectively, while the governance role is to give strategic direction to the enterprise, as well as ensuring
accountability. ‘If management is about running the business; governance is about seeing that it is run
properly’ (Tricker 1984, p. 7). This is a very critical distinction in governance. If the board is performing
its role effectively, it will ensure that management is held to account. However, this does not mean that
the board intervenes in the management of the enterprise. The board must work with and through the chief
executive officer (CEO) and other executive directors and senior executives of the company. It is the senior
executives’ role to run the company, but within the policy and strategic parameters that have been set by
the board.
The multi-faceted elements of governance are clearly revealed in Tricker’s (2015) framework for
analysing board activities (figure 3.3). The framework illustrates the accountability activities of the board:
monitoring and supervising management by reviewing business results and budgetary controls. Externally,
the board provides accountability through reporting to shareholders and ensuring regulatory compliance.
The board also has a role in performance through policy making and approving budgets. By creating a
corporate culture, a framework for performance improvement is put in place, which is focused through
strategic analysis and reviewing competitiveness.
ACCOUNTANTS AND EFFECTIVE GOVERNANCE
Accounting, as part of the overall governance process, involves improving decision making and achieving
goals and objectives while maintaining and strengthening controls. One risk is that accountants spend too
much time on conformance and compliance-based work, and too little on enhancing business performance.
It is important that, as accountants, our focus combines both value creation and value protection.
The International Federation of Accountants (IFAC) recognises that performance as part of governance
is specifically related to value creation and resource allocation. The skills, knowledge and judgment of
accountants in this area of decision making will be crucial and the role of professional judgment is
fundamental to achieving performance success. ‘The focus is on helping the board to: make strategic
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140 Ethics and Governance
decisions; understand its appetite for risk and its key drivers of performance, and; identify its key points
of decision-making’ (IFAC 2004 p. 4).
3.6 CORPORATE GOVERNANCE FRAMEWORK
This section provides an overview of the key components of governance that commonly exist in large listed
corporations and, to a lesser extent, smaller corporations. As previously noted, the professional accountant
plays an important role in corporate governance and, combined with the ethical duties expected of them,
accountants can add significantly to the success of corporations.
Obviously, there will be differing governance approaches across organisations, with the actual components also varying from one organisation to another. Appreciating the following most basic component
parts of governance is a first step on the path to full understanding.
Figure 3.2 offers a process view of the components of governance, with the external framework of
governance established through the legal and regulatory activity of governments, the requirements of
investors, and the standards set by industry and professional bodies. The internal governance of the
company is established by the board, who are appointed by the shareholders, and who in turn appoint
the chief executive officer. Finally, the external auditor assures the financial reporting of the company
(Kiel et al. 2012).
FIGURE 3.2
Corporate governance framework
External Governance
Internal Governance
OWNERS/MEMBERS
Governments — set the
legal and regulatory
environment
Confirm
appointment
Reporting and Appointment
accountability and review
Stakeholders — may set
specific requirements,
e.g. owners
Audit
Set the
frameworks
BOARDS
Reporting and Appointment
accountability and review
Industry/professional
bodies
Accounding standards,
industry standards etc.
Reporting and
accountability
Recommend
appointment
Reporting and
accountability
External
Auditor
Review and
recommend
MANAGEMENT,
LED BY A CEO
Source: Kiel, G et al. 2012, Directors at Work, Thomson Reuters, Sydney. Reproduced with permission.
.......................................................................................................................................................................................
CONSIDER THIS
From figure 3.2 identify the components of the framework that have been covered in this module so far.
Although shareholders and boards have been examined in terms of their relative powers, this section
examines them in more detail followed by the other components of the corporate governance framework.
SHAREHOLDERS
Shareholders are the persons or entities who own a company and have an important part to play in corporate
governance. Shareholders elect directors to operate the business on their behalf and, therefore, should hold
them accountable for its success or failure. One needs to recognise that shareholders have delegated much
authority to the directors. This is the classic principal/agent relationship.
There are different kinds of shareholders that are involved in dealing with companies. These shareholders
are typically defined as:
• individual shareholders, or
• institutional shareholders.
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These types are discussed in more detail below but it should be noted that all shareholders do not have
the same need or opportunity to participate in the governance of the company. In fact, as the company is
a separate legal entity, the powers of shareholders are often clearly defined in law and limited to certain
decisions including, as detailed previously:
• changes in a company’s constitution
• the appointment and removal of directors and auditors
• the approval of directors’ remuneration.
The issues that concern each group of shareholders will vary and depend, for example, on the number
of shares they hold, the length of time their shares will be held, and the level of interest demonstrated by
the shareholders. Despite varying levels of need and opportunity, shareholders in general do have similar
rights and obligations.
Shareholders who hold a significant stake in a company are often able to use their voting power to gain
places for themselves or their nominees on the board. In principle, these nominee directors are supposed to
act in the interests of the company, not the interests of the major shareholders. However, in practice, there is
a risk of decisions being made that favour major shareholders at the expense of the minority shareholders.
If any shareholder has a controlling shareholding, then it may be possible for them to use their voting power
to create a board that is unbalanced. Boards should be balanced and demonstrate substantial independence
in their composition.
Individual Shareholders
The increase in the number of individuals holding shares is having far-reaching effects on companies.
A substantial number of these shareholders may be retired and have time to devote to the task of keeping
themselves informed. This has been facilitated by greater access to technology such as the internet.
In addition, there are organisations that represent the collective interests of smaller shareholders, such
as the Australian Shareholders’ Association (ASA), which has been active in striving for improvements in
the corporate governance of Australian companies (see example 3.6).
Individual shareholders want companies to be run efficiently and profitably, and for the companies to be
adequately supervised by the board. They also want honesty from directors and managers. To achieve these
objectives, shareholders are prepared to be more vocal. The media and the internet have provided vehicles
for shareholders to more publicly express their concerns regarding poor corporate governance practices.
EXAMPLE 3.6
Institutional Shareholder Power
ASA to Vote Against the AMP Remuneration Report
ASA will vote against the remuneration report of AMP at its upcoming AGM on Thursday 2 May 2019, but
will vote for the election of David Murray AO as a director.
Last year ASA voted against AMP’s remuneration report, which received a first strike of 62%. While
the Board of AMP slashed bonuses in 2018 and is adopting a new remuneration model in line with ASA’s
guidelines, it has not been finalised. There is therefore insufficient detail about the 2019 KPIs, targets or
vesting to deliver confidence to shareholders. This is compounded by an excessive sign-on benefit for
the new CEO, with the sole vesting condition being continuous employment.
ASA remains concerned about governance and culture at AMP, as the incentives revealed to date are
weighted in favour of driving the share price up. The failure to seek shareholder approval of the sale of the
life business also provided little comfort.
However, ASA will vote in favour of Mr Murray’s election and appointment as Chairman. His considerable
regulatory and banking experience will be required in light of the magnitude of the task ahead for the
AMP Board. His appointment has no doubt helped attract the experienced non-executive directors the
company needs. The changes to Board structure and remuneration also reflect his involvement and
commitment to change for the organisation.
Source: Australian Shareholders’ Association 2019, ‘ASA to vote against the AMP Remuneration Report’, accessed
October 2019, www.australianshareholders.com.au/common/Uploaded%20files/MEDIA%20RELEASES/MR_20190424_
ASA_votes_against_AMP_rem_report.pdf.
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142 Ethics and Governance
Institutional Shareholders
The terms ‘institutional shareholders’ or ‘institutional investors’ include insurance companies, superannuation funds, investment trusts and professional investment fund managers. This class of shareholder is
becoming more important in corporate governance, due to the substantial retirement savings they manage,
of which a significant proportion is invested in shares.
Because of the size of their shareholding and the nature of their business, institutional investors can be
seen to have a greater responsibility and ability to hold management to account. In many cases they have
in-house analysts who monitor the companies that they invest in. In other cases, they use the services of
proxy advisors. Increasingly the ‘clients’ of institutional investors are looking for more transparency and
accountability. In response, institutional investors and proxy advisors are publishing or becoming signatory
to stewardship guidelines or publishing voting guidelines.
.......................................................................................................................................................................................
CONSIDER THIS
Most Australians have superannuation funds which in the main are managed by large superannuation funds.
a) A superannuation fund is reacting to calls for it to be more accountable and transparent in its stewardship by
looking to become a signatory to a stewardship code. Which of the following codes would you want your fund
to use?
– Australian Asset Owner Stewardship Code, www.acsi.org.au/images/stories/ACSIDocuments/Stewardship_
code/AAOSC_-_Final.pdf
– ICGN Global Stewardship Principles, http://icgn.flpbks.com/icgn-global-stewardship-principles/#p=1
b) The superannuation fund that manages your superannuation funds does have its own in-house analysts but
sometimes also relies on proxy advisors to provide information to determine how they will vote. If you had to
choose a proxy advisor for the fund which one of these three would you choose?
– Glass Lewis Guidelines, www.glasslewis.com/wp-content/uploads/2018/09/2018_19_AUSTRALIA_
GUIDELINES.pdf
– Ownership Matters Voting Guidelines, www.ownershipmatters.com.au/voting-guidelines (an email address
needs to be submitted to access the document)
– ISS Australia Proxy Voting Guidelines, www.issgovernance.com/file/policy/active/asiapacific/Australia-VotingGuidelines.pdf
Information Asymmetry
Investor knowledge comes from individual research, shareholder activists and proxy advisers. Access to
knowledge may be limited to information which the company publishes or information which shareholders
or their representatives can encourage companies to share. In a perfect world, everyone would have
equal access to all information. However, there is often significant information asymmetry within the
company structure.
QUESTION 3.8
(a) Define the terms ‘information asymmetry’ and ‘moral hazard’.
(b) Explain how the terms are related and their consequences.
A recent example of information asymmetry that may have led to a moral hazard can be seen in the 2019
Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry. An
excerpt from interim report is provided in example 3.7.
EXAMPLE 3.7
Information Asymmetry and Moral Hazard
3.1 Flex Commissions
I discussed the use of flex commissions in the Interim Report. As I recorded there, under that kind of
arrangement, the lender fixed a base rate of interest that would be charged under the loan agreement. If
the dealer could persuade the borrower to agree to pay a higher rate the dealer received a large part of
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MODULE 3 Governance Concepts 143
the interest payable over and above the base rate. In more recent times, lenders provided that the agreed
rate must not exceed a rate fixed by the lender but, below that cap, the dealer was free to offer a loan on
behalf of the lender at a rate greater than the base rate fixed by the lender.
Many borrowers knew nothing of these arrangements. Lenders did not publicise them and dealers did
not reveal them. The dealer’s interest in securing the highest rate possible is obvious. It was the consumer
who bore the cost. To the borrower, the dealer might have appeared to be acting for the borrower by
submitting a loan proposal on behalf of the borrower. The borrower was given no indication that in fact
the dealer was looking after its own interests rather than acting as a mere conduit between lender and
borrower. For all the borrower knew, the interest rate the dealer quoted had been fixed by the lender. But,
whenever the dealer quoted a rate larger than the base rate, the dealer was acting in its own interests.
Since 1 November 2018, flex commissions have been banned. But, because at least one large lender,
Westpac, was continuing to offer flex commission arrangements to car dealers when the Commission
looked at these matters in March 2018. There were many car loan contracts where the interest rate being
charged was above whatever rate the lender fixed at the time as its base rate.
Until 1 November 2018, the conduct was not unlawful. It was conduct that Westpac accepted could
create unfairness in individual transactions. But despite recognising this, Westpac considered that it could
not stop the practice because doing that ‘would simply leave the market to others who did not’.
Flex commissions stand as one of the starker examples of changes to practices in the financial services
industry – even changes seen by important industry participants as desired and desirable – foundering
on the rock of first-mover disadvantage. There are times, and this was one, where regulatory intervention
was necessary to achieve change.
Source: Australian Government 2019, ‘Royal Commission into Misconduct in the Banking, Superannuation and Financial
Services Industry. Final Report’, accessed October 2019, www.royalcommission.gov.au/sites/default/files/2019-02/fsrcvolume-1-final-report.pdf, pp. 85–86.
THE BOARD
Boards and directors are the most significant components of corporate governance. It is essential to develop
a clear understanding of what a director is and what a board of directors is. The following description of a
company and the directors is useful in considering the role that directors play in an organisation.
A company may in many ways be likened to a human being. It has a brain and a nerve centre which controls
what it does. It also has hands which hold the tools and acts in accordance with directions from the centre.
Some of the people in the company are mere servants … who are nothing more than hands to do the work
and cannot be said to represent the mind or will. Others are directors and managers who represent the
directing mind and will of the company, and control what it does. The state of mind of these people is the
state of mind of the company and is treated by the law as such (L J HL Bolton Engineering Co. Ltd v. TJ
Graham & Sons Ltd [1957] 1 QB 159 at 179).
In this section we provide a considerable discussion about various aspects of this area, including the
main functions of the board of directors (see figure 3.3 and table 3.5) and various board committees.
.......................................................................................................................................................................................
CONSIDER THIS
As an exercise to assess your own financial reporting knowledge in preparation for advising a board or becoming a
board member, access and complete the ASIC quiz at https://asic.gov.au/regulatory-resources/financial-reportingand-audit/directors-and-financial-reporting/financial-reporting-quiz-for-directors.
Boards of directors are composed of a chair, executive directors (usually including the CEO) and nonexecutive directors, some or all of whom may be independent.
Board Chair
Each board must have a chair. The role of the chair is to lead the board of directors, including determining
the board’s agenda, obtaining contributions from other board members as part of the board’s deliberations,
and monitoring and assessing the performance of the directors. This role is crucial in ensuring that the
board works effectively.
In some countries, it is important that the chair be independent (i.e. without any direct link to the
company), while in other countries this is not seen as critical. For example, in the United Kingdom (UK),
the largest listed companies are expected to have a chair who is independent at the time of appointment.
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144 Ethics and Governance
In contrast to this, many companies in the United States (US) allow a person to fulfil both the role of CEO
and chair of the board at the same time. However, an increasing number of US companies are separating
the roles of CEO and chair; and, where the roles are combined, it is the usual practice to have a senior
independent director who can express an independent view.
Summary of Board Functions and Responsibilities
Boards and directors perform a wide range of vital functions for the company. According to the Tricker
model (figure 3.3) and as detailed by Henry Bosch, one of the foremost Australian authorities on corporate
governance, the board’s responsibilities and functions, include those listed in table 3.5.
FIGURE 3.3
The primary functions of the board
Outward
looking
Providing
accountability
Strategy
formulation
Approve and work with
and through the CEO
Monitoring and
supervising
Policy
making
Inward
looking
Future focused
Past and present focused
Source: Tricker, RI 2015, Corporate Governance: Principles, Policies and Practices, 3rd edn, Oxford University Press, Oxford.
.......................................................................................................................................................................................
CONSIDER THIS
Choose two separate listed companies and find their board charters on their website. What are the features you
notice? How do they align with Tricker’s analysis of what boards should be doing as people in charge of governance?
Each item in the list of important board functions in table 3.5 has either a performance or
conformance focus.
TABLE 3.5
Board responsibilities
Function
Responsibilities
Monitoring and supervising
• Taking steps designed to protect the company’s financial position and
its ability to meet its debts and other obligations as they fall due.
• Adopting an annual budget for the financial performance of the
company and monitoring results on a regular basis.
• Ensuring systems are in place that facilitate the effective monitoring and
management of the principal risks to which the company is exposed.
(continued)
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MODULE 3 Governance Concepts 145
TABLE 3.5
(continued)
Function
Responsibilities
Providing accountability
• Determining that the company has instituted adequate reporting
•
•
•
•
Strategy formulation
systems and internal controls (both operational and financial) together
with appropriate monitoring of compliance activities.
Determining that the company accounts conform with Australian
Accounting Standards and are true and fair.
Determining that satisfactory arrangements are in place for auditing the
company’s financial affairs and that the scope of the external audit is
adequate.
Selecting and recommending auditors to shareholders at general
meetings.
Ensuring that the company has in place a policy that enables it to
communicate effectively with shareholders, other stakeholders and the
public generally.
• Determining the company’s vision and mission.*
• Reviewing opportunities and threats to the company in the external
environment, and strengths and weaknesses within the company.*
• Considering and assessing strategic options for the company.*
• Adopting a strategic plan for the company, including general and
specific goals, and comparing actual results with the plan.
Policy making
• Establishing and monitoring policies directed at ensuring that the
•
•
•
•
•
•
company complies with the law and conforms to the highest standards
of financial and ethical behaviour.
Selecting and, if necessary, replacing the CEO, setting an appropriate
remuneration package for the CEO, ensuring adequate succession plans
are in place for the CEO, and giving guidance on the appointment and
remuneration of other senior management positions.
Adopting formal processes for the selection of new directors and
recommending them for the consideration of shareholders at general
meetings, with adequate information to allow shareholders to make
informed decisions.
Reviewing the board’s own processes and effectiveness, and the
balance of competence on the board.
Approving and working with and through the CEO.
Adopting clearly defined delegations of authority from the board to the
chief executive officer (CEO) or a statement of matters reserved for
decision by the board.
Agreeing on performance indicators with management.
*Bullet points identified by asterisk are not from the Bosch Report, but are added by the author of this text.
Source: Bosch, H 1995, Corporate Practices and Conduct, 3rd edn, Pitman, Melbourne, p. 9. Reproduced with permission.
QUESTION 3.9
Classify each of the board responsibilities above as having either a performance focus or a
conformance focus.
Committees of the Board
The effectiveness of the board, and particularly of non-executive directors, is likely to be enhanced by
the establishment of appropriate board subcommittees, usually simply referred to as ‘committees’. These
committees enable the distribution of workload to allow a more detailed consideration to be given to
important matters, such as executive remuneration and external financial reporting.
Furthermore, in relation to issues that involve conflicts of interest (e.g. related party transactions, financial reporting and setting executive remuneration), subcommittees are important for creating environments
where independent directors’ views can take priority in order to achieve independent decisions.
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146 Ethics and Governance
The chairs of committees are singled out for attention in some corporate governance requirements or
guidance. In particular, the importance of independent directors as chairs can be observed. This role is
discussed later in part D with regard to specific codes and guidance on corporate governance.
However, these committees do not reduce the responsibility of the board as a whole, and care needs
to be taken to ensure that all those concerned understand their functions. It is important to note that the
board of directors is still responsible for decisions made by the committees. The delegation of duties from
the board to the committees enables examination of issues in greater detail and discussion of issues in the
absence of executive directors — and in some cases, with only independent directors present.
Carefully written terms of reference for each committee are required along with defined procedures for
reporting to the full board. Modern corporate governance principles allow that some matters may be delegated fully (e.g. executive remuneration delegated to a remuneration committee). The recommendations of
such a committee will be accepted by the board without further consideration by the whole board. Where
this occurs, very careful attention to procedures and protocols is required so that board delegations are
fully understood and properly carried out.
Important committees that may exist are discussed below. The four committees that are normally
required by various corporate governance codes/recommendations are the:
• nomination committee
• remuneration committee
• audit committee
• risk management committee.
Boards are also free to choose to have any additional committees that may assist in creating a better
governance structure for running the corporation.
Nomination Committee
This committee is primarily responsible for recommending the succession procedures within an organisation. Succession is the concept of identifying and selecting people who will replace senior staff when
they leave.
This committee, because of the skills each member acquires in this role, is valuable in assessing the
overall performance of the board and, sometimes, the performance of key executives. An important aspect
of succession responsibilities is recommending candidates for shareholders to vote on to the board as
directors. Given that boards comprise a balance of directors, including executives, it is appropriate for the
nomination committee to include executive directors.
Remuneration Committee
This committee deals with remuneration, especially for senior executives. Important aspects of remuneration include what and how directors and executives are paid. It is apparent that this area is particularly
complex. One of the main causes of the GFC was the setting of inappropriate remuneration policies
that focused almost entirely on short-term revenue generation and marginalised the concern for risk
management. The sensitivity of setting a remuneration policy can be reduced if executives are not involved
in the committees that decide their remuneration. Furthermore, in order to ensure independence, it is
necessary that executives do not set the remuneration of independent directors.
Audit Committee
The audit committee is, in many ways, the most important in relation to the conformance aspects of
corporate governance. It is often considered the appropriate conduit between the company and the external
auditor, ensuring that the work of the external auditor maintains the utmost integrity and independence.
While this committee is recommended for all listed companies (and will be valuable in many others),
it can also be mandatory to have an audit committee. Listed entities in the S&P All Ordinaries Index
at the beginning of their financial year are required, under the listing rules, to have an audit committee
for that whole financial year. There are some tighter requirements for those listed entities that are on the
ASX 300 Index, which also includes that they must comply with the structure and disclosure requirements
of the audit committee recommendation.
To ensure the independence of the audit committee, it is recommended that the audit committee comprise
only non-executive members, with a majority being independent. An audit committee with no executives
means that communications with the external auditor at a formal level will take place without the CFO.
This is an important aspect of good governance at the auditing/reporting phase.
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MODULE 3 Governance Concepts 147
Under the US Sarbanes–Oxley Act (US Congress 2002), all US-listed companies must have an
audit committee. The committee must comprise only independent directors and must be the principal
communication conduit between the company and the external auditor. The Sarbanes–Oxley Act also
provides that the audit committee has the responsibility to ‘hire and fire’ auditors.
The audit committee has many responsibilities and its role should include reviewing the adequacy
of operational and internal controls (including the internal audit function) and reviewing half-year and
full-year financial statements prior to board approval (Percy 1995). Percy identifies that the audit
committee’s review should place particular focus on changes in accounting policies, areas requiring the use
of judgment and estimates, audit adjustments, and compliance with accounting, legal and stock exchange
requirements. A detailed list of audit committee responsibilities is provided in Appendix 3.1, which reviews
relevant extracts from the FRC Code (FRC 2018) and will be discussed later in this module.
It is also preferable that, in order to avoid misunderstandings, the role and responsibilities of the audit
committee be explicitly set out in a written charter.
Benefits of Audit Committees
An audit committee undertaking good practice will provide benefits to the board and the entity by:
• strengthening the internal control structure and helping to ensure the maintenance of appropriate
accounting records
• supporting the independence of external auditors and assisting in creating improved ‘independence
regimes’ for internal auditors (despite the fact that, as employees, internal auditors will not achieve
full independence)
• facilitating appropriate communication channels between management, the board, external auditors and
internal auditors
• improving the quality of financial disclosures and the effectiveness of the audit function by providing
an independent review of these functions
• acting as a forum for the resolution of disagreements between management and external auditors and
also assisting with such issues involving internal auditors
• improving the effectiveness of external and internal auditors by providing a coordinated approach to
audit planning
• keeping the board fully informed about relevant accounting and auditing issues
• advising the board of directors on independence issues and, where appropriate, analysing whether
members of the board have exercised due care in fulfilling their responsibilities
• highlighting relevant important matters that require the board’s attention
• ensuring that an effective whistleblower system is in place within the corporation.
Limitations of Audit Committees
Audit committees have limitations with regard to improving corporate governance standards. It is important
to be aware of these limitations so that, as professional accountants, it is possible to put in place
mechanisms to remedy the following possible weaknesses.
• The audit committee may not have the power to enforce its recommendations.
• Financial report users may have unrealistic expectations of audit committees.
• The establishment of an audit committee may cause dissent within the board, particularly between
executive and non-executive directors. Many CFOs believe they, more than anybody else, should be
on the audit committee but, in reality, the CFO is the most important person to exclude from the audit
committee in order to ensure auditor independence.
• The audit committee may be ineffective due to a lack of competent, financially skilled members.
• Committee members may be selected because of their association with the CEO or chair, thus reducing
their real independence.
• The presence of management may inhibit open discussion and affect committee independence.
• The responsibilities of the audit committee may impinge on those of management, creating an
atmosphere of conflict and distrust.
• The maintenance of an audit committee is time-consuming and costly.
• Ambiguous terms of reference may create misunderstandings and undermine the committee’s authority.
• The terms of reference of the committee may be so broad as to require the participation of all members
of the board.
Audit committees may also be formed as a means of giving the appearance of good corporate governance
without achieving any useful purpose for the organisation and with little commitment to attempting to
improve the monitoring of the organisation. However, with the major corporate failures linked to audit
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148 Ethics and Governance
failure, and the increasing emphasis of regulation including Sarbanes–Oxley Act 2002 in the US, and the
Corporate Law Economic Reform Program (CLERP) in Australia, companies are invariably taking the
work of their audit committees more seriously.
One situation in which audit committees are formed without regard for quality or effectiveness of their
work, is fear of litigation. Although it could be argued that the mere fact that a firm has an audit committee
is evidence that the directors take due care in performing their duties, if this is the only reason for the audit
committee being formed, then potentially the whole board is derelict in its duty. An effective board will
always ensure the audit committee is performing its role with diligence and competence.
The effectiveness of audit committees is considered in example 3.8, in relation to Enron Corporation.
Read this and then answer question 3.10.
EXAMPLE 3.8
The Enron Audit Committee
Enron’s audit committee seemed to fulfil all of the requirements of best practice. It consisted of seven
well-known and highly qualified board members who were all non-executive directors of the company.
But, like many things at Enron, the reality was quite different.
One member of this committee, John Wakeham, had in place a USD$72 000 per year consulting
contract with Enron. Two other committee members had been employees of universities that had received
significant charitable contributions from Enron or its chairman, Kenneth Lay (Lavelle 2002, p. 28).
Specifically, one of these members, Jon Mendelsohn, was also president of the MD Andersen Cancer
Centre at the University of Texas. Lavelle (2002, p. 29), reported that this centre had received USD$332 150
from Enron and Lay since 1999. Under disclosure rules at the time, it was not necessary to disclose this
relationship to Enron’s shareholders and there was no voluntary public disclosure of these arrangements.
Another committee member, Wendy Gramm, was an employee at the Mercatus Centre at George Mason
University. According to the university’s records, USD$50 000 was collectively paid by Enron and Lay
to this centre from 1997. Moreover, Wendy Gramm’s spouse, Senator Phil Gramm (Republican, Texas),
received USD$80 000 in political campaign donations from Enron and its employees from 1993, when she
became a director of Enron (Lavelle 2002).
It should also be noted that the chair of Enron’s audit committee, Robert Jaedicke, was aged 72 years
at the time of Enron’s collapse. While he was eminently qualified for the role — he had worked at Stanford
University as an accounting professor until his retirement some 10 years earlier — his advanced age and
the complexity of Enron’s finances and operations called into question his competence for this high-level
role (Lavelle 2002).
There were also concerns about the lack of action taken by the audit committee against questionable
accounting practices by management. The minutes of an audit committee meeting held in February 1999
indicated that the senior audit partner had told the committee that accounting work relating to several
areas, including ‘highly structured transactions’, was considered ‘high risk’.
The accounting firm’s (Arthur Andersen) legal counsel later testified that this risk rating was designed to
convey to the audit committee that the company was ‘using accounting practices that, due to their novel
design, application in areas without established precedent or significant reliance on subjective judgements
by management personnel, invited scrutiny and presented a high degree of risk of non-compliance with
generally accepted accounting principles’ (COGA 2002, pp. 15–16). The audit committee seemingly chose
to ignore these warnings.
The Enron case demonstrates that good governance is about far more than establishing board committees. The members of each committee need to demonstrate independence and be prepared to stand up
to management in the event of questionable practices. Moreover, they need to adopt a sceptical view of
management submissions and be prepared to delve deeper when they do not receive the answers they want
or they suspect something is not quite right. Clearly, the individual members of an audit committee are
required to be competent, experienced and even courageous in adequately performing such a key role.
QUESTION 3.10
Examine the Enron audit committee role and independence in light of the earlier discussion on the
benefits and limitations of audit committees. Evaluate the effectiveness of the committee and list
steps you would recommend to improve the Enron audit committee in this situation.
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MODULE 3 Governance Concepts 149
Risk Management Committee
Risk management is important to ensure that risk is assessed, understood and appropriately managed. This
is important both for conformance and performance. It is essential that strategic planning and management
decisions are made appropriately in the context of the risk appetite of the corporation and its various
stakeholders, especially its shareholders. If a company does not have a good understanding of risk, the
likelihood of conformance and performance failure is high.
A good understanding of risk is assisted by a clear understanding of strategy. The Professional
Accountants in Business Committee (PAIB) of IFAC recommends that companies should establish a
strategy committee that reviews strategy in all its dimensions including risk (IFAC 2004, p. 6). In fact,
many organisations do have a risk management committee that oversees the systems and processes for
managing risks (including currency, interest rate risk and operational risk). It is also common for risk
committees to assess the risks attached to corporate strategy — in which case IFAC’s recommendation
is also satisfied. In a more recent publication, IFAC (2015) has highlighted the need to move away from
a bolt-on review of risk as if this were a marginal aspect of doing business, and accept that risk must be
managed as an integral part of overall enterprise management.
AUDITORS
Most large organisations have an internal audit department, which generally reports directly to the audit
committee. Internal auditors undertake a variety of tasks that contribute to good corporate governance. In
general, the internal auditor plays an important role in ensuring that internal financial controls, compliance
controls, operational controls and risk management systems are operating effectively.
The external audit is also a vital part of the corporate governance process. Investors rely heavily
on information provided in financial reports. It is essential that these reports are accurate and free
from material misstatement. Accordingly, the capacity of external auditors to conduct a thorough and
independent review of the financial statements is the cornerstone of the corporate governance process.
‘Audit failure’ is the term used when an audit is deficient due to negligence, incompetence or lack of
independence by the auditor. While the vast majority of audits are conducted in a satisfactory manner,
regrettably, there are exceptions.
The external auditor, as an independent party with a detailed knowledge of the entity’s financial affairs,
is able to provide substantial advice to the audit committee. The external auditor may also assist the audit
committee by informing it of any developments such as legislative changes or new accounting standards.
It is also important that the external auditor should attend the full board meeting when the financial
statements are approved, to enable all directors to ask any questions they may have regarding the financial
statements or the audit process.
REGULATORS
Objective of Regulation
The business environment is increasingly competitive, with companies constantly trying to improve
performance. There are often strong incentives to achieve these objectives and, sometimes, questionable
methods may be used.
Effective regulation and enforcement is essential to ensure that companies can compete against each
other in a fair and reasonable manner. Failure to create such an environment can lead to poorer outcomes
for all stakeholders. ASIC states that the following are traits of a sound regulatory system, which are also
relevant internationally.
• Companies can get on with doing business confident that the same rules are applied to everybody. They
•
•
•
•
can seek capital in Australian markets at rates that are broadly competitive with leading world markets
and without paying a significant market risk premium.
Financial products and services businesses can operate profitably and efficiently, while treating customers honestly and fairly. Being in a well-regulated market helps them do business across borders.
Financial markets are well respected and attractive internationally, and clean, fair and reliable.
Everybody can find and understand their obligations.
Investors and consumers participate confidently in our financial system, using reliable and trustworthy
information to make decisions, with ready access to suitable remedies if things go wrong.
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150 Ethics and Governance
• The community is confident that markets, corporations and businesses involved in them operate
efficiently and honestly and contribute to improving Australia’s economic performance. Firm action
is taken against fraud, dishonesty or misconduct. The regulatory system is respected (ASIC 2006, p. 4).
From this regulatory perspective, the purpose of regulation is to support free and open markets. Yet many
businesses and some economists argue that imposing restrictions on corporations’ activities, and the way
they are governed, stifles incentive, creativity and entrepreneurship. They believe that wealth creation is
maximised by allowing markets to be free of restrictions. Nobel prize–winning economist Milton Friedman
is of the view that ‘there is one and only one social responsibility of business — to use its resources and
engage in activities designed to increase its profits so long as it engages in open and free competition
without deception or fraud’ (Friedman 1970). However, critics ask: at the expense of whom?
Others argue that corporations do not exist in a vacuum. Instead, they are an integral part of society and
the focus should be much broader than just increasing profits and returns to shareholders.
Self-interest often appears to be the guiding philosophy of certain groups, even if they do appear to
be ideologically based. Business groups and trade associations that promote free markets and limited
regulation often are led by the vested interests, which can sometimes be inconsistent with the advocacy of
free markets. They may strongly favour government intervention, such as subsidies or tariffs, when it assists
that particular industry, while opposing government intervention elsewhere in the economy. Governments
may also advocate free trade while continuing to protect certain domestic industries for political purposes.
Principles-Based Versus Rules-Based Regulation
While there is no single best model of corporate governance, many countries, governments and other
authorities have attempted to address corporate governance issues through two broad models of regulation.
A principles-based approach is where broad principles or recommendations on corporate governance
are specified. Organisations are expected to operate within these general guidelines, but with some
flexibility to choose how they do this. Under this approach, corporations will normally be expected to
follow the principles or recommendations — as to do otherwise is essentially to ‘break the rules’ of
accepted good corporate governance. Later in this module, we will outline the OECD Principles, the ASX
Principles and the FRC Code, which all reflect a principles-based approach.
This approach provides more flexibility in implementing specific corporate governance practices in view
of the potential diversity of corporations. Under the UK and Australian approach (also seen in Singapore,
for example), the board of a corporation may decide not to follow the local principles or recommendations,
which may be allowed, but it must then disclose that it is not following them and explain why. Sometimes,
some principles or recommendations must be followed fully and the board is not allowed a choice.
By contrast, a rules-based approach is more detailed and prescriptive, as reflected in the approach
adopted in the US Sarbanes–Oxley Act (US Congress 2002), and in the Dodd-Frank Wall Street Reform and
Consumer Protection Act 2010, which was introduced following the GFC. Specific and detailed regulations
are provided and must be complied with. There is no flexibility in deciding whether to comply or not.
To help appreciate the difference between these two approaches to forming an audit committee, consider
example 3.9.
EXAMPLE 3.9
Approaches to Audit Committee Formation
Principles-Based Approach
The regulations may state that it is important to have an audit committee, and it should have members
who are suitable to the role. If there is no audit committee, an explanation must be provided.
Rules-Based Approach
The regulation may state that there must be an audit committee. It must have at least four members. These
members must all be independent directors. These members must all have financial qualifications.
From this example, it is clear that the principles approach creates a broad guideline, which it is then
up to the company to apply in the most appropriate way. The rules-based approach gives very specific
instructions and must be complied with.
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MODULE 3 Governance Concepts 151
STAKEHOLDERS
The term ‘stakeholder’ is used in a very broad sense, meaning anyone who is affected by the operations
of an entity. These stakeholders include not just shareholders (for corporate entities) but other parties,
such as employees, competitors, customers and suppliers, lenders, society generally and, indeed, even
the environment.
Stakeholder Concept
The Anglo-American corporation law approach is that directors must act in the best interests of the
corporation as a whole. This means corporations are run according to corporate law duties in relation
to shareholders. However, this approach does not mean that a corporation should be run for the exclusive
benefit of its shareholders. Any director or senior manager who believes that acting according to this
approach will lead to long-term success and satisfactory corporate governance is mistaken. The success
of an organisation depends on the successful management of all the relationships an organisation has
with its stakeholders. The principal focus of our discussion in this module is on the Anglo-American
derivative duties approach to stakeholders. Stakeholder theory is considered further in module 5 as part of
the discussion of sustainability and social responsibility concerns.
Stakeholder Map
Stakeholders differ across organisations. Figure 3.4 provides a diagram of potential stakeholders that may
be of concern to an organisation and table 3.6 expands on the nature of each stakeholder relationship.
In any situation, some stakeholders will be more important than others to a particular corporation at a
particular time and, inevitably, this stakeholder map may omit relevant stakeholders. You should observe
that stakeholders are not only people or corporate entities — even the environment is a stakeholder (as a
corporation’s operations may have an effect on it). Notice also that competitors are treated as stakeholders
because there must be a commitment to open and fair competition in the market place, and if a competitor
undermines this, both producers and consumers suffer. Those affected by a particular corporation are
stakeholders of that corporation. Where a stakeholder’s interest is significant, corporations must manage
the relationship carefully.
FIGURE 3.4
Corporate stakeholders
Environment
Community
Agents
Government
Owners
Corporation
Regulators
Employees
Consumers
Auditors
Source: CPA Australia 2015.
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152 Ethics and Governance
Suppliers /
Lenders
Competitors
MODULE 3 Governance Concepts 153
Purchasers of
goods or services
Supply goods/
services
Supply funds
Provide labour
Customers
Suppliers
Lenders
Employees
Society
Investors can withdraw finance if they are
dissatisfied with the company’s processes.
Voting power at general meetings
Business relationship
Political power by influencing politicians and
social media
Economic power through spending elsewhere
Provide standard
operating practices
(legal and social
permissions)
Economic power through the taxation system
Legal and political power through Acts of
parliament
Legal power through the Fair work, Disability
and discrimination and Work health and
safety Acts
Lobbying may exist to shut down or prevent an
industry from starting up or expanding.
Poor behaviour from a company can lead to an
industry being ostracised by the community.
Positive impact on society
Good corporate citizen
Government may choose to impose greater
regulation on a sector if specific companies are
perceived to be misbehaving.
Legal compliance
Economy
Society’s interest
Source of revenue
Employees can withdraw labour if conditions at
a workplace get worse.
Important life activity
Job security
Salaries and wages
Lenders may choose not to lend depending on
the credit rating of an entity.
Economic power by the lending terms and
conditions of the lending contract
Political power by withdrawal of labour
Revenues from interest
Voting power by having a director on the board
Poor experiences with a company may lead
to a refusal by a supplier to deal with the
company.
Revenue from sales
Economic power by restricting supply
Legal power through the Competition and
Consumer Act and the ACCC
Legal power through the Competition and
Consumer Act and the ACCC
Economic power by spending elsewhere
Dissatisfaction can lead to customers not
wanting to buy services and it may lead to
negative publicity by word of mouth or social
media.
Satisfaction with value from purchase
Satisfaction from ownership interest
Political power through institutional investors
Political power through word of mouth, media
and social media
Return on investment
Interest and influence
Legal power through the Corporations Act
Type and source of power
Consume
goods/services
Provide general
infrastructure.
Impose regulations
Receive taxes
Owners who are a
source of finance in
the form of equity
Investors
Government
Relationship
Nature of the corporation and some stakeholder relationships
Stakeholder
TABLE 3.6
Source: CPA Australia 2015.
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Directors may bear the consequences for
poor decisions made in relation to services
offered, goods sold and the company’s attitude
towards corporate social responsibility.
Threat of regulatory enforcement directed at
boards where they or responsible staff fail to
comply
Boards may find an increase in regulatory risks
that arise from new laws and regulation.
Misconduct by employees may lead the
organisation to suffer reputational damage.
Poor management of employees can lead the
board to see evidence of employee turnover.
Finance may be unobtainable if the company
cannot pay back the principal plus interest.
Faulty goods or services received from a
supplier may also lead to the company’s
reputation being damaged.
Directors may need to source other products
from other suppliers if the company fails to pay
the supplier for goods or services.
Reputation risk management will be needed
if customers receive poor service or faulty
products.
Underperformance may mean withdrawal of
investment or investor pressure to remove
directors.
Risk
In addition to the problem of identifying significant stakeholders, other issues arise from stakeholder
theory, including the following.
• How should managers allocate (prioritise) limited time, energy and other resources among stakeholders
— and according to what time frame? Balancing the interests of stakeholders is obviously an important
aspect of corporate success, and the best boards and managers do this well and will enjoy success
accordingly.
• Some argue that stakeholder theory places too much discretion with management. They contend that
stakeholder theory is too vague. For example, management could claim to be balancing the interests of
various stakeholders while in fact acting to further their own interests. Generally, self-interest is not a
bad motivator, but it must not be at the expense of stakeholders. In module 5, the concept of enlightened
self-interest is discussed further. In this module, we have discussed remuneration approaches under
agency theory and have seen that self-interest is a key factor in seeking to ensure that agents perform
their duties to a high standard.
• Critics of stakeholder theory decry the infringement of property rights of the owners of the corporation.
For example, free market supporters have taken the approach of Milton Friedman and argued that
stakeholders other than shareholders should not form part of management thinking.
• Some consider that under ‘stakeholder management’, there is the potential for stakeholders to be
co-opted, captured and controlled. Stakeholder management approaches are considered in module 5.
Employees
These are important stakeholders in any corporate environment, which is why they are included in
figure 3.4. In increasingly knowledge-based businesses, it is the knowledge and skill of the employees
(including managers) that will be critical to the success of the company. In this sense, the employees
become the greatest asset (e.g. in professional service firms) and without this asset the company cannot
compete. In some jurisdictions, where dual board structures exist (e.g. Germany), employees may have
a more formal role on boards — especially on the lower-tier board. It is not uncommon for very senior
managers also to be on boards. For example, the CFO may well join the CEO on the board and will therefore
also possess the joint characteristic of being an executive and a director — and have the complex mix of
two sets of duties.
Importantly, in all jurisdictions, managers and employees alike are owed duties by corporations and,
in turn, owe duties to the corporation. For example, employees are entitled to safe working conditions
and holiday periods, while employers are entitled to expect diligent service and protections such as
confidentiality about commercially sensitive information.
Suppliers and Lenders
We have previously emphasised the importance of all stakeholders and addressed issues relating to
various stakeholders. The significance of customers in the value chain is obvious and much emphasis has
been given to the economy, to competitors and to consumers/customers. Suppliers and lenders, although
‘upstream’ in business relationships, are also very important stakeholders.
Developing and maintaining good relationships with suppliers and lenders will improve performance
(e.g. ensuring legal compliance and correct ethical relationships). On the performance side, good relationships add value by avoiding disruptions, and reducing transaction costs and the cost of borrowing (through
lower interest rates if lenders better understand a borrower). In fact, often businesses are more immediately
dependent on the goodwill of their suppliers and lenders for their continuing success on a day-to-day basis
than on their shareholders with whom they may have a more distant relationship which only becomes
focused more sharply at the time of reporting the annual results.
It is important to appreciate that, just as a business will wish to have dealings with ethical lenders and
suppliers based on well-understood relationships, lenders and suppliers will have the same expectations in
return. Good ethical relationships will make it easier to conduct business and will reduce overall costs.
Table 3.7 provides a basic list of important matters to consider in regard to suppliers and lenders as
stakeholders of a corporation.
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154 Ethics and Governance
TABLE 3.7
Considering suppliers and lenders as stakeholders
Stakeholder
Areas for consideration
Suppliers
•
•
•
•
•
•
•
Reliability and ‘on time’ performance
Quality at delivery
Terms for payment, including timing and discounts
Financial security and alternative suppliers
Refund and warranty policies for goods acquired
Willingness to work in partnership — within the law
Compatibility of ethical standards and codes of conduct
Lenders
•
•
•
•
•
•
Security required
Significant debt covenants involved
Interest rate applicable — fixed/variable
Up-front fees, rollover fees and ongoing charges
Principal and interest repayment timing and costs
Special-purpose financial reports or information
Source: CPA Australia 2015.
Consumers (Customers)
Consumers or customers are very important stakeholders. Corporations recognise that the long-term
support from consumers for their outputs will be important for value generation and corporate performance.
However, many managers and corporations succumb to the temptation to seek quick profits without proper
care for consumers and their long-term needs. Sometimes, there are even deliberate attempts to target
vulnerable consumers by deception and dishonesty. Consumer law is discussed in module 4.
For many businesses, the relationship with customers is changing. Rather than the customer being the
passive purchaser of a good or service, the customer’s views and ideas are actively canvassed as a means of
product and performance improvement. This can serve to deepen the relationship with customers and, in
some instances, customers become more active collaborators in the design of products and services. This
form of active customer intelligence and involvement is what is required in rapidly changing markets with
constant innovation.
MANAGEMENT
As has been emphasised in this module, in formal corporate governance principles, managers are the agents
of the board, responsible for pursuing the vision of the company as developed by the board, and fulfilling
the strategic direction determined by the board. The CEO in most companies is also a director and a member
of the board (and there are often other executive directors such as the CFO of the company). These executive
directors have a full role working with the board to advance strategic direction and establish the policy and
values of the company. Once these are decided, it is the manager’s duty to actively pursue these, and the
board’s role is to monitor the results for the business.
Of course, in reality the interface of governance and management is more complex. Often boards and
managers respect and understand the different roles, and have a commitment to make the relationship
work. However, sometimes tensions do emerge, for example, in the choice of strategy. Because of rapidly
changing markets and technology, boards often have to be continuously engaged in strategic decisions. At
times, managers may feel that the board is becoming too involved in the implementation of strategy when
it is the management team who have the operational experience required to guide strategies to success.
On other occasions, the board may feel that managers are making significant strategic decisions without
properly securing the approval of the board.
Skeet (2015) examines this issue from the perspective of both the board of directors and the management
team. When CEOs are asked what issues contribute to the board and management being at cross purposes,
they point to two main factors: directors acting ‘out of position’ and attempting to play a management
role; or a conflict of interest where, even if disclosed, directors are not able to place the interests of the
organisation above their own or those of the group they are representing.
Often what boards interpret as arrogance of the CEO and the management team can be, in reality, a
lack of experience, strategic direction differences or deceit. These can all lead to the management team
withholding information from the board. Board members should consider what information they do not
currently have and request this additional information if they feel the CEO or management team may be
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MODULE 3 Governance Concepts 155
concealing something. This is a legal right of the board, and the management team is not permitted to
suppress this information, once requested. The board is able to draw on multiple points of view when
making decisions, which is a strength of shared governance (Skeet 2015).
This tension occurred some years ago at BHP Billiton when a newly appointed CEO began negotiating
for major acquisitions without fully consulting the board. The board became concerned about the serious
risk implications of the CEO’s actions, and the contract of the CEO was terminated. With the appointment
of another new CEO, the BHP board was careful to agree on a series of protocols regarding the scope
for independent decision making by the CEO on financial and other matters, and the issues that always
needed to be brought to the board for consideration. These protocols appear to have worked well and, in
other large corporations, similar, clear understandings exist between board and executive management on
their respective roles and powers.
.......................................................................................................................................................................................
CONSIDER THIS
Choose a listed company and locate its board charter on its website. Read the charter and note the references to
stakeholders. Are stakeholders adequately covered?
Operational Management
Management is at the sharp end of delivering the aspirations of the board for the company. Boards of
directors are often highly skilled at financial analysis, strategic thinking and policy development, but it
is the managers who have to implement all of these, which requires considerable intellectual, operational
and technical skills. It is management who must inspire employees with the goals of the enterprise, delight
customers with the quality of the product or service, convince suppliers and distributors that the company
deserves their full support, and keep stakeholders onside.
Ensuring that there is the energetic commitment of managers to their task of realising the vision of the
board and making a success of the company is ultimately the role of the CEO, who is the essential link
between the governance mechanisms and the operational mechanisms of the company.
SUMMARY
Governance is the means by which entities — in the case of corporate governance, corporations —
are directed and controlled, and accountability is assured. Governance relates to the responsibilities of
the board of directors towards investors and other stakeholders, and involves setting the objectives and
direction of the company. Governance is distinct from the day-to-day management of the enterprise, which
is the responsibility of executives.
Good corporate governance involves ensuring the corporation operates in the best interests of its
stakeholders. Good corporate governance is also linked to the ability to achieve the strategic goals of
the organisation. Accountants play an important role in good corporate governance by providing useful
information for decision making that ultimately results in value creation while maintaining controls that
ensure compliance.
The precise components of the system of corporate governance vary based on the nature of the
organisation, but there are several common key elements that make up a corporate governance framework.
These include external elements (governments, stakeholders, and industry/professional bodies), internal
elements (owners/members, boards, and management, led by a CEO) and the audit function.
The key points covered in this part, and the learning objective they align to, are listed below.
KEY POINTS
3.1 Describe corporate governance and explain why it is important.
• Corporate governance is the system by which companies are directed and controlled, and accountability and transparency are assured.
• Good corporate governance helps the corporation to act in the best interests of its stakeholders,
achieve its strategic goals, including by accessing capital and complying with regulations.
• Corporate governance relates to the responsibilities of the board of directors towards investors and
other stakeholders, and involves setting the objectives and direction of the company. The board’s
role is distinct from day-to-day management.
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156 Ethics and Governance
• Boards of directors and managers of companies need to engage with all stakeholders in a manner
that is appropriate for each group.
3.2 Evaluate the importance of the key elements of the corporate governance framework.
• The external framework of governance is established through the legal and regulatory activity of
governments, the requirements of investors and the standards set by industry and professional
bodies.
• The internal governance of the company is established by the board, who are appointed by the
shareholders, and who in turn appoint the chief executive officer.
• The external auditor reviews the financial reporting of the company and thus helps ensure the
information provided by directors to stakeholders, particularly capital providers, is free from material
misstatement.
• Directors (and the board that they constitute) are the most important components of the corporate
governance framework as they direct and control the overall actions of the corporation and are
accountable for those actions.
• Shareholders delegate authority to the directors, but maintain some influence through the appointment and removal of directors and setting director remuneration. Institutional shareholders tend to
have most power, but individual shareholders have become more active in recent years.
• Regulators create a system of rules within which businesses are required to operate, thus ensuring
they act in a manner that is acceptable and beneficial to the society that hosts them.
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MODULE 3 Governance Concepts 157
PART C: INTERNATIONAL PERSPECTIVES
ON CORPORATE GOVERNANCE
INTRODUCTION
As described in part B, corporate governance involves a set of relationships between a company’s
management, board and stakeholders and establishes a structure by which objectives are set, pursued
and monitored. Within this overall scope of corporate governance, various approaches exist based on
different perspectives of how the overall aim of good corporate governance is best achieved. This part of the
module explores some of these alternative approaches, the factors that drive changes to aspects of corporate
governance frameworks and significant developments in corporate governance that have occurred in
recent decades.
In particular, any examination of the history of regulation in any country shows that major corporate
collapses or share market calamities are followed by regulatory changes designed to improve corporate
governance, in particular the market behaviour of corporations. Some reforms take the shape of laws,
while others involve the introduction or revision of codes of conduct or best practice guidelines.
3.7 GLOBAL PUSH FOR IMPROVED GOVERNANCE
Large global corporations have a significant impact on economies around the world. These entities are
subject to intense competition, and require investor and customer confidence to underpin their activities.
Poor governance adversely affects customers and investors, and makes corporations uncompetitive. This
can also affect entire economies. In the context of the GFC, the collapse of the US investment bank Lehman
Brothers demonstrates that corporate failure can hurt economies globally. The failure of Lehman Brothers
to properly manage and understand risk is a clear example of the failure of good governance.
The modern corporate governance world has become very complex and accountants must be aware
of this. As an internationally mobile profession, working with and within international corporations,
accountants must be equipped to deal with this complexity and be prepared to provide leadership on
corporate governance.
Key factors driving the need for better corporate governance internationally include the following.
• Corporations are being exposed to more competition as a direct result of globalisation. This has placed
additional pressure on corporations as they strive to improve on their historic levels of performance.
• Capital markets have been ‘freed up’ as a result of advances in technology and globalisation allowing
rapid flows of debt and equity capital, each requiring optimal returns. The long process of deregulation
in international capital markets was interrupted by the GFC. However, as we have seen in the post-GFC
world, only the best organisations will attract low-cost capital. Therefore, corporations exhibiting high
levels of good governance will receive the lowest cost debt and equity finance.
• Company performance and other related measures are more readily available to the public as a result of
technological advances and the consequential rapid growth of timely and easily accessible information.
Investors have also become more sophisticated due to an improved understanding of economic systems.
This has further heightened the demand for information and performance.
• Shareholder activism, which is growing for two key reasons.
1. The global aging population is demanding adequate financing of retirement. This has led to
significant growth in superannuation funds and pension plans and, with that growth, the need for
superior financial performance of those plans. The California Public Employees’ Retirement System
(CalPERS), which managed pension and health benefits for more than 1.6 million Californian public
employees, retirees and their families, is one example of an active (institutional investor) pension
fund. The investment power of pension funds is becoming a globally significant factor.
2. The significant growth in small shareholder ownership of major corporations internationally has
meant there are more interested stakeholders demanding accountability. The growth in Australia
of self-managed superannuation funds has also contributed to a high level of small shareholder
ownership.
The professional accountant has an important role in corporate governance. Areas of involvement
include the internal audit function, providing external audits, and being a key partner in providing
management with information relevant to decision making and planning. Furthermore, by ensuring that
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158 Ethics and Governance
professional ethical standards applicable to accountants are complied with fully, the accountant can make
an important contribution to enhancing the business ethics of the corporation.
Before we explore international frameworks more closely, it is necessary that we look at the events
that cause countries to reflect on whether their legal and extra-legal frameworks need change. Corporate
collapses and financial scandals have created the need for changes to law to tighten rules. These are
summarised in table 3.8.
TABLE 3.8
Corporate governance events and responses
Events
1980s
Responses
US
US
• Savings and loan crisis (1986–1995)
• Texaco bankruptcy (1987)
• Stock market crash (1987)
• Financial Institutions Reform, Recovery and
Enforcement Act of 1989
Australia
• Ariadne collapse (1988)
• Rothwells Merchant Bank collapse (1989)
• Qintex collapse (1989)
1990s
International
International
• Swedish banking crisis (1991–1992)
• Asian financial crisis (1997)
• OECD Principles of Corporate Governance
(1999)
UK
UK
• Polly Peck collapse (1990)
• Bank of Credit and Commerce International
• Cadbury Report and Code of Best Practice
fraud scandal (1991)
• Barings Bank collapse (1995)
• Greenbury Report (1995)
• Hampel Report (1998)
• Turnbull Report (1999)
(1992)
US
US
• Long-Term Capital Management collapse
• NACD Blue Ribbon Commission on Director
(1998)
Professionalism (1996)
• Sunbeam accounting fraud (1998)
• Waste Management fraud scandal (1998)
Australia
Australia
• Bond Corporation (1991)
• National Safety Council (Victorian Division)
• Corporations Law 1991
• Hilmer Report (1993)
(1991)
• State Bank of South Australia (1991)
2000s
International
International
• Parmalat financial scandal (2003)
• Global financial crisis (2008–09)
• Satyam accounting scandal (2009)
• OECD Revised Principles of Corporate
UK
Marconi collapse (2002)
MG Rover Group collapse (2005)
Northern Rock collapse (2008)
Royal Bank of Scotland collapse (2008)
BAE Systems corruption scandal (2009)
•
•
•
•
•
US
Cendant accounting fraud (2000)
Enron collapse (2001)
WorldCom bankruptcy (2002)
Lehman Brothers collapse (2008)
•
•
•
•
Governance (2004)
• ICGN Global Governance Principles (2009)
UK
Myners Review (2001)
Higgs Review (2003)
Combined Code of Practice (2003)
Companies Act of 2006
•
•
•
•
US
• NACD Blue Ribbon Commission Role of the
Board in Corporate Strategy (2000)
• Business Roundtable Principles of Corporate
Governance (2002)
• Sarbanes-Oxley Act (2002)
Australia
HIH Insurance (2001)
One.Tel (2001)
NAB forex scandal (2004)
AWB oil-for-wheat scandal (2005)
James Hardie asbestos scandal (2005)
•
•
•
•
•
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Australia
Corporations Act 2001
ASX Principles (2003) (Revised 2007)
Standards Australia (AS8000–2003) (2003)
CLERP 9 (2004)
•
•
•
•
(continued)
MODULE 3 Governance Concepts 159
TABLE 3.8
(continued)
Events
2010s
Responses
International
International
• Volkswagen emissions scandal (2015)
• Toshiba accounting scandal (2015)
• Kobe Steel falsified data scandal (2016)
• G20/OECD Principles of Corporate
UK
GlaxoSmithKline bribery scandal (2014)
Tesco accounting scandal (2014)
Carillion collapse (2018)
British Steel collapse (2019)
•
•
•
•
US
Dynegy bankruptcy (2012)
Valeant Pharmaceuticals scandal (2015)
Wells Fargo fake account scandal (2016)
Goldman Sachs 1MDB Malaysian sovereign
wealth fund scandal (2015–2019)
• Boeing 737 Max scandal (2019)
•
•
•
•
Governance (2015)
• ICGN Global Governance Principles (2016)
UK
• UK Corporate Governance Code (2010; 2012;
2014; 2016; 2018)
• FRC Guidance on Board Effectiveness (2018)
• UK Stewardship Code (2012; 2012)
US
• Dodd-Frank Act of 2010
• Report of the NSE Commission on Corporate
Governance (2010)
• Commonsense Principles of Corporate
Governance (2016)
• ISG Corporate Governance Principles For US
Listed Companies (2017)
Australia
ANZ bank bill swap scandal (2016)
Dick Smith collapse (2016)
APRA Inquiry into CBA (2017)
Banking Royal Commission (2017–2018)
•
•
•
•
Australia
• ASX Principles (2010; 2014; 2019)
• Corporations Amendment (Executive
Remuneration) Act 2011
• ACNC Governance Standards (2013; 2019)
• Banking Executive Accountability Regime
(BEAR) (2018)
• AICD NFP Principles (2019)
• Treasury Laws Amendment (Enhancing
Whistleblower Protections) Act 2019
SPECIFIC AUSTRALIAN CHANGES SINCE 2001
Ramsay Report
Ian Ramsay chaired a committee that produced the Ramsay Report (Ramsay 2001). That report examined
the adequacy of Australian legislative and professional requirements regarding the independence of
external auditors and made recommendations for changes. Some parts of the report were concerned directly
with audit independence (employment relationships, financial relationships and the provision of nonaudit services) and others were designed generally to enhance audit independence (e.g. establishing audit
committees and a board to oversee audit independence issues).
One of the key recommendations was that auditors would not be seen to be independent if their
employment relationships with the audit client created a conflict of interest. For example, holding financial
investments in the client, owing debts to the client, or if members of the team had a business relationship
with the client can all create a conflict of interest. Ramsay (2001) did not recommend a ban on the
provision of non-audit services to audit clients. Instead, he recommended that the disclosure requirements
be enhanced.
ASX Corporate Governance Principles and Recommendations
In 2002, the Australian Stock Exchange (since renamed the Australian Securities Exchange) responded
to calls for it to play a greater role in corporate governance through the establishment of the Corporate
Governance Council. The council, comprising representatives from business, investment and shareholder
groups, aimed to develop a principles-based framework for corporate governance that would be applicable
to listed companies. The council released the first edition of its Principles of Good Corporate Governance
and Best Practice Recommendations (ASX CGC 2003) in 2003 — providing 10 recommendations. These
were revised in 2007 and titled Corporate Governance Principles and Recommendations. The 2007
revision was amended in 2010. The third edition was released in 2014 and a fourth in 2019. The 2019
iteration of the principles is discussed later in the module.
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Corporate Law Economic Reform Program (CLERP) Act 2004 (Cwlth)
The Australian Government released a discussion paper in the aftermath of the collapses of, among others,
Enron in the US and HIH Insurance in Australia. This paper outlined proposals for audit and financial
reporting reform, as well as other legislative proposals, to improve corporate governance practices in
Australian companies. The discussion paper was part of the government’s ongoing reform program.
The CLERP discussion paper (CLERP 2004, referred to as CLERP 9, as it resulted from the ninth set of
deliberations in this scheme of legislative amendments) took into consideration the initiatives introduced
by the Sarbanes–Oxley Act, as well as the recommendations of the Ramsay Report. After a period of
consultation, the Corporate Law Economic Reform Program (Audit Reform and Corporate Disclosure)
Act 2004 (Cwlth) was passed by the Australian Government, coming into effect on 1 July 2004. Some of
the key changes are described below.
Audit Reform
• Oversight of auditors was strengthened.
• The Auditing and Assurance Standards Board (AUASB) became a Commonwealth statutory body
(rather than remaining controlled by the major accounting bodies in Australia).
• The auditing standards made by the AUASB were given legal authority (under the Corporations Act).
• Independence requirements for auditors were introduced.
Financial Reporting
• Requirements for the CEO and CFO to make a written declaration stating whether the financial records
have been properly maintained, and whether the financial statements and notes comply with accounting
standards and give a true and fair view.
• Expansion of the requirements for the disclosure of the remuneration of directors and executives of
listed companies.
3.8 ALTERNATIVE INTERNATIONAL APPROACHES
TO GOVERNANCE
While corporate governance rules and guidelines largely originated from developed markets such as the US
and UK, the importance of good governance is now recognised in both developed markets and emerging
markets in South-East Asia, Eastern Europe and Latin America. This global awareness is due to:
• a general trend in society towards openness, transparency and disclosure
• a gradual realisation of the growing significance of the scale and activity of corporations in determining
the prosperity and wellbeing of economies
• the growth of international capital markets resulting in companies globally needing to comply with
acceptable corporate governance practices in order to tap the funding available in these markets
• the increasing amounts of individual wealth held in equities through the huge growth of investment
institutions, including pension funds and insurance companies
• the growing acceptance by many people, including senior business and government officials, that good
corporate governance can be a matter of national interest.
The different systems of corporate governance found globally are classified as either market-based or
relationship-based systems. Each of these systems has inherent strengths and weaknesses that have been
demonstrated in recent times. Note that there are several terms that are used interchangeably to describe
each type of governance system.
Terms used to describe the market-based systems include the outsider system, the Anglo-Saxon system
and the shareholder system. Terms used to describe the relationship-based systems include the insider
system and the stakeholder system. Examples of each type of system are shown in table 3.9.
TABLE 3.9
Governance systems
Market-based systems
Relationship-based systems
United States
Continental Europe (e.g. Germany, France)
United Kingdom
Asia (e.g. Japan)
(continued)
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TABLE 3.9
(continued)
Market-based systems
Relationship-based systems
Australia
New Zealand
Source: CPA Australia 2015.
MARKET-BASED SYSTEMS
The market-based systems of corporate governance in the US and the UK are the most established and
have had the greatest influence on the rest of the world. This is because of the historical strength of the
US and UK capital markets, and the growth of their investment institutions that have become increasingly
active internationally. This is the model that has been adopted in many other countries, including Australia
and New Zealand. The central characteristics of the market-based system are as follows:
• widespread equity ownership among individuals and institutional investors, with institutions often
having large shareholdings
• shareholder interests as the primary focus of company law
• an emphasis on minority shareholder protection in securities law and regulation
• stringent disclosure requirements.
In these countries, a growing amount of the national wealth is held by institutions, including:
• insurance companies
• pension funds
• mutual funds.
There has been considerable growth in the financial assets of institutional shareholders relative to GDP
over the last decade. Institutional shareholders have been the dominant owners of equity in the UK for some
time now, and they are achieving this position in the US as well. They are charged with the responsibility
of securing the maximum return on their investments for their beneficiaries, balancing risk and return over
time, and in accordance with their investment mandates.
In the past, institutional shareholders demonstrated little interest in influencing the companies they
invested in, employing strategies of portfolio diversification and indexation. However, more recently, there
has been evidence of institutional shareholders becoming more actively engaged.
The market-based system of corporate governance has been characterised as disclosure based, as the
numerous investors depend on access to a reliable and adequate flow of information to make informed
investment decisions. Regulation is intended to ensure all investors remain fully informed, and to prevent
privileged groups of shareholders sharing information only among themselves.
The role of the banks is less central in a market-based system of corporate governance. Normally, bank
finance is short term, and usually banks operate at arm’s length in their dealings with corporations. Equity
finance is seen as more important as a means of developing companies (Nestor & Thompson 2000, p. 7).
Under a market-based system, shareholders have the right to use their voting power to select the board
and decide on certain issues facing the company, such as the appointment of an external auditor. However,
in practice, fragmented investors rarely exercise this control when faced with an informed and determined
management.
In the past, investors who were dissatisfied with how a company was being managed and directed tended
to sell their shares in the company. When this happens in sufficient numbers, it can depress the share price
to the point where a company becomes a target for hostile takeover.
Moreover, many institutional shareholders have become so large that they need to invest in a large
number of companies to spread their risk. Some investors, such as pension funds and insurance companies,
being typical institutional investors, also need to take a longer-term view of their investments.
These factors, together with pressure from regulators and beneficiaries, are forcing more institutional
shareholders to practise ‘responsible investing’ and to become more engaged with companies they are
investing in. This means that, rather than just selling their shares when they are unhappy with the
management or board, they are using a range of strategies — such as private meetings, voting against
resolutions, and applying public pressure using the media.
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QUESTION 3.11
Why is disclosure important for the integrity of equity markets? In your answer, you should address
what occurs when information is monopolised by privileged groups.
The US is the world’s major capital market. It operates a market-based system that has some distinct
characteristics. In the US, the board of directors is entrusted with an important responsibility — to monitor
the company on behalf of shareholders. However, in the US, boards of directors are often dominated by
the company management.
As a consequence, there have been efforts to achieve greater accountability by requiring that boards
have a majority of independent non-executive directors. This is now required under the listing rules of
the two major stock markets in that country: the New York Stock Exchange (NYSE) and the NASDAQ.
(When NASDAQ was originally conceived in the 1970s, the acronym stood for the National Association
of Securities Dealers Automated Quotations. Since then it has been known for its listing of growth
companies.) Moreover, in the US, it is common for the chair of the board and the CEO to be the same
person. This practice differs from many other countries where these roles are expected to be separate.
To enhance the oversight function of boards and limit the powers of CEOs, committees were established
in the 1980s in US corporations to undertake critical tasks. These tasks included the remuneration of
executive directors, nomination of new board members and key decisions in respect of auditing. As a
result, most CEOs of large companies in the US could no longer decide their own pay, select their own
board and audit their own financial performance. However, in many companies, CEOs continued to wield
considerable power in the boardroom, partly because they also retained the role of chair.
Notwithstanding these developments, controversy still exists in relation to issues such as executive
remuneration. The GFC has placed the pay and performance of senior bank executives at the forefront
of public debate again. Many US banks that received government bailout monies continued to pay large
amounts to their key executives, despite their recent mediocre performance and seemingly excessive risktaking behaviours. The result was that the US Government announced that caps on executive pay and
bonuses would be placed on the salaries of CEOs of banks subject to taxpayer-funded bailouts.
Other checks on management include the more active role being played by institutional shareholders
and rules such as Sarbanes–Oxley. As previously noted, many of these large investors, such as CalPERS,
closely monitor the corporate governance practices of companies in which they invest. However, in
practice, shareholders in the US possess limited power to appoint or remove directors. This is because,
in a public company with widely dispersed share ownership, it is difficult and expensive for shareholders
to take all of the actions and achieve the necessary coordination to remove directors. There are also other
administrative hurdles.
QUESTION 3.12
Is interest in corporate governance regulation and legislation inevitably associated with recession,
market failure and corporate collapse, or is it possible to maintain attention on improving standards
of corporate governance at times of market expansion and business growth?
QUESTION 3.13
Identify the strengths and weaknesses of the market-based system of corporate governance as
practised in countries such as the US, UK and Australia.
RELATIONSHIP-BASED SYSTEMS — EUROPEAN
APPROACHES
European countries exhibit diversity in corporate governance practices and structures, and have participants
that reflect differences in histories, cultures, financial traditions, ownership patterns and legal systems.
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The main difference between corporate governance systems in the US and the UK and those of European
countries is that the Europeans emphasise cooperative relationships and consensus, whereas the AngloSaxon tradition emphasises competition and market processes (Nestor & Thompson 2000).
With the move towards equity financing and broader share ownership in Europe in the 1990s, it seemed
at times that the market-based system was gaining favour. However, important elements of the European
tradition have proved resilient and enduring.
The European relationship-based or insider system relies on the representation of interests on the board
of directors. More diverse groups of stakeholders are actively recognised, including:
• workers
• customers
• banks
• other companies with close ties
• local communities
• national governments.
Stable investment and cross-shareholdings mean that the discipline of management by the securities
market is not strong; and the market for corporate control is weak, with hostile takeovers rarely occurring.
In other words, long-term large shareholders give a company a degree of protection from both the stock
market and the threat of takeover. The continental European system is characterised by a supervisory
board for the oversight of management, where banks play an active role, inter-corporate shareholdings are
widespread and, often, companies have close ties to political elites.
In most European countries (and indeed most countries in the world), ownership and control are held
by cohesive groups of insiders who have long-term stable relationships with the company (La Porta et al.
1999). Groups of insiders tend to know each other well and have some connection with the company
in addition to their investment (e.g. through family interests, allied industrial concerns, banks and holding
companies). Insider groups monitor management that often acts under their control. The agency problem of
the market-based system is much less of a problem in the relationship-based system (Nestor & Thompson
2000, p. 9).
Corporate finance in such countries is highly dependent upon banks, with companies having high debtto-equity ratios. Banks often have complex and longstanding relationships with corporations, rather than
the arm’s length relations of equity markets. As a result, rather than the emphasis on public disclosure
as in the market-based system, the insider system is based on a deeper but more selective exchange of
information among insiders.
Different Political, Legal and Regulatory Structures
A number of important distinctions remain among European countries that also distinguish the European
approach from other models of corporate governance, policy and practice (Weil, Gotshal & Manges 2002,
pp. 3–5).
• Company law. Many European countries have a distinctive tradition of company law influenced by
prescriptive Roman law. In France, regulations on incorporation were inspired by the Napoleonic code.
In Germany, regulation insisted upon a board of supervision separate from the company’s board of
directors to represent and protect shareholders’ interests. Company law is embedded in different and
often unique political, cultural and social traditions.
• Employee representation. Employee representation is embedded in law in Austria, Denmark, Germany,
Luxembourg and Sweden. Employees of companies of a certain size have the right to elect some
members of the supervisory board. In Finland and France, company articles may provide this right.
In other European countries, it is the shareholders who elect the members of the supervisory board.
• Stakeholder issues. Different European countries articulate the purpose of corporate governance in
different ways. Some place emphasis on a broader range of stakeholder interests, while others strongly
emphasise the ownership rights of shareholders.
• Shareholder rights and participation mechanics. Laws and regulations relating to the equitable treatment
of shareholders, including minority rights in takeovers and other transactions, vary significantly among
countries. Limits on shareholder participation rights pose barriers to cross‐border investment.
• Board structure, roles and responsibilities. Two main corporate board structures exist. First, the unitary
board (single tier) structure that is used in most common-law countries, and second, the two-tier
structure, which characterises the German governance system. In France, the legal system allows firms
to choose between a one-tier or two-tier board structure. There are similarities in practices between
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one- and two-tier boards. For example, both recognise a supervisory function and a management
function, although the distinction between them is more formally recognised in a two-tier board. It
is valuable to note that the two-tier board structure can also be found commonly in Japan and in
China — but not in South Korea.
• Supervisory body independence and leadership. The purpose of the supervisory board is to ensure
accountability and provide strategic guidance, leaving management with the capacity to make decisions
— management normally will have significant input to the ‘management board’ where a two-tier
structure exists.
• Disclosure. Variations in disclosure requirements and the resulting differences in information provided
to investors are a potential impediment to a single European equity market. Nevertheless, the amount
of disclosure is increasing, and there is more agreement about the type of information that needs to be
disclosed. In part, this is due to the promotion of International Financial Reporting Standards (IFRS).
Germany
The German business sector is typified by the following characteristics:
• a relatively strong concentration of ownership of individual enterprises
• the importance of small and medium-sized unincorporated companies
• a close correspondence between owners and managers
• the limited role played by the stock market.
The central characteristic of the corporate governance of German enterprises is their relationshipbased nature in which all interested stakeholders are able to monitor corporate performance. The German
Corporate Governance Code was first published in 2002 and has since been amended several times,
including in 2015. It stresses the need for transparency and clarifies shareholder rights in order to promote
the trust of investors and capital market development. It also seeks to enhance investors’ understanding
of the complex civil law–based corporate governance framework by setting out key principles in the one
document (Government Commission 2015). Moreover, the code’s ‘comply or explain principle’ seeks to
foster transparency by requiring an explanation from those corporations not complying with the provisions
of the code (Enriques & Volpin 2007).
France
France and Italy are the European countries with the smallest ownership of company shares by financial
institutions. The majority of shares have traditionally been owned by non-financial enterprises, which
reflects an elaborate structure of cross and circular ownership. That is, companies own one another’s shares
in a circular relationship. No external party can readily gain entry to the network, or seize control of any
entity in the network, and all of the member companies support one another against outsiders.
Another distinguishing feature of France is the concentration of ownership, which is higher than in any
other Group of Seven (G7) industrialised country, with the exception of Italy. In France, half the firms are
controlled by one single investor who owns the absolute majority of capital. On boards, the role of nonexecutive directors is muted, as business tends to be dominated by the president directeur général (PDG)
who combines the functions of chair and CEO. The independence of the PDG is reinforced by the legal
notion that enterprises should pursue the intérêt social de l’entreprise (the social interest of the company).
This law is interpreted in two ways:
1. that management has to act in the interests of shareholders; but also
2. that management has to act in the interest of the enterprise (e.g. to ensure its survival) (OECD 1997,
p. 113).
QUESTION 3.14
Identify the advantages and disadvantages of the European relationship-based insider system of
corporate governance.
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RELATIONSHIP-BASED SYSTEMS — ASIAN APPROACHES
Differing Corporate Governance Models
Countries in Asia also have a rich cultural diversity with different political and legal structures, and social
traditions. This leads to differences in corporate governance policy and practice. Many countries in Asia
are also still engaged in a process of institutional development. Many countries in the region have corporate
governance systems that are essentially based on close relationships (usually involving family control) and
further ongoing close relationships with creditors, suppliers and major customers. In some systems, this is
reinforced by close relationships with regulators and state officials.
In certain Asian countries, there are still many government-controlled organisations carrying out roles
that are typically performed by the private sector in Western countries. This situation reflects the history
of countries where, during the mid-20th century, governments created and owned all significant business
entities, before later reforming state-owned enterprises, with many small and medium-sized enterprises
being privatised.
Nevertheless, there are still many government-controlled entities in existence today. They are typically
controlled by local governments and the central government. Given their public charter, they are expected
to perform roles that are consistent with the broad social aims of the government. Consequently, their
governance structure and processes reflect heavy government influence and control.
In Singapore, many of the largest listed companies have the state as the largest shareholder although,
in terms of number, there are more listed companies that have either families or founder-managers as the
largest shareholders.
The relationship-based form of conducting business contrasts with the rules-based systems that predominate in Western industrial countries, where a combination of internal and external controls is exerted on
companies. Internally, company directors are responsible for exercising a duty of care and diligence that
includes ensuring financial controls are effective. This financial discipline is reinforced by the requirement
to audit the annual company accounts. Externally, the company operates within a framework of company
law that is enforced by regulatory authorities. Finally, there is the enveloping discipline of the capital
market, the effect of which is to exercise a commercial discipline on companies.
A common problem is that Asian economies have a considerable concentration of ownership of companies. Most companies in Asia either have a majority shareholder or a cohesive group of minority
shareholders who act together to control the company. Often, the company is part of an extensive corporate
network, which in turn has majority shareholders, which allows influential shareholders to control not just
individual companies but entire networks of companies, often concealing the true extent of their influence.
The most prevalent company form in East Asia is the diversified conglomerate that is controlled and
managed by a single extended family. Companies with widely dispersed ownership are rare in Asia. In
this context, it is difficult to protect the rights of minority shareholders. Though there are usually laws and
penalties against insider-trading and related party transactions, as well as on the conduct of substantial
transactions and takeovers, it is open to question how often and how rigorously these are enforced
(Prowse 1998). An example of change can be seen in Japan which, in very recent years, has taken a number
of steps to improve corporate governance, including new rules designed to improve independence in
the boardroom.
In the past, the boards of directors of companies in Asia have often served little more than a nominal
role. The role of non-executive directors has frequently been relatively unimportant and consequently
boards have not always exercised strong control over executives (including executive directors) and the
relationships that exist between the corporation and third parties.
Boards have been (and often still are) effectively dominated by majority shareholders. A result is
that disclosure and transparency are often minimal, making it more difficult for investors and regulatory
authorities to have adequate knowledge about corporate activities. Furthermore, in the past, institutional
shareholders and fund managers have not been significant in Asian markets, so the extent of external
monitoring by powerful institutions is only now becoming an influential force for better corporate
governance. This influence is now beginning to grow, with a significant proportion of foreign institutional
ownership of shares in Japan.
The economies of East Asia have rebounded from the 1997 Asian financial crisis. The GFC also
affected some of these countries, although generally the impact was far less than in Europe and the US.
All of the countries concerned are committed to a reform of corporate governance. A range of external
agencies including the International Monetary Fund, World Bank and Asian Development Bank have an
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interest in sustaining the reform process and they have all engaged in major initiatives to facilitate and
support the reform process.
The reform process will take different paths in different countries, but the main principles and objectives
can be outlined as:
• ensuring clear and effective financial control structures within firms
• developing external monitoring and control, with improvements in the legal framework, regulatory
agencies and disclosure environment
• advancing training and development programs to encourage the understanding of corporate governance
procedures and issues.
In conclusion, corporate governance development in East Asia requires action on several related fronts:
• activating the mechanisms in firms for more accountable and transparent operations
• establishing the viability and independence of regulatory institutions and agencies
• ensuring more effective control and regulation of firms by external agencies
• extending education and training to develop an understanding of sound corporate governance practices.
The following overviews of corporate governance in Japan and India illustrate how their different
cultures and histories have shaped the development of their corporate governance models.
Japan
The formal legal features of the Japanese corporate governance system resemble those in most other
advanced industrial countries. Corporate law in Japan was modelled, starting in 1899, on the German
system, with the establishment of limited liability corporations, typically with a two-tier board structure.
As in most OECD countries, the majority of enterprises are organised as public limited companies, though
in Japan, a significant number of medium-sized firms are private limited corporations.
The functioning of all of the major institutions and mechanisms of corporate governance, including
shareholders, banks and boards of directors, is different in Japan. For example, in the West, the board of
directors is largely appointed from outside the company and serves to monitor management. However,
in Japan, the main board of directors plays a more strategic and decision‐making role, and is more fully
drawn from the ranks of management who are employed by the company. Putting it simply, in the West,
the board members are outsiders representing the shareholders while, in Japan, the board members are
insiders leading management (Yasui 1999, p. 4).
A problem with this approach is that, over time, there is a tendency for boards to grow in size as more
managers need to be rewarded. The average board size in Japan is much larger than in the West, often with
around 20 directors, with some boards reaching as many as 40 members. As a result, most companies
form a board committee whereby some senior board members make all of the essential management
decisions, which are later ratified by the main board as a formality. Thus, the role of Japanese boards
may be considered superficial in supervising the executive management. In terms of responsibility for the
company, the Japanese main board’s role is limited. However, there is no doubt regarding the executive
management’s commitment to and responsibility for the company, which is often more intense than
anything experienced in the West.
The ownership structure of Japanese companies is also different from those in Western countries. Many
large companies are formed into what are termed keiretsus, which are essentially sets of companies with
interlocking business relationships and shareholdings. The major keiretsus are centred on one bank, which
lends money to the keiretsus member companies and holds equity positions in the companies.
Each bank has significant control over the companies in the keiretsus and acts as a monitoring entity and
as an emergency bail-out entity. Prominent keiretsus are Mitsubishi and Toyota. One effect of this structure
is to minimise the incidence of hostile takeovers. This concentrated pattern of shareholding has created
considerable stability, but at the potential expense of the market, due to corporate control being restricted.
Traditionally, keiretsus have put more emphasis on expanding their business rather than on seeking shortterm returns.
Though Japanese companies may be moving in the direction of the Anglo-Saxon model, this movement
is one of degree. The distinctive interrelated elements of the Japanese economic and social systems,
together with legal, regulatory, financial market and employment systems, will continue to have a powerful
effect. Though reforms are under way in the Japanese system of corporate governance, the progress has at
times been at only a gradual pace. The Japanese highly value their culture and institutions, and are not eager
to change them without fully understanding or accepting the reasons for change (Seki & Clarke 2014).
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India
Despite a legal system substantially similar to that of Britain and therefore a corporate governance approach
that follows the Anglo-American model, India has still found it difficult to develop a fully functional
corporate governance system. It requires a system that balances international approaches with its unique
culture, including extensive family control of even the largest corporations and, in recent years, the
phenomenal rate of growth achieved, locally and internationally, by Indian corporations.
An example of corporate governance failings involved one of India’s largest corporate frauds —
resulting in substantial international damage. In 2009, the internationally-significant listed Indian
computer corporation Satyam Computer Services was the subject of a major fraud involving, among
other things, extensive overstatement of profits. Its founder, R Ramalinga Raju, resigned after admitting
that the company had fraudulently misrepresented its profits. In addition to criminal prosecutions in India,
there have been international ramifications — including regulatory legal action in the US. In April 2011,
Satyam Computer Services and its former auditor, PW India (an affiliate of PricewaterhouseCoopers),
accepted fines totalling USD$17.5 million in the US in relation to the fraud and the negative impact it had
on trading on Satyam shares on the New York Stock Exchange (The Hindu 2011).
It seems that at least some of the corporate governance problems in India arise from the fact that British
corporate governance approaches, which have formed the basis of Indian corporate governance, do not
easily fit into the Indian environment.
India’s most significant governance issue is likely to be ensuring that a dominant shareholder does
not abuse their power, and protecting minority shareholders. This is different from the Western focus
on the separation of owners (principals) and control (agents) and the need to align the two. This may
limit the ability to transfer external models of corporate governance directly into the Indian commercial
environment. In addition to this, India has trouble with weak enforcement of corporate governance
regulations (Pande & Kaushik 2011, p. 2).
We can deduce from these observations that corporate governance in India is still in development, but
that India is prepared to take major steps to achieve successful corporate governance. The fact that rapid
changes in direction in the past have not solved problems shows that achieving better corporate governance
is a slow and painstaking process that requires constant effort and an acceptance that perceptions and
approaches matter more than rules.
If we accept that Australia and the UK, for example, have more-effective corporate governance, it must
be remembered that, in each of those locations, the development of better corporate governance has been
constant in direction and effort for decades. Even so, we still find examples of failure in both — so it is
hardly surprising if things are difficult in a society as socially complex as India. Progress may be slower
than wished in India, but long-term improvements are taking place and will continue to do so.
.......................................................................................................................................................................................
CONSIDER THIS
Download a copy of the OECD Corporate Governance Factbook - 2019 and look at tables 2.1, 2.2 and 2.3. Choose
two countries* and compare their regulatory regime with that of Australia’s. What is different? What is the same?
Summarise the key differences you find in a note that does not exceed 300 words.
* Ensure that you choose at least one country that has a different regulatory culture to Australia’s.
See link at: www.oecd.org/daf/ca/corporate-governance-factbook.htm
Family-Controlled Companies and Business Networks
A widespread business concern is that the most rapid economic growth in the world is occurring in
Asia, on weak institutional foundations. The OECD (2011) reports that approximately two‐thirds of listed
companies in Asia are family run, including many large firms. These firms have demonstrated flexibility
and dynamism that have resulted in strong economic growth and substantial increases in living standards
for several decades.
However, in most East Asian economies, families are in a position to exercise ownership and control
over many listed entities. This dominance of companies by families casts doubt on the relevance of the
theory of the separation of ownership and control, and of the principal/agent model that informs much of
Western thinking regarding corporate governance.
In Asia, there is a tendency to establish interlocking networks of subsidiaries and sister companies that
include partially owned listed companies. This allows investors to support the management team of their
choice, and invest in industries in which particular subsidiary companies specialise:
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A particular feature of the Asian corporate landscape is a relatively high concentration of family-run or
state-owned firms. Quite frequently, ownership control is effected through extensive, interlocking networks
of subsidiaries and related companies that include partially-owned, publicly-listed firms.
On the one hand, the use of such subsidiaries and affiliated companies permits investors not only to place
their money with the management team of their choice, but to direct their money to the markets and
industries in which particular subsidiaries specialise and which investors believe hold the greatest potential
for profits. On the other hand, by spreading operations across companies that have different pools of noncontrolling shareholders, controlling insiders invariably create tensions and conflicts when deciding how
to allocate capital and business opportunities among these companies (OECD 2011, p. 44).
QUESTION 3.15
Outline the benefits and costs of the family-based insider system of corporate governance
practised in Asia.
SUMMARY
Corporate governance practices change over time. In particular corporate collapses and financial crises tend
to trigger changes in rules and regulations that apply to the governance of corporations. Such changes in
recent decades have included legislative measures to tighten regulation of directors and other company
officers. One example of this is the Sarbanes–Oxley Act that was introduced in the US to improve
governance practices following the collapse of Enron and the implosion of major accounting firm Arthur
Andersen. Individually the UK and Australia developed guidance to ensure their regulatory literature had
some parity or similarity with the work done in the US.
The US, UK, Australia and New Zealand have market-based systems of corporate governance in which
shareholder interests have primacy. Various European and Asian countries have relationship-based systems
of corporate governance reflecting each country’s own cultures and financial traditions.
The European model of corporate governance tends to emphasise cooperation and consensus, in
contrast with the market-based system that emphasises competition. The European model places greater
importance on recognising the interests of a wider range of stakeholders, including communities, workers
and customers. Investment tends to be relatively stable compared to the market-based systems and thus
companies are generally less subject to the consequences of share market movements.
The Asian relationship-based model is based on the tradition of strong, close and personal relationships
between stakeholders, including owners, creditors, suppliers and customers, and even extending in some
cases to regulators. These close relationships can be seen to hinder transparency and accountability. The
1997 Asian financial crisis and GFC prompted reforms which are still underway, but involve increased
accountability and transparency, greater independence for regulators and developing a more robust form
of corporate governance.
The key points covered in this part, and the learning objective they align to, are listed below.
KEY POINTS
3.7 Explain the various international approaches to corporate governance.
• Market-based systems of corporate governance have shareholder interests as the primary focus
of company law. They are characterised by widespread equity ownership among individuals
and institutional investors, an emphasis on minority shareholder protection in securities law and
regulation and stringent disclosure requirements.
• Market-based systems exist in the USA, UK, Australia and New Zealand.
• Relationship-based systems of corporate governance recognise a wider range of stakeholder
interests, including those of workers, customers, banks, other companies, communities and
governments.
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• The European relationship-based model emphasises cooperation over competition and investment
in companies tends to be more stable than in market-based systems.
• The Asian relationship-based model is based on close relationships between stakeholders. These
relationships can hinder transparency and accountability and corporate governance practices in Asia
have been changing since the 1997 Asian financial crisis and GFC.
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PART D: CODES AND GUIDANCE
INTRODUCTION
Earlier in the module, we discussed a framework for corporate governance, what constitutes good corporate
governance, recent changes in corporate governance, including associated regulation and guidance, and
different international approaches to corporate governance.
In this part of the module we will firstly consider the international best practice principles of corporate
governance issued by the OECD. Then we will look at two of the corporate governance codes that have been
developed from these principles, namely the FRC’s Code for the UK and the ASX Corporate Governance
Council’s Code for Australia.
It is important to understand and be able to apply the central principles underlying these codes, but it is
not necessary to memorise every clause.
3.9 OECD PRINCIPLES OF CORPORATE
GOVERNANCE
The OECD, with members and funding sources from countries with major market-orientated economies,
has developed international best practice principles of governance. The OECD Principles of Corporate
Governance (OECD Principles), were first published in 1999 and were updated in 2004 with a new first
principle giving a broad view of governance including performance. A review of these principles started
in 2014 and, following extensive consultation, the updated principles were released in September 2015,
entitled G20/OECD Principles of Corporate Governance (OECD 2015).
The OECD Principles are general or principles based. The OECD Principles are ‘good practice
guidelines’ and are not written for companies or directors. They are written so that governments writing
detailed laws relevant to individual nations will have a framework that provides sound guidance. They
are also valuable for ensuring that corporate governance guidelines developed by various agencies are
consistent with the OECD Principles. The OECD Principles can also be used as a guidance framework for
profit-seeking businesses and NFP organisations.
The OECD Principles specify six principles relating to:
I.
II.
III.
IV.
V.
VI.
ensuring the basis for an effective corporate governance framework
the rights and equitable treatment of shareholders and key ownership functions
institutional investors, stock markets, and other intermediaries
the role of stakeholders in corporate governance
disclosure and transparency
the responsibilities of the board.
In the discussion that follows we introduce each principle with its sub-principles.
PRINCIPLE I. ENSURING THE BASIS FOR AN EFFECTIVE
CORPORATE GOVERNANCE FRAMEWORK
The corporate governance framework should promote transparent and fair markets, and the efficient
allocation of resources. It should be consistent with the rule of law and support effective supervision and
enforcement (OECD 2015, p. 13).
A. The corporate governance framework should be developed with a view to its impact on overall economic
performance, market integrity and the incentives it creates for market participants and the promotion of
transparent and well-functioning markets.
B. The legal and regulatory requirements that affect corporate governance practices should be consistent
with the rule of law, transparent and enforceable.
C. The division of responsibilities among different authorities should be clearly articulated and designed
to serve the public interest.
D. Stock market regulation should support effective corporate governance.
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E. Supervisory, regulatory and enforcement authorities should have the authority, integrity and resources
to fulfil their duties in a professional and objective manner. Moreover, their rulings should be timely,
transparent and fully explained.
F. Cross-border co-operation should be enhanced, including through bilateral and multilateral arrangements for exchange of information.
Source: OECD 2015, G20/OECD Principles of Corporate Governance, OECD Publishing, Paris, pp. 14–17, accessed October 2015,
www.oecd.org/daf/ca/Corporate-Governance-Principles-ENG.pdf.
As the OECD advises governments on corporate governance, its focus here is on macro performance at
the market level. This acknowledges that the appropriate mix of legislation, regulation, self-regulation and
voluntary standards will vary across jurisdictions.
PRINCIPLE II. THE RIGHTS AND EQUITABLE TREATMENT OF
SHAREHOLDERS AND KEY OWNERSHIP FUNCTIONS
The corporate governance framework should protect and facilitate the exercise of shareholders’ rights
and ensure the equitable treatment of all shareholders, including minority and foreign shareholders. All
shareholders should have the opportunity to obtain effective redress for violation of their rights (OECD
2015, p. 18).
A. Basic shareholder rights should include the right to: 1) secure methods of ownership registration;
2) convey or transfer shares; 3) obtain relevant and material information on the corporation on a timely
and regular basis; 4) participate and vote in general shareholder meetings; 5) elect and remove members
of the board; and 6) share in the profits of the corporation.
B. Shareholders should be sufficiently informed about, and have the right to approve or participate in,
decisions concerning fundamental corporate changes such as: 1) amendments to the statutes, or articles
of incorporation or similar governing documents of the company; 2) the authorisation of additional
shares; and 3) extraordinary transactions, including the transfer of all or substantially all assets, that in
effect result in the sale of the company.
C. Shareholders should have the opportunity to participate effectively and vote in general shareholder
meetings and should be informed of the rules, including voting procedures, that govern general
shareholder meetings.
1. Shareholders should be furnished with sufficient and timely information concerning the date,
location and agenda of general meetings, as well as full and timely information regarding the issues
to be decided at the meeting.
2. Processes and procedures for general shareholder meetings should allow for equitable treatment of
all shareholders. Company procedures should not make it unduly difficult or expensive to cast votes.
3. Shareholders should have the opportunity to ask questions to the board, including questions relating
to the annual external audit, to place items on the agenda of general meetings, and to propose
resolutions, subject to reasonable limitations.
4. Effective shareholder participation in key corporate governance decisions, such as the nomination
and election of board members, should be facilitated. Shareholders should be able to make their
views known, including through votes at shareholder meetings, on the remuneration of board
members and/or key executives, as applicable. The equity component of compensation schemes
for board members and employees should be subject to shareholder approval.
5. Shareholders should be able to vote in person or in absentia, and equal effect should be given to
votes whether cast in person or in absentia.
6. Impediments to cross border voting should be eliminated.
D. Shareholders, including institutional shareholders, should be allowed to consult with each other on
issues concerning their basic shareholder rights as defined in the Principles, subject to exceptions to
prevent abuse.
E. All shareholders of the same series of a class should be treated equally. Capital structures and
arrangements that enable certain shareholders to obtain a degree of influence or control disproportionate
to their equity ownership should be disclosed.
1. Within any series of a class, all shares should carry the same rights. All investors should be able to
obtain information about the rights attached to all series and classes of shares before they purchase.
Any changes in economic or voting rights should be subject to approval by those classes of shares
which are negatively affected.
2. The disclosure of capital structures and control arrangements should be required.
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F. Related-party transactions should be approved and conducted in a manner that ensures proper management of conflict of interest and protects the interest of the company and its shareholders.
1. Conflicts of interest inherent in related-party transactions should be addressed.
2. Members of the board and key executives should be required to disclose to the board whether they,
directly, indirectly or on behalf of third parties, have a material interest in any transaction or matter
directly affecting the corporation.
G. Minority shareholders should be protected from abusive actions by, or in the interest of, controlling
shareholders acting either directly or indirectly, and should have effective means of redress. Abusive
self-dealing should be prohibited.
H. Markets for corporate control should be allowed to function in an efficient and transparent manner.
1. The rules and procedures governing the acquisition of corporate control in the capital markets, and
extraordinary transactions such as mergers, and sales of substantial portions of corporate assets,
should be clearly articulated and disclosed so that investors understand their rights and recourse.
Transactions should occur at transparent prices and under fair conditions that protect the rights of
all shareholders according to their class.
2. Anti-take-over devices should not be used to shield management and the board from accountability.
Source: OECD 2015, G20/OECD Principles of Corporate Governance, OECD Publishing, Paris, accessed October 2015,
www.oecd.org/daf/ca/Corporate-Governance-Principles-ENG.pdf.
Within companies, shareholders are considered to be important stakeholders. Principle II concerns the
protection of shareholders’ rights and the ability of shareholders to influence the behaviour of corporations.
It lists some basic rights including obtaining relevant information, sharing in residual profits, participating
in basic decisions, fair and transparent treatment during changes of control and the fair operation of voting
rights. Shareholders, as the legal owners of corporations, should expect to be able to enjoy these rights in
all jurisdictions.
This principle emphasises that all shareholders, including minority and foreign shareholders, should
be treated equitably by controlling shareholders, boards and management. Transparency is required with
respect to distribution of voting rights and the way that voting rights are exercised. Insider trading and
abusive self-dealing are prohibited. There should be appropriate disclosure of all material interests that
managers and directors have in transactions or matters affecting the corporation.
PRINCIPLE III. INSTITUTIONAL INVESTORS, STOCK
MARKETS, AND OTHER INTERMEDIARIES
The corporate governance framework should provide sound incentives throughout the investment chain and
provide for stock markets to function in a way that contributes to good corporate governance (OECD 2015,
p. 29).
A. Institutional investors acting in a fiduciary capacity should disclose their corporate governance and
voting policies with respect to their investments, including the procedures that they have in place for
deciding on the use of their voting rights.
B. Votes should be cast by custodians or nominees in line with the directions of the beneficial owner of the
shares.
C. Institutional investors acting in a fiduciary capacity should disclose how they manage material conflicts
of interest that may affect the exercise of key ownership rights regarding their investments.
D. The corporate governance framework should require that proxy advisors, analysts, brokers, rating
agencies and others that provide analysis or advice relevant to decisions by investors, disclose and
minimise conflicts of interest that might compromise the integrity of their analysis or advice.
E. Insider trading and market manipulation should be prohibited and the applicable rules enforced.
F. For companies who are listed in a jurisdiction other than their jurisdiction of incorporation, the applicable
corporate governance laws and regulations should be clearly disclosed. In the case of cross listings,
the criteria and procedure for recognising the listing requirements of the primary listing should be
transparent and documented.
G. Stock markets should provide fair and efficient price discovery as a means to help promote effective
corporate governance.
Source: OECD 2015, G20/OECD Principles of Corporate Governance, OECD Publishing, Paris, pp. 32–35, accessed October 2015,
www.oecd.org/daf/ca/Corporate-Governance-Principles-ENG.pdf.
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In many jurisdictions, the reality of corporate governance and ownership is no longer characterised by a
straight relationship between the performance of the company and the income of the ultimate beneficiaries.
In reality, the investment chain is often complex, with numerous intermediaries between the company and
the ultimate beneficiary. The Principle III recommends that institutional investors disclose their corporate
governance policies. Shareholder engagement is also noted to take various forms from voting at shareholder
meetings to direct contact and dialogue with the board and management.
PRINCIPLE IV. THE ROLE OF STAKEHOLDERS IN
CORPORATE GOVERNANCE
The corporate governance framework should recognise the rights of stakeholders established by law or
through mutual agreements and encourage active co-operation between corporations and stakeholders in
creating wealth, jobs, and the sustainability of financially sound enterprises (OECD 2015, p. 34).
A. The rights of stakeholders that are established by law or through mutual agreements are to be respected.
B. Where stakeholder interests are protected by law, stakeholders should have the opportunity to obtain
effective redress for violation of their rights.
C. Mechanisms for employee participation should be permitted to develop.
D. Where stakeholders participate in the corporate governance process, they should have access to relevant,
sufficient and reliable information on a timely and regular basis.
E. Stakeholders, including individual employees and their representative bodies, should be able to freely
communicate their concerns about illegal or unethical practices to the board and to the competent public
authorities and their rights should not be compromised for doing this.
F. The corporate governance framework should be complemented by an effective, efficient insolvency
framework and by effective enforcement of creditor rights.
Source: OECD 2015, G20/OECD Principles of Corporate Governance, OECD Publishing, Paris, p. 37, accessed October 2015,
www.oecd.org/daf/ca/Corporate-Governance-Principles-ENG.pdf.
The OECD sees duties to stakeholders as an important and integral part of corporate governance. In
some countries, stakeholders who are not shareholders have significant influence (e.g. banks are involved
in Japanese companies and employees in German companies).
Under Anglo-American legal approaches, companies are run for shareholders, being the owners
of the companies, with the duty to stakeholders being a derivative of this primary duty. Under the
stakeholder model, there are arguably ‘direct duties’ to stakeholders, but the OECD recognises that duties
to stakeholders are only valid if also balanced against the duties and rights of shareholders (see Principle II).
The differences between ‘shareholder models’ and ‘stakeholder models’ are largely theoretical
in the global corporate world. We will consider this further when we explore the FRC Code and the
ASX Principles.
In developed economies where various stakeholders’ interests are protected by general community
laws (e.g. laws of contract, labour laws, health and safety laws, environmental laws) stakeholders’
rights may need little additional attention to satisfy OECD Principles. In less developed economies it
may be that corporations will have extra requirements imposed on them under the OECD Principles.
This is consistent with the ambition of the OECD that its guidelines should lead to improvements to
economies internationally.
PRINCIPLE V. DISCLOSURE AND TRANSPARENCY
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 (OECD 2015, p. 37).
A. Disclosure should include, but not be limited to, material information on:
1. The financial and operating results of the company.
2. Company objectives and non-financial information.
3. Major share ownership, including beneficial owners, and voting rights.
4. Remuneration of members of the board and key executives.
5. Information about board members, including their qualifications, the selection process, other
company directorships and whether they are regarded as independent by the board.
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174 Ethics and Governance
6.
7.
8.
9.
B.
C.
D.
E.
Related party transactions.
Foreseeable risk factors.
Issues regarding employees and other stakeholders.
Governance structures and policies, including the content of any corporate governance code or policy
and the process by which it is implemented.
Information should be prepared and disclosed in accordance with high quality standards of accounting
and financial and non-financial reporting.
An annual audit should be conducted by an independent, competent and qualified, auditor in accordance
with high-quality auditing standards in order to provide an external and objective assurance to the board
and shareholders that the financial statements fairly represent the financial position and performance of
the company in all material respects.
External auditors should be accountable to the shareholders and owe a duty to the company to exercise
due professional care in the conduct of the audit.
Channels for disseminating information should provide for equal, timely and cost-efficient access to
relevant information by users.
Source: OECD 2015, G20/OECD Principles of Corporate Governance, OECD Publishing, Paris, pp. 42–49, accessed
October 2015, www.oecd.org/daf/ca/Corporate-Governance-Principles-ENG.pdf.
In economies where freedom of accurate information and disclosure have not traditionally been
practised, the impact of Principle V will be immediately obvious.
PRINCIPLE VI. THE RESPONSIBILITIES OF THE BOARD
The corporate governance framework should ensure the strategic guidance of the company, the
effective monitoring of management by the board, and the board’s accountability to the company and
the shareholders (OECD 2015, p. 45).
A. Board members should act on a fully informed basis, in good faith, with due diligence and care, and in
the best interest of the company and the shareholders.
B. Where board decisions may affect different shareholder groups differently, the board should treat all
shareholders fairly.
C. The board should apply high ethical standards. It should take into account the interests of stakeholders.
D. The board should fulfil certain key functions, including:
1. Reviewing and guiding corporate strategy, major plans of action, risk management policies and
procedures, annual budgets and business plans; setting performance objectives; monitoring implementation and corporate performance; and overseeing major capital expenditures, acquisitions and
divestitures.
2. Monitoring the effectiveness of the company’s governance practices and making changes as needed.
3. Selecting, compensating, monitoring and, when necessary, replacing key executives and overseeing
succession planning.
4. Aligning key executive and board remuneration with the longer term interests of the company and
its shareholders.
5. Ensuring a formal and transparent board nomination and election process.
6. Monitoring and managing potential conflicts of interest of management, board members and
shareholders, including misuse of corporate assets and abuse in related party transactions.
7. Ensuring the integrity of the corporation’s accounting and financial reporting systems, including the
independent audit, and that appropriate systems of control are in place, in particular, systems for risk
management, financial and operational control, and compliance with the law and relevant standards.
8. Overseeing the process of disclosure and communications.
E. The board should be able to exercise objective independent judgement on corporate affairs.
1. Boards should consider assigning a sufficient number of non-executive board members capable
of exercising independent judgement to tasks where there is a potential for conflict of interest.
Examples of such key responsibilities are ensuring the integrity of financial and non-financial
reporting, the review of related party transactions, nomination of board members and key executives,
and board remuneration.
2. Boards should consider setting up specialised committees to support the full board in performing
its functions, particularly in respect to audit, and, depending upon the company’s size and risk
profile, also in respect to risk management and remuneration. When committees of the board
are established, their mandate, composition and working procedures should be well defined and
disclosed by the board.
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3. Board members should be able to commit themselves effectively to their responsibilities.
4. Boards should regularly carry out evaluations to appraise their performance and assess whether they
possess the right mix of background and competences.
F. In order to fulfil their responsibilities, board members should have access to accurate, relevant and timely
information.
G. When employee representation on the board is mandated, mechanisms should be developed to facilitate
access to information and training for employee representatives, so that this representation is exercised
effectively and best contributes to the enhancement of board skills, information and independence.
Source: OECD 2015, G20/OECD Principles of Corporate Governance, OECD Publishing, Paris, pp. 52–61, accessed
October 2015, www.oecd.org/daf/ca/Corporate-Governance-Principles-ENG.pdf.
This principle states the OECD’s basic view on the board and its responsibilities. As a document for
global consumption, it states a series of general requirements but does not provide a detailed analysis of
the type we will see when we look at the UK FRC Corporate Governance Code or at the ASX corporate
governance guidelines.
QUESTION 3.16
Refer back to Principle II and discuss the potential for conflict between sub-principles A4 and G.
QUESTION 3.17
Evaluate the following case study using the OECD Principles.
Sweet Dreams Ltd is a technology company that is developing natural organic sleeping pills for
people who have trouble sleeping. The company has been listed for one year and has:
• established a board of directors made up of executive and non-executive directors. The two nonexecutive directors include a major potential customer who works closely with the company, and
a major shareholder who has asked for a board position to monitor their investment closely
• required shareholders who purchased shares in the initial public offering to purchase and hold
shares for at least two years — the explanation for this requirement is that the company wants
to ensure a stable position on the stock market while it establishes itself in the marketplace
• announced that, to prevent a takeover by one of its competitors (resulting in it either being shut
down or its intellectual property being taken), it has created contracts with senior management
that will see them paid $20 million each if such a takeover occurs.
Outline three actions in the case study that create issues in relation to the OECD Principles.
3.10 UK FINANCIAL REPORTING COUNCIL
CORPORATE GOVERNANCE CODE
The UK FRC Corporate Governance Code, which was amended in 2018, demonstrates the way that
governance has developed in most jurisdictions using the Anglo-American model. Under this model,
company law developed in conjunction with common law principles. The first modern joint stock
companies (i.e. with shares) were formed in the 1860s under the very simple Companies Acts. Inevitable
gaps in the law were filled by the courts as litigation on particular issues arose.
The principles in the UK Code follow in the traditional of guidance that is not legislated but its
authority is persuasive because they are generally accepted as the guidance companies should follow when
considering board appointments, structure of committees, risk management and remuneration matters
amongst others.
The Code has a series of changes that were introduced in 2018 and these include the following.
• Workforce and stakeholders. There is a new provision to enable greater board engagement with the
workforce to understand their views. The Code asks boards to describe how they have considered the
interests of stakeholders when performing their duty under Section 172 of the 2006 Companies Act.
• Culture. Boards are asked to create a culture which aligns company values with strategy and to assess
how they preserve value over the long-term.
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176 Ethics and Governance
• Succession and diversity. To ensure that the boards have the right mix of skills and experience,
constructive challenge and promote diversity, the new Code emphasises the need to refresh boards
and undertake succession planning. Boards should consider the length of term that chairs remain in
post beyond nine years. The new Code strengthens the role of the nomination committee on succession
planning and establishing a diverse board. It identifies the importance of external board evaluation for
all companies. Nomination committee reports should include details of the contact the external board
evaluator has had with the board and individual directors.
• Remuneration. To address public concern over executive remuneration, the new Code emphasises that
remuneration committees should take into account workforce remuneration and related policies when
setting director remuneration. Importantly formulaic calculations of performance-related pay should be
rejected. Remuneration committees should apply discretion when the resulting outcome is not justified.
The changes were added to reflect more-contemporary perspectives on issues such as diversity on boards
and other issues. Example 3.10 is a letter from the UK FRC chairman, outlining the changes made with
the introduction of the 2018 UK Corporate Governance Code.
EXAMPLE 3.10
Letter to Company Chairs
Letter to Company Chairmen from Sir Winifried Bischoff, the UK FRC Chairman
July 2018
Dear Company Chair
The FRC has published the new 2018 UK Corporate Governance Code. This is a result of a substantial
outreach and consultation and we thank respondents for their contributions.
Over 26 years the Code has improved standards of practice and reporting on governance. The UK has
a strong reputation in this field of which we should be proud. But this reputation is tarnished when we
see corporate collapses accompanied by poor governance and conduct. Such events harm public trust
in business and deter investment.
The 2018 Code has substantially evolved and builds on the progress we have made to improve the
quality of governance in the UK. There are significant changes to its structure and content. It is shorter
and sharper, there is a renewed emphasis on the Principles and there are fewer Provisions. The new Code
takes a broader view of governance and emphasises the importance of a healthy corporate culture and
constructive relations with a wider range of stakeholders in delivering long-term sustainable success.
By reporting on the application of the Principles in a manner that can be evaluated, companies should
demonstrate how the governance of the company contributes to its long-term sustainable success and
achieves wider objectives. This statement should cover the application of the Principles in the context
of the particular circumstances of the company, how the board has set the company’s purpose and
strategy, met objectives and achieved outcomes through its decisions. High-quality reporting will include
signposting and cross-referencing to other relevant parts of the annual report.
The effective application of the Principles should be supported by high-quality reporting on the more
detailed Provisions. Companies should avoid a tick-box approach. An alternative to complying with
a Provision may be justified in particular circumstances. Explanations are a positive opportunity to
communicate, not onerous obligation. These should set out the background and provide a clear rationale
for the action the company is taking.
We are writing to other parties involved in making the Code a success. Before it comes into force, we
will be working with stakeholders to embed the Code and enable the improvements in governance we all
wish to see. After the introduction of the 2018 Code we intend to escalate our monitoring of practice and
reporting.
The FRC’s mission is to promote transparency and integrity in business. We look forward to continuing to
work with you so that we can ensure a strong flow of investment into successful UK companies, delivering
long-term growth which supports a prosperous economy and society.
Source: ‘Open letter to Company Chairs from Sir Winifried Bischoff’, FRC, July 2018, www.frc.org.uk/
getattachment/d067c1e6-6890-4a67-8160-4de53fa2dfda/Open-letter-from-Sir-Win-to-company-chairs-about-2018-CodeJuly-2018.pdf.
............................................................................................................................................................................
CONSIDER THIS
Read the letter above and identify the approach that the UK FRC chairman says companies must avoid when
drafting disclosures meant for users of their annual reports and other statements.
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Study Appendix 3.1 and answer questions 3.18 and 3.19.
QUESTION 3.18
Under the UK FRC Corporate Governance Code:
(a) Who is responsible for reviewing a company’s internal controls?
(b) How often should a board undertake a formal evaluation of its own performance?
(c) Outline whether a chief executive may also be the chair. Suggest reasons why the FRC Code
has taken this view.
QUESTION 3.19
Review the following scenario.
A large listed company has a board of directors with seven members.
• The chair is a non-executive director who holds a 25% shareholding in the company.
• Four of the members are executive directors including the CEO and the CFO.
• The board has one subcommittee — an audit committee with three members. This includes the
chair, an independent director and the CFO, who is able to provide specific information about
the company.
Outline areas where this structure does not comply with components of the FRC Code that are
outlined in Appendix 3.1.
3.11 ASX CORPORATE GOVERNANCE COUNCIL’S
PRINCIPLES AND RECOMMENDATIONS
The fourth edition of the ASX Principles is effective from 1 January 2020 (ASX CGC 2019). One important
change in the more recent versions of these recommendations relates to gender balance on the board
of directors. Another change in later versions compared to the earlier versions relates to membership
recommendations for the remuneration committee — and these are linked to mandatory requirements of
new ASX Listing Rules, which apply to certain larger companies.
There are eight broad principles, which are supported by 35 main recommendations and three additional
recommendations. The eight principles are:
1. Lay solid foundations for management and oversight: A listed entity should clearly delineate the respective roles and responsibilities of its board and management and regularly review their performance.
2. Structure the board to be effective and add value: The board of a listed entity should be of an appropriate
size and collectively have the skills, commitment and knowledge of the entity and the industry in which
it operates, to enable it to discharge its duties effectively and to add value.
3. Instil a culture of acting lawfully, ethically and responsibly: A listed entity should instil and continually
reinforce a culture across the organisation of acting lawfully, ethically and responsibly.
4. Safeguard the integrity of corporate reports: A listed entity should have appropriate processes to verify
the integrity of its corporate reports.
5. Make timely and balanced disclosure: A listed entity should make timely and balanced disclosure of
all matters concerning it that a reasonable person would expect to have a material effect on the price or
value of its securities.
6. Respect the rights of security holders: A listed entity should provide its security holders with appropriate
information and facilities to allow them to exercise their rights as security holders effectively.
7. Recognise and manage risk: A listed entity should establish a sound risk management framework and
periodically review the effectiveness of that framework.
8. Remunerate fairly and responsibly: A listed entity should pay director remuneration sufficient to attract
and retain high quality directors and design its executive remuneration to attract, retain and motivate
high quality senior executives and to align their interests with the creation of value for security holders
and with the entity’s values and risk appetite (ASX CGC 2019).
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178 Ethics and Governance
These specific principles often need to be applied to particular sets of case facts, so a thorough
understanding of them is required. These principles are recommended for implementation in specific
ways — just as was the case in the UK — although the Australian principles are a little different as are
the Australian implementation recommendations. Further discussion of each of the core principles and
recommendations of the ASX Principles follows.
UNDERSTANDING THE ASX PRINCIPLES
A literal approach to applying the recommendations of the ASX Principles is not appropriate. Even where
detailed guidance is given, the spirit of the ASX Principles remains vital. This means that compliance
with a detailed guidance item is meaningless if it is accompanied by other actions that ignore the spirit of
good governance. This framework approach is consistent with the OECD approach and the thrust of the
FRC Code as applied both in its UK context and its international context.
In fact, all ASX corporate governance principles and recommendations for listed companies apply
on the ‘if not, why not’ approach. This concept is similar to the ‘comply or explain’ approach in the
UK FRC Code. It operates so that non-compliance is generally permitted as long as this non-compliance
is identified and explained in the company’s corporate governance statement which is disclosed in its
annual report or on its website.
QUESTION 3.20
Choose a company that is listed on the ASX and review its disclosures on corporate governance
as you read through the principles and recommendations. Track the company’s disclosures in their
corporate governance statement and note where it complies with the corporate governance rules
and where you believe they fall short. The purpose of this exercise is to observe how a listed
company implements these guidelines.
THE ASX PRINCIPLES AND RECOMMENDATIONS
Principle 1 — Lay Solid Foundations for Management and Oversight
A listed entity should clearly delineate the respective roles and responsibilities of its board and management
and regularly review their performance
Recommendation 1.1
A listed entity should have and disclose a board charter setting out:
(a) the respective roles and responsibilities of its board and management; and
(b) those matters expressly reserved to the board and those delegated to management.
…
Recommendation 1.2
A listed entity should:
(a) undertake appropriate checks before appointing a director or senior executive or putting someone
forward for election as a director; and
(b) provide security holders with all material information in its possession relevant to a decision on whether
or not to elect or re-elect a director.
…
Recommendation 1.3
A listed entity should have a written agreement with each director and senior executive setting out the terms
of their appointment.
…
Recommendation 1.4
The company secretary of a listed entity should be accountable directly to the board, through the chair, on
all matters to do with the proper functioning of the board.
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…
MODULE 3 Governance Concepts 179
Recommendation 1.5
A listed entity should:
(a) have and disclose a diversity policy;
(b) through its board or a committee of the board set measurable objectives for achieving gender diversity
in the composition of its board, senior executives and workforce generally; and
(c) disclose in relation to each reporting period:
(1) the measurable objectives set for that period to achieve gender diversity;
(2) the entity’s progress towards achieving those objectives; and
(3) either:
(A) the respective proportions of men and women on the board, in senior executive positions and
across the whole workforce (including how the entity has defined “senior executive” for these
purposes); or
(B) if the entity is a “relevant employer” under the Workplace Gender Equality Act, the entity’s
most recent “Gender Equality Indicators”, as defined in and published under that Act.
If the entity was in the S&P/ASX 300 Index at the commencement of the reporting period, the measurable
objective for achieving gender diversity in the composition of its board should be to have not less than 30%
of its directors of each gender within a specified period.
…
Recommendation 1.6
A listed entity should:
(a) have and disclose a process for periodically evaluating the performance of the board, its committees
and individual directors; and
(b) disclose for each reporting period whether a performance evaluation has been undertaken in accordance
with that process during or in respect of that period.
…
Recommendation 1.7
A listed entity should:
(a) have and disclose a process for evaluating the performance of its senior executives at least once every
reporting period; and
(b) disclose for each reporting period whether a performance evaluation has been undertaken in accordance
with that process during or in respect of that period.
Source: ASX CGC 2019, ‘Corporate Governance Principles and Recommendations’, 4th edn, pp. 6–11. © Copyright 2019 ASX
Corporate Governance Council.
In relation to Recommendation 1.6 the Governance Institute of Australia has published a Good
Governance Guide: Issues to consider in board evaluations. This is available at: www.asx.com.au/documents
/asx-compliance/issues-to-consider-in-board-evaluations.pdf.
Principle 2 — Structure the Board to be Effective and 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.
Recommendation 2.1
The board of a listed entity should:
(a) have a nomination committee which:
(1) has at least three members, a majority of whom are independent directors; and
(2) is chaired by an independent director,
and disclose:
(3) the charter of the committee;
(4) the members of the committee; and
(5) as at the end of each reporting period, the number of times the committee met throughout the period
and the individual attendances of the members at those meetings; or
(b) if it does not have a nomination committee, disclose that fact and the processes it employs to address
board succession issues and to ensure that the board has the appropriate balance of skills, knowledge, experience, independence and diversity to enable it to discharge its duties and responsibilities
effectively.
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…
180 Ethics and Governance
Recommendation 2.2
A listed entity should have and disclose a board skills matrix setting out the mix of skills that the board
currently has or is looking to achieve in its membership.
…
Recommendation 2.3
A listed entity should disclose:
(a) the names of the directors considered by the board to be independent directors;
(b) if a director has an interest, position or relationship of the type described in Box 2.3 but the board is
of the opinion that it does not compromise the independence of the director, the nature of the interest,
position or relationship in question and an explanation of why the board is of that opinion; and
(c) the length of service of each director.
…
Recommendation 2.4
A majority of the board of a listed entity should be independent directors.
…
Recommendation 2.5
The chair of the board of a listed entity should be an independent director and, in particular, should not be
the same person as the CEO of the entity.
…
Recommendation 2.6
A listed entity should have a program for inducting new directors and for periodically reviewing whether
there is a need for existing directors to undertake professional development to maintain the skills and
knowledge needed to perform their role as directors effectively.
Source: ASX CGC 2019, Corporate Governance Principles and Recommendations, 4th edn, pp. 12–15,. © Copyright 2019 ASX
Corporate Governance Council.
In relation to Recommendation 2.2 the Governance Institute of Australia has published a Good Governance Guide: Creating and disclosing a board skills matrix. This is available at: www.asx.com.au/documents
/asx-compliance/creating-disclosing-board-skills-matrix.pdf.
The recommendations of the ASX Corporate Governance Council are expanded on and supplemented
by materials published by other organisations. These organisations include:
• Governance Council of Australia, www.governanceinstitute.com.au
• Australian Institute of Company Directors (AICD), https://aicd.companydirectors.com.au
Boxes highlighting specific issues are also provided among the recommendations and principles.
For example, figure 3.5 shows Box 2.3, which was referred to in an earlier question and is linked to
Recommendation 2.3.
FIGURE 3.5
Factors relevant to assessing the independence of a director
Box 2.3: Factors Relevant to Assessing the Independence of a Director
Examples of interests, positions, associations and relationships that might cause doubts about the
independence of a director include if the director:
• is, or has been, employed in an executive capacity by the entity or any of its child entities and there has
not been a period of at least three years between ceasing such employment and serving on the board;
• is, or has within the last three years been, a partner, director or senior employee of a provider of material
professional services to the entity or any of its child entities;
• is, or has been within the last three years, in a material business relationship (e.g. as a supplier or
customer) with the entity or any of its child entities, or an officer of, or otherwise associated with,
someone with such a relationship;
• is a substantial security holder of the entity or an officer of, or otherwise associated with, a substantial
security holder of the entity;
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MODULE 3 Governance Concepts 181
• has a material contractual relationship with the entity or its child entities other than as a director;
• has close family ties with any person who falls within any of the categories described above; or
• has been a director of the entity for such a period that his or her independence may have been
compromised.
In each case, the materiality of the interest, position, association or relationship needs to be assessed to
determine whether it might interfere, or might reasonably be seen to interfere, with the director’s 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.
Source: ASX CGC 2019, Corporate Governance Principles and Recommendations, 4th edn, p. 14 © Copyright 2019 ASX
Corporate Governance Council.
One way to enhance company behaviour is to create formal codes of conduct. If these are carefully
considered and well-constructed, they will provide a far stronger basis for the implementation of good
business ethics. From that point of view, it will be necessary to ensure all staff are trained appropriately
in the ethical code of business conduct and then to ensure that the code is maintained and developed as
necessary according to business and environment changes.
Principle 3 — Instil a Culture of Acting Lawfully, Ethically and Responsibly
A listed entity should instil and continually reinforce a culture across the organisation of acting lawfully,
ethically and responsibly.
Recommendation 3.1
A listed entity should articulate and disclose its values.
...
Recommendation 3.2
A listed entity should:
(a) have and disclose a code of conduct for its directors, senior executives and employees; and
(b) ensure that the board or a committee of the board is informed of any material breaches of that code.
…
Recommendation 3.3
A listed entity should:
(a) have and disclose a whistleblower policy; and
(b) ensure that the board or a committee of the board is informed of any material incidents reported under
that policy.
…
Recommendation 3.4
A listed entity should:
(a) have and disclose an anti-bribery and corruption policy; and
(b) ensure that the board or a committee of the board is informed of any material breaches of that policy.
Source: ASX CGC 2019, Corporate Governance Principles and Recommendations, 4th edn, pp. 16–18 © Copyright 2019 ASX
Corporate Governance Council.
.......................................................................................................................................................................................
CONSIDER THIS
Refer to the ASX’s Corporate Governance Principles and Recommendations. If the organisation that you work for is
a listed company, compare your company’s whistleblower policy with the ASX’s suggestions in Box 3.3.
See link at: www.asx.com.au/documents/regulation/cgc-principles-and-recommendations-fourth-edn.pdf.
Principle 4 — Safeguard the Integrity of Corporate Reports
A listed entity should have formal and rigorous processes that independently verify and safeguard the
integrity of its corporate reporting.
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182 Ethics and Governance
Recommendation 4.1
The board of a listed entity should:
(a) have an audit committee which:
(1) has at least three members, all of whom are nonexecutive directors and a majority of whom are
independent directors; and
(2) is chaired by an independent director, who is not the chair of the board,
and disclose:
(3) the charter of the committee;
(4) the relevant qualifications and experience of the members of the committee; and
(5) in relation to each reporting period, the number of times the committee met throughout the period
and the individual attendances of the members at those meetings; or
(b) if it does not have an audit committee, disclose that fact and the processes it employs that independently
verify and safeguard the integrity of its corporate reporting, including the processes for the appointment
and removal of the external auditor and the rotation of the audit engagement partner.
…
Recommendation 4.2
The board of a listed entity should, before it approves the entity’s financial statements for a financial
period, receive from its CEO and CFO a declaration that, in their opinion, the financial records of the entity
have been properly maintained and that the financial statements comply with the appropriate accounting
standards and give a true and fair view of the financial position and performance of the entity and that the
opinion has been formed on the basis of a sound system of risk management and internal control which is
operating effectively.
…
Recommendation 4.3
A listed entity should disclose its process to verify the integrity of any periodic corporate report48 it releases
to the market that is not audited or reviewed by an external auditor.
Source: ASX CGC 2019, ‘Corporate Governance Principles and Recommendations’, 4th edn, pp. 19–20 © Copyright 2019 ASX
Corporate Governance Council.
Under the ASX Listing Rules, audit committees are compulsory for all companies listed in the top 500
(Standard & Poor’s listing of the ASX) according to market capitalisation (i.e. total market value of the
shares). The Sarbanes–Oxley Act and the FRC Code both require at least one financial person on the board.
The ASX’s Recommendation 4.1 states:
The audit committee should be of sufficient size and independence, and its members between them should
have the accounting and financial expertise and a sufficient understanding of the industry in which the
entity operates, to be able to discharge the committee’s mandate effectively.
Arguably, it would be a poor board structure that did not select people with appropriate skills. One of
the greatest failures a true professional can make is to accept duties that are not within their capabilities.
It is strongly arguable that a director who, without appropriate skills, takes a place on an audit committee
would be making a negligent ‘business judgment’. Negligent business judgments can result in significant
legal difficulties for a director (and perhaps for the entire board) who act in this way.
Another feature of the Sarbanes–Oxley requirements that contrasts with the ASX Principles is that all
members of the audit committee must be independent at all times according to strict criteria. Furthermore,
Sarbanes–Oxley mandates that the primary external auditor relationship must be with the audit committee.
Note that these specific legislative requirements are not part of the framework in Australia or the UK.
Principle 5 — Make Timely and Balanced Disclosure
A listed entity should make timely and balanced disclosure of all matters concerning it that a reasonable
person would expect to have a material effect on the price or value of its securities.
Recommendation 5.1
A listed entity should have and disclose a written policy for complying with its continuous disclosure
obligations under listing rule 3.1.
…
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MODULE 3 Governance Concepts 183
Recommendation 5.2
A listed entity should ensure that its board receives copies of all material market announcements promptly
after they have been made.
…
Recommendation 5.3
A listed entity that gives a new and substantive investor or analyst presentation should release a copy of the
presentation materials on the ASX Market Announcements Platform ahead of the presentation.
Source: ASX CGC 2019, ‘Corporate Governance Principles and Recommendations’, 4th edn, pp. 21–22 © Copyright 2019 ASX
Corporate Governance Council.
Principle 6 — Respect the Rights of Security Holders
A listed entity should provide its security holders with appropriate information and facilities to allow them
to exercise their rights as security holders effectively.
Recommendation 6.1
A listed entity should provide information about itself and its governance to investors via its website.
…
Recommendation 6.2
A listed entity should have an investor relations program that facilitates effective two-way communication
with investors.
…
Recommendation 6.3
A listed entity should disclose how it facilitates and encourages participation at meetings of security holders.
…
Recommendation 6.4
A listed entity should ensure that all substantive resolutions at a meeting of security holders are decided by
a poll rather than by a show of hands.
…
Recommendation 6.5
A listed entity should give security holders the option to receive communications from, and send
communications to, the entity and its security registry electronically.
Source: ASX CGC 2019, Corporate Governance Principles and Recommendations, 4th edn, pp. 23–25 © Copyright 2019 ASX
Corporate Governance Council.
Principle 7 — Recognise and Manage Risk
A listed entity should establish a sound risk management framework and periodically review the effectiveness of that framework.
Recommendation 7.1
The board of a listed entity should:
(a) have a committee or committees to oversee risk, each of which:
(1) has at least three members, a majority of whom are independent directors; and
(2) is chaired by an independent director,
and disclose:
(3) the charter of the committee;
(4) the members of the committee; and
(5) as at the end of each reporting period, the number of times the committee met throughout the period
and the individual attendances of the members at those meetings; or
(b) if it does not have a risk committee or committees that satisfy (a) above, disclose that fact and the
processes it employs for overseeing the entity’s risk management framework.
…
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184 Ethics and Governance
Recommendation 7.2
The board or a committee of the board should:
(a) review the entity’s risk management framework at least annually to satisfy itself that it continues to be
sound and that the entity is operating with due regard to the risk appetite set by the board; and
(b) disclose, in relation to each reporting period, whether such a review has taken place.
…
Recommendation 7.3
A listed entity should disclose:
(a) if it has an internal audit function, how the function is structured and what role it performs; or
(b) if it does not have an internal audit function, that fact and the processes it employs for evaluating
and continually improving the effectiveness of its governance, risk management and internal control
processes.
…
Recommendation 7.4
A listed entity should disclose whether it has any material exposure to environmental or social risks and, if
it does, how it manages or intends to manage those risks.
Source: ASX CGC 2019, Corporate Governance Principles and Recommendations, 4th edn, pp. 26–28 © Copyright 2019 ASX
Corporate Governance Council.
Principle 8 — Remunerate Fairly and Responsibly
A listed entity should pay director remuneration sufficient to attract and retain high quality directors and
design its executive remuneration to attract, retain and motivate high quality senior executives and to align
their interests with the creation of value for security holders and with the entity’s values and risk appetite.
Recommendation 8.1
The board of a listed entity should:
(a) have a remuneration committee which:
(1) has at least three members, a majority of whom are independent directors; and
(2) is chaired by an independent director,
and disclose:
(3) the charter of the committee;
(4) the members of the committee; and
(5) as at the end of each reporting period, the number of times the committee met throughout the period
and the individual attendances of the members at those meetings; or
(b) if it does not have a remuneration committee, disclose that fact and the processes it employs for setting
the level and composition of remuneration for directors and senior executives and ensuring that such
remuneration is appropriate and not excessive.
…
Recommendation 8.2
A listed entity should separately disclose its policies and practices regarding the remuneration of nonexecutive directors and the remuneration of executive directors and other senior executives.
…
Recommendation 8.3
A listed entity which has an equity-based remuneration scheme should:
(a) have a policy on whether participants are permitted to enter into transactions (whether through the use
of derivatives or otherwise) which limit the economic risk of participating in the scheme; and
(b) disclose that policy or a summary of it.
Source: ASX CGC 2019, Corporate Governance Principles and Recommendations, 4th edn, pp. 29–30 © Copyright 2019 ASX
Corporate Governance Council.
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MODULE 3 Governance Concepts 185
Additional Recommendations
In addition to the recommendations associated with Principles 1–8, there are a number of additional
recommendations that apply only in certain cases.
Recommendation 9.1
A listed entity with a director who does not speak the language in which board or security holder meetings
are held or key corporate documents are written should disclose the processes it has in place to ensure
the director understands and can contribute to the discussions at those meetings and understands and can
discharge their obligations in relation to those documents.
…
Recommendation 9.2
A listed entity established outside Australia should ensure that meetings of security holders are held at a
reasonable place and time.
…
Recommendation 9.3
A listed entity established outside Australia, and an externally managed listed entity that has an AGM,
should ensure that its external auditor attends its AGM and is available to answer questions from security
holders relevant to the audit.
Source: ASX CGC 2019, Corporate Governance Principles and Recommendations, 4th edn, p. 32. © Copyright 2019 ASX Corporate
Governance Council.
.......................................................................................................................................................................................
CONSIDER THIS
Consider what you have noted throughout the financial statements in the company that you chose to examine in
question 3.20. What would you ask them to expand, remove or change as a result of your assessment of the quality
of their disclosure?
SUMMARY
Over time corporate governance guidance has been refined. Specifically the OECD Principles have been
used as the basis for codes of corporate governance developed in the UK and Australia.
These codes and the disclosures they recommend serve as benchmarks and information sources for
stakeholders seeking to evaluate the robustness of a company’s corporate governance standards.
The European and ASX codes are principles-based rather than rules-based. They require entities to
provide an explanation if particular provisions of best practice governance guidance are not followed.
The key points covered in this part, and the learning objective they align to, are listed below.
KEY POINTS
3.9 Interpret and apply codes and principles of corporate governance.
• The OECD has developed a set of principles that governments and other regulators may use as
the basis of development for their own corporate governance codes. The OECD principles are
considered best practice.
• Various jurisdictions develop their own best practice documents that provide corporate governance
guidance to companies and their office bearers.
• The UK has a governance code issued by its FRC. This code is also regarded as international best
practice.
• The ASX’s Corporate Governance Principles provide guidance to Australian companies.
• All codes and guidance on corporate governance can be used by external stakeholders as a
benchmark by which to measure a company’s performance against corporate governance best
practice.
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186 Ethics and Governance
PART E: NON-CORPORATES
AND GOVERNANCE
INTRODUCTION
This module began with an introduction to the corporate form and has presented a discussion of corporate
governance mainly applicable to large publicly listed corporations. Such corporations are often among
the most influential economic entities in any country, but considerable economic and other activity
is conducted by other forms of business, including family-owned businesses, small and medium-sized
enterprises, and organisations in the NFP and public sectors. It is important to note that the same general
concepts of governance apply to these other types of organisations, including privately held corporations
and public sector entities. There are, however, a number of special considerations.
In this final part of the module we will consider governance in:
• family-owned businesses, and small and medium-sized enterprises (SMEs)
• NFP organisations
• the public sector.
3.12 FAMILY-OWNED BUSINESSES, AND SMALL
AND MEDIUM-SIZED ENTERPRISES
So far, corporate governance as a mechanism for reducing agency costs has been discussed. However,
this point needs some clarification with regard to SMEs. The agency problem essentially arises from the
separation of management and the owners of an organisation. However, in many small companies with
an owner/manager or with family or minor shareholding, this separation does not exist. Therefore, it is
necessary to examine what corporate governance issues there are for these companies and the extent to
which improvements in corporate governance are useful.
SMEs are often family-owned. Corporate governance for family-owned firms has been the focus of the
paper by Sir Adrian Cadbury, author of the Cadbury Report, which was the forerunner for the Combined
Code on Corporate Governance. The paper, ‘Family firms and their governance: Creating tomorrow’s
company from today’s’ (Cadbury 2000), states that family-owned firms comprise 75% of registered
companies in the UK and 95% of companies in some economies.
Distinctive features of family firms were identified by Cadbury (2000). These included a longer-term
perspective with a focus on building the firm to be passed onto future generations, often combined with a
culture based on the unique values of a founder. Conflict between family members poses significant risk,
as does the problem of successful growth. While this might seem unusual, a major issue occurs when the
business grows successfully, beyond the ability of family members to manage it effectively. This often
leads to the need for external professional support and this transition can be very difficult. Moving to more
formal methods of decision making and control can be troublesome and many companies do not make the
transition successfully.
To combat these issues, Cadbury recommended that a family council be used to structure family engagement and that a board of directors should be established. The inclusion of outside directors would benefit
the company through the introduction of new ideas and a broad range of experience. The establishment
of a board would reorient the firm from being based on family relationships to being based on business
relationships.
There are several concerns for small companies, and a key issue is the level and cost of compliance.
The need to conform to the recommended audit committee, which requires a minimum number of three
directors, one of whom is to have financial expertise, may be impractical for a small, closely held company.
However, the involvement of the company’s external accountants can overcome some of the resource
limitations in ensuring good corporate governance, particularly with regard to risk management, the
introduction and management of internal controls, and the adequacy of financial reporting.
.......................................................................................................................................................................................
CONSIDER THIS
Read the article on the IFAC website below and take note of the four benefits the author says are derived by good
governance in small businesses.
See link at: www.ifac.org/global-knowledge-gateway/governance/discussion/governance-all-including-smes
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MODULE 3 Governance Concepts 187
3.13 NOT-FOR-PROFIT ORGANISATIONS
Good corporate governance is equally essential for entities that do not have a profit motive as their main
objective. From a performance perspective, effectiveness in achieving goals will be crucial for an NFP
organisation. The ideals and broad objectives of NFP organisations can be very compelling. However,
there is sometimes difficulty in translating these broad objectives into specific goals. This can be difficult
as the goals of such organisations may not be clearly stated and will often have no discernible financial
component of a type that most business people can readily understand. Efficiency in the conversion of
resources into outputs will also be important for such organisations.
Furthermore, the price at which resources are acquired and converted (economy) will be important. It
is not only the three Es (economy, efficiency and effectiveness) of performance that are important. NFPs
often aim to achieve a great deal with very few resources, and therefore these must be utilised even more
carefully than in a commercial organisation. Conformance is also important in terms of adherence to basic
rules of governance standards, risk management, and financial and operating procedures. For example,
NFPs such as charities may be susceptible to scandal or fraud, which may have an adverse impact on
the public’s perception of the particular organisation or indeed the entire sector of which the organisation
forms a part. The non-conformance can also have a major performance impact.
NFPs may be organised in a number of different forms, including foundations, trusts, associations and
special types of companies (e.g. in Australia, a public company limited by guarantee). Furthermore, they
can represent such diverse sectors of the community as:
• the provision of social services (e.g. Red Cross)
• arts and entertainment sectors (e.g. Sydney Symphony Orchestra)
• sports and leisure sectors (e.g. International Olympic Committee).
Unlike profit-oriented entities, NFPs are accountable principally to stakeholders rather than shareholders. These stakeholders can include the founder of the organisation, its clients, employees, volunteers and
sponsoring partners, including individuals, corporations and government. In many cases, there may be
a high level of emotional involvement from these stakeholders, which is not a key ingredient in a large
listed company. As a result, a key objective of NFP organisations is to improve trust and relationships with
their stakeholders.
Despite the different corporate governance goals between profit-oriented and NFPs, there are many
similarities in their objectives and principles. For example:
• Similar responsibilities exist to maintain solvency within their available funding.
• A similar focus is required on strategy, performance, accountability and stewardship.
• Larger NFPs will have committee structures similar to their for-profit counterparts.
• Although the directors may act in an honorary (unpaid) capacity or receive minimal director compensation, the same director’s liability may exist as that expected in a for-profit company.
In addition to this, an NFP organisation that is structured as a company limited by guarantee (or other)
must comply with appropriate provisions of the Corporations Act.
Guidance for NFPs is available from a variety of sources including:
• Australian Charities and Not-for-Profits Commission (ACNC), www.acnc.gov.au
• AICD, https://aicd.companydirectors.com.au
• ASIC, https://asic.gov.au/for-business/running-a-company/charities-registered-with-the-acnc
• Australian Indigenous Governance Institute, www.aigi.com.au
• Not for Profit Law, www.nfplaw.org.au
• School Improvement and Governance Network, www.viccso.org.au/school-councils/how-to-improvegovernance.
The first two of these will be addressed in this module.
ACNC GUIDANCE
ACNC guidance is specifically for charities and includes two sets of standards; one for charities operating
in Australian and a separate set for charities operating overseas.
Charities must meet the ACNC’s Governance Standards to be registered and remain registered with the
ACNC. The Governance Standards do not apply to a limited category of charities called ‘Basic Religious
Charities’ (ACNC n.d.).
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188 Ethics and Governance
ACNC Governance Standards
The governance standards that apply to the Australian operations of a charity are as follows.
Standard 1: Purposes and not-for-profit nature
Charities must be not-for-profit and work towards their charitable purpose. They must be able to demonstrate this and provide information about their purposes to the public.
Standard 2: Accountability to members
Charities that have members must take reasonable steps to be accountable to their members and provide
them with adequate opportunity to raise concerns about how the charity is governed.
Standard 3: Compliance with Australian laws
Charities must not commit a serious offence (such as fraud) under any Australian law or breach a law that
may result in a penalty of 60 penalty units (equivalent to $12,600 as at December 2018) or more.
Standard 4: Suitability of Responsible Persons
Charities must take reasonable steps to:
• be satisfied that its Responsible Persons (such as board or committee members or trustees) are not
disqualified from managing a corporation under the Corporations Act 2001 (Cwlth) or disqualified from
being a Responsible Person of a registered charity by the ACNC Commissioner, and
• remove any Responsible Person who does not meet these requirements.
Standard 5: Duties of Responsible Persons
Charities must take reasonable steps to make sure that Responsible Persons are subject to, understand and
carry out the duties set out in this Standard.
Source: Australian Charities and Not-for-profits Commission n.d. ACNC Governance Standards, accessed October 2019,
www.acnc.gov.au/for-charities/manage-your-charity/charity-governance/governance-standards.
Duties of Responsible Persons
In relation to Standard 5 the following seven duties are specified for ‘Responsible Persons’.
1. Act with reasonable care and diligence.
2. Act honestly in the best interests of the charity and for its purposes.
3. Not misuse the position of responsible person.
4. Not to misuse information obtained in performing duties.
5. Disclose any actual or perceived conflict of interest.
6. Ensure that the charity’s financial affairs are managed responsibly.
7. Not allow a charity to operate while insolvent.
.......................................................................................................................................................................................
CONSIDER THIS
Compare this list of duties to the list of director duties earlier in the module.
External Conduct Standards
The international operations of charities are governed by the ACNC’s External Conduct standards.
Standard 1: Activities and control of resources (including funds)
This Standard covers the way a charity manages its activities overseas, and how it is required to control the
finances and other resources it uses overseas.
Standard 2: Annual review of overseas activities and record-keeping
This Standard covers the requirements for a charity to obtain and keep sufficient records for its overseas
activities.
Standard 3: Anti-fraud and anti-corruption
This Standard covers the requirements for a charity to have processes and procedures that work to combat
fraud and corruption in its overseas operations.
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Standard 4: Protection of vulnerable individuals
This Standard covers the requirement for a charity to protect the vulnerable people that it works with when
conducting its overseas operations.
Source: ACNC, n.d., The External Conduct Standards, accessed October 2019, www.acnc.gov.au/for-charities/manage-yourcharity/governance-hub/acnc-external-conduct-standards.
NFPs have different structures and the decision-making committee or board may have different names.
The notion of a responsible person, which is embedded in the ACNC’s standards and other materials, is
designed to capture all individuals that are responsible for the running of the entity subject to the ACNC’s
oversight. The term is similar to a phrase that occurs in auditing standards related to those in charge of
governance. It simply means the people who run the organisation.
AICD GUIDANCE
The AICD also provides governance principles for not-for-profit entities. The most recent (January
2019) edition contains 10 principles, and supporting practices and guidance for each principle.
This is available at https://aicd.companydirectors.com.au/-/media/cd2/resources/director-resources/notfor-profit-resources/nfp-principles/pdf/06911-4-adv-nfp-governance-principles-report-a4-v11.ashx.
.......................................................................................................................................................................................
CONSIDER THIS
Compare the ASX Corporate Governance Principles to the snapshot of the AICD’s Governance principles, https://
aicd.companydirectors.com.au/-/media/cd2/resources/director-resources/not-for-profit-resources/nfp-principles/
pdf/06911-5-adv-nfp-governance-principles-summary-report-a4-web.ashx, and consider whether there is anything
in the latter that might be a useful addition to the former.
Good corporate governance in NFP organisations, therefore, has many similarities to profit-orientated
entities and, as a result, many NFP organisations are voluntarily complying with the corporate governance
guidelines applicable to for-profit entities.
DIVERSITY IN THE NOT-FOR-PROFIT SECTOR
The extent of the diversity of the NFP sector is considerable as the sector covers many forms of social,
health, cultural, sporting and leisure pursuits. Within the sector are diverse organisations including
cooperatives, community businesses, credit unions, trading charities, housing associations and sports
clubs. These enterprises may take many different legal forms and can be registered as companies
limited by guarantee, charities or unincorporated non-profit organisations. The critical difference between
these enterprises and commercial enterprises is that the surpluses are reinvested for the purpose of the
organisations and not for the benefit of the employees or owners.
NFPs are usually autonomous organisations with independent governance and ownership structures, run
by and for the stakeholders of the organisation. They are accountable to the stakeholders and the wider
community and are dedicated to the provision of goods or services to this community.
As with commercial organisations, NFPs face governance dilemmas. The first is securing people with
the appropriate skills and experience to contribute to making the board an effective body for governing the
organisation. In this sector, board members are invariably volunteers, and few may possess professional
experience. Resources are usually in extremely short supply and the funds of the NFP have to be carefully
managed. The loss or misallocation of the funds of NFPs is a serious issue that can damage the work and
reputation of the organisation. However, many NFPs are exceptionally cost conscious and do a remarkable
job of conserving resources and applying them to best effect.
One particular governance problem experienced by NFPs is that if a paid manager is employed, they are
rarely given much freedom to manage since they are surrounded by committed volunteers who feel they
have a right to be involved in decision making. This calls for special qualities of consultation, deliberation
and engagement, which the NFPs are very experienced in. The great strength of NFPs is the vitality and
commitment of their members; however, this can also lead to instability in these organisations. Often, there
are not clear lines of succession, so if the original founders move on the future of the NFP sometimes
becomes doubtful. However, this process of continuous regeneration in relatively short life cycles is
common in NFPs as it is in other small businesses.
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190 Ethics and Governance
Example 3.11 examines some of these issues in relation to the governance of a community childcare
centre.
EXAMPLE 3.11
Governance of a Childcare Centre
A group of young parents with pre-school children were tired of being unable to find adequate and
affordable child care in their community, and set about establishing their own childcare centre. At first
they attempted to do this informally, but realised that they required more formal structures to ensure the
safety of the children and the viability of the operation. They found suitable premises and hired a qualified
childcare worker and an assistant. Initially they met monthly, but realised they would require more formal
governance processes to sustain an effective operation.
They called for elections to the board and at the first meeting of the board, a chair was elected. Then they
discovered they had no-one on the board with financial skills and had to nominate someone to the board
to become the treasurer. They realised it would be advantageous to form a company limited by guarantee
for their dealings with the bank, other suppliers and their employees. After seeking legal advice, they
succeeded in registering their company, and as the popularity of the childcare centre grew, they realised
there was a future for the centre.
However, in the second year of operation some members of the board wanted to extend the hours
of the centre, and to introduce new facilities. The full-time manager of the centre was cautious about
this initiative, and was concerned the centre might not be able to meet its obligations. Relations became
strained and the manager moved on to a larger childcare centre. After recruiting a replacement, the board
realised they would have to work more cooperatively with the manager of the centre, and that they could
not simply impose their will. Over time, the increasing experience and professionalisation of the board
membership and procedures meant it was easier for the manager to bring concerns to the board, confident
that the board would listen and contribute to resolving issues in a productive way. The maturing of the
governance of the childcare centre was allowing the provision of a more efficient and effective service.
3.14 PUBLIC SECTOR ENTERPRISES
In the past two decades, the extent of commercialisation and corporatisation of government businesses has
focused attention on corporate governance in the public sector. In the public sector, corporate governance
is also about how the government, boards and parliament relate to one another in stewardship matters.
Whereas companies focus mainly on shareholder returns, the public sector’s role is to implement
programs cost-effectively in accordance with government legislation and policies. There are also review
processes normally imposed by governments and their committees. The international association of
auditors-general (i.e. government auditors) is the International Organisation of Supreme Audit Institutions
(IntOSAI). IntOSAI identifies the three Es — economy, efficiency and effectiveness — as the heart of
public sector governance.
Government agencies must satisfy a complex range of political, economic and social objectives, and
operate according to a different set of external constraints and influences compared to private or public
businesses. In addition, they are subject to the expectations of, and forms of accountability to, their various
stakeholders, who are more diverse and likely to be more contradictory in their demands than those of a
private sector company. Nevertheless, private sector approaches can be adapted to reflect the different
nature of public sector agencies, in particular their different statutory and managerial frameworks and
their wider and more complex accountabilities.
The fact that the public sector collects and redirects public monies for the greater social good is in itself
a reason to require good corporate governance. It could be said that failure to ensure that objectives and
accountabilities are met will be reflected in the electoral process, but with election time frames of three or
four years in most cases, that process is not timely in ensuring ongoing good governance.
According to Harris (1997), a former auditor-general of New South Wales in Australia, there are
important guiding principles that achieve more effective governance by boards in the public sector. In
addition to having clear and separate roles of ministers and boards, Harris also strongly recommends the
use of legislation to set out the roles, powers and responsibilities of the board and provide the board with
enough authority to perform its role.
Uhrig (2003) noted a lack of effective governance for several statutory authorities due to a range
of factors, including unclear boundaries in their delegation, a lack of clarity in their relationships
with ministers and portfolio departments, and a lack of accountability in the exercise of their power
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(Uhrig 2003, p. 5). To address these issues, he recommended several best practice approaches that are very
similar to recommended best practice for publicly listed companies. These included the use of committees
to enhance effectiveness, annual board reviews, appropriate experienced directors, and set terms to ensure
a rotation of directors. In addition to these items, he also suggested that representational appointments (e.g.
specific appointments to a board by a government minister) be limited.
QUESTION 3.21
How can the broad public service mission of public sector enterprises be focused and delivered
through better governance?
THE UNIQUENESS OF THE PUBLIC SECTOR
In earlier decades, the public sector gained a reputation for being poorly governed. Often public bodies
were subjected to the changing fortunes of governments and sometimes to the whims of their government
ministers. Lacking autonomy in centralised government systems, the senior management of public
organisations often simply looked to their political masters for guidance, and sometimes ignored the
interests of their clients — the general public — who were rendered relatively powerless compared to
market-based business systems.
However, a process of reform has taken place in the public sector just as dramatic and far reaching as in
the private sector, and often inspired by the transformation of private sector governance. For example the
Uhrig Report on public sector governance argued:
There are benefits in looking to developments and lessons learnt in the private sector when considering
appropriate governance frameworks for the public sector. The environment in which the private sector
operates creates significant challenges for companies. The consequences of failure and threat of takeover
provide incentives for the private sector to constantly strive to improve governance practices. In dealing
with the challenges of the market, the private sector has gained considerable experience in applying the
core elements of governance (Uhrig 2003, p. 26).
As a result of the widespread reform movement in the public sector in Australia and in other countries,
public organisations now have much more responsive governance, including autonomous boards with
independent directors responsible for strategies to meet clients’ needs, and with authority to distribute
resources appropriately (within agreed parameters).
Yet the public sector remains different in values, objectives and methods compared to the private sector:
• The public sector produces ‘public values’, promotes equity, and protects the collective interests (e.g.
about the environment and international relations) as well as market ones.
• The public sector operates in a complex decision-making environment, usually manages many and
diverse stakeholder interests and often considers short, medium, and long range effects of decisions
(inter-generational equity is one example).
• The public sector’s effectiveness often relies on the co-operative, as opposed to the competitive,
participation of others. Competition has a dysfunctional effect if applied inappropriately in the public
sector: examples include service duplication, loss of scale economies, the dismantling of collaborative
institutional arrangements, and the focusing on marketing at the expense of service delivery.
• The public sector uses diverse resources to achieve its policy ends, involving not only public money but,
significantly, public power as well (Halligan & Horrigan 2005, p. 16).
In the previous analysis, whatever delegated powers the board of a public organisation are given, there
is an obligation to work broadly within the framework of government policy, and to engage with other
public agencies in the achievement of policy goals, rather than pursuing separate institutional policies. Yet
‘the conventional spectrum of bureaucratisation, commercialisation, corporatisation and privatisation of
government entities still leaves much room for a multiplicity of governance arrangements at both sectoral
and organisational levels’ (Edwards et al. 2012, p. 175).
Example 3.12 illustrates the governance dilemmas frequently encountered in the public sector: pursuing
a much wider and more vital public purpose; enjoying a degree of autonomy, which must be exercised with
extreme care; and being subject to the ultimate sanction of the government, even if this is rarely, if ever,
exercised.
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192 Ethics and Governance
EXAMPLE 3.12
Governance in the Public Sector
The Reserve Bank of Australia (RBA) is a body corporate charged by the Australian Government to ensure
‘that the monetary and banking policy of the Bank is directed to the greatest advantage of the people
of Australia’, and that its powers are directed towards contributing to ‘the stability of the currency of
Australia’ and the ‘maintenance of full employment’ and ‘the economic prosperity and welfare of the
people of Australia’ (s. 10(2) Reserve Bank Act 1959 (Cwlth).
Clearly these are more substantive and demanding objectives than commercial banks face. The RBA
has two boards: the RBA board, which is responsible for monetary and banking responsibility, and the
Payment Systems Board, which is responsible for payment systems. Successive Australian governments
have emphasised the RBAs independence, yet the bank is connected to the government in a number
of ways. The board must keep the government informed of its monetary and banking policy, and if the
RBA and the federal Treasurer disagree on how well the policy is serving the Australian people, they must
strive to reach agreement. If they cannot reach agreement, the government has formal mechanisms at its
disposal to ensure its view prevails, but governments are very reluctant to ever exercise this power as not
only would it undermine the independence of the RBA, it would damage the government, and possibly
the Australian economy (Edwards et al. 2012, p. 187).
GUIDANCE FOR PUBLIC SECTOR GOVERNANCE
There are various sources available for public sector organisations. In 2015 the OECD published its
Guidelines on Corporate Governance of State Owned Enterprises. This document is to be read in
conjunction with the OECD’s Corporate Governance Principles and is designed as:
• recommendations to governments on how to ensure that SOEs operate efficiently, transparently and
in an accountable manner. They are the internationally agreed standard for how governments should
exercise the state ownership function to avoid the pitfalls of both passive ownership and excessive state
intervention (OECD 2015).
Domestic corporate governance codes or frameworks that specify the kind of behaviour that is expected
of individuals involved in the public sector exist across all jurisdictions. Some of these requirements
are stipulated by the Australia Public Sector Commission (APSC) in a range of publications on the
commission’s website, but there are various publications issued by Commonwealth, state and territory
government departments that articulate what constitutes acceptable conduct when reflecting on governance
of public sector entities.
The APSC published a guide in 2007 called Building Better Governance that outlined a series of
governance principles. These principles are consistent with those you may find in other governance
contexts, but tailored for the government sector. It defines public sector governance as being ‘the set of
responsibilities and practices, policies and procedures, exercised by an agency’s executive, to provide
strategic direction, ensure objectives are achieved, manage risks and use resources responsibly and with
accountability’. The guide also lays down two key components of good governance in the public sector.
These components as stated in Building Better Governance, which were also reflected in guidance
produced by the Australian National Audit Office in 2003, are:
• performance — how an agency uses governance arrangements to contribute to its overall performance
and the delivery of goods, services or programmes, and
• conformance — how an agency uses governance arrangements to ensure it meets the requirements of
the law, regulations, published standards and community expectations of probity, accountability and
openness.
In other words, performance means how well agencies performance as measured against their various
programme or service requirements and conformance covers how a government agency fulfils the role of
the public sector equivalent of the good corporate citizen.
There are six principles articulated in the 2007 guidance document that set down the core values for
public sector employees. These are:
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• accountability — being answerable for decisions and having meaningful mechanisms in place to ensure
the agency adheres to all applicable standards
• transparency/openness — having clear roles and responsibilities and clear procedures for making
decisions and exercising power
• integrity — acting impartially, ethically and in the interests of the agency, and not misusing information
acquired through a position of trust
• stewardship — using every opportunity to enhance the value of the public assets and institutions that
have been entrusted to care
• efficiency — ensuring the best use of resources to further the aims of the organisation, with a commitment
to evidence-based strategies for improvement
• leadership — achieving an agency-wide commitment to good governance through leadership from
the top.
These principles are included in corporate governance frameworks issued by state and territory
government departments. One example is the Department of Education and Training in Queensland. It
published these principles as a focus for its employees within the department. Other states also have specific
guidelines. The Victorian Public Sector Commission (VPSC) has developed a framework that illustrates
the accountability of various groups of public servants. The framework is shown in figure 3.6.
FIGURE 3.6
Victorian public sector accountability framework
Parliament
Stakeholders
• Customers and clients
• Victorian community
• Ministers and
departments
responsible for
functions affected
by the operations of
the public entity
• Public sector
organisations that
cooperate with the
public entity
Minister
Directions, delegations
and advice
Portfolio Department
Secretary,
managers and staff
Directions, priorities,
advice and reports
• Business partners
such as companies
and NGOs
• Local government
Monitoring
and advice
• Regulators
Integrity bodies
• IBAC
Portfolio Entities
Board Chief Executive Officer
Chief Finance and Accounting Officer
Manager and staff
• Ombudsman
• Auditor-General
Source: Victorian Public Sector Commission 2015, ‘Governance Structure’, https://vpsc.vic.gov.au/wp-content/uploads/2015/03/
Governance-Structure.png.
The VPSC states that there are a series of stakeholders involved in the running of any individual public
entity. The list of key parties involved, according to the Victorian authority is:
• a minister (and parliament) and those who support the minister directly
• a department (and departmental secretary)
• a public entity board and non-executive (and executive) board directors
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194 Ethics and Governance
• a board chair
• board committees (and chairs of the committees), including audit and risk management committees that
could include specialist independent members who are not themselves directors of the public entity
• a board secretary
• a chief executive officer
• a chief finance and accounting officer (or CFO)
• public entity managers and other employees
• other stakeholders.
This list largely reflects internal public sector stakeholders except for the final category, which will
include those members of the community — individuals and groups — that use the services or may be
regulated by a specific government or public sector entity.
3.15 SIGNIFICANCE OF THE NON-CORPORATE
SECTOR
As noted in this section, there are many forms of business association, and large corporations are only one
form of association. Because of the scale and impact of the economic activity of large listed corporations,
the governance literature has concentrated very much on these, both in Australia and around the world.
The SME sector is of great significance in every economy and community, providing substantial
economic activity and employment. The SME sector represents the corner shop and the local business
without which communities could not function properly, and they are vital to the provision of many
goods and services. While the governance of small enterprises is necessarily simple, it is nonetheless
important that these enterprises are accountable to assure those that they do business with will not
encounter unexpected losses.
Consider the Australian Small Business and Family Enterprise Ombudsman (ASBFEO 2016) statistics
presented in table 3.10. The ASBFEO report categorises businesses as small, medium or large. The bulk
of the 3 717 large businesses are probably the 2200 entities listed on the ASX. In comparison the report
states that there are more than 2 million small businesses.
TABLE 3.10
Business size measured by employment
Business size
Small (0–19 employees)
Medium (20–199 employees)
Large (200+ employees)
Total
Count
%
2 066 523
97.4
50 995
2.4
3 717
0.2
2 121 235
100
Source: Australian Bureau of Statistics, ABS Counts of Australian Businesses 8165.0, February 2016 and ASBFEO calculations
(excludes nano businesses with no GST role)
In addition, there is the public sector, which continues to have a substantial impact even after the episodes
of privatisation in recent decades. For example, there are government business enterprises, which remain
part of federal and state governments, and maintain governance accountability to the elected government,
such as the Australian Postal Corporation and the NBN Co Limited.
A further dimension of economic activity (which begins to merge with social, cultural and sporting
activity) is the work of NFP organisations. These are organisations that cannot distribute their earnings to
those who exercise control in the organisation, but are dedicated to a wider purpose (Hansmann 1980).
The Australian Charities and Not-for-Profits Commission (2019) said in a report that they had reviewed
around 47 000 annual information statements lodged by charities during 2017. The report also revealed
the following.
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•
•
•
•
•
Total revenue of $146.1 billion
Government grants as a revenue source increased by $7 billion
Donations and bequests as a revenue source totalled $9.9 billion
3.3 million volunteers across Australia’s charities
Most registered charities (36%) are ‘extra small’, a subset of small
MODULE 3 Governance Concepts 195
• 30% of charities reported their main activity was religious activities
• 4567 charities operate overseas
It is clear from the above that the charitable and NFP sectors are large and a major part of the
economy. There is a need to ensure that governance processes of a similar stringency operate in the case
of government bodies, NFP organisations and charities because listed companies and private entities are
not the only entities that deal with the allocation of scarce resources on behalf of stakeholders.
SUMMARY
Non-corporate entities have governance principles that generally align with those applying to corporate
entities, but the context in which non-corporate entities operate is different and some special considerations
apply.
Family-owned businesses and many SMEs do not exhibit the separation of ownership and management
that occurs in large corporations. The owners and managers are often the same people. To overcome potential conflicts and ensure the business can cope with growth and increasing complexity, it is recommended
that formal management structures and processes are put in place to ensure good governance.
Guidance for non-corporate entities that are charities is available from the ACNC which, as the regulator
of the charities sector, requires entities to have appropriate governance systems in place. The Australian
Institute of Company Directors and a number of other sources provide guidance for other types of
NFP organisations.
Commonwealth, state and territory governments have public sector authorities (known as commissions)
that set the behavioural norms for public sector entity boards. There are values that are embedded in
government guidance that entities are encouraged to follow and implement to ensure they perform in
accordance with their operating charters as well as maintain a level of accountability.
The key points covered in this part, and the learning objective they align to, are listed below.
KEY POINTS
3.8 Analyse how robust governance is relevant to public sector and non-corporate entities.
• Governance standards for non-corporate bodies are generally aligned with corporate standards
although the context differs.
• The public sector has established hierarchies that require a chain of accountability within public
sector entities.
• The chain of accountability in public sector entities extends to the ministerial level and to the
parliament.
• In Australia, key documents are issued by each state and territory government that embed common
public sector values derived from Commonwealth publications.
• Private sector NFPs are accountable to their stakeholders and thus must demonstrate robust
governance, regardless of whether they are structured as a corporation. NFPs’ goals are often
different in nature to those of for-profit entities, but they must still demonstrate effective use of
resources in pursuing those goals.
• Family businesses and SMEs often lack the separation of ownership and management that
characterises large corporations. In order to deal with potential conflicts and adapt to changing
circumstances, such organisations should adopt a governance framework.
REVIEW
Governance refers to the system used to operate and control an organisation. This module explored the
importance of having clear principles in place for guiding organisations to achieve their objectives while
conforming to expected business behaviour and rules and respecting the right of stakeholders.
The module explained how various stakeholders perform their governance roles. Directors, with their
relevant duties and obligations, have the greatest role in governance, and also the power to have the
most impact on the organisation. Shareholders, auditors and regulators all have roles to play in the
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196 Ethics and Governance
corporate governance framework to ensure that problems are quickly identified and rectified, and to help
organisations pursue their goals and objectives appropriately and successfully.
After considering the development of corporate governance best practice over the past 30 years, the
module focused specifically on best practice principles as outlined in the OECD Principles, the FRC Code
and the ASX Principles. This included a detailed review of specific items that have been recommended
as helpful or essential for ensuring good governance in both corporate and non-corporate sectors. It is
recognised that there are alternatives approaches to corporate governance in different national cultures,
with the main ones being marked-based and relationship-based.
Finally, the non-corporate sector (including family-owned businesses and SMEs, NFP organisations
and the public sector) has various special characteristics. While certain specific considerations apply
to the governance of these organisations, generally the principles underlying corporate governance are
broadly applicable.
APPENDIX 3.1
UNDERSTANDING THE UK FRC CORPORATE GOVERNANCE CODE
The 2018 version of the UK FRC Corporate Governance Code (FRC Code) is an important mechanism
designed to improve corporate governance from the conformance and performance perspectives. Although
it only formally applies in the UK, it has international importance. You will find it valuable to download
and review this document. Only the parts of the FRC Code that are reproduced in the Study Guide
(including this Appendix) are examinable.
The FRC Code (2018) is available online at: www.frc.org.uk/getattachment/88bd8c45-50ea-4841-95b0d2f4f48069a2/2018-UK-Corporate-Governance-Code-FINAL.pdf.
You should download a copy of the Code for your own reference so that you see the following elements
of the FRC Code in their full context. We are only examining relevant extracts from the FRC Code.
Governance and the FRC Code
The FRC Code applies in a similar fashion to the Corporate Governance Council recommendations issued
by the ASX Corporate Governance Council. The UK FRC advises entities reporting under the Code that
they must ‘report meaningfully when discussing the application of the principles and to avoid boilerplate
reporting’. In other words, the entities should report in a manner that tells the story of the entity rather than
produce template disclosures that could be applied in differing circumstances.
The ‘comply or explain’ approach is outlined on page 2 of the FRC Code and relevant sections are
reproduced below.
1. The effective application of the Principles should be supported by high-quality reporting on the
Provisions. These operate on a ‘comply or explain’ basis and companies should avoid a ‘tick-box
approach’. An alternative to complying with a Provision may be justified in particular circumstances
based on a range of factors, including the size, complexity, history and ownership structure of a company.
Explanations should set out the background, provide a clear rationale for the action the company is
taking, and explain the impact that the action has had. Where a departure from a Provision is intended
to be limited in time, the explanation should indicate when the company expects to conform to the
Provision. Explanations are a positive opportunity to communicate, not an onerous obligation.
2. In line with their responsibilities under the UK Stewardship Code, investors should engage constructively
and discuss with the company any departures from recommended practice. In their consideration of
explanations, investors and their advisors should pay due regard to a company’s individual circumstances. While they have every right to challenge explanations if they are unconvincing, these must not
be evaluated in a mechanistic way. Investors and their advisors should also give companies sufficient
time to respond to enquiries about corporate governance.
Source: FRC Code 2018, The UK Corporate Governance Code, FRC, p. 2. Reproduced with permission.
The Principles in the Code and their Application
There are five different categories of principles within the UK FRC’s Code. These categories each
have a series of principles attached to them. There is also guidance to assist in the interpretation and
implementation of the principles. The areas covered by the principles are:
1. Board Leadership and Company Purpose
2. Division of Responsibilities
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3. Composition, Succession and Evaluation
4. Audit, Risk and Internal Control
5. Remuneration
The Code as revised in 2018 by the UK FRC applied to all companies that have a premium listing
irrespective of whether they are incorporated within the UK or in another country. This means that an
Australian company, for example, that might be listed or considering getting a listing in the UK will need
to factor these guidelines into their regulatory risk management. The revised Code applies to accounting
periods or financial reporting periods beginning on or after 1 January 2019.
There are some specific provisions set down for the application of the Code to certain kinds of entities.
For parent companies with a premium listing, the board should ensure that there is adequate co-operation
within the group to enable it to discharge its governance responsibilities under the Code effectively. This
includes the communication of the parent company’s purpose, values and strategy.
Externally managed investment companies (which typically have a different board and company structure
that may affect the relevance of particular Principles) may wish to use the Association of Investment
Companies’ Corporate Governance Code to meet their obligations under the Code. In addition, the
Association of Financial Mutuals produces an annotated version of the Code for mutual insurers to use.
Source: FRC Code 2018, The UK Corporate Governance Code, FRC, p. 3. Reproduced with permission.
.......................................................................................................................................................................................
CONSIDER THIS
Reflect on whether the UK FRC Code is a document that covers all of the essential issues related to the governance
of an entity as you read through the principles.
The Format of the Principles
The principles are grouped together in their category and the relevant application guidance is published
immediately below the principles to which it applies. The key principles and applicable guidance
appear below.
Category 1 Board Leadership and Company Purpose
Principles
A. A successful company is led by an effective and entrepreneurial board, whose role is to promote the
long-term sustainable success of the company, generating value for shareholders and contributing to
wider society.
B. The board should establish the company’s purpose, values and strategy, and satisfy itself that these
and its culture are aligned. All directors must act with integrity, lead by example and promote the
desired culture.
C. The board should ensure that the necessary resources are in place for the company to meet its objectives
and measure performance against them. The board should also establish a framework of prudent and
effective controls, which enable risk to be assessed and managed.
D. In order for the company to meet its responsibilities to shareholders and stakeholders, the board should
ensure effective engagement with, and encourage participation from, these parties.
E. The board should ensure that workforce policies and practices are consistent with the company’s values
and support its long-term sustainable success. The workforce should be able to raise any matters
of concern.
Provisions
1. The board should assess the basis on which the company generates and preserves value over the longterm. It should describe in the annual report how opportunities and risks to the future success of the
business have been considered and addressed, the sustainability of the company’s business model and
how its governance contributes to the delivery of its strategy.
2. The board should assess and monitor culture. Where it is not satisfied that policy, practices or behaviour
throughout the business are aligned with the company’s purpose, values and strategy, it should seek
assurance that management has taken corrective action. The annual report should explain the board’s
activities and any action taken. In addition, it should include an explanation of the company’s approach
to investing in and rewarding its workforce.
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198 Ethics and Governance
3. In addition to formal general meetings, the chair should seek regular engagement with major shareholders in order to understand their views on governance and performance against the strategy. Committee
chairs should seek engagement with shareholders on significant matters related to their areas of
responsibility. The chair should ensure that the board as a whole has a clear understanding of the views
of shareholders.
4. When 20% or more of votes have been cast against the board recommendation for a resolution, the
company should explain, when announcing voting results, what actions it intends to take to consult
shareholders in order to understand the reasons behind the result. An update on the views received
from shareholders and actions taken should be published no later than six months after the shareholder
meeting. The board should then provide a final summary in the annual report and, if applicable, in the
explanatory notes to resolutions at the next shareholder meeting, on what impact the feedback has had
on the decisions the board has taken and any actions or resolutions now proposed.1
5. The board should understand the views of the company’s other key stakeholders and describe in the
annual report how their interests and the matters set out in section 172 of the Companies Act 2006
have been considered in board discussions and decision-making.2 The board should keep engagement
mechanisms under review so that they remain effective.
For engagement with the workforce,3 one or a combination of the following methods should be used:
• a director appointed from the workforce;
• a formal workforce advisory panel;
• a designated non-executive director.
If the board has not chosen one or more of these methods, it should explain what alternative arrangements
are in place and why it considers that they are effective.
6. There should be a means for the workforce to raise concerns in confidence and – if they wish –
anonymously. The board should routinely review this and the reports arising from its operation. It should
ensure that arrangements are in place for the proportionate and independent investigation of such matters
and for follow-up action.
7. The board should take action to identify and manage conflicts of interest, including those resulting from
significant shareholdings, and ensure that the influence of third parties does not compromise or override
independent judgement.
8. Where directors have concerns about the operation of the board or the management of the company
that cannot be resolved, their concerns should be recorded in the board minutes. On resignation, a nonexecutive director should provide a written statement to the chair, for circulation to the board, if they
have any such concerns.
Category 2 Division of Responsibilities
Principles
F. The chair leads the board and is responsible for its overall effectiveness in directing the company. They
should demonstrate objective judgement throughout their tenure and promote a culture of openness and
debate. In addition, the chair facilitates constructive board relations and the effective contribution of all
non-executive directors, and ensures that directors receive accurate, timely and clear information.
G. The board should include an appropriate combination of executive and non-executive (and, in particular,
independent non-executive) directors, such that no one individual or small group of individuals
dominates the board’s decision making. There should be a clear division of responsibilities between
the leadership of the board and the executive leadership of the company’s business.
H. Non-executive directors should have sufficient time to meet their board responsibilities. They should
provide constructive challenge, strategic guidance, offer specialist advice and hold management to
account.
I. The board, supported by the company secretary, should ensure that it has the policies, processes,
information, time and resources it needs in order to function effectively and efficiently.
Provisions
9. The chair should be independent on appointment when assessed against the circumstances set out in
Provision 10. The roles of chair and chief executive should not be exercised by the same individual.
A chief executive should not become chair of the same company. If, exceptionally, this is proposed
1 Details of significant votes against and related company updates are available on the Public Register maintained by The Investment
Association – www.theinvestmentassociation.org/publicregister.html.
2 The Companies (Miscellaneous Reporting) Regulations 2018 require directors to explain how they have had regard to various
matters in performing their duty to promote the success of the company in section 172 of the Companies Act 2006. The Financial
Reporting Council’s Guidance on the Strategic Report supports reporting on the legislative requirement.
3 See the Guidance on Board Effectiveness Section 1 for a description of ‘workforce’ in this context.
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MODULE 3 Governance Concepts 199
10.
11.
12.
13.
14.
15.
16.
by the board, major shareholders should be consulted ahead of appointment. The board should set
out its reasons to all shareholders at the time of the appointment and also publish these on the
company website.
The board should identify in the annual report each non-executive director it considers to be independent. Circumstances which are likely to impair, or could appear to impair, a non-executive director’s
independence include, but are not limited to, whether a director:
• is or has been an employee of the company or group within the last five years;
• has, or has had within the last three years, a material business relationship with the company, either
directly or as a partner, shareholder, director or senior employee of a body that has such a relationship
with the company;
• has received or receives additional remuneration from the company apart from a director’s fee,
participates in the company’s share option or a performance-related pay scheme, or is a member
of the company’s pension scheme;
• has close family ties with any of the company’s advisers, directors or senior employees;
• holds cross-directorships or has significant links with other directors through involvement in other
companies or bodies;
• represents a significant shareholder; or
• has served on the board for more than nine years from the date of their first appointment. Where
any of these or other relevant circumstances apply, and the board nonetheless considers that the
non-executive director is independent, a clear explanation should be provided.
At least half the board, excluding the chair, should be non-executive directors whom the board considers
to be independent.
The board should appoint one of the independent non-executive directors to be the senior independent
director to provide a sounding board for the chair and serve as an intermediary for the other directors
and shareholders. Led by the senior independent director, the non-executive directors should meet
without the chair present at least annually to appraise the chair’s performance, and on other occasions
as necessary.
Non-executive directors have a prime role in appointing and removing executive directors. Nonexecutive directors should scrutinise and hold to account the performance of management and
individual executive directors against agreed performance objectives. The chair should hold meetings
with the non-executive directors without the executive directors present.
The responsibilities of the chair, chief executive, senior independent director, board and committees
should be clear, set out in writing, agreed by the board and made publicly available. The annual report
should set out the number of meetings of the board and its committees, and the individual attendance
by directors.
When making new appointments, the board should take into account other demands on directors’ time.
Prior to appointment, significant commitments should be disclosed with an indication of the time
involved. Additional external appointments should not be undertaken without prior approval of the
board, with the reasons for permitting significant appointments explained in the annual report. Fulltime executive directors should not take on more than one non-executive directorship in a FTSE 100
company or other significant appointment.
All directors should have access to the advice of the company secretary, who is responsible for advising
the board on all governance matters. Both the appointment and removal of the company secretary should
be a matter for the whole board.
Category 3 Composition, Succession and Evaluation
Principles
J. Appointments to the board should be subject to a formal, rigorous and transparent procedure, and an
effective succession plan should be maintained for board and senior management.4 Both appointments
and succession plans should be based on merit and objective criteria5 and, within this context, should
promote diversity of gender, social and ethnic backgrounds, cognitive and personal strengths.
K. The board and its committees should have a combination of skills, experience and knowledge.
Consideration should be given to the length of service of the board as a whole and membership regularly
refreshed.
L. Annual evaluation of the board should consider its composition, diversity and how effectively members
work together to achieve objectives. Individual evaluation should demonstrate whether each director
continues to contribute effectively.
4 The definition of ‘senior management’ for this purpose should be the executive committee or the first layer of management below
board level, including the company secretary.
5 Which protect against discrimination for those with protected characteristics within the meaning of the Equalities Act 2010.
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200 Ethics and Governance
Provisions
17. The board should establish a nomination committee to lead the process for appointments, ensure plans
are in place for orderly succession to both the board and senior management positions, and oversee the
development of a diverse pipeline for succession. A majority of members of the committee should be
independent non-executive directors. The chair of the board should not chair the committee when it is
dealing with the appointment of their successor.
18. All directors should be subject to annual re-election. The board should set out in the papers accompanying the resolutions to elect each director the specific reasons why their contribution is, and continues
to be, important to the company’s long-term sustainable success.
19. The chair should not remain in post beyond nine years from the date of their first appointment to the
board. To facilitate effective succession planning and the development of a diverse board, this period
can be extended for a limited time, particularly in those cases where the chair was an existing nonexecutive director on appointment. A clear explanation should be provided.
20. Open advertising and/or an external search consultancy should generally be used for the appointment
of the chair and non-executive directors. If an external search consultancy is engaged it should be
identified in the annual report alongside a statement about any other connection it has with the company
or individual directors.
21. There should be a formal and rigorous annual evaluation of the performance of the board, its
committees, the chair and individual directors. The chair should consider having a regular externally
facilitated board evaluation. In FTSE 350 companies this should happen at least every three years.
The external evaluator should be identified in the annual report and a statement made about any other
connection it has with the company or individual directors.
22. The chair should act on the results of the evaluation by recognising the strengths and addressing any
weaknesses of the board. Each director should engage with the process and take appropriate action
when development needs have been identified.
23. The annual report should describe the work of the nomination committee, including:
• the process used in relation to appointments, its approach to succession planning and how both
support developing a diverse pipeline;
• how the board evaluation has been conducted, the nature and extent of an external evaluator’s contact
with the board and individual directors, the outcomes and actions taken, and how it has or will
influence board composition;
• the policy on diversity and inclusion, its objectives and linkage to company strategy, how it has been
implemented and progress on achieving the objectives; and
• the gender balance of those in the senior management6 and their direct reports.
Category 4 Audit, Risk and Internal Control
Principles
M. The board should establish formal and transparent policies and procedures to ensure the independence
and effectiveness of internal and external audit functions and satisfy itself on the integrity of financial
and narrative statements.7
N. The board should present a fair, balanced and understandable assessment of the company’s position
and prospects.
O. The board should establish procedures to manage risk, oversee the internal control framework, and
determine the nature and extent of the principal risks the company is willing to take in order to achieve
its long-term strategic objectives.
Provisions
24. The board should establish an audit committee of independent non-executive directors, with a minimum
membership of three, or in the case of smaller companies, two.8 The chair of the board should not be a
member. The board should satisfy itself that at least one member has recent and relevant financial
experience. The committee as a whole shall have competence relevant to the sector in which the
company operates.
6 See footnote 4.
7 The board’s responsibility to present a fair, balanced and understandable assessment extends to interim and other price-sensitive
public records and reports to regulators, as well as to information required to be presented by statutory instruments.
8 A smaller company is one that is below the FTSE 350 throughout the year immediately prior to the reporting year.
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MODULE 3 Governance Concepts 201
25. The main roles and responsibilities of the audit committee should include:
• monitoring the integrity of the financial statements of the company and any formal announcements
relating to the company’s financial performance, and reviewing significant financial reporting
judgements contained in them;
• providing advice (where requested by the board) on whether the annual report and accounts,
taken as a whole, is fair, balanced and understandable, and provides the information necessary for
shareholders to assess the company’s position and performance, business model and strategy;
• reviewing the company’s internal financial controls and internal control and risk management
systems, unless expressly addressed by a separate board risk committee composed of independent
non-executive directors, or by the board itself;
• monitoring and reviewing the effectiveness of the company’s internal audit function or, where there
is not one, considering annually whether there is a need for one and making a recommendation to
the board;
• conducting the tender process and making recommendations to the board, about the appointment,
reappointment and removal of the external auditor, and approving the remuneration and terms of
engagement of the external auditor;
• reviewing and monitoring the external auditor’s independence and objectivity;
• reviewing the effectiveness of the external audit process, taking into consideration relevant UK
professional and regulatory requirements;
• developing and implementing policy on the engagement of the external auditor to supply non-audit
services, ensuring there is prior approval of non-audit services, considering the impact this may have
on independence, taking into account the relevant regulations and ethical guidance in this regard, and
reporting to the board on any improvement or action required; and
• reporting to the board on how it has discharged its responsibilities.
26. The annual report should describe the work of the audit committee, including:
• the significant issues that the audit committee considered relating to the financial statements, and
how these issues were addressed;
• an explanation of how it has assessed the independence and effectiveness of the external audit process
and the approach taken to the appointment or reappointment of the external auditor, information on
the length of tenure of the current audit firm, when a tender was last conducted and advance notice
of any retendering plans;
• in the case of a board not accepting the audit committee’s recommendation on the external auditor
appointment, reappointment or removal, a statement from the audit committee explaining its
recommendation and the reasons why the board has taken a different position (this should also be
supplied in any papers recommending appointment or reappointment);
• where there is no internal audit function, an explanation for the absence, how internal assurance is
achieved, and how this affects the work of external audit; and
• an explanation of how auditor independence and objectivity are safeguarded, if the external auditor
provides non-audit services.
27. The directors should explain in the annual report their responsibility for preparing the annual report and
accounts, and state that they consider the annual report and accounts, taken as a whole, is fair, balanced
and understandable, and provides the information necessary for shareholders to assess the company’s
position, performance, business model and strategy.
28. The board should carry out a robust assessment of the company’s emerging and principal risks.9 The
board should confirm in the annual report that it has completed this assessment, including a description
of its principal risks, what procedures are in place to identify emerging risks, and an explanation of
how these are being managed or mitigated.
29. The board should monitor the company’s risk management and internal control systems and, at least
annually, carry out a review of their effectiveness and report on that review in the annual report.
The monitoring and review should cover all material controls, including financial, operational and
compliance controls.
30. In annual and half-yearly financial statements, the board should state whether it considers it appropriate
to adopt the going concern basis of accounting in preparing them, and identify any material uncertainties
to the company’s ability to continue to do so over a period of at least twelve months from the date of
approval of the financial statements.
9 Principal risks should include, but are not necessarily limited to, those that could result in events or circumstances that might
threaten the company’s business model, future performance, solvency or liquidity and reputation. In deciding which risks are principal
risks companies should consider the potential impact and probability of the related events or circumstances, and the timescale over
which they may occur.
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202 Ethics and Governance
31. Taking account of the company’s current position and principal risks, the board should explain in the
annual report how it has assessed the prospects of the company, over what period it has done so and why
it considers that period to be appropriate. The board should state whether it has a reasonable expectation
that the company will be able to continue in operation and meet its liabilities as they fall due over the
period of their assessment, drawing attention to any qualifications or assumptions as necessary.
Category 5 Remuneration
Principles
P. Remuneration policies and practices should be designed to support strategy and promote long-term
sustainable success. Executive remuneration should be aligned to company purpose and values, and be
clearly linked to the successful delivery of the company’s long-term strategy.
Q. A formal and transparent procedure for developing policy on executive remuneration and determining
director and senior management10 remuneration should be established. No director should be involved
in deciding their own remuneration outcome.
R. Directors should exercise independent judgement and discretion when authorising remuneration
outcomes, taking account of company and individual performance, and wider circumstances
Provisions
32. The board should establish a remuneration committee of independent non-executive directors, with a
minimum membership of three, or in the case of smaller companies, two.11 In addition, the chair of the
board can only be a member if they were independent on appointment and cannot chair the committee.
Before appointment as chair of the remuneration committee, the appointee should have served on a
remuneration committee for at least 12 months.
33. The remuneration committee should have delegated responsibility for determining the policy for
executive director remuneration and setting remuneration for the chair, executive directors and senior
management.12 It should review workforce13 remuneration and related policies and the alignment of
incentives and rewards with culture, taking these into account when setting the policy for executive
director remuneration.
34. The remuneration of non-executive directors should be determined in accordance with the Articles of
Association or, alternatively, by the board. Levels of remuneration for the chair and all non-executive
directors should reflect the time commitment and responsibilities of the role. Remuneration for all
non-executive directors should not include share options or other performance-related elements.
35. Where a remuneration consultant is appointed, this should be the responsibility of the remuneration
committee. The consultant should be identified in the annual report alongside a statement about any
other connection it has with the company or individual directors. Independent judgement should be
exercised when evaluating the advice of external third parties and when receiving views from executive
directors and senior management.14
36. Remuneration schemes should promote long-term shareholdings by executive directors that support
alignment with long-term shareholder interests. Share awards granted for this purpose should be
released for sale on a phased basis and be subject to a total vesting and holding period of five years or
more. The remuneration committee should develop a formal policy for post-employment shareholding
requirements encompassing both unvested and vested shares.
37. Remuneration schemes and policies should enable the use of discretion to override formulaic outcomes.
They should also include provisions that would enable the company to recover and/or withhold sums
or share awards and specify the circumstances in which it would be appropriate to do so.
38. Only basic salary should be pensionable. The pension contribution rates for executive directors, or
payments in lieu, should be aligned with those available to the workforce. The pension consequences
and associated costs of basic salary increases and any other changes in pensionable remuneration, or
contribution rates, particularly for directors close to retirement, should be carefully considered when
compared with workforce arrangements.
39. Notice or contract periods should be one year or less. If it is necessary to offer longer periods to new
directors recruited from outside the company, such periods should reduce to one year or less after the
initial period. The remuneration committee should ensure compensation commitments in directors’
terms of appointment do not reward poor performance. They should be robust in reducing compensation
to reflect departing directors’ obligations to mitigate loss.
10
11
12
13
14
See footnote 4.
See footnote 8.
See footnote 4.
See the Guidance on Board Effectiveness Section 5 for a description of ‘workforce’ in this context.
See footnote 4.
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MODULE 3 Governance Concepts 203
40. When determining executive director remuneration policy and practices, the remuneration committee
should address the following:
• clarity – remuneration arrangements should be transparent and promote effective engagement with
shareholders and the workforce;
• simplicity – remuneration structures should avoid complexity and their rationale and operation
should be easy to understand;
• risk – remuneration arrangements should ensure reputational and other risks from excessive rewards,
and behavioural risks that can arise from target-based incentive plans, are identified and mitigated;
• predictability – the range of possible values of rewards to individual directors and any other limits
or discretions should be identified and explained at the time of approving the policy;
• proportionality – the link between individual awards, the delivery of strategy and the long-term
performance of the company should be clear. Outcomes should not reward poor performance; and
alignment to culture – incentive schemes should drive behaviours consistent with company purpose,
values and strategy.
41. There should be a description of the work of the remuneration committee in the annual report, including:
• an explanation of the strategic rationale for executive directors’ remuneration policies, structures
and any performance metrics;
• reasons why the remuneration is appropriate using internal and external measures, including pay
ratios and pay gaps;
• a description, with examples, of how the remuneration committee has addressed the factors in
Provision 40;
• whether the remuneration policy operated as intended in terms of company performance and
quantum, and, if not, what changes are necessary;
• what engagement has taken place with shareholders and the impact this has had on remuneration
policy and outcomes;
• what engagement with the workforce has taken place to explain how executive remuneration aligns
with wider company pay policy; and
• to what extent discretion has been applied to remuneration outcomes and the reasons why.
Source: FRC Code 2018, The UK Corporate Governance Code, FRC, pp. 7–18. Reproduced with permission.
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Jensen, M & Meckling, W 1976, ‘Theory of the firm: Managerial behavior, agency costs and ownership structure’, Journal of
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La Porta, R, Lopez-de-Silanes, F & Schleifer, A 1999, ‘Corporate ownership around the world’, Journal of Finance, vol. 54, no. 2,
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MODULE 3 Governance Concepts 205
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206 Ethics and Governance
MODULE 4
GOVERNANCE IN
PRACTICE
LEARNING OBJECTIVES
After completing this module, you should be able to:
4.1 evaluate the implications of board diversity and executive remuneration in relation to corporate governance
including corporate performance
4.2 identify a range of operational responsibilities which affect some significant stakeholders and that are
important for good governance
4.3 identify aspects of corporate governance that arise in relation to audit responsibilities and regulatory
compliance
4.4 evaluate the importance of good corporate governance as a factor in mitigating the risks of financial failures
4.5 understand and apply policy laws and regulations that exist for the protection of markets and services, and
relevant stakeholders including consumers
4.6 identify some important rules that exist for the protection of financial markets and the value of corporations.
ASSUMED KNOWLEDGE
Knowledge from modules 1–3 of this study guide is assumed.
LEARNING RESOURCES
The following resources will be referred to in this module.
• Treasury Laws Amendment (Enhancing Whistleblower Protections) Act 2019 (Whistleblower Act)
• Corporations Act 2001 (Cwlth)
• Reading 4.1: Open letter endorsing Commonsense Corporate Governance Principles (available on My Online
Learning)
PREVIEW
In module 3 we looked at the theory of corporate governance along with the key elements of a corporate
governance framework and guidelines for international best practice. In this module we will explore the
practical aspects of corporate governance. This relates to specific actions those charged with governance
can take to demonstrate accountability and achieve good corporate governance.
Corporate governance is a complex area both in theory and in practice, but it is central to achieving the
organisation’s objectives and being accountable to stakeholders. Corporations that have good corporate
governance are more likely to succeed in achieving their long-term goals.
This module explores the application of corporate governance principles. In particular, in this module
we will examine:
• the role of corporate governance in the prevention of corporate financial failure
• a board’s operational responsibilities including legislation in relation to stakeholders
• mechanisms for the protection of financial markets and the value of corporations.
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PART A: CORPORATE GOVERNANCE
SUCCESS FACTORS
INTRODUCTION
One practical outcome of poor corporate governance is the financial failure of the corporation. Boards are
charged with preventing this through adherence to good corporate governance practices. The following
areas all contribute to reducing the risk of financial failure:
• board selection (including ensuring diversity), operation, evaluation and departures
• executive remuneration and performance appraisal
• compliance with the Corporations Act 2001 (Cwlth)
• auditing the financial statements.
This part of the module will examine each of these areas in turn. We will begin with a discussion of
the make-up of the board of directors itself. Most of what corporate boards should be doing structurally is
contained within the Australian Securities Exchange (ASX) Corporate Governance Council’s Corporate
Governance Principles and Recommendations (ASX CGC 2019). Implementation of the principles is
another matter and is dependent on the quality of the board and making sure that there is a match
between what is required to govern the organisation and the attributes of directors. The ASX principles
are referenced where relevant in the following discussion.
4.1 MITIGATING THE RISK OF FINANCIAL FAILURE
Corporate failure can have many causes and it is rare that a company fails for a single or unexpected reason.
Following a spate of corporate collapses, including Enron, former KPMG chairman David Crawford stated
that there ‘ain’t no new way of going broke’ (cited in Gettler 2001). Crawford said that businesses that fail
often ignore the fundamentals, and research conducted by various academics and institutions has supported
that conclusion. Altman and Hotchkiss (2006) note that management inadequacies are often at the core.
This can be reflected in management not being able to read the market and not understanding the effect
external factors can have on the organisation’s operations.
COMMON CAUSES OF CORPORATE FAILURE
Following an in-depth examination of a number of high-profile corporate failures — including Enron,
Barings Bank, WorldCom, Tyco and Parmalat — Hamilton and Micklethwait (2006) believe that the main
causes of failure can be grouped into six categories, a number of which stem from governance failure:
(1) Poor strategic decisions. Management fails to understand the relevant business drivers when they
expand into new products or markets, leading to poor strategic decisions.
(2) Greed and the desire for power. High-achieving executives can be ambitious, eager for more power and
may attempt to grow the company in a way that is not sustainable.
(3) Overexpansion and ill-judged acquisitions. Integration costs often far exceed anticipated benefits.
Cultural differences and lack of management capacity can also be problems.
(4) Dominant CEOs. Boards can sometimes become complacent and not adequately scrutinise the CEO.
(5) Failure of internal controls. Internal control deficiencies may relate to complex and unclear organisational structures and failure to identify and manage operational risks. This can lead to gaps in
information flow, control and risk management systems.
(6) Ineffective boards. While directors are expected to provide an independent view, occasionally they
can become financially obligated to management, which can impede their judgment (Hamilton &
Micklethwait 2006).
Lamers (2009) also highlights the importance of cash flow in ensuring the ongoing viability of a
business. Dun & Bradstreet Chief Executive Officer (CEO) Christine Christian notes that businesses are
more likely to fail because of poor cash flow than poor sales, with this being more prevalent in times of
economic recession or downturn (Heaney 2011). National Credit Insurance (Brokers) Pty Ltd, which offers
insurance to protect companies in the event of bad debts in their debtors’ lists, reported a significant rise in
the number of claims against bad debtors following the global financial crisis (GFC), indicating businesses
were not prepared for the slowdown in the economy, resulting in a strain on cash flows (Lamers 2009).
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208 Ethics and Governance
Corporate culture has also been identified as a significant factor in corporate failure. The following
extract from Cruver (2002) about the collapse of Enron demonstrates the culture in that company during
the 1990s.
Fear among competitors, suppliers, customers, and even Enron’s own employees … Greed among those
who dreamed of colossal bonuses, millions in stock options, and generous campaign contributions. Fear
and greed … were radically and permanently entrenched — throughout the culture, the people, and the
industries Enron touched (Cruver 2002, p. xv).
This highlights the importance of understanding agency theory and the related issues and costs.
According to Monks and Minow (2008), there has been significant abuse, not just by the directors, but
by all involved in the corporate governance process. This includes incompetence and negligence as well
as corruption by managers and directors as well as other peripheral players including securities analysts
and lawyers, accountants and financiers, and even shareholders.
The GFC provided a number of lessons for governance. The OECD identified that corporate governance
weaknesses in remuneration, risk management, board practices and the exercise of shareholder rights had
played an important role in the development of the financial crisis and that such weaknesses extended to
companies more generally (OECD 2010a, p. 3). These issues are explored further in the following extract
from an article that considers the corporate governance lessons from the GFC.
The financial crisis can be to an important extent attributed to failures and weaknesses in corporate
governance arrangements. When they were put to a test, corporate governance routines did not serve their
purpose to safeguard against excessive risk taking in a number of financial services companies.
A number of weaknesses have been apparent. The risk management systems have failed in many cases
due to corporate governance procedures rather than the inadequacy of computer models alone: information
about exposures in a number of cases did not reach the board and even senior levels of management, while
risk management was often activity rather than enterprise based.
These are board responsibilities. In other cases, boards had approved strategy but then did not establish
suitable metrics to monitor its implementation. Company disclosures about foreseeable risk factors and
about the systems in place for monitoring and managing risk have also left a lot to be desired even though
this is a key element of the Principles.
Accounting standards and regulatory requirements have also proved insufficient in some areas leading the
relevant standard setters to undertake a review.
Last but not least, remuneration systems have in a number of cases not been closely related to the strategy
and risk appetite of the company and its longer-term interests.
The Article also suggests that the importance of qualified board oversight, and robust risk management
including reference to widely accepted standards is not limited to financial institutions. It is also an essential,
but often neglected, governance aspect in large, complex non-financial companies.
Potential weaknesses in board composition and competence have been apparent for some time and widely
debated. The remuneration of boards and senior management also remains a highly controversial issue in
many OECD countries (Kirkpatrick 2009).
A KPMG guide to corporate collapses (KPMG 2016) also provides some insight into the key drivers
of certain corporate misadventures by analysing a series of case studies. The global firm summarises the
following factors as being principal causes of corporate failure:
1.
2.
3.
4.
5.
6.
7.
8.
9.
Greed or sense of making magic happen
Over-ambitious corporate expansions leading to complex structures
Excessive debt to fund expansions or personal expenses
Incentives to management increase the motivation to commit fraud
Pressure to achieve market expectations
Corporate governance failures as a result of incompetent or ineffective boards and board committees
Sense of entitlement by senior management
Failure and override of internal controls
Manipulation of financial records and/or fraudulent financial reporting to disguise the true nature of
underlying problems (KPMG 2016).
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MODULE 4 Governance in Practice 209
Other issues that have been linked to governance failures include remuneration, wilful blindness and
poor risk management — especially in relation to managing complex financial products. These are
discussed below.
Remuneration
Two major issues arise in relation to the remuneration that senior executives receive.
First, there are concerns about the extent to which high executive earnings are linked to performance.
Remuneration methods may fail to achieve alignment or congruency between the agent and principal. They
may actually encourage the agent to behave in ways that the principal does not desire at all. This may
be the result of linking too much remuneration to excessive risk-taking, or to focusing remuneration too
closely on short-term performance while ignoring long-term sustainable and reliable growth and profits.
Yeoh (2016) emphasised the point in a paper on corporate governance failure that ‘executive compensation
schemes induced extreme risk-taking without punishing failures while focusing on short-term interests
without aligning with the long view of risk’.
Second, there is frequently shareholder concern regarding the total amount that executives receive,
which is often regarded as excessive and involves a residual loss agency cost. This cost is borne by the
shareholders whose returns are reduced by the payments received by senior executives. Despite constant
attempts by organisations and corporate governance advisory bodies, most attempts to manage and control
remuneration levels have not been successful.
A further problem that was emphasised throughout debates on misconduct in the financial services
sector were the incentives paid to financial services professionals for selling products. These featured
prominently in discussions related to the Hayne Royal Commission and were cited as a primary reason
why various acts of misconduct were committed. Incentives may lead to a skewing of decision making in an
inappropriate manner.
Wilful Blindness
‘Wilful blindness’ (or ‘wilful ignorance’) is a term that is sometimes used to refer to types of cases
involving serious corporate governance failure. Although it is not a formal legal term under, for example,
Australian or UK law, it is a term referred to in US legislation such as the US Foreign and Corrupt Practices
Act (1977) and the US Bankruptcy Code.
In essence, wilful blindness refers to situations where individuals seek to avoid their legal liability for
a wrongful act by deliberately putting themselves in a position where they are unaware of facts that will
make them liable. In US cases where defendants have sought to escape legal liability on this basis, the
courts have frequently rendered defendants liable on the basis that they could and should have known of
facts that, had they been acted upon, would have prevented the wrongful act.
The concept of wilful blindness was referred to in the case involving Enron CEOs Kenneth Lay and
Jeffrey Skilling. The Sarbanes–Oxley regulations aim to prevent this type of approach by requiring the
CEO and Chief Financial Officer (CFO) to sign off on the financial accounts and certify the appropriateness
of internal controls.
From a corporate governance perspective, allegations of wilful blindness can have serious reputational
consequences for the individuals and organisations concerned, and potentially serious legal consequences.
This highlights that it is important for directors and others to uphold ethics and follow good corporate
governance practices in order to prevent such incidents in the first place.
Poor Risk Management
Poor risk management is a common theme in relation to corporate governance failures. A major implication
in relation to the GFC is a lack of expertise of some boards of directors in understanding and effectively
managing the risks involved with trading in complex financial instruments. It is clear that some bank boards
were not aware of the substantial risks that the trading of these instruments had brought to their bank.
Such a finding mirrors earlier lessons learned from banking disasters such as the collapse of Baring
Brothers in the mid-1990s. In that case, a rogue trader built up significant exposures to falls in some market
prices, seemingly without the board being aware until it was too late. More recently, a much larger scandal
erupted concerning the fixing of the rates with the London Interbank Offered Rate (LIBOR), which is the
primary benchmark for short-term interest rates around the world. It was discovered that traders at a large
number of international banks were manipulating these rates, leading to excessive interest payments by
customers. The banks involved were heavily fined, though the boards of the banks and senior executives
insisted they were not aware of the systemic manipulation of rates that was taking place.
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210 Ethics and Governance
These examples demonstrate where a range of companies had failed. The following sections explore
what companies are able to do to improve the quality of governance in order to reduce the likelihood of
poor performance and ultimate closure.
SELECTION, MONITORING, EVALUATION AND CESSATION OF
BOARD APPOINTMENTS
Companies are like a wrist watch. Each part of the watch needs to function in order for the watch to tell the
time properly and consistently. Anyone not monitoring the watch and checking that it is working correctly
may notice that it is right at least on two occasions each day. A watch needs to be wound up or have a
battery replaced to ensure that it is fit for purpose. A company is the same. All of the parts, elements or
departments within a corporation need to be considered when analysing whether things work or there are
problems. For example, the kickbacks that AWB Ltd (formerly the Australian Wheat Board) paid to Iraq’s
former government and the News Corporation phone hacking scandal that erupted in the UK in 2011 show
what can happen in the absence of good governance and adherence to ethical norms or practice.
This module builds on the discussion of corporate governance in module 3 through the consideration of
additional issues and international trends (including new regulation) in relation to boards and management.
Important factors relate to how directors are appointed and the diversity of board candidates and managers.
We also look at the role of shareholders in voting for the appointment of directors, and how directors cease
to be on the board. This voting power is gaining new significance because of the vexed issue of executive
remuneration and corporate performance as a key part of good corporate governance.
Appointment of Directors
Capable directors, properly appointed, are vital to the effective oversight of modern corporations. In
Australia, in common with most countries, only a natural person (i.e. a human being, in contrast to merely
a legal person) of at least 18 years of age can be formally appointed as a director. A person currently
disqualified ‘from managing a corporation’ cannot be appointed a director (and also cannot be appointed
as a senior executive).
Notwithstanding the various corporate governance recommendations discussed in module 3, in Australia
and some other jurisdictions, the law does not specify that directors must hold any particular qualifications
or capabilities. In contrast, the majority of executives who are also directors will be required to have
qualifications relevant to their appointed executive position. Further, while it is expected that those
recommending board appointments to shareholders (e.g. the nomination committee) will properly assess
each candidate before appointment (and reappointment in the case of incumbent directors), it is noteworthy
that some appointments seem to add little value to the corporation.
The appointment of directors is traditionally strongly influenced by the board, even though the
shareholders legally appoint directors. In most jurisdictions, the annual general meeting of shareholders
will vote in favour of candidates recommended by the board (or by the nomination committee). Indeed,
endorsed directors of ASX 200 companies have averaged about 95% of the vote in favour since 2000.
Where a ‘casual vacancy’ arises, it is common for the board to use its powers to appoint a director
immediately (for later ratification by shareholders’ vote at the next AGM). Rarely are shareholders
presented with a range of candidates from which to choose.
Election of Directors
There have been two approaches that have emerged for the election of directors. One of these approaches
is a ‘staggered’ approach to election of directors. The staggered approach is one that places a greater
emphasis on ensuring that there is some preservation of corporate memory and consistency of decision
making over time.
For a nine-member board over a three-year period, a staggered approach would look like the following.
• 2019: Board members 1, 2 and 3 are required to retire from their position and, if they want to re-join
the board, must be subject to a shareholder vote of approval.
• 2020: Board members 4, 5 and 6 are required to retire, and these directors also require a shareholder
vote of approval to re-join the board.
• 2021: Board members 7, 8 and 9 are required to retire and also require a shareholder vote of approval
to re-join the board.
The standard period of director appointment has tended to be around the three years in most countries —
with just a few directors being re-elected by shareholders each year under staggered voting. A three-year
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MODULE 4 Governance in Practice 211
staggered vote cycle for directors means that every year, one-third of the directors are required to resign
and then typically all, or most, of these individuals will stand for re-election.
The other approach that has grown in use is referred to as ‘destaggering’. This approach refers to placing
all directors up for election each year rather than using a staggered approach. The destaggered approach
is gaining acceptance as it is set to enhance director accountability and shareholder power.
Australian investors have been exposed to this direction change (e.g. at the 2012 AGMs of Rio Tinto,
BHP and News Corp). In the United States (US), annual voting for all directors is now very common,
which is a major step forward from past practices where US shareholders could not actually vote ‘against’
a director, but instead simply ‘withheld’ a vote in favour.
A process by which all directors are appointed in an annual basis would look like this:
• 2019: All board member appointments expire and reappointment is subject to shareholder vote and
approval.
• 2020: All board member appointments expire again and reappointment is once again required.
In Australia, an election exemption exists for the managing director, under ASX Listing Rule 14.4.
The managing director is usually the CEO of the organisation. Many managing directors will employ this
exemption and may never face a shareholder election.
An annual cycle still leaves the possibility of ‘continuing appointment’ of directors who have been on
the board for some time. Boards need renewal, as weary or tired directors are unlikely to bring new ideas
to the boardroom and may often be resistant to change.
Further, the relationships that arise within boards mean that independent directors will gradually lose
their independence as board and corporate familiarity grow over time.
Both the UK and Australia have specified maximum periods for directors to be considered independent,
although boards often conclude that independence persists despite the fact that directors have moved
beyond the recommended time limits (e.g. 10 years). This is less than satisfactory, because deciding that
independence is likely to cease after a designated period can encourage board renewal and help create a
clear majority of independent directors.
While holding annual elections of the whole board is regarded by some as a way of improving corporate
governance, an appropriate degree of board continuity (i.e. all directors not being replaced at the same time)
is also important to ensure the orderly oversight of corporations by directors with ‘corporate knowledge’.
As in all matters of good corporate governance, a balance of skills and judgment is vital in ensuring sound
board composition. On this, Kiel and colleagues offer the following advice.
Since it takes a year for a director to experience the full board cycle, anything less than two (and possibly
three) years is likely to underutilise the skills of the individuals involved. Similarly, by presenting an upper
limit of around five years before a director has to stand for re-election, the board guards against directors
becoming entrenched (Kiel et al. 2012, p. 215).
Evaluation of Board Performance
A key to properly governing any entity is to ensure that a board reviews its own performance at least
annually to ensure that it is performing at the optimal level. A range of areas need to be examined in the
review of board performance. EY (2018) and Deloitte (2014) identifies several key areas for review, which
are categorised and presented in figure 4.1.
Recommendation 1.6 of the ASX Corporate Governance Council’s principles issued in February 2019
suggests that listed companies have periodic reviews of board performance and that companies disclose
whether an evaluation has taken place in a given reporting period.
Departures
Directors may resign from their position during the current term or, alternatively, choose not to stand for
re-election at the end of their current board term. The resignation or death of a director will result in
a board vacancy that allows the board, if it chooses, to make a temporary appointment, subject to later
shareholder vote.
While a director’s resignation does not have the same negative connotations as a formal ‘removal’ or a
legal ‘disqualification’, it is important for shareholders to be informed of the reasons behind any particular
resignation. In Australia, shareholders and other stakeholders will normally be informed through ASX
disclosure processes or by the Australian Prudential Regulation Authority (APRA). Similar agencies exist
in many jurisdictions.
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212 Ethics and Governance
FIGURE 4.1
Parameters of board evaluation
Governance
Evaluate:
• corporate governance
guidelines
• committee charters
• codes of conduct and ethics
• whistleblower provisions
• control mechanisms.
Company strategy, culture
and performance
Evaluate:
• company strategy
• company culture
• company performance
• risk management.
Evaluation process
Board operations
• Measure performance against
objectives.
• Obtain feedback from each
board member.
• Agree on actions to address
issues identified.
• Establish accountability for
addressing issues.
Evaluate:
• board meetings
• meeting agendas
• meeting materials
• minutes
• participation
• role of chair.
Stakeholder engagement
Evaluate:
• investor and other stakeholder
engagement on board
composition and performance.
Board structure and
composition
Evaluate:
• board dynamics
• board operations
• board structure
• diversity (perspectives, skills,
experience).
Source: Adapted from EY 2018 and Deloitte 2014.
The problem is that the real reasons for resignation are not usually known. Even if there is good reason
to believe that something is seriously wrong, resignation statements generally indicate such reasons as
‘health’ or to ‘pursue other interests’. Corporate governance can be greatly enhanced if directors who
resign on a point of principle follow the Bosch Committee recommendation and make their concerns
known either to shareholders or to the relevant regulator (Bosch 1995).
Removal
As with appointments of directors, in most jurisdictions a vote by shareholders at a general meeting can
also remove a director from office. Furthermore, in some countries, it may be possible for the remaining
directors to pass a resolution to remove a director, although there usually needs to be just cause to do so.
Removal of a director of a public company in Australia before their term has expired can only be by
a shareholders’ vote at a general meeting. Under Australian law, shareholders have three ways to force a
motion to remove individual directors by way of an ordinary resolution requiring support of 50% of the
votes cast.
Firstly, any individual or group of shareholders holding 5% of the votes can require the board to call an
extraordinary general meeting, and the meeting is held at the company’s expense.
Secondly, any individual or group of shareholders holding 5% of the votes are also able to call a general
meeting at their own expense, which is unlikely due to the substantial costs involved.
Thirdly, where a company has already called a general meeting, shareholders holding 5% of the votes
— or 100 members entitled to vote — can seek to give the company notice of a proposed resolution to be
put to the meeting, including removal of directors.
These processes can be difficult and costly exercises and should not be undertaken lightly. It is also
significant in a legal sense and local corporate regulators will usually require an explanation of the removal
of a director before their term expires. Such a vote commonly will require the support of larger institutional
shareholders if it is to be successful.
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MODULE 4 Governance in Practice 213
Two-Strikes Rule — Shareholders Spill the Whole Board of Listed Company
In 2011, the Corporations Act was amended to provide for ‘two strikes and re-election’ of all board
members of listed companies. The rule, which was recommended in a report Executive Remuneration
in Australia (Productivity Commission 2009), relates specifically to rising dissatisfaction among shareholders and in the general community about the generosity of remuneration policies within corporations,
especially for senior executives.
The two-strikes rule is accompanied by a range of measures designed to provide better information to
shareholders. Other accompanying measures also control who may vote and the way that ‘remuneration
consultants’ can be used by boards and management. Remuneration is now a matter to be considered by
the board’s remuneration committee, which must have a majority of independent members.
The two-strikes rule provides that the entire board can be removed after a shareholder vote ‘to spill the
board’. However, this spill vote can only occur after the eligible shareholders have voted twice against the
remuneration report. When voting on remuneration policies, not all shareholders are permitted or eligible
to vote. Those shareholders who hold key management positions or are conflicted in some other way are
not eligible to vote. When there is a large number of ineligible shareholders (e.g. when the managers own a
large proportion of the shares), this gives the other shareholders significant power to reject the remuneration
report and potentially cause a spill of the whole board.
The first strike occurs where 25% or more of the eligible shareholders vote ‘No’ on the mandatory
resolution by the board that shareholders accept the corporation’s remuneration report presented in the
annual report.
Following the first strike, the company’s subsequent remuneration report (i.e. in the next annual report)
must explain the board’s action in response to the negative vote or, if no action was taken, the board’s
reason for inaction. The subsequent remuneration report must also disclose all relevant information for
the (second) year, just ended. The second strike occurs where, once again, 25% or more of eligible votes
are ‘No’ in respect of the second year’s board resolution to shareholders that the remuneration report
be accepted.
Following the second strike, and at the same annual general meeting at which it occurs, a resolution to
‘spill’ (i.e. remove the whole board) must be put to shareholders. Other than the managing director, all
directors who were on the board when it resolved for the second time to put the remuneration report to
shareholders must be subject to the spill vote.
The spill resolution is successful if a simple majority (i.e. 50% or more) of ‘eligible votes’ is in favour
of the spill at that time. This concept is extremely important, as no key management personnel (KMP)
(or any of their related parties) are eligible to vote on either the remuneration reports or the spill motion.
Importantly, this generally gives independent shareholders larger voting power proportions than usual,
because the large numbers of shares often held by directors and executives (and their related parties) are
not permitted to vote. Note that the Corporations Act specifically uses the KMP definition from AASB 124
Related Party Disclosures:
Key management personnel are those persons having authority and responsibility for planning, directing
and controlling the activities of the entity, directly or indirectly, including any director (whether executive
or otherwise) of that entity (AASB 2010, para. 9).
The shareholders’ meeting to elect a new board must take place within 90 days. At this meeting, all
shareholders are permitted to vote, as the board represents all shareholders including KMP. The 90-day
period allows for new persons to nominate for appointment to the board by shareholders’ vote. Notably,
the law provides that at least two of the old directors (other than the managing director) are required to
continue in order to ensure continuity of the board.
This is an important new direction but, with this new power being given to shareholders in the search
for improved corporate governance, we must fully understand how the measures operate and how they
may be used. The newspaper report (Wen 2013) in example 4.1 describes the first board spill under the
two-strikes rules.
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EXAMPLE 4.1
Reaction to Shareholder Spills
‘Penrice Duo Pass Two-Strike Spill’
The directors of Penrice Soda have called for the ‘two-strikes’ policy to be revoked, after avoiding going
down in history as the first board dumped under the contentious rule.
Chairman David Trebeck and deputy Andrew Fletcher were both re-elected after receiving 78% of the
vote at an extraordinary general meeting in Adelaide on Friday.
Both men had already created a bit of unwanted Australian corporate history, with the small Adelaidebased chemicals manufacturer that has a market capitalisation of $10 million thrust into the spotlight for
being the first board to be spilled and forced to fight for re-election.
Shareholders rejected the company’s remuneration report for the second year in a row in October.
The ‘two-strikes’ rule was designed to deliver shareholders a greater say in the executive remuneration
policies of large corporates, particularly as pay packets bulged, often at odds with diminishing shareholder
returns.
But after the meeting on Friday, Mr Trebeck said the negative vote against the remuneration report ‘had
more to do with general shareholder disaffection’ — the company’s poor performance, a declining share
price and the absence of dividends — than it did with excessive executive pay.
‘Ideally, the two-strikes policy should be terminated,’ he said, adding that before the two-strikes rule,
shareholders who were disgruntled with the performance of the board could still muster enough support
to request an extraordinary general meeting and move against some or all directors.
Shareholder advocacy groups and large institutional funds have largely delivered positive feedback
on the ‘two-strikes’ regime, and the fact that company directors were now more open to shareholder
feedback.
Influential fund manager AMP Capital said earlier this month that it had experienced a ‘dramatic
increase’ in companies engaging with it, when previously concerns ‘fell on deaf ears’.
Source: Wen, P 2013, ‘Penrice duo pass two-strike spill’, The Age, 26 January, accessed October 2015, www.theage.
com.au/business/penrice-duo-pass-twostrike-spill-20130125-2dca3.html.
QUESTION 4.1
Explain the significance of the shareholder vote in the ‘two-strikes’ rule and the fact that, at different
points, it includes 25% and 50% of ‘eligible votes’, and finally the participation of all shareholders
as a simple majority.
Disqualification
Disqualification from managing corporations in any circumstances, either as a director or as an officer,
depends on the existence of some element of legally defined commercially unacceptable behaviour or
legal wrongdoing. Specific ‘wrongs’ that may lead to disqualification include:
• responsibility for certain civil wrongs (which are specified in legislation)
• financial market misconduct
• responsibility for multiple insolvencies
• significant dishonest actions and corporate crimes
• civil and criminal wrongs in relation to anti-competitive conduct in markets for goods and services.
Disqualification may be ‘automatic’. In this case, circumstances surrounding a director may mean that,
without any formal declaration of disqualification occurring, a person is disqualified — typically for a
period of five years.
For example, a person who is declared bankrupt is automatically disqualified from continuing their
company directorships. Similarly, criminal offences involving breaches of laws governing corporations
will typically involve automatic disqualification. While the rules vary slightly across jurisdictions, the
underlying principles demonstrate great consistency internationally. In most jurisdictions, automatic
disqualification applies only where criminal breaches have been proven.
Disqualification may also occur because of an order of the court, where the misbehaviour of a director
or other senior officer is of a type that the courts are empowered to impose disqualification — with periods
of disqualification that could be as long as 20 years. The types of misbehaviour leading to court-ordered
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disqualification involve various legislatively defined ‘civil wrongs’ including legislatively defined breaches
that lead to civil penalties.
In some circumstances, disqualification can be prescribed by regulatory agencies (such as the Australian
Securities and Investments Commission (ASIC) or APRA in Australia — and even gaming authorities can
disqualify) where directors and other senior officers have been involved in multiple insolvencies or have
breached relevant probity provisions.
Ethics of Disqualification
Offences relating to dishonesty will usually automatically disqualify a person from serving as a director
of a corporation. Disqualification aims to act as a deterrent to would-be offenders and helps protect the
public from exposure to persons who may reoffend. It also gives reassurance to markets and individual
investors.
It is useful to note that the rules regarding disqualification relate to managing a corporation as a director
and also managing a corporation as a senior executive (or other ‘officer’), whether a director or not. Simply
being a poorly performing director, who is not in breach of a relevant law, and where the companies they
manage have not been placed into insolvency as described below, will not result in disqualification — so
the appointing capable people who can do the job is very important, as the removal of poor appointees
may simply not occur.
When looking at the reasons for disqualification, it is possible that a person who has exercised poor
judgment on a number of occasions, leading to the insolvent failure of the corporation of which they
are a director, may be disqualified because of that poor judgment. In doing so, it is arguable that the
disqualification of the person from managing the corporation is not to act as a deterrent to others or
to punish unethical behaviour — rather it is to remove that person from the commercial arena and,
therefore, prevent further harm. Inherent in the word ‘failure’ is the financial harm caused to creditors
of the corporation. To some extent, there does appear to be measurable overlap between the law and
underlying ethical precepts. Arguably, a person who allows multiple insolvencies to occur really is not
behaving properly in a corporate context.
QUESTION 4.2
From the perspective of the disqualified person, what is the effect of being disqualified and what
is the key difference between disqualification that is ordered by the courts (or by ASIC) and a
disqualification that is automatic?
4.2 DIVERSITY — FAIRNESS AND PERFORMANCE
Diversity includes an individual’s race, ethnicity, gender, sexual orientation, age, physical abilities,
educational background, socioeconomic status, and religious, political or other beliefs. One key area
where the subject of diversity arises is in relation to discrimination in employment. This relates to fairness.
Diversity is also an important factor in performance. These two issues are described below.
Under Australian state, territory and federal legislation, it is unlawful for an employer to discriminate
against employees on certain prohibited grounds of discrimination such as race, gender, sexual orientation
and religion. For example, the Equal Opportunity for Women in the Workplace Act 1999 (Cwlth) has done
much to advance gender diversity by requiring organisations with 100 or more employees to establish a
workplace program to remove the barriers to women entering and advancing in their organisation.
In recognition of a lack of gender diversity in Australian boardrooms and at the request of the Australian
Government, the Corporations and Markets Advisory Committee (CAMAC 2009) reported on Diversity
on Boards of Directors. Following the CAMAC report, the ASX Principles were amended in 2010 to
promote greater diversity, particularly gender diversity, among the employees and boards of ASX-listed
companies (ASX CGC 2010). The recommendations on diversity in the ASX Principles aim to address
the major challenge of balancing gender on boards, since there are currently far fewer women than men
who can progress to board level in the upper levels or echelons of organisations. The Australian Census
of Women in Leadership (WGEA 2012) indicated that the number of women on ASX 200 boards was
only 12.3%, with even fewer women in executive ranks. Since then, a considerable effort has been made
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to increase the participation of women in leadership by the ASX, the Australian Institute of Company
Directors (AICD) and other bodies, with a marked improvement to 20%. However, though targets have
been set in major Australian corporations, in European countries that have adopted mandatory quotas, 40%
of board members of large corporations are now women.
The ASX Corporate Governance Recommendations were amended again in 2019. Recommendation 1.5
was revised by the Corporate Governance Council to embed a 30% target for senior executives and the
general workforce to be of each gender within a specified timeframe, as well as 30% of each gender on
boards of directors.
The approach in Australia is similar to that of the United Kingdom (UK), where the FRC Code includes,
among other things, a recommendation that companies apply a formal, rigorous and transparent procedure
when appointing new directors to the board, with due regard to the benefits of diversity, including gender.
Indeed, many countries are now including recommendations that boards establish policies on the board’s
approach to achieving diversity (FRC 2018, Principle J). For example, the Malaysian Code on Corporate
Governance (Securities Commission Malaysia 2012) suggests that boards should disclose their gender
diversity policies and targets in their annual reports.
Since corporations look to corporate governance codes to benchmark their performance, the inclusion
of diversity in such codes is an important way to reinforce the concept that a diverse board can be
a source of new skill sets and innovation and can ultimately add value to the corporation. However,
countries such as Norway, France and Spain have gone further and have introduced mandatory quotas
to increase gender diversity on boards. These quotas have proven successful in addressing the gender
imbalance on boards (Credit Suisse 2012), and other countries have announced that they will introduce or
are considering introducing similar quotas. An alternative to the quota approach is that of the 30% Club
which was established in the UK in 2010. At the time of writing it has chapters in 14 countries including
Australia. ‘The 30% Club aims to develop a diverse pool of talent for all businesses through the efforts of
its Chair and CEO members who are committed to better gender balance at all levels of their organisations’
(30% Club 2019).
In Australia, leading corporations are voluntarily committing to achieving significantly greater participation of women on boards, and backing this up with commitments to also increase the participation
of women in senior executive ranks. Creating greater gender balance in management is a sign of
the preparedness on the part of companies to utilise all of their potential talent (Klettner, Clarke &
Boersma 2015).
The importance of improving the gender balance of boards is backed by research. For example,
research by Credit Suisse found that over a six-year period, ‘companies with at least some female board
representation outperformed those with no women on the board in terms of share price performance’
(Credit Suisse 2012). Other published research in the area of diversity (Ali et al. 2014) has indicated that
there are great benefits in getting a diverse board in place with a range of academics finding that diverse
boards that feature members of different genders, ages and backgrounds are able to provide differing
perspectives. Researchers have commented on the fact that there were sound economic reasons to aim
for diversity as well as there being a social justice rationale for ensuring boards that were diverse in
their constituency.
The social justice rationale, which is evidenced by regimes that actively promote the appointment of
women to boards, is one where the objective is to achieve an environment where men and women would
experience equality at every level in society. Ali and colleagues note that ‘push initiatives’ designed to
elevate the importance of achieving gender equality on boards would take some years to bear significant
fruit. The researchers note that there are studies the point to the fact that diverse boards can have some
positive impacts.
• Diverse boards may make the organisation an employer of choice for people with different backgrounds
because the board is seen as championing diversity.
• Diverse boards may also provide a broad range of networks that could include potential customers
and suppliers.
• Broad range of ages on a board may mean that different levels of education and perspectives are available
to the board.
Ali and colleagues note that diverse boards ‘may help improve strategic directions, expand networks,
and engage talent, which may help organisations to become productive and financially successful’. Ntim
(2015) found that market valuation of companies does take account of board diversity, which includes both
gender and ethnicity, but that ethnic diversity was valued more highly in the context of this specific study
than gender diversity.
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ADOPTING DIVERSITY
Adopting diversity is not just a matter of rules and targets. It is necessary to create an environment where
diversity becomes part of the culture of good corporate governance generally. This can result in long-term
high performance of the organisation and a contribution to the capabilities of the entire community.
The National Australia Bank (NAB) is an example of an early adopter of diversity in the boardroom and
at management levels (consistent with the ASX Principles). As stated on its website, ‘NAB believes that
investing in its employees is crucial to building a sustainable business’ (AICD 2010).
Diversity improvements take time to effect actual changes. As at August 2015, NAB’s board of
10 directors included two female members and the bank’s senior executive group also included three
female executives of the total of 10. The impact of adopted diversity policies may be slow, but progress
is being made in many organisations. At September 2019, the NAB board had 9 directors, three of whom
were female and the senior executive group had 11 executives, four of whom were female. NAB’s formal
adoption and implementation of relevant policies will no doubt see female involvement at board and senior
executive levels increase further in future years.
One of the more vital campaigns is that of the 30percentclub.org, which is an industry-led body looking
for a rapid increase in the UK, Australia and other countries to 30% female participation on boards. As we
saw above, this requirement has been met by the NAB board.
An AICD report (AICD 2010) quotes the set of detailed diversity approaches being implemented at
NAB. These approaches provide a valuable platform for considering at least some of the issues of making
diversity an effective part of good corporate governance within the organisation. They also will equip a
more diverse array of people to contribute as part of society generally, as a large corporation such as NAB
would expect many employees to move to other corporations in their working lives.
The key points of NAB’s diversity approach identified by the AICD are:
• career development and mentoring programs specifically designed to support women progress
their careers
• an initiative to prevent parental leave disconnection, which keeps employees in touch while on
parental leave
• recruitment practices that ensures a mix of males and females are short-listed for each role, and that
both males and females make hiring decisions together
• positive recruitment targeting women looking to join the financial services industry
• remuneration fairness
• age, disability and other diversity initiatives such as addressing employment opportunities for Indigenous Australians, job sharing, telecommuting and supporting mature age workers.
Subsequently, in a path-breaking report, the Business Council of Australia (the lead body for large
Australian corporations) committed to a policy to increase the number of women in senior executive
positions to 50% within 10 years (BCA 2013). To assist member companies in achieving this goal, the
BCA commissioned a report on best practices for recruitment, selection and retention.
In considering diversity and its implementation, it is important to reiterate that policies are actually set
by boards working in conjunction with managers. Good policies are always crucial for good corporate
governance. Ensuring the right people are contributing within an organisation and that the right people are
chosen as managers and directors is crucial for good corporate governance.
EXECUTIVE REMUNERATION AND PERFORMANCE
In recent years, the remuneration of senior executives including CEOs and executive directors (and
sometimes, non-executive directors) has been the focus of considerable attention. Debate inevitably
focuses on the absolute levels of remuneration paid (i.e. the total size of all components of remuneration
packages including termination payments) in comparison with the pay of average wage and salary earners,
and increasingly on the extent to which payments are made regardless of past performance success.
Furthermore, as a result of the GFC, attention is now being paid to the apparent willingness of directors
and senior executives to take risks to create profits, leading to the appearance of solid financial performance
by their organisations. Some boards and executives took higher risks when their remuneration was based
upon short-term financial performance, effectively acting for personal gain.
Debate has now turned to whether payments effectively achieve future performance, and how they relate
to incentive and motivation. The pressure to link performance and pay has seen some jurisdictions mandate
the disclosure of executive remuneration to shareholders and the wider community, described as ‘having
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a say on pay’ in countries such as Australia, the UK and the US. More recently, recommendations for
boards to institute ‘clawback’ policies to recoup excessive performance-based remuneration have featured
in best-practice guidance.
As this discussion shows, the debate on executive remuneration is complex; this is further demonstrated
by the subject occupying almost 500 pages in the Productivity Commission’s 2009 report on executive
remuneration in Australia, which has influenced legislative changes in Australia. A speech delivered in
2012 by Jan du Plessis, chairman of Rio Tinto, revealed that corporations are beginning to recognise the
need to curb remuneration excess. He stated that the ‘spiral’ in executive pay in the past two decades
‘simply cannot continue … Many businesses sometimes appear to have lost all touch with reality’
(du Plessis 2012).
Example 4.2 further illustrates that the perceptions of shareholders, employees and the community with
respect to excessive executive remuneration are having an effect.
EXAMPLE 4.2
Remuneration — Headline Illustration
‘Narev Signals End to CBA’s Pay Freeze’
Commonwealth Bank of Australia will lift a freeze on executive salaries in the wake of its record annual
profit, paving the way for pay increases for its senior managers.
CBA, which reported a $7.8 billion profit last week, had the freeze on salary increases in place throughout
the 2013 financial year, but will not continue it into 2014.
Despite ending the salary pause, CBA chief Ian Narev has sought to play down expectations of big pay
increases.
‘The specific freeze, we haven’t said that we are going to roll that over, but we have said to everybody
starting with me that we are going to be very, very moderate in the way that we think about any
remuneration. And those decisions for this year are just starting to be made now,’ Mr Narev said.
‘We are keeping a very strong look on year-on-year remuneration increases, that has always got to start
with me and my executive team.
‘We are not saying anything publicly about exactly what the numbers on remuneration increases are but
we are keeping them very much in tune with the environment.’
CBA’s pay freeze applied to the bank’s top 400 managers, including Mr Narev and his senior executive
team.
However, it only covered fixed salaries and not performance-based incentive bonuses, which are linked
to meeting targets for profits, share price performance, customer satisfaction and other factors.
CBA’s shares are trading at near-record highs following its bumper profit result last week, while it is
ranked number one for customer satisfaction among the big four banks for both retail and business
customers.
The bank will disclose the pay of senior executives for 2013 — including bonuses — in its annual report
this week.
‘In an environment where customer satisfaction is good, shareholders are happy, people engagement
is good and we have managed risk well, the executives tend to do pretty well, that’s what short-term
incentives are all about. But again, overall in terms of remuneration, we have to make sure we cut our
cloth to suit the times,’ Mr Narev said.
Source: Liondis, G 2013, ‘Narev signals end to CBA’s pay freeze’, The Australian Financial Review, 19 August, accessed
October 2015, www.afr.com.
International Debates about Remuneration Levels and Fairness
An important factor in the debate about executive remuneration (even before we consider the relationship
between remuneration and performance) is that excessive remuneration is an issue of international concern.
For example, a report on this issue in the Economic Times (Goyal 2012) comments on the need for
Indian corporations to remunerate top executives on a global scale so that Indian corporations can succeed
(perform) at international levels. We assume that new Indian graduates earn relatively low levels of pay
consistent with national pay levels in India. Perhaps this results in the very high multiple seen in India (see
comparisons in table 4.1), which indicates that a CEO’s compensation is on average 675 times that of the
minimum wage earned by entry-level graduates. Whatever the reason, it emphasises that executive salaries
are indeed the subject of strong social and political commentary.
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TABLE 4.1
Wage gap between CEOs and entry-level graduates (multiples)
Location
Multiple
EU Zone
142
Australia
197
China
268
UK
270
Canada
295
US
423
India
675
Source: Adapted from Goyal 2012.
It is interesting to note that this table shows that, in the eurozone, the CEO remuneration package is
142 times that of a new graduate, and for Australia it is 197 times — which seem relatively moderate when
compared to the US figures. However, even in Europe, remuneration is a topic of debate. For example, on
14 June 2013, the Swiss Federal Council (the executive branch of the Swiss federal government) submitted
for public consultation a draft ordinance on ‘say-on-pay’ and excessive executive remuneration. The new
rules aim to limit excessive remuneration practices and boost shareholders’ roles and responsibilities
regarding remuneration matters. Bypassing this legislative approach, French corporations agreed to a new
code that includes a vote on executive remuneration for shareholders at annual general meetings, similar
to current practice in the UK and US (Carnegy 2013). While not legally binding, in the case of a negative
vote, the board would have to consult its remuneration committee and make public the action it intends to
take in response. As discussed earlier, the two-strike rule is exerting pressure on boards to ensure executive
remuneration is linked to performance and supported by shareholders.
A further brake on executive reward introduced recently in the US is an SEC requirement for companies
to disclose the ratio of CEO pay to ordinary workers in their company (SEC 2015). This pay ratio disclosure
highlights the frequent disparity between rapidly inflating CEO pay and average wages, which have
remained fairly static in most US corporations for many years.
The question, only very slowly being answered, is how far corporations can increase salaries without
creating community reactions that hurt themselves and shareholder wealth. The surge in procedures
designed to empower shareholders to control executive salaries and specific responses by governments
indicate that there is a limit — albeit a limit hard to state with any precision.
Payments for Past and Future Performance — and Motivation
As noted in module 3, according to the FRC Code and the ASX Principles, remuneration approaches for
executive directors and non-executive directors should be very different. To communicate this information,
Recommendation 8.2 of the ASX Principles states that ‘a listed entity should separately disclose its policies
and practices regarding the remuneration of nonexecutive directors and the remuneration of executive
directors and other senior executives’ (ASX CGC 2019, p. 30).
Non-Executive Directors
Good practice guidance, such as the ASX Principles, recommend that non-executive directors should not
be remunerated according to performance achieved or to be achieved, except to the extent that they hold
shares in the company and benefit from a rising share price. Their remuneration should be based primarily
on a reasonable return for time dedicated to the corporation’s business. They should not receive incentivebased payments and should receive only basic additional payments (such as superannuation at reasonable
levels and out-of-pocket expenses).
The payment of non-executive directors is best undertaken by deliberation of the entire board. Their
overall remuneration packages should be fully known and understood by shareholders so that they
understand how non-executive directors are remunerated and also so that any shareholder approvals are
fully informed. While current Australian law gives shareholders limited influence over the amount of cash
paid to executives or employees, the overall pool of cash paid to the non-executive directors as a whole
requires specific shareholder approval.
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The reason for the different pay arrangements for non-executive directors and executives is simple —
performance-based remuneration is not consistent with an independent approach to decision making and
it is necessary that all non-executive directors (even those otherwise not independent) are not subject to
remuneration types that lessen or deny independence.
Executive Directors and Other Senior Executives
Modern corporate governance approaches assume that the remuneration of executive directors (and some
senior executives who are not directors) is the key focus of those directors who comprise the remuneration
committee. Following the GFC of 2007–08, new regulations came into place to ensure that remuneration
committees have far greater independence to ensure better practices with respect to remuneration of
executives and executive directors. Such rules include the fact that the FRC Code 2018 (provision 32)
requires that only independent directors should be on the remuneration committee. In Australia, the ASX
Principles permit executives to be on the remuneration committee, but the Principle 8 commentary states
that ‘no individual director or senior executive should be involved in deciding his or her own remuneration’
(ASX CGC 2019, p. 30).
Performance-Based Remuneration
Payments to economic agents (in this case, executive directors and other managers — sometimes
also including other ‘incentivised’ employees) typically consist of ‘fixed’ and ‘at-risk’ remuneration
components. The fixed portion represents a base payment that is constant regardless of individual
and/or corporation performance, such as flat annual salaries and superannuation (i.e. retirement fund
contributions). The at-risk portion (i.e. failure to perform means that the recipient will suffer reduced or
non-payment) is based on the agent and/or entity reaching certain goals and performance benchmarks (both
short- and long-term). These benchmarks are often called key performance indicators (KPIs). In Australia,
short-term incentive payments tend to be paid annually and they are more likely to be cash based, whereas
long-term incentives are based over three to four years of performance and have a greater focus on shares
or options.
Remuneration of executives is often referred to as packaged (which can be very complex, partly for
tax reasons). The performance-related components of these packages can be especially complicated and
may consist of bonuses, shares and share options, other financial benefits, and even some types of private
expense reimbursements, such as allowances for a second home.
Performance payments should not just be a reward for past superior performance but should be designed
to motivate future performance. This motivation needs careful consideration because, recognising the
nature of agency theory, it is vital that the remuneration structure appropriately builds on the self-interest
of the manager(s). A good remuneration system will promote goal congruence between the managers, the
board and the shareholders, and will help avoid the worst aspects of agency costs.
Ideally, KPIs should not refer only to past performance but also to motivate and enhance future
performance. For example, share-based awards may be granted to certain executives for good past
performance, but may also include future performance conditions (including service conditions) that must
be satisfied before the executive becomes unconditionally entitled to the share-based award.
An area of recent strong attention relates to payments made upon early resignation from executive
responsibilities. Boards and their remuneration committees need to take great care to ensure that payments
made when executive directors and other senior executives retire or resign are in fact relevant to
performance, and that the concerns of shareholders and society generally are understood and addressed.
The concept of repayment of undeserved remuneration is another important control measure, sometimes
referred to a ‘clawback’. This concept is consistent with a rule in the US Sarbanes–Oxley Act 2002
and Provision 37 in the FRC Code. It is also seen in the current ASX Principles, in the commentary
to Recommendation 8.2, which states that the report should ‘include a summary of the entity’s policies
and practices regarding the deferral of performance-based remuneration and the reduction, cancellation or
clawback of performance-based remuneration in the event of serious misconduct or a material misstatement
in the entity’s financial statements’ (ASX CGC 2019, p. 30).
Australia’s prudential regulator, APRA, released a draft set of prudential requirements for remuneration
that reflected concerns expressed during the royal commission into misconduct in the financial services
sector chaired by Commissioner Kenneth Hayne. Commissioner Hayne’s concerns related to performance
based incentive payments being tied to financial success while being perceived to downplay the need for
advisers, bankers and other participants in the financial services sector to look after the welfare of the
consumer (APRA 2019a).
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The four objectives of the revised regime announced by APRA as a part of consultation were to:
• strengthen governance of remuneration frameworks and outcomes, in particular through an expanded
Board role, where the Board needs to be active and have direct oversight;
• set overarching remuneration objectives that inform design of all remuneration arrangements and
influence remuneration outcomes;
• limit the use of financial performance metrics (share price and profit-based); and
• set minimum deferral periods (up to seven years) for senior executives to provide more ‘skin-in-thegame’ through better alignment to the time horizon of risk and performance outcomes (APRA 2019a).
The point suggesting that remuneration metrics ought to have a limited focus on share price and company
profits is seeking to directly address the concern raised in the interim and final reports of the Hayne
Royal Commission. Conversely, media reports have periodically suggested that approaches that do not
tie remuneration to financial success are disapproved of by shareholders and shareholder advocates.
Disclosure, Transparency and Remuneration
Increased reporting in relation to remuneration, especially to shareholders and others who are the intended
users of annual reports, is a growing trend internationally.
Best practice corporate governance requires that there should be transparency in setting directors’
remuneration. A key governance principle is that no individual should be involved in setting or determining
their own remuneration levels. This can become difficult when setting the chairman’s fee, although at
least Australian shareholders must approve the overall fee cap available to the non-executive directors.
To enhance the transparency of the remuneration-setting process, as we have already discussed, internationally, laws now require a remuneration report to be included within the annual directors’ report to
shareholders.
The Productivity Commission’s 2009 report on executive remuneration provides valuable discussion of
some international approaches to remuneration disclosure (some of which are undergoing further changes
to improve performance linkage and shareholder understandings and control). For example, the report
notes that in Germany, public limited corporations must provide a breakdown of total earnings of each
member of the management board. Corporations can opt out where three-quarters of shareholders vote to
do so and only for a maximum of five consecutive years (Productivity Commission 2009, p. 245). This is
part of an international trend towards requiring disclosure of executive remuneration (Right2Info n.d.).
In the US, the Securities and Exchange Commission (SEC) amended its rules in December 2006. It
required that executive remuneration be accompanied by a detailed explanation of the rationale for that
remuneration, to strengthen the communication with shareholders on remuneration issues. The Dodd–
Frank Act (US), effective from January 2011, has given shareholders a non-binding vote on top executive
compensation.
In the UK too, investors are better informed about how much directors have been and will be paid, along
with how pay relates to corporate performance. As a result, shareholders of the approximately 900 Main
Market companies (i.e. larger, more established corporations listed on the London Stock Exchange) will
be better prepared to hold companies to account, using clearer information on pay to exercise their new
legally binding vote on executive pay (BIS 2013).
Not everyone agrees with the strong emphasis on disclosure and reporting, as wide disclosure may not
always lead to the expected benefits. Some commentators argue that an increase in remuneration disclosure
has led to higher and, indeed, excessive levels of remuneration being paid to executives and some directors.
The argument is based on the premise that remuneration committees do not wish to be seen to be paying
less-than-average market remuneration. Therefore, as corporations seek to set their remuneration levels
slightly above the average, this leads to higher payments across the market incrementally over time. If
we accept these concerns as real, then it becomes apparent that the growing strength of direct shareholder
voting (as in the Australian two-strikes rule) is an important factor in controlling possible reporting-induced
salary growth.
Tightening Rules Regarding Remuneration — Australian Illustrations
As noted above, the two-strikes rule in Australia, along with its related reporting changes, is a direct
result of the 2009 Productivity Commission report on executive remuneration and is consistent with
general changes in other jurisdictions internationally. The changes include greater clarity in reporting
remuneration, including the true nature of current, past and future remuneration available to executives.
Shareholders should more easily be able to understand the real nature of remuneration and whether there
is a direct relationship with performance. If, contrary to recommendations, performance-related at-risk
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222 Ethics and Governance
remuneration is being paid to any non-executive directors, the clearer reporting regime will also identify
this undesirable corporate behaviour.
One legislative response to excessive remuneration that has proved successful is the noticeably reduced
size of so-called ‘golden handshakes’. In 2009, the law was changed so that any termination payment
exceeding more than 100% of the executive’s 12-month fixed pay would need shareholder approval.
Previously, the limit was seven times the average total pay of an executive over their final three years
of employment. This earlier ‘seven times’ rule allowed Oz Minerals to correctly pay its departing CEO
$8.35 million in 2008. It is interesting to note that an earlier proposal to pay the CEO $10.7 million at
his departure had been voted down by shareholders (Leyden 2008). This larger amount was subject to a
shareholder vote as it exceeded the payment that could, at that time, be made without shareholder approval.
A broad-ranging report into executive remuneration in Australia was completed by the Australian
Government Corporations and Markets Advisory Committee (CAMAC 2011). This inquired into aligning
executive remuneration with company performance, and examined how the incentive components of
executive pay arrangements could be simplified in order to improve transparency and strengthen the
correlation between the interests of the company’s executives and the interests of shareholders.
Remuneration, Risk and the GFC
An issue of great prominence since the GFC is that performance payments should relate to genuinely
superior performance and proper understandings of risk. Complex financial products that were not well
understood appeared to create very large positive financial outcomes (i.e. profits). Many corporations,
rewarding executives for achieving these large profits, paid enormous bonuses and profits-based rewards.
These reward mechanisms encouraged executives to take higher risks to gain higher bonuses related to
the rising profits. However, not only were the risks associated with the complex financial products not
understood, but frequently the expected profits eventually proved, in the long term, to be non-existent or
far smaller than previously measured. However, by then the bonuses had been paid.
This matter has also been addressed in the banking and finance sector internationally by the Financial
Stability Board (FSB), which was established under the auspices of the G20 nations. The FSB publishes
a range of documents, including internationally recommended implementation standards that relate to
its ‘Principles for sound compensation practices’ (FSB 2009). In US terminology, ‘compensation’ is the
equivalent of ‘remuneration’. These standards reflect the types of approaches we are considering at present
but with a significant addition — the concept that, within financial sector institutions, it is important for
boards and management to identify persons who are material risk-takers and to enact special procedures
in relation to remuneration for these people.
Reward structures should be designed so that self-seeking executives cannot damage corporations by
seeking early reward with high-risk deals that have dubious long-term consequences.
Public Examples
A criticism of many organisations is that, despite poor performance during and after the GFC, remuneration
levels for executives were often unaffected. Bonuses paid to executives of organisations who were performing very poorly led to public anger and frustration. Many executives who experienced a remuneration
decline were even able to renegotiate their contracts to ensure they did not suffer as badly. Headlines at
the time were scathing and highly personal.
It is hardly surprising that, internationally, there was a flurry of regulatory changes. Examples 4.3 and
4.4 provide further insight in this area. BHP (formerly BHP Billiton) is an example of a corporation that
arguably is fully in touch with modern regulatory good corporate governance. Note its emphasis on clearly
defined KPIs (including non-financial KPIs) that link to shareholder value. Also, note the fact that it clearly
defines that severance payments should not result in unjustified payments.
EXAMPLE 4.3
America’s Most Overpaid CEOs
1. John Chambers
Company: Cisco Systems
Total compensation: USD$18 871 875
Change in stock price: –31.4% (FYE: 7/30/2011)
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MODULE 4 Governance in Practice 223
Cisco (NASDAQ: CSCO) was once considered the most well-run large company in Silicon Valley. That
has changed in the last year as it has become clear that Chambers, a dean of Valley CEOs, diversified
that company too far beyond its core router business. Margins in the new set-top box, WiFi, and video
conference businesses do not match those of routers. Chambers has begun a retreat from his M&A
[Mergers & Acquisitions] strategy, trying to refocus the company. He has had only limited success so
far. Cisco has also announced that its rapid growth will slow considerably in the next two years.
Source: McIntyre, DA 2011, ‘America’s most overpaid CEOs’, 24/7 Wall Street, 20 October, accessed October 2015, http://
247wallst.com/2011/10/20/america%E2%80%99s-most-overpaid-ceos/3.
Example 4.3 identifies the CEO of Cisco as the most overpaid CEO in terms of remuneration (compared
with stock performance). Cisco agreed to pay USD$5 billion for controversial News Corp subsidiary NDS
in early 2012 and its market capitalisation recovered to above USD$100 billion in August 2012.
There are many examples in the press illustrating the nature of the problem. Commonly, the reports
are accompanied by highly emotive language that illustrates the feelings held by many where corporate
excesses are represented. These excesses are most commonly represented by excessive remuneration and
that is where the most attention arises. Interestingly, other issues can be of concern too — including
the extent to which some executives and directors seem to seek power and/or self-publicity — although
controls on these additional excesses are as yet few.
In contrast to the previous discussion about perceived excessive remuneration, consider BHP (formerly
BHP Billiton).
EXAMPLE 4.4
BHP
In August 2012, the BHP CEO unveiled a USD$2.7 billion write-down and promptly declared he would
neither receive nor accept any short-term bonus for the 2011/12 financial year. This large multinational
corporation has the following key principles in its Remuneration Committee’s policy on remuneration.
In determining the policy, the Committee will take into account all factors which it deems necessary.
The objectives of the policy will be to:
• support the execution of the Group’s business strategy in accordance with a risk framework that
is appropriate for the organisation;
• provide competitive rewards to attract, motivate and retain highly skilled executives willing to work
around the world;
• apply demanding key performance indicators including financial and non-financial measures of
performance;
• link a large component of pay … to the creation of value for the Group’s shareholders …;
• ensure remuneration arrangements are equitable and facilitate the deployment of human resources
around the Group; and
• limit severance payments on termination to pre-established contractual arrangements that do not
commit the Group to making unjustified payments in the event of non-performance.
Source: BHP 2019, ‘Remuneration Committee Terms of Reference’, p. 2, accessed August 2019, www.bhp.com/-/
media/documents/ourapproach/governance/190812_remunerationcommitteetermsofreference.pdf?la=en.
QUESTION 4.3
A publicly listed corporation’s remuneration committee is interested in the forms of remuneration
that can be offered to management to motivate them to maximise value for the shareholders.
(a) In the context of remuneration (and related agency issues), what are the benefits to be obtained
by the appointment of independent directors?
(b) To which performance measures could different forms of remuneration be linked?
(c) How can shareholders be confident that managers are paid appropriately?
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224 Ethics and Governance
COMPLIANCE WITH THE CORPORATIONS ACT
Directors must comply with their obligations under the Corporations Act and, of particular relevance
to members, this includes the requirements to comply with reporting obligations to their stakeholders.
Part 2M.3 in Volume 2, Chapter 2M of the Corporations Act deals with the financial reporting and auditing
obligations and relevant divisions cover:
• annual financial reports and directors’ reports (Division 1)
• half-year financial reports and director’s reports (Division 2)
• annual financial reporting to members (Division 4)
• lodging reports with ASIC (Division 5).
There are a series of provisions in the Corporations Act that tie directly into what members of an
accounting body required to comply with ethical pronouncements issued by the APESB must adhere to
as professional obligations. Members are required to ensure they comply with accounting standards as
issued by the relevant standard setter. This is also a requirement of a person who assumes the role of a
director of a company under s. 296 of the Corporations Act. Compliance with the accounting standards
is paramount as is compliance with s. 297, which requires any company preparing financial statements to
ensure those statements represent a true and fair view of the company’s or consolidated entity’s overall
financial performance and financial position.
Directors are obliged to provide additional information in the notes to financial statements if compliance
with accounting standards will not give a true and fair view. It should be noted that the additional
information a company may provide can only be provided in the notes to the financial statements and
that the main financial statements must be compliant with accounting standards. Failure to comply with
accounting standards may make it difficult for users to compare financial statements and it also makes a
reader more uncertain about the basis on which the financial statements were prepared.
Boards must also be careful that they do not engage in earnings management, which is sometimes
known as ‘window dressing’ financial statements so that they look more favourable to stakeholders than
they otherwise might if the company had accounted for transactions appropriately. Earnings management
may include trying to find ways of deferring income to a later financial period and bringing income
forward so the business engineers a more positive financial result. Deferring or bringing forward income
or expenditure is a way of seeking to present company results in a misleading way, which is contrary to
director obligations under the Corporations Act.
.......................................................................................................................................................................................
CONSIDER THIS
Read sections 296 and 297 and take a note of the reason why the law would only permit information provided by a
company in the notes to financial statements in circumstances where directors feel truth and fairness is compromised
by complying with accounting standards.
.......................................................................................................................................................................................
CONSIDER THIS
Consider the issue of earnings management and take note of which of the fundamental principles of APES 110 Code
of Ethics engaging in earnings management may breach.
AUDITING THE FINANCIAL STATEMENTS
Boards must understand the role of the independent external auditor and the regulations that surround audit,
including the role of International Standards on Auditing (ISAs) and International Financial Reporting
Standards (IFRS). These bodies of international standards are imported into the Australian reporting
framework with the necessary additions to ensure they are able to be applied under Australian law. There
are also guidance statements that are issued that deal with the application of auditing standards in specific
circumstances. Auditing requirements and the role of the external auditor is set down in Division 3 of
Part 2M.3 of the Corporations Act:
• Section 307: Audit
• Section 307A: Audit to be conducted in accordance with auditing standards
• Section 307B: Audit working papers to be retained for 7 years
• Section 307C: Auditor’s independence declaration
• Section 308: Auditor’s report on annual financial report
• Section 309: Auditor’s report on half-year financial report
• Section 310: Auditor’s power to obtain information
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MODULE 4 Governance in Practice 225
• Section 311: Reporting to ASIC
• Section 312: Assisting auditor
• Section 313: Special provisions on audit of debenture issuers and guarantors.
The sections of the Corporations Act referred to above must be read by members engaged in audits in
conjunction with obligations outlined in auditing standards and codes of ethics.
.......................................................................................................................................................................................
CONSIDER THIS
Look up the Corporations Act and read Division 3 of Part 2M.3 in its entirety. Take detailed notes on the key elements
of the provisions covered in this section of the law.
See link at: www.legislation.gov.au/Details/C2019C00216/Html/Volume_2#_Toc13831914
.......................................................................................................................................................................................
CONSIDER THIS
Review s. 540 of APES 110 Code of Ethics and briefly summarise the significance of the section as it relates to the
conduct of audit.
The auditing and accounting standards and their related rules, which are contained in laws, regulations
or supplementary guidance developed by standard setters, have become very important in recent years,
with a new focus on audit and audit committees, especially as part of international corporate governance
reforms. These reforms have been under development for a long time. The major impact of the GFC, and
the consequent turmoil in the banking sector internationally, prompted further emphasis on the need for
changes, which are ongoing. Boards and management in all corporations must understand the existing
rules at any time and also the changes as they occur.
Internal auditors are also important but they are very different and are not discussed further in this module
as they do not have, and cannot have, the same recognised actual independence. This lack of independence
comes from working as employees within the company and under the authority of senior management.
Boards must realise that this lack of independence exists and be aware of the potential pressures faced
by internal auditors from other employees and management that may affect their independence. Boards
should therefore consider the measures that can be taken to give the internal audit function some degree
of independence from management.
Note that various audits, including internal audit, are covered in detail in the Advanced Audit and
Assurance subject.
The international auditing standards state that the external auditor (referred to as the practitioner in the
auditing standards) of general purpose financial statements (annual and other reports) is required to express
an opinion, resulting from a professionally formed judgment, whether the reports and related information
are drawn up in accordance with an identified financial reporting framework. The reports themselves are
prepared by the responsible party (the board and senior management) based on proper operations within
the corporation, including the correct operation of the entire accounting system.
The auditor’s report is most importantly addressed to the ‘intended users’ — including the shareholders
and other users who, in the auditor’s professional judgment, objectively are relevant. The preparation of
the reports and the auditing of the reports are both required to comply with a relevant framework — most
commonly IFRS. The company prepares its systems and accounts so that the information is compliant with
the accounting standards.
The auditor then checks the systems and the information that results to ensure that the accounting
standards compliance required has been achieved. Professional scepticism is required by auditors to detect
instances of earnings management. ASIC in INFO 222 states that:
Exercising professional scepticism is a critical part of conducting quality audits. The auditor must critically
assess, with a questioning mind, the validity of the audit evidence obtained and management’s judgements
on accounting estimates and treatments.
Once checks have been completed, the auditor will give a statement of their professional-judgment–
based opinion, upon which intended users are entitled to rely. The auditor is obliged to obtain sufficient
appropriate evidence to support their opinion and a failure to do so can leave the auditor liable for not
identifying a risk of misstatement in the reports. This is why auditors can be liable where materially
misleading information results in, for example, loss to shareholders. Even so, the fundamental liability
for materially incorrect information being in the reports is that of the board and management.
Beyond this, the board must understand the importance of auditor independence. For example, when
the Enron failure occurred, one of the biggest issues related to the fact that the corporation’s auditor,
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226 Ethics and Governance
Arthur Andersen, counted Enron among its largest clients, billing Enron USD$52 million for audit
(USD$25 million) and non-audit services (USD$27 million) in 2000 (Permanent Subcommittee 2002).
The auditing standards now impose obligations on auditors to identify a threat to independence where fees
from one client are unduly large. If a board (or management) seeks to control or influence auditors in a
material way (in the auditor’s judgment), this must be reported — including in the auditor’s statement in
the annual report. Some jurisdictions also require notification to local corporate regulators.
The auditing standards require that auditors identify those charged with governance within the organisation. This group should comprise those with whom the auditor communicates on matters relating to audit
and reporting. Ideally, the group would comprise a correctly structured audit committee that includes
only non-executive directors. In some jurisdictions, the non-executive directors must fully satisfy the
independence rules, while in other jurisdictions, a majority should be independent and the remainder,
while still non-executive, may be non-independent.
Since the auditor is auditing executives, such as the CFO and the CEO, the auditor should not report to
these people. To do so would be contrary to the required independence. The board (and senior management
generally) must be aware of these general rules and that the rules will be enforced by local legislation.
Commonly, the accounting standards and the auditing standards are enforced as part of the local laws.
The Centro case (Harper 2012), discussed in module 3, is revisited in example 4.5 to emphasise the
importance of basic good corporate governance including the need for clear understandings and good
policies regarding disclosure, auditing and related regulations.
EXAMPLE 4.5
Centro and PwC Auditor Liability
‘PwC, Centro Pitch in for Investor Losses’
Global accountancy group PricewaterhouseCoopers will pay almost $70 million to investors who lost
money in the collapse of the Centro property group. Centro Retail Australia revealed yesterday it would
pay $85 million of the $200 million settlement bill — the biggest in Australian class-action history.
PricewaterhouseCoopers, Centro’s auditor, will pay $67 million. Centro Retail released details of the
settlement carve-up yesterday, while confirming it had agreed to settle shareholder class actions. It came
as trading resumed in Centro Retail shares, which closed 2.3% higher yesterday at $1.89. Centro Retail
had requested a trading halt on Tuesday ahead of the settlement announcement.
About 5000 investors, represented by Maurice Blackburn and Slater & Gordon, had joined a class action
case against Centro for failing to disclose in 2007 it had $3 billion of debt due to be rolled over within a
year. The property group, made up of Centro Properties and the business it managed, Centro Retail, has
since restructured itself as Centro Retail Australia.
Centro Retail Australia chairman Dr Bob Edgar said the settlement was a commercial decision taken
to allow the company to ‘put this matter behind it’ without the distraction and expense of a trial
or appeals. The former Centro Properties Group will pay $10 million of the settlement balance, with
$38 million available through insurance proceeds.
Source: Harper, J 2012, ‘PwC, Centro pitch in for investor losses’, Herald Sun, 11 May, accessed August 2014,
www.heraldsun.com.au/ipad/pwc-centro-pitch-in-for-investor-losses/story-fn6bn4mv-1226352454792.
REVIEWS OF AUDIT QUALITY AND AUDIT REGULATION
The work done by auditors is reviewed on a frequent basis by ASIC in its capacity as a regulator of audit
services and that review is in the form of an audit firm inspection program. This program involves the
regulator inspecting the way in which firms regulate auditing processes within their own organisations and
whether compliance with auditing standards, professional standards and relevant laws is achieved in the
way they deal with audit over time. An ASIC information sheet INFO 222 provides insight as to what the
corporate regulator looks for inside an audit firm when it inspects audit working papers and the professional
culture within a practice.
The information sheet states that:
Audit quality refers to matters that contribute to the likelihood that the auditor will:
• achieve the fundamental objective of obtaining reasonable assurance that the financial report as a whole
is free of material misstatement; and
• ensure material deficiencies detected are addressed or communicated through the audit report
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(ASIC 2017).
MODULE 4 Governance in Practice 227
The corporate regulator further states that:
auditors should deliver professional, high quality audits through:
a strong internal culture focused on quality audits and professional scepticism
applying appropriate resources, experience and expertise to audits
effective internal supervision and review
robust accountability mechanisms
identifying and addressing audit risks and issues on a timely basis
accepting and addressing findings from audit inspections, including findings on asset values and revenue
recognition (ASIC 2017).
•
•
•
•
•
•
ASIC reviews a sample of audit files from the firms that audit the largest number of listed companies
in Australia and issues a report reflecting the results of the inspection. Report 607 — Audit Inspection
Program report for 2017–18 was issued in January 2019 (ASIC 2019a) and found that, while there was
some improvement in audit quality evident through the sample, weaknesses in audit processes continued
to be evident. The review considered 98 files that were reviewed from 20 firms in total, with the six largest
firms being the source of 78 audit files that were reviewed by the regulator. ASIC recommended that audit
firms still needed to pay attention to the valuations of assets that appeared in financial statements and
also the way in which revenue was accounted for by entities. The top six audit firms in Australia were
also found to have conflicts with independence rules. ASIC found three instances where an audit firm’s
provision of other services to an external audit client resulted in a perception of a loss of independence.
‘In one case, the firm provided co-sourced internal audit work and, after consultation with the firm’s
independence experts, risk advisory services. In another case, the fees for non-audit services were double
the audit fee and there was no consultation with the firm’s independence experts,’ the ASIC inspection
report noted. ‘In the third case, the firm provided actuarial services to the company (not including final
valuation figures) and that work was also used as audit evidence.’ The ASIC inspection report emphasised
the need for accounting firms to ensure they evaluated the appropriateness of selling or providing non-audit
services to clients for which they are engaged to audit.
.......................................................................................................................................................................................
CONSIDER THIS
Download a copy of the inspection report cited above and read Part E on quality control. Identify the fundamental
principles that are under threat when audit firms fail to properly deal with possible conflicts and breaches of
independence rules in APES 110. See link at: https://download.asic.gov.au/media/4990650/rep607-published-24january-2019.pdf
The Parliamentary Joint Committee on Corporations and Financial Services began the process of
launching an inquiry into audit regulation following concerns raised by the parliamentarians that there
had been a decline in audit quality and that there was a dispute between the FRC and the ASIC about what
constituted audit quality. The parliamentary committee has issued its terms of reference and, at the time
of writing ,was awaiting community submissions on the following topics:
1.
2.
3.
4.
5.
6.
7.
8.
9.
the relationship between auditing and consulting services and potential conflicts of interests;
other potential conflicts of interests;
the level and effectiveness of competition in audit and related consulting services;
audit quality, including valuations of intangible assets;
matters arising from Australian and international reviews of auditing;
changes in the role of audit and the scope of audit products;
the role and effectiveness of audit in detecting and reporting fraud and misconduct;
the effectiveness and appropriateness of legislation, regulation and licensing;
the extent of regulatory relief provided by the Australian Securities and Investments Commission
through instruments and waivers;
10. the adequacy and performance of regulatory, standards, disciplinary and other bodies;
11. the effectiveness of enforcement by regulators; and
12. any related matter (APH 2019).
The committee published a timeline for submissions to be lodged by the end of October 2019 and for
the final report to be tabled in the Federal Parliament by March 2020.
QUESTION 4.4
What are some measures the board can undertake to enhance the likelihood of auditor
independence?
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228 Ethics and Governance
(Note that the auditor has a responsibility to make a statement of independence to those charged
with governance for inclusion in the corporation’s reports. Essentially, this question pertains to
the types of measures that can, and should, occur within the corporation to enhance auditor
independence rather than just relying on the auditor’s statement.)
4.3 IMPROVING CORPORATE GOVERNANCE
The module has discussed several ways to mitigate the risk of financial failure. In most cases this involved
aspects of corporate governance.
Now, in this section we identify two important additional recommendations for improving corporate
governance. The first is a more rigorous approach to risk management. The second involves focusing
more strongly on ensuring an independent chair.
RISK MANAGEMENT
Risk management enables a company to maximise opportunities and minimise losses (of all types) by
assessing the different types of risk and improving safety, quality and business performance.
Often, the result of risk assessment can enable the board to determine appropriate insurance cover, but
there will be occasions when no amount of insurance will protect the company. The successful management
of risk and the laying down of guidelines on how risk is to be assessed can have additional positive benefits.
The analysis of the data collected to enable the risks to be evaluated can lead to regular monitoring by
the board and management, thus raising their awareness of the issues involved for the company.
Risk management has been defined as ‘the culture, processes and structures which come together to
optimise the management of potential opportunities and adverse effects’ (Standards Australia 2004).
Within each organisation, the board must determine the framework it considers appropriate for the
company’s needs. Risk management is a process designed to serve a number of goals including to identify,
analyse, evaluate, treat, monitor and communicate the information gathered for the benefit of the company.
The nature of the data collected will depend very much on the activities undertaken by the company.
Risks may be associated with any activity, function or process of the company. For example, one type of
risk might stem from legal liability arising from the company’s conduct (e.g. the liability for environmental
damage in the 1984 Union Carbide gas disaster at Bhopal, India, or the BP oil spill in the Gulf of Mexico
in 2010).
Identifying, evaluating and addressing risk are essential features of modern management techniques.
The role of the board in understanding and dealing with enterprise risks has been well articulated in
many of the recommendations made by various committees over the years. The International Federation
of Accountants (IFAC) Professional Accountants in Business committee (PAIB) (IFAC 2004) identified
risk as being important for both performance and conformance aspects of governance.
The OECD (2010) specifically identified the failure to properly identify and manage risk as being
central to the GFC. The need for improvement is apparent from the large number of corporate and
government failures seen in the GFC period. Good risk control should give superior performance, but
bad risk understanding and practices have resulted in financial disasters. In Australia, APRA has instituted
a rigorous policy of risk management in major financial institutions which comprises:
systems for identifying, measuring, evaluating, monitoring, reporting, and controlling or mitigating
material risks that may affect its ability, or the ability of the group it heads, to meet its obligations to
depositors and/or policyholders. These systems, together with the structures, policies, processes and people
supporting them, comprise an institution’s risk management framework (APRA 2019b).
Internal Control and Risk Management
ISA 315 Identifying and Assessing the Risks of Material Misstatement through Understanding the Entity
and its Environment states that internal control is:
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The process designed and effected by those charged with governance [usually the board — but in
some audit circumstances may be the audit committee], management, and other personnel to provide
reasonable assurance about the achievement of the entity’s objectives with regard to reliability of financial
reporting, effectiveness and efficiency of operations and compliance with applicable laws and regulations
(IFAC 2018).
MODULE 4 Governance in Practice 229
Auditors must obtain an understanding of the internal control structure and gather related evidence to
support their assessment. Effectiveness and efficiency are performance-related matters. Weaknesses in
internal control can result in material losses (under-performance). Weaknesses in internal control can also
impact on compliance with legal and regulatory requirements, including resulting in misstatements in the
financial reports.
External auditors are required to report material weaknesses to the board on a timely basis and internal
auditors are expected to assist in this process using as much independent judgment as possible.
Over the past two decades, organisations have invested heavily in improving the quality of their internal
control systems because:
1. good internal control is good business — it helps organisations ensure that operating, financial and
compliance objectives are met
2. more organisations are required to report on the quality of internal control over financial reporting,
compelling them to develop specific support for their certifications and assertions
3. internal control assists in providing reasonable assurance that the entity is complying with applicable
laws and regulations.
One of the factors observed by Mardjono (2005) as being significant in corporate failures is that there are
companies that have had systems in place but they have been poorly implemented. Mardjono considered the
cases studies of both HIH and Enron and found that principles of good governance were violated because
of the ‘inappropriate implementation of such a framework according to their own version of financial
benefits’.
Similar themes emerged throughout the various inquiries conducted into the Australian financial services
sector over more than a decade. In most instances, there were internal policies that required good
governance and quality control checks but egregious misconduct still took place because there were
financial incentives that promoted this behaviour.
The Sarbanes–Oxley Act in the US has received much attention about the necessity of documenting
the internal controls that affect the financial information communicated to the investing public. In
particular, s. 404 of this Act specifies that annual reports lodged with the SEC must state management’s
responsibility for establishing and maintaining an adequate internal control structure and procedures for
financial reporting. Furthermore, the annual report must contain an assessment of the effectiveness of the
company’s internal control structure and procedures for financial reporting, as at the end of the most recent
financial year.
Another example of this link between corporate governance and risk management is found in ASX
Principle 7 which states that a listed entity should establish a sound risk management framework and
periodically review the effectiveness of that framework (ASX CGC, 2019).
Internal Control and Risk Systems — Including Accounting, Risk Control and Internal Audit
Good accounting systems are vital for information — for shareholders and other stakeholders in terms
of external reporting and also for the immediate information needs of managers. The internal auditor can
assist in ensuring ongoing compliance, fraud control and system integrity and may assist in making the
work of the external auditor less costly and complex. Risk control systems are important for ensuring that
board policies regarding risk are effectively managed, so management decisions are undertaken safely and
unknown risks are minimised.
INDEPENDENCE OF THE CHAIR OF THE BOARD
The OECD (2010) has provided the following discussion in relation to the independence of the chair of
the board.
6.1 An important role for the chair of the board
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[para. 46] The Key Findings (Box 3) note that there is an emerging consensus that the separation of
CEO and Chair of the board is a good practice but not one that should be mandated…‘in a number of
countries with single tier board systems, the objectivity of the board and its independence from management
may be strengthened by the separation of the role of the chief executive and chairman, or, if these roles
are combined, by designating a lead non-executive director to convene or chair sessions of the outside
directors. Separation of the two posts may be regarded as good practice, as it can help to achieve an
appropriate balance of power, increase accountability and improve the board’s capacity for decision
making independent of management’. The annotations [to the OECD principles] also cover the case of
two tier boards noting that it is not good practice for the CEO to move to the chair’s post of the supervisory
board on retirement. Much the same can be said of single tier boards. A new chair that is the retired CEO
230 Ethics and Governance
may still be too close to management and hence may not be sufficiently detached and objective. There may
also be confusion as to who is leader of the company.
…
[para. 49] When the roles of CEO and the Chair are not separated, it is important in larger, complex
companies to explain the measures that have been taken to avoid conflicts of interest and to ensure the
integrity of the chairman function.
There is no imperative statement by the OECD that the chair should not also be the CEO. The fact that,
in many US corporations, ‘presidents’ are the chair and the CEO at the same time is perhaps an influencing
factor in the OECD conclusions. However, it seems that this policy of role separation is slowly achieving
traction even in the US. As noted earlier, there is a gradual trend in S&P 500 companies in the US towards
separating the roles of chair and CEO. Nonetheless, the importance of independence, or independence
protocols, is clearly identified in the US in Sarbanes–Oxley and in other governance systems principles.
Provision 9 in the UK FRC Governance Code states that the roles of the chair and CEO should not be
exercised by the same individual. In Australia, Recommendation 2.5 in the ASX CGC’s document states
that the chair of the board of a listed entity should be an independent director and, in particular, should not
be the same person as the CEO of the entity.
CONTINUED EVOLUTION OF CORPORATE GOVERNANCE
This brief discussion of potential improvements to corporate governance shows that it is a constantly
evolving process rather than something that has already been finalised and perfected. There are many more
opportunities for improvement that hopefully will limit the effect of economic downturns in the future and
improve the performance of organisations.
4.4 GOVERNANCE ISSUES IN THE
NON-CORPORATE SECTOR
GOVERNMENT BODIES
The ideal of service in government bodies is normally associated with higher standards of ethics in the
service of the general public. In a less competitive and profit-driven environment, the culture of the public
sector emphasises professional commitment in the delivery of government policy. There have been many
efforts to reform the governance of the public sector and to learn the lessons from the earlier reforms
introduced in the private sector.
However, there are many pressures exerted on the public sector, with changes in policy and practice
occurring with changes in government. Also, encountering almost unlimited demand for services (e.g. in
health care), the resourcing of the public sector is often stretched to the limits. The public sector is complex
and often challenging to management and employees.
The public sector also experiences governance and fraud problems as in the private sector. The boards
of directors of public agencies have to be as informed and vigilant as boards in the private sector.
Based on their Global Economic Crime Survey about fraud and fraud risks, PwC (2011) reports:
• Government and state-owned enterprises on average experienced a higher incidence of fraud than listed
•
•
•
•
•
private entities. More than one-third (37%) of respondents from government and state-owned enterprises
said they experienced economic crime in the previous 12 months.
Government and state-owned enterprises reported that 69% of the fraud they suffered related to the
misappropriation of assets and this category of fraud needs to be a focus for senior executives.
Staff members perpetrated more than half (57%) of fraud reported by government and state-owned
enterprises, compared to only 25% for financial services organisations.
Senior staff are more likely to commit fraud in government and state-owned enterprises than in any other
industry.
More than one-third (39%) of New South Wales government agencies told the state Auditor-General
their fraud risk assessments were not effective and senior executives need to understand why this is the
case in their organisation.
Government appears to be lenient on perpetrators of fraud, with only 51% of internal fraudsters at
government and state-owned enterprises being dismissed from their jobs. This compares to 60% across
all industries.
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MODULE 4 Governance in Practice 231
The public sector, as with most organisations, is reluctant to publicise incidents of fraud and corruption
when they occur. However, the fact that even the most established of public sector institutions can be
tainted by corruption was revealed when the Reserve Bank of Australia was called to explain allegations
how its wholly owned subsidiary Note Printing Australia (NPA), which had contracts for bank-note printing
throughout countries of Asia, was involved widely in bribery and corruption. In 2011, the Australian
Federal Police charged NPA and former NPA employees with paying bribes in foreign countries to advance
their business (Joye 2013, p. 7).
The PwC analysis examined the causes of fraud and determined:
From our experience, Australian government and state-owned enterprises are most susceptible to fraud
when:
• they have large, demand-driven spending commitments driven by policy, which do not allocate enough
time and resources to assess risk or implement controls to detect, investigate and mitigate fraud.
• power is centralised unduly; for example, when a single individual has the power to make decisions on
procurement, contracting and approval.
• standard contracting procedures are bypassed using the justification of ‘addressing urgent business
needs’. This temporary approach may then be extended to avoid the checks and balances of procurement
policies.
• policies and rules to minimise fraud and corruption are not applied with the same rigour in remote
operations as in the head office.
• an excessive focus on outcomes can result in increased pressure to improperly modify results, a loss of
accountability and poor maintenance of associated business records.
• when fraud is suspected, if processes are flawed and associated records are inadequate, this may lead
to insufficient evidence being available to mount a successful investigation or prosecution. It may also
result in the agency concerned being unable to instigate civil recovery action.
• as leaders within their organisation, senior executives have a critical role to play in controlling fraud in
the government sector. It is important that they set the right tone from the top (PwC 2011).
It is apparent that the public sector demands as much attention to governance, accountability and risk
management, and fraud detection as large, complex corporations in the market sector.
CHARITIES AND NOT-FOR-PROFIT SECTOR
The charities and not-for-profit sectors are widely respected for doing good with scant resources. To a
considerable degree this is true because the charities and not-for-profits working in health, education,
social and public welfare commonly face the governance problem of responding to a growing demand
with limited funds. Many surveys highlight the growing strengths of the governance of a sector that is
large both in size and in the revenue that individual not-for-profits receive and administer on behalf of
beneficiaries or members (Grant Thornton 2014).
Although the sector is known for robust and effective governance, this is not always the case. In
2015 the Australian Charities and Not-for-profits Commission (ACNC) issued a notice to the effect that
4000 charities listed on the register had failed to lodge financial reports, and a further 5500 had their charity
status revoked after failing to complete their reporting for two consecutive years. As Ferguson reported in
the Australian Financial Review:
Over the past 20 years there have been numerous inquiries into the charities sector. All agreed the sector was
complex, lacked transparency and accountability and needed a dedicated regulator. In 1995, the Industry
Commission (now the Productivity Commission) found there was ‘a lack of consistent data, a lack of access
to public information and a lack of standardised financial reporting’. It made a series of recommendations,
including the introduction of an accounting standards for the sector and better public access to information.
There still isn’t a standardised financial reporting that charities must comply with. This means there is no
way to detect how efficient a charity is in the delivery of service because there is no accounting standard
to benchmark charities. There have also been attempts to investigate whether the tax arrangements are
appropriate (Ferguson 2015).
As one of the regulators for the charities sector ACNC regularly produces a summary of its compliance
activities. Their 2018 Charity Compliance Report (2019) includes an analysis of the concerns assessed
by the compliance team by risk type. Further analysis shows the risk category of potential breaches in
concerns assessed by the compliance team. These are both shown in figure 4.2. Note that a total of 85.5%
of the total potential breaches are related to the ACNC’s governance standards (ACNC 2019).
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232 Ethics and Governance
Concerns assessed by compliance team by risk type
FIGURE 4.2
2%
Risk type
0.3%
0.3%
0.4%
2%
Private benefit
Poor governance
Other
Criminal or improper purposes
3%
4%
26%
5%
Mismanagement
Harm to beneficiaries
6%
Conficts of interest
Disqualifying political purposes
7%
Risk that assets will be lost
Not entitled to charity subtype
22%
10%
Reporting issues
Terrorism
13%
Record-keeping
Disqualified persons
Risk Category
Governance standard 1: Purposes and
not-for-profit nature of a registered charity — this
includes concerns such as private benefit or
failing to comply with its charitable purposes.
Governance standard 2: Accountability to
members — this includes concerns such as failing
to hold annual general meeting or not providing
sufficient information to its members.
2.4%
2.7%
4.6%
Governance standard 3: Compliance with
Australian Laws — this includes concerns such
as fraudulent or other criminal activity.
4.7%
41.2%
31.8%
Governance standard 4: Suitability of
responsible persons — this includes concerns
such as disqualified persons being responsible
persons for charities.
Governance standard 5: Duties of responsible
persons — this includes concerns such as financial
mismanagment, managing conflicts of interest.
Entitlement to registration: this includes
concerns such as sham charities, disqualifying
purposes or private benefit.
11.9%
0.3%
0.3%
Non-compliance with record keeping
obligations: this includes concerns such
as a failure to keep adeguate financial or
operational records.
Non-compliance with reporting obligations:
this includes concerns such as a failure to
notify of changes to charity details, failure to
lodge annual information statement and errors
in financial reporting.
Concerns outside of the ACNC’s jurisdiction.
Source: ACNC 2019.
An earlier ACNC report (2014) offers three case studies illustrating problems of fraud, governance and
private benefit in charities, indicating that there can be multiple causes of concern. These are reproduced
in examples 4.6, 4.7 and 4.8.
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MODULE 4 Governance in Practice 233
EXAMPLE 4.6
Fraud
An employee of a charity contacted the ACNC, concerned that a senior member of staff was using the
charity’s credit card to make private purchases, unrelated to the work of the charity.
The ACNC contacted the charity’s board about the allegations, and commenced working with the charity
as part of its investigation. As an initial step, the board removed the individual alleged to have made the
purchases, the purchases were admitted and the individual repaid some of the debts.
However, the ACNC investigation found that the theft of funds was more extensive and significant than
initially identified. The charity worked with the ACNC throughout the investigation, committed to dealing
with the matter and continuing their charitable endeavours. With the support of the ACNC, they worked
through the issues of governance that had allowed the theft to occur, and sought to implement changes
to address the identified vulnerabilities. At the ACNC’s behest the charity filed a report to the police so
that the alleged fraud could be investigated by the appropriate authority.
Source: ACNC 2014, An Overview of the First Year of Compliance Activity, 28 January 2014. © Commonwealth of
Australia 2014.
EXAMPLE 4.7
Governance and Fraud
A former director of a charity contacted the ACNC to report a number of allegations of serious
mismanagement and fraud against a husband and wife, who were directors on the charity’s board. The
couple took over the charity, initially with the support of the members and existing board; however many
members cancelled their membership following the couple’s increasing abuse of their position within the
charity.
The complainant alleged that the couple illegally changed the charity’s constitution, redirected funds
for their own personal gain, and initiated the sale of the charity’s assets, without the knowledge or the
authority of its members. They also transferred large amounts of cash from the charity’s bank accounts
to personal accounts offshore.
The ACNC’s investigation into this charity suggests serious problems with the charity’s governance,
including failure to invite members to meetings, failure to hold discussions or votes regarding changes
to the charity’s constitution and selling the charity’s assets. It also found that records of meetings were
incomplete or inaccurate.
The charity is no longer operating on a day-to-day basis and the individuals who are the subject of the
complaint have left Australia; they have no intention of returning. The ACNC is liaising with the relevant
authorities overseas, as well as working to ensure control of the charity is returned to its members and
the assets protected.
Source: ACNC 2014, An Overview of the First Year of Compliance Activity, 28 January 2014. © Commonwealth of
Australia 2014.
............................................................................................................................................................................
CONSIDER THIS
Reflect on what steps ought to be taken by a board to avoid conflicts or perceived conflicts. How should a
board deal with issues related to fraud as described in example 4.7?
EXAMPLE 4.8
Governance, Private Benefit, Conflict of Interest
The ACNC received a referral from another government agency in relation to a concern that members
of a charity were using charitable funds for personal gain and not providing the services they claimed.
The ACNC investigated the issue and found that the charity is providing charitable services. However,
the charity’s founders were benefiting financially through arrangements they had put in place. These
arrangements included purchasing a property in their own name for the charity’s use and then leasing
the property back to the charity – the charity in effect was paying the mortgage of the individuals, with no
provision for the assets to be retained by the charity. The charity also provided a significant contract to a
company that was owned by a member of the board.
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234 Ethics and Governance
The ACNC is working with the charity’s board to ensure their governing documents protect the charity,
and to assist the charity in dealing with the conflicts of interest arising. We are also making sure that they
develop legal agreements to guarantee long-term protection of the charity’s assets.
Source: ACNC Compliance, An Overview of the First Year of Compliance Activity, 28 January 2014. © Commonwealth of
Australia 2014.
These cases clearly illustrate that governance and fraud problems do occur in the charity and notfor-profit sectors and that rigorous governance standards, financial reporting and accountability are as
imperative here as in corporations working in the market economy.
To this end ACNC has developed a self evaluation tool which can be downloaded and completed.
Although not assessable in this subject, if you are involved with the governance or audit of a charity it may
be a useful resource. It is available at: www.acnc.gov.au/for-charities/manage-your-charity/governancehub/governance-standards/self-evaluation-charities.
SUMMARY
Part A has examined the role of corporate governance and in particular a number of specific corporate
governance practices that are crucial to the corporation’s success. We began with a discussion of common
causes of and contributors to corporate failure. These include poor strategic decisions, greed, the pursuit
of power, overexpansion, overly dominant CEOs, the failure of internal controls and ineffective boards.
The selection and evaluation of the board is therefore a key factor in ensuring good corporate governance.
It is increasingly recognised that diversity in the members of the board of directors contributes to corporate
success. In addition, ensuring compliance with the Corporations Act and having financial statements
audited by an independent party help ensure good governance.
Each element of governance needs to be working properly to ensure that a company is run according
to best practice and that conduct within an entity is ethical. Failure at any level of a company’s internal
controls and other governance mechanisms could leave gaps for corporate misconduct to take place.
The key points covered in this part, and the learning objective they align to, are listed below.
KEY POINTS
4.1 Evaluate the implications of board diversity and executive remuneration in relation to corporate
governance including corporate performance.
• Company boards are composed of individuals elected by shareholders or members.
• It is beneficial for boards to maintain a degree of continuity to ensure corporate knowledge is not lost,
but it is also important to have some turnover of members so that fresh perspectives are brought in.
• Diversity in the membership of a board is linked with good corporate governance.
• Diversity refers to factors such as gender, age and race, as well diversity of experience and
qualifications. A diverse board composition allows for a broad range of ideas and input to be
considered.
• There is an increasing realisation that ensuring gender balance is one way to ensure a broad range
of perspectives can be taken into account.
• Remuneration of non-executive directors is designed to be a reasonable compensation for their time
and effort. It may also be linked to overall corporate success (such as indicated by the company
share price), but direct performance-related compensation is not used for non-executive directors
as it could compromise their independence.
• Executive directors and other employed management personnel often have part of their remuneration linked to corporate performance (in general terms and in relation to more specific targets).
Performance-based remuneration is a crucial tool for aligning the actions of employees with the
goals of the company.
4.3 Identify aspects of corporate governance that arise in relation to audit responsibilities and
regulatory compliance.
• Companies in Australia are required to comply with the Corporations Act, which regulates many
aspects of companies, including aspects of financial statements and audit compliance.
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MODULE 4 Governance in Practice 235
• The board of directors is responsible for the company’s financial report, which includes the financial
statements and commentary on financial performance and financial position.
• External auditors are charged with the task of auditing financial statements to provide assurance that
they comply with the requirements set down in accounting standards, relevant laws and regulations.
• ASIC reviews the auditing of financial statements and often identifies weaknesses, including the
failure to gather sufficient appropriate evidence and the existence of concerns about auditor
independence.
4.4 Evaluate the importance of good corporate governance as a factor in mitigating the risks of
financial failures.
• Key causes of corporate failure are poor strategic decisions, greed, the pursuit of power, overexpansion, overly dominant CEOs, the failure of internal controls, failure of risk management and ineffective
boards.
• Good corporate governance includes the creation and maintenance of a corporate culture and a set
of internal controls that combat the factors that contribute to corporate failures.
• Performance-based remuneration policies need to effectively align employees and managers with
company objectives while not encouraging unethical behaviour or actions detrimental to the
company.
• In order to preserve independence, non-executive directors should not have remuneration directly
linked to specific performance factors.
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236 Ethics and Governance
PART B: OPERATIONAL OBLIGATIONS AND
OVERSIGHT
INTRODUCTION
In addition to the Corporations Act, various other pieces of legislation are relevant to governance. In
general, these relate to the stakeholders for which boards have an overarching operational responsibility.
Some of this legislation and the relevant stakeholders are listed in table 4.2.
TABLE 4.2
Legislation relevant to governance
Legislation
Oversight body
Stakeholder
Safe Work Australia Act 2008
Safe Work Australia
Employees
Fair Work Act 2009
Fair Work Commission
Employees
Disability and Discrimination Act 1992
AHRC (Australian
Human Rights
Commissioner)
Customers
Employees (existing and
potential)
Privacy Act 1988
OAIC (Office of the
Australian Information
Commissioner)
Customers
Work Health and Safety Act 2011
Work Health and Safety Regulations 2011
Privacy Amendment (Notifiable Data breaches) Act 2017
Freedom of Information Act 1982
Australian Information Commissioner Act 2010
Before looking at these, this part of the module will provide a general overview of the Australian legal
system. The module will also look at the protections for consumers and the goods and services market
as a whole. These are given force by the Competition and Consumer Act 2010 (Cwlth) and the ACCC
(Australian Competition and Consumer Commission).
4.5 THE LEGAL SYSTEM
Understanding the overall legal system is highly significant for good corporate governance. From previous
learning, including in this subject, you will be aware that, of the many laws relevant in society, a great
number of them affect corporate life. In civil law countries, detailed legislative prescriptions seek to
clarify almost every aspect of law in society. In common law countries (typically those that use the AngloAmerican company law approach), many laws originated through the court system and became legislation
over time. However, not all laws in common law jurisdictions have court-based origins. Governments often
initiate laws, especially where creation of complex innovative legal forms such as corporations are the goal.
Our discussion of laws primarily will refer to Anglo-American type common law and corporate systems
as seen in common law jurisdictions (e.g. South Africa, Singapore, US, UK, Bermuda, Australia, New
Zealand and India). In each of these places, modern complex laws are the result of extensive parliamentary
deliberation leading to fairly precise legislative form.
In these common law countries, the courts review these precise legislative forms and make interpretive
decisions that give additional, and sometimes new, meaning to the legislation. In these countries, if
legislation does not cover a matter, the courts may also make appropriate law relevant to the circumstances
of the particular matter being litigated.
If a matter is not litigated, the relevant law will not be interpreted. Sometimes, court interpretations are
considered very good sound and may be left untouched by the government — or the legislature will write
laws restating court decisions in formal laws to be passed by the parliament. Sometimes the government
will not agree with the courts’ approach and will write laws to overturn the principles made by the courts’
decision. In either case, parliament may pass more laws so that the laws are more clearly stated in the
legislation and therefore lead to more predictable court (and community) interpretations. Good laws should
achieve good outcomes and should do so reliably. Very importantly, laws should give predictable outcomes.
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MODULE 4 Governance in Practice 237
Under the Anglo-American system, some of the most important laws that underlie corporate life include
general community-wide laws on:
• the rights of individuals such as employees
• contracts
• negligence
• property
• ownership rights
• arrangement of these rights when a company is insolvent.
These laws all began, at least to some extent, through the common law decisions of the courts and have
become highly refined as they are subject to additional legislative responses.
THE ECONOMY AND THE LEGAL SYSTEM
The economy as a whole is heavily dependent on corporate activity. Corporations operate within the
economy. This mutual importance underlies a great deal of our discussion regarding corporate governance.
The economy and society as a whole must be regarded as crucial stakeholders. If economies are not
nurtured, then corporations cannot succeed. So, we find a number of laws that are designed to protect
the economy and important aspects of the economy such as fair competition, open financial markets and
the rights of individuals including consumers. Similarly, if the legal system is not designed, at least in part,
to encourage the success of corporations, then economies based on capital models will not succeed. There
are many laws that must be understood by boards and other management so that the balances required by
society are recognised in decision making within the corporation.
It is not possible within this module to provide any detailed analysis of laws in general. We must
note, however, that good corporate governance and the effective operation of business need these laws
to be reliable, predictable and commonly understood. Furthermore, for any commercial framework to be
fundamentally successful in the long term, it is vital that all participants within the framework can protect
their rights and seek redress for any wrongs. Therefore, a strong and reliable court system is a vital part of
the overall corporate governance framework. One important example of laws that are part of the corporate
governance framework are the legislative and court protections in place for whistleblowers, which will be
discussed later in the module in part C.
Corporations must respect the law, understand it and ‘play within the rules’. The legal system is
enormously important as it enables the very existence of corporations and provides the rules and
regulations under which corporations will succeed. Understanding these rules and ensuring that boards
and management have the appropriate awareness and access to detailed knowledge are key requirements
in building good corporate governance practices. As always, boards must ensure that appropriate policies
are in place to deal with every issue that is, or may be, material to the interests of the corporation.
We begin our discussion by looking at the way that laws can be regarded as criminal or civil in nature and
the types of consequences that may arise. We look at how those who are ‘in the wrong’ may be made liable
to compensate those who have been hurt, and also at how measures may be designed to punish or prevent
continuing unacceptable conduct. These are matters that boards and management must understand, and
where caution must be exercised. If matters are not dealt with correctly, the costs to corporations can be
very high — and in some cases, the individuals involved can be imprisoned or face harsh financial penalties.
Proof, Penalties and Redress — Criminal and Civil
We begin by noting that, in countries using the common law system, no court would normally contemplate
conducting a trial that involves both civil and criminal matters at the same time. The cases would be
totally separate and would be carried out in different ways. There would be different procedures, different
relationships (criminal cases always have a state authority as the prosecutor), different expectations and
different outcomes. If, as is common, one piece of legislation has operative provisions that may be used in
respect of criminal liability or civil liability, then this is merely a convenient (but potentially confusing)
way of stating that the issues addressed by the legislation may be subject to two very different courtroom
approaches in two different courts at two different times. Breaches of the Corporations Act, depending on
the section or sections breached, can result in either criminal or civil court cases.
Laws Leading to Criminal Penalties
A criminal is a person who has been found guilty after being charged with a crime (also called a ‘criminal
offence’ or just an ‘offence’). The concept of crime has been in existence for centuries. Crimes such as
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238 Ethics and Governance
murder and theft have always carried common law crime status. Criminal cases are always carried out by
agencies of the state and never by individuals or corporations.
Traditionally, in common law countries (which almost always includes those Anglo-American company
law traditions), crimes require the person charged to be subject to a court trial in which the prosecutor has
the duty to establish facts proving beyond reasonable doubt that the crime was committed. This includes
establishing that the person accused of the crime had the necessary criminal intent. If all of this cannot
be proved beyond reasonable doubt, the person will go free. While systems in countries that do not have
a common law tradition vary, the essential nature of crime is the same, with the outcomes of fines and jail
after prosecution being standard.
In recent decades, there has been a tendency to introduce new crimes in various pieces of legislation.
Laws made this way can reflect whatever the parliament making the law may wish (e.g. it may lessen the
need to prove criminal intent).
Criminal sanctions can take many forms but, most commonly will be in the form of fines and/or jail
sentences. In the US, competition laws are usually described as anti-trust laws, and breaches of these laws
may be punished by jail sentences of up to 10 years along with fines. Similarly, in Australia, there are
now criminal penalties for cartel conduct. Australia also provides penalties of up to 150 years jail for
individuals (including officers of corporations) and, under complex rules about fines, maximum penalties
for corporations of up to $10 million or as much as 10% of group turnover.
It is also common in legislation for other outcomes to be relevant so that criminal actions result in
compensation or damages being payable to those who have been adversely affected by the crimes. This
occurs when the prosecutor requests consideration be given by the court to those who have been harmed.
An interesting aspect of some legislative schemes is where a criminal prosecution would be hard to start
(e.g. if proof beyond reasonable doubt is very hard to establish) or, once started, it fails. In these instances,
it is possible either to bring a civil action instead, or to do so after the criminal action has failed. A civil
action cannot be commenced after a successful criminal action. This is because the successful case would
have already been proved beyond reasonable doubt and the level of proof for civil cases is lower, meaning
that the outcome of the civil trial would be already known, therefore wasting the resources of the courts
and all potential parties to such a case.
Laws with Civil Outcomes and Penalties
In common law jurisdictions, the fundamental characteristic of a civil case is that any aggrieved party can
bring an action. While civil penalties previously did not exist under common law (but do now under some
legislation), civil cases have been in existence for centuries. If X has a contract with Y and Y breaches the
contract, then X can take Y to court seeking a court decision and a court-enforceable outcome (e.g. damages
and/or an injunction — a court order compelling a party to undertake or refrain from undertaking a
specific act).
In a civil case, the court requires each party to argue its case as strongly as possible and the person with
the case that is determined to be stronger relation to the relevant law will win. The standard applied is
‘proof based on the balance of probabilities’ rather than ‘proof beyond reasonable doubt’ as in criminal
cases. Neither party will be punished by jail or fines in a civil case, as these penalties apply only in criminal
cases. The court may award damages to the injured party, apply injunctions or make other orders such as
rescission (revoking or annulling) of contracts, many of which may apply at the cost of the losing party.
There are many and varied orders that have developed over the centuries and to which relevant legislation
has been added.
In recent decades, some legislation has been written so that civil wrongdoers are punished. This is an
important development. The concept of civil penalty means that a penalty has been prescribed within the
relevant legislation. Importantly, this will be a penalty in relation to conduct that requires proof according
to the ‘balance of probabilities’ and not ‘beyond reasonable doubt’. Penalties that apply will be pecuniary
penalties payable to the state. The term ‘pecuniary penalty’ is applied in place of the term ‘fine’, as fines
are criminal penalties. However, public statements made by the press and even statutory authorities often
refer to these pecuniary penalties as being fines. Therefore, careful reading is required in order to determine
whether, for example, a corporate officer is in fact guilty of a crime or is a wrongdoer in a civil case.
For instance, when a former Telstra director accepted that he had acted improperly in civil proceedings brought by ASIC about his share dealings, the corporate regulator made a possibly confusing
announcement that headlined a civil penalty as being a fine, although the text of the announcement correctly
stated that it was a pecuniary penalty (see example 4.9).
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MODULE 4 Governance in Practice 239
EXAMPLE 4.9
Vizard Case
‘Steve Vizard banned for 10 years and fined $390,000’
Mr Jeremy Cooper, Acting Chairman of the Australian Securities and Investments Commission (ASIC),
today announced that Mr Stephen William Vizard has been banned from managing any corporation for
10 years and ordered to pay pecuniary penalties of $390,000.
Justice Finkelstein of the Federal Court of Australia found that Mr Vizard had breached his duties
as a director of Telstra Corporation Limited (Telstra) on three occasions when he used confidential
Telstra information to trade in the shares of three listed public companies, Sausage Software Limited,
Computershare Limited and Keycorp Limited between March and July 2000.
‘ASIC welcomes the length of the banning, which sets a new benchmark for future civil penalty cases
that ASIC brings’, said Mr Cooper.
‘This means that Mr Vizard is disqualified from managing any corporation in Australia until July 2015.
‘It was a pre-meditated and cynical exploitation of a privileged position held by Mr Vizard and showed
a complete disdain for the confidentiality of the boardroom’, he said.
Source: ASIC (Australian Securities and Investments Commission) 2005, ‘Steve Vizard banned for 10 years and fined
$390,000’. © Australian Securities & Investments Commission. Reproduced with permission.
Mr Vizard was not subject to any criminal charges. He also was not subject to an action for insider
trading — on either a criminal or a civil basis. He was taken to court only in respect of civilly breaching
his duties as a director.
Traditionally, laws dealing with civil matters sought only to create civil outcomes and did not lead to
penalties. Almost always, laws that deal with civil issues will provide for compensation and redress for
victims of civil wrongs. This is pursued further in the following discussion.
Redress Compared with Penalties
The potential victims of wrongdoings by corporations include a variety of stakeholders who deal with
corporations including; shareholders, lenders, suppliers, customers and final consumers, and indeed
the whole economy. An illustration may be seen in the Centro case (considered previously), where
shareholders were harmed by Centro’s failure to identify its current liabilities with sufficient accuracy.
The correct disclosure, when it occurred on 17 December 2007, led to a significant decline in the value of
Centro shares. Arguably, the Centro group would have struggled to cope with existing large levels of debt
at the time of the GFC. However, shareholders could have expected better information when the 2006/07
results were released more than four months earlier, in August 2007. The Centro case redress was by way
of agreed damages under a court-approved settlement between the parties rather than a court decision.
The deliberately non-legal term ‘redress’ is used here to describe generally the ways in which
wrongdoers can be required to correct the harm they have caused. Under modern complex legislation, the
redress of wrongs is covered by provisions that provide for compensation, injunctions and other actions
that are designed to ensure that victim’s rights are addressed and that any losses or costs are recovered
or repaid. Some victims would also regard an order disqualifying a person from managing a corporation
as a form of redress as the victim will feel better, although others might regard it as a penalty. However,
the principal concern here is to regard redress not as a penalty but rather as part of the process of putting
corporate governance matters right and of keeping these matters in good order for the future.
Damages or compensation involves having the offender make payments (i.e. pay damages) to the injured
party to compensate for the harm or loss caused. Injunctions are hearings where courts try to act quickly
to prevent wrongs from continuing or becoming worse by getting a corporation, for example, to stop its
anti-competitive conduct. Injunctions can be sought by any relevant party. Other types of remedy include
adverse publicity orders, which require the corporation to advertise to society at large the wrongs in which
it has been involved. Individuals may also be prohibited from managing a corporation, or from holding
important officer or director roles.
Penalties are different from remedies as they are meant to punish a wrongdoer. Punishment obviously
goes beyond simply redressing wrongs — as well as working in conjunction with redress. The penalties
may have been specifically designed to stop breaches (by acting as a deterrent) and courts may decide to
compensate those who have been harmed by the breaches as well as impose penalties on the wrongdoers.
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In Australia, breaches of corporations law legislation commonly result in criminal fines and civil
penalties of $1 million or more, with individuals potentially subject to large civil penalties, and fines
and jail for criminal breaches.
The Competition and Consumer Act, including the Australian Consumer Law in Schedule 2, contains
large financial penalties for breaches, applicable both to relevant individuals and/or the corporation on
whose behalf the individuals act. In recent years, cartel conduct has been made a criminal breach, with
individuals subject to jail for breaches (10 years maximum) — just as they can be for some specific conduct
that may damage consumers.
The Australian cartel provisions and other related provisions (the cartel provisions being criminal as
well as civil) have maximum penalties for individuals as high as $500 000. Additionally, corporations can
be heavily penalised for criminal and civil breaches — including fines/pecuniary penalties that, for any
corporation, can be as high as $10 million and, for larger corporations, can be in the hundreds of millions
of dollars (10% of group turnover as a possible maximum).
LEGAL COMPLIANCE AND GOVERNANCE
Corporations, their directors, managers, employees and other agents unfortunately sometimes take quick
and easy pathways to achieve their individual and/or corporate goals. Sometimes this entails engaging in
unethical or illegal behaviour (some of which we have already discussed). With competition and consumer
protection laws and other laws gaining greater exposure and involving significantly greater penalties, it
pays to consider the ethical and legal ramifications and do the right thing from the outset. In addition to
criminal and civil sanctions, there are always other real costs (many of which are intangible and difficult
to quantify) associated with publicised wrongdoings. Some of these include:
• the human resource costs of finding and producing relevant information for regulators, trials, etc.
• the cost of legal advice and briefing advisers
• the impact of negative publicity on employee morale, share prices and profits
• the diversion of resources and management effort away from core value-building activities
• managers and other employees undergoing considerable stress, leading them to take time off work, or
even resigning
• knowledge gaps and the replacement costs if employees leave.
It is wise for boards to understand the benefit of careful planning and the need to develop and implement
appropriate ‘due diligence’ policies and approaches. This is particularly important for legal compliance,
and the development of a compliance program has been the subject of particular attention in the area
of competition law in Australia. It is also a part of effective risk management and is of great interest to
insurance companies. Insurance premiums payable by an organisation are a direct function of the risks in
existence and ‘due diligence’ compliance programs — including legal compliance — are a major factor
in achieving reduced corporate risk.
Why Have a Compliance Program? … As Identified by Professor Fels
A former chairman of the ACCC, Professor Alan Fels (Fels 1999), gave a speech that was especially strong
in identifying the need for a relevant competition and consumer law compliance program. As we consider
his views, it is apparent that his comments are not only valuable but have universal application to legal
compliance by boards and management generally. The core principles Fels identified can be applied to
reduce the risk of poor compliance with all regulatory and legal requirements. They can even be extended
to compliance with internal ethics codes and with managing risk generally. Compliance programs are
beneficial for corporations, shareholders, boards, management, employees and for all other stakeholders
— including consumers, financial markets and society at large.
Professor Fels observed that a compliance program is a system designed to assess and reduce an
organisation’s risk of breaking the law. It also promotes a culture of compliance and encourages ‘good
corporate citizenship’. A compliance program should never be seen as just an education or training exercise
and must become part of an integrated business system. Procedures need to be put in place to ensure
compliance with the law (a management support system), and these procedures must be audited and
reviewed regularly.
Having an effective compliance program offers a number of benefits identified by Professor Fels.
Compliance programs are increasingly important, and it is not only regulators that are promoting their
use. Corporations acknowledge their value and in some instances courts have had favourable regard to the
programs’ existence when considering the legal outcomes affecting corporations in relevant cases. Legal
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compliance is becoming a top priority and compliance programs help to reduce corporate risk. However,
fewer corporations believe or understand how a good compliance program may help them to compete more
effectively. Professor Fels summarised his views as follows.
Why have a compliance program?
Two main benefits of compliance programs are that they help a corporation to:
• avoid breaking the law and, consequently, save time and money; and
• enhance its business operations by focusing on positive business purposes (rather than reactive risk
management).
Avoiding harm
Effective compliance programs should be cost-effective and should lead to reduced risks of incurring
penalties and help limit liability for damages. They may also help avoid other financial and non-financial
costs associated with investigations, prosecutions and their aftermath.
A recent option for a person who thinks that they may have breached the Australian Consumer Law is to
offer the regulator an enforceable undertaking. This undertaking would include that they will not breach
the law again and will improve their compliance regime.
The positive business case for compliance
Possible significant benefits for compliance programs include:
• improved safety and quality of products and services;
• improved innovation;
• fostering customer goodwill;
• problems are identified systematically and may be minimised or avoided;
• encouraging identification and mitigation of risks;
• improved communication and reporting;
• increased ethical behaviour; and
• enhanced saleability of the business.
Who else can benefit from a good compliance program?
Corporation activities affect a wide variety of stakeholders. A compliance program that focuses not just
on trade practices but overall legal compliance, with all the laws that affect the corporation, may lead to
benefits for all major stakeholders, including:
• customers (through consumer protection laws);
• competitors (through competition laws);
• employees (through occupational health and safety (OHS) and industrial relations laws);
• shareholders (through corporations and securities laws); and
• the general community and the environment (e.g. through pollution laws).
Source: Fels, A. 1999, ‘Compliance programs: The benefits for companies and their stakeholders’, ACCC Journal, no. 24, pp. 14–18.
© Commonwealth of Australia.
4.6 OBLIGATIONS TO EMPLOYEES
A board is responsible for ensuring that appropriate policies are set for its activities. It is the responsibility
of management to implement these policies on behalf of the board and the shareholders and, as observed in
module 3, management will assist in developing policies that are approved by the board. It is not possible
to look at every one of the operational areas where policies are important. Here, we consider some matters
not dealt with at length in this, or other, subjects — beginning with a general comment on employees.
We then briefly discuss occupational health and safety, pay and working conditions, and family and leave
entitlements.
Another important area of development in recent years affecting employees (and others) has been
whistleblower protection whereby laws have been enacted in an attempt to mitigate retaliatory responses
against those who expose corporate misconduct. Whistleblower provisions will be discussed in part C of
this module in the wider context of financial market protection.
Employees are central stakeholders in any organisation. For good governance, it is crucial that policies
are in place to ensure that appropriate relationships exist between the corporation as employer and every
employee. We should not forget that executives are also employees.
The crucial understanding that we must appreciate is that boards cannot simply leave all the responsibility to management. Boards have a duty to be aware of the issues and to be sure that these issues are
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being appropriately addressed within the organisation, according to policies that are set at board level and
are consistent with legal obligations and community standards.
For example, laws recognising the importance of employees as stakeholders (e.g. in the EU and
Australia) make it even more important for corporations advertising employment positions to get it right.
It is significant that the protections effectively apply to the whole community, as they apply not only to
existing employees but to every potential employee. The Australian Consumer Law (s. 31, Schedule 2
of the Competition and Consumer Act) creates the Australian version of this new type of ‘employee’
protection.
Directors and managers of corporations need to comply with (or exceed) the requirements of the law in
the way they treat the whole pool of potential employees — and contractors’ employees. If they do not,
they will damage both the corporation’s value and the shareholders’ interests. Example 4.10 describes
an instance where a business was found to have failed to comply with legal requirements in relation
to recruitment.
EXAMPLE 4.10
Smith v Redflex
Job applicant Jessica Smith received a finding in her favour that included a recommendation she receive
$2500 in compensation after the Australian Human Rights Commission (AHRC) determined a potential
employer discriminated against her in the application process.
Smith had a criminal record with two offences — assault occasioning actual bodily harm and possession
of a prohibited drug — and it was confirmed that it was her criminal record and not any other factor such
as an inappropriate skill set that ruled her out of contention for a position with Redflex Traffic Systems
Pty Ltd.
The AHRC found that Redflex had discriminated against Smith given that it had failed to communicate
with her about her National Police Check that was done after they had given her an indication that she
had done well in the application process. Smith had contacted the company on several occasions and
went to the AHRC to resolve the impasse.
Amongst the issues that AHRC President Rosalind Croucher addressed in the decision on the Smith
matter was the fact that the offences that were in her criminal record could have been examined further
by the company before refusing to take Smith on as an employee.
‘The offence of “assault occasioning actual bodily harm” can cover a range of conduct, from the infliction
of temporary bruises and scratches, to more permanent injury. In November 2004, a conviction for “assault
occasioning actual bodily harm” was punishable by up to five years imprisonment,’ Croucher said. ‘That
Ms Smith was sentenced to community service, and not a custodial sentence, suggests that her offence
was considered to fall at the lower end of the scale of objective seriousness. Similarly, her second offence
of possession of marijuana was disposed of by the Local Court by way of a fine.’
Croucher noted that the two offences did not themselves constitute a reason in their own right for the
nonappointment of Smith to a role with the company.
‘In my view, without more, the existence of a nearly 12 year old conviction for the offence of ‘assault
occasioning actual bodily harm’ and a 9 year old offence for minor drug possession did not necessarily
mean that Ms Smith was untrustworthy or of bad character in 2016,’ Croucher said. ‘I am not satisfied
that, simply because Ms Smith committed these two offences, it inevitably followed that she could not
meet high standards of character and trustworthiness many years later.’
Source: Ms Jessica Smith v Redflex Traffic Systems Pty Ltd [2018] Aus HRC 125, www.humanrights.gov.au/ourwork/legal/publications/ms-jessica-smith-v-redflex-traffic-systems-pty-ltd-2018.
OCCUPATIONAL HEALTH AND SAFETY
Workplaces often create situations that can cause significant risks to employees. Laws in this area are
diverse and, even within countries ,there are significant differences between regions. In some jurisdictions,
there may be virtually no protections or compensation available to workers, while in other jurisdictions
both civil and criminal laws and relevant remedies are very strong.
From a corporate governance perspective, a common national approach makes it easier for boards to set
appropriate policies and for management to implement policies.
It is to be expected that large corporations, wherever they operate, should pay attention to employees as
stakeholders.
Workplace injuries can severely affect a business by lowering productivity, losing sales, damaging
employee morale and diminishing public respect. Under state law in Australia, if a worker is injured in the
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course of their employment they are entitled to make a workers’ compensation claim. Because of better
health and safety at work regulation, and the efforts of employers to guard against the possibility of serious
accidents to workers, in recent decades the number of employees involved in serious injury in Australia has
reduced significantly. However, in 2017, a total of 190 fatalities were recorded in Australian workplaces.
This was up from 187 in 2016 (Safe Work Australia 2018).
Example 4.11 describes a court finding and the penalties imposed after a business owner had failed to
comply with OHS laws.
EXAMPLE 4.11
OHS Breach
A 72-year old owner of a scrap metal business was sentenced to six months jail and ordered to pay a
$10 000 fine for exposing people to risks on the site of her scrap metal enterprise.
The LaTrobe Valley Magistrate’s Court heard the matter concerning scrap metal entrepreneur Maria
Jackson on 19 December 2018. Jackson pleaded guilty to two charges under Victorian occupational
health and safety laws. These charges related to a failure to comply with her duty as a self-employed
person to not expose other people to risks from the work she does, which is covered by section 24 of the
Occupational Health and Safety Act 2004. The second charge related to an offence of recklessly engaging
in conduct that places or may place another person who is at a workplace in danger of serious injury, which
is in section 32 of that same piece of legislation.
Jackson was at the centre of an incident in February 2017 while driving a forklift. An individual died as a
result of falling from the forklift’s tynes that were about three metres from the ground. Both the deceased
person and a metal bin fell from the tynes. The bin struck the individual concerned.
The scrap metal business owner failed to check that the bin was properly secured before doing anything
with the bin.
The court also ordered Jackson to pay court costs as well as the previously mentioned $10 000 fine.
Source: Based on Zuchetti, A 2019, ‘Jail sentence for employer over workplace death’, January, accessed October 2019,
www.mybusiness.com.au/human-resources/5361-jail-sentence-for-employer-over-workplace-death.
FAIR PAY AND WORKING CONDITIONS
There is an argument that buoyant economies will have a high demand for labour, which in turn will ensure
fair pay and working conditions as labour will be able to set a high price. Though this argument may hold in
theory (under a limited set of assumptions), the reality can be quite different. Employees are not always in
a strong bargaining position, so their pay and working conditions can be at the mercy of their employer. It
is for these reasons that many countries have laws and regulations covering minimum wages and working
conditions.
Both boards and managers must ensure that employees are paid appropriately, which will engender
efficiency and loyalty to the business. It may be wise to identify some additional reward payments relative
to superior performance. As with executive payments, performance-based payments need to be carefully
considered and have an emphasis on motivation rather than just reward for past performance.
This aspect, as part of the performance component of corporate governance, is also looked at in
some detail in the subject Strategic Management Accounting.
In many jurisdictions, it is common for employers to contribute to employee pension funds. In Australia,
such payments are called superannuation payments, which are required by law and are designed to ensure
that employees are adequately funded into retirement.
Penalties are often applied to businesses that fail to meet their obligations in relation to pay and
entitlements. Examples 4.12 and 4.13 describe two cases.
EXAMPLE 4.12
Fashion Box Pty Ltd
A fashion start-up was hit with a total of $329 000 in penalties by the Federal Circuit Court when it was
found that fashion entrepreneur, Kathleen Enyd Purkis, had underpaid three workers.
Purkis ran a business called Fashion Box Pty Ltd and both she and the company were given penalties
by the court for failing to properly pay three individuals with one of those three being taken on for what
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was described as an unpaid internship. That individual was deemed to be a part time employee by
the court.
‘The Court found three employees aged in their mid-20s were underpaid a total of $40 543 for their
entitlements including minimum hourly rates, overtime, public holiday pay and annual leave between
2013 and 2015,’ a media release issued by the Fair Work Ombudsman said. ‘One of the employees,
a graphic designer who had completed a university degree, worked two-days per week for almost six
months without pay under a purported “unpaid internship” before receiving a one-off payment of just
$1000. She was underpaid $6913.’
Ombudsman Sandra Parker said that complaints were received from the workers and inspectors were
placed on the case to determine precisely what had happened.
Fair Work Ombudsman Sandra Parker said inspectors investigated after receiving underpayment
complaints from the young workers.
‘Business operators cannot avoid paying lawful entitlements to their employees simply by labelling them
as interns. Australia’s workplace laws are clear — if people are performing productive work for a company,
they are legally entitled to be paid minimum award rates,’ Parker observed.
Judge Nicholas Manousaridis said contraventions of the law in this case were ‘serious and sustained
contraventions of important provisions of the Fair Work Act’. He said that Purkis knew she (the company)
was not paying workers proper amounts.
‘The penalty should be set at a level that, having regard to the other circumstances of the case, should
signal to employers who might be tempted not to inquire into their legal obligations as employers or not
to comply with their legal obligations, particularly in relation to inexperienced workers, that there is a
significant risk of being exposed to the imposition of a pecuniary penalty if they are to succumb to such
temptation,’ the Judge noted.
Source: Australian Fair Work Ombudsman 2019, ‘Fashion start-up penalised over unpaid internship’, accessed
October 2019, www.fairwork.gov.au/about-us/news-and-media-releases/2019-media-releases/march-2019/20190301-herfashion-box-penalty-media-release.
EXAMPLE 4.13
Safecorp Security
The operator of two defunct security companies was hit with a $39 090 penalty for underpaying security
guards, according to a 3 July 2019 media statement issued by the Fair Work Ombudsman.
Sydney man John Lohr, who formerly operated Brookvale-based companies Safecorp Security Pty Ltd
and Safecorp Security Group Pty Ltd, was given the penalties by the Federal Circuit Court. The companies
are no longer operating.
There were 45 security guards employed on a casual basis at various sites and these guards were owed
a total of $35 540.84.
The guards were being paid flat hourly rates between $20 and $25 and these rates did not cover casual
loading, weekend, overtime and other circumstances in which a greater payment ought to have been
made. The penalty imposed on the former security business owner was to be used to pay all affected
individuals.
Source: Information from Australian Fair Work Ombudsman 2019, ‘Penalty for underpayment of Sydney security guards’,
3 July, media release, accessed October 2019, www.fairwork.gov.au/about-us/news-and-media-releases/2019-media-releases
/july-2019/20190703-safecorp-security-penalty-media-release.
FAMILY AND LEAVE ENTITLEMENTS
Entitlements in many countries commonly include annual leave, parental (maternity/paternity) leave and
other types of entitlements. It is common for legislation to prescribe specific leave requirements. These
entitlements are sometimes voluntarily accepted by organisations, but more commonly are the subject
of legislative prescription. Legislated leave or holidays commonly include regular public holidays and
annual leave.
Different jurisdictions prescribe different amounts of leave. In the US, two weeks of annual leave is
common (but is not a legal requirement). In Australia and the UK, four weeks of leave is the standard legal
minimum. In Singapore, however, leave entitlement is on a sliding scale, with the maximum 14 days’ leave
applying only after eight years’ service. Additionally, in most jurisdictions, employees receive an amount
of legislated public leave. Full-time employees are paid at normal rates of pay for prescribed leave.
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In Australia, the National Employment Standards (NES) set the minimum leave entitlements for employees. While other leave entitlements can be provided in an award, registered agreement or employment
contract, these cannot be less than what is set out in the NES (Fair Work Ombudsman n.d.).
Some business owners resent such impositions, but it is important to be aware that corporate governance
standards express society’s wishes and expectations, and these cannot be ignored because society at large
is a crucial stakeholder to which corporations must pay appropriate attention.
Example 4.14 illustrates strongly that employees need protection that Australia’s Fair Work Ombudsman
provides — in this case a 487 skilled visa holder.
EXAMPLE 4.14
First Paid Parental Leave Legal Action
In another first, we took legal action against an employer who failed to transfer the Australian Government’s
Paid Parental Leave funds to an employee. The affected employee was on a 487 skilled visa. After she
had a child, the Department of Human Services (DHS) transferred her paid parental leave to her employer,
Noorpreet Pty Ltd, to transfer to her. After many unsuccessful attempts by the employee to retrieve her
payment, DHS referred her to us to resolve the matter. During the investigation, Noorpreet’s director
provided a FWO Inspector with a false document that claimed the company had already paid the parental
leave payment to the employee’s husband, in cash. The court found the company and the director had
engaged in ‘deliberate deception’. Stating that deterrence against the employer’s conduct guided his
decision, the Judge issued penalties of nearly $120 000 to the company and the director (who were also
found to have engaged in several record-keeping and pay slip contraventions).
Source: Fair Work Ombudsman n.d., ‘Fair Work Ombudsman performance report: Enforcement outcomes’, accessed October
2019, www.fairwork.gov.au/annual-reports/annual-report-2017-18/02-fwo-performance-report/enforcement-outcomes.
ETHICAL OBLIGATIONS — EMPLOYEE GOVERNANCE
Ethics were considered in module 2, and we must also be aware that there is a strong linkage with
corporate social responsibility (see module 5). Business ethics and their relationship with employees must
be understood in relation to society and the environment, and to the way in which the business interacts
with all stakeholders.
We should also note that, just as employers have ethical obligations to employees, so do employees
towards employers. Employees have the obligation of loyalty that carries with it such concepts as regular
attendance, confidentiality of employers’ secrets and intangible property, care of employers’ tangible
property, and respect of fellow workers and their rights. As indicated earlier, it is also apparent that
employers must be aware of how their contractors treat their employees.
A well-designed code of conduct, being a corporate policy that gives full and proper attention to
employees, is an important corporate governance component. It should state the rights of employees and
what is expected of employees. Modern codes of conduct also state requirements imposed on contractors
so that contractors treat their employees correctly. As with all policies, the code of conduct needs to be
carefully prepared, communicated fully to those it is designed to affect and carefully updated as times and
expectations change.
Case Examples of Failure in Relation to Employees
Employers who do not meet the needs of employees appropriately, and who bypass or ignore fundamental
principles and laws, have been seen to suffer serious adverse consequences through bad publicity and the
loss of reputation. This is demonstrated in example 4.15. Example 4.15 demonstrates a poor standard of
behaviour visible in boards of even apparently reputable corporations operating in countries reputedly with
the best legal systems. Clearly, there is never room for inattention.
EXAMPLE 4.15
Pike River Coal Mine
In late 2010, 29 miners died when they were trapped 1.5 kilometres underground by a methane explosion
inside a coal mine in Pike River, New Zealand.
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A report into the incident stated:
The lessons from the Pike River tragedy must not be forgotten … That would be the best way to
show respect for the 29 men who never returned home on 19 November 2010, and for their loved
ones who continue to suffer …
Protecting the health and safety of workers is not a peripheral business activity. It is part and parcel
of an organisation’s functions and should be embedded in an organisation’s strategies, policies and
operations.
This requires effective corporate governance. Governance failures have contributed to many
tragedies, including Pike River …
The board and directors are best placed to ensure that a company effectively manages health and
safety. They should provide the necessary leadership and are responsible for the major decisions
that most influence health and safety: the strategic direction, securing and allocating resources and
ensuring the company has appropriate people, systems and equipment.
Source: Royal Commission on the Pike River Coal Mine Tragedy 2012, ‘Report of the Royal Commission on the Pike River
Coal Mine Tragedy’, accessed October 2015, http://pikeriver.royalcommission.govt.nz/Final-Report.
Clearly, one of the major effects of poor employee relations is loss of the corporation’s reputation and,
with an increasingly vigilant media, loss of brand value, share value and the threat of greater attention from
regulators. You will also observe the ability of the law to ‘strike at the agents’ — and this is appropriate
because, as observed in module 3 and using Lord Denning’s words, they are the ‘directing mind and will’
of the corporation.
Trade and Labour Unions
A trade union, also known as a labour union (or just a ‘union’), is a term for a group of workers who
have banded together to achieve collective representation of their interests. Unions are typically large and
powerful and commonly seek to achieve outcomes through collective bargaining with employers. If the
collective bargaining process fails, then industrial action may occur. This can take the form of go-slows
(deliberately working slowly), work to rule (workers performing their duties with over-attention to strict
detail compared to normal workplace practice, causing deliberate difficulties for employers), or strikes
(refusing to work).
Employees are important stakeholders, as are formalised industrial unions of employees. Good corporate
governance demands that unions are understood by both boards and management, and are dealt with
appropriately for ethical reasons and also out of self-interest (as unions can be powerful). Because they
project the great combined power of employees as stakeholders, unions remain highly prominent in many
countries.
4.7 PROTECTING THE GOODS AND
SERVICES MARKET
The term competition policy refers to the measures that governments take to suppress or deter anticompetitive practices, promote the efficient and competitive operation of markets and bring about
economic growth. One vital component of competition policy is an effective competition law that prohibits
or otherwise deals with specific anti-competitive practices, such as cartels and monopolies.
A competitive market is one where enough corporations exist, at arm’s length from each other, for
consumers to have freedom of choice, with a wide range of alternative products and efficiency-based
pricing. By contrast, a monopolistic (i.e. tending towards entirely uncompetitive) market structure is
one where a few powerful corporations, or perhaps even only one corporation, dominate. Monopolist
corporations are able to reduce supply below the competitive level in order to maximise profits, including
through artificially high prices.
It is generally agreed that competitive markets will have greater ability than other non-competitive
options to efficiently produce goods and services at prices that provide value to customers — reflecting
the fact that customers demand choice and quality as part of that value. As a relatively small and
isolated country, Australia has developed highly concentrated markets over the years in industries such
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as grocery retailing, newspapers, shopping centres, banking, insurance, gaming, telecommunications,
building products, aviation, construction and liquor. Australia also does not have the forced divestiture
powers of countries like the US and the UK, where companies may be compelled to sell off parts of
their business.
WORKABLE COMPETITION
While perfect competition is difficult to achieve, the concept sought by most modern economies (including
through sometimes complex government regulation) is workable or effective competition within an
economy. The requirements of workable or effective competition include the following.
• There should be a sufficient number of buyers and suppliers so that there are real alternatives.
• No individual trader should have the power to dictate to its rivals or be free of competitive pressure.
• New traders should be able to enter the market without facing artificial barriers.
• There should be no collusion on prices, customers or trading policy.
• Customers should be able to choose their supplier.
• No trader should have an advantage because of legal or political considerations.
Note that all of these concepts are dependent on identifying a relevant market — a combination of the
product market and the geographic market that is not always easy to identify. While economists debate
what comprises a market, we find that the decision is a matter to be decided in courts of law. In a relevant
case, the court will consider the arguments of two protagonists in the courtroom and make a rational,
balanced judgment (often including consideration of the views of experts). That judgment will be based
on the balance of probabilities according to the court, based on the facts given in evidence. For those who
are not experts or judges, we can make rational, balanced judgments about what comprises a market —
especially if we use the guidance that is available from previous court decisions (precedents).
In the case of Outboard Marine Australia Pty Ltd v. Hecar Investments No. 6 Pty Ltd (1982) 66 FLR
120, the head note to the judgment of CJ Bowen, J Fisher and J Fitzgerald states that ‘the correct approach
to determine the state of competition in a market is to undertake a detailed analysis of the market, the state
of competition therein, and the likely effect of the conduct upon competition in the market’. Being aware
that this is how market competition is determined in respect of any situation or any dispute is valuable
knowledge. There are many cases in various international jurisdictions that demonstrate the approach
described in the Hecar case.
COMPETITION AND STAKEHOLDERS
It is commonly recognised that all organisations seek to achieve competitive advantage in the sale of their
goods and services. The logical purpose of seeking competitive advantage is to develop an overwhelming
competitive advantage and eventually achieve a monopoly. In theory the greatest efficiencies can be
achieved by the largest scale of activity, which logic indicates would be a monopoly. This is contrary
to the protection of competition in markets for goods and services. Further, it may be a self-defeating
endeavour, as a lack of competition and the innovative pressures that competition creates may make the
monopolist lazy, inefficient and an easy target for new entrants to the market.
Consumers are generally hurt by lack of competition because prices are not competitive, outdated
technologies and inefficiencies can prevail, and the product range and availability are directed by the
monopolist. The reduction in business opportunities and efficiencies, combined with potential diminution
of overall activity, damages the entire economy.
Internationally, laws designed to protect competition universally seek to prevent monopolies. But
sometimes, as with the developing National Broadband Network (NBN) in Australia, governments will
take deliberate short- to medium-term initiatives, including the creation of monopolies, in order to achieve
specific long-term outcomes. Any such move will be subject to great debate as the real merits and longterm benefits of approaches are likely to be considered by many to be improper in a competitive sense.
For example, many suggest that the Australian NBN, by adopting a monopolistic approach in respect of a
single technology, may fail in key respects as market-based newer alternative technologies will be ignored.
(Though the NBN might respond that its brief is to serve the whole Australian market with an efficient
service, while other technologies and providers are aimed at selected profitable niches in the market.) The
NBN debate demonstrates that competition issues can become very complex.
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The Australian Government’s concept of actively creating the NBN monopoly has also been the subject
of international commentary. These commentaries show that many, not simply opposition members
of parliament, believe the deliberate ‘legislated monopoly’ approach of the Australian Government
is not appropriate in an age of market freedom — quite aside from the long-term possibility of a
series of economically and technically inappropriate decisions and outcomes. The OECD stated very
clearly that:
While establishing a monopoly in this way would protect the viability of the government’s investment
project, it may not be optimal for cost efficiency and innovation. Empirical studies have stressed the value of
competition between technological platforms for the dissemination of broadband services (OECD 2010b).
Regardless of government monopolies, the challenge for corporations internationally is to improve
productivity and become more efficient, innovative and flexible but not to misuse market power or act
in anti-competitive ways. Competition pushes corporations to improve, adapt and respond to the changing
environment. This usually leads to better prices and choices for consumers. The broader economy will also
benefit due to greater efficiency, economic growth and more employment opportunities.
Most commonly, corporations will rely on the law as the arbitrator or provider of very clear rules that
establish competition policies within the corporation. Notwithstanding the need to act ethically within
the corporation, relying on the law as it is developed and refined is both inevitable and wise, as the
law creates common standards that apply equally to all corporations within any jurisdiction. Fortunately,
while many detailed rules differ, internationally there are broad similarities in the way countries approach
competition policy.
Even so, correct balances can be hard to achieve and the laws in individual countries will change from
time to time. Further, the fact that even a government (as with the Australian NBN) is willing to protect its
own investments through creating a new, artificial monopoly is an indicator that selfinterest is difficult to
overcome if entities are permitted (or feel free) to use their market power, or their ability to breach other
competition rules, to their own advantage.
Full awareness of competition policy, laws and regulations is a crucial part of corporate governance
framework. It is necessary to define and understand unacceptable anti-competitive behaviour so that this
can be avoided on all occasions — even though this is difficult where governments, who otherwise enforce
competition rules, seek to bypass the principles on occasion. The governance balance is difficult but it must
be understood and incorporated into appropriate board-approved policies as well as into a meaningful
compliance program for competition law and other legal and regulatory risks.
Table 4.3 provides examples of international competition legislation and regulators. As noted, legislation
is very similar across different jurisdictions. This is inevitable as markets and competition have become
global, so international competition rules and regulations need to operate consistently.
TABLE 4.3
International competition legislation and regulators
Jurisdiction
Legislation
Regulator
Australia
Competition and Consumer Act 2010
Australian Competition and Consumer
Commission (ACCC)
Canada
Competition Act (R. S. 1985)
Consumer Packaging and Labelling Act
(R. S. 1985)
Competition Bureau Canada
United Kingdom
Competition Act 1998
Competition Commission
Office of Fair Trading
European Union
Competition rules of the Community Treaties
including Articles 101 and 102 of the Treaty
on the functioning of the EU
European Commission — Directorate
General for Competition
Indonesia
Law No. 5/1999 (Anti-Monopoly Practice
and Unfair Business Competition)
Commission for the Supervision of
Business Competition
Source: CPA Australia 2015.
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REGULATING ANTI-COMPETITIVE BEHAVIOUR
As shown in table 4.3, internationally there are laws and regulations that seek to create a common
competition basis for all corporations. We now consider the following conduct and the rules that exist
to regulate:
• abuse of market power
• mergers and acquisitions
• agreements between competitors (cartel conduct)
• unilateral restrictions on supply (exclusive dealing)
• resale price maintenance (vertical price controls).
Abuse of Market Power
To ensure that some level of competition is maintained in a marketplace, the abuse of market power is
prohibited. For example, in Australia the law governing this area is s. 46 of the Competition and Consumer
Act, which states the following.
Misuse of market power
(1) A corporation that has a substantial degree of power in a market shall not take advantage of that power
in that or any other market for the purpose of:
(a) eliminating or substantially damaging a competitor of the corporation or of a body corporate that
is related to the corporation in that or any other market;
(b) preventing the entry of a person into that or any other market; or
(c) deterring or preventing a person from engaging in competitive conduct in that or any other market.
The prohibition on misuse of market power is aimed at preventing powerful entities from taking
advantage of that market power for the purpose of disadvantaging weaker organisations.
Strategies to increase profits and market share may include lower prices, better products or greater
levels of service. These strategies generate competition and are good for the consumer. However, some
corporations are able to obtain significant market power, for example, through their size, technology or
branding. It is not in the best interests of consumers to allow these corporations to compete so vigorously
that they use their market power to destroy, eliminate or harm competitors. Therefore, in many jurisdictions,
the use of market power for these purposes is not permitted.
As another example of regulation in this area, Article 102 (formerly Article 82) of the ‘Treaty on the
functioning of the European Union’ (EUR-Lex 2012), prohibits anti-competitive business practices that
threaten the internal market of the EU, harm consumers and small and medium-sized enterprises, and
reduce business efficiency. The relevant EU provisions are operationally almost identical to the provisions
in Australia and the US, and the treaty has strong universal application. Article 102 provides as follows:
Any abuse by one or more undertakings [organisations] of a dominant position within the internal market
or in a substantial part of it shall be prohibited as incompatible with the internal market insofar as it may
affect trade between Member States.
Such abuse may, in particular, consist of:
(a) directly or indirectly imposing unfair purchase or selling prices or other unfair trading conditions;
(b) limiting production, markets or technical development to the prejudice of consumers;
(c) applying dissimilar conditions to equivalent transactions with other trading parties, thereby placing
them at a competitive disadvantage;
(d) making the conclusion of contracts subject to acceptance by the other parties of supplementary
obligations which, by their nature or according to commercial usage, have no connection with the
subject of such contracts (EUR-Lex 2012).
As is apparent from the EU legislative approach, the main principle for establishing abuse of market
power focuses on whether a corporation that has market power has used that power to eliminate a
competitor or to prevent a competitor from entering or properly competing in a market for goods or
services.
A specific example of abuse of market power is known as predatory pricing. Predatory pricing is the
supply of goods or services below cost price over a period of time. While this looks beneficial to consumers,
it is an example of misuse of market power and is covered by specific provisions in many jurisdictions.
Predatory pricing is a prohibited activity because the likely real ambition is for powerful corporations to
eliminate less powerful competitors who cannot sustain the ongoing losses of competing at artificially low
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prices. This eventually allows the powerful corporation to become dominant and then to set higher prices
and exploit customers through artificially high prices based on monopolistic market positioning.
In Australia, the principal regulator in this area is the ACCC. The ACCC, even more broadly than similar
bodies such as the Hong Kong Competition Commission, undertakes a number of functions involving
regulation, legislation development, competition law education, prosecution and administrative decision
making (through its functionally separate tribunal). In this administrative role, the ACCC secured a record
penalty against Cabcharge, as discussed in example 4.16.
EXAMPLE 4.16
Cabcharge — $14 million Penalty for Breach
The ACCC pursued Cabcharge for abusing its market power (ACCC v. Cabcharge Australia Ltd [2010] FCA
1261). Cabcharge supplies an electronic and voucher payment system to the Australian taxi industry. It is
dominant in the market and is reported to be the supplier of 96% of Australian taxis’ payment systems.
The ACCC initiated proceedings against Cabcharge in 2009 alleging that it had misused its market
power by:
• refusing to deal with competing suppliers of electronic payment systems;
• refusing to allow Cabcharge payments to be processed through electronic terminals operated by rival
payment networks; and
• supplying taxi meters and fare schedule updates below cost or free of charge.
It was argued by the ACCC that this low cost supply was because taxis with an integrated Cabcharge
payment system and taxi meter would be significantly less likely to deal with Cabcharge’s competitors.
The matter settled on 23 September 2010 and Cabcharge paid a substantial penalty of $14 million
and was ordered also to pay costs of about $1 million. Other parties adversely affected by Cabcharge’s
behaviour, if sufficiently concerned, could also consider bringing actions for damages under the Competition and Consumer Act. The case was widely reported, resulting in substantial adverse publicity for
Cabcharge, and its share price was reported as being down by 20% after the case. The share price fall
may have been related to adverse publicity, but it was more likely a market response to its strong market
presence potentially being reduced as other competitors gain easier market entry.
Source: Information from ACC v Cabcharge Australia Ltd [2010] FCA 1261, Australian Competition Law, accessed October
2019, http://australiancompetitionlaw.org/cases/cabcharge2010.html.
There appears to be a renewed international focus on this type of behaviour. We previously observed
some aspects of this in the EU law. Example 4.17 is based on the EU legislation.
EXAMPLE 4.17
Intel Fined EUR€1.06 billion
In May 2009, the European Commission fined Intel Corporation EUR€1.06 billion for anti-competitive
practices. Intel, with over 80% market share for PC microprocessors, was found to have been paying
manufacturers and a retailer to favour its computer chips in preference to those of its main competitor,
AMD. The payments were disguised as hidden rebates and occurred over a six-year period. The
manufacturers involved often delayed or cancelled the release of products containing the competitor’s
products (BBC 2009).
Examples 4.18 and 4.19 examine ACCC actions in relation to price fixing and market dominance.
EXAMPLE 4.18
Flight Centre and Price-fixing
In April 2018 the Full Federal Court of Australia ordered Flight Centre to pay penalties totalling $12.5 million
for attempting to induce three international airlines to enter into price-fixing arrangements between 2005
and 2009. Under the arrangement, each airline would agree not to offer airfares on its own website
that were lower than those offered by Flight Centre. In March 2014 the trial judge imposed a penalty of
$11 million against Flight Centre. Flight Centre appealed the liability finding and the ACCC appealed the
$11 million penalty orders because it considered that the penalty would not send a strong deterrence
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message to Flight Centre and other businesses. In May 2014 the Full Federal Court found that Flight
Centre’s conduct did not breach the CCA. The ACCC sought special leave to appeal and in December
2016 the High Court allowed the ACCC’s appeal. The matter was remitted to the Full Federal Court. In April
2018 the Full Federal Court ordered an increase in penalties to $12.5 million. Flight Centre is Australia’s
largest travel agency, with $2.6 billion in annual revenue. The ACCC will continue to argue for stronger
penalties which it considers better reflect the size of the company, as well as the economic impact and
seriousness of the conduct. Significant penalties act also as a general deterrent to other businesses that
may be considering such conduct.
Source: Information from ACCC 2018, ‘Flight Centre ordered to pay $12.5 million in penalties’, media release, 4 April,
accessed October 2019, www.accc.gov.au/media-release/flight-centre-ordered-to-pay-125-million-in-penalties.
EXAMPLE 4.19
Pfizer and Market Dominance
Market dominance and market control in the pharmaceutical industry has been of concern to the
competition regulator and it took on Pfizer Australia Pty Ltd over what it alleged was Pfizer’s attempt
to abuse its market position by deterring people seeking to produce generic medications.
The ACCC first took Pfizer to court in 2014, alleging that the company ‘misused its market power ...
to prevent or deter competition from other suppliers selling generic atorvastatin products to pharmacies’
and engaged in ‘exclusive dealing conduct for the purpose of substantially lessening competition in the
market for atorvastatin’, the ACCC media release said. The ACCC lost its application in the courts in 2015.
The court found that the company has taken advantage of market power by engaging in the conduct
concerning the competition regulator. It was noted by the court that Pfizer’s dominance was not that great
at the time it made offers to community pharmacies. The ACCC sought to challenge that decision by
appeal but that appeal was rebuffed by the Full Federal Court with the result that the ACCC has flagged
it would apply to the High Court of appeal the matter further.
Source: Information from ACCC 2018, ‘High Court refuses the ACCC special leave to appeal Pfizer decision’, media
release, 19 October, accessed October 2019, www.accc.gov.au/media-release/high-court-refuses-the-accc-special-leave-toappeal-pfizer-decision.
QUESTION 4.5
Markets work well when fair-dealing businesses are in open, vigorous competition with each other.
With reference to examples 4.16 and 4.17, complete the following.
(a) What are the corporate governance implications of these examples for a board?
(b) Do competition laws stifle a corporation’s ability to be competitive?
(c) In what ways can respect for competition law drive competitive advantage for individual
corporations?
Mergers and Acquisitions
A significant underlying reason for many mergers and acquisitions is to reduce the number of competitors
in a market for goods and services. Therefore, in many jurisdictions, regulations are in place that prohibit or
limit mergers and acquisitions unless they are formally approved. With larger multinational corporations,
these approvals need to be obtained for each country in which the organisation plans to operate, and may
lead to specific requirements, such as the divestment of businesses where the merged entity would have
too much market power.
As discussed previously, and illustrated by example 4.20, approval for a merger or acquisition may rest
on a court’s decision in identifying the ‘relevant market’.
EXAMPLE 4.20
ACCC v. Metcash Trading Ltd [2011] FCAFC 151
Metcash is Australia’s largest independent grocery, fresh produce and liquor wholesaler and distributor. It
supplies IGA and other independent retailers. In July 2010, Metcash sought informal clearance from the
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252 Ethics and Governance
ACCC for its proposed acquisition of Franklins’ supermarkets and grocery distribution business in NSW
and the ACT. The ACCC opposed the acquisition, arguing that the relevant market was the wholesale
supply of groceries to independent supermarkets in NSW and ACT, in which the major supermarkets do
not participate, and that the acquisition would substantially lessen competition in this market.
At trial, the ACCC’s argument was rejected. The court found that in addition to being a wholesaler,
Metcash was involved in retail activities through IGA stores. The acquisition would not substantially
lessen competition but would strengthen the capacity of independent retailers operating as IGA stores
to compete vigorously with the major supermarket chains.
Source: Information from Australian Competition and Consumer Commission v. Metcash Trading Limited [2011]
FCAFC 151 (30 November 2011), accessed October 2019, www8.austlii.edu.au/cgi-bin/viewdoc/au/cases/cth/FCAFC/
2011/151.html.
Agreements Between Competitors — Cartel Conduct
Cartel conduct involves the existence of a cartel provision in a contract, arrangement or understanding
between competitors. Such collusion is effectively a form of conspiracy, and conspiracies to cause harm
are usually considered particularly harshly by societies and legislatures. Therefore, it has been the subject
of the largest penalties in many jurisdictions. As part of good governance, boards and management must
understand the nature of collusion from a competition perspective.
Collusive behaviour is generally defined as any horizontal agreement or even a mere understanding
between competitors in a market that affects competition (i.e. a market test applies) or that is otherwise
defined by the law as simply not permitted (in which case it is simply not allowed — or is ‘per se illegal’).
It is the agreement between competitors who should be actively competing rather than conspiring that
makes collusion highly inappropriate.
It has been common internationally for cartel conduct, like most other anti-competitive conduct, to be
dealt with on a civil basis (in which case compensation and often very large civil pecuniary penalties occur,
based on the balance of probabilities standard of proof). However, in recent years, following the example of
the US, jurisdictions such as Australia have made cartel conduct also subject to criminal sanctions (based
on the beyond reasonable doubt standard of proof). The law still provides for compensation but also for
very large criminal fines and even jail sentences. Note that civil actions, with the lesser standard of proof,
are also available.
Attempts by competitors to gain advantage through collusion are heavily controlled (once again by
similar rules in most jurisdictions). The Hong Kong competition law contains specific provisions to stop
collusion. Each jurisdiction mentioned in table 4.3 also has relevant laws, as does the US. In the Eurozone,
EU Article 102, covers competition law.
Cartel behaviour can be categorised into four different types of conduct, which are individually
addressed in the Australian Competition and Consumer Act:
• output restrictions
• allocating customers, suppliers or territories
• bid-rigging
• price-fixing.
The main questions or tests we can ask to assess whether these prohibited behaviours have occurred are
as follows.
• Has there been a contract, agreement or understanding (i.e. an arrangement)?
• Has this occurred between competitors?
• Is the outcome of a type that is simply prohibited or alternatively is the outcome one that has a significant
impact on competition in the market?
Behaviour or conduct that meets these tests will be in breach of the law.
As an example, Visy Industries Holdings Pty Ltd received a $36 million fine in November 2007
for market sharing and price-fixing. Visy and its competitor, Amcor Ltd, coordinated price rises and
swapped information when negotiating quotes for larger customers to ensure that each would retain specific
customers, thereby maintaining static market shares in the corrugated fibre packaging (cardboard) industry.
On occasions when the collusion was unsuccessful and a customer elected to swap supplier, another
customer contract of around the same value would be exchanged by the two parties. The regulator granted
Amcor immunity from prosecution in return for blowing the whistle on the cartel under the ACCC Immunity
Policy for Cartel Conduct (ACCC 2009).
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Boards must have a strong understanding of the nature of the four types of cartel conduct and,
if necessary, gain professional advice regarding the exact details of legislation that may affect their
corporation in any jurisdiction within which it is active. Boards must also understand the basic character
of the issues involved in order to establish and oversee appropriate policies.
Output Restrictions
Output restrictions refer to conduct where competitors agree to apply restrictions on output that will
cause shortages in markets and thus result in price rises. Such price rises will advantage suppliers and
are the reverse of a competitive situation where competitors help push prices down. An example of this
behaviour is the attempt to restrict the supply of oil to help maintain prices by the Organization of the
Petroleum Exporting Countries (OPEC) cartel. The benefit to the cartel and the cost to consumers are both
immediately apparent.
Allocating Customers, Suppliers or Territories
Dividing up markets, customers or regions between competitors is another way of limiting competition.
Also known as market sharing, this activity creates artificial monopolies in respect of segments of the
market. Customers in such an environment therefore do not receive the same level of choice or price
competition.
Bid-Rigging
Competitive tenders and quoting are used by customers to let suppliers compete vigorously against each
other to win work. Bid-rigging is where competitors collude when asked to tender or bid for work. To
ensure that prices are maintained, all competitors may agree to submit similar pricing, or allow one of the
competitors to win the work by having the rest of the cartel artificially inflate prices.
Price-Fixing
Price-fixing is where competitors collude to create common prices. An example of price-fixing could
be two competitors agreeing to supply goods to customers at the same price. An understanding between
competitors to stop discounting on a certain day might be less obvious, but it would also be price-fixing.
It does not matter if there is an unwritten agreement or a written agreement.
Effective competition should see consumers receiving lower prices and better-quality goods and
services. By fixing prices, competitors are able to maintain profits and have less incentive to improve their
efforts. This has a significant effect on competition and the penalties may be severe (see example 4.21).
When determining if price-fixing has taken place, we need to focus on identifying an agreement between
suppliers. This is important because there is one price-setting activity that may look unlawful, but is actually
permitted. This is so-called parallel conduct and price-following. An example of this occurring is evident
in parallel pricing, where Company Y sets its selling price at the same level and at the same time as
Company X without collusion. This may seem improbable, but can in fact be common. Corporate databases
are now very sophisticated and they will have the price of all competitors’ products in all markets, and will
employ this data independently in setting their own prices.
EXAMPLE 4.21
Midland Brick Case
The Federal Court of Australia (Australian Competition and Consumer Commission v. Midland Brick Co
Pty Ltd [2004] FCA 693 (31 May 2004) — see especially paras 26 and 42 regarding penalties) ordered
Metro Brick, a subsidiary of listed building products company Boral, to pay a pecuniary (civil) penalty of
$1 million dollars for its part in price-fixing arrangements with Midland Brick Company Pty Ltd (Midland
Brick). A senior manager of Metro Brick was also ordered to pay $25 000 in civil penalties. Legal costs of
$190 000 were also awarded against Midland Brick.
It was found that in the last quarter of November 2001, Metro Brick and Midland Brick had agreed to
apply price rises for clay-brick products on specified dates. It was also established that the two companies
had made an agreement on fixed minimum pricing in relation to tendering for contracts.
Source: Information from Australian Competition and Consumer Commission v. Midland Brick Co Pty Ltd [2004] FCA 693
The case is an example of how the competitive rush by managers can see things go wrong. It
demonstrates how the law applies and it shows how rapid returns to good ethics, including providing swift
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254 Ethics and Governance
assistance to regulators, can reduce harm. By fixing prices, competitors are able to maintain profits and
have less incentive to provide genuine customer value. This has a strong negative effect on competition
generally. Market disruption penalties are very severe, to discourage this behaviour and to recognise the
strong self-interest that may motivate corporations. Penalties include large fines, disqualification from
managing companies and jail.
It provides a strong message that professional accountants’ role in eliminating problems can be
significant if we are aware of relevant laws and apply them with strong professional ethics. To emphasise
the international character of this type of situation, consider example 4.22.
EXAMPLE 4.22
International Airline Pricing Cartel
A global price-fixing cartel involving at least 15 airlines received significant penalties for fixing the prices
in the air cargo industry. Hundreds of millions of US dollars in fines have been levied against the airlines
whose illegal conduct included price-fixing and attempts to eliminate competition by fixing rates. The
airlines involved included:
• Nippon Cargo Airlines (Japan)
• Cargolux Airlines International SA (Luxembourg)
• Asiana Airlines Inc. (Korea)
• LAN Cargo SA (Chile)
• Aerolinhas Brasileiras SA (Brazil)
• El al Airlines (Israel)
• British Airways PLC (UK)
• Qantas Airways Ltd (Australia)
• Air France (France)
• KLM Royal Dutch Airlines (Netherlands
• Cathay Pacific Airways (Hong Kong) (Weber 2009).
In June 2012, the ACCC published a report (see below) on the continuing significance of this cartel,
which has also been extensively dealt with under laws in other jurisdictions.
‘Malaysia Airlines Cargo Sdn Bhd penalised $6 million for price fixing cartel’
The Federal Court in Sydney has penalised Malaysia Airlines Cargo Sdn Bhd $6 million for price fixing as
part of a cartel following action by the ACCC.
‘This penalty sees the total penalties ordered against this international cartel increase to a record
$58 million. These penalties are the highest generated by a single ACCC Investigation,’ ACCC Chairman
Rod Sims said.
The ACCC has been pursuing a number of international airlines for cartel conduct relating to the carriage
of air freight. Malaysia Airlines Cargo Sdn Bhd is the ninth airline to settle proceedings against it.
‘The ACCC’s focus on stopping cartel conduct has sent a strong message. It is crucial for the proper
functioning of business in Australia that the ACCC continues to tackle cartel conduct with the full force
of the law. Cartel conduct is damaging and unlawful because it harms competition and usually inflates
prices for consumers,’ Mr Sims said.
The ACCC instituted proceedings against Malaysia Airlines Cargo Sdn Bhd on 9 April 2010, alleging
that it reached and gave effect to understandings with other international airlines regarding the level of
particular surcharges and fees relating to air freight carriage from Indonesia. Malaysia Airlines Cargo Sdn
Bhd has admitted that it did so in relation to:
• fuel surcharges between April 2002 and September 2005
• security surcharges between October 2001 and October 2005, and
• customs fees between May 2004 and October 2005.
Justice Emmett also made orders restraining Malaysia Airlines Cargo Sdn Bhd from engaging in similar
conduct for a period of five years and to pay $500 000 towards the ACCC’s costs.
Source: ACCC 2012a, ‘Malaysia Airlines Cargo Sdn Bhd penalised $6 million for price fixing cartel’, media release, 14 June.
© Commonwealth of Australia.
Unilateral Restrictions on Supply (Exclusive Dealing)
Exclusive dealing is when a single corporation decides, in the absence of agreements or understandings
with competitors (which would amount to collusion and therefore cartel conduct), to deal only wi