Governance, Risk and Ethics

2 Section A: Governance and responsibility Section B: Internal control and review Section C: Identifying and assessing risk Section D: Controlling risk Section E: Professional values and ethics Governance, risk and ethics

3 Section A: Governance and responsibility A1. The scope of governance A2. Agency relationships and theories A3. The board of directors A4. Board committees A5. Directors’ remuneration A6. Different approaches to corporate governance A8. Governance: Reporting and disclosure Designed to give you knowledge and application of:

4 Study Guide A2: Agency relationships and theories  Define agency theory. [2]  Define and explain the key concepts in agency theory. [2]  Explain and analyse the transaction costs & stakeholder theories used to explain aspects of the agency relationship. [2] Learning Outcomes

5 Define agency theory Accountability ManagementShareholders Responsibility Authority Refer to Case Study in A2.2 Agency relationship Contract between two parties Performs some services on behalf of principal Principal Agent Gets some decision making authority Agency theory Division of authority, responsibility & accountability Relationship between management, shareholders & stakeholders acting in the best interests of the company agency costs - costs of monitoring directors

6 Define and explain the key concepts in agency theory Agent a person who acts / has an authority to act & enter into contracts & dealings on behalf of another Director  Agent of shareholders  Enters into employment contract  In a position of trust but is not a trustee in the legal sense Duties towards companies Fiduciary duty Duty of care & skill to be honest and to act without conflict of interest to use skill, care and caution in making decisions in the interests of shareholders Principal person on whose behalf agent acts In relation to agency, shareholders are the principals Refer to Examples on page 60

7 Supervision cost, costs of meeting Cost of creating various checklists & MIS reports costs arising due to business decisions going wrong Agency costs Monitoring costBonding costResidual loss Measuring, observing & controlling agent’s behaviour Incurred by directors in setting up & adhering to structures to act in best interests of shareholders Cost that arises due to conflicting interests of shareholders & directors

8 Refer to Test Yourself 2 on page 65 Fiduciary responsibility Act in good faith Use powers for the proper purpose Avoid conflicts of duty and interest to act in good faith of the persons for whom the directors work to act bona fide in the interests of the company dealing in private property with company Maintain unfettered discretion directors are responsible for all actions they take to run the business for stakeholders

9 Transaction costs & stakeholder theories in context of the agency relationship Stakeholders theory takes into account the entire group of stakeholders Focus is on a wider group of stakeholders  Employees  Credit providers  Government  Local communities Importance given to shareholders becomes less dominant Maximisation of shareholder wealth is also of prime importance Continued…

10 Instrumental view of stakeholders an organisation only has economic and legal responsibilities major responsibility is to take care of aspirations and expectations of stakeholders who contribute financially concerned only with stakeholders seeking profit making companies Continued…

11 Normative view of stakeholders organisations are morally responsible for the environment in which they work organisations also have ethical and humanitarian responsibilities organisations should consider the possible effects on the environment, nearby ecosystems, habitats, rights of any religious groups etc. Refer to Test Yourself 5 on page 69 Continued…

12 RECAP  Define agency theory. [2]  Define and explain the key concepts in agency theory. [2]  Explain and analyse the transaction costs & stakeholder theories used to explain aspects of the agency relationship. [2]