Fin management materials / P4AFM-Session01_j08

SESSION 01 – THE ROLE OF FINANCIAL STRATEGY

4.6The Combined Code

The Combined Code of the Committee on Corporate Governance was first issued in June 1998 and revised in July 2003. In many ways it is derived from the Cadbury and Greenbury Codes.

The Combined Code is included in the Listing Rules of the London Stock Exchange. Although compliance is not obligatory, any listed company which does not comply with the Combined Code must explain its reasons for non-compliance.

It sets out the following UK Principles of Good Governance:

¾Every listed company should be headed by an effective board which should lead and control the company.

¾Chairman and CEO – there should be a clear division of responsibilities at the head of the company between running the board and running the business; no single individual should dominate.

¾The board should have a balance of executive and independent non-executive directors.

¾All directors should be required to submit themselves for re-election at least every three years.

¾Remuneration committees should be 100% independent non-executive directors.

¾Remuneration committees should provide the packages needed to attract, retain and motivate executive directors and avoid paying more.

¾Executive service contracts should be for one year or less.

¾No director should be involved in setting his own remuneration.

4.7The Turnbull Report

Issued in 1999 to give implementation guidance on aspects of the Combined Code dealing with internal control, internal audit and risk management.

It states that “the board should maintain a sound system of internal control to safeguard shareholders’ investment and the company’s assets”.

The key objective of the Turnbull report was to reflect best business practice by adopting a risk-based approach to designing, operating, and maintaining a sound system of internal control. The guidance it offers is based on a framework of principles rather than checklists. It also encourages making meaningful disclosure.

Instead of specifying particular controls for all companies, the report requires the board of directors of listed companies to identify those risks that are significant to the fulfilment of their particular corporate business objectives and to implement a sound internal control system to manage these effectively. This requires the board to have a clear understanding of the company’s long-term strategic aims.

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SESSION 01 – THE ROLE OF FINANCIAL STRATEGY

Illustration 1

Briefly explain what is meant by corporate governance and discuss the major differences that exist between corporate governance practice in the UK, US and Japan.

Answer

Corporate governance is the system by which companies are controlled. In the UK this is the responsibility of the directors. The function of the director is the high level management of the company, strategy etc and reporting the performance of the company to the owners. The auditors provide a check on the accuracy of financial statements and help to satisfy the owners that a system of corporate governance exists.

The actions of the directors of course affect all interest groups not just the business owners. Their general behaviour is governed by the articles of association but there exists also a body of civil and criminal law which can restrict their actions. This body of law is much larger in the US than in the UK, UK directors are more subject to voluntary codes of conduct and The Cadbury Report in the UK has suggested that this may be the most effective way of introducing controls. In addition to conventional laws and codes of conduct the behaviour of directors is also “controlled” by the Stock Exchanges, again the rules of the New York exchange (SEC) are much more comprehensive than in London.

As one would expect the culture of Japan is reflected in its approach to corporate governance. No detailed framework or system of laws exists. Everybody is expected to work together for the good of the company and not for the shareholders alone. The system is therefore, in principle, more flexible and responsive.

Boards are often split into different levels each with its own remit, for example:

(i)Policy boards responsible for strategy.

(ii)Functional boards where senior management discusses the main functional responsibilities.

(iii)Monocratic boards which tend to be symbolic and have few actual functions.

In Japan a close relationship exists between the banks and their clients, banks usually have board representation and take in active role in decision making. The US is more of a middle ground where creditors or other corporations may be represented. The UK companies tend to be the most insular.

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SESSION 01 – THE ROLE OF FINANCIAL STRATEGY

5ETHICS

5.1Main Components

¾Act with integrity

¾Be a credit to the profession

¾Use independent professional judgement.

¾Be competent.

5.2Fundamental responsibilities

Know and comply with laws, regulations, ethical codes and professional standards

Do not knowingly participate or assist others in any violation of applicable regulations or ethical codes.

5.3Relationship with the profession

Use ACCA designation with dignity.

Do not engage in any act which adversely reflects on your honesty, trustworthiness or professional competence.

Do not plagiarise.

5.4Relationship with and responsibility to the Employer

Members must inform employers of their obligation to comply with the ACCA Code of Ethics and Standards of Professional Conduct.

Do not undertake any independent practice in competition with your employer without his consent and the consent of the client.

Disclose to your employer all matters that could be reasonably expected to impair your ability to render an unbiased and objective opinion.

Disclose to your employer all monetary and other benefits received for services other than the usual compensation paid by your primary employer.

5.5Interaction with clients (relevant to financial advisors)

Members must place their client’s interest before their own.

Members must have a reasonable and adequate basis for stating opinions.

Members must use reasonable judgement to include relevant facts, distinguish between fact and opinion and use independence and objectivity in making opinions.

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SESSION 01 – THE ROLE OF FINANCIAL STRATEGY

5.6International aspects

Specific ethical issues may arise for businesses operating overseas. The following questions may have to be faced:

¾should “facilitation payments” be made to local officials to overcome problems with “red tape” such as slow customs clearance?

¾is it acceptable to use transfer pricing internationally to minimise tax liabilities?

¾if laws overseas are more relaxed than at home e.g. regarding the employment of child labour, should the company follow the more relaxed local laws or apply the business practices of its home country?

There may be no right or wrong answer to such questions - you are expected to express an opinion in the exam.

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SESSION 01 – THE ROLE OF FINANCIAL STRATEGY

Key points

The first step in developing the objectives of financial management is to identify the relevant stakeholders in the organisation

In the corporate sector the key stakeholders are clearly the shareholders. Most traditional finance theory is therefore built on the assumption that a company’s objective is to maximise the wealth of its shareholders

However modern Corporate Social Responsibility (CSR) suggests that directors should also take into account other stakeholders and therefore also follow a range of non-financial objectives e.g. employee satisfaction, reducing environmental impacts

Such non-financial objectives may be in conflict with maximising shareholder wealth. Therefore the overall objective may be to produce satisfactory returns for shareholders, whilst attempting to meet the demands of other interest groups

In practice managers may also have personal objectives which conflict with their responsibilities as agents of the shareholders. Some managers may try to maximise personal wealth e.g. through manipulating bonus schemes or even theft of company assets.

This creates agency costs for the shareholders. Well designed remuneration systems and good corporate governance should reduce these costs to an acceptable level.

Part of CSR involves ethical corporate behaviour – the “good corporate citizen”

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SESSION 01 – THE ROLE OF FINANCIAL STRATEGY

FOCUS

You should now be able to:

¾consider the nature and scope of financial strategy;

¾identify key stakeholders in organisations;

¾identify the objectives of stakeholders and how they may conflict;

¾discuss the meaning of goal congruence and understand how it may achieved through alternative reward systems;

¾understand the corporate governance issues raised by the Cadbury Report, the Greenbury Code, the Combined Code, the Turnbull Report and the Sarbanes – Oxley Act;

¾discuss the impact of ethic considerations upon financial management.

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