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CORPORATE GOVERNANCE CG 601 PROJECT PAPER

STUDENT NAME: MARK MISOMALI

STUDENT ID NO: 24ELI-11765

INTAKE AND VENUE: EVENING 24, LILONGWE

LECTURERs NAME: GAW KACHALI

DATE SUBMITTED: DECEMBER 01, 2011

PREFACE Many organizations of private or public nature are not spared from the risks of fraud and corruption. The complex business processes make it impossible to find a common solution for combating fraud and corruption. Even in similar business processes the nature of fraud and corruption cannot be predicted. As a result of this a lot of resources are lost, wasted, and abused. Other organizations have put in strict punitive measures for the culprits but still this has not relatively reduced incidences of fraud and corruption. There is growing consensus that organizations with good corporate governance practices have marginal incidences of fraud and corruption. In this paper I will discuss the link between corporate governance and prevention of fraud and corruption.

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Table of Contents
Introduction..1 Purpose and Methodology.2 Organization of the study...2 Chapter 1: Corporate Governance Background....3 Chapter 2: Composition of the Board......5 Chapter 3: The Role of the Board....8 Chapter 4: Board Committees....10 Chapter 5: Corporate Governance and Fraud.....12 Conclusion.....13 Appendix....14

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NEXUS BETWEEN CORPORATE GOVERNANCE AND THE PREVENTION OF FRAUD AND CORRUPTION IN THE WORK PLACE CHAPTER ONE: INTRODUCTION In this chapter, I will attempt to define what corporate governance is; then, I will identify the key players of corporate governance. The rest of the report will discuss how corporate governance can be used to prevent fraud and corruption. Definition The reader should know that there is no single definition for such a term as corporate governance. In simplest terms corporate governance means how corporations or companies are run. R.I. Tricker (1984) observed that if management is about running the business, governance is about seeing that it is run properly. The Cadbury committee defines Corporate Governance as the system by which companies are directed and controlled. Corporate governance players In running a company, we can say that there are three major players, namely shareholders, board of directors, and management. The success or failure of companies to a large extent depends on the actions of these three major players. The fight against fraud and corruption should be a collective effort by these three parties. While fulfilling their duties, the parties must operate within the guidelines of legal and regulatory framework including other agreed upon rules and procedures of the company. Consequently Government and other stakeholders are also interested parties. The board of directors is therefore not only accountable to shareholders but also to Government and other stakeholders. The shareholders main role is to appoint and provide guidance to the directors. The directors set strategic direction while the management implements the strategic goals. Page |1

Of the three major players, the directors play a pivotal role in ensuring effective corporate governance. It is for this reason that much discussion is dedicated to the composition, role, and function of the board of directors and its committees. PURPOSE AND METHODOLOGY This report has been commissioned as part of an academic study for the Executive MBA course in Corporate Governance. The methods used to collect data are through: books internet published articles, magazines ORGANIZATION OF THE STUDY The study has 5 main chapters as follows: Corporate Governance Background Corporate Governance and Fraud Composition of the Board The Role of the Board Board Committees Each of those areas is discussed in detail looking at how it relates to the prevention of fraud and corruption in the work place. At the end of the discussion I present my conclusion.

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Chapter One: Corporate Governance Background The concept of corporate governance emerged from the time when ownership and management of businesses were separated. The concept of stewardship and the role of auditor emerged from this separation of management and ownership. The owners wanted to have a way of monitoring the performance of individuals managing their businesses. Below is a diagram representing this tri-parte relationship:Owner

Oversight body

Steward

Industrial revolution brought about expansion of enterprises that required heavy investment of capital which led to emergence of incorporated enterprises. A corporation is a legal entity but can only act through the agency of natural persons. It is for this reason that the need for directors arises. The directors are not only agents of the company but they are also its trustees. Initially, company legislation dealt with all corporate governance matters such as the appointment of directors, the operations of board of directors, and the role of auditors. Later events have caused several developments leading to evolvement of an extensive academic literature dealing with the principal-agent relationship. Corporate governance involves putting in place systems and structures for the operation and control of a company with the following specific aims; Fulfilling long-term strategic goals of owners

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Taking care of the interests of employees A consideration for the environment and local community Maintaining excellent relations with customers and suppliers Proper compliance with all the applicable legal and regulatory requirements. Good governance is integral to the very existence of a company. It builds confidence amongst stakeholders and prospective investors. Investors are willing to pay higher price to organizations with internationally accepted norms of corporate governance. Effective accountability to all stakeholders is the essence of corporate governance.

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Chapter Two: Corporate Governance and Fraud A proper review of financial statements by directors may reveal errors in recording of transactions. However, fraudulent transactions, which are carefully recorded with the intent to conceal, are extremely difficult to identify. Fraud and corruption involves the perpetrator having intention to deceive causing the deceived person or entity suffering some kind of loss. Fraud and corruption involves circumventing the systems. Very often fraud is discovered after lapse of a considerable period of time. It is for this reason that corporate governance seeks to ensure that the business and management of corporate entities is carried out in accordance with the highest prevailing standards of ethics to safeguard and promote the interests of all stakeholders. For this purpose, it is vital to recognize the importance of stakeholders and their rights. Communication between stakeholders is considered to be an important feature of corporate governance. Developments in corporate governance There has been renewed interest in corporate governance practices of modern corporations due to the high-profile collapses of a number of large corporations most of which involved fraud. Corporate scandals such as the Enron corporation and MCI Inc. have led to the regulation of corporate governance, such as, The Cadbury Report (UK, 1992), OECD principles of corporate governance (2004), and the Sarbanes-Oxley Act (US, 2002). These reports present general principles around which businesses are expected to operate to assure proper governance. These principles are as follows:Rights and equitable treatment of shareholders Organizations should respect rights of shareholders and help them exercise those rights through effective communication. Since shareholders are normally not involved in the day-to-day running of the organization, they can provide an independent and objective view of the way the organization is run. Some loopholes can best be spotted from an

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outside look thereby saving the organization from risks of fraud and corruption. Some fraud and corruption incidences are perpetrated by the board itself, so allowing participation of shareholders can act as a deterrent from such bad acts. In addition to basic duties, a shareholder must focus on such issues as the election of the board, amendments to the companys rules, approval of extraordinary transactions. In order to do this, a shareholder must participate in general meetings. Interests of other stakeholders Organizations should recognize that they have social and other obligations to other stakeholders other than shareholders including employees, suppliers, creditors, local communities, customers, policy makers. Realizing that there are many interested parties to the affairs of the organization can enforce discipline and put the board and management on guard to act with care and prudence. Role and responsibilities of the board The board needs sufficient and relevant skills to review and challenge management performance. It also needs adequate size and appropriate levels of independence and commitment to fulfill its duties and responsibilities. Management runs the organization and the board ensures that it is run properly. The recruitment of members into the board must follow a formal process similar to that followed when recruiting employees of a company. The board must have the necessary skills, receive adequate orientation and undergo regular training to effectively discharge its duties and responsibilities. The primary responsibility for the administration and performance of a company lies with the directors. Their role is so crucial such that an extensive discussion is reserved for chapter four. Integrity and ethical behavior Integrity should be a fundamental requirement in choosing corporate officers and board members. Corruption and fraud are basically due to a crisis in ethics. Integrity counts more in the fight against corruption and fraud than the academic and professional

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qualifications. The recruitment process must include background check of individuals elected into the board to assess their past records. Disclosure and transparency Organizations should clarify and make publicly known the roles and responsibilities of board and management to provide stakeholders with a level of accountability. Disclosure of material matters concerning the organization should be timely and balanced to ensure that all investors have access to clear, factual information. Prevention of fraud It is imperative that the board and management take appropriate measures for prevention and timely detection of fraud. This is possible through the implementation and continued operation of adequate accounting and internal control systems. The internal control system extends beyond those matters that relate directly to the functions of the accounting system and comprise of the control environment and control procedures. Control environment refers to the overall attitude, awareness and actions of directors and management regarding the internal control system and its importance in the company. Factors reflected in the control environment include: The function of the board of directors and its committees Management philosophy and operating style The companys organizational structure and methods of assigning authority and responsibility Managements control system including the internal audit function, personnel policies and procedures and segregation of duties Management implements the strategies and policies set out by the board of directors. Management should establish control procedures to achieve entitys specific objectives. Specific control procedures include: Reporting, reviewing and approving reconciliations Approving and controlling of documents

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Limiting direct physical access to assets and records Comparing internal data with external sources of information Chapter Three: Composition of the Board A well constituted board is a catalyst for effective corporate governance which can lead to prevention of fraud and corruption. The following guidelines are worth considering when composing the board: The board should comprise a balance of executive and non-executive directors, with a majority of independent non-executive directors to reduce possibility of conflicts of interest. There must be an appropriate balance of power and authority so that no one individual or group dominates. All directors should be individuals of integrity and courage to be able to challenge management. There must be a minimum of two executive directors, Chief Executive Officer (CEO) and Chief Financial Officer (CFO) to ensure there is more than one point of contact between the board and management The board should be led by an independent non-executive chairman who should not be CEO of the company. The chairman should be independent and free of conflicts of interest in order to effectively discharge his duties of providing the necessary direction of the company The board should appoint an effective and ethical chief executive officer. The CEO serves as the chief spokesperson and plays a strategic role in the operations and success of the company. He should ensure that a positive and ethical work climate is maintained. Other factors to consider are the qualifications of the board members, the size of the board, the time and energy of the board members.

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Qualifications Board members should be elected based on a demonstrated record of possessing the specific qualifications and competencies necessary for effective governance. William Bowen writes that every trustee should bring a specific competence or experience needed on the board. Eligibility for election to another term should be based on performance and ability to contribute a competency that is still needed by the organization. Size The knowledge, skills, and other resources required should determine the number of directors to serve on the board. It is very helpful for the board to include directors with relevant technical skills for the core business to understand the nature and operations of the company. Every board should consider whether its size, diversity and demographics make it effective. No one individual should wield more power to dominate the decisions of the board. Time Time is very crucial for board members to attend meetings and contribute towards the successes of the company. When recruiting board members, consideration should be given to their availability to attend meetings and participate in other activities.

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Chapter Four: The Role of the Board The four cornerstones of corporate governance are the board of directors, management, external audit, and internal audit. The corporate governance framework should ensure the strategic guidance of the company, the effective monitoring of management by the board, and the boards accountability to the company and the shareholders (OECD Principles of Corporate Governance, 2004 ).The board provides oversight ensuring that the company is run properly. The board is the focal point of corporate governance structure in the company and is the link between the stakeholders and the company. The functions of the board are broad and include the following: To promote the success of the company by directing and supervising the company affairs To cultivate and promote an ethical corporate culture Appreciate that strategy, risk, performance and sustainability are inseparable. Identify key risk areas and ensure that management direct its mind to pertinent risks. Manage conflict of interests of directors Ensure that there is an effective risk-based internal audit Ensure the integrity of financial reporting Report on the effectiveness of internal financial controls An article in the Point of View magazine summarizes the 5 things which the board should be focusing on, and which distinguish exceptional boards from the rest as follows:Effective board leadership The effective functioning of a board depends on a number of factors, including the mix of knowledge and experience among the directors, the quality of information they receive and the ability to operate as a team. The board chairman will ensure that the

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board not only evaluate the performance of the CEO, but take the formal assessment of their own work seriously and use the findings to develop and hold themselves to objectives for improvement. Strategy The Companys successes and shareholder satisfaction are dependent on the board making wise strategic decisions. Every board member must be very clear about what is expected of them in the strategy discussion. Usually the executive team develops strategy; the board fine tunes it and then oversees its execution by management, measuring CEOs performance against a set of agreed-upon objectives. Risk Oversight Risk should be defined in the broadest terms, encompassing not just financial matters but also areas such as health and safety, the environment, industrial relations and corporate reputation. Risks are inherent in any business that is going to deliver longterm value to its stakeholders. The board should determine whether they have optimal structure for overseeing risk. Succession The board should have a rigorous succession planning methodology in place for both planned and emergency scenarios, to identify the next CEO, the chairman and the rest of the board. The planning process should start as early as possible, even if this makes the incumbent uncomfortable. Sustainability Boards of listed companies have an obligation to build and protect long-term shareholder value and to ensure short-term decisions do not jeopardize the sustainability of the enterprise. All forms of capital financial, human, natural and social are essential for value creation. More evidence is mounting that overlooking social responsibility has negative consequences in the sustainability of organizations.

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The primary responsibility for the administration and performance of a company lies with the board of directors.

Chapter Five: Board Committees The board works through committees. The number of committees depends on the needs of the organization. The King Report requires that at a minimum, each board should have an audit, and Remuneration committees. Additionally it recommends a board to have a nomination committee. Audit committee The audit committee is the principal governance watchdog in most companies whose purpose is to provide additional focus on financial issues. According to the Blue ribbon Committee of US SEC, the role of the audit committee is to function as the ultimate guardian of investors interest and corporate accountability. Remuneration Committee This is probably the second most important governance committee. Its main tasks are to review, assess and make recommendations to the main board on matters concerning directors remuneration, incentive schemes, and measurement criteria for the performance of executive directors. Nomination Committee The purpose of this committee is to ensure that the board consists of the skills and attributes needed by the company. Its functions include reviewing the size and composition of the board, establishing succession plans, recommending the appointment of directors.

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Conclusion From the discussion above, it is clear that there is a link between corporate governance and the prevention of fraud and corruption at work places. The opportunity to do business or provide goods and services opens up risks associated with the resources involved in the transactions. Cases of fraud and corruption are common among private and public enterprises. The board of directors has fiduciary duties to ensure that resources of organization are protected from the risk of fraud and corruption. This requires a competent board composed of members who are honest, have the requisite skills, knowledge, and ability to strategically position the organization to achieve desired results while complying with all the necessary rules and regulation. Modern technology has also come with new challenges making it imperative that the board should have continuous professional development to gain new management and control techniques.

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Appendix

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