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Department of Finance and Banking Jahangirnagar University Savar, Dhaka

FNB211: Auditing & Taxation

Assignment on Corporate Governance Comparison

Submitted by:
Sariful Islam (Student ID: 610) Tamjid Saleh (Student ID: 611) Ashfaq-ul- haq oni (Student ID: 621) Jafrin Siddique (Student ID: 1922) Zunaid Hossain (Student ID: 1928) K. M. Zeman Adnan (Student ID: 2128) William Masterson Shah (Student ID: 2129) October 16, 2012

Submitted to: Md. Shariful Islam

Lecturer Department of Accounting & Information System Jahangirnagar University

Introduction: Corporate governance is a concept that has drawn attention from the corporate world globally in the last decade. A corporate entity cannot survive in a social vacuum. It has to satisfy the needs of diversified interest groups including shareholders, creditors, auditors and regulators. They are interested to know how the business is governed and whether it is governed in the right way or not. Regulators would like to know to what extent companies comply with preset rules and/or how they apply principles in practice. It is observed that in some countries (like Bangladesh), there is rulebased code on corporate governance; there is principle-based code on corporate governance in some other countries (like Australia) and there is also hybrid code on corporate governance in others. With this end, this paper is an attempt to critically analyze and compare the codes of two different countries on corporate governance. The rest of the sections have been organized as follows: Section 2 presents the concept of corporate governance; Section 3 and 4 describes the functioning of code on corporate governance and the necessity of having a code respectively. Section 5 and 6 entail a precise description of the existing Codes of two different countries- Bangladesh and Malaysia; Section 7 presents a critical but lucid comparison of these two Codes and Section 8 provides few constructive suggestions for Bangladesh and draws a conclusion of the study. What is corporate governance? In todays corporate world, corporate governance is a big buzzword. Corporate governance is a pervasive concept, which basically tells about the code of conduct of the companys operation. Corporate governance is the set of laws, policies and procedures, and institutions affecting the way a corporation is directed, administered and controlled. It includes the interrelationship of the stakeholders, i.e., shareholders, management and the board of directors, employees, suppliers, customers, banks and other lenders, regulators, the environment and the community at large. This definition let us demarcate the micro form of corporate governance from the macro model. The micro model is defined by the internal micro players such as employees, directors and managers. The macro model is defined by the external players to corporation and includes the regulatory institutions like stock exchange authorities, Securities and Exchange Commission [SEC], legislatures and courts, fiscal acts and amendments, pressure groups (Bangladesh Enterprise Institute, Center for Policy Dialogue etc.) and monetary policies. The term Corporate Governance gives an important insight regarding how a business should be governed. Sarkar and Ahmed 1 conceptualized the issue as, Corporate practices to meet the corporate objectives. This encompas ses many issues like internal control, rights and relation with stakeholders, corporate social responsibility, structure and role of the management committee, management transparency (refers to the disclosure of all reliable and relevant information) and accountability (refers to broader corporate objectives to manage the socioeconomic resources efficiently) and the like. Parker 2 defined corporate governance as, The way in which power is exercised over the management and direction of the entity. Corporat e governance is basically the whole system of governing the company. Ahmad and Baree 3 viewed corporate governance as, The system by which business organizations are directed and controlled. Its structure specifies the distribution of rights and responsibilities among companys different participants, such as board, management, shareholders, and other stakeholders. Transparency and accountability are its major attributes. For good governance, companies need either statutory regulation (imposed by SEC, government, Registrar of Joint Stock Companies, Bangladesh bank etc.) or self-control. There are few key players who can play pivotal role in governance of corporate affairs: corporate shareholders, board of directors, auditors and regulators. The functioning of a code of Corporate Governance: The obvious function of a Code of Corporate Governance is to improve the general quality of corporate governance practices and scenario. The Code does this by defining best practices of corporate governance and specific steps that organizations can undertake for good governance. The Code, thereby, begins to raise the quality and level of corporate governance to be expected from organizations. Basically, the Code can be rule-based (providing certain guidelines only), principlebased (providing certain broad principles only) or a hybrid (combination of rule-based and principlebased). The Code provides certain principles, which allows the companies to develop their own


judgment and disclose corporate governance practice of their own- where regulation may not work better. The Code also provides certain guidelines- where the companies have to comply with rules and regulations. The Code functions well when it consists of both rules and principles (the hybrid approach). Necessity of having a Code of Corporate Governance: Developing and using a Code to strengthen good governance can not only benefit the organizations at the micro level but also the whole nation at the macro level. The Taskforce on Corporate Governance4 sought out several potential benefits of having a code of corporate governance as follows: a) An economy with sound system of corporate governance will be rewarded with more investment and higher quality investors; b) Corporate governance systems can better enable the capital market, private investors, international donors and financial institutions to identify and fund successful enterprises; c) By identification of better performing enterprises, and thereby through more efficient allocation of capital, corporate governance can lead to greater economic growth by enabling the country to maximize the resources it has; and d) a culture of corporate governance will begin to address the pervasive corruption that is crippling the Bangladesh economy and development as a whole. In short, corporate governance can be a catalyst for change, for higher economic growth, for a more efficient use of resources, for private sectors that are accountable to investors and society, for a reduction in corruption, and for a healthy climate of investment atmosphere. Code on Corporate Governance- Bangladesh perspective: The corporate governance scenario is not up to the mark in Bangladesh. Moreover, there existed no specific code on corporate governance in the country up to 2004. Even corporate people were not also aware of this issue. Recently there is a growing awareness of corporate governance among the corporate sectors. Consequently, The Taskforce on Corporate Governance (2004) convened and supported by Bangladesh Enterprise Institute (BEI) developed a full-fledged Code on Corporate Governance for Bangladesh in order to improve the general quality of corporate governance practices. Securities and Exchange Commission (SEC) of Bangladesh has not fully adopted this code. The Taskforce suggested that the SEC could adopt the Code on Comply or Explain basis as a regulatory step (which was later accepted by SEC). Finally, SEC Bangladesh has felt the necessity of having a code on corporate governance for the listed public limited companies. SEC5 has issued Corporate Governance Guidelines in 2006, in order to enhance corporate governance in the interest of investors and the capital market. Companies listed with Dhaka Stock Exchange (DSE) and Chittagong Stock Exchange (CSE) shall be subject to certain conditions underlying these guidelines on Comply or Explain basis. They should comply with these conditions or shall explain the reasons for non compliance. The Corporate Finance Department of SEC monitors the compliance status of listed companies. They also examine the Directors report; Auditors report etc. to check whether the requirements have duly been complied with. As SEC newly introduced such guidelines for the listed companies, these are flexible. There are few issues which SEC did not take into consideration under the broad scope of rules such as compensation committee, ethical issues, nomination committee etc. As far as these issues are concerned, companies are at liberty to choose their own way of doing and disclose their own practice. This regulatory body basically follows the governance framework practiced by Thailand. Broadly, these guidelines comprise of five conditions; 1. Board of Directors, 2. Chief Financial Officer (CFO), Head of Internal Audit, 3. Audit Committee, 4. External/Statutory Auditors and 5. Reporting the compliance in the Directors report. Imposition of aforesaid guidelines is compelling the listed companies to improve their corporate practices to a significant extent. Despite the fact, corporate governance scenario is yet to develop much. Guidelines issued by SEC have been issued as conditions under Section 2CC of Securities and Exchange Ordinance, 1969. Any condition imposed under said Section has overriding effect i.e. be adhered to, despite the fact that those conditions contradict with any other Acts including Companies Act, 1994. Failure to comply or explain, therefore, shall be violation of securities law and hence liable to be disciplined.


The Guidelines have specified that Chairman and CEO should preferably be manned by separate person. The word preferably should not have been used. In that situation the listed companies would be compelled to have separate person as Chairman and CEO. SECs Guidelines borrowed certain provisions from Sarbanes Ox ley Act of USA. Auditors have been barred to carry out non-audit functions. In a recent follow-up it has been found that significant number of companies is complying with SEC Guidelines. SEC has put pressure on delinquent companies to comply with the guidelines. Companies that informed that they have complied with the guidelines have been asked to inform SEC how they have complied with the guidelines. SEC Guidelines put maximum emphasis on disclosure and transparency issues, especially, functions of audit committee and functions and reporting of auditors. The guidelines elaborately focus on the constitution of the audit committee, reporting of auditors to the board of directors, Securities and Exchange Commission, shareholders and general investors also restrict the non-audit services by the external auditors. The listed companies just comply with certain guidelines only; they do not feel encouraged to disclose their own corporate governance practice. The reasons why they are not inclined to disclose are many. The main reason is that they try to conceal their profit and they try to evade tax. Entrepreneurs and management in the corporate sectors lack necessary skill and awareness to disclose corporate governance practices of their own. Moreover, many listed companies in Bangladesh are familyoriented. They are not also ethically sound. While the awareness of the corporate management does not suffice, the implementation and strict monitoring with reward and punishment remain a far cry. In order to have objective reporting of issuer, SEC has been exerting pressure on statutory auditors. If it is found that financial statements have not been prepared by the issuer in accordance with IAS and financial statements have not been audited in adherence to ISA, SEC issue show cause notice and provide the auditor an opportunity of being heard to refute the allegation raised by SEC as to not discharging professional responsibility while auditing. If the auditor fails to defend, Commission under securities laws may take disciplinary measures against the auditors. Because of Commissions efforts statutory auditors are behaving more professionally. Despite the fact that Companies Act, 1994 addresses entire array of governance issues, yet administration of the same is very dismal. Office of the Registrar of Joint Stock Companies and Firms are not capable of enforcing Companies Act due to shortage of manpower and dearth of skill. Code on Corporate Governance- Malaysian Perspective: The Malaysian Code on Corporate Governance was developed by the Working Group on Best Practices in Corporate Governance and subsequently approved by the high level Finance Committee 6 on Corporate Governance. The members of the Working Group comprise a mix of private and public sector participation. The private sectors play a key role to initiate the Code in order to lead a review and to establish reforms of standards of corporate governance at a micro level. The Code essentially aims at setting out principles and practices on structures and processes that companies may use in their operation so that they can achieve optimal governance framework. This structures and processes includes issues such as the composition of the board, procedures for recruiting new directors, remuneration of directors, the use of board committees, their mandates and their activities etc. This is based on the fact that there are some aspects of corporate governance, where statutory regulation is necessary and others where self-regulation, complemented by market regulation is more appropriate. There are three broad approaches to the issue of corporate governance that have been undertaken by jurisdictions around the world; Prescriptive approach (This approach simply requires compliance of certain corporate governance guidelines along with specifying desirable practices), nonprescriptive approach (This approach simply requires corporate governance practices in a company to be disclosed) and hybrid approach ( This approach requires that there is a need for broad principles and that all concerned should then apply these flexibly and with common sense to the varying circumstances of individual companies. This is the approach preferred by the Hampel Committee). Malaysia has accepted the Hampel approach7 in 2000 for two reasons; First, best practice prescriptions are necessary as the standards of corporate governance in Malaysia were lacking and


therefore there was a need to raise these standards. Second, companies must be encouraged to consciously address their governance needs. The Code comprises of four parts such as: a) Part 1 specifies broad Principles of good corporate governance for Malaysia, which allow companies to apply these flexibly and scrupulously considering the varying circumstances of individual companies; b) Part 2 consists of Best practices in corporate governance for companies, which identifies a set of guidelines or practices intended to assist companies in designing their approach to corporate governance; c) Part 3 is addressed to investors and auditors to enhance their role in corporate governance; and d) Part 4 provides explanatory notes for the Code set out so far. A critical comparison between codes of Corporate Governance of these two countries: The Code practiced in Bangladesh is more than a rule-based approach (Prescriptive approach) as this follows certain guidelines with a greater emphasis on the condition of Comply or Explain basis. The biggest problem with such approach is that it would encourage directors to concentrate on form rather than on exercising their discretion on what corporate governance practices are best suited for their companies. Directors simply adopt a practice of ticking a series of boxes to indicate that they have complied with the prescribed best practices. Moreover, the checklist method of ticking every box may be perceived by investors as implying endorsement by the regulator (the Exchange) of the companys corporate governance practices. Shareholders or their advisors would be interested only in whether the letter of the rule has been complied with- yes or no. A Yes would receive a tick. Besides, lazy or unscrupulous directors may get the unfair opportunity to arrange matters in such a way so that the letter of every governance rule is complied with but not the substance. Even it might be possible to emerge in a company with, on paper, a 100% compliance with rules. So box ticking is neither fair to companies, nor likely to be efficient in preventing abuse. Bangladesh basically follows the findings of the Cadbury and Greenbury reports with certain conditional rule- comply or explain basis. The strongest point in this Code is that companies need to explain in case of non-compliance with any rule, otherwise, the regulator can adopt any legal action upon the respective company. Unlike the rule-based approach, Malaysia follows the Hampel Committee recommendations, which is basically the combination of rule-based approach and principle-based approach. The principle-based approach is that companies apply the broad principles flexibly and with judgment as individual companies may encounter varying circumstances. It was recommended that companies should include in the annual report a narrative statement of how they apply the relevant principles to their particular circumstances. Given that good corporate governance lies with the board of directors, the written description of the way in which the board has applied the principles of corporate governance represents a key part of the process. Such clarification or explanation ensures that the investment community receives an explanation for the companys approach to governance so that it is in a position to support the approach or work to influence change. In such a way, the investors may confide in the corporate affairs. The Code does not prescribe the form and content of the narrative statements. Rather it aims to secure sufficient disclosure so that investors and other can assess the companys performance and governance practices, and can respond in an informed way. In contrast with the rule-based approach, Malaysian Code on Corporate Governance is more flexible in the sense that it allows companies to develop and nourish their own corporate governance approach. Because the reality is that corporate governance scenario and practice vary from company to company. Box-ticking system wont inspire companies to develop such practice. The Working Group in Malaysia has the very real experience regarding box-ticking system in the form of audit committees, where companies merely comply in form by setting up such committees without giving heed to the spirit of the requirement by ensuring, for example, the quality of the people within the committee. Under this Code, there is no hard and fast rule as to the strict compliance with best practice prescription as while the prescriptions establish a sound approach to corporate governance, companies may develop alternatives that may be just as sound.


To quote the Hampel report (1998), With guidelines, one asks, how far are they complied with? With principles, the right question is How are they applied in practice? The Hampel Committee did not add any radical recommendations over findings of the two earlier committees, viz. The Cadbury (1992) and Greenbury Committees but set out a number of general principles of good corporate governance. Serious application of Cadbury and Greenbury Codes ended up in box-ticking rather than the application of informed and independent judgment by exp erienced and qualified individual from executives and non-executive directors, shareholders and auditors. It was recommended that companies should include in their annual reports as a narrative statement as to how they apply the principles and the explanations for any exception. The principles focused in the Hampel Committee include directors appointment; remuneration etc., shareholders voting, AGM and finally accountability and audit. Hence the Hampel report is the most acceptable Code of Corporate Governance to the business community worldwide. Hence the Hampel report is the most acceptable code of corporate governance to the business community worldwide. Recommendations: From the previous discussion and comparison, the following recommendations can be developed: 1. Entrepreneurs of Bangladesh mostly belong to first generation of entrepreneurs. Because of lesser knowledge about running companies combining with poor state governance at post independence period governance scenario could not take a good shape. Guidelines on corporate governance could not be a panacea unless improvement in ethical area improves. Justice system, police enforcement system and above all dismal status of state governance need to be improved that have different ramification. 2. Unless investor becomes vocal about their rights governance scenario will not be improved to a desired level whatever efforts put by regulators. Investors have hardly ever filed a case against the directors, auditors or officers for violating fiduciary responsibility. 3. Box-ticking system (Rule-based approach) may not improve the corporate governance scenario in Bangladesh as dishonest and unscrupulous directors are likely to comply 100% with rules on paper without regard to the spirit of them. So the regulators can take necessary steps to critically monitor and check the compliance status of listed companies. If such monitoring is carried out by the regulators even on sample basis, this will give a message to those companies, where directors tend to unscrupulously play the game. 4. Even in case of non-compliance, the SEC should carefully justify the reasons as set out by the companies in the annual report and take actions if the reasons are not proper for the noncompliance. 5. Corporate entities can set up an independent Corporate Governance Committee, which will continuously monitor and oversee the Corporate Governance affairs inside the organizations. The Committee should include at least one member appointed by the regulatory body. The board should be held responsible and accountable to the Corporate Governance Committee in case of Corporate Governance affairs. The Committee can also suggest any change or direct the board of directors regarding how the entities comply with and implement the Corporate Governance guidelines. Finally, this will submit a report on corporate governance on biannually or yearly basis to the regulatory body. 6. As corruption has mushroomed in all the sectors of Bangladesh and there is no or low moral or ethical standards in business practice, the regulators should go for rigorous standards for corporate governance like Malaysian Code on corporate governance. If it is possible to shift from the rule-based approach to principle-based approach, each company will be at liberty to develop their own governance framework. 7. Gradually Bangladesh should go for the hybrid approach- the combination of rule-based approach and principle-based approach. In this regard, two-fold benefits can be obtained; a) companies will follow the best practice prescriptions (rules) accompanying with a narrative statement in the annual report where statutory regulation is necessary, and b) companies will be encouraged to develop their own governance practice and disclose it in the interest of






investors and others- where self-regulation is necessary. Such hybrid system will prevent the abuses as possibly suffered from the box-ticking system; rather regulators will get a true picture of corporate governance. The narrative statement given in the annual report will explain how companies apply principles in practice. Companies can disclose its practice and be transparent to the investors. Like the Malaysian Code on Corporate Governance, the regulators in Bangladesh can also include a part in its Code towards investors and auditors- two other big players in good corporate governance to enhance their role in corporate governance. This will increase their awareness of good governance. Corporate governance is a continuous process in which many can contribute. Everybody, who is a part of it, should play their role in the way they are expected of. Stockholders, auditors, directors and regulators should contribute to the working of good governance in the corporate sectors. SEC has also shortage of manpower and to some extent lacks skill. Compensation package of SEC staff members is similar to government servants. Capacity of SEC should be enhanced so that effectively exercise oversight on companies and contribute towards elevation of good corporate governance. Companies Act, 1994 needs to be updated. Moreover, manpower and efficiency of the Office of the Registrar of the Joint Stock Companies and Firms need to be enhanced for their effective enforcement of Companies Act.

Conclusion: Corporate governance is not about rules and regulations, principles and procedures. It is about the spirit in which the business is operated in the best interest of stockholders and others. Neither rulebased approach nor principle-based approach of corporate governance works better if there is no constant awareness on the part of key players of corporate governance- board of directors, corporate shareholders and auditors. Despite the fact it is experienced that principle-based approach of corporate governance is better than rule-based approach over the world to ensure good governance in the corporate sectors. The hybrid approach (combination of rule-based approach and principlebased approach) is best suited in most of the cases. The regulators have to prescribe Codes on corporate governance so that companies will comply with rules in some cases where regulation seems to work and at the same time they will be encouraged to develop and disclose their own corporate governance practice. On the other hand, key players in ensuring corporate governance should also be constantly watchful of such practice. Stakeholders particularly auditors and investment community have to enhance their role to have better governance in the corporate sectors in context of Bangladesh. This is how; Bangladesh can go a long way to achieve good governance in the corporate sectors.