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2/14/2016

CORPORATE GOVERNANCE

By Kendhoo

Corporate Governance

Corporate governance is the means by which companies are directed, administered and controlled

It influences how the objectives of the company are set and achieved, how risk is monitored and assessed, and how performance is optimised

MNU Business School / ACC235 / 2016 S1 / Kendhoo

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Corporate Governance

A company that is well governed is one that is

accountable and transparent

to its shareholders and other stakeholders, such as employees, creditors, customers and society at large

such as employees, creditors, customers and society at large MNU Business School / ACC235 / 2016

MNU Business School / ACC235 / 2016 S1 / Kendhoo

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Corporate Governance

Good corporate governance enables companies to create value (through entrepreneurialism, innovation, development and exploration) and provides accountability and control systems commensurate with the risks involved

Corporate governance is a key element in improving organisational performance and sustainability as well as enhancing stakeholder confidence

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Corporate Governance

Embedding sustainable development within corporate governance requires companies to identify and understand their environmental and social impact and responsibilities and to act accordingly

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Corporate Governance

There is a

clear link between governance and financial, ethical and

sustainability

traditional accounting, reporting and audit do not effectively capture

that

issues

MNU Business School / ACC235 / 2016 S1 / Kendhoo

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Corporate Governance

The process involves using the knowledge and experience of the leadership and others in the business to establish:

Responsibilities – of whom and in relation to which issues?

Accountabilities – to whom are those with responsibilities accountable and how?

Checks and balances – what systems of supervision, control and communication flows are required?

MNU Business School / ACC235 / 2016 S1 / Kendhoo

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Corporate Governance

Governance must draw not just on financial but also on social and environmental accounting, reporting and audit to understand the full scope of a firm’s activities and performance and to establish an integrated approach to sustainability

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Corporate governance and the financial crisis 2008/09

– where did it all go wrong?

The 2008/09 financial crisis can, to an extent, be attributed to failures and weaknesses in corporate governance

When corporate governance mechanisms were put to a rigorous test, they failed; they did not protect against excessive risk taking and irresponsible behaviour

MNU Business School / ACC235 / 2016 S1 / Kendhoo

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Corporate governance and the financial crisis 2008/09

– where did it all go wrong?

So what were the governancerelated reasons for the current turmoil?

First, it was clear that dysfunctional boards did not fully understand the risks and impact associated with the strategies and activities they approved

Neither did they understand these activities and risks in relation to sustainability

Furthermore, in many cases, boards did not provide adequate monitoring of implementation, accounting, reporting and audit

MNU Business School / ACC235 / 2016 S1 / Kendhoo

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Corporate governance and the financial crisis 2008/09

– where did it all go wrong?

Getting governance wrong is not a small matter that can be dismissed lightly

These failures have contributed to recession, the collapse of large businesses, widespread redundancies, consumer mistrust, and a fundamental recasting of the relationship between the state and financial institutions

MNU Business School / ACC235 / 2016 S1 / Kendhoo

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Corporate governance and the financial crisis 2008/09

– where did it all go wrong?

The lack of appropriately qualified nonexecutive directors also contributed to the problem, as the broad range of skills and knowledge required to fully understand the complex financial and non financial factors that influence organisational performance were not available

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Corporate governance and the financial crisis 2008/09

– where did it all go wrong?

Dysfunctional boards are symptomatic of the irresponsible ownership that has contributed to the financial crisis; powerful shareholders did not play an active enough role in improving governance

As a result, new ownership and governance models are being considered or in some cases, such as RBS and Lloyds TSB, being forced upon companies

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Corporate governance and the financial crisis 2008/09

– where did it all go wrong?

The investor community has also failed in its wider role

It failed to engage actively enough or push hard enough for meaningful reform, and certainly did not identify and reward examples of success sufficiently

Now that investors have been reminded how crucial adequate governance is and what failure can mean, they need to use their weight to influence change

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Corporate governance and the financial crisis 2008/09

– where did it all go wrong?

The Cooperative Bank has emerged relatively unscathed from the current financial crisis, causing Jonathon Porritt, chairman of the UK’s Sustainable Development Commission, to suggest that,

‘at the very least, the relative resilience of this business model should prompt both Treasury and the sector’s regulators to think again about alternative ownership and governance structures in the financial services sector’

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Corporate governance and the financial crisis 2008/09

– where did it all go wrong?

Remuneration systems that have encouraged shortterm thinking and unsustainable risk taking at the expense of longer term sustainability are also symptomatic of failed governance

Bonuses awarded for short term annual performance, with limited consideration of the impact on longer term performance, encouraged employees to act in ways that undermined the efficient and sustainable functioning of markets

Ineffective governance allowed large mismatches between risk assessment, incentives and internal controls

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Corporate governance and the financial crisis 2008/09 – where did it all go wrong?

It is clear that risk assessment procedures have not worked; they have not always looked at the right things, or assessed them in the right way

Taken together, these issues contributed to the recent large scale business failures

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Corporate governance and sustainability

The trajectories of corporate governance and sustainability are meeting head on and new demands are being placed on companies and their leadership

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Corporate governance and the financial crisis 2008/09 – where did it all go wrong?

Corporate governance failings were certainly not the only cause but they were a significant contributor to the current financial crisis and recession

It has become clear that corporate governance models need changing

Enhanced governance practices should be seen as integral to an overall solution aimed at restoring confidence to markets, developing a sustainability approach to business and protecting us from future crises

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Corporate governance and sustainability

“ Corporate governance is concerned with holding the balance between economic and social goals and between individual and communal goals

The governance framework is there to encourage the efficient use of resources and equally to require accountability for the stewardship of those resources

The aim is to align as nearly as possible the interests of individuals, corporations and society”

Sir Adrian Cadbury, Corporate Governance Overview, 1999 World Bank Report

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Corporate governance and sustainability

Corporate governance is on the radar screens of corporations, regulators and stakeholders as never before

With the business media dominated by corporate activities such as the subprime mortgage lending crisis, carbon trading schemes and the collapse of many high profile organisations including Lehman Brothers and Enron, the role of companies in society is under evergreater scrutiny

Global companies are subject to increasing demands from activists, employees and investors to behave in a sustainable manner, taking into account important social, environmental and ethical issues

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Corporate governance and sustainability

While certain sustainability concerns are core to success, they do not always lend themselves to discussion and debate within governance frameworks that focus on financial indicators and controls

For example, the financial lens of the audit committee may not fully focus on some of the important non financial issues associated with sustainability

In

recognition

of

these

limitations

new

approaches to governance are evolving

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Corporate governance and sustainability

The trajectories of corporate governance and sustainability are meeting head on and new demands are being placed on companies and their leadership

Regulation (such as the King II report) and the materiality of sustainability issues are forcing organisations to integrate such concerns more fully into governance structures

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Corporate governance and sustainability

The increasing importance of sustainability issues is now recognised by many companies, but for such issues to truly become integrated into strategy, operations and performance, they need to be embedded in governance systems

The key to successfully embedding sustainability in governance is getting the right issues into the mix and getting the right voices heard

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Corporate governance and sustainability

These need to be given due consideration and not treated as a mere side issue

This requires aligning the strategic direction of the organisation with strategic environmental and social goals and ensuring governance oversight mechanisms understand and play their role in maintaining that focus

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THE ROLE OF BOARDS

The board needs to realistically evaluate the nature and significance of the sustainability issues facing the company, as well as where sustainability needs to be considered in relation to issues such as succession planning and performance evaluation

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Corporate governance and sustainability

Mainstream governance conversations have traditionally focused on legal and risk issues, finances, management structures, individual competencies, leadership and independence

Yet today’s governance issues, related to sustainability, all operate beyond mere legal requirements and focus on process innovations that engage key knowledge brokers through ‘softer’ forms of governance that take account of values and principles

Sustainability is gradually reshaping

the

way

organisations approach corporate governance

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THE ROLE OF BOARDS

Boards are a crucial component of governance structures and, as with other governance mechanisms, need to embrace sustainable development

There is a need to ensure that boards have the ability to lead with integrity and possess the right skills to make difficult decisions and manage risk

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THE ROLE OF BOARDS

The voices of wider stakeholders clearly need to be included in the governance process

Employee representatives have participated in boards for a number of years; perhaps the most well known cases are in Germany and Japan

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THE ROLE OF BOARDS

Non executive directors need the right blend of skills, experience and personal qualities to enable them to advise, monitor and challenge effectively

Organisations need to be encouraged to cast the net widely in seeking such people and to develop a deeper understanding of what skills are required

The board needs to realistically evaluate the nature and significance of the sustainability issues facing the company, as well as where sustainability needs to be considered in relation to issues such as succession planning and performance evaluation

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THE ROLE OF BOARDS

But, clearly there is a need to look beyond employee representatives alone and to carefully select non executive directors with sustainability related expertise in areas such as the environment, health and safety, consumer relations or human resources, as well as those from non business backgrounds who can bring valuable perspectives into the boardroom

These skills and perspectives can enable companies to evaluate key strategic sustainability issues more comprehensively and monitor their performance more effectively

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THE ROLE OF BOARDS

Expert stakeholder advisory panels can also help bridge the gap between an organisation’s wider stakeholder engagement and its governance, by bringing experts together with senior management

Companies are increasingly using expert panels to advise how to respond to emerging social and environmental issues in a way that is strategically aligned to the organisation’s business model

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THE ROLE OF BOARDS

The existence of a committee responsible to the board allows specific issues to be explored in more depth than is possible at board level, while ultimate responsibility remains with the board as a whole

Where these panels exist it is crucial that they are credibly integrated into the traditional governance structures

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King Report

on Corporate Governance for South Africa

It is a set of principles

It does not determine a detailed course of action

It states that the board is responsible for the process of risk management and that it must decide the company’s appetite and tolerance for risk

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King Report

on Corporate Governance for South Africa

King II is the abbreviated name for the King Report on Corporate Governance for South Africa published 2002

It followed a 1994 report commonly known as King I

Companies listed on South Africa’s JSE Securities Exchange have to comply with King II

MNU Business School / ACC235 / 2016 S1 / Kendhoo

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King Report

on Corporate Governance for South Africa

The board must ensure that an assessment of the processes and outcomes of key risks is undertaken annually

And,

importantly,

risk

management

information should be disclosed annually

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King Report

on Corporate Governance for South Africa

It sets out the following seven characteristics of good corporate governance:

discipline (a commitment to adhere to ‘proper’ behaviour)

transparency (ease with which an outsider can analyse a company)

independence (use of mechanisms to prevent conflicts of interest)

accountability (decision makers must be accountable for decisions)

responsibility (for behaviour allowing for corrective action and for mismanagement)

fairness (systems must be balanced)

social responsibility (awareness and response to social issues)

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Remuneration and incentives

Remuneration and incentives, while not often thought of as a sustainability concern, would benefit from being viewed through a sustainability lens

Remuneration needs to be considered in terms of pay equity and pay differentials as well as in relation to the way in which it influences unacceptable risk taking

Shortterm performancerelated pay is seen by many as central to many of the problems, particularly within the banking system, that caused the global financial crisis

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Remuneration and incentives

There is growing pressure to redesign corporate regulation and governance to emphasise the importance of long term sustainability in relation to remuneration practices

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Remuneration and incentives

“ It would be useful to have further

sustainability related

responsibilities from the board level through to the executive committee, including whether and how remuneration includes incentives based on sustainability performance “

clarification of

Alcoa Stakeholder Panel, 2008

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Remuneration and incentives

There is growing pressure to redesign corporate regulation and governance to emphasise the importance of long term sustainability in relation to remuneration practices

Central to this is the need to dismantle incentives which have led to shorttermism and an undermining of corporate ethics

Incentives clearly need to encourage sustainable behaviour

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Remuneration and incentives

While clearly a more fundamental review of remuneration practices is needed, there is evidence of an existing trend towards longer term incentives

A report by PWC in 2007 found that there has been a ‘continued emergence of bespoke long term incentive plans designed for specific business circumstances’

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Remuneration and incentives

They need to be based on longer term performance characteristics and encourage decision making that will advance the sustainability of organisations, incorporating both financial and non financial metrics

Including sustainability issues in the creation of new remuneration and incentive structures will give a greater focus to these issues at both a strategic and day to day level

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Remuneration and incentives

The same report also suggests that two thirds of companies surveyed had adopted a balance scorecard linking nonfinancial performance to rewards, and across the FTSE, just 20% of companies relied solely on financial metrics to judge executive remuneration

Increasingly executive bonuses will depend on nonfinancial performance, with customer satisfaction, employee engagement and health and safety ranking as the most commonly considered issues

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Panels and CSR Governance at British Telecom

BT has had a CSR leadership panel for several years

The purpose of the panel is to encourage innovation and leadership on sustainability and corporate responsibility

The panel consists of external and independent thought leaders in the fields relevant to both sustainable development and BT’s strategy and operations

It meets four times a year and has a remit which includes advising on key areas of performance and strategy

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THE ROLE OF INVESTORS

Questioning the suitability of nonexecutive directors in understanding the materiality of nonfinancial issues is crucial

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Panels and CSR Governance at British Telecom

The panel’s primary contact is with the BT CSR team but links into the BT board and presents to them at least once a year when the BT board discusses corporate social responsibility strategy, performance and risks

The panel keeps the board informed of emerging issues and changing stakeholder expectations that may affect its duties

In addition the panel provides an annual independent comment on BT’s social and environmental performance within the non financial report

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THE ROLE OF INVESTORS

Institutional investors and fund managers have a responsibility to generate long term value on behalf of their shareholders, the individual savers, investors and pensioners for whom they are ultimately working

They should insist that the companies they invest in put sufficient resource into developing governance mechanisms that deliver long term value

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THE ROLE OF INVESTORS

Shareholders should take governance into account as part of their investment decisionmaking

Institutional investors and other shareholders need to understand what questions they should be asking boards

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THE ROLE OF INVESTORS

Ultimately investors need to ask if the board and individual members are delivering

Part of this is establishing whether governance meets international standards

The case below indicates the reaction of investors when the answers are not as they wish

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THE ROLE OF INVESTORS

For example, does the board have the knowledge and competencies necessary to understand the sustainability implications of the current market and does the board composition reflect the direction of the future strategy?

Questioning the suitability of non executive directors in understanding the materiality of nonfinancial issues is crucial

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The Brazilian Novo Mercado

The Brazilian Novo Mercado is a premium stock market listing for shares issued by companies that have voluntarily adopted corporate governance practices and transparency requirements beyond those requested by law

Created by the Sao Paulo Stock Exchange Bovespa in 2001, it is based on the premise that stock valuation and liquidity are positively affected and assured by shareholders’ rights and the quality of company information

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The Brazilian Novo Mercado

The primary market restricted entry to those that met stringent standards including:

the issuance of only voting shares

a minimum of 25% of shares not controlled by majority shareholders

12 month terms for board members

provision of statements in accordance with USGAAP and IASGAAP

settlement of shareholder conflicts by arbitration

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Corporate Governance and Investors:

Marks & Spencer

The Co operative’s responsible investment manager at the time stated

‘The structure clearly departs from best practice. We are also disappointed by the lack of prior consultation with shareholders.’

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Corporate Governance and Investors:

Marks & Spencer

Marks & Spencer sparked a furious reaction from big institutional investors in 2008 after announcing that it was combining the roles of chairman and chief executive to keep Sir Stuart Rose at the business until 2011

Investors reacted strongly to the decision and, although they have since been reassured to a certain degree, the incident highlights the ability of investors to influence and stresses the importance of governance to this community

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Corporate Governance and Investors:

Marks & Spencer

The head of equities for Legal & General, one of the largest shareholders, emphasised the importance of accountable governance:

‘As set out in the Combined Code we believe strongly in the separation of the roles of chairman and chief executive, believing this allows a much needed balance in the boardroom and prevents the potentially damaging concentration of power.’

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Other governance models

The quality of governance is important not only for individual companies but also for collaborative initiatives, partnerships and wider economic systems

Collaborative governance

New global governance

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Collaborative governance

Partnership performance depends on effective governance

Partnerships are supposed to create new ways for citizens, stakeholders and interested parties to engage in the delivery of sustainable outcomes

To ensure the governance of partnerships is effective there is a need to create incentives for good partnership governance, to ensure partnership governance systems gain the trust of core stakeholders and to build the knowledge and capacity of partnerships and their stakeholders to govern effectively

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Collaborative governance

Collaborative initiatives and various types of partnerships (including public private partnerships) are seen by many as a way to successfully address many sustainability challenges

However, these collaborative

initiatives and

partnerships do not always deliver their objectives

Underlying many of the challenges are governance systems that fail to deliver accountable decision making

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New global governance

Current economic circumstances raise serious questions as to the adequacy or perhaps even relevance of many preconceived notions of good corporate governance, especially those emanating from international best practice rooted broadly in AngloSaxon approaches that have proved lacking

There is a growing feeling that now is the right time to forge a cooperative approach to the crisis, and to build a stronger, more inclusive international financial and economic governance architecture that will also address other global challenges such as energy and climate change, security and terrorism, and poverty and health issues

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New global governance

European Commission President Barroso has indicated that ‘major reform’ is needed on the current financial supervision and regulation model ‘at international level’ and that it should be built on the principles of ‘transparency, responsibility, crossborder supervision and global governance’

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The Role of Accountants

The work of accountants is clearly crucial to effective governance, especially in relation to its traditional focus on financial performance and accounting integrity

The fundamental role of the accountant is to provide transparency in reporting, financial or otherwise, to shareholders and the broader stakeholder groups who have an interest in the performance of the business

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The Role of Accountants

The fundamental role of the accountant is to provide transparency in reporting, financial or otherwise , to shareholders and the broader stakeholder groups who have an interest in the performance of the business

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The Role of Accountants

To undertake this role accountants must ensure they are familiar with the general management, risk management, operational and reputational aspects of the business to provide context to the figures presented in the financial statements

In order to provide independent opinion on a company’s financial statements, ie their annual report, accountants must have access to information on all company activities which could be material to its financial position

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The Role of Accountants

Accountants working in a business are involved in several of the governance mechanisms, which may include nominations committees (identifying appropriate candidates/nonexecutive directors) for the board, remuneration committees and risk and compliance committees as well as the audit committee

The SarbanesOxley Act 2002 defines the audit committee as ‘a committee (or equivalent body) established by and amongst the board of directors of an issuer for the purpose of overseeing the accounting and financial reporting processes of the issuer and audits of the financial statements of the issuer’

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The Role of Accountants

Accountants bring their regulatory knowledge and industry standard experience to their clients to drive through best practice

Additionally they interpret the listing requirements relevant to their business and legal structure

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The Role of Accountants

Audit committee members are faced with increased expectations from many groups, including shareholders, shareholder and governance activists, regulators, the media, and fellow board members

The other area where accountants working in business currently support good corporate governance is in ‘decoding’ regulation for the company and supporting internal integration and adherence

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The Role of Accountants

Accountants bring a professional rigour in demanding transparency; in order to maintain professional integrity, accountants must follow standards and procedures that will highlight concerns

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The Role of Accountants

The Role of Accountants

 

They must make sure their risk discussions with management are healthy and productive and help the company and the board to prepare for change

It is within their professional conduct to have this role and dispute practice which is not in the interests of the long term sustainability of the company and its stakeholders

Accountants are also in the best position to provide an independent challenge to practices they observe within a business

Aligning their thorough approach to preparing financial statements with wider governance reviews enables accountants to provide a full comment on a company’s annual and long term performance

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The Role of Accountants

 

Ultimately this will provide the company, its stakeholders and society with a truer and more robust reflection of the business performance and its potential impact on wider social, environmental and ethical concerns

     

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