Corporate governance, and the role of directors and audit committees

Corporate governance broadly refers to the mechanisms, relations, and processes by which a company is controlled and directed. It is the framework of rules and practices by which a board of directors ensures accountability and transparency in a company’s relationship with its stakeholders, be they shareholders, customers, suppliers, top management, employees, the community and the government. The framework consists of: (a) explicit and implicit contracts between the company and its stakeholders for the distribution of responsibilities, rights, and rewards; (b) procedures for reconciling the sometimes conflicting interests of stakeholders in accordance with their duties, privileges, and roles; and (c) procedures for proper supervision, control and flow of information to serve as a system of checks and balances.

Cadbury report on corporate governance

In May 1991, the Financial Reporting Council, the London Stock Exchange and the accounting profession established a committee under the chairmanship of Sir Adrian Cadbury to examine the issue of corporate governance and to make recommendations for improvement.

At the time, there were concerns about the perceived low level of confidence in financial reporting and audit as a result of a number of corporate failures. Contributing factors included: (a) the inability of the external auditors to provide the necessary safeguards and assurances to the users of financial statements; (b) the inadequacy of accounting standards used at the time; (c) the absence of a clear framework for ensuring that directors kept under review the controls within their companies; and (d) competitive pressures both on companies and their auditors made it difficult for the latter to stand up to demanding boards.

When the Committee was about to commence its work, two other scandals unfolded – the collapse of the Bank of Credit and Commerce International (BCCI) and the Maxwell Group. BCCI was rocked with several scandals, including massive money laundering and other financial crimes in its extensive operations in bank secrecy jurisdictions while the Maxwell Group collapsed after the mysterious death of its founder Robert Maxwell.

The Cadbury report, as it became known, was issued in December 1992 under the title “The Financial Aspects of Corporate Governance”. An integral aspect of the report is the promulgation of a Code of Best Practice designed to lift standards of corporate behaviour. The Code has been widely adopted in the European Union, the United States and the World Bank, among others.

Some ten years later, a number of other scandals broke out involving Enron, Tyco International, Adelphi, Peregrine Systems and WorldCom. These scandals prompted the U.S. Government to enact the Sarbanes-Oxley (SOX) Act of 2002. Key requirements include: (a) the creation of the Public Company Accounting Oversight Board; (b) enhanced standards to secure auditors’ independence; (c) senior executives being made responsible for the completeness and accuracy of financial reporting; (d) enhanced relationship between external auditors and audit committees; (e) improved financial reporting requirements; and (f) adequate internal controls for ensuring the accuracy of financial reporting and disclosures, duly certified by the responsible officers, as well as external auditing and reporting on their adequacy.

Role of directors

The Cadbury Report considers that it is the primary responsibility of boards of directors for the governance of their companies, including: setting strategic objectives; providing the necessary leadership to implement the strategies; supervising the management of the organization; and reporting to shareholders on their stewardship. The shareholders’ responsibility is to appoint the directors and the auditors and to satisfy themselves that an appropriate governance structure is in place. This includes: (a) the way boards set financial policies and how they oversee their implementation, including the implementation of financial controls; and (b) how they report on the activities and progress of companies to the shareholders. The report made it clear that in law, all directors, whether or not they have executive responsibilities, are responsible for the stewardship of a company’s assets. They also have a monitoring role to play and are responsible for ensuring that the necessary controls over the activities of their companies are in place and are working satisfactorily.

In essence, boards of directors are required to provide effective oversight of the management of organizations as well as the sense of direction and leadership so vitally necessary for organisations to survive and grow in today’s highly competitive and demanding environment. Although the Cadbury Report was prepared in the context of companies operating in the private sector, it has equal applicability to public sector organisations.

The following outlines the Code of Best Practice as it relates to directors:

Board of Directors

1. The Board should meet regularly, retain full and effective control over the company and monitor the executive management.
2. There should be a clearly accepted division of responsibilities at the head of a company, which will ensure a balance of power and authority, such that no one individual has unfettered powers of decision. Where the Chairman is also the Chief Executive, it is essential that there should be a strong and independent element on the Board, with a recognised senior member.
3. The Board should include Non-Executive Directors of sufficient calibre and number for their views to carry significant weight in the board’s decisions.
4. The Board should have a formal schedule of matters specifically reserved to it for decision to ensure that the direction and control of the company is firmly in its hands.
5. There should be an agreed procedure for Directors in the furtherance of their duties to take independent professional advice if necessary, at the company’s expense.
6. All Directors should have access to the advice and services of the Company Secretary, who is responsible to the Board for ensuring that Board procedures are followed and that applicable rules and regulations are complied with. Any question of the removal of the Company Secretary should be a matter for the Board as a whole.

Non-Executive Directors

1. Non-Executive Directors should bring an independent judgement to bear on issues of strategy, performance, resources, including key appointments, and standards of conduct.
2. The majority should be independent of management and free from any business or other relationship which could materially interfere with the exercise of their independent judgement. Their fees should reflect the time which they commit to the company.
3. Non-Executive Directors should be appointed for specified terms and reappointment should not be automatic.
4. Non-Executive Directors should be selected through a formal process and both this process and their appointment should be a matter for the Board as a whole.

Executive directors

1. Directors’ service contracts should not exceed three years without shareholders’ approval.
2. There should be full and clear disclosure of directors’ total emoluments and those of the chairman and highest-paid UK Director, including pension contributions and stock options. Separate figures should be given for salary and performance-related elements and the basis on which performance is measured should be explained.
3. Executive Directors’ pay should be subject to the recommendations of a remuneration committee made up wholly or mainly of Non-Executive Directors.

Reporting and Controls

1. It is the Board’s duty to present a balanced and understandable assessment of the company’s position.
2. The Board should ensure that an objective and professional relationship is maintained with the auditors.
3. The Board should establish an Audit Committee of at least three Non-Executive Directors with written terms of reference which deal clearly with its authority and duties.
4. The Directors should explain their responsibility for preparing the accounts next to a statement by the auditors about their reporting responsibilities.
5. The Directors should report on the effectiveness of the company’s system of internal control.
6. The Directors should report that the business is a going concern, with supporting assumptions or qualifications as necessary.

Under the Guyana Companies Act of 1991, it is the duty of the Directors to: (a) exercise the powers of the company directly or indirectly through employees and agents of the company; and (b) direct the management of the business and its affairs. Directors must exercise due care, diligence and skill expected of a reasonable, prudent person in comparable circumstances. They must also act honestly and in good faith, and must place the interest of the company first and foremost. In determining the best interest of the company, due regard must be given to the interest of employees in general as well as the interest of the shareholders.

Role of Audit Committees

Audit Committees play an important role in assisting directors of companies in discharging of their stewardship and fiduciary responsibilities. They act as a go-between involving executive management and the external auditors The Code of Best Practice outlines the following requirements for Audit Committees:

1. The Committee shall be appointed by the Board from amongst the non-executive directors of the company and shall consist of not less than three members. A quorum shall be two members.
2. The chairperson of the Committee shall be appointed by the Board.
3. The Finance Director, the Head of Internal Audit, and a representative of the external auditors shall normally attend meetings. Other Board members shall also have the right of attendance. However, at least once a year the Committee shall meet with the external auditors without Executive Board members present.
4. The Company Secretary shall be the Secretary of the Committee.
5. Meetings shall be held not less than twice a year. The external auditors may request a meeting if they consider that one is necessary.
6. The Committee is authorised by the Board to investigate any activity within its terms of reference. It is authorised to seek any information it requires from any employee and all employees are directed to co-operate with any request made by the Committee
7. The Committee is authorised by the Board to obtain outside legal or other independent professional advice and to secure the attendance of outsiders with relevant experience and expertise if it considers this necessary.
8. The duties of the Committee shall be:

(a) to consider the appointment of the external auditor, the audit fee, and any questions of resignation or dismissal;

(b) to discuss with the external auditor before the audit commences the nature and scope of the audit, and ensure co-ordination where more than one audit firm is involved;

(c) to review the half-year and annual financial statements before submission to the Board, focusing particularly on: (i) any changes in accounting policies and practices(ii) major judgmental areas (iii) significant adjustments resulting from the audit (iv) the going concern assumption(v) compliance with accounting standards(vi) compliance with stock exchange and legal requirements;

(d) to discuss problems and reservations arising from the interim and final audits, and any matters the auditor may wish to discuss (in the absence of management where necessary);

(e) to review the external auditor’s management letter and management’s response;

(f) to review the Company’s statement on internal control systems prior to endorsement by the Board;

(g) to review the internal audit programme, ensure co-ordination between the internal and external auditors, and ensure that the internal audit function is adequately resourced and has appropriate standing within the Company;

(h) to consider the major findings of internal investigations and management’s response; and

(i) to consider other topics, as defined by the Board.

9.  The Secretary shall circulate the minutes of meetings of the Committee to all members of the Board.