CHAPTER 1

CORPORATION AND CORPORATE GOVERNANCE

Ambrose Bierce - Corporation: an ingenious device for obtaining profit without individual responsibility.

WHAT IS A CORPORATION?
A corporation is an artificial being created by operation of law, having the right of succession and the powers,
attributes and properties of expressly authorized law or incident to its existence.

From the definition we can get the following attributes of corporation:

Artificial Being - Which means that, by fiction of law a corporation is a juridical person whose personality is
separate and distinct from the owner.
Created by Operation of Law - Which means it will come into existence through a charter or a grant from the
state.
Right of Succession- A corporation can continue to exist even in the death, in capacity or insolvency of any
stockholder or member. Means the corporation will not be dissolved even when there are transfer of
ownership.
Power, Attributes and Properties - Which means it is authorized to do activities within the purposes of its
creation, it has its own traits, and it operates based on what has been expressly provided in the charter
including those that considered incident to its existence as a corporation.
STAKEHOLDER OF A CORPORATION
stakeholders in a corporation include management, creditors, shareholders, employees, clients, government
and public.
Management- this refers to the party given the authority to implement the policies as determined by the board
in directing the course/business activities of the corporation.
Creditors-refers to the party who lends to the corporation goods, services or money.
Shareholders- this refers to people who invest their capital in the corporation.
Employees- these are the people who contribute their skills, abilities, and ingenuity to the corporation.
Clients – the party considered to be the very reason for the existence of the corporation.
Government- has several interest in private corporation the most apparent of which are the taxes that the
corporation are paying.
Public- public has a stake in corporation considering that the provides the citizens with the essentials such as
goods, services, employment and tax money for public programs.
PURPOSES OF A CORPORATION
Is to benefit its shareholders academics speak of the “shareholder primacy norm,” and many talk of corporate
managers’ task as “shareholder wealth maximization.”
1.Early stage Survival
There are several theories on the aims and objectives of a corporation. However, for entity which has just
started, the main objective would be survival especially during the early years of its existence.
2. To Increase Profit
According to Milton Friedman, the social responsibility of business is to increase profit.
3.To offer Vital Service to the General Public
There are services that are hard for the government to offer to the vast majority of people without the help of
private enterprises.
4To Offer Goods and Services to the Mass Market
Some corporation are run not only for the sole purpose of generating profit but also to provide service to
masses.
Shareholders
shareholder or stockholders are artificial or natural person that are legally regarded as owners of the
corporation. Stockholders are bestowed with the special privileges depending on the class of their
stockholdings.
They have 5 rights to include:
1.The right to vote on matters such as elections of the board of directors.
2.The right to propose shareholder resolutions.
3.The right to receive dividends.
4.Pre-emption right which is the right to purchase new shares issued by the company to maintain its
percentage of ownership in the company. This can also be called right to first refusal.
5. The right to liquidating dividends. That is the right to receive the company assets during liquidation or
cessation of business.
SHAREHOLDERS
Are considered principals, and the directors and officers are considered agents under the theory in
governance.
BONDHOLDERS
A bondholder is generally defined as a person or entity that is the holder of a currently outstanding bond.
A bond being a certificate of indebtedness by the issuing corporation provides some advantages on the holder
of the said instrument.
Board of Directors-will be headed by chairman of the board who is considered as the most influential person in
the corporation.
BOD-refers to the collegial body that exercises the corporate powers of all corporation form under the
corporation code (SEC Code of Corporate Governance.
Duties of the Boards of Directors
Governing the organization by establishing board policies and objectives.
Selecting, appointing, supporting and reviewing the performance of the chief executive.
Ensuring the availability of adequate financial resources.
Approving annual budgets.
Accounting to the stakeholders the organizations performance
CATEGORIES OF INTERNATIONAL CORPORATION
* MULTINATIONAL COMPANIES
* Transnational CORPORATIONS
Transnational corporations with headquarters in U.S. have played an increasingly dominant role in the world
economy.
Another concerns with TNC is their ability to use foreign subsidiaries to minimize their tax liability.
motives
Desire for growth
Preventing from competition.
reduced cost, mainly through the use of cheap foreign labor in developing countries.
Corporate governance
Malaysian High Level Finance Committee Report on Corporate Governance defined corporate governance as
follows:
“Corporate Governance is the process and structure used to direct and manage the business and affairs of the
company towards enhancing business prosperity and corporate accountability with the ultimate objective of
realizing long-term shareholder value, whilst taking into account the interest of the other stakeholders.
Wall street Journal (23 June 1999)
- “Corporate governance, in principle, refers to the joint responsibility imposed on the Board of Directors and
management to protect shareholder rights and enhance shareholder value. In practice, the Board is the real
representative of shareholders and acts as a check against management. The Board must ensure, among
other things, that the company is accountable to shareholders, that it gives equitable treatment to all its
"owners," small as well as large, and that it acts transparently”
Corporate governance refers to a system whereby shareholders, creditors and other stakeholders of a
corporation ensure that management enhances the value of the corporation as it competes in an increasingly
global market place
(SEC Memorandum Circular No. 2, Series of 2002, Code of Corporate Governance).
According to Sir Adrian Cadbury, corporate governance is concerned with holding the balance between
economic and social goals and between individual and communal goals.
Fundamental objectives of corporate governance
Improve of Shareholders Value
Conscious Consideration of the Interest of Other Stakeholders
What Governance Promotes
Transparency – It is vital with respect to corporate governance due to the critical nature of reporting financial
and non-financial information.
The aim includes maintaining investors, consumer, and other stakeholders.
Accountability – Is the recognition and assumption of responsibility for the decisions, actions, policies,
administration, governance and implementation of programs and plans for the corporation and people
involved, including the obligation to report, explain and be answerable for resulting consequences.
• Set a POLICY
• Set GOALS
• Disclose CREDIBLE INFORMATION
Prudence - Defined within the Code of Governance as “care, caution, and good judgment as well as wisdom
looking ahead”.
Benefits of Governance
Reduced Vulnerability – Good corporate governance practice leads to an improved system of internal control.
This leads to greater accountability, protection of corporate resources and will eventually, better profit
margins.
Marketability - Embracing principles of good corporate governance can also play a role in enhancing the
corporate value of companies. This leads to easy access to capital in financial market which helps in even
more competitive environment. It will also make the company more attractive in open market.
Credibility – One of the benefits that companies having good corporate governance practices is that they
does not need to spend more resources in compliance with regulatory and other financial requirements
necessary since all of these things are already integrated in company’s operating approach.
Agency Problems in Corporation
Agency Relationships and Cost – The connection between managers and owners is called principal – agent
problem and the conflict is called agency relationship. Such relationship exists whenever someone ( the
principal ) hires another (the agent) to represent his interest. Agency costs are incurred when

1. Managers do not attempt to maximize firm value

2. Shareholders incur costs to monitor the managers and influence their actions
Goals of Financial Management - Having a financial goal (to make money) is a little vague. Examining
different ways of formulating it in order to come up with a more precise definition is important because it leads
to an objective basis for making and evaluating financial decisions.
Do Managers Act in the Stockholder’s Interest? – Manager’s action in the interest of stockholders depends on
two factors.

• The way managers are being compensated

• Can management be replaced if they do not pursue stockholder’s goals?
Agency Theory in Governance
Firm can be viewed as a loosely defined contract between resource providers and the resource controllers

• Argues that in modern corporation, in which share ownership is publicly and widely held managerial actions
sometimes depart from those required to maximize shareholder return.
• In agency theory language, the owners are the principals and the managers are agents, and there is an
agency loss necessary, the extent of which is the benefits that should have accrued to the owners been the
ones who exercised direct control of the corporation.
• Agency loss can be reduced through the installation of some mechanism such as providing financial
incentives for executives and managers for their efforts of putting priority or maximizing the shareholder’s
wealth.
EFFECTS OF AGENCY IN GOVERNANCE
CONCEPT OF GOAL CONGRUENCE
PERFORMANCE INCENTIVES AND DISINCENTIVES
PRINCIPAL AGENT
SHAREHOLDERS / OWNERS
MANAGERS
BOARD OF DIRECTORS
EXECUTIVES
Effects of agency in corporate governance
1. Conflict of interest – occurs when a party has competing interests or loyalties because of their duties to more
than one person or organization.
2. managerial opportunism - refers to the act by the agent of taking advantage on things that are within his
control.
3. incurrence of agency cost - is a type of internal company expense, which comes from the actions of an
agent acting on behalf of a principal.
4. shareholder activism - is a way that shareholders can influence a corporation's behavior by exercising their
rights as owners of the company.
5. managerial defensiveness – this is in relation to issue of takeovers whereby management will employ some
strategy to discourage takeovers and buyouts.
Concept of goal congruence
Is the harmony and alignment of goals of both the principal and the agent.
Performance incentives and disincentives
1) pay dependent on profit level
2) shares incentives
3) Shareholders’ intervention
4) Threat of being fired
5) takeover threat
ROLES OF THE
NON-EXECUTIVE DIRECTORS
A non-executive director is a member of the board of directors of a company who does not take part of the
executive function of the management team.
This director is not an employee of the company.
He bring an independent judgment to bear on issues of strategy, performance and resources including key
appointments and standards of conduct.
Responsibilities of the Non-executive directors :
Strategy – Development is the normal role of the non-executive director , to offer a creative contribution and to
act as a constructive reviewer in looking at the goals and plans developed by the chief executive and his
executive team.
Establishing Networks – One of the important functions of the non-executive director is to represent the
company in some external corporate undertaking.
Monitoring of Performance – is included in his responsibility to monitor and examine the performance of
management in meeting agreed goals and objectives of the company.
Audit – A non-executive director has an important role to play in fulfilling this responsibility whether or not a
formal audit committee of the board has been established.
ROLES OF THE CHIEF FINANCIAL OFFICER (CFO)
Implements Internal Control
Supervises Major Impact Projects
Develops Relations with Financing Sources
Advisor to Management
Drives Major Strategic Issues
Risk Manager
Relationship Role
Objective Referee
ROLES OF THE AUDIT COMMITTEE
The audit committee is an essential component in the overall corporate governance system.
The committee should be geared toward carrying out practical , progressive changes in the functions and
expectations placed on corporate boards.
Committee members should be independent from the operational aspects of the company
Understanding the Audit Committee’s Responsibilities
Responsible for the company ’s financial reporting processes and the quality of its financial reporting.
Must have a working knowledge on the company’s goals and its long-term plans and visions including the
issues the company is facing in trying to achieve these objectives.
Examples of issues that the committees should consider:
*Risk identification and response
ØExternal Risk (Independent)
vRapid technology changes
vDownturns in the industry
vUnrealistic earnings expectations by analysts
ØOperating/ Internal Risk
ØInformation and Control Risk
*Pressure to manage earnings
*Internal controls and company growth
ROLES OF THE EXTERNAL AUDITOR
Auditing is a systematic process by which a competent, independent person objectively obtains and evaluates
evidence regarding assertions about the economic actions and events.
NEED FOR EXTERNAL AUDITOR
The need for independent auditor because of the apparent separation of ownership and management.
FACTORS THAT CONTRIBUTE TO INFORMATION RISK
1.Remoteness of Information Providers to the Information Users
2.Bias of Information Providers
3.The Volume of Data
4.Complexities in Transactions
Auditor’s Duties
The auditor has a legal duty to make a report to the enterprise on the fact and fairness of the entity’s annual
accounts.
In the conduct of an audit, the auditor must consider whether the following are present:
1.Proper accounting records being kept by the company.
2.Financial statement figures that agree with accounting records.
3.Adequacy of notes to financial statement and other disclosures necessary.
4.Compliance with relevant laws and standards of financial accounting and reporting.