Solutions manual

to accompany

Contemporary issues in
accounting
2 edition
nd

by

Rankin, Ferlauto, McGowan and

Stanton

Prepared by
Kimberly Ferlauto

© John Wiley & Sons Australia, Ltd 2018

Solution manual to accompany: Contemporary issues in accounting 2e by Rankin et al.

Chapter 7: Corporate governance

Contemporary issue 7.1

Audit committees put risk management at the top of their agendas

Questions
1. Traditionally, audit committees have primarily focused on managing
financial reporting risk (i.e. risk of misstatements in financial statements)
and reviewing aspects such as internal control systems. Do you believe the
expansion of this committee’s role to consider business risk appropriate?
2. The extract notes a link between compensation structures within companies
and risk management. Explain how these are related?

1. There is no correct answer here and students may have different views. Points to
make could include:
 An essential part of any audit committee, even if focussing primarily on
financial reporting issues, would include an assessment of risk as this would
impact on issues such as going concern, impairment, values in financial
statements etc., so the committee does need to understand the company’s risk
profile.
 Given significance and importance of risk management (and failures
associated with this in the global financial crisis) there is a need to manage and
control risk. It could be argued that given its other functions, that necessarily
require an understanding of this risk, that the audit committee is well placed to
provide such control and oversight.
 Alternative views are:
o This could overburden audit committees and impede its effectiveness.
o It could be preferable to have a separate risk committee who can
therefore concentrate on business risk

The Institute of Chartered Accountants in Australia together with the UK Financial

Reporting Council and the Institute of Chartered Accountants of Scotland, have
recently published a paper “Walk the line: Discussions and insights with leading audit
committee members” which provides insights from a series of interviews with audit
committee chairmen of publicly listed companies about the role and challenges facing
audit committees. This can be accessed from:
 http://www.charteredaccountants.com.au/Industry-Topics/Audit-and-
assurance/Current-issues/Recent-audit-headlines/News-and-updates/Thought-
leadership-paper-reviews-the-role-of-the-audit-committee

2. It should be understood, that compensation structures provide powerful signals

about what an organisation values and rewards. As such they provide a way to direct
employee behaviour. Hence compensation structures should consider how they will
be interpreted by employees and what actions they will encourage (and discourage). If
compensation structures for example reward risk (for example, focusing on short term
targets and not considering long term impacts) then these would be expected to
increase the companies risk profile.

Students may think of some specific examples:

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 Chapter 7: Corporate governance

 If a bank pays bonuses on the basis of loans granted but does take into account
the risk associated with the loan (i.e. whether there is likely to be a default by
the customer) this would seem to explicitly encourage granting of loans even
where risk of default is high. (A compensation package to deter this could
either have a ‘claw back’ provision – so if loan goes ‘bad’ bonus needs to be
repaid, or have a large part of bonus paid at a later time when the likelihood
of default can be more accurately assessed).

© John Wiley and Sons Australia, Ltd 2018 7.2

Solution manual to accompany: Contemporary issues in accounting 2e by Rankin et al.

Contemporary issue 7.2

The individual must take responsibility for doing the right thing

Questions
1. This article discusses the issue of a code of conduct in corporate governance.
Discuss whether a code of conduct is necessary for good corporate
governance.
2. The article states that it is impossible to legislate for ethics. Do you agree with
this? If this is the case, does this mean regulation is ineffective?

1. A code of conduct is necessary for good corporate governance. A well designed

and implemented code of conduct should reduce risk of inappropriate or damaging
behaviour on the part of employees. Such behaviour can have a great impact on
companies both financially and in terms of reputation.

The existence of a robust code of conduct portrays integrity in the eyes of

stakeholders. It sets the tone and contributes to the positive image of the organisation.

2. Student responses may vary here. Some may agree with this statement while others
may not. Points for consideration include:
 Can we predict what ethical dilemmas may arise and are we therefore able to
cater for every possible situation in the potential legislation?
 Is it always black and white? Right or wrong? Or does it depend on context?
 There could be more than one way of dealing with an ethical dilemma.
 How would we monitor compliance and enforce if ethics were regulated?
 Is legislative backing necessary for employees to take a code of conduct
seriously?

It does not mean that regulation is ineffective. It does however highlight the
difficulties associated with implementing and enforcing legislation. We are also
talking about predicting and managing human behaviour and each individual is
unique. This makes a blanket approach such as implementation of legislation that
applies to all people and all situations impossible. Regulation is not ineffective, but
rather, difficult to apply and enforce when it comes to ethical behaviour.

© John Wiley and Sons Australia, Ltd 2018 7.3

 Chapter 7: Corporate governance

Review questions

7.1 Explain what is meant by corporate governance and why it is needed. (LO2)

Corporate governance in very simple terms is ‘the system by which business

corporations are directed and controlled’ (Cadbury, cited in Cowan, 2004, p. 15.).

The OECD’s definition expands on this:

The corporate governance structure specifies the distribution of rights

and responsibilities among the different participants in the organisation
— such as the board, managers, shareholders and other stakeholders —
and lays down the rules and procedures for decision-making. By doing
this, it also provides the structure through which the company objectives
are set, and the means of attaining those objectives and monitoring
performance.

To have a good corporate governance system ensures that the corporation sets
appropriate objectives, and then puts systems and structures in place to ensure those
objectives which are set are met. It also provides a means for persons both within and
outside the corporation to be able to control and monitor the activities of the
corporation and its management.

With the increasing globalisation of business and competition for capital, companies
that can provide assurances of good corporate governance will have a competitive
edge in the market place and facilitate economic growth.

7.2 ‘Corporate governance is primarily focused on protecting the interests of

shareholders.’ Discuss. (LO2)

This would depend on what point-of-view you take:

(a) Traditional — the role of the corporation from a traditional view by Milton
Friedman is that ‘corporate governance is to conduct the business in accordance
with the owner or shareholders’ desire, which generally will be to make as much
money as possible while conforming to the basic rules of the society embodied
in law and local customs’.

(b) Pluralist model — the responsibility of corporations goes beyond the narrow
interests of shareholders and should be extended to a wider group of
stakeholders.

(c) Anglo-Saxon model — tends to focus on the problems caused by the

relationship between managers and owners and often takes a control-orientated
approach, concentrating on mechanisms to curb self-serving managerial
decisions and actions.

In practice, shareholders are a key focus on most corporate government systems in

large corporations. Whether the focus should be primarily on shareholders interest is

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Solution manual to accompany: Contemporary issues in accounting 2e by Rankin et al.

of course debatable and this would make a good discussion question for the class. Of
course, other entities (such as not-for-profit and public sector entities) should also
practice good corporate governance and these entities would not have ‘traditional’
shareholders. Students may wish to consider whose interests would be of primary
focus with such entities.

7.3 What are risks of poor corporate governance and the advantages of good
corporate governance? (LO2)

Risks of poor corporate governance can be from:

 a company making use of resources to benefit themselves. In some cases, it may
go as far to involve fraud. It is often more subtle in regard to false reporting
because of the desire to maintain the value of benefits provided to corporate
managers.
 corporations taking actions that shareholders may not consider desirable
 corporations ‘hiding’ or providing ‘false’ information to shareholders to avoid
consequences
 disparity between payments received by managers or corporations to their
performance.

Ultimately students should realise that such actions can risk the wealth of
shareholders and other stakeholder groups (such as employees and customers), can
increase costs to the corporation and even put at risk the continuation of the
corporation itself.

Advantages of good corporate governance:

 provides assurance that companies are properly managed
 required for an efficient market
 facilitates economic growth.

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 Chapter 7: Corporate governance

7.4 Explain what is meant by the positive accounting theory and its relationship
to corporate governance. (LO3)

Positive accounting theory, using as its basis contracting theory, views the firm as a
network of contracts or agreements. These contracts determine the relationships with
and among the various parties involved. A key relationship is the agency contract.
An agency relationship by definition has two key parties:
1. a principal who delegates the authority to make decisions to the other party
2. an agent who is the person given the authority to make decisions on behalf of
the principal.

In this context the agent is the manager and the principals are the shareholders. Whilst
the agent has a duty to act in the interests of the principals there is a common
assumption in economic theory which is, if individuals are rational, they will act in
their own best interests and this can lead to the agent making decisions to maximise
their own wealth, rather than the principals.
Principals are also rational and will expect that the managers will not always act
in the shareholders’ interests. This leads to three costs associated with this agency
relationship:
• monitoring costs. These are costs incurred by principles to measure, observe and
control the agent’s behaviour.
• bonding costs. These are restrictions placed on an agent’s actions deriving from
linking the agent’s interest to that of the principal
• residual loss. This is the reduction in wealth of principals caused by their
agent’s non-optimal behaviour.

This theory also identifies ways in which managers can act against shareholders’
interests known as ‘agency problems’, and that these problems can be reduced by
linking management’s rewards to certain conditions. Students should refer to the
chapter, which provides an overview of the shareholder–manager relationship in
agency theory.

Corporate governance is concerned with controlling and directing businesses and in

the company context there is often a clear separation of owners (shareholders) and
managers. Hence an agency relationship exists. A number of the principles in
corporate governance (and these are further reflected in more specific
prescriptions/rules) are espoused to address the problems associated with the agency
relationship as outlined in positive accounting theory.

For example the OECD principles of corporate governance specify that:

• managers’ remuneration should be linked to shareholder interest and that a key
responsibility of the Board is ‘aligning key executive and board remuneration
with the longer term interests of the company and its shareholders’.
• the remuneration policy for executives and board members needs to be
disclosed to shareholders.

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Solution manual to accompany: Contemporary issues in accounting 2e by Rankin et al.

7.5 Identify the key areas addressed in corporate governance and provide
examples of practices related to each of these areas. Explain how any
individual practices identified help ensure good corporate governance.
(LO4)

Corporate governance involves ensuring that the decisions made by those managing
the corporation are appropriate and providing a means to monitor corporate activities
and the decision making itself. It is primarily concerned with managing the
relationship between the shareholders, the key managers of the corporation (this is
usually the Board of Directors), other senior managers within the corporation, and
other stakeholders. Many countries have developed suggested (and sometimes
required) lists of rules or descriptions of the types of practices that should be included
in corporate governance systems. However, it is generally acknowledged that there is
no ‘one’ system of corporate governance. The practices and procedures required or
desired will be affected by:
 The nature of the particular corporation and its activities. For example, in some
companies there are dominant shareholders whereas in others shareholding may
be more widely spread, and
 The environment in which the corporation operates

The text identifies three key areas to be addressed by any corporate governance
system:
1. processes and methods to control and direct the actions of managers of the
corporation to ensure make appropriate decisions
 Specific examples of corporate governance requirements here are minimum
standards of experience for directors; requirements that at least some of
members of board of directors be independent.

2. processes and procedures to ensure that stakeholders (such as shareholders) have

the ability to protect their interests
 Specific examples here would be voting rights and rights of shareholders to
call meetings.

3. to ensure that adequate information is provided to ensure transparency and meet

accountability obligations of management.
 Specific examples here include requirements in relation to annual reports.

Students may also wish to consider how these areas are addressed in the summary of
3 codes of corporate governance in table 7.1).

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 Chapter 7: Corporate governance

7.6 What is the rules-based approach to corporate governance and what are
the advantages and disadvantages of this approach? (LO5)

Rules-based approach identifies precise practices that are required or recommended

to ensure good corporate governance. For example, there may be a rule that an audit
or remuneration committee be established. The text provides some examples of
specific rules.

The advantages of this approach are:

 It provides at least a set of minimum corporate governance practices that must
be followed by all corporations, and
 There is no uncertainties as to which practices are required. This also assists
with enforcement and with potential liability in terms of litigation.

The disadvantages of this approach are:

 While this provides a minimum set of practices, it is likely that good corporate
governance requires practices beyond the minimum prescribed.
 It also can encourage a ‘check list’ (form over substance) approach to corporate
governance.
 The legislative backing of rules can result in the view that corporate governance
is about dealing with legal liability rather than about promoting the interests of
shareholders and stakeholders (Bruce, 2004).
 It is generally accepted that there is no ‘one’ model of corporate governance. A
rules-based approach is essentially a ‘one size fits all’ approach and does not
take into account the specific circumstances of the particular entity (e.g. such as
distribution of shareholders, nature of environment).

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Solution manual to accompany: Contemporary issues in accounting 2e by Rankin et al.

7.7 Explain the difference between a rules-based and a principles-based

approach to corporate governance. What are the advantages and
disadvantages of each approach? (LO5)

A rules-based approach identifies specific practices that are required to achieve good
corporate governance. A principles-based approach provides broad principles or
objectives for the corporate governance system that reflect good corporate
governance practice and it is up to management to determine how this objective can
best be achieved. For example, the broad principle may be that the corporation
should ensure that there is accurate and adequate disclosure of information. Rather
than identifying the specific practices that may assist in helping meet this objective, a
principles-based approach places the responsibility on managers to consider which
specific practices are most appropriate, given the individual circumstances of the
entity.

The advantages of a rules-based approach are:

 It provides a minimum set of corporate governance practices that must be
followed by all corporations
 No uncertainty around which practices are required
 Easy to enforce (they have either implemented the required practice or they
have not)
 No blurred lines with regard to potential liability in terms of litigation

The disadvantages of a rules-based approach are:

 It encourages a minimalist checklist type approach. Good corporate
governance should be something to aspire to. It requires much more than
meeting a minimum set of standard practices.
 Legislative backing changes the focus from promoting the interests of
shareholders and stakeholders to about what we need to do to avoid legal
liability.
 Promotes a one size fits all approach which may not be appropriate when each
entity faces its own unique circumstances.

The advantages of a principles-based approach are:

 It places a higher level of duty on directors to determine which corporate
governance practices are required, rather than simply accepting a minimum set
of practices as being adequate.
 Its flexibility means that the corporate governance practices can be adapted for
the particular circumstances of the entity and the environment in which it
operates.

The disadvantages of a principles-based approach are:

 It essentially leaves it to the directors to interpret these principles and decide
which corporate governance practices are needed and so relies on their honesty,
integrity and commitment to good governance.
 Directors may not be competent or act in good faith. Many of the corporate
abuses that have renewed the interest in corporate governance practices have
stemmed from people not acting appropriately.
 It can lead to uncertainty about what constitutes appropriate practices.

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 Chapter 7: Corporate governance

7.8 Discuss the impact of the global financial crisis and recent corporate
collapses on corporate governance practices. (LO6)

There has been an increased focus on risk management. Company failure to manage
and control risk has been found to be a big contributor to the global financial crisis. It
is also a common cause of corporate collapses or failures. Risk management is often
ineffective because the process of risk identification and analysis is not carried out in
enough depth. We first need to fully understand the risks before we can put controls
and safeguards in place to manage and control them. This has also led to an increasing
role for audit committees.

There has also been an increased focus on executive remuneration. The issues
associated with exorbitant executive remuneration have been contentious for a while
and were highlighted even more so during the global financial crisis. Issues of
concern that arose were that directors and executives were paid huge bonuses which
appeared to be unrelated to performance of the company. These are paid even when
company performance was deficient. Another issue was that remuneration packages
and bonuses were found to reward short term goals and this encouraged excessive risk
taking.

7.9 Explain the term risk management. Why is risk management such an
important part of good corporate governance practice? (LO6)

Oversight and responsibility for risk management lies with the board. Risks can be
wide ranging and as the ASX code states may include “operational, environmental,
sustainability, compliance, strategic, ethical conduct, reputation or brand,
technological, product or service quality, human capital, financial reporting and
market-related risks”. It is important that the board identifies, analyses and considers
an overall strategy for managing and controlling these risks.

The text outlines 4 problems with risk management.

1. A disjointed approach to risk management where risk was not managed or

monitored at the entity level but at individual activity level so no effective
understanding or oversight of risk for the corporation overall.
2. Information about risks not reaching the board or board members not being
able to understand or appreciate the risks involved.
3. Culture (pursuing growth in profits) of the corporation encouraged risk
taking.
4. A ‘disconnect’ or ‘mismatch’ between a company’s overall risk strategy and
related procedures. For example, many remuneration packages provided
incentives for high-risk activities and short-term outlooks.

A good corporate governance system ensures that the corporation sets appropriate
objectives, and then puts systems and structures in place to ensure those objectives
which are set are met. It also provides a means for persons both within and outside the
corporation to be able to control and monitor the activities of the corporation and its
management. A key role is to protect the interests of stakeholders (including
shareholders). To do this it is essential that risk is understood, monitored and

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Solution manual to accompany: Contemporary issues in accounting 2e by Rankin et al.

managed. However, historically most corporate governance models have not

highlighted the importance of risk management.
7.10 Explain the problems identified over the years in relation to risk
management and remuneration and discuss how these relate to corporate
governance. (LO6)

Problems identified in relation to risk management include:

1. Ultimate oversight and responsibility for risk management lies with the board.
Risks can be wide ranging and as the ASX code states may include “operational,
environmental, sustainability, compliance, strategic, ethical conduct, reputation or
brand, technological, product or service quality, human capital, financial reporting
and market-related risks”. Hence it is important that the board considers the overall
strategy. Managing these risks in isolation (at activity level) is not sufficient.

2. Cleary the board needs information about risks the company faces and how these
are managed. Without sufficient information, and understanding of these, the board
cannot perform its duties. It is claimed this was problematic given the complexity
of the financial instruments associated with in the global financial crisis. The ASX
code now recommends that management provide a report to the Board about the
risk management systems implemented and their effectiveness.

3. Every organisation has its own unique culture or value set. Most organisations
don’t consciously try to create a certain culture. The culture of the organisation is
typically created unconsciously, based on the values of the top management and
influenced by reward systems, management actions and attitudes. A culture of
growth needs to be balanced with consideration given to any risks.

4. There needs to be a consistent approach to risk management and it needs to be

reflected in the company’s procedures and practices. For example, any formal
policies to reduce or control risk are likely to be s disregarded if compensation
packages actually reward risk.

Problems identified in relation to remuneration include:

1. A disconnect/mismatch between bonuses paid to executives and company
performance. This was seen as particularly problematic given lack on information
about these packages and any ability to curb/stop these bonuses.

There can be really 2 concerns here. First, often there is a perception that
remuneration to some executives is excessive- how can these people warrant such
huge payments. In good corporate governance directors/executives are supposed to
act in the best interests of shareholders. Yet paying what seems unjustifiable amounts
to themselves could be seen as a conflict of interest. Second, remuneration packages
are supposed to be tied to company performance; this is what the Board and other
executives are responsible for and hence what they are rewarded for. Yet despite poor
or deteriorating company performance (even in some cases failure) many executives
still received large (and increased) bonuses. How can this be justified?

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 Chapter 7: Corporate governance

2. Compensation packages focused on short terms goals and encouraged excessive

risk.

It should be understood that compensation structures provide powerful signals about

what an organisation values and rewards. As such they provide a way to direct
employee behaviour. Hence compensation structures should consider how they will
be interpreted by employees and what actions they will encourage (and discourage). If
compensation structures for example reward risk (for example, focusing on short term
targets and not considering long term impacts) then these would be expected to
increase the companies risk profile.

Students may think of some specific examples:

 If a bank pays bonuses on the basis of loans granted but does not take into
account, the risk associated with the loan (i.e. whether there is likely to be a
default by the customer) this would seem to explicitly encourage granting of
loans even where risk of default is high.
 A compensation package to deter this could either have a ‘claw back’ provision
– so if loan goes ‘bad’ bonus needs to be repaid or have a large part of bonus
paid at a later time when the likelihood of default can be more accurately
assessed.

7.11 Corporate governance has been highlighted as an important factor in

alleviating the risk of corporate failure. Evaluate which aspects of
corporate governance are likely to guard against corporate failure. (LO8)

Strong corporate governance that is likely to guard against failure will have the
following characteristics:

 Boards are active in setting and approving the strategic direction of the
company
 Boards are effective in overseeing risk and setting an appropriate risk level for
the entity
 Boards consist of independent directors, with audit, compensation and
nomination committees made up completely from independent directors
 Directors own an equity stake in the company
 Director quality - At least one of the independent directors should have
expertise in the entity’s core business, attend the majority of meetings and
limit the number of boards they sit on
 Boards should meet regularly without management present

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Solution manual to accompany: Contemporary issues in accounting 2e by Rankin et al.

7.12 ‘Any corporate governance system is only as good as the people involved
in it’. Discuss. (LO9)

As the text notes decisions in, and about, corporations are made by people. The
quality of any corporate governance is ultimately affected by the people involved in it.
The following points could be discussed:
 Competence — clearly, if individuals do not have the requisite expertise or
experience then this will adversely impact on decisions they make and reduce
the quality of corporate governance.
 Integrity (ethics) of individuals. Whether or not individuals will act ethically is
affected by a number of factors. These include:
– the individual’s own moral code
– the culture of the corporation and of peers. This is particularly important in
relation to top management. In a number of corporations it is argued that
either ethical or unethical behaviour permeates due to the stance taken by
the ‘leaders’.
– the consequences of the decision. For example, if asked to do something
that is not ‘right’ by a manager and refusing could impact on
employment/future promotion; how ‘wrong’ is the decision and will it
have a significant impact on others; what is the likelihood of being caught
and what are the consequences if found to be acting unethically).
 Does the quality of individuals become more or less important if you have rules-
based or principles-based corporate governance codes?
– There is no correct answer here. Rules-based allows companies to restrict
practices to the specific rules and, hence, can argue that a form over
substance approach can justify or defend unethical behaviour so long as
rules are followed. Principles-based requires interpretations —
presumably, if individuals do not act ethically there will be flexible
interpretations of these. This is also obviously affected by enforcement
and also legal issues (such as courts and what standards they consider
when determining guilt and penalties for unethical behaviour).
 Does the quality of individuals become more or less important if you have
voluntary or legislated corporate governance codes?
– This relates to the points made above. Again, if voluntary then relies more
on individuals. However, legislated codes again can lead to the same
problems as rules-based approach. The text notes the example in Hong
Kong where codes are high but often not implemented.

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 Chapter 7: Corporate governance

Application questions

7.13 Obtain the annual reports of a range of companies in the same industry
and country and search for any disclosures in relation to corporate
governance principles and practices. In relation to these disclosures:
(a) identify the key areas considered by these companies
(b) are there any differences or similarities in corporate governance
practices?
(c) do you believe you could judge or rank the relative standard of
corporate governance of these companies based on the information
provided? If not, what other information would you need to do so?
(d) which company would you rank has having the best (or worst)
corporate governance from these disclosures? Explain how you have
arrived at this decision.
(e) compare your rankings with those of other students. Identify and
discuss the reason for any discrepancies between rankings.
(LO4, LO5, LO6 and LO7)

No specific answers can be provided as this will depend on the companies considered.
Go online and download a couple of annual reports in the same industry, from 2013 to
2018 and see the differences. Discuss the following in class:
(a) What have you found out about the key areas?
(b) Explain the differences and similarities in class, on your Blackboard or WebCT.
(c) Discuss the judgement you have made.
(d) Did you identify the best and worst cases or corporate governance?

7.14 Obtain the annual reports of a range of companies in the same industry in
different countries and search for any disclosures in relation to corporate
governance principles and practices. In relation to these disclosures:
(a) Identify any differences or similarities in corporate governance
practices.
(b) Can you provide any reasons from the business and regulatory
environments in the countries that would explain these differences?
(LO4, LO5, LO6, LO7 and LO10)

No specific answers can be provided as this will depend on the companies considered.
Again go online and download annual reports from various countries to discuss in
class. It may also be useful to consider, identify and compare:
 country economic and business environmental factors
 any specific corporate governance guidelines or requirements issued for
companies in the specific countries considered, for example by local stock
exchanges, as well as considering enforcement mechanisms.
In class, explain the differences or similarities in corporate governance practices.

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Solution manual to accompany: Contemporary issues in accounting 2e by Rankin et al.

7. 15 Many small companies argue that corporate governance requirements are

too costly and onerous and should be restricted to the large ‘top’
companies.
(a) Do you think that corporate governance principles should apply to
smaller companies?
(b) Provide examples of particular corporate governance practices or
principles that you do not think should apply to smaller companies?
Explain why you think these practices or principles are also
important for smaller companies.
(c) What would be the advantages of smaller companies complying with
corporate governance principles?
(d) What might be the consequences for smaller companies of not
complying with corporate governance principles?
(LO4, LO5, LO6 and LO7)

(a) The basic principles of corporate governance would appear to apply to all
companies, even smaller and medium-size companies. As discussed in question 1,
corporate governance in very simple terms is ‘the system by which business
corporations are directed and controlled’ (Cadbury, cited in Cowan, 2004, p. 15.).

To have a good corporate governance system ensures that the corporation sets
appropriate objectives and then puts systems and structures in place to ensure those
objectives which are set are met. It also provides a means for persons both within and
outside the corporation to be able to control and monitor the activities of the
corporation and its management.

The basic principles would apply to all corporations, large or small. Although it could
be argued that the mechanisms to achieve these would vary as these issues become
more critical in larger companies with greater separation, and also in smaller
companies cost efficiencies would need to be more carefully considered.

(b) Student answers may vary here. It is suggested that the same principles should
apply but specific practices may vary. For example, PCW have produced a toolkit for
corporate governance in small and medium enterprises.

This is the link to the tool kit http://www.himaa.org.au/Governance/toolkit_print.pdf

Smaller companies should still strive to fulfil the same principles and objectives as
larger companies when it comes to corporate governance. In smaller companies there
may be less emphasis on protection of shareholders and other stakeholder interests
because there are less of them, but in principle, this is still important. Good corporate
governance practices will also enhance reputation and increase confidence in the
entity. The principles and objectives are the same and are just as important for smaller
entities. It is just that they go about achieving them in different ways. Specific
practices Implemented might be different to those implemented by larger
corporations. Please see toolkit above for examples.

(c) Advantages of good corporate governance would also apply to smaller companies.
In particular, for small companies these would include:
 provides processes and assurance that companies are properly managed

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 Chapter 7: Corporate governance

 managing risk and facilitating economic growth (including entering emerging

markets as investors need assurance that appropriate controls/systems are in
place).

(d) These were noted in question 3 above, that risks of poor corporate governance can
be from:
 a company making use of resources to benefit themselves. In some cases, it may
go as far as to involve fraud. It is often more subtle, false reporting because of
the desire to maintain the value of benefits provided to corporate managers.
 corporations taking actions that shareholders may not consider desirable
 corporations ‘hiding’ or providing ‘false’ information to shareholders to avoid
consequences.
Students may wish to consider the following:
(a) List the particular websites that address corporate governance for small
companies.
(b) Did you find any advantages to small companies having corporate governance
requirements?
(c) What were the consequences?

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Solution manual to accompany: Contemporary issues in accounting 2e by Rankin et al.

7.16 A friend cannot understand why executives and directors of companies

are often paid bonuses and not simply paid a set salary.
(a) Using principles from positive accounting theory, explain the reasons
for, and nature of, bonus plans offered to directors and executives.
(b) Why are shares or share options often incorporated as part of a
manager’s remuneration package?
(LO3)

(a) Need to first explain agency theory which is a key principle in positive accounting
theory. An agency relationship by definition has two key parties:
1. a principal who delegates the authority to make decisions to the other party
2. an agent who is the person given the authority to make decisions on behalf of
the principal.

The separation of ownership and control means that managers can act in their own
interests which may be contrary to the interests of shareholders. Managers have
variety of ways of reducing wealth to shareholders for the benefit of themselves.
These problems include risk aversion, dividend retention and horizon. Given these
specific difficulties (the problems discussed below) to alleviate these problems
managers remuneration is not simply paid as salary but by a bonus linked to variables
that try to reduce these problems. The problems are:

i the risk aversion problem — managers prefer less risk than shareholders because
their human capital is tied to the firm. Shareholders are more diversified because
their human capital is not tied to the firm. Managers can reduce their own risk by
investing in low risk investments rather than maximising the value of the firm
through higher risk projects.
A bonus plan that relates managers’ salaries to profit may encourage less risk
aversion.

ii the dividend retention problem — managers prefer to pay out less of the
company’s earnings in dividends in order to pay for their own salaries and
perquisites (big offices, expensive business trips).
Relating a part of mangers’ remuneration to profit and requiring that a minimum
dividend payout ratio be maintained can help.

iii the horizon problem—managers are only interested in cash flows for the period
they remain with the firm whilst shareholders have a long term interest in the
firm’s cash flows.
Principals may relate part of managerial compensation to share prices,
particularly for managers whose tenure is nearing completion.
Bonus schemes can reduce these problems by tying manager’s remuneration to some
index of the firm’s performance, which has a high correlation with the value of the
firm (share prices, earnings). This ties managerial compensation to performance.
Remuneration can also be tied to dividend payout ratios or to options or share bonus
schemes

Hence, this explains why is it preferable to pay managers a bonus (linked to

appropriate variables/targets) rather than a set salary.

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 Chapter 7: Corporate governance

It may be interesting to examine details of remuneration packages of directors etc.

(often these are disclosed in annual reports or available on the company’s web page as
a separate remuneration report) and see how these principles are reflected in the
packages.

(b) The rationale for incorporating shares or share options as part of a manager’s
remuneration is to reduce the potential problems that arise due to the agency
relationship between mangers and shareholders. In other words, it addresses the issue
of conflicting interests. It aligns the interests of managers and shareholders so that
managers are more likely to act in the best interests of shareholders, rather than acting
in their own self-interest in a way that is detrimental to shareholders.

© John Wiley and Sons Australia, Ltd 2018 7.18

Solution manual to accompany: Contemporary issues in accounting 2e by Rankin et al.

7.17 Obtain the annual report for a listed company and examine the
remuneration packages provided for executives.
(a) Identify the key components of the remuneration packages for
directors and executives. Do the principles of agency theory provide a
rationale for each of these components?
(b) Would these packages provide incentives for these executives to
manipulate accounting figures?
(c) How much information is provided about any bonuses paid? Is this
information sufficient to allow shareholders to determine if these
packages are reasonable?
(LO3)

Note: these are disclosed in annual reports (or available on the company’s web page
as a separate remuneration report) and see how these principles are reflected in the
packages.

A suggested example is the 2010 annual report for AMP — this includes details of the
remuneration package and related benchmarks. You can access this from links from
http://www.amp.com.au/ or the 2011 annual report for Crown Ltd which includes
details of the amounts of potential cash bonuses. You can access this from links from
http://www.crownlimited.com.

(a) Relate the key components of the remuneration packages identified to the three
problems of agency theory identified. These problems include risk aversion, dividend
retention and horizon and are discussed in the answer to 7.4.

You may wish to consider the following:

 Are the benchmarks/targets for obtaining these bonuses clear?
 Are these reasonable for rewarding performance? For example, if linked to the
share price of the company do they take into account general share price
movements for similar companies? If they do not, then they may be penalising
or rewarding managers for market factors rather than their own performance.
 Are there any components that do not ‘fit’ with the principles of the
shareholder/manager agency relationship? If so, why do you think these
components are included?

(b) You will need to consider the following:

 If any of the bonuses are linked directly to accounting numbers (such as profit)
then there may be incentives to manipulate to increase bonuses
 If linked to non-accounting numbers (such as dividends or share price) then you
would need to consider market efficiency? For example, if the market would
increase share price if profit increases via changes in accounting profit (i.e. the
market is not efficient) then this would also create incentives to manipulate
accounting figures.

(c) This will depend on the reports that you have found. You will probably find that in
many cases there is limited information (in particular about benchmarks — often
generic information about benchmarks is included rather than specifics). This makes it
difficult for shareholders to consider however there could be legitimate coemptive
reasons for not disclosing this information.

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 Chapter 7: Corporate governance

7.18 In many countries in Asia it is claimed that concentration of

ownership/control by families of companies causes particular difficulties
with corporate governance. For example, Hong Kong billionaire Richard
Li owns 75 per cent of Singapore-listed Pacific Century Regional
Developments.
(a) Examine corporate governance guidelines and identify specific
recommendations for practice aimed at protecting minority investors.
(b) Would these suggested practices be effective where there is a higher
concentration of family control in a company?
(LO3 and LO4)

(a) This will vary depending on the guidelines examined. For example:

 The ASX principles of best practice do not seem to specifically refer to minority
shareholders. However general principles regarding shareholders and
requirements of independent board members may assist. Link to ASX if this
needed is http://www.asx.com.au/governance/corporate-governance.htm

 The OECD principles do refer to minority shareholder interests in a number of

specific instances.
http://www.oecd.org/dataoecd/32/18/31557724.pdf
 The Chinese code has many references to minority shareholders
http://www.ecgi.org/codes/documents/code_en.pdf
 The Pakistan Corporate Governance guide for family- owned campiness also
specifically identifies the need to respect and protect minority shareholders
http://www.cipe.org/regional/southasia/pdf/CG_Guide_Pakistan_08.pdf

(b) There is no correct answer here. However, should consider issues such as:

 Even where codes specifically address issue of minority shareholders how can it
be ensured that rights considered given influence that any dominant
shareholders will have.
 Given that investment is choice and minority shareholders would know of
limitations to their power/influence when investing does this justify should
corporate governance be focused on majority concerns.

Students may also wish to go online and download information on Pacific Century
Regional Developments and consider the specific circumstances of the company.

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Solution manual to accompany: Contemporary issues in accounting 2e by Rankin et al.

7.19 Each year various bodies give corporate governance awards. Examples are,
in Malaysia, an annual award is made by Malaysian Business, sponsored by
the Chartered Institute of Management Accountants (CIMA), and with
The Australasian Reporting Awards (Inc.) – an independent not-for-profit
organisation – makes annual awards.
(a) Locate the criteria on which these awards are based and compare these
for different awards.
(b) Are there any significant differences between the criteria?
(c) In what areas of corporate governance reporting did winning
companies outperform other companies?
(d) Does the wining of an award for reporting necessarily mean that these
companies have best corporate governance practices?(LO6 and LO7)

(a) For example, the Australasian Reporting Awards and criteria for corporate
governance awards states that “These Awards seek to recognise the quality and
completeness of disclosure and reporting of corporate governance practices in the
annual reports of business entities in the public and private sectors.” for private sector
entities states. Review the criteria section at http://www.arawards.com.au/

(b) This will depend on awards criteria reviewed.

(c) This will depend on information available. For example, the Australasian
Reporting Awards identifies companies that have been ranked as gold, silver or
bronze and specifies what the differences are in being awarded this rating. So it may
be useful to look at reports for companies in these different rankings to identify any
differences. For example, one difference between gold and silver is that gold requires
‘full’ disclosure whereas silver requires ‘adequate’ disclosure.

(d) Students should consider:

 How would you tell if a company did not follow these practices that they have
claimed?
 How likely it is that companies who do not have good corporate governance
practices would disclose this fact? It may be what is not disclosed that is important.

(Remember: Enron was perceived as one of the best but fell short in practice)

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 Chapter 7: Corporate governance

7.20 Australian companies listed on the ASX must report on their corporate
governance practices on the basis of ‘comply or explain’. That is, they are
not required to comply with all of the specific corporate governance
practices detailed by the ASX but if they choose not to comply, they must
identify which guidelines have not been ignored and provide a reason for
their lack of compliance.
(a) Examine the corporate governance disclosures of some Australian
listed companies and identify any instances where best practice
recommendations of the ASX have not been met.
(b) Do you believe that the noncompliance in these instances is justified?
(c) What are the advantages of having a ‘comply or explain’ requirement
rather than requiring all companies to comply with all best practice
recommendations?(LO4)

(a) Examples are in questions 7.9 and 7.10. Students should be able to find own
examples.

(b) See responses to questions 7.9 and 7.10. Responses will depend on the nature of
non-compliance and also circumstances and reasons given by particular company for
non-compliance.

(c) The advantages is that this allows specific circumstances of a company to be

considered when determining appropriate corporate governance practices (so for
example, does not impose a ‘one size fits all’ approach regardless of the size of the
company). This is consistent with the principles-based approach to corporate
governance. While this allows flexibility, the fact that the need to disclose and justify
non-compliance also allows shareholders and other stakeholders to clearly identify
any instances of non-compliance and also requires management to consider this (it
could be argued as need to disclose if do not comply then management need to
explicitly consider whether or not non-compliance is justified as will be open to
scrutiny).

© John Wiley and Sons Australia, Ltd 2018 7.22

Solution manual to accompany: Contemporary issues in accounting 2e by Rankin et al.

7.21 In the 2009 annual report of Boral Ltd (an Australia-listed company), the
corporate governance disclosures include the following note:

The Board has considered establishing a nomination

committee and decided in view of the relatively small
number of Directors that such a Committee would not be a
more efficient mechanism that the full Board for detailed
selection and appointment practices. The full Board
performs the functions that would otherwise be carried out
by a Nomination Committee.

(a) Examine the ASX corporate governance principles and identify the
best practice recommendations in relation to nomination committees.
(b) What potential governance problems are these recommendations
designed to meet?
(c) Is Boral’s deviation from these best practice recommendations
justified?
(d) In March 2010 (see 2010 annual report), Boral did introduce a
Nomination Committee (as part of the Remuneration Committee)
although it is noted that the number of directors remained the same.
What reason can you think of for this change, given Boral’s
previously stated reason for not complying with this best practice
recommendation previously?
(LO4)

(a) ASX Corporate Governance Principles can be found at

http://www.asx.com.au/governance/corporate-governance.htm

The ASX recommendations for a nomination committee are related to Principle 2;

Structure the Board to add value. The specific recommendation for the nomination
committee is 2.4. This indicates that for smaller companies a separate, formal
committee may not realise desired efficiencies.

The recommendation includes:

 A charter establishing roles and responsibilities
 Composition of at least 3 with majority independent and chaired by
independent director
 Responsibilities include making recommendations about required
competencies of directors, succession plans, appointments and process for
evaluation of performance
 Selection and appointment process and re-election of directors

(b) Students should see that given the role of the Board of Directors is it essential that
those on the board are the ‘best’ people for this role. Also the responsibility to ensure
that the composition of the Board is of the right level of expertise, experience and
independence to ensure that it can meet its obligations, lies with the Board itself, a
nomination committee assists in this by specialising in the recruitment (so ensuring
that the company is able to recruit the ‘best’ people for these positions) and also
should assist in ensuring a balance of executive and non-executive directors (o to
avoid potential dominance. bias and protect shareholders interests).

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 Chapter 7: Corporate governance

If the nomination of Board members is undertaken without a nominations committee

this means that the Board itself is deciding on members without input or review from
any others. Firstly, the Board itself may not have the time or expertise to search and
recruit the best people (especially given their other duties). Also it is difficult for the
Board to consider itself and its members objectively. Historically, in particular the
recruitment of non-executive directors by the chairman of the Board, has been seen as
often compromised at least in terms of independence — clearly, if appointed by the
Board itself, new directors may feel under an obligation to support the people who
have appointed them. Students should recognise that a key risk in the Board making
appointments without a nomination committee is that the existing Board may choose
members who will agree with their own views and not be willing to challenge or
provide objective advice/criticism.

(c) Boral website is boral.com.au. Information about these best practice

recommendations can be found on the website: Boral 2009 annual report relating to
Board appointments and nomination committee and the annual directors review.
Boral site is http://www.boral.com/

Boral have justified their non-establishment of a nomination committee on the basis

of efficiency in light of the small number of Board members (this was 6 but was
increased in 2007 to 8). The ASX guidelines do state that for smaller boards a
nomination committee may not be efficient. Also, Boral notes that they do use an
external consultant in the process of identifying and assessing potential candidates.
This could alleviate some of issues of not having a nomination committee. Students
may arrive at different views as to whether deviations from best practice guidelines
are acceptable.

(d) The 2010 Boral annual report states:

In March 2010, the Board decided that it would be desirable to have a

committee to assist the board with its nomination responsibilities.
Accordingly, the responsibilities of the Remuneration Committee were
expanded to encompass nomination responsibilities, and the
Remuneration Committee was reconstituted as the Remuneration and
Nomination Committee. In addition to responsibilities relating to
remuneration, the Committee now has responsibility for making
recommendations to the Board on matters such as succession plans for
the Board, suitable candidates for appointment to the Board, Board
induction and Board evaluation procedures. P34

It should be noted that in 2010 although the number of directors remained the same
(at 8) there was a change in 2 directors. Also a comparison of the 2009 and 2012
annual reports reveals that more information is provided about this corporate
governance area in the 2010 annual report and it is also apparent that a review of
company policy in this area was undertaken. For example:
The 2009 Annual report stated:

The Directors believe that limits on tenure may cause loss of experience
and expertise that are important contributors to the efficient working of

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Solution manual to accompany: Contemporary issues in accounting 2e by Rankin et al.

the Board. As a consequence, the Board does not support arbitrary limits
on tenure and regards nominations for re-election as not being automatic
but based on the individual performance of Directors and the needs of the
Company. (p 33).

The 2010 Annual report stated:

The Directors have adopted a policy that the tenure of Non-Executive

Directors should generally be no longer than nine years. A Non-
Executive Director may continue to hold office after a nine year term
only if the Director is re-elected by shareholders at each subsequent
Annual General Meeting. It is expected that this would be recommended
by the Board in exceptional circumstances only.(p 35).

There is no correct answer to why Boral has changed this practice. Possible
reasons/motivations could include:
 The changes in 2 new directors may have motivated the board to review this
policy. They may have decided that the task was more appropriately and
efficiently handled by a committee.
 Increased scrutiny (or expected) on corporate governance practices following
the global financial crisis. In particular in Australia the changes relating to
shareholders voting and rights in relation to directors remuneration could have
prompted company to undertaken these changes.
 It is also likely that the company overall would be under increased scrutiny due
to its performance. As company operating in the building industry, the company
has been adversely affected by the global financial crisis (particularly the impact
on US property market) and also by a downturn in the Australian building
industry. Given the impacts on profits/earnings etc. this would be expected to
bring more scrutiny on directors’ performance/abilities etc.

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 Chapter 7: Corporate governance

7.22 In the 2010 Annual report of Biota Ltd (an Australia-listed company), the
corporate governance note disclosed an audit committee composed of two
directors (chaired by an independent nonexecutive director and
supported by one other nonexecutive director).
(a) Examine the ASX corporate governance principles and identify the
best practice recommendations in relation to audit committees.
(b) What potential governance problems are these recommendations
designed to meet?
(c) Does Biota’s audit committee meet these guidelines and if not, is any
deviation from these best practice recommendations justified?
(LO4)

(a) The ASX practices are outlined below in principle 4. Recommendations include:
 Establishing an audit committee
 Structure of this committee
 A formal charter
 Disclosures

(b) Students should recognise that the audit committee recommendations relate to
Principle 4.

So the establishment of an audit committee is seen as essential to safeguard the

integrity of the financial reporting. The outline of the audit report above indicates the
problems that this is trying to alleviate. The audit committee is trying to ensure that
the financial information is not compromised (i.e. for example, it aims to ensure that
the selection and appointment of the auditor who checks the reports is independent,
that the financial information provided to shareholders is adequate, and that the
internal control systems and management processes underlying financial reports are
adequate). This committee also assists in trying to ensure that reporting is not unduly
influenced by management.

(c) Information about the company’s ASX Corporate Governance Council Guidelines
can be found in the 2010 Biota annual report (www.biota.com.au)

Obtain the annual report for Biota and answer the questions.

Clearly Boral has not met the minimum three membership requirements
as recommended by the ASX, although both members are non-executive
independent directors.

It states (p. 12) that “The Board is of the view that the composition of the Audit and
Risk Committee and the skills and experience of its members are sufficient to enable
the Committee to discharge its responsibilities with the charter. All other non-
executive directors are able to attend meetings at the discretion of the Committee
Chair as observers.”

Biota could argue that have reduced membership on basis that it is a smaller company
with only 7 directors. Also 6 of the 7 board members are independent, including the
Board Chairman, and it is noted that “The Board Chairman attends most meetings as
an ex officio member of the committee.” The fact that is chaired and supported by

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Solution manual to accompany: Contemporary issues in accounting 2e by Rankin et al.

non-executive directors could be argued to alleviate any concerns, as well. Also the
fact that auditor has policy of rotation also may alleviate concerns.

Students may arrive at different views as to whether deviations from best practice
guidelines are acceptable.

7.23 At times there are problems (and subsequent investigations) with

corporate governance, which include deficiencies in financial reporting.
(a) Search the website of the Australian Securities and Investment
Commission and identify a case that has been investigated that
involves issues of corporate governance.
(b) Briefly discuss the corporate governance issues and the role financial
reporting played in these. Provide specific examples of deficiencies in
financial reporting that led to the issues.
(c) Suggest what specific procedures or practices could have prevented
these abuses from occurring.
(LO4, LO6 and LO7)

(a) The ASIC annual report provides a summary of major cases and the media centre
often provides summaries of cases considered or investigated (access from
http://www.asic.gov.au). The ‘key matters’ section at
http://www.asic.gov.au/asic/ASIC.NSF/byHeadline/Media%20centre has information
on major investigations/cases.

For example the 2010/11 annual report has details re breaches of duties by directors:
http://www.asic.gov.au/asic/asic.nsf/byheadline/Westpoint+bulletin?openDocument

Students will find other cases. For example, on the SEC (US) http://www.sec.gov/
site:
 http://www.sec.gov/news/press/2012/2012-21.htm - discusses a case of
accounting fraud.

(b) This will depend on the cases found by students. It may be useful to look at the
annual reports of companies involved in investigations and consider their corporate
governance disclosures (and practices).

(c) Gain, this will depend on the cases found by students. It may be useful to consider
the nature of cases and problems: e.g. did these require collusion (i.e. involvement of
more than one person); how were problems detected (this may give hint of how could
be prevented and whether corporate governance processes could have assisted); what
corporate governance disclosures did these entities make (do these indicate systems
acceptable).

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 Chapter 7: Corporate governance

Case study questions

Case study 7.1

Reining in executive pay

Questions
1. This article discusses the recent changes to address alleged excessive
executive remuneration. Identify the main features of the reforms and how
these could be effective.
2. The article argues that the effectiveness of the reforms is based on the
assumptions that shareholders will act. Is this assumption reasonable? What
are the barriers to effective share holder control?
3. The article argues that other ‘incentives’ — such as taxation laws and
denying contracts — should be implemented. Do you think such measures
would improve corporate governance practices?
(LO3 and LO4)

1. The article discusses changes in the US under the Financial Reform Act. These are
aimed at improving accountability and transparency.
The main features as described in the article are:
 Increased rights of shareholders: e.g. providing shareholders with rights to
vote (although non-binding) on executive compensation and also to ability
(under certain conditions) to nominate potential board members.
 Increased disclosure: e.g. of executive pay and how relates to actual financial
performance of the company; ratio of CEO compensation to median workers’
pay
 Increased control i.e. board compensation committee must be independent

Effectiveness of these reforms is interrelated. For example, adequate disclosure is

required if shareholders are to be able to make an informed vote on whether or not to
approve the compensation package. The type of information disclosed (such as how
relates to actual performance and relationship to ‘median’ pay) would presumably
‘highlight’ more clearly any disparities or incongruities. It could be argued that as the
shareholders vote is non-binding, this could be simply ignored; however companies
(and directors) would presumably wish to avoid the situation where shareholders vote
against their packages, particularly if there are provisions to allow these same
shareholders to nominate their own board candidates.

(Further details of reforms can be found in actual legislation but students are not
expected to consider beyond article).

Although not asked in the question it may be useful to consider the Australian
situation where there is now a ‘two- strike’ rule, where if more than 25% of
shareholders vote no to the company’s remuneration report at 2 consecutive annual
general meetings then there is a possible ‘spill’ of the Board.

2. Students may note the following as barriers to effective shareholder control:

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Solution manual to accompany: Contemporary issues in accounting 2e by Rankin et al.

 Willingness to act. It could be argued that shareholders with diverse portfolios

are less ‘concerned’ about specific companies, than their overall portfolios.
They can manage risk by diversification and holding a range of
shares/investments. In such cases they may be reluctant to intervene/take
action. This has also been claimed to apply to some institutional shareholders
who take a passive approach. Any ‘action’ here is likely to be restricted to
changing their portfolio of shares (e.g. selling shares) rather than actively
acting to challenge or question company management.
 Diversity and fragmentation of shareholders. In many companies there are
numerous minority shareholders. To take effective action such shareholders
would need to ‘combine’. This is difficult. In many cases few minority
shareholders even attend annual meetings etc. Further, many of these
shareholders may lack sophisticated business expertise.
 Cost of action. This also relates to discussion above. Taking action involves
costs- be these time, money. For minority shareholders (or investors with
diversified portfolios) the costs are likely to outweigh any potential benefits.
 Lack of information. Most shareholders rely on the information provided to
them by the company. If this is deficient then the effectiveness of any action
can be impeded.

3. The ‘incentives’ raised in the article are essentially economic incentives. Such
incentives are used to promote or deter certain actions. The incentives mentioned in
the article are:

 Setting a limit to tax deductions for executive pay

 Applying conditions on executive pay to be awarded government contacts

If such incentives were introduced this effectively places a potential ‘real’ economic
cost on companies (for example, if tax deductions limited for executive pay then any
amounts over the limited cost the company ‘more’ as no deductions would be
allowed).
Students could argue regarding possible effectiveness:

 In practice it is likely that such ‘incentives’ agree to and implemented, would

only be applied to extreme cases. Therefore their effectiveness is only limited
to a few companies. Also incentives such as those related to government
contracts would also only impact those companies involved in such contracts.
 Would these costs be material to a particular company- and therefore be an
effective control/deterrent? For large companies, even though executive pay
may appear disproportionate, these costs are usually minimal in the overall
company’s costs.
 People and companies are very inventive. It is possible (if not likely) that if
such incentives were introduced companies may ‘structure’ arrangements to
avoid any such limitations. We see examples in relation to the law or even
accounting standards where there can be the claim that the companies are
following the ‘letter’ of the law but not the spirit’. If companies can avoid any
limitations by such arrangements then this would impede effectiveness.

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 Chapter 7: Corporate governance

Case study 7.2

ABC Learning ‘reliant’ on debt to cover cash shortfalls

Questions
1. Outline the importance of cash flow to ensuring the ongoing operation of a
company.
2. Discuss the corporate governance and board mechanisms that could have
served to limit the chances of corporate failure in the case of ABC
Learning.
(LO4 and LO8)

1. The ongoing operation of a company requires adequate cash flow to pay debts
when they fall due. It does not matter how bigger profit they report on the
Income statement or how many assets are on their balance sheet. If they are
unable to pay for goods and services to maintain the current level of
operations, or if they are unable to repay their debts, the business will not be
sustainable.

2. Student responses will vary here but some key points for discussion include:
 Design and implementation of more stringent policies and procedures with
a strong commitment to Internal control from the top down
 Closer monitoring of financial reporting and results
 More long term planning and a solid strategy with regard to growth and
expansion of the business. This case is an example of too much too fast
with little integration.
 A more structured approach to risk assessment including closer monitoring
of liquidity and long term solvency

© John Wiley and Sons Australia, Ltd 2018 7.30