Lecture 1-Corporation and Introduction to Corporate Governance PDF

ACC 132 – Governance, Business Ethics, Risk Management, and Internal Control LECTURE 1: Corporation and Introduction to Corporate Governance Expected Learning Outcomes After studying Lecture 1, we should be able to: 1. Define a corporation and identify its characteristics; 2. Identify a...

ACC 132 – Governance, Business Ethics, Risk Management, and Internal Control LECTURE 1: Corporation and Introduction to Corporate Governance Expected Learning Outcomes After studying Lecture 1, we should be able to: 1. Define a corporation and identify its characteristics; 2. Identify and discuss the advantages and disadvantages of a corporate form of organization; 3. Identify the components of a corporation; 4. Describe what governance involves; 5. Enumerate the different contexts in which governance can be applied; 6. Explain the characteristics of good governance; 7. Explain the meaning, purpose and objectives of corporate governance; 8. Know and describe the principles of effective corporate governance; and 9. Understand how the principles of good corporate governance can be applied. Definition of a Corporation A corporation is an artificial being created by operation of law, having the right of succession and the powers, attributes and properties expressly authorized by law or incidental to its existence (Section 2, Revised Corporation Code of the Philippines). Characteristics of a Corporation 1. Separate legal entity – artificial being. A corporation is an artificial being with a personality that is separate from that of its individual owners. Thus, it may, under its corporate name, take, hold, or convey property to the extent allowed by law, enter into contracts, and sue or be sued. 2. Created by operation of law. A corporation is generally created by operation of law. The mere agreement of the parties cannot give rise to a corporation. 3. Right of succession. A corporation has the right of succession. Irrespective of the death, withdrawal, insolvency, or incapacity of the individual members or shareholders, and regardless of the transfer of their interest of share capital, a corporation shall have perpetual existence unless its articles of incorporation provides otherwise. Note: SEC. 11. Corporate Term. – A corporation shall have perpetual existence unless its articles of incorporation provides otherwise (RA 11232-Revised Corporation Code of the Philippines). Under the previous Corporation Code of the Philippines (Batas Pambansa Bilang 68), a corporation cannot exist for a period exceeding 50 years. The Revised Corporation Code of the Philippines (RCC), which took effect on 23 February 2019, has made a significant change in this aspect. Under Section 11 of the RCC, the term of a corporation is now perpetual, unless stated otherwise. 4. Powers, attributes, and properties authorized by law. A corporation has only the powers, attributes and properties expressly authorized by law or incident to its existence. Being a mere creation of law, a corporation can only exercise powers provided by law and those powers which are incidental to its existence. 5. Ownership divided into shares. Proprietorship in a corporation is divided into units known as share capital. The buyers of this share capital are called shareholders or stockholders and are 1  ACC 132 – Governance, Business Ethics, Risk Management, and Internal Control considered owners of the business. 6. Board of directors. Management of the business is vested in a board of directors elected by the shareholders. The board of directors is the governing body or decision-making body of the corporation. The Corporation Law provides that the number of directors be not less than five but not more than fifteen. Note: Board of Directors vs Management Board of directors is the governing body elected by the stockholders that exercises the corporate powers of a corporation, conducts all its business and controls its properties while Management is a group of executives given the authority by the Board of Directors to implement the policies it has laid down in the conduct of the business of the corporation. Advantages of a Corporation 1. The corporation enjoys continuous existence because of its power of succession. 2. The corporation has the ability to obtain a strong credit line because of continuity of existence. 3. Large scale business undertakings are made possible because many individuals can invest their funds in the enterprise. 4. The liability of its investors or shareholders is limited to the extent of their investment in the corporation. 5. The transfer of shares can be effected without the need for prior consent of other shareholders. 6. Its smooth operation is guaranteed because of centralized management. Disadvantages of a Corporation 1. It is not easy to organize because of complicated legal requirements and high costs in its organization. 2. The limited liability of its shareholders may weaken its credit capacity. 3. It is subject to rigid governmental control. 4. It is subject to more taxes. 5. Its centralized management restricts a more active participation by shareholders in the conduct of corporate affairs. Components of a Corporation 1. Incorporators – stockholders or members mentioned in the Articles of Incorporation as originally forming and composing the corporation and who are signatories thereof. They must be natural persons as distinguished from artificial persons. Note: The Articles of Incorporation enumerate the powers and limitations conferred upon the corporation by the government. 2. Corporators – those who compose a corporation, whether as stockholders or shareholders in a stock corporation or as members in a nonstock corporation. 3. Stockholders or shareholders – they are the corporators of a stock corporation. Note: A stock corporation is a private corporation in which the capital is divided into shares of stock and is authorized to distribute corporate earnings to holders on the basis of shares held. 4. Members – they are the corporators of a non-stock corporation. Note: A non-stock corporation 2  ACC 132 – Governance, Business Ethics, Risk Management, and Internal Control is a private corporation in which capital comes from fees paid by individuals composing it. 5. Promoters – they are the persons who undertake to (a) form a company based on a given project, (b) set it going, (c) take the necessary steps to accomplish the purpose for which the corporation is organized. 6. Subscribers – they are the persons who have agreed to take original, unissued shares but will pay at a later date. They may be incorporators or not and they may eventually become shareholders the moment the full payment of their subscriptions is made. 7. Underwriters – they are those who undertake to dispose of the shares to the general public. For more information about corporation, refer to Republic Act No. 11232 or the Revised Corporation Code of the Philippines (a copy is uploaded in the Google Drive). Definition of Governance (In General) Generally, governance refers to a process whereby elements in society wield power, authority and influence and enact policies and decisions concerning public life and social upliftment. It comprises all the processes of governing – whether undertaken by the government of a country, by a market or by a network – over a social system and whether through the laws, norms, power, or language of an organized society. Governance therefore means the process of decision-making and the process by which decisions are implemented (or not implemented) through the exercise of power or authority by leaders of the county and/or the organization. Characteristics of Good Governance 1. Participation. Participation by both men and women is a key cornerstone of good governance. Participation could be either direct or through legitimate institutions or representatives. It is important to point out that representative democracy does not necessarily mean that the concern of the most vulnerable in society would not be taken into consideration in decision making. Participation needs to be informed and organized. This means freedom of association and expression on one hand and an organized civil society on the other hand. 2. Rule of Law. Good governance requires fair legal frameworks that are enforced impartially. It also requires full protection of human rights, particularly those of minorities. Impartial enforcement of laws requires an independent judiciary and an impartial and incorruptible police force. 3. Transparency. Transparency means that decisions taken and their enforcement are done in a manner that follows rules and regulations. It means that information is freely available and directly accessible to those who will be affected by such decisions and their enforcement. It also means that enough information is provided and that it is provided in easily understandable forms and media. 3  ACC 132 – Governance, Business Ethics, Risk Management, and Internal Control RA 10633, Sec. 91. Official Website and Transparency Seal. To enhance transparency and enforce accountability, all agencies of government, including Constitutional Offices enjoying fiscal autonomy, SUCs, GOCCs and LGUs shall maintain an official website where its transparency seal shall be posted and which shall contain the information like the agency’s mandates and functions, names of its officials with their position and designation and contact information and physical accountability reports, financial accountability reports, among others. The respective heads of the agencies and their web administrators or their equivalent shall be responsible for ensuring compliance with section 91. 4. Responsiveness. Good governance requires that institutions and processes try to serve the needs of all stakeholders within a reasonable timeframe. RA No. 11032 which is an Act promoting ease of doing business and efficient delivery of government services. One provision is that all government agencies shall set up their respective most current and updated service standards to be known as the Citizen’s Charter in the form of information billboards which shall be posted at the main entrance of offices or at the most conspicuous place, in their respective websites and in the form of published materials. This includes the maximum time or period to conclude the process, for example, for business permit and licensing procedure – the LGU should indicate the time or period for it to receive and process applications, receive payments, and issue approved licenses, clearances, permits, or authorizations. 5. Consensus Oriented. Good governance requires mediation of the different interest in society to reach a broad consensus on what is in the best interest of the whole community and how this can be achieved. It also requires a broad and long-term perspective on what is needed for sustainable human development and how to achieve the goals of such development. This can only result from an understanding of the historical, cultural, and social contexts of a given society or community. 6. Equity and Inclusiveness. Good governance ensures that all its members feel that they have a stake in it and do not feel excluded from the mainstream of society. This requires all groups, but particularly the most vulnerable, have opportunities to improve or maintain their well-being. 7. Effectiveness and Efficiency. Good governance means that processes and institutions produce results that meet the needs of society while making the best use of resources at their disposal. The concept of efficiency in the context of good governance also covers the sustainable use of natural resources and the protection of the environment. 8. Accountability. Accountability is a key requirement of good governance. Not only governmental institutions but also the private sector and civil society organizations must be accountable to the public and to their institutional stakeholders. Who is accountable to whom varies depending on whether decisions or actions taken are internal or external to an organization or institution. In general, an organization or an institution is accountable to those who will be affected by its decisions or actions. Accountability cannot be enforced without transparency and the rule of law. 4  ACC 132 – Governance, Business Ethics, Risk Management, and Internal Control Corporate Governance: An Overview Corporate governance is defined as the system of rules, practices, and processes by which business corporations are directed and controlled. It basically involves balancing the interests of a company’s many stakeholders, such as shareholders, management, customers, suppliers, financiers, government, and the community. Good corporate governance is all about controlling one’s business and so is relevant, and indeed vital, for all organizations, whatever size or structure. According to SEC, corporate governance is the system of stewardship and control to guide organizations in fulfilling their long-term economic, moral, legal, and social obligations towards their stakeholders. Corporate governance is a system of direction, feedback and control using regulations, performance standards and ethical guidelines to hold the Board and senior management accountable for ensuring ethical behavior – reconciling long-term customer satisfaction with shareholder value – to the benefit of all stakeholders and society. Purpose of Corporate Governance ü The purpose of corporate governance is to facilitate effective, entrepreneurial and prudent management that can deliver long-term success of the company. ü The fundamental aim of corporate governance is to enhance shareholders’ value and protect the interests of other stakeholders by improving the corporate performance and accountability. ü It is about what the board of directors of a company does, how it sets the values of the business firm. ü According to SEC, the purpose of corporate governance to maximize the organization’s long- term success, creating sustainable value for its shareholders, stakeholders and the nation. Note: Stakeholders – any individual, organization or society at large who can either affect and/or be affected by the company’s strategies, policies, business decisions and operations, in general. This includes, among others, customers, creditors, employees, suppliers, investors, as well as the government and community in which it operates (SEC). Objectives of Corporate Governance 1. Fair and Equitable Treatment of Shareholders ü All shareholders deserve equitable treatment and this equity is safeguarded by a good governance structure in any organization. ü In some organizations, a group of high net-worth individual and institutions who have a substantial proportion of their portfolios invested in the company remain active through occupation of top-level positions that enable them to guard their interest. 2. Self-Assessment ü Corporate governance enables firms to assess their behavior and actions before they are scrutinized by regulatory agencies. Business establishments with a strong corporate governance system are better able to limit exposure to regulatory risks and fines. ü An active and independent board can successfully point out deficiencies or loopholes in the company operations and help solve issues internally on a timely basis. 3. Increase Shareholders’ Wealth ü Corporate governance also aims to protect the long-term interests of the shareholders. Firms with strong corporate governance structure are seen to have higher valuation attached to their 5  ACC 132 – Governance, Business Ethics, Risk Management, and Internal Control shares by businessmen. This only reflects the positive perception that good corporate governance induces potential investors to decide to invest in a company. 4. Transparency and Full Disclosure ü Good corporate governance aims at ensuring a higher degree of transparency in an organization by encouraging full disclosure of transactions in the company accounts. Basic Principles of Effective Corporate Governance Effective corporate governance is transparent, protects the rights of shareholders and includes both strategic and operational risk management. It is concerned in both the long-term earning potential as well as actual short-term earnings and holds directors accountable for their stewardship of the business. Positive answers to the following questions indicate a firm’s conformance and compliance with the basic principles of good corporate governance: 1. Transparency and Full Disclosure ü Does the board meet the information needs of investment communities? ü Does it safeguard integrity in financial reporting? ü Does the board have sound disclosure policies and practices? Does it make timely and balances disclosure? Can an outsider meaningfully analyze the organization’s actions and performance? 2. Accountability ü Does the board clarify its role and that of management? Does it promote objective, ethical and responsible decision making? Does it lay solid foundation for management oversight? Does the composition mix of board membership ensure an appropriate range and mix of expertise, diversity, knowledge and added value? Is the organization’s senior official committed to widely accepted standards of correct and proper behavior? 6  ACC 132 – Governance, Business Ethics, Risk Management, and Internal Control 3. Corporate Control ü Has the board built long-term sustainable growth in shareholders’ value for the corporation? ü Does it create an environment to take risk? Does it encourage enhanced performance? Does it recognize and manage risk? Does it remunerate fairly and responsibly? Does it recognize the legitimate interests of stakeholders? Are conflicts of interest avoided such that the organization’s interests prevail at all times? Illustrative Application of the Basic Principles of Corporate Governance and Best Practice Recommendations Principles of Good Corporate Governance Best Practice Recommendations 1. A company should lay solid foundation for a. Formalize and disclose the functions management and oversight. It should reserved to the board and those delegated to recognize and publish the respective roles management. and responsibilities of board and management. 2. Structure the board to add value. Have a a. A board should have independent directors. board of an effective composition, size and b. The roles of chairperson and chief commitment to adequately discharge its executive officer should not be exercised responsibilities and duties. by the same individual. c. The board should establish a nomination committee. 3. Promote ethical and responsible decision- a. Establish a code of conducts to guide the making. Actively promote ethical and directors, the chief executive officer (or responsible decision-making. equivalent), the chief financial officer (or equivalent) and any other key executives as to: The practices necessary to maintain confidence in the company’s integrity; and The responsibility and accountability of individuals for reporting and investigating reports of unethical practices. b. Disclose the policy concerning trading in company securities by directors, officers and employees. 4. Safeguard integrity in financial reporting. a. Require the chief executive officer (or Have a structure to independently verify equivalent) and the chief financial officer and safeguard the integrity of the (or equivalent) to state in writing to the 7  ACC 132 – Governance, Business Ethics, Risk Management, and Internal Control company’s financial reporting. board that the company’s financial reports present a true and fair view, in all material respects, of the company’s financial condition and operational results and are in accordance with relevant accounting standards. b. The board should establish an audit committee. c. Structure the audit committee so that it consists of: Only non-executive or independent directors; An independent chairperson, who is not chairperson of the board; and At least three (3) members. 5. Make timely and balanced disclosure. a. Establish written policies and procedures Promote timely and balanced disclosure of designed to ensure compliance with IFRS. all material matters concerning the b. Listing Rule disclosure requirements and to company. ensure accountability at a senior management level for compliance. 6. Respect the rights of shareholders and a. Design and disclose a communications facilitate the effective exercise of those strategy to promote effective rights. communication with shareholders and encourage effective participation at general meetings. b. Request the external auditor to attend the annual general meeting and be available to answer shareholder questions about the audit. 7. Recognize and manage risk. Establish a a. The board or appropriate board committee sound system of risk oversight ad should establish policies on risk oversight management and internal control. and management. b. The chief executive officer (or equivalent) and the chief financial officer (or equivalent) should state to the board in writing that: The statement given in accordance with best practice recommendation 4-a (the integrity of financial statements) is founded on a sound system of risk management and internal compliance and control which implements the policies 8  ACC 132 – Governance, Business Ethics, Risk Management, and Internal Control adopted by the board; and The company’s risk management and internal compliance and control system is operating efficiently in all material respects. 8. Encourage enhanced performance. Fairly a. Disclose the process for performance review and actively encourage enhanced evaluation of the board, its committees and board and management effectiveness. individual directors, and key executives. 9. Remunerate fairly and responsibly. Ensure a. Provide disclosure in relation to the that the level and composition of company’s remuneration policies to enable remuneration is sufficient and reasonable investors to understand: and that its relationship to corporate and The costs and benefits of those individual performance is defined. policies; and The link between remuneration paid to directors and key executives and corporate performance. b. The board should establish a remuneration committee. c. Clearly distinguish the structure of non- executive director’s remuneration from that of executives. d. Ensure that payment of equity-based executive remuneration is made in accordance with thresholds set in plans approved by shareholders. 10. Recognize the legitimate interests of a. Establish and disclose a code of conduct to stakeholders. Recognize legal and other guide compliance with legal and other obligations to all legitimate stakeholders. obligations to legitimate stakeholders. 9  ACC 132 – Governance, Business Ethics, Risk Management, and Internal Control References: Baysa, G. J. and Lupisan, M. Y. (2018). Accounting for Partnership and Corporation (2018 edition). Millenium Books, Inc. Cabrera, M. B., Cabrera, G. B. and Cabrera, B. B. (2021). Corporate Governance, Business Ethics, Risk Management and Internal Control (2021-2022 Edition). GIC Enterprises & Co., Inc. Meneses, J. L. and Villaceran, E. V. (2022). Governance, Business Ethics, Risk Management and Internal Control (First Edition). Millan, Z. B. (2021). Financial Accounting and Reporting. Official Gazette (2019). Revised Corporation Code of the Philippines. Retrieved September 2, 2022 from https://www.officialgazette.gov.ph/downloads/2019/02feb/20190220-RA- 11232-RRD.pdf Securities and Exchange Commission. (2016). Memorandum Circular No. 19. s. 2016 – Code of Corporate Governance for Publicly-Listed Companies. Retrieved September 2, 2022 from https://www.sec.gov.ph/corporate-governance/code-of-corporate-governance/ 10