Professional Accountant assignment - Essay Example

?Professional accountant Assignment Part a) Comparison of the UK approach to governance with the US approach United s corporations abide by a rules-based approach to corporate governance. Most of them rely on the Sarbanes Oxley Act of 2002. This law was passed in order to restore public confidence in corporations after their failure to exhibit prudent judgement (International Corporate Governance Network, 2009). The method is highly structured, punitive and paternal. The intention of the Act is to ascertain that the process of financial reporting is done effectively. It also seeks to reorient accountants back to ethical ways. Furthermore, the approach focuses on maintaining corporate governance at the top. A principles-based approach is the domain of the UK. The Cadbury report defines the UK’s method of corporate governance. It states that corporate governance is a mechanism for directing and controlling companies (Cadbury, 1992). This document was later followed by others like the Combined Code. In essence, all these reports seek to place corporate governance responsibilities in the hands of company boards. An institution must alter corporate governance issues in accordance with their context. Furthermore, individuals are expected to make their choices known to their shareholders. Therefore, in the rules-based approach, as practiced in the United States, parties answer to external bodies while in the principles-based approach, institutions answer to their shareholders (Tricker, 2008). While the United Kingdom places the responsibility of oversight on individual firms, the United States has an accounting oversight board which acts independently and ensures compliance. The US even has rules governing how the external auditor needs to behave. Conflict of interest is prohibited while appointment of new auditors is done under strict rules. The manner in which those audit reports are reported is also stipulated in law. Financial reporting is strictly enforced in the rules-based approach. Here, almost all parties have responsibilities under the law. Executive members must ensure accuracy and promptness of financial reports. Managers need to create internal controls for reporting while accountants must act honestly when reporting. Cases of alteration, falsification or concealment of information are all severely punished. In certain respects, punishment may be institution-wide. Here companies that do not ascribe to rules laid down by the Securities Exchange Commission will be delisted (SEC, 2003). Conversely in the United Kingdom, after a board has settled on a particular principle, it must comply with it or explain to its shareholders why it has not done so. Usually, the principles selected may emanate from the Cadbury Report, the Combined Code or general governance practice. The main reasoning behind this strategy is that corporate governance is not something to be policed. Instead, it should be done proactively by businesses. This demonstrates faith in organisations and their ability to practice these principles. The most glaring difference between these two systems is that in one punishment is clear. It is handled by specific bodies and the process by which oversight authorities come up with those punishments is well documented. These consequences also happen speedily, especially after non compliance in the US. Conversely, the effects of poor corporate governance are ambiguous in the principles-based approach. It is assumed that exposure of these unhealthy practices would damage the credibility of an organisation and hence its long term viability. Therefore, results may manifest after relatively long periods of time, and may not always be predictable. One key failure in the rules-based system is the tendency to establish very low standards of practice (McNamara & Banff, 2012). In order to ensure that members of the corporate community abide by rules in the US governance system, members have to agree on certain standards. In an effort to obtain consensus, these standards may be too low for concerned parties. A case in point was the NYSE rules regarding an independent director. It states that this must be someone whose income from the concerned company must not have exceeded $100,000. However, several middle to small businesses still consider amounts near that figure, like $90,000, as red flags. Persons who have ever earned such amounts from the institution may have some interests in the company, so they are unlikely to be independent. This approach thus tends to reduce governing standards to a minimum level. It also creates a situation where members try to flout the rules by using various tactics. After experts became familiar with the Sarbanes Oxley Act, they found ways of evading some of the severe restrictions in the law. Furthermore, certain matters are not clearly laid out in these rules, so they may be practised regardless of how unethical they are. This explains why institutions in the US found themselves in the 2008 financial crisis. On the other hand, the rules-based approach has worked for the United States because it has curbed collusions among various corporate players. The Sarbanes Oxley Act has prevented the kind of negative cooperation between auditors and banks that led to the Enron scandal. Furthermore, in a competitive environment like the US, it is essential to have some well-laid rules to minimise excesses that come with seeking an edge of others. The principles based approach also has its successes and failures. Owing to a lack of preset minimum standards, it is assumed that corporations will use the principles of their communities to establish governance practices. In essence, if a company appears to be evading these best practices, then it is likely to experience a loss of confidence from the public. As a result, organisations tend to go for high standards because minimal compliance will be frowned upon by society (FRC, 2010). This method of governance is not curved in stone as is the case with the rules-based approach. Therefore, organisations in the UK have the opportunity to keep improving their outcomes irrespective of the prevailing standards. It is often a painstaking process to change rules in the US as this involves politics, which is always contentious. Organisations are diverse bodies that operate under different business conditions. It is thus wise to allow them to select their own practices to suit their industrial and business needs. The principles-approach gives companies this flexibility as they only guide companies. Customisation is always an advantage in situations where the dynamics are very fluid. One challenge in the principles system is the excessive amount of time it takes to get everyone to engage in certain best practices. Some companies may take longer than usual to comply with best practice. Furthermore, even failure to comply may still not guarantee extermination from that community of members. Policing is not explicitly prevalent in the UK approach; however, it still exists in some manner. Special interest groups as well as the media are the ones who report organisational practices to the public. Therefore, they have the onus to select companies that have failed or succeeded in this endeavour. It is sometimes difficult for members of the media to practice sound judgment on reporting since some of them have minimal experience in the corporate arena. Therefore, leaving accountability in the hands of non experts may be a problem for the UK as some individuals may not understand the complexities of certain governance actions. b) Lessons that the UK can learn from other jurisdictions to improve As explained in the earlier portions of the paper, members of the rules-based approach often understand the rules with which they must comply. This is not a luxury for them as severe repercussions await those who lack this information. In the principles approach these governance practices may not be clearly laid out. UK organisations can borrow a leaf from their counterparts in the UK regarding rule clarity. It is necessary for all the members of the board to grasp the rules that apply to it. Sometimes these come in the form of tax laws, environmental or even corporate laws. Members of the rules-based approach are also in tune with their oversight authorities. They know what is expected from them and will act in accordance. Likewise, UK organisations may use the same approach when perceiving oversight parties. They must listen and communicate with their communities in order to understand what these stakeholders expect from them. Thereafter, they should develop a transparent relationship with these external players as they are their natural stewards (Arjoon, 2006). A soft incorporation of rules is sometimes necessary because when principles are the only methods, then minimal incentives to act will prevail. It is critical to have some form of enforcement in order to influence actions. However, this should not be the major framework of the corporate governance system in the UK. Instead, members should start with principles and then face a degree of repercussions for failing to comply. Generally, many UK residents are satisfied with the region’s corporate governance systems. However, they also accept that some things can be changed. An Airmic (2010) report illustrates how the public views changes that have been made in governance. Nature of parameter Percentage Persons that support the Principles-based support 5% Persons that support the prescription-based approach 17.5% Persons that support a combination of the two 77.5% Persons who believed that the balanced approach would work 90.6% Persons who thought the corporate governance code was well-focused 26.5% Persons who thought the code had missed the mark 67.6% (Airmic, 2010) Part 2 a) Whether the UK corporate governance code correctly defined roles of NED s in UK business The UK Corporate governance code covers some general elements of corporate governance but certain roles have still not been mentioned in the code. A director’s effectiveness is dependent on the information the person receives. Since the NED is not involved in the daily goings-on of the organisation, then his or her decisions must be based on accurate and timely information. These board members must seek data from management in an unrelenting fashion. They must clarify the quality of information they require and the means of delivery of the same. Otherwise, failure to do so could cause dire consequences. Several NEDs receive information but it is in too much detail that they cannot interpret it. These individuals need to understand the overall financial health of their institutions (Smerdon, 2010). A case in point was that of an organisation called Marconi. The board of directors failed in their role as NEDs because this company closed down. It was later established that they had not been relying on relevant information to make their decisions. They used reports that were based on events from the previous quarter and month (Starovi & Hayward, 2010). If they had been competent, they would have insisted on getting the right information at the right time, and this would have enabled them to detect errors in the company’s business practices. The document on corporate governance does focus on board diversity. Many NEDs know that their responsibility is to shareholders. Therefore, most of their activities will usually revolve around the economic component of business. If a board has a diverse mix of members, then it will focus on other aspects of business other than finance. Stakeholder value is still a critical part of a board’s functions, and this needs to be covered in boardroom meetings. Matters of conflict of interest may arise during the selection of NEDs. The ideal situation would be a board member who is independent. However, sometimes the most experienced person may have substantial interactions with their target company. It is therefore necessary for the board to weigh its options before committing to an NED. Disclosure is essential in contributing to this solution. A case in point was that of a non executive director known as Angela Burns who wanted to work for a UK mutual society. However, she was also working as an NED in another UK mutual society. She did consulting for an investment manager that was handling accounts from both organisations. The firms placed bids to the investment manager while Burns was aware of both their intentions. This was regarded as a conflict of interest by the Financial Conduct Authority, which fined Burns the sum of 154,000 pounds (Lovells et. al., 2013). The NED should have been more rigorous about their expectations from the new director. They should have looked into her background before accepting her as one of their own. In this case, matters of disclosure as mandated by existing board members, have not been explicitly covered in the code. This leaves room or loopholes and other complications. b) Institutional investors as absentee landlords The cultural norm for most institutional investors is absenteeism. Shareholdings have become quite dispersed, so this distances them from the organisations that they invest in. From as far back as the 1980s, institutional investors started relying on quarterly results for financial decisions. A number of them abandon the shares of a certain organisation for the next one if they are displeased with their earnings per share. This approach leads to the prevalence of superficial tactics and a focus on external outcomes. Group think becomes the custom as institutional investors want to outdo each other (Tricker, 2011). Intelligent debates among institutional investors are not common because these parties do not have a long term view on their role as stewards. These patterns have been reported in the news over the past few years. In 2009 and 2013, Lord Myners attacked shareholders for their propensity to act as absentee landlords (Burgess, 2013). He stated that these entities did not engage deeply with their organisations, so they were not influencing corporate behaviour. Another party that challenged the status of institutional investors in the UK was the CEO of the Financial Services Authority. He stated that organisational investors were not doing enough to challenge the institutions to which they were affiliated. It is particularly alarming that despite the domination of institutional investors in several UK institutions, their coverage in the Combined Code accounts for less than 5% of the document (FRC, 2009). Therefore, these bodies almost have a free pass when it comes to their decisions on governance. It is one thing to expect shareholders to act as stewards as stipulated in the law, and it is quite another matter to witness the same. Some institution shareholders feel that regulations exist on corporate disclosure, so it is not necessary to engage in dialogue between institutional investors and the companies they invest in. Shareholders ought to make meaningful suggestions to the companies that they are working with. However, this may not always be true because of a number of reasons. First, institutional investors may not participate actively in auditor appointments. Many individual shareholders already lack information on voting decisions. The same patterns also exists among institutional investors. This explains why appointment of auditors was done poorly in 2008. These professionals were unable to detect problems in the financial health of their respective institutions. If institutional shareholders had strong voting powers, they would have exercised their role there thus leading to effective outcomes. Institutional investors have also done little to affect executive pay in their chosen organisations. This is largely because the same principle of short termism still operates in the realm of executive pay as it does in the institutional investment world. Executives are eligible for bonuses if they perform well within a certain quarter. Many of them may forgo long term investments in assets or business processes as their results would not be immediately visible. The consequence of this focus is failure to engage in long-term growth. Institutional investors operate under the same rules as they also focus on these short-term outcomes. It is thus unlikely for them to complain about the nature of executive pay if they inspired it in the first place (Soloman, 2010). Individual shareholders in the UK have had an awakening especially after the financial crisis of 2008. Many of them want to participate in institutional changes and will do whatever they can to ascertain that this takes place. On the other hand, large institutional investors do not share this same enthusiasm, as a number of them are still distantly connected to their organisations of choice. Their large portfolio prevents them from taking a personal interest in just one institution. References Airmic, 2010. Challenging corporate governance structures. London: Airmic. Arjoon, S., 2006. Striking a Balance Between Rules and Principles-based Approaches for Effective Governance: A Risks-based Approach. Journal of Business Ethics, 68(3), pp. 53-82. Burgess, K., 2013. Myners urges ‘absentee landlord’ shareholders to be more involved. Financial Times, 15 Oct. p. 18. Cadbury, A., 1992. The Committee on the Financial Aspects of Corporate Governance. London: Gee and Company FRC, 2009. Review of the Effectiveness of the Combined Code. London: Financial Reporting Council. FRC, 2010. The UK Approach to Corporate Governance. London: Financial Reporting Council. International Corporate Governance Network, 2009, The International Corporate Governance Network report. [online] Available at: [accessed 22 October 2013] Lovells, H., Pearson, A., Ufland, R. and Stanbrook, J., 2013. Directors take note: FCA Decision Notice against non-executive director for failure to recognise and disclose conflicts of interest. [online] Available at: < http://www.lexology.com/library/detail.aspx?g=f39844cb-e408-477b-a47c-6840fb7a9849>[accessed 22 October 2013] McNamara, D. & Banff, P., 2012. Improving governance performance rules-based vs. Principles-based approaches. [online] Available at: [accessed 22 October 2013] SEC, 2003, SEC actions in relation to SOX Act. [online] Available at: [accessed 22 October 2013] Smerdon, R., 2010. A Practical Guide to Corporate Governance. London: Sweet and Maxwell Soloman, J., 2010. Corporate governance and accountability. New York: Wiley. Starovi, D. & Hayward, C., 2010. The role of the non executive director. London: the Chartered Institute of Management Accountants. Tricker, B., 2008. Corporate Governance: Principles, Policies and Practices. Oxford: Oxford University Press Tricker, B., 2011. Re-inventing the Limited Liability Company. Corporate Governance: An International Review, 19(4), pp. 384–393 Read More