## **Learning Outcomes**

After reading this article, you will be able to explain what corporate governance means in the context of audited entities, describe internationally recognised best practice principles, evaluate the main features and structure of effective boards, and identify key roles and responsibilities of directors, non-executive directors, committees (such as audit and remuneration), and auditors. You will be able to analyse governance strengths and weaknesses, make suitable recommendations, and understand the importance of governance in minimising risk and supporting audit quality for the ACCA AA exam.

## **ACCA Audit and Assurance (AA) Syllabus**

For ACCA Audit and Assurance (AA), you are required to understand the purpose and principles of corporate governance and the roles of directors, non-executives, committees, and auditors. This includes:

- The objectives, relevance, and significance of corporate governance for audit and assurance.
- Internationally recognised codes and principles of best practice (e.g. OECD, UK Corporate Governance Code).
- Specific governance requirements on director responsibilities, risk management, internal control, and the reporting role of auditors.
- Evaluating deficiencies in governance, making recommendations to achieve compliance.
- Roles and benefits of board committees such as audit and remuneration committees.
- The link between governance, risk management, and internal control.
- The impact of corporate governance on the external audit process and auditor reporting requirements.

## **Test Your Knowledge**

_Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision._

1. What is the core objective of corporate governance in a public company?
2. List two essential responsibilities of an audit committee.
3. True or false? The CEO and board chair must always be the same individual in a well-governed company.
4. Briefly explain the main purpose of having independent non-executive directors on a board.
5. Give one example of a governance weakness and an action a company could take to address it.

## **Introduction**

Corporate governance refers to the system by which companies are directed and controlled, balancing the interests of shareholders, the board, management, and wider stakeholders. Effective governance aims to ensure responsible management, transparency, and accountability. Poor governance may result in abuses of power, fraud, or business collapse—as seen in prominent failures such as Enron or Carillion.

> **Key Term: corporate governance**  
> The set of rules, practices, and processes by which a company is directed and controlled, aiming for accountability, fairness, and transparency.

## The Objectives and Importance of Corporate Governance

Good corporate governance seeks to ensure the long-term success of a company by:

- Safeguarding stakeholder interests (shareholders, employees, creditors, customers, the public).
- Enhancing transparency and accountability around management decisions.
- Supporting efficient operations and sustainable growth.
- Reducing opportunities for fraud, mismanagement, or excessive risk-taking.

Companies with strong governance frameworks are less likely to experience severe management failures or significant control breaches.

### **Worked Example 1.1**

**Scenario:** The board of Jasper Plc consists only of executive directors directly involved in day-to-day management, all of whom set their own salaries. There is no audit committee, and no independent review of the company’s financial statements.

> **Answer:** This board structure lacks independence, oversight, and appropriate checks—key indicators of governance weaknesses. Jasper Plc should introduce independent non-executive directors and create audit and remuneration committees to separate decision-making and strengthen accountability.

## International Best Practice: Codes and Principles

Major governance codes, such as those from the Organisation for Economic Co-operation and Development (OECD) and UK Corporate Governance Code, set out widely adopted principles. Key areas include:

- Effective and balanced board leadership.
- Clear division between board chair and chief executive.
- Appointment of independent non-executive directors (NEDs).
- Formal committees (audit, nomination, remuneration) staffed mostly by independent NEDs.
- Transparent reporting and disclosure practices.
- Effective risk management and internal control systems.

> **Key Term: non-executive director (NED)**  
> A board member not involved in daily management, providing independent oversight and contributing to strategy and accountability.

## Board Structure and Responsibilities

A well-governed board typically includes a mix of executive directors (managing operations) and independent NEDs (monitoring, advising, providing external viewpoints). Independence is strengthened by separation of key roles:

- **Chair:** Leads and manages the board, ensuring meetings are productive and discussions are balanced.
- **Chief Executive Officer (CEO):** Manages the company’s business and leads executives.
- **NEDs:** Challenge, oversee, and bring wider experience and judgment.

> **Key Term: audit committee**  
> A formal sub-committee of the board, made up mainly of independent NEDs, overseeing financial reporting, external audit, and internal controls.  
> **Key Term: remuneration committee**  
> A sub-committee responsible for setting executive director pay and ensuring remuneration supports long-term company goals.

### Board Committees: Functions and Benefits

Committees are essential for detailed oversight:

- **Audit Committee:** Reviews financial statements, recommends auditor appointments, monitors audit independence, evaluates controls, and considers whistleblowing arrangements.
- **Remuneration Committee:** Sets executive pay policies, avoids conflicts, and links pay to company performance.
- **Nomination Committee:** Manages board appointments, promoting fair and transparent selection.

### **Worked Example 1.2**

**Scenario:** Rowan Co’s audit committee includes two executive directors and only one NED. No member has recent financial specialist knowledge.

> **Answer:** This structure does not meet best practice guidelines, which require audit committees to consist only of independent NEDs, with at least one having recent, relevant financial experience. Rowan Co should replace executive members with NEDs possessing required skills.

### Stakeholder Interests and Accountability

Good governance requires boards to consider interests beyond shareholders, such as employees, customers, suppliers, and society. Transparent disclosure, fair reporting, and mechanisms for workforce concerns (e.g., whistleblowing) are expected.

> **Key Term: accountability**  
> The obligation of those in authority to explain and justify their decisions and actions to stakeholders.  
> **Key Term: stewardship**  
> The responsibility of directors to safeguard and manage company resources in the long-term interests of owners and stakeholders.

### The Role of the Auditor in Governance

External auditors contribute to governance by providing an independent opinion on the financial statements and communicating significant findings to the board and audit committee. In some jurisdictions, auditors also report on corporate governance statement compliance.

> **Key Term: external auditor**  
> An independent professional engaged to express an opinion on an entity’s financial statements and, in some cases, on governance matters.

## Typical Governance Deficiencies and Recommendations

Common governance weaknesses include:

- Too few independent NEDs—risk of board domination by executives.
- A single person as both CEO and chair—excessive concentration of power.
- Lack of formal committees—insufficient specialist oversight.
- Committee members lacking appropriate independence or specialist knowledge.
- Poor disclosure of risk management, internal controls, or director pay.
- Audit committee lacking specialist financial knowledge.

### **Worked Example 1.3**

**Scenario:** Oak Ltd’s board has two executive directors, both related to each other, and one “independent” NED who previously worked for the company. No board committees exist.

> **Answer:** The NED’s independence is questionable due to recent employment by the company. Oak Ltd should appoint additional independent NEDs and set up audit and remuneration committees, ensuring no former executives serve as independent members until a sufficient cooling-off period has passed.

### **Exam Warning**

> For the exam, be able to identify weaknesses in a board’s structure or processes and propose practical recommendations—these questions are often scenario-based.

## Benefits and Limitations of Good Governance

Benefits

- Increased market confidence and ease of raising capital.
- Better risk management and internal control.
- More effective strategic decision-making.
- Reduced likelihood of fraud, mismanagement, or regulatory issues.

Limitations

- May increase administrative costs and complexity.
- Cannot guarantee the prevention of all wrongdoing—effective governance reduces, but does not eliminate, risk.

## Governance, Risk Management, and Internal Control

Strong governance supports:

- Proactive identification and management of risks.
- Robust internal control structures.
- Systematic monitoring of control effectiveness.
- Prompt communication and rectification of deficiencies.

> **Key Term: risk management**  
> The process by which a company identifies, assesses, and addresses risks that could hinder achievement of its objectives.

## Board Reporting and Auditor Interaction

Effective governance requires regular and transparent reporting:

- Annual reports should describe the board’s work, major risks, and the outcomes of committee reviews.
- Boards should explain any departures from best practice codes (“comply or explain” principle).
- Auditors and audit committees should communicate significant audit matters, control issues, and independence concerns.

### **Revision Tip**

> Practise analysing scenarios describing board structures or committee setups. Make clear, practical recommendations referencing code principles.

## **Summary**

Corporate governance is the framework ensuring companies conduct activities transparently, fairly, and accountably. It relies on effective board structure, independent committees, and robust reporting. Exam questions may ask you to identify weaknesses or suggest improvements—focus on board balance, independence, committee composition, and clear disclosure.

## **Key Point Checklist**

_This article has covered the following key knowledge points:_

- Define corporate governance and its objectives.
- List main features of international governance codes (OECD, UK Code).
- Identify the roles of executive directors, NEDs, board chair, and committees.
- Explain typical audit committee responsibilities and benefits.
- Recognise common governance deficiencies and how to address them.
- Describe the link between governance, risk management, and internal control.
- State the auditor’s responsibilities relating to corporate governance.
- Analyse board structures and recommend improvements in exam scenarios.

## **Key Terms and Concepts**

- corporate governance
- non-executive director (NED)
- audit committee
- remuneration committee
- accountability
- stewardship
- external auditor
- risk management

Governance, laws, and auditor responsibilities - Corporate governance principles and roles