## **Learning Outcomes**

After reading this article, you will be able to evaluate how corporate governance frameworks influence financial policy and decisions. You will understand the functions of the board, the purpose of governance codes, and the importance of checks and balances to protect stakeholder interests. You should be able to identify sources of stakeholder conflict, outline good governance structures, and discuss regulatory expectations in decision-making.

## **ACCA Advanced Financial Management (AFM) Syllabus**

For ACCA Advanced Financial Management (AFM), you are required to understand how the regulatory and market environment, especially corporate governance systems, influence financial decision-making. Revision should focus on:

- The purpose and key features of corporate governance in relation to finance functions
- Board structures, roles, and responsibilities in governance frameworks
- Stakeholder and agency issues impacting financial decisions
- Regulatory codes, such as OECD principles, UK Corporate Governance Code, and their practical effects on financial management
- Mechanisms for resolving stakeholder conflicts and ensuring director accountability
- The implications of regulatory requirements on financial reporting and strategic finance decisions

## **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. Who is responsible for approving major financial decisions in a listed company?
   a) Individual executive directors  
   b) The full board of directors  
   c) Finance department staff  
   d) External auditors

2. Describe one key agency problem relevant to financial management decisions.

3. True or false? Corporate governance codes are legally binding on all companies.

4. Explain how non-executive directors contribute to good governance in the finance function.

## **Introduction**

Corporate governance describes the system by which companies are directed and controlled. In the context of financial management, governance structures and regulatory requirements directly influence decisions such as capital allocation, risk management, and funding choices. Sound governance ensures that financial decisions are made transparently, ethically, and in the best interest of stakeholders—particularly shareholders, but also employees, creditors, and the wider community.

Companies face increasing scrutiny from regulators and investors, making robust governance frameworks essential for sustained success. This article explains the main features of corporate governance, common sources of conflict, and practical measures to ensure effective oversight of financial decisions.

> **Key Term: corporate governance**
> The system of rules, practices, and processes by which a company is directed and controlled to achieve accountability, fairness, and transparency in its relationships with stakeholders.

## **THE ROLE OF THE BOARD IN FINANCIAL DECISIONS**

The board of directors sits at the core of the governance system. Board approval is typically required for significant finance decisions, such as investments exceeding thresholds, major borrowing arrangements, or dividend policy changes.

### Board Structure and Key Roles

Good governance separates oversight from daily management:

- **Executive directors** are involved in day-to-day operations and propose financial strategies.
- **Non-executive directors (NEDs)** provide independent oversight, challenge executive decisions, and represent shareholder interests.
- **Committees** such as audit and remuneration committees improve scrutiny over financial reporting, risk, and director pay.

> **Key Term: non-executive director**
> A board member who is not part of daily management, appointed to independently monitor, guide, and challenge executives.
>
> **Key Term: audit committee**
> A board committee overseeing financial reporting processes, internal controls, and relationships with auditors.

### Separation of Chair and CEO

Good governance codes advise splitting the roles of board chair (responsible for leadership of the board) and CEO (responsible for running the business), minimizing concentration of power and conflicts of interest.

## **GOVERNANCE CODES AND REGULATORY EXPECTATIONS**

Most jurisdictions have established corporate governance codes that set standards for listed companies. While not always legally binding, adherence is often required by stock exchanges and boosts investor confidence.

### Common Code Principles

- Clear division of responsibilities between leadership and management
- Independence and effectiveness of board oversight
- Transparent appointment and remuneration policies for directors
- Regular performance evaluation of the board and its committees
- Robust risk management and internal controls

> **Key Term: governance code**
> A set of best practice recommendations for boards of companies, aimed at strengthening oversight and protecting shareholders.

### Example: UK Corporate Governance Code

This code requires listed companies to explain any departures from its recommendations. Regulatory focus is placed on the structure and conduct of the board, audit committee effectiveness, and the integrity of financial statements.

### Regulatory Impact on Financial Reporting

Regulators expect boards to ensure fair presentation of financial results, appropriate disclosure of risks, and compliance with laws and standards. Governance failures in financial reporting can lead to penalties, reputational damage, or even delisting.

## **STAKEHOLDER CONFLICTS AND THE AGENCY PROBLEM**

Boards are responsible for balancing often competing interests of various stakeholder groups.

> **Key Term: stakeholder**
> Any group or individual affected by or with an interest in the company’s activities, such as shareholders, employees, creditors, customers, and regulators.
>
> **Key Term: agency problem**
> A conflict where management’s personal goals diverge from those of the company's owners, potentially leading to decisions not aligned with shareholder or wider stakeholder interests.

### Sources of Conflict

- Management may prefer less risky strategies than shareholders, or seek personal benefits from investment projects.
- Shareholders typically want maximum return, while creditors focus on security, and employees may prioritize job stability.
- Divergence between short-term financial targets and long-term sustainable growth.

### Mechanisms to Address Conflict

- Performance-related pay aligns management rewards with shareholder value.
- Regular and transparent board reporting fosters accountability.
- Appointment of independent directors and board committees provides objective oversight.
- Shareholder votes on key decisions strengthen control.

### **Worked Example 1.1**

A CFO proposes a large investment in overseas expansion. The project carries high risk and potential long-term returns. Short-term, it may reduce dividends and increase debt. Some board members worry about the impact on share price and job security.

**Question:** What governance steps should the board take before approving this financial decision?

> **Answer:**
> The full board (including NEDs) should review detailed risk analysis and ensure effective internal controls are in place. An audit committee should vet financial projections. The board should consult major shareholders if dividend policy is affected. A transparent decision-making process and regular progress reporting will uphold good governance.

## **GOVERNANCE AND REGULATORY FRAMEWORKS IN ACTION**

Strong governance frameworks help companies manage compliance and strategic risks, enabling sound financial decisions.

### Impact of Regulations

Industry-specific regulations (e.g., banking, utilities) or listing requirements impose extra controls:

- Restrictions on certain transactions (e.g., related party loans)
- Stricter capital adequacy rules
- Prescribed disclosure and transparency requirements

Non-compliance can restrict access to finance, raise the cost of capital, or trigger regulatory sanction.

### **Exam Warning**

> Boards must ensure that financial statements are free from material misstatement and not rely solely on the audit committee. Failure to promptly address auditor concerns is a common exam pitfall.

## **Summary**

Corporate governance frameworks establish the authority and accountability structures over finance decisions. A well-composed, independent board and robust committees are essential. Effective governance protects against conflicts of interest, ensures regulatory compliance, and enables sustainable financial strategy aligned with stakeholder expectations and market regulation.

## **Key Point Checklist**

_This article has covered the following key knowledge points:_

- Define corporate governance and its role in financial decision-making
- Describe key governance roles: board, executive directors, non-executive directors, and committees
- Explain main features of governance codes and their regulatory significance
- Identify and resolve stakeholder and agency conflicts in finance decisions
- Recognise the practical influence of regulation over financial disclosure, risk, and strategy

## **Key Terms and Concepts**

- corporate governance
- non-executive director
- audit committee
- governance code
- stakeholder
- agency problem

Regulatory and market environment - Corporate governance influences on finance decisions