Ethics and Corporate Governance

Chapter 17
 Learning Outcomes (1)
Explore the relationship between ethics
and corporate governance.
Distinguish between various approaches
to corporate governance and their
ethical dimensions.
Understand why corporate governance
has become so prominent in recent
years.
 Learning Outcomes (2)
Explore the ethics dimension of King 4.

Understand the requirement for social

and ethics committees introduced by the
2008 Companies Act.
Explore a comprehensive framework for
the governance of ethics.
 Introduction (1)
First chapter of King 4 is titled:
“Leadership, Ethics & Corporate
Citizenship.”
No coincidence that King 4 starts with
a chapter on ethics.
It can be seen as a recognition that
good governance has an ethical
foundation.
 Introduction (2)
The first principle on King 4 states
that: “The governing body should lead
ethically and effectively” (IoDSA,
2016: 43)
 Corporate Governance: Perceptions
and Approaches (1)

Internal and external corporate

governance.
Shareholder and stakeholder
approaches to corporate
governance.
 Corporate Governance: Perceptions
and Approaches (2)

Mandatory and voluntary corporate

governance.
The ethics of governance and the
governance of ethics.
 Internal and External Corporate
Governance (1)
Internal corporate governance – locus
of control resides within corporation (i.e.
with board of directors & executive
management).
Internal corporate governance refers to
the way which a company directs &
controls its own affairs.
 Internal and External Corporate
Governance (2)
Widely used definition in UK Cadbury report
– “system by which a company is directed &
controlled.”
Internal corporate governance –
responsibility for corporate governance lies
with board of directors & executive
management. Consists of two main functions:
the direction & control of the company.
 Internal and External Corporate
Governance (3)
Board of directors and executive
management – firstly responsible for
determining the strategic direction and hence
ultimate performance of company.
- secondly, board of directors is responsible
for the control of company (conformance
responsibility).
 Internal and External Corporate
Governance (4)
King 4 – the process of internal corporate
governance is described according to four
governance responsibilities that should deliver
for outcomes.
Responsibilities of governing bodies – a)
Strategy, b) Policy, c) Oversight, and d)
Disclosure.
 Internal and External Corporate
Governance (5)
Outcomes:
a) an ethical culture that is embedded in the
organisation,
b) sustained good performance that creates value for
stakeholders,
c) an effective control environment that ensures risks
are identified and dealt with, and
d) the legitimacy of the organisation as displayed in a
good reputation and trust by its stakeholders
 Internal and External Corporate
Governance (2)
External corporate governance – locus of control located
outside the corporation (i.e. with government & other
regulatory institutions).
External control over corporation can be exercised by
regulatory institutions, societal norms or the market itself.
Regulatory institutions – laws, regulations, professional
standards, listing requirements, etc. which are imposed upon
corporations.
Regulatory institutions determine the playing field. External
corporate governance is often mandatory.
 Internal and External Corporate
Governance (3)
External control can also be exercised in a more informal
manner through societal norms that influence corporate
behaviour.
Informal control comes in the form of social values, practices,
and conventions.
Neither mandatory nor enforced by formal sanctions,
however, influence nevertheless real.
External control can also be exercised by means of the
market for corporate control in the form of corporate
takeovers or acquisitions.
Shareholder & Stakeholder Approaches
to Corporate Governance
Key question: For whose benefit should corporations be
governed?
When governance is focused on the interests of shareholders
only, the internal or external corporate governance can be
characterised as shareholder-oriented. Also referred to as the
exclusive approach to corporate governance.
Shareholder model associated with agency theory.
Approaches to corporate governance that not only focus on
shareholders but also focus on other stakeholders, is called
stakeholder-oriented or inclusive models of corporate
governance.
Stakeholder models premised on stakeholder theory.
 Mandatory & Voluntary Corporate
Governance (1)
When companies are compelled to abide by corporate
governance standards, the corporate governance
dispensation is mandatory. Referred to as “comply or else”.
Corporate governance standards are written into law &
regulations. Failure to adhere may result in sanctions e.g.
fines or imprisonment for directors or executive management.
Sarbanes-Oxley Act in US is an example of mandatory
corporate governance.
Mandatory corporate governance to be effective, laws &
regulations have to be clear and enforceable.
 Mandatory & Voluntary Corporate
Governance (2)
Voluntary corporate governance – corporate governance
standards take the form of best-practice principles &
recommendations that companies are advised to adhere to.
This is a self-regulatory approach whereby companies can
choose whether they wish to apply the recommended
principles or practices at their own discretion.
There is, however, an expectation that companies should
provide in their corporate reports (e.g. annual reports) an
explanation for their decision not to comply with specific
governance practices.
Referred to as a “comply or explain” or “apply or explain”
approach.
 The Ethics of Governance & The
Governance of Ethics (1)
Ethics of governance – refers to the ethical values &
principles that underpin a specific corporate governance
regime.
The ethics of governance that support a corporate
governance regime are not always made explicit.
All corporate governance regimes or codes have an
underpinning ethic irrespective whether explicitly articulated
or not.
 The Ethics of Governance & The
Governance of Ethics (2)
Governance of ethics – refers to the way in which
corporations are expected or required to manage ethics.
Governance of ethics is always presented in an explicit
manner.
Governance of ethics includes aspects such as codes of
ethics, training programmes in ethics for boards of directors
and staff, ethics audits, reporting on ethics performance, etc.
Unlike the ethics of governance, which underpins the entire
corporate governance regime in all its manifestations, the
governance of ethics is just one aspect that might, or might
not, be addressed within a specific corporate governance
regime.
 The Prominence of Corporate
Governance
Trust in corporations.
Investor demand.
Stakeholder activism.
Social influence of corporations.
Risk management.
Sustainability
 Trust in Corporations
Clear correlation between lack of trust in business and
corporate governance reform.
Corporate governance reform often follows in the wake of a
major scandal that shatters societies trust in business e.g.
UK’s Cadbury report in response to the Maxwell scandal;
Sarbanes-Oxley Act in the US in response to WorldCom and
Enron.
Corporate governance reform can be regarded as an attempt
to ensure that corporations conduct their business in a
responsible, accountable, fair & transparent manner. It is
precisely this commitment by companies to these basic
values that holds the potential for trust in business to be
restored.
 Investor Demand
ICT has shrunk countries & continents – created a global
market.
Global market – investors are able to take better advantage of
international investment opportunities & the mobility of capital
has increased dramatically.
Investors have freedom to invest their money wherever they
believe they might receive the highest returns.
Corporate governance has become a significant factor.
Investors look for proper governance.
Several studies have confirmed the link between investor
confidence and good corporate governance.
New for of investment called “socially responsible investment”
or simply “responsible investment.”
 Stakeholder Activism
Change in attitude among shareholders & other stakeholders
towards the modern corporation.
In recent years, shareholders, especially institutional
shareholders, have come to play a much more significant role
in the governance of business. They have started prompting
boards & executive management of companies to improve
their standards of corporate governance.
The Principles of Responsible Investment (PRI, 2006) is a
good indication of how leading institutional investors demand
good corporate governance of corporations they invested in.
Good corporate governance has become an important
strategy for boards to minimise risk of hostile takeovers.
Other stakeholder groups have also been more vocal.
 Social Influence of Corporations (1)
Companies have increased in terms of social influences.
Businesses have a major impact on society, economy &
environment.
Decisions that a company makes can have either beneficial
or detrimental consequences for individuals and communities
(e.g. company relocation).
The discrepancy between growing corporate social influence
and the lack of public accountability has been another trigger
for the reform of corporate governance.
Most obvious way out of this dilemma is for state to impose
stricter corporate control. However, not a preferred option for
companies. They prefer self-regulation.
 Social Influence of Corporations (2)
Special-interest groups is another way to control the social
influence of companies.
Voluntary corporate governance reform is one way that
companies can assure citizens and the state that they are
willing to administer their powers in ways that are sensitive to
those who are affected by them.
By taking responsibility for their economic & environmental
impact on society, companies can wrest the initiative for
control over corporate activities from the state & special-
interest groups.
This way, improved corporate governance on the part of a
company sends out a clear message to government & all
affected stakeholders that the entity takes responsibility for its
social impact.
 Risk Management (1)
The prominence of corporate governance can also be
attributed to the increased need for the protection of
corporate assets.
Board of directors have always had a duty to protect the
assets of the companies they serve & these assets have
always been at risk.
In recent years both the duties of directors & corporate
risk has escalated significantly.
Although modern technology has many benefits, it has
made companies vulnerable to new types of risks e.g.
breaches of confidentiality, fraud, losing important data,
etc.
 Risk Management (2)
Risks associated with communication technology does
not only threaten the physical & financial assets of a
company, but also their symbolic assets in the form of
their public reputation.
Modern communication technology (internet, social
media, etc.) has made it possible to expose irresponsible
behaviour of business on a global scale.
The new kinds of risk facilitated by information and
communication technology are a further incentive for
business to step up its standards of corporate
governance.
 Sustainability (1)
The challenge of sustainability has contributed to the
coming to the fore of corporate governance.
Two categories of sustainability:
 Global sustainability
 Enterprise sustainability
The notion of global sustainability grew out of the
realisation that current modes of human production &
consumption are unsustainable. By depleting non-
renewable resources & through high levels of pollution,
we are seriously endangering the future of life on earth.
Companies have a huge role to play in ensuring the
sustainability of the earth.
 Sustainability (2)
The cost of corporate externalities cannot simply be
shifted onto the state & society. It is the responsibility of
the board of directors to direct & control the operations
of their companies to ensure that they play their part in
securing the sustainability of our planet.
Growing awareness that business sustainability does
not merely depend on the financial performance of a
company. There are non-financial issues that are import
e.g. ethical, social & environmental performance of a
company.
Some predict that the 21st century will be the century of
governance.
 Corporate Governance in South
Africa
History closely linked to King reports on
corporate governance in South Africa.
- King 1 published in 1994.
- King 2 published in 2002.
- King 3 published in 2009.
- King 4 published in 2016
New Companies Act of 2008 came into effect in
2011.
 Corporate Governance in King 4 (1)
King 4 focuses on the internal level of
governance – centres on corporate governance
at the enterprise level.
As such, the report makes recommendations
about the principles of corporate governance in
the public, private sectors, or non-profit sectors”
(IoDSA, 2016: 6).
Although the report recognises the importance
of corporate governance at the regulatory level,
it deliberately chooses not to make any
recommendations with regard to the regulatory
level.
 Corporate Governance in King 4 (2)
Instead, King 4 report concentrates on the
discretionary realm within organisations,
where governing bodies can decide how
an organisation should be directed &
controlled. The report clearly regards
external & internal levels of corporate
governance as complimentary dimensions
of the corporate governance regime
(IoDSA, 2016: 35).
 Corporate Governance in King 4 (3)
King 4 makes it clear that a voluntary and not a
mandatory approach to corporate governance is
followed. “Apply and Explain” rather than
“Comply or Else”. (King 3 was “Apply or
Explain”).
King 4 aligns itself with the inclusive or
stakeholder approach to corporate governance.
According to the report, the separation between
shareholder and stakeholder interests is a false
dichotomy, as it is believed that the interests of
shareholders and stakeholders tend to coincide
in the long run.
Link between Ethics and Governance (1)
In King 4, there is a very clear link between
ethics and governance. This link is already clear
in King 4’s definition of corporate governance
which states that corporate governance is the
“exercise of ethical and effective leadership by
the governing body towards the achievement of
the following governance outcomes:
- Ethical culture,
- Good performance,
- Effective control,
- Legitimacy” (IoDSA, 2016: 11).
Link between Ethics and Governance (2)
King 4 deliberately takes an outcomes-based
approach.
By identifying an ethical culture as the first
outcome of corporate governance, it is clear that
all aspects covered in the report, such as “the
roles and responsibilities of the governing body;
audit committees; risk management and internal
auditing” should all contribute to the
development of an ethical culture in the
organisation.
 Link between Ethics and Governance (3)
In the very first principle of King 4 report it is
stated that “The governing body should lead
ethically and effectively” (IoDSA, 2016: 43).
In the discussion of the first principle, it is made
clear that members of the governing body can
only give expression to this principle if they
have cultivated a number of core characteristics.
These core characteristics are expressed in the
acronym ICRAFT.
ICRAFT stands for: Integrity, Competence,
Responsibility, Accountability, Fairness and
Transparency.
Link between Ethics and Governance (4)
ICRAFT stands for: Integrity, Competence,
Responsibility, Accountability, Fairness and
Transparency.
It is evident that most of these characteristics
are of an ethical nature, thus reinforcing the
basic assumption underpinning the King 4
Report, that Good Corporate Governance Can
Never Be Divorced From Ethics.
For detail of ICRAFT, see pages 222 – 223 of
prescribed textbook. Also see IoDSA, 2016: 43 –
44.
 The Governance of Ethics (1)
King 4 Report also explicitly addresses
the responsibility of the governing body to
ensure that the organisation internally
adheres to its ethical values & acts in a
responsible manner towards economy,
society & the natural environment.
The governing is therefore called upon to
ensure that the ethics of the organisation
is actively governed.
 The Governance of Ethics (2)
This process of governing the ethics of an
organisation starts with the governing
body. They have to set the ethics tone and
the ethics example for the organisation.
The governing body as a whole shares the
responsibility to set the ethical values that
should guide the organisation and to build
and sustain an ethical culture in the
organisation.
 The Governance of Ethics (3)
The responsibility of governing body articulated
in the second principle of King: “The governing
body should govern the ethics of an
organisation in a way that supports the
establishment of an ethical culture” (IoDSA,
2016: 44).
The ethical culture should permeate every
dimension of the organisation, including its
vision, objectives and operations.
 The Governance of Ethics (4)
Although the cultivation and maintenance
of an ethical culture start with the tone and
standards set by the governing body, a
process of managing the ethical
performance of the organisation is also
needed.
 The Governance of Ethics (5)
According to King 4, an ethics
management process consists of the
following: ethics strategy; ethics risk
assessment; code of conduct and ethics
policies; familiarising stakeholders with
ethics standards of the organisation;
monitoring adherence to ethics standards;
providing a safe-reporting mechanism to
report unethical conduct; assessment,
monitoring and reporting of ethics.
 The Companies Act of 2008 (Act 71 of
2008) (1)
Compels all listed companies, state-owned
enterprises & all other companies with
significant public interest to have a social &
ethics committee as a standing statutory
subcommittee of their board of directors.
The purpose of the social & ethics committee is
to monitor the company’s impact on its
immediate environment & to report that impact to
the board & to the annual general meeting.
The Companies Act of 2008 (Act 71 of 2008)
(2)
The issues that need to be monitored & reported can be
grouped into four broad areas:
1) Company’s impact on the economy
2) Impact on company’s own employees
3) Company’s impact on societies in which it operates
4) Company’s impact on the natural environment
The introduction of the social & ethics committee
compelled companies for the first time to attend to social
& ethics matters in a disciplined & regulated manner.
 Framework for the Governance of
Ethics (1)
1. Leadership commitment
2. Governance structures
3. Ethics management process
a. Ethics risk assessment
b. Ethics strategy
c. Code & policies
d. Institutionalisation
e. Monitoring & reporting
4. Independent assessment & external reporting
 Leadership commitment
The governing body, executive
management and leaders on all levels
of the organisation should set a clear
ethical tone.
Without such a visible and audible
commitment, the governance of
ethics is doomed to fail.
 Governance Structures
The governance structures such as the
board and the social and ethics
committee should take the responsibility
for directing and overseeing the ethics of
the organisation.
These structures need to be given clear
for the roles that they have to play in the
governance of ethics.
 Ethics Management Process (1)
Ethics risk assessment – an ethics risk and
opportunity assessment should be conducted
to ensure that an organisation understands its
ethics profile.
Strategy – a strategy and plan for managing
ethics in the organisation must be formulated’
informed by the ethics risk profile of the
organisation.
Code and policies – the organisation should
develop a code of ethics and other relevant
ethics-related policies to ensure that the
identified risks are addressed.
 Ethics Management Process (2)
Institutionalisation – the ethics management
strategy and ethics standards must be
implemented to ensure that all contracted
stakeholders are familiar with, and adhere to,
the ethical standards of the organisation.
Monitoring and reporting – the implementation
of the ethics management strategy should be
monitored and regularly to the management
and governance structures that oversee the
ethics management of the organisation.
 Independent Assessment and
External Reporting
There should be independent assessment of
the ethics management process (e.g. by
internal auditing).
The ethics performance of the organisation
should also be reported in the sustainability
and integrated annual report of the
organisation, and be disclosed to stakeholders.