There are five major theoretical frameworks that can be identified from the corporate governance literature: agency, stewardship, resource dependence, stakeholder and managerial-hegemony . These theories have evolved from many disciplines such as finance, economics, accounting, law, management and organizational behavior. For example, agency theory arises from the field of finance and economics and stakeholder theory from a more social-oriented perspective on corporate governance. All these disciplines have contributed to the development of theoretical aspects of corporate governance . Two of the theories; agency and stewardship were generally associated with several previous corporate governance researches in Malaysia and East Asia.
Nevertheless, a number of characteristics of the five governance theories are embedded in Malaysia’s business and corporations. This is because, Malaysia has the business culture and environment of a developing country combined with a unique socio-political background. As such, multi-faceted theories exist in Malaysia.
The first is Agency theory
The agency relationship is seen as a contractual link between the shareholders (the principals) that provide capital to the company and the management (agent) who runs the company. The principals engage the agent to perform some services on their behalf and would normally delegate some decision-making authority. However, as the number of shareholders and the complexity of operations grew, management, who had the expertise and essential knowledge to operate the company, increasingly gained effective control and put them in a position where they were prone to pursue their own interests .
The literature on agency theory addresses three types of problems that could transpire from the separation of ownership and management, which might consequently affect firm value. They are the effort problem, the assets’ use problem and differential risk preferences problem. The effort problem concerns whether or not managers apply proper effort in managing corporations so as to maximize shareholders’ wealth. Problems arise because principals are not able to determine if the managers are performing their work appropriately. Managers may not exert the same high effort levels required for firm value maximization as they would if they owned the firm.
The use of assets problem concerned the insiders who control corporate assets. They might abuse these assets for purposes that are harmful to the interests of shareholders such as diverting corporate assets, claiming excessive salaries and manipulating transfer prices of assets with other entities they control . The differential risk preferences problem arises because the principal and managers have different views on risk taking. Managers may not act in the best interest of shareholders and may have different interests and risks preferences. For example, managers have a wider range of economic and psychological needs (such as to maximize compensation, security, status and to boost their own reputation), which may be adversely affected by a project that increases a firm’s total risk or has rewards in the longer-term. This may result in managers being too cautious in making investments and thus failing to maximise shareholders’ wealth.
Hence, agency theorists recommended that corporate governance mechanisms are needed to reduce these agency conflicts and to align the interests of the agent with those of the principal. These mechanisms include incentive schemes for managers which reward them financially for maximising shareholder interests. Such schemes typically include strategies whereby senior executives acquire shares, conceivably at a bargain price, thus aligning financial interests of executives with those of shareholders. Other mechanisms include fixing executive compensation and levels of benefits to shareholders returns and having part of executive compensation deferred to the future to reward long-run value maximisation of the corporation. Besides that, appointing more NEX on the boards to check on managers’ behaviour could also reduce agency costs.
I will discuss the other four corporate governance theories in my next posting.
Wednesday, 7 December 2011
Tuesday, 6 December 2011
Board's Culture
Effective boards understand their role and duties, are actively engaged in the work of governance, and accept accountability for their performance and the performance of the organization they govern. Over time, either deliberately or not, every board of directors creates a governance culture—a pattern of beliefs, traditions and practices that prevail when the board convenes to carry out their duties. Each board is responsible for shaping its own culture. As stated by Joaan Reed:
“Good governance is hard work. Boards must develop a culture of accountability and engagement. Board leaders should pay strict attention to how much board time is spent passively listening to reports and how much time is spent discussing strategic issues and the duties of care and loyalty. Active and vigorous board discussion, debate and questioning is not only a sign of a good board, it is the sign of an engaged board. Board members should not allow a ‘don’t-ask-questions’ culture to thrive and become the norm. An open culture of cooperation and transparency is healthy and will attract skilled board members.”
In too many cases, boards are insufficiently committed, the governance culture is passive, and the result is under performance. There is a growing belief that effective governance requires a proactive culture of commitment and engagement that drives both the board and the organization it governs toward high performance.Non executive directors must be bold enough to challenge the CEO's decision so as to create healthy discussion and debate on company's business strategies. Board meetings is a place where board's members are able to contribute their ideas in decision making process. Many research findings has shown that an active board is able to drive company's performance.A good corporate governance practices must always be observed so that shareholders' interests is always paramount.
“Good governance is hard work. Boards must develop a culture of accountability and engagement. Board leaders should pay strict attention to how much board time is spent passively listening to reports and how much time is spent discussing strategic issues and the duties of care and loyalty. Active and vigorous board discussion, debate and questioning is not only a sign of a good board, it is the sign of an engaged board. Board members should not allow a ‘don’t-ask-questions’ culture to thrive and become the norm. An open culture of cooperation and transparency is healthy and will attract skilled board members.”
In too many cases, boards are insufficiently committed, the governance culture is passive, and the result is under performance. There is a growing belief that effective governance requires a proactive culture of commitment and engagement that drives both the board and the organization it governs toward high performance.Non executive directors must be bold enough to challenge the CEO's decision so as to create healthy discussion and debate on company's business strategies. Board meetings is a place where board's members are able to contribute their ideas in decision making process. Many research findings has shown that an active board is able to drive company's performance.A good corporate governance practices must always be observed so that shareholders' interests is always paramount.
Monday, 5 December 2011
FRAUD INVESTIGATION FRAMEWORK
Fraud investigation is not an easy matter. It requires a qualified and experienced investigator to conduct and complete an investigation. An investigation framework is important as it allows investigators to detect the incidence of fraud at its preliminary stage. It is a strategic plan and model which guide investigators to perform their tasks in a systematic manner in ensuring all important aspects, procedures and steps are followed closely. It also assures that the chain of documents and evidence will not be lost. In any fraud investigation, it is vital to first understand any report or complaint received. The report should provide the basis and direction of the investigation approach in the quest to find details regarding the facts of the case, the extent of the fraud, legal violations and the suspects. Investigators should always consider the 1H (How) and 5 W (What, Why, Who, When and Where) in every step of the investigation process to ensure that nothing is being overlooked.
Internal investigation can be summarized as followed and the details of each phase can be revealed in the flowing section:-
i. Problem recognition
ii. Investigation planning
iii. Method of Investigation
iv. Gathering evidence and analyzing available documents
v. Conducting interview and recoding statement
vi. Evaluation and preservation of evidence
vii. Reporting
The initial stage of the framework is identifying fraud exposure. This is considered as one of the most difficult stage as it is not easy to immediately identify fraud perpetrated by the top management of a company. Analyzing financial statement alone would not suffice to detect any fraudulent activity in a company. Thus, according to Albrecht et al. (2009), the fraud exposure rectangle is helpful in identifying management fraud exposure. Figure 1 illustrates the fraud exposure rectangle.
Adopted from ' Forensic Accounting and Management Case Studies' , a book co-authored by Azmi Abdul Hamid and Rozainun Abdul Aziz
Internal investigation can be summarized as followed and the details of each phase can be revealed in the flowing section:-
i. Problem recognition
ii. Investigation planning
iii. Method of Investigation
iv. Gathering evidence and analyzing available documents
v. Conducting interview and recoding statement
vi. Evaluation and preservation of evidence
vii. Reporting
The initial stage of the framework is identifying fraud exposure. This is considered as one of the most difficult stage as it is not easy to immediately identify fraud perpetrated by the top management of a company. Analyzing financial statement alone would not suffice to detect any fraudulent activity in a company. Thus, according to Albrecht et al. (2009), the fraud exposure rectangle is helpful in identifying management fraud exposure. Figure 1 illustrates the fraud exposure rectangle.
Adopted from ' Forensic Accounting and Management Case Studies' , a book co-authored by Azmi Abdul Hamid and Rozainun Abdul Aziz
FINANCIAL CRIMINOLOGY AND FRAUD
Fraud is defined by the Malaysian Approved Standards on Auditing (2001) as: an intentional act by one or more individuals among management, employees, or third parties, which results in a misrepresentation of financial statement. It is believed that fraud is among the most serious corporate problems. Management fraud can be defined as “deliberate fraud committed by management that injures investors and creditors through misleading financial statement” (Eliot and Willingham, 1980). According to Wallace (1995), fraud is “a scheme designed to deceive; it can be accomplished with fictitious documents and representations that support fraudulent financial statements”. The study of Vanasco (1998) on several fraud cases documented that cash, inventory, and related party transactions are more prone to fraud. Losses can occur in almost any area from cash to accounts receivable, expenditures and inventory losses (Spathis, 2002).
New Straits times (2001), reported that more than 60% of Malaysian listed companies surveyed had experienced some form of fraud. It was found that almost a quarter were found to have lost more than RM1 million each to fraud. However, there is no information or formal reports on the number of business failures that are caused by fraud. In Malaysia, for example, there were several cases involving public listed companies fraud schemes such as misappropriation of funds, submitting false statements to the Malaysian Securities Exchange Berhad (now known as Bursa Malaysia Securities Berhad), defrauding investors and other types of offences. Based on the Enforcement Related Press Releases produced by Securities Commission of Malaysia website, it is observed that most of the convicted case and the enforcement action taken included the top management personnel of the convicted listed companies. Chief Executive Officer, Managing Director, Chief Financial Controller were among persons convicted for misconduct. As such, accountability by all parties especially the board of directors play an important role in order for companies to reduce the number of financial fraud cases. This aspect is directly related to corporate governance good practices as stakeholders will be satisfied with all the information disclosed by the company that they have interest in. Accountability is a key point of interest in corporate governance and this also takes prominence in addressing issues relating to ethical conduct or behaviour.
Adopted from 'Forensic Accounting and Management Case Studies',book by Azmi Abdul Hamid and Rozainun Abdul Aziz
New Straits times (2001), reported that more than 60% of Malaysian listed companies surveyed had experienced some form of fraud. It was found that almost a quarter were found to have lost more than RM1 million each to fraud. However, there is no information or formal reports on the number of business failures that are caused by fraud. In Malaysia, for example, there were several cases involving public listed companies fraud schemes such as misappropriation of funds, submitting false statements to the Malaysian Securities Exchange Berhad (now known as Bursa Malaysia Securities Berhad), defrauding investors and other types of offences. Based on the Enforcement Related Press Releases produced by Securities Commission of Malaysia website, it is observed that most of the convicted case and the enforcement action taken included the top management personnel of the convicted listed companies. Chief Executive Officer, Managing Director, Chief Financial Controller were among persons convicted for misconduct. As such, accountability by all parties especially the board of directors play an important role in order for companies to reduce the number of financial fraud cases. This aspect is directly related to corporate governance good practices as stakeholders will be satisfied with all the information disclosed by the company that they have interest in. Accountability is a key point of interest in corporate governance and this also takes prominence in addressing issues relating to ethical conduct or behaviour.
Adopted from 'Forensic Accounting and Management Case Studies',book by Azmi Abdul Hamid and Rozainun Abdul Aziz
Saturday, 3 December 2011
What is a Learning Organization?
Recently Accounting Research Institute, the umbrella entity of Government Linked Companies Research Centre, organised a training in Islamic Finance. The two day training was conducted by IBFIM, a renowned training centre of Islamic Financing. The training was attended by 21 lecturers of the Faculty Of Accountancy, UiTM. It is part of our ongoing training to equip our lecturers in the skills of Islamic Finance.
Other than universities, , a corporation or companies also needs training. It has been shown in many research findings that a learning organizaton is able to perform well in their annual financial results. A learning organization starts from the top. If board of directors and senior management are serious in implementing learning and knowledge management in their corporations, middle and lower management including the lowest level of employees, would be more than ready to participate. A learning organization requires the board to commit to and act upon four conditions:
1. That each member of the organization is encouraged to learn regularly and rigorously from their daily work, and to ensure time is budgeted from this.
2. That there are systems in place to capture that learning, celebrate and reward it, and move it to where it is needed.
3. That the organization is encouraged by its owners and directors to transform itself continouslythrough its internal and external learning processes.
4. That such learning is valued in the appraisal and reward systems and in the asset base of the organization.
Other than universities, , a corporation or companies also needs training. It has been shown in many research findings that a learning organizaton is able to perform well in their annual financial results. A learning organization starts from the top. If board of directors and senior management are serious in implementing learning and knowledge management in their corporations, middle and lower management including the lowest level of employees, would be more than ready to participate. A learning organization requires the board to commit to and act upon four conditions:
1. That each member of the organization is encouraged to learn regularly and rigorously from their daily work, and to ensure time is budgeted from this.
2. That there are systems in place to capture that learning, celebrate and reward it, and move it to where it is needed.
3. That the organization is encouraged by its owners and directors to transform itself continouslythrough its internal and external learning processes.
4. That such learning is valued in the appraisal and reward systems and in the asset base of the organization.
WHO SHOULD RUN GLCs?
During the UMNO Convention at PWTC, Kuala Lumpur, a Perak delegate proposed that UMNO stalwarts should head GLCs to ensure that qualified Malay entrepreneurs and companies receive projects from GLCs. I doubt whether this is a good proposal.
Firstly, appointing politicians as directors could hamper firm performance. This is due to the fact that most of them do not possess appropriate expertise and skills in strategic goals, firm’s operations and products. Since they know very little about the nature of business of a corporation, what can they contribute to the board decision making? Running a political party is not the same as running a corporation. A corporation must be headed by a person who has the vision to enhance the shareholders’ value of the company. The company must be run with proper corporate governance mechanisms, with accountability, transparency and high integrity.
Since politicians were typically appointed as non-executive directors, they would have limited access to management except during board meetings. As such, their contribution to firm performance raises reservations. I would prefer GLCs be run by professionals who can deliver.
On top of that, tenders and contracts from GLCs cannot be distributed freely to all because only capable, and experienced companies, whether it is a bumi or non-bumi are allowed to make bidding.
Firstly, appointing politicians as directors could hamper firm performance. This is due to the fact that most of them do not possess appropriate expertise and skills in strategic goals, firm’s operations and products. Since they know very little about the nature of business of a corporation, what can they contribute to the board decision making? Running a political party is not the same as running a corporation. A corporation must be headed by a person who has the vision to enhance the shareholders’ value of the company. The company must be run with proper corporate governance mechanisms, with accountability, transparency and high integrity.
Since politicians were typically appointed as non-executive directors, they would have limited access to management except during board meetings. As such, their contribution to firm performance raises reservations. I would prefer GLCs be run by professionals who can deliver.
On top of that, tenders and contracts from GLCs cannot be distributed freely to all because only capable, and experienced companies, whether it is a bumi or non-bumi are allowed to make bidding.
Wednesday, 30 November 2011
HOW CORPORATE GOVERNANCE AFFECTS THE CAPITAL MARKET?
Although Corporate Governance Codes that were released by many countries towards the end of the twentieth century and into the 21 st century was only a mechanism to check on the boards of directors and top management in running corporations, just imagine, what would be the situation of the corporate world without all these Codes? As I mentioned in my earlier posting, Enron, the largest corporation that collapsed at the beginning of this century, took into consideration all the best practices of good corporate governance. Yet, corporate governance best practices could not dig up and traced the corporate scandal until it was too late.
Nonetheless, just imagine if there were no governance codes at all. I am optimistic that a lot more corporate scandals and wrongdoings might have incurred in all these years. In Malaysia, the Asian Financial Crisis was a wake-up call for the country to study and eventually released its Corporate Governance Codes in year 2000. Even when the code was already in place, many corporations in Malaysia involved in activities that are contrary to the spirit of good governance practices.
Good ethical behaviors of corporate players are the main factor for corporate governance to have good impact on firm performance. These ethical behaviors would eventually reflect itself in their Annual Reports and Financial Statements. In turn, companies that performed well and provide good returns to shareholders are able to attract potential shareholders to invest in listed companies. This will eventually create a better capital marketplace for investors be they retail players, institutional investors or foreign investors to enter the capital market.
There are many advantages of good practices of corporate governance.
First, there will be an increased access to external financing by firms. This in turn can lead to larger investment, higher growth, and greater employment creation.
Secondly, good corporate governance is able to lower the cost of capital and associated higher firm valuation. This makes more investments attractive to investors, also leading to growth and more employment.
Third, there will be better operational performance through better allocation of resources and better management. This creates wealth more generally.
Fourth, good corporate governance can be associated with a reduced risk of financial crises. This is particularly important, as financial crises can have large economic and social costs.
Fifth, good corporate governance can mean generally better relationships with all stakeholders. This helps improve social and labor relationships and aspects such as environmental protection.
All these advantages matter for growth, employment, poverty, and well-being of corporations and countries.
Nonetheless, just imagine if there were no governance codes at all. I am optimistic that a lot more corporate scandals and wrongdoings might have incurred in all these years. In Malaysia, the Asian Financial Crisis was a wake-up call for the country to study and eventually released its Corporate Governance Codes in year 2000. Even when the code was already in place, many corporations in Malaysia involved in activities that are contrary to the spirit of good governance practices.
Good ethical behaviors of corporate players are the main factor for corporate governance to have good impact on firm performance. These ethical behaviors would eventually reflect itself in their Annual Reports and Financial Statements. In turn, companies that performed well and provide good returns to shareholders are able to attract potential shareholders to invest in listed companies. This will eventually create a better capital marketplace for investors be they retail players, institutional investors or foreign investors to enter the capital market.
There are many advantages of good practices of corporate governance.
First, there will be an increased access to external financing by firms. This in turn can lead to larger investment, higher growth, and greater employment creation.
Secondly, good corporate governance is able to lower the cost of capital and associated higher firm valuation. This makes more investments attractive to investors, also leading to growth and more employment.
Third, there will be better operational performance through better allocation of resources and better management. This creates wealth more generally.
Fourth, good corporate governance can be associated with a reduced risk of financial crises. This is particularly important, as financial crises can have large economic and social costs.
Fifth, good corporate governance can mean generally better relationships with all stakeholders. This helps improve social and labor relationships and aspects such as environmental protection.
All these advantages matter for growth, employment, poverty, and well-being of corporations and countries.
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