Suggested answers and examiner’s comments

Corporate Governance
June 2015

Important notice

When reading these answers, please note that they are not intended to be viewed as a definitive ‘model’
answer, as in many instances there are several possible answers/approaches to a question. These
answers indicate a range of appropriate content that could have been provided in answer to the
questions. They may be a different length or format to the answers expected from candidates in the
examination.

Examiner’s general comments

The general standard of answers in June 2015 suggests that the recent improvements in standards of
scripts has been maintained, although many candidates had difficulty in finding four questions that they
could answer well for this examination.

As has been commented before, if candidates are able to demonstrate a reasonable knowledge and
understanding of corporate governance, they are likely to do reasonably well in the examination. Where
answers do not meet a pass standard, this is usually due a combination of insufficient preparation and
studying, together with a lack of basic examination technique, such as presenting a clear and well-
constructed answer and giving adequate time to each question.

By far the biggest cause of answers not achieving a pass standard was inadequate knowledge of the
subject matter shown, although there seem to have been improvements in this area in June 2015.
Writing for three hours on corporate governance will expose the lack of awareness of anyone who is
under-prepared. Just one answer earning low marks puts pressure on candidates to do well in the other
three questions: for anyone with only a limited knowledge of the subject, this can be difficult.

Problems with examination techniques and style persist.

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Time-keeping was again a problem for a number of candidates. Some candidates wrote at length on
questions they appear to have been comfortable with, even if they wrote far too much for the number of
marks available for the question. Other candidates wrote very short answers for questions where they
appeared to lack the relevant knowledge of the topic, even though the question might be worth up to 15
or 17 marks. As far as possible, candidates should try to divide their time equally between the four
answers they write, and try to make a sufficient number of different points to earn the marks that are
available for the question.

Many answers do not focus sufficiently on the specific requirements of a question. Comments by
markers that sections of answers are ‘not relevant’ or ‘irrelevant’ are common. Marks are only awarded
for comments which are relevant to the question. As in the past, some candidates wrote around the
subject without providing a direct answer. Some answers were also general in nature, without providing
sufficient detail to demonstrate knowledge of the subject or to answer the question adequately.

It has been suggested in the past that candidates should consider spending a very short time (perhaps a
minute or two) drafting a list of points for an answer, and checking that they all seem relevant to the
question, before starting to write an answer. It is a useful way of thinking about how to structure an
answer, as well as to check that there will be enough relevant points in the answer to earn good marks
for the question. It is also a useful check on whether it would be a good idea to attempt the question, as,
if you cannot think of enough relevant points for the marks available, you can decide to answer a
different question instead.

It has also been commented in the past that points need to be explained in sufficient detail, and it is
insufficient to cover a point in just a very small number of words. Some answers include incomplete
explanations with a brief list of short bullet points, making two, three or even four different points in a
single short sentence, when making each point separately and slightly more completely is likely to earn
more marks. There was an improvement in this area for the June 2015 paper: there were some
candidates who provided brief and inadequate bullet point lists, but these seem less common than in the
past.

The key to success in this examination, however, is knowledge and understanding of the topics across
the full syllabus range. This comes from studying sufficiently, and thinking about the subject.

© ICSA, 2015 Page 2 of 21

1 You are the company secretary of a listed company. The company’s Chairman also acts as an
adviser to the government. Write a report to the Chairman, setting out:

(a) For a listed company, the benefits of good corporate governance and the potential drawbacks of
having standards of corporate governance that fall below the level required by the UK Corporate
Governance Code (or a similar national code).
(17 marks)

Suggested answer

To: Chairman
From: Company Secretary
Date: 4 June 2015

Report: Governance for listed companies and for government bodies

This report sets out the benefits of good governance, and then explains the potential consequences
of failing to achieve the standards of governance that are expected.

(a) Corporate governance in listed companies

High standards of corporate governance in a listed company should strengthen investor confidence.
Investors expect companies to act in the best interests of the shareholders, and compliance with the
standards of governance in a voluntary code of practice (as well as compliance with regulatory
requirements) provides investors with reassurance that this is happening. Financial centres with a
reputation for high standards of corporate governance are more likely to attract investment capital
than centres where governance standards are lower. A potential consequence of poor governance is
a lower share price, due to investor doubts about holding the company’s shares.

There have been cases in the past where the financial collapse of a company has been attributed
partly to poor standards of governance, and decision-making by the board or its leaders that
exposed the company to unsustainable risks. This, however, is an extreme consequence of poor
governance. Poor governance does not necessarily result in financial collapse, although it may
increase the possibility.

Other stakeholders, such as lenders, employees and customers, also expect a company to have
regard for their interests. Good corporate governance is typically associated with a good reputation.
Poor governance increases reputation risk, and could deter potential customers and employees, and
may also possibly make lenders more reluctant to provide funding, except at higher interest rates.

A code of corporate governance, such as the UK Corporate Governance Code (UK Code), sets out
principles and provides detailed guidelines (provisions) that listed companies are expected to comply
with. Principles must be adhered to, and any non-compliance with specific provisions should be
explained.

A key requirement of good governance is that a company should be led by an effective board of
directors that provides entrepreneurial leadership for the company. An effective board requires
competent leadership by the chairman, and provides direction for the company. An ineffective board
will fail to provide the clear leadership that a company needs, and may either fail to make crucial
decisions or may make ill-judged decisions that are not in the company’s best interests. The board
may not meet sufficiently often. With poor leadership, a company cannot be expected to perform to
the best of its potential.

The board of directors should also be well-balanced. In the UK, there is a requirement for the
majority of the board of a major listed company to consist of independent non-executive directors.
The UK Code requires that a board and its committees should have the appropriate balance of skills,
experience, independence and knowledge of the company to enable them to discharge their
responsibilities effectively. A potential consequence of having a board that lacks balance and

© ICSA, 2015 Page 3 of 21

 experience is that deliberations by the board may fail to recognise all the issues involved in particular
decisions. A lack of sufficient independent directors on a board may also expose the company to a
risk that decisions are taken in the interests of powerful individuals on the board, rather than in the
interests of the company, its shareholders and other stakeholders.

A well-governed company should also have effective systems for managing strategic risks,
operational risks, financial risks and compliance risks. The board should specify the risk appetite of
the company, and the strategic risks that the company should be willing to accept in order to achieve
its objectives. Failure to set limits to strategic risk and monitor strategic risk exposures, could result
in the company having excessive exposures to risk that threaten its profitability, share price and,
possibly, survival. Other risks should be managed effectively by an internal control system; failure to
control risks effectively could result in unnecessary exposures to risk and losses.

Good corporate governance also requires a remuneration policy for executive directors and senior
executives that is seen to be fair, providing sufficient incentives to executives without over-paying
them. Remuneration policies that are considered unfair by shareholders, providing excessive
rewards to executives without sufficient incentives, can result in conflict between a company and its
shareholders. In the UK, quoted companies face the risk of shareholders voting against the
proposed remuneration policy of the board, and obliging the board to change its policy.

A company, through its board of directors, should be accountable to the shareholders. Accountability
is achieved mainly through financial and business reporting, which should provide a fair, balanced
and understandable assessment of the company’s affairs. A potential consequence of poor and
inadequate reporting is that shareholders may be misled and may be persuaded to make investment
decisions that are different from those they would have made if they were better informed.

Good governance also requires constructive dialogue between shareholders and the board of
directors. A well-governed company will respond to the concerns of shareholders. A poorly-governed
company may disregard their concerns. A potential consequence of lack of dialogue is a greater risk
of mistrust between shareholders and the board, resulting not only (possibly) in a lower share price,
but also a greater probability of shareholder action against the board, such as votes against
remuneration policy or the re-election of board members at the annual general meeting (AGM).

As chairman, you can expect to be supported in your role by the company secretary who should
provide authoritative and professional advice on matters of corporate governance.

Examiner’s comments

A good answer to this question would have been one which considered each of the main areas of
corporate governance and explained why good governance in each of these areas could be
important for shareholders and other stakeholders: the board and its composition and effectiveness;
adequacy of risk management and internal control; financial reporting and audit; remuneration of
senior executives; relations with shareholders; and corporate social responsibility (CSR).

Some candidates identified this requirement and produced good answers. Others seem to have
used Question 1 as a fourth question, to be answered in a limited amount of time, and so did not
produce a well-considered or accurate answer.

(b) For a government organisation, the benefits of high standards of governance and the potential
consequences of failing to uphold the Nolan principles (or similar standards).
(8 marks)

Suggested answer

In the public sector, high standards of governance help to maintain public trust in government and
the institutions of government.

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 Governance in a government organisation differs from corporate governance. In government, key
decisions are made by the relevant government minister or ministers, with advice from civil servants.
Committees that are set up to advise government departments do not have decision-making
responsibilities. Ministers ultimately are accountable to parliament and the electorate, but
government committees do not have any formal accountability for the advice that they give.

Good governance in the public sector should be based (in the UK) on the Nolan principles of public
life. These are selflessness, integrity, objectivity, accountability, openness, honesty and leadership.
These principles apply to the holders of public office, and do not directly concern individuals, such as
you, who are unpaid members of an advisory committee.

A government organisation should have a clear vision of its purpose and the intended outcomes it
hopes to achieve. It should have an effective governing body, capable of taking informed and
transparent decisions, and managing risk. Its leaders should demonstrate the qualities required by
the Nolan principles.

Failure by holders of public office to uphold the Nolan principles could be a recipe for corrupt
government, with government conducted in the interests of those in power and against the best
interests of the country as a whole. The potential consequences of ignoring advice from individuals
outside government are ineffective decision-making, and poor government of the country.

Public trust in the machinery of government may fall to a level where popular support for government
is lost and disaffection with government increases, in the media and in the political activities of
opponents of the government.

Examiner’s comments

Some candidates showed a good awareness of the Nolan principles and related them to the public
sector. Other answers to part (b) were very brief, possibly because it was not a topic the candidates
had given much time to studying.

© ICSA, 2015 Page 5 of 21

2 Foxtrot plc (‘Foxtrot’) is a major listed company. Three months ago its Chief Operating Officer, who
was a member of the board, retired. More recently, the Finance Director resigned, leaving the Chief
Executive Officer (CEO) as the only remaining executive director of the company. There are six non-
executive directors, including the Chairman.

The Chairman and CEO do not get on well. They disagree about the scope of authority that should
be given to the CEO to run the company’s business operations without interference from the board.
The Chairman has accused the CEO of wanting to run the company as a dictator.

Despite this, a number of institutional investors who hold shares in Foxtrot have expressed concern
about its declining profitability and have said they would like the Chairman to take over as CEO on a
temporary basis.

The CEO argues that the company’s problems are caused by slow and ineffective decision-making
by the board.

Required

(a) Describe the respective roles of the CEO and Chairman of a listed company, and explain why it
is generally considered inappropriate for the same individual to hold both positions.
(15 marks)

Suggested answer

The CEO is the leader of the executive management team of a company and is responsible for the
management of the company’s business operations, within guidelines determined by the board of
directors. Although there may be several executive directors on a board, the CEO is the individual
who is accountable to the board for the performance of the company and its management team.

The CEO is responsible for implementing policy decisions by the board, and converting these into
detailed business strategies, plans and operational activities.

The board Chairman is responsible for management of the board of directors. The Chairman is the
leader of the board and should ensure that the board acts effectively in providing leadership to the
company. The UK Corporate Governance Code (UK Code) states that the Chairman is responsible
for the leadership of the board and ensuring effectiveness in all aspects of its role. To create an
effective board, the Chairman should also ensure the effective contribution of individual directors to
decision-making and effective contributions to the work of the board by its board committees.

As leader of the board, the Chairman is responsible for the detailed conduct of board affairs, by
setting the agenda for board meetings, providing directors with sufficient relevant and timely
information, and promoting a culture of openness and debate at board meetings.

To fulfil these responsibilities effectively, the Chairman should ensure that matters reserved for
decision-making by the board are not delegated to executive management.

The Chairman also has responsibility, working with the nominations committee, for reviewing the
performance of the board and also the composition of the board.

These responsibilities extend to ensuring that new directors are given suitable induction and that all
directors receive appropriate ongoing training.

The Chairman also has a role to play with the company’s shareholders and the media. He is
responsible for maintaining good relations and dialogue with shareholders, through meetings with
individual shareholders and effective use of the AGM. He should also be aware of media reporting of
the company, although the CEO may play a more active role in this regard.

© ICSA, 2015 Page 6 of 21

 Crucially, the Chairman has a responsibility for creating a constructive relationship between the
board and the management team. To do this, he must work with the CEO. When there are problems
with the company’s performance, he should be prepared to act, criticising the CEO and indicating
the likely concerns of the rest of the board as well as shareholders.

The positions of Chairman and CEO are the two most powerful positions on the board of directors. If
the same individual were to hold both positions, there would be a risk that he would be a dominant
force on the board, capable of persuading the rest of the board to agree with his views about
decisions that the board should take. The UK Code states that no individual should have unfettered
powers of decision.

With a dominant leader, there is a risk that decisions will be taken that are not in the best interests of
the company and its shareholders.

It may also be argued that providing effective leadership to the board and effective leadership to the
management team is difficult for a single individual, because of the time and effort required to fulfil
both roles effectively.

An additional problem is that as CEO the individual would be accountable to the board for the
company’s performance, but his accountability would be largely to himself, as leader of the board.
An individual cannot be properly accountable to himself.

There may be occasions when it is appropriate for the same individual to hold both positions, but as
a general rule this should be a temporary arrangement until a new Chairman or CEO can be
appointed.

Examiner’s comments

On the whole, this question was answered quite well. Some answers did not give adequate attention
to each part of the question. As a result some candidates gave too much attention to some issues
and not enough to others. However, this was an area where many candidates showed that they
were reasonably well prepared.

(b) Comment on the size and structure of the board of Foxtrot and recommend measures that
should be taken to review the composition of the board.
(10 marks)

Suggested answer

The composition of boards of directors of listed companies can vary substantially between countries.
In the UK, the UK Code states that the board should be of sufficient size so that changes in
membership will not disrupt its activities, but the board should not be so large as to be unwieldy.

The UK Code also states that there should be an appropriate combination of executive directors and
non-executive directors (NEDs), particularly independent NEDs. Except for smaller companies, the
majority of the board (excluding the chairman) should be independent NEDs.

The main principle in the UK Code relating to the composition of the board is that the board should
have an appropriate balance of skills, experience, independence and knowledge to fulfil its
responsibilities effectively.

No individual or small group of individuals should be in a position to dominate decision-making by

the board.

The recent loss of the COO and Finance Director from the board of Foxtrot has left the CEO as the
only executive director. This in itself is not a breach of the UK Code, although it may be argued that
there is an unsatisfactory balance between executive directors and NEDs, and the board may not

© ICSA, 2015 Page 7 of 21

 contain enough members with a sufficient knowledge of the company’s business. Dissatisfaction
with the performance of the CEO, who accuses the board of ineffectiveness, and the poor working
relationship between the Chairman and the CEO, seem to indicate that the current situation should
not be allowed to continue.

One possible way forward would be to make new appointments of executive directors to the board.
However, there is no information about whether there are suitable individuals capable of becoming
executive directors. It is also not clear what the working relationship between the CEO and any new
executive directors might be.

A second solution would be for the board to give the CEO authority to make the decisions that the
CEO considers necessary for the company. This would probably mean a delegation of authority by
the board to the CEO and failure by the board to fulfil its responsibilities.

The most appropriate way forward is probably to ask the CEO to resign, but only if a sufficient
number of influential shareholders and board directors agree. The Chairman could be appointed as
CEO, but only as a temporary measure until a new CEO is appointed. To protect the company’s
share price, removing the CEO would have to be made with shareholder support and should be
presented to the stock market as a necessary measure to improve the company’s performance and
reverse the decline in profitability.

Unless the CEO resigns, the Chairman should consider his own position. A good working
relationship between CEO and Chairman is a necessary requirement for an effective board, and if
the two individuals do not get on well, one of them should resign. If it is not the CEO, it should be the
Chairman. In this situation, the Senior Independent Director may be asked to take on the role of
board Chairman, at least temporarily until a new Chairman can be found.

Examiner’s comments

Candidates appeared to have found this part of the question a bit more challenging. Good answers
made perceptive references to the question scenario, and gave clear explanations for the
recommendations that they made. Virtually all candidates took the view that the company’s board
now lacked a sufficient balance between executive and non-executive directors. Some answers just
stated this as a fact, but better answers gave a reason for the opinion made.

© ICSA, 2015 Page 8 of 21

3 The Chairman of Oscar plc (‘Oscar’) is not sure how to organise the performance review of Oscar’s
board. Last year, Oscar used the services of external facilitators, but the Chairman thinks the board
should be capable of carrying out the review itself this year.

He has asked you, as company secretary, for your advice on this matter.

Required

(a) Explain the requirements of the UK Corporate Governance Code with regard to the
performance evaluation of the board of a listed company in the FTSE 350, its committees and
its individual directors.
(8 marks)

Suggested answer

The UK Corporate Governance Code (UK Code) states that a board should undertake a formal and
rigorous annual evaluation of its own performance, and the performance of its committees and
individual directors.

Evaluation of the board should consider the balance of skills, experience, independence and
knowledge of its members, its diversity (including gender) and how it works together as a unit.

The Chairman should act on the results of the performance evaluation, recognising the strengths
and weaknesses of the board. Where appropriate, the Chairman should propose that new members
should be appointed to the board or should seek the resignation of existing directors.

Performance evaluation of individual directors should consider whether each director continues to
contribute effectively to the work of the board and shows commitment to the role of director
(including commitment of time).

The UK Code also contains three specific provisions about evaluation.

 The board should state in the annual report how performance evaluation of the board, its
committees and individual directors has been conducted.

 Evaluation of the boards of FTSE350 companies should be ‘externally facilitated’ at least every
three years, and the external facilitator should be identified in the annual report.

 Led by the Senior Independent Director, the NEDs should be responsible for the performance
evaluation of the Chairman, taking into consideration the views of the executive directors.

Examiner’s comments

This was a factual question. The marks awarded for this question depended on how much
candidates demonstrated what they knew. Some candidates demonstrated that they had learned the
details of this topic and scored well; others showed a more limited knowledge of the topic.

(b) Advise the Chairman on how a performance review might be carried out internally by the board.
Giving reasons for their importance, identify aspects of performance that should be reviewed
for:

(i) individual directors (not including the Chairman); and

(ii) the board as a whole.

(17 marks)

© ICSA, 2015 Page 9 of 21

 Suggested answer

The Chairman should ensure that the requirements of the UK Code with regard to evaluation are
implemented. He should therefore ask the Senior Independent Director (SID) to make arrangements
for his own performance evaluation. He should not give any detailed instructions about the method
of evaluation, since he should not try to influence the process.

The UK Code does not give any other specific guidance about the conduct of the evaluation, but if
the board does not want to use external facilitators this year, the process will have to be carried out
by board members. This could be co-ordinated by the company secretary and could be carried out
with the use of a detailed questionnaire and follow up interviews with an unattributed summary
provided for board discussion. Any action points agreed as a result of the review could also be
tracked during the year by the company secretary and regularly reported to the board.

My advice to the Chairman is that the board should agree collectively the aspects of performance
that should be evaluated. This will involve preparing a list of performance criteria against which
actual performance should be judged. These criteria should be based on the aspects of performance
considered in the previous year by the external facilitators, as it would be sensible to maintain some
continuity and consistency in the approach that is taken from one year to the next.

The Chairman may decide to be involved personally in the performance appraisal of individual
directors and the board committees. Evaluation of the performance of the board as a whole may be
difficult to separate from evaluation of the performance of the Chairman himself, and some
involvement by the SID would probably be appropriate.

There should be feedback to individual directors and to the committees, so that any measures taken
by the Chairman to act on the findings of the evaluation can be understood by the individuals
affected.

Individual directors

The main issues that should be considered with regard to the performance of individual directors
should include the following.

 The commitment shown by the individual to the work of the board, including the commitment of
time. When a director is appointed, there may be an understanding or written agreement about
the amount of time that a NED is expected to commit to the board. If so, the actual time
committed should be compared with the time commitment that is expected. Individuals who are
not committed to the board should not be involved in providing leadership for the company.

 The contribution of an individual to discussions and deliberations in board and committee

meetings should also be considered. Individuals should be expected to contribute
constructively, using their skills, experience, knowledge or independence. The value as well as
the amount of contributions by each individual should be assessed.

 Linked to the assessment of the value of individual contributions should be an assessment of

how well informed the director appears to be about the affairs of the company. If an individual
does not keep himself well-informed, it will be difficult for him to contribute as well as he should
to the work of the board and its committees.

 Directors are expected to keep up-to-date with developments in the business world and the
training undertaken by the director, both in the previous year and collectively over time, should
be assessed, to decide whether this seems sufficient. The performance review should consider
whether any directors require training for their work on board committees where they are a
member or where they will soon become a member.

© ICSA, 2015 Page 10 of 21

  For directors who are considered independent, their independence should be reviewed. There
may be a tendency for NEDs to lose their independence over time. Where there is evidence that
a NED may no longer be sufficiently independent, he or she may be asked to resign from the
board.

 Individual board members should also be able to work well with board colleagues and the
company secretary, and to have the respect of senior executive managers. Personal
relationship skills help an individual to operate effectively; lack of such skills acts as a barrier to
effectiveness.

The board as a whole

The board should provide entrepreneurial leadership to the company, giving the company a clear
sense of its objectives and the broad strategies for achieving those objectives. The board should
consider whether it does share a common sense of agreed objectives and strategy. It should also
consider the contribution of the board in the previous year to the achievement of the company’s
strategic objectives.

The board is responsible for monitoring the performance of the company and its executive
management. The board should consider whether, and in what ways, it has made management
properly accountable.

The board should review its size and composition, and consider whether it is too large or too small,
and whether its members together have a sufficient range and depth of knowledge, experience and
skills to provide effective leadership for the company. Areas of expertise (if any) where the board is
lacking should be identified.

Although there is a connection with the performance of the Chairman as leader of the board, the
board should consider the efficiency and effectiveness of its own activities. It should review the
number of board meetings in the previous year, and whether these were sufficient. It should also
consider the decisions made by the board and whether these were communicated clearly to
management and other stakeholders. There should also be a review of the quality of decision-
making by the board, and the discussions at board meetings that led up to those decisions.

The board should be responsible for deciding the risk appetite of the company, and the exposures to
strategic risks that the company should be willing to take. The board should review whether it has
given a clear indication of its risk appetite and whether strategies implemented by management are
consistent with that risk appetite.

The board should consider the quality of its relationships with management and also with
shareholders and employees. If there are problems in the relationship between the board and any of
its major stakeholders, this could be an indication of poor performance by the board.

The performance of a board may also be judged by any incidents that occurred in the previous year,
such as incidents that caused damage to the company’s reputation and adverse media coverage.
Where there have been events that have affected the standing of the company with the general
public, regulators or investors, the board should consider the extent to which it may have been to
blame, and the effectiveness of its efforts to deal with the problem.

The board provides leadership to the company and is influential in formulating the culture of the
company and its employees. The board may wish to consider whether its own actions and
leadership are consistent with the corporate ethics and culture that they wish to uphold.

© ICSA, 2015 Page 11 of 21

 Examiner’s comments

There were a large number of points that could have been made in answer to this question. Some
candidates assumed that the annual performance review of the board and directors should be linked
to the review of remuneration of senior executives. This seemed to show a lack of awareness of the
difference between the functions of the board and those of management. Pay is not an issue that
should dominate the annual board performance review.

There were relatively few errors of fact in candidates’ answers. Quite simply, the answers which did
not achieve a pass level did not include enough points.

© ICSA, 2015 Page 12 of 21

4 The annual reports and accounts of major companies have been criticised for their length,
complexity and lack of clarity.

The UK’s Financial Reporting Council commented in a discussion paper in 2009 (‘Louder than
Words’):

“Concerns about the increasing complexity and decreasing relevance of corporate reports have
been growing in recent years. Many people point to the increasing length and detail of annual
reports – and the regulations that govern them – as evidence that we have a problem. Others are
more worried that reports no longer reflect the reality of the underlying businesses, with key
messages lost in the clutter of lengthy disclosures and regulatory jargon.”

Required

(a) Explain the meaning and value of transparency in company reporting, and suggest reasons why
financial reporting by companies often fails to provide the transparency that shareholders
require.
(8 marks)

Suggested answer

Reporting by a company is the principal way in which the company’s board communicates with
shareholders and other stakeholders. Reports can be used to make a board accountable to its
shareholders. They are also important in providing information that can assist stakeholders in
making decisions about their involvement with the company. For example, the annual report and
accounts may contain information that affects decisions by shareholders to hold on to their shares,
buy more shares or sell shares that they hold. Financial reports may also be used by banks and
other investors when deciding whether to lend to a company.

Information about a company is used by all types of stakeholders to reach decisions. Without reliable
information, poor decisions may be taken.

Transparency means openness. Transparency in reporting by companies means providing

information to shareholders and other stakeholders about the company that is honest. Transparency
is also linked to clarity and understanding, and also to a willingness to provide the information that
stakeholders should expect to receive, which they can used to make well-informed decisions.

The opposite of transparency is ‘opaqueness’ or ‘vagueness’, where it is not clear from the
information provided exactly what a company’s positions or intentions are.

Financial reporting often fails to provide the transparency that shareholders and other stakeholders
require. This is largely due to the complexity of company accounts. There are extensive financial
reporting standards that companies are required to use in preparing reports, but understanding is
made difficult by the detailed technicalities of both reporting and accounting policies used. The
length of notes to the financial statements also contributes to their opaqueness.

Financial reporting is essentially backward-looking. Annual financial statements provide a report on

what the company has achieved in the previous financial year, but they give no indication of where
the company will be in the future.

Agency theory may also be suggested as a reason for lack of transparency in reporting. The
directors should provide leadership for their company in a way that services the best interests of the
shareholders (and other stakeholders), but they may instead give priority to their own personal
interests. As a feature of the potential ‘conflict’ between directors and shareholders, the directors
may seek to avoid accountability for their actions and performance by making the financial
statements (and supporting reports) long, complex and difficult for readers to comprehend.

© ICSA, 2015 Page 13 of 21

 Examiner’s comments

A number of answers to this question provided incorrect definitions of transparency. Transparency

means that something should be clear and visible, rather than opaque and unclear. Transparency in
reporting means making it clear what the organisation has done in the past and intends to do in the
future.

(b) Describe the aspects of a company’s affairs that listed companies are required to provide for
their shareholders, other than the information in the published financial statements, and suggest
reasons why this information is of value to them.
(17 marks)

Suggested answer

(Note: This example answer is based on reporting requirements for UK companies. Answers based
on reporting requirements in other countries were marked on their merits.)

Companies may choose to provide information voluntarily about aspects of their affairs, such as
social and environmental performance. In the UK, most of the regulatory requirements concerning
disclosures are contained in the Companies Act 2006 (as amended). In addition, listed companies
are required by the UK Corporate Governance Code (UK Code) and the Disclosure and
Transparency Rules and Listing Rules to make certain disclosures.

Information about corporate governance arrangements enables shareholders and other investors to
assess the quality of corporate governance within a company. This may have some influence on
their investment decisions, and should provide some reassurance to investors that the company’s
governance arrangements are satisfactory. Disclosures by a listed company about governance
include:

 Information relating to the size, composition and functions of the audit committee.

 A report on the main features of the company’s internal control and risk management systems
for the financial reporting process and a report on the annual review by the board of the
effectiveness of these systems.

 Information about the composition and operation of the board and its committees.

Stakeholders use non-financial information, as well as financial information, to assess the past
performance, current position and future prospects of a company. With the exception of small
companies, all companies are required to include a strategic report in their annual report and
accounts.

A strategic report should contain a fair review of the company’s business and a description of the
main risks and uncertainties that it faces. It should provide an analysis of the development and
performance of the company’s business during the past financial year and the position of the
company as at the end of the year.

The review should also contain an analysis of key financial performance indicators and where
appropriate larger companies should also provide analysis using non-financial KPIs relating to
environmental matters and employee matters.

The strategic report of a quoted company should also include the main trends and factors likely to
affect the company in the future and information on policies (and their effectiveness) relating to
environmental matters, employee matters and social, community and human rights issues.

© ICSA, 2015 Page 14 of 21

 For quoted companies the strategic report should also contain a description of the company’s
strategy and business model, and also an analysis of its directors, senior executives and other
employees by gender.

The information in a strategic report is therefore broad-ranging, largely non-financial and also largely
forward-looking. These aspects of a company’s affairs are critical for the company’s future, but are
not reported in financial statements. Stakeholders can also use this information to base their
decisions on factors other than purely historical financial performance, such as environmental and
social issues. The UK regulations on environmental information additionally require quoted
companies to report annually in the directors’ report on greenhouse gas emissions.

In the UK, the UK Code and the Listing Rules also require companies to include a going concern
statement in the annual report and accounts. This statement is not a part of the financial statements
by a company, but should provide reassurance to investors that the company expects to remain a
going concern for at least the next 12 months.

Information about directors’ remuneration must be provided by quoted companies in the UK. A
remuneration report, included in the annual report, should contain information about the company’s
policy on directors’ remuneration and an implementation report, stating how the remuneration policy
was implemented during the financial year. This information is needed by shareholders to make their
decision about whether or not to approve the remuneration policy and to monitor whether the policy
has been implemented properly during the year. Shareholders in quoted companies have a binding
vote on the remuneration policy at least once every three years.

In summary, UK companies, particularly quoted companies, are required to provide extensive

information in addition to their annual financial statements, with the intended purpose of improving
the range and quality of information to stakeholders, enabling them to make better-informed
decisions about their involvement with the company.

Examiner’s comments

This question was not generally answered very well. Not much detail was covered on the contents of
a strategic report and very few answers discussed CSR reporting or sustainability reporting, and the
reasons why the contents of these reports might provide value to shareholders.

Some answers focused on corporate governance reports, such as reports of the board committees.
Others discussed a company’s announcements to the stock market. In general, candidates were not
well prepared for a question on reporting to shareholders.

© ICSA, 2015 Page 15 of 21

5 Sandra Lee (‘Sandra’) is the newly-appointed Chairman of the audit committee of Papa plc, a UK
listed company. Her first task is to agree a plan with the other committee members for the annual
review of the effectiveness of the company’s internal control and risk management systems. She is
aware that the audit committee may not have been as rigorous in its review as it possibly should
have been under the previous Chairman.

Several matters have come to her attention. She is aware that the internal auditors restrict their
auditing work to reviews of financial controls and financial reporting. The company secretary has
informed Sandra that she is unaware of any incidents of whistleblowing within the past 12 months.
The Chief Executive Officer (CEO) has also informed her that risk registers are not used as part of
the procedures for risk management.

Required

(a) Describe the requirements of the UK Corporate Governance Code with regard to the review of a
company’s internal control system, and suggest the various elements of the internal control
system and the nature of the internal controls that should be subject to the review.
(10 marks)

Suggested answer

The UK Corporate Governance Code (UK Code) states that the board should maintain sound risk
management and internal control (IC) systems. At least annually, the board should carry out a
review of the effectiveness of the company’s IC system and should report to shareholders that it has
done so. (The Disclosure and Transparency Rules go further, requiring disclosure of the main
features of the IC systems for the financial reporting process.)

The review should cover all material controls, including financial, operational and compliance
controls. Further guidance on the review is contained in the Turnbull guidance.

The UK Code also states that unless another committee is established for the purpose, or the board
does the review itself, the audit committee should be responsible for the review of the effectiveness
of the company’s IC controls (as well as the effectiveness of the internal audit function).

It may also be argued that the company’s whistleblowing system is an element in the IC system of a
company. If so, a further requirement is that the audit committee should review the whistleblowing
arrangements, with the objective of ensuring that arrangements are in place for an investigation of
whistleblowers’ reports and for appropriate follow-up action.

A review of the effectiveness of the IC system (or systems) should not be restricted to the internal
controls themselves. It should review all aspects of the IC system. There are different ways of
analysing the elements of an IC system. One of these is the COSO model of an IC system, which
consists of five elements: a suitable control environment and risk awareness culture; procedures for
identifying, assessing and prioritising risks; the design and implementation of internal controls to
manage these risks; arrangements for communicating information about risks and risk management
to the individuals concerned; and regularly monitoring the effectiveness of the IC system.

The review should ensure that suitable measures are in place to monitor risks, identify new or
developing risks and assess their potential significance.

The risks that are managed by an IC system can be categorised into financial risks (or financial
reporting risks), operational risks and compliance risks.

Financial risks are risks of errors or fraud in the financial reporting and book-keeping system, such
as failures to record accounting transactions fully or accurately. Operational risks are risks of losses
arising from failures in internal processes, systems or people, and from external events. They
include risks of losses arising from machine failures, system failures and human errors. Compliance
risks are risks of losses arising from failure to comply with relevant laws and regulations.

© ICSA, 2015 Page 16 of 21

 The controls within an IC system should be designed to prevent or mitigate losses arising from these
categories of risk event, or to detect risk events when they occur with a view to dealing with them.

A review of the effectiveness of internal controls within an IC system should check whether the
internal controls that are in place are sufficient to deal adequately with the significant risks that have
been identified.

Examiner’s comments

Although answers varied in the amount of clarity and understanding shown, candidates in general
showed awareness of the issues that were relevant to the question.

(b) Advise Sandra about ways in which the audit committee should carry out the review of the
company’s internal control system and explain how she might address the issues that have
come to her attention.
(15 marks)

Suggested answer

The audit committee needs evidence to assess whether the IC system is effective, and this should
be obtained from several different sources.

The audit committee may be aware of failures that have occurred in the IC system, such as an
incident of fraud or a breakdown in an important IT system. Where there have been known cases of
IC failures, the audit committee should ask for a report on why the failure occurred, how it was dealt
with, and what measures have been taken since to prevent or mitigate the effects of a recurrence of
the same problem.

However, the committee should not rely on the existence or absence of reported IC failures to
assess the effectiveness (or ineffectiveness) of the IC system. As non-executive directors, the
committee members are not in a position, and do not have the time, to carry out detailed
investigations themselves. Instead, they should rely on information from three sources.

As a part of the annual external audit, the company’s auditors should write to the company with
comments about any weaknesses they have identified in the IC system, indicating the potential
seriousness of each weakness. The audit committee should study a copy of this letter, and ask
representatives of the management team (such as the finance director) how they have responded or
are responding to the comments and suggestions of the auditors.

Management have a responsibility for the effectiveness of the IC system, and the audit committee
should ask for a report from management about the measures they have taken during the year to
implement and review the IC system. Management should be asked about arrangements for the
identification and assessment of risks, and should provide details of any new risk assessments that
have been made. Management should also be asked about arrangements for communicating
information about risks and internal controls to relevant individuals within the organisation. They
should also explain how they have dealt with any internal control failures that the audit committee
were not aware of.

Many large companies have an internal audit function. An important role of the internal auditors is to
review the effectiveness of elements of the IC system. The head of internal audit may be asked to
prepare an annual report on its work during the year and problems with internal control that have
been discovered. The audit committee may also receive reports throughout the year from the head
of internal audit on different aspects of the IC system. The audit committee should seek reassurance
from the internal auditors that in their view the IC system is effective, and any identified weaknesses
in the IC system have been dealt with by management.

© ICSA, 2015 Page 17 of 21

 The matters that have been brought to Sandra’s attention should be considered by the committee.
By restricting their work to audits of financial reporting and financial controls, the internal auditors do
not review the effectiveness of operational and compliance controls. The committee needs to review
how operational risks and compliance risks are controlled and how their effectiveness is reviewed.
The committee should also establish whether there have been any reports by whistleblowers in the
past 12 months (or longer). If there have been no reports, the committee should consider the
effectiveness of whistleblowing procedures within the company.

Risk registers are a useful method of recording the identification and assessment of risks, measures
that have been taken to manage risks and responsibilities for the management of the risks. They are
not an essential requirement for effective risk management, and other procedures may be used. The
audit committee should review the procedures and processes used within the company for
identifying and assessing risks, evaluating and prioritising them, responsibilities for risk
management, actions taken to manage risks and measures taken to review the effectiveness of such
actions.

In all these matters the audit committee will need to take a view on the effectiveness of the existing
system of risk management, and should report their conclusions and recommendations to the board.
On the basis of the evidence they gather, the audit committee should report to the full board on the
effectiveness of the IC system.

Examiner’s comments

Answers varied in quality, mainly according to the points they made and the clarity of explanations.
The best answers were very good indeed.

However, some candidates took the view that the audit committee has extensive executive powers
to make changes, which is not the case. For example, there were suggestions that the audit
committee should introduce the use of risk registers for documenting risks and risk management
actions; others discussed whistleblowing at length and the changes that the audit committee should
make. The audit committee, through the board, can give policy directions but it is up to management
to carry out the executive tasks of putting policy into practice.

© ICSA, 2015 Page 18 of 21

6 Ivan Brook (‘Ivan’) is the company secretary of November plc, a listed company. He leads a team at
head office that he considers to be excellent administrators, but he is aware that most of the team
members do not have much understanding of corporate governance or corporate social
responsibility (CSR).

The board of directors has recently announced a review of its CSR policies and has established a
CSR sub-committee of the board, under the chairmanship of the Senior Independent Director (SID).

Required

(a) Explain the contribution of the company secretary to maintaining standards of governance in a
listed company.
(16 marks)

Suggested answer

The company secretary is not a company director and so is not directly accountable for corporate
governance. However, the company secretary has an important role in maintaining standards of
governance.

The company secretary provides support to the company chairman, who has responsibility for the
effectiveness of the board. In this role, the company secretary assists the chairman with
arrangements for board meetings, including the provision of timely information to board members in
advance of board meetings. He or she is also responsible for the preparation and circulation of
minutes of board and committee meetings.

The company secretary should establish a list of matters that the board has decided should be
reserved for its own decision-making, and should ensure that the board deals with all the matters on
this list and does not delegate any of the decision-making responsibilities to management.

The company secretary should be a source of advice and guidance on governance issues, and
should be a person that directors (especially non-executive directors) can ask for help. He or she
should be able to advise the board (through the chairman) on matters of governance and should be
in a position to advise the board on any matter where it is in breach of the code of corporate
governance.

Various regulations relate to governance issues, such as shareholder voting rights (for example, on
the company’s remuneration policy) and disclosures in the annual report. The company secretary
should try to ensure that the company complies with all relevant regulations, and that breaches of
regulations are dealt with appropriately.

All directors should have access to the services and advice of the company secretary, who has a
responsibility for ensuring that board procedures are complied with.

The company secretary should also advise the board chairman on periodic reviews by the chairman
of governance arrangements in the company, to establish whether they are satisfactory or whether
improvements should be made. For example, the company secretary may suggest to the chairman
that changes should be made to the composition of the board or its committees, to keep these
refreshed.

New directors should be given an induction programme when they are first appointed to the board,
and should receive ongoing training throughout their time on the board. The chairman is responsible
for ensuring that directors receive induction and training, but the company secretary will assist with
the arrangements.

The company secretary should ensure that there is a good flow of information between board
committees and the board. As a matter of good practice, he or she should act as secretary to the
nominations committee, audit committee and remuneration committee and should also provide

© ICSA, 2015 Page 19 of 21

 administrative support, such as assisting with arrangements for interviews by the nominations
committee with potential new directors.

The UK Corporate Governance Code states that there should be an annual evaluation of the
performance of the board, its committees and individual directors. Although it is unlikely that the
company secretary will carry out the evaluation personally, he or she may be involved in
arrangements for carrying out the review.

It is usually the responsibility of the company secretary to ensure that appropriate directors’ and
officers’ liability insurance is provided for board members.

The company secretary may also be asked to draft elements of the annual report that deal with
corporate governance issues.

The company secretary needs to be in a position of some independence from the board, and should
not be under the influence of board members. It may be suggested that the company secretary acts
as the ‘conscience of the company’, advising the board on what would be inappropriate, in terms of
governance or, more generally, ethical conduct.

Examiner’s comments

In answering this question, far too many candidates did not make enough points about the role of the
company secretary in corporate governance. There was also a limited sense of proportion, with
candidates considering the task of arranging meetings and taking minutes to be more important for
corporate governance (rather than efficient administration) than other functions such as reminding
the board about the company’s regulatory and governance obligations.

(b) Critically evaluate the importance of CSR and suggest how Ivan might be involved in a
programme by the board to develop CSR policies for the company.
(9 marks)

Suggested answer

CSR is the responsibility that a company recognises and accepts towards the society in which it
exists and operates. Companies may be described as corporate citizens and, as such, should be
expected to act as ‘good citizens’.

The principles of CSR are consistent with the stakeholder theory of corporate governance, which is
based on the view that the company’s leaders (board of directors) should consider the interests and
concerns of all major stakeholders, not just those of the shareholders.

A company could include in its CSR programme its responsibilities towards employees, the
environment, human rights, communities and social welfare, social investment and ethical conduct.

ICSA Guidelines have suggested that the company secretary should share responsibility with
relevant specialists for ensuring that the board is aware of current guidelines relating to CSR. In the
role of conscience of the company, the company secretary may also try to ensure that the board
identifies and takes account of significant CSR issues.

The board has established a CSR sub-committee and it would seem appropriate for Ivan Brook to be
appointed as secretary to this committee. In this role, he should provide support and assistance to
the committee chairman, and should ensure that there are good communication flows between the
committee and the board.

The CSR sub-committee will probably need to prioritise CSR issues for consideration. Ivan Brook
should assist the sub-committee with the task of formalising priorities.

© ICSA, 2015 Page 20 of 21

 It seems probable that the company will publish more information on CSR issues, possibly in a social
and environmental report. Ivan Brook will probably be involved in the drafting of these reports.
Ivan Brook should try to encourage his staff in the company secretarial department to understand
and appreciate the importance of CSR for corporate governance, and the role of the department in
providing support to the board.

Examiner’s comments

A surprising number answers to this question were very brief, with candidates commenting simply
that CSR was now ‘increasingly important’, without giving an explanation of their reason or reasons
for this assertion. Some candidates wrote about reporting on CSR rather than discussing the
importance of CSR policies themselves.

The scenarios included here are entirely fictional. Any resemblance of the information in the scenarios
to real persons or organisations, actual or perceived, is purely coincidental.

© ICSA, 2015 Page 21 of 21