Shareholders, boards and board committees — study companion

Accounting Ahead | Original study resource | accountingahead.com.au

The governance framework

MODULE 3 | PART B.2 | STUDENT COMPANION

Outside influences shape every company. Inside, shareholders elect the board, the board appoints the chief

executive and uses committees, and the external auditor gives independent assurance.

OUTSIDE THE COMPANY INSIDE THE COMPANY

Laws and the regulators who

enforce them

What investors expect

Industry and professional

standards

Stakeholders: staff, customers,

lenders, community

Shareholders

Elect the board

elect

Board of directors

Directs and oversees

appoints and delegates

Chief executive and

management

External auditor

Independent assurance on the

financial reports

Board committees

Nomination, remuneration,

audit, risk and sustainability.

They examine; the board stays

responsible.

works with audit

Two kinds of shareholder

Individual shareholders Institutional shareholders

Who People who own shares directly, many of

them retirees

Super funds, insurers, investment trusts, fund

managers

What they want Efficient, profitable, honestly run companies Returns for their own members over the long

term

How they

influence

Votes, questions at meetings, media and

online, shareholder associations

Large votes, in-house analysts, proxy

advisers, stewardship codes, private

engagement

Information asymmetry - one side knows much more than the other. Moral hazard - someone takes

more risk, or less care, because they won't bear the full consequences and others can't easily see what

they do. The first often opens the door to the second.

ETHICS & GOVERNANCE | M3 PART B.2 | STUDENT COMPANION

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Accounting Ahead | Original study resource | accountingahead.com.au

Committees and the audit committee

MODULE 3 | PART B.2 | COMMITTEES AT A GLANCE

Committee Main job Who should sit on it

Nomination Succession, board evaluation,

recommending director candidates

Mostly independent directors; executives can

contribute

Remuneration Pay for directors and senior executives Independent directors; executives never set their

own pay

Audit Financial reporting, internal control, internal

and external audit

Non-executives only, mostly independent,

independent chair who is not the board chair,

financial expertise

Risk Risk framework and risk appetite, including

strategic and climate risks

Mostly independent directors

Sustainability Climate, emissions, modern slavery,

cybersecurity, sustainability reporting

Works closely with the risk and audit committees

Audit committee health check

1 All members non-executive?

2 Mostly independent, with an independent chair who is not the

board chair?

3 Enough accounting and financial expertise, and industry

knowledge?

4 A written charter giving clear authority and reporting lines?

5 Meets the auditors, including without management present?

All yes

Independent, skilled and genuinely

at work

Any no

A warning sign: fix it, or for

recommendations, explain why not

Benefits when it works Limitations to watch for

Stronger internal control and record keeping May lack power to enforce its recommendations

Supports the external auditor's independence Members lacking financial skills, or chosen for loyalty

Better-quality financial reports Management's presence stifling open discussion

A forum for auditor-management disagreements; checks

whistleblowing channels work

Unclear terms of reference, time and cost, or existing for

appearances only

ETHICS & GOVERNANCE | M3 PART B.2 | STUDENT COMPANION

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Accounting Ahead | Original study resource | accountingahead.com.au

Practice questions

MODULE 3 | PART B.2 | TRY THESE BEFORE THE WORKED ANSWERS

Question 1 - Lakeside Medical Devices Ltd

Imagine Lakeside Medical Devices Ltd, a company in the S&P/ASX 300. Its audit committee has two

members. It is chaired by the chief operating officer, an executive director. The other member, a non-executive,

is the chief executive's brother-in-law. Neither has accounting or financial qualifications. The committee meets

once a year, a week before the annual results, has no written charter, and the external auditor reports its findings

to the chief executive rather than to the committee. Identify the weaknesses and suggest a fix for each.

Question 2 - Westward Logistics Ltd

Regional managers at Westward Logistics Ltd earn a bonus for on-time deliveries. The board sees only the

on-time percentage. Managers know some drivers skip rest breaks to hit targets. Explain the problem using the

terms information asymmetry and moral hazard, and suggest two fixes.

Lakeside Medical Devices and Westward Logistics are imagined examples. Study guide reference: Module 3, Part B, section 3.6.

ETHICS & GOVERNANCE | M3 PART B.2 | STUDENT COMPANION

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Accounting Ahead | Original study resource | accountingahead.com.au

Worked answers

MODULE 3 | PART B.2 | WORKED ANSWERS - ATTEMPT THE QUESTIONS FIRST

Question 1 - Lakeside's audit committee

Weakness Why it matters Fix

Only two members Too small to give depth and independence At least three members

Chaired by an executive

director

Management would be overseeing its own

reporting

Non-executives only, with an independent

chair who is not the board chair

Member is the CEO's

brother-in-law

Close family ties to management

undermine independence

Replace with an independent director so

most members are independent

No financial qualifications Can't challenge judgements, estimates or

audit findings

Appoint members with accounting and

financial expertise

Meets once a year Too late to influence reporting or audit

planning

Meet regularly through the year, including

half-year and year-end reviews

No written charter Authority and duties are unclear Adopt a written charter with clear reporting

to the board

Auditor reports to the

CEO

Defeats the committee's role as the link to

the auditor

Auditor reports to, and meets, the

committee, including without management

Because Lakeside is in the S&P/ASX 300, the listing rules also require it to follow the recommended audit

committee structure, so these are not optional design choices.

Question 2 - Westward Logistics

Information asymmetry: the managers know drivers are skipping rest breaks, but the board sees only a strong

on-time figure. Moral hazard: the managers gain the bonus while the safety risk, fines and harm fall on the

drivers, the company and the public, and the board can't easily see what is happening.

Give the board richer information, such as fatigue, safety incident and rest-break data.

Balance the bonus with safety measures, or make safety a gateway the managers must pass before any

bonus.

Arrange independent checks, for example internal audit reviews of driver logbooks.

ETHICS & GOVERNANCE | M3 PART B.2 | WORKED ANSWERS

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