Corporate Governance, Business Ethics, 2019-2020 Edition MA. ELENITA BALATBAT CABRERA BBA MBA CPA CMA PRESENTLY: Academic and Business Consultant President and CEO, CLA Consultancy and Training Center, Inc. FORMERLY: Vice Chairman and Examiner, Professional Regulatory Board of Accountancy World Bank Consultant Dean, College of Business Administration, Lyceum University of the Philippines CPA Review Director & Reviewer, Professional Review and Training Center, Inc. Professor of Accounting & Finance, University of the East, Far Easter University, ‘De La Salle University, Centro Escolar University, St. Scholastica’s College Audit Staff, SGV and Co., CPAs GILBERT ANTHONY B. CABRERA BBA MBA CPA PRESENTLY: Vice President - Risk and Finance, Global Insurance Brokerage, USA. FORMERLY: ‘Chief Financial Officer, Food Retail Conglomerate, USA. Senior Auditor, SGV and Co., CPAS Accounting Instructor University of Maryland, Robert Smith School of Business University of the East. ManilaPhilippine Copyright, 2019 by MA. ELENITA BALATBAT CABRERA CILBERP AA OBYB. CABRERA Any copy of this book not bearing the signature of the author(s) shall be considered as proceeding from an illegal source The Internet addresses listed in the text were accurate at the time of publication, The inclusion of a website does not indicate endorsement by the authors or GIC Enterprises & Co,, Inc. and they do not guarantee the accuracy of information presented at these sites. ALL RIGHTS RESERVED ISBN: 978-621-416-073-0 Published & Printed by: GIC ENTERPRISES & CO., INC. *National Book Development Board Registered 2017 C. M. Recto Avenue, Manila PhilippinesAbout the Authors Ma. Elenita B. Cabrera BBA MBA CPA CMA Dean Cabrera graduated Magna Cum Laude from the University of the East with a degree of Bachelor of Business Administration, major in Accounting and was one of the topnotchers when she passed the CPA Licensure Board Examination. She earned her Master in Business Administration major in Financial Management from the University of the Philippines and is a candidate for Doctor of Education at the University of the East. She.is a holder of a Certificate in Management Accounting from the Institute of Certified Management Accountants of Victoria, Australia. Dean Cabrera worked with SGV & Co. as Staff Auditor. She taught Financial Accounting, Financial Management, Management Advisory Services, Auditing Theory and Practice in various colleges and universities and authored books in these subjects. She previously held the position of Dean of the College of Business Administration at the Lyceum of the Philippines University. ‘A former Vice Chairman of the Professional Regulatory Board of Accountancy, she was the BOA representative to the Financial Reporting Standards Council (FRSC), Philippine Interpretations Committee (PIC) and Auditing and Assurance Standards Council (AASC). She served as the Chairman of the PRC CPE Council for Accountancy and Chairman of the CHED Technical Committee for Accountancy Education. She was a World Bank Project Consultant on the creation of an Accounting Oversight Board in the Philippines. ‘She was a recipient of the Philippine Institute of Certified Public Accountants (PICPA) awards as Outstanding CPA in Education, Honorary Life Membership, Distinguished ‘Accountancy Author and 2018 Accountancy Hall of Fame. Gilbert Anthony B. Cabrera BBA MBA CPA Gilbert received his bachelor’s degree in Accountancy from the University of the East, Cum Laude. He obtained a Master in Business Administration degree with concentrations on Intemational Finance and Accounting from the University of Maryland, College Park, Robert H. Smith School of Business. A certified public accountant, he has public accounting experience with SGV & Co. (Emst and Young Member Firm) and teaching experience with the University of the East, Manila and University of Maryland, Robert H. Smith School of Business. Presently; he is ~ Vice-President, Risk and Finance, of Global Insurance Brokerage in California, USA. An active member of the Association of Filipino Finance Managers in California, he is also a former Board Member of Bay Area Red Cross.Preface The business environment continues to change in dramatic ways and university graduates joining the corporate world or entering the accountancy profession, whether it be in the public practice sector, management accounting practice, intemal audit or accounting information system management, must be prepared for a high standard of responsibilty. This textbook on Corporate Governance, Business Ethics, Risk Management and Internal Control, aims fo equip its readers the basic knowledge, skis and perspective that are necessary in facing this challenge. Having a solid understanding of fundamental business, its governance, risk management, ethical practices and intemal control will become even more important in a world of advancing technology. While businesses in different industry have strikingly different characteristics, most have some fundamental characteristics in common. A fundamental widely accepted model of business consists of governance, objectives, strategies, business processes, risks, controls and reporting. This book is organized to provide authoritative, practical and contemporary content as follows: Unit | - Corporate Governance This unit describes Corporate governance and the parties involved in it. It discusses the structure that specifies the distribution of rights and responsibilities among different participants in a corporation. It also spells out the rules and procedures for making decisions on corporate affairs. Unit Il - Business Ethics This unit discusses the various forms of unethical business practices. It also articulates how to institutionize integrity in all aspects of business process and how business with integrity enjoys competitive advantage in both government and private transactions. Unit Ill - Risk Management This unit emphasizes the nature, forms and basic management of risks related to business. Unit IV - Internal Control: A Vital Tool in Managing Risk This unit articulates the nature, scope, elements and importance of internal control. It also covers extensive discussion of what how fraud can be prevented, detected and reduced if not fully eliminated in an enterprise. The end of chapter materials have been thoroughly chosen and streamlined to be much more user friendly. ‘Special thanks to our families for their continued support and encouragement. &. 2. @. G.2.6.Preface UNIT Chapter Chapter Chapter Chapter UNIT Chapter Chapter Chapter Chapter Chapter Chapter Ir Contents in Brief CORPORATE GOVERNANCE INTRODUCTION TO CORPORATE GOVERNANCE CORPORATE GOVERNANCE RESPONSIBILITIES AND ACCOUNTABILITIES SECURITIES AND EXCHANGE (SEC) COMMISSION CODE OF CORPORATE GOVERNANCE SEC CODE OF CORPORATE GOVERNANCE, CONTINUED BUSINESS ETHICS INTRODUCTION TO ETHICS BUSINESS ETHICS COMMON UNETHICAL PRACTICES OF BUSINESS ESTABLISHMENTS. ETHICAL DILEMMA ADVOCACY AGAINST CORRUPTION INITIATIVES TO IMPROV, E BU: AND REDUCE CORRUPTION ee 26 76 93 94 103 109 121 128 146UNIT ur Chapter Chapter 12 UNIT IV Chapter 13 Chapter 14 Chapter 15 Chapter 16 Chapter. 17 Appendices Appendix A Appendix B Appendix C Appendix D Appendix E Appendix F Appendix G References INTRODUCTION TO RISK MANAGEMENT RISK MANAGEMENT PRACTICAL INSIGHTS IN REDUCING AND MANAGING BUSINESS RISKS INTERNAL CONTROL: A VITAL TOOL IN MANAGING RISK OVERVIEW OF INTERNAL CONTROL FRAUD-AND ERROR ERRORS AND IRREGULARITIES IN THE TRANSACTION CYCLES OF THE BUSINESS ENTITY INTERNAL CONTROL AFFECTING ASSETS INTERNAL CONTROL AFFECTING LIABILITIES AND EQUITY Code of Ethics for Professional Teachers International Standards for the Professional Practice of Internal Auditing International Standards of Ethical Conduct for Practitioners of Management Accounting Code of Business Conduct and Ethics of a Telecommunications Company Code of Business Conduct and Ethics of a Manufacturing Company Code of Business Conduct and Ethics ofa Commercial Bank : Partial List of Organizations who are actively Participating in the “Integrity Initiative” ‘Campaign against Corruption ut 162 163 180 195 196 217 232 244 264 273 281 283 287 293 303 307 3ilContents Preface I CORPORATE GOVERNANCE ORPORATE r 1 INTRODUCTION TO C eee GOVERNANCE UNIT Expected Learning Outcomes What is Governance? Characteristics of Good Governance Corporate Governance: A Overview Purpose of Corporate Governance Objectives of Corporate Governance Basic Principles of Effective Corporate Governance Mlustrative Application of the Basic Principles of Corporate Governance and Best Practice Recommendations Review Questions 2 CORPORATE GOVERNANCE RESPONSIBILITIES AND ACCOUNTABILITIES Expected Learning Outcomes Chapter Introduction Relationship between Shareholders / Owners and Other Stakeholders Parties involved in Corporate Governance Their Respective Broad Role and Specific Responsibilities ° Shareholders Board of Directors Non-Executive or Independent Directors Management Audit Committees Regulators Board of Accountancy External Audit Internal Audit Review Questions Baauew wvSECURITIES AND EXCHANGE COMMISSION (SEC) CODE OF CORPORATE GOVERNANCE Expected Learning Outcomes The Board's Governance Responsibilities Principles 1 to7 Disclosure and Transparency Principles 8 to 11 Internal Control System and Risk Management Framework Principle 12 Cultivating a Synergies Relationship with Shareholders Principle 13 Duties to Stakeholders Principles 14 to 16 Introduction The Code of Corporate Governance Objective Approach Organization Recommendation Explanations Coverage Definition of Terms The Board’s Governance Responsibilities Establishing a Competent Board Establishing Clear Roles and Responsibilities of the Board Establishing Board Committees Fostering Commitment Reinforcing Board Independence “Assessing Board Performance ‘Strengthening Board Ethics ‘Enhancing Company Disclosure Policies and Procedure Strengthening the External Auditor's Independence and Improving Review Questions and Exercises 26 28 28 ed 29 29 29 29 a 30 30 30 30 30 30 30 31 31 31 34 4 34 39 49 37 59 65 67 68 1 14 26vi Chapter UNIT Chapter 4 SEC CODE OF CORPORATE GOVERNANCE, CONTINUED Expected Learning Outcomes Increasing Focus on Non-Financial and Sustainability Reporting Promoting a Comprehensive and Cost-effcient ‘Access to Relevant Information Strengthening the Internal Control System and Enterprise Risk Management Framework Cultivating a Synergic Relationship with Shareholders Respecting Rights of Stockholders and Effective Redress for Violation of Stakeholder's Rights Encouraging Employees Participation Encouraging Sustainability and Social Responsibility Review Questions Il BUSINESS ETHICS INTRODUCTION TO ETHICS Expected Learning Outcomes Introduction Characteristics and Values Associated with Ethical Behavior Why is Ethical Behavior Necessary? ary? Why do People Act Unethically? Categories of Ethical Principle The Need for Professional Ethics Review Questions 76 71 8 78 83 87 88 90 91 94 95 96 98 98 99 100 102 76 93vit Chapter 6 BUSINESS ETHICS - Expected Learning Outcomes 103 Basic Concept of Business Ethics 104 Purposes of Business Ethics 104 Main Purpose 104 Special Purpose ‘ 104 Scope and Impact of Business Ethies 105 Economic Impact 106 Social Impact 106 Environmental Impact 106 Impact on Business Managers 7 106 Ethical Challenges in Today's World 107 Review Questions 108 Chapter. 7 COMMON UNETHICAL PRACTICES OF BUSINESS ESTABLISHMENTS 109 Expected Learning Outcomes 7 109 Common Unethical Practices of Business Establishments 110 Misrepresentation and Over Persuasion , 0 Direct Misrepresentation 110 Deceptive packaging 110 Misbranding or mislabeling 110 False or misleading advertisement 110 Adulteration M1 Weight understatement mn Measurement understatement mn Quantity understatement 112 Indirect Misrepresentation 112 Caveat emptor 112 Deliberate withholding of information 112 Passive deception 112 Over Persuasion 113 Corporate Ethics 113 Unethical Practices of Corporate Management 13 Board of Directors 13 Executive Officers and Lower Level Managers 14 Some Unethical Practices of Employees 7 Review Questions 119viii ETHICAL DILEMMA Chapter 8 121 Expected Learning Outcomes : 122 Introduction Buenas i sIving Ethical Ditemi : : Herons Case: Resolving an Ethical Dilemma i Ethical Issue : Who is Affected and How is each Affected ae Bert’s Available Alternatives We Consequences of Each Alternative i Appropriate Action 126 Review Questions and Exercises Chapter. 9 ADVOCACY AGAINST CORRUPTION Expected Learning Outcomes 128 What is Corruption? —- 129 What does Corruption Look Like? 130 Why aind how does a Person Become Corrupt? 131 Ill Effects of Corruption 131 Characteristics of Corruption 133 The Philippine Corruption Report 137 Judicial System 137 Police 138 Public Services 138 Land Administration 139 Tax Administration 139 Customs Administration 140 Public Procurement 140 Natural Resources 141 Prevention of Corruption 141 Clear Business Process saa Policy on Gifts and Entertainment 142 Declaration of Confit of Interest 142 _omenient Corruption Reporting System 142 Efforts to Curb C islet Vigilance afin Soon” Through Legislation ia Review Questions 145Chapter 10 _ INITIATIVES TO IMPROVE BUSINESS ETHICS AND REDUCE CORRUPTION nas Expected Learning Outcomes 146 Introduction 147 The Integrity Initiative Campaign 147 Corporate Values 148 Need for a Code of Conduct 149 The Unified Code of Conduct for Business 150 > Top Management 150 Human Resources 150 Sales and Marketing 150 Finance and Accounting 15) Procurement 1 Logistics 152 Implementation and Monitoring 152 Bishops-Businessmen’s Conference Philippines — Code of Ethics for the Philippine Business 153 Survey of Laws Advocating Business Ethics 159 Review Questions 160 UNIT Ill INTRODUCTION TO RISK MANAGEMENT 162 Chapter. 11 RISK MANAGEMENT 163 Expected Learning Outcomes 163 Introduction 164 Risk Management Defined 164 Basic Principles of Risk Management 165 Process of Risk Management 165 Elements of Risk Management 166 Relevant Risk Terminologies 167 1. Risk Associated with Investments 167 Il. Risks Associated with Manufacturing, Trading and Service Concerns 170 IIL. Risk Associated with Financial Institutions 171 Potential Risk Treatments im ‘Areas of Risk Management 173 ‘Risk Management Framework 174 ‘Steps in the Risk Management Process 175, Review Questions 178x ISIGHTS IN REDUCING AND Chapt 12 PRACTICAL IN: ee MANAGING BUSINESS RISKS Expected Learning Outcomes Understand the Nature of Risk Identify and Prioritize Risks Consider the Acceptable Level of Risk Understand Why Risks Become Reality Apply a Simple Risk Management Process Risk Assessment and Analysis Risk Management and Control Avoiding and Mitigating Risks Create a Positive Climate for Managing Risk Overcoming the Fear of Risk Controlling and Monitoring Enterprise-wide Risk Practical Considerations in Managing and Reducing Financial Risk Improving Profitability Assessment of Market and Exit Barries Break-even Analysis Controlling Costs Practical Techniques to Improve Profitability Avoiding Pitfalls Review Questions and Exercises UNIT IV INTERNAL CONTROL: . A VITAL TOOL IN MANAGING RISK Chapter 13_ OVERVIEW OF INTERNAL CONTROL Expected Learning Outcumes Nature and Purpose of Internal Control Internal Control System Defined Elements of Internat Control A. Control Environment B. Entity’s Risk Assessment Process C. Information System, including the Business Processes, Relevant to Financial Reporting and Communication D. Control Activities E. Monitoring of Controls Review Questions and Exercises 180 180 181 181 183 183 184 184 185 186 186 187 187 188 188 189 189 190 191 192 194 195 196 196 197 197 198 198 198 203 205 210 2ilChapter Chapter 14 15 FRAUD AND ERROR Expected Learning Outcomes Introduction Types of Misstatements Misstatements arising from Misappropriation of Assets Misstatements arising from Fraudulent Financial Reporting The Fraud Triangle Incentives or Pressure to Commit Fraud Opportunities to Commit Fraud Rationalizing the Fraud Risk Factors arising from Misappropriation of Assets Risk Factors arising from Fraudulent Financial Reporting Responsibility for the Prevention and Detection of Fraud Review Questions and Exercises ERRORS AND IRREGULARITIES IN THE TRANSACTION CYCLES OF THE BUSINESS ENTITY Expected Learning Outcomes Sales and Collections Cycle Errors in Recording Sales Collections Transactions Frauds in sales and Collections “Acquisition and Payments Cycle Errors in the Acquisitions and Payments Cycle ‘Frauds in the Acquisitions and Payments Cycle Payroll and Personnel Cycle Errors Frauds involving Payroll Review Questions and Exercises 217 218 218 218 219 219 220 220 221 223 224 226 227 232 233 233, 233 235 235 237 237 237 239 xi 217 232xii Chapter 16 Chapter 17 INTERNAL CONTROL AFFECTING ASSETS Expected Learning Outcomes Internal Control over Cash Transactions Potential Misstatements — Cash Receipts Potential Misstatements — Cash Disbursements Internal Control over Financial Investments Potential Misstatements — Financial Investments Internal Control over Receivables ‘Sources and Nature of Notes Receivable Internal Control of Accounts Receivable and Revenue Control Environment Potential Misstatements — Revenue / Receivables Internal Control over Notes Receivable 244 244 245 246 248 249 250 251 251 251 252 252 254 Internal Control over Inventories and Cost of Goods Sold 255 Sources and Nature of Inventories and Cost of Goods Sold Potential Misstatements — Inventory / Cost of Goods Sold Internal Control over Property, Plant and Equipment Potential Misstatements — Investments in Property, Plant and Equipment Review Questions and Exercises INTERNAL CONTROL AFFECTING LIABILITIES AND EQUITY Expected Learning Outcomes Internal Control over Accounts Payable Potential Misstatements ~ Accounts Payable Internal Control over Other Debts Internal Control over Debt Authorization by the Board of Directors Use of an Independent Trustee Interest Payments of Boards and Notes Payable Internal Control over Owners’ Equity Internal Control on Equity Control of Share Capital Transactions by the Board of Directors Independent Registrar and Stock Transfer Agent Internal Control over Dividends Review Questions and Exercises 255 256 257 259 260 264 265 266 267 267 268 268 268 269 269 269 270 271Appendices Appendix Appendix Appendix Appendix Appendix Appendix Appendix References w Code of Ethics for Professional Teachers International Standards for the Professional Practice of Internal Auditing International Standards of Ethical Conduct for Practitioners of Management Accounting Code of Business Conduct and Ethics of'a Telecommunications Company Code of Business Conduct and Ethics of a Manufacturing Company Code of Business Conduct and Ethics of a ‘Commercial Bank Partial List of Organizations who are actively Participating in the “Integrity Initiati Campaign against Corruption 273 281 283 287 293 303 xiiiUNIT I CORPORATE GOVERNANCE Chapter 1 Introduction to Corporate Governance Corporate Governance Responsibilities and Accountabilities Securities and Exchange Commission (SEC) Code of Corporate Governance SEC Code of Corporate Governance, ContinuedChapter INTRODUCTION TO CORPORATE GOVERNANCE Expected Learning Outcomes After studying the chapter, you should be able to ... 4: 2. Describe what governance involves Enumerate the different contexts in which governance can be applied Name and explain the characteristics of good governance Explain the meaning, purpose and objectives of corporate governance Know and describe the principles of effective corporate governance Understand how the principles of good super ip! good corporate governance QLI05CHAPTER 1 INTRODUCTION TO CORPORATE GOVERNANCE WHAT IS GOVERNANCE? Generally, governance refers to a process whereby elements in society wield Power, authority and influence and enact policies and decisions concerning, public life and social upliftment. It comprises all the processes of governing — whether undertaken by the government of a country, by a market or by a network — over a social system and whether through the laws, notms, power or language of an organized society. Governance therefore means the process of decision-making and the process by which decisions are implemented (or not implemented) through the exercise of power or authority by leaders of the country and / or organizations. Governance can be used in several contexts such as corporate governance, international governance, national governance and local- governance. The focus of this book is on Corporate Governance. CHARACTERISTICS OF GOOD GOVERNANCE Whatever context good governance is used, the following major characteristics should be present: Participation Rule of Law "accountability 000 Fetfectiveness & Transparency = Governance.” Efficiency A-T™N ‘nespensvnes! | fain boner “Consensus _Oriented4 Chapter 1 These characteristics are bri Participation Rule of Law Transparency Responsiveness Consensus Oriented fly described as follows: n by both men and women is a key cornerstone ernance. Participation could be either direct or te institutions or representatives. It is t out that representative democracy does not necessarily “mean that the concern of the most vulnerable in society would not be taken into consideration in decision making. Participation needs to be informed and organized. This means freedom of association and expression on one hand and an organized civil society on the othér hand. Good governance requires fair legal frameworks that are enforced impartially. It also requires full protection of human rights, particularly those of minorities. Impartial enforcement of laws requires an independent judiciary and an impartial and incorruptible police force. Participatior of good gov’ through legitima important to point Transparency means that decisions taken and their enforcement are done in a manner that follows rules and regulations. It means that information is freely available and directly accessible to those who will be affected by such decisions and their enforcement. It also means that enough information is provided and that it.is provided in easily understandable forms and media. Good governance requires that institutions and processes try to serve the needs all stakeholders within a reasonabl timeframe. F Good governance requires mediation of the different interests in Society to reach a broad consensus on what is in the best interest of the whole community and how this can be achieved. It also requires a broad and long-term Perspective on what is needed for sustainable human development and ‘how to achieve the goals of such development. This can only result from an understanding of the historical, cultural and social contexts of a given society or community.Introduction to Corporate Governance _5 Equity & Ensures that all its members feel that they have a stake in it Inclusiveness and do not feel excluded from the mainstream of society. This requires all groups, but particularly the most vulnerable, have opportunities to improve or maintain their well being. Effectiveness Good governance means that processes and institutions Efficiency produce results that meet the needs of society while making the best use of resources at their disposal. The concept of efficiency in the context of good governance also covers the sustainable use of natural resources and the protection of the environment. Accountability Accountability is a key requirement of good governance. Not only governmental institutions but also the private sector and civil society organizations must be accountable to the public and to their institutional stakeholders. Who is accountable to whom varies depending on whether decisions or actions taken are internal or external to an organization or institution. In general, an organization or an institution is accountable to those who will be affected by its decisions or actions, Accountability cannot be- enforced without transparency and the rule of law. CORPORATE GOVERNANCE: AN OVERVIEW Corporate governance is defined as the system of rules, practices and processes by which business corporations are directed and controlled. It basically involves balancing the interests of a company’s many stakeholders, such as shareholders, management, customers, suppliers, financiers, government and the community. Corporate governance is a topic that has received growing attention in the public in rovent years as policy makers and others become more aware of the contribution good corporate governance makes to financial market stability and Geonomic growth. Good corporate governance is all about controlling one’s business and so is relevant, and indeed vital for all organizations, whatever size or structure.6 Chapter I . al 5 distribution of rights and The cory x ce structure specifies the distrit bilities among, dife rats in the corporation, such as the board, responsibilities among different participa’ th t the rules and rs a ‘and other stakeholders, and spells ou! tule managers, shareholders, and rporate affairs. By doing this, it also procedures for making decisions on corporate a provides the structure through which the objectives are set and the means of attaining those objectives and monitoring performance. PURPOSE OF CORPORATE GOVERNANCE ance is to facilitate effective, entrepreneurial and feliver long-term success of the company. In simple terms, the fundamental aim of corporate governance is to enhance shareholders’ value and protect the interests of other stakeholders by improving the corporate performance and accountability. It is also about what the board of directors of a company does, how it sets the values of the business firm. The purpose of corporate govern: prudent management that can d OBJECTIVES OF CORPORATE GOVERNANCE The following are the basic objectives of corporate governance: 1. Fair and Equitable Treatment of Shareholders A corporate governance structure ensures equitable and fair treatment of al! shareholders of the company. In some organizations, a group of high- net-worth individual and institutions who have a substantial proportion of their’ portfolios invested in the company, remain active through occupation of top-level positions that enable them to guard their interest. However, all shareholders deserve equitable treatment and this equity is safeguarded by a good governance structure in any organization. 2. Self-Assessment Corporate governance enables firms to assess their behavior and actions before they are scrutinized by regulatory agencies. Business establishments with a strong corporate governance system are better able to limit exposure to regulatory risks and fines. An active and independent board can successfully point out deficiencies or loopholes in the company operations and help solve issues internally on a timely basis.Introduction to Corporate Governance 7 Increase Shareholders Wealth ee Corporate governance's main objective is to protect the long- interests of the shareholders. Firms with strong corporate Se strut are sen to have higher valuation alached 1 their sinessmen. This only reflects the positive perception that good corporate governance induces potential investors to decide to invest in a company, 4. Transparency and Full Disclosure Good corporate governance aims at ensuring a higher degree of transparency in an organization by encouraging full disclosure of transactions in the company accounts. BASIC PRINCIPLES OF EFFECTIVE CORPORATE GOVERNANCE Effective corporate governance is transparent, protects the rights of shareholders and includes both strategic and operational risk management. It is concerned in both the long-term earning potential as well as actual short-term earnings and holds directors accountable for their stewardship of the business. ‘The basic principles of effective corporate governance are threefold as presented below: Transparency and Full Disclosure Is the board telling us what is going on? ‘Accountability Is the board taking responsibilty? Good and Effective Governance Corporate Control Is the board doing the right thing?sitive compliance with the ba conformance and awers to the following questions indicate a firm’s principles of good corporate governance: ie ‘Transparency and Full Disclosure needs of investment Does the board meet the information communities Does it safeguard integrity in financial reporting? and practices? Does the board have sound disclosure policies > Does it make timely and balanced disclosure? > Can an outsider meaningfully analyze the organization's actions and performance? B. Accountability Does the board clarify its role and that of management? Does it promote objective, ethical and responsible decision making? > Does it lay solid foundations for management oversight? > Does the composition mix of board membership ensure an appropriate range and mix of expertise, diversity, knowledge and added value? > Is the organization’s senior official committed to widely accepted standards of correct and proper behavior? ta C. Corporate Control Has the board built long-term sustainable growth in shareholders’ value for the corporation? Does it-create an environment to take risk? > Does it encourage enhanced performance? > Does it recognize and manage risk? > Does it remunerate fairly and responsibly? > Does it recognize the legitimate interests of stakeholders? > Are conflicts of interest avoided such that the organization's best interests prevail at all times?Introduction to Corporate Governance 9 ILLUSTRATIVE APPLICATION OF THE BASIC PRINCIPLES OF CORPORATE GOVERNANCE AND BEST. PRACTICE RECOMMENDATIONS Principles of Good Corporate Governance Best Practice Recommendations 1. Acompany should lay solid foundation for management and oversight. It should recognize and publish the respective roles and responsibilities of board and management. Tra, Formalize and disclose the functions reserved to the board and those delegated to management. 2. Structure the board to add value. Have a . board of an effective composition, size and commitment to adequately discharge its responsibilities and duties. . ‘2a. Aboard should have independent directors. 2b. The roles of chairperson and chief executive officer should not be exercised by the same individual. 2b. The board should establish a nomination committee 3. Promote ethical and responsible decision- making. Actively promote ethical and responsible decision-making. 3-a. Establish a code of conduct to guide the directors, the chief executive officer (or equivalent), the chief financial officer (or equivalent) and any other key executives as to: ‘© The practices necessary to maintain confidence in the company's integrity; and © The responsibility and accountability of individuals for reporting and investigating reports of unethical practices 3b. Disclose the policy concerning trading in company securities by directors, officers and employees.10 Chapter I @__ Safeguard integrity in financial reporting. Have a structure to independently verify and safeguard the integrity of the company's financial reporting. 7a, Require the chief executive of (or equivalent) and the chief financial officer (or equivalent) to state in writing to the board that the company's financial reports. present a true and fair view, in all material respects, of the company's financial condition and operational results and are in accordance with relevant accounting standards. The board should establish an audit committee. 4-c, Structure the audit committee so that it consists of © Only non-executive or independent directors; Anindependent chairperson, who is not chairperson of the board; and Atleast three (3) members. 4. s 5, Make timely and balanced disclosure. Promote timely and balanced disclosure of all material matters concerning the company. 5-a. Establish written policies and procedures designed to ensure compliance with IFRS. 5b. Listing Rule disclosure requirements and to ensure accountability at a senior management level for compliance. 6. Respect the rights of shareholders and faciltate.the effective exercise of those rights. 6-a. Design and disclose a communications strategy to promote effective communication with shareholders and encourage effective participation at general meetings. Request the external auditor to attend the annual general meeting and be available to answer shareholder questions about the audit, ® 6b. sIntroduction to Corporate Governance _\\ Recognize and manage risk. Eslabish a sound system of isk oversight and management and intemal control, 7-a, The board or appropriate board committee should establish policies on risk oversight and management. 2-a, The chief executive officer (or equivalent) and the chief financial officer (or equivalent) should state to the board in wring that © The statement given in accordance with best practice recommendation 4-a (the integrity of financial statements) is founded on a sound system of risk management and internal ‘compliance and control which implements the policies adopted by the board; and © The company's risk management and internal compliance and control system is operating efficiently in all material respects. Encourage enhanced performance. Fairly review and actively encourage enhanced board and management effectiveness. B-a, Disclose the process for performance evaluation ofthe board, its committees and individual directors, and key executives. Remunerate fairy and responsibly. Ensure that the level and composition of remuneration is sufcient and reasonable and that its relationship to corporate and individual performance is defined. 9a, Provide disclosure in relation to the ‘company’s remuneration policies to enable investors to undérstand: © The costs and benefits of those policies; and ‘© Thelink between remuneration paid to directors and key executives and corporate performance. The board should establish a remuneration committe. 9-c. Clearly distinguish the structure of non- executive director's remuneration from that of executives. Ensure that payment of equity-based executive remuneration is made in accordance with thresholds set in plans approved by shareholders. 9 9%12 Chapter 1 10. Recognize the legitimate interests of stakeholders. Recognize legal and other 70-a. Establish and disclose a code of conduct to guide compliance with legal and other obligations to legitimate igatic all legitimate stakeholders. ocr tae stakeholders. REVIEW QUESTIONS Questions 2 What does governance mean? Explain whether the following statement is true or false. “Governdince is exercised only by the goverriment of a country”. Explain how governance can be used in the following contexts and give appropriate examples: a. national governance b. local governance c. corporate governance d._ international governance Explain briefly the eight (8) basic characteristics of good governance. Transparency and accountability are synonymous. Explain whether the statement is correct or not. Explain whether the following statement is true or false. “Responsiveness usually results to effectiveness and efficiency”. Define corporate governance. What does corporate governance structure involve? State the purpose of corporate governance. . Explain the basic objectives of corporate governance. - Explain the three basic principles of effective corporate governance.Introduction to Corporate Gove 13 Multiple Choice Questions lL The basic Principle of “transparency and full disclosure” for effective Corporate governance responds positively to the following questions except. a. Does the board of directors safeguard integrity in financial reporting? b. Does the board meet the information needs of investment communities? Can an outsider meaningfully analyze the firm’s actions and performance? Has the board -built long-term sustainable growth in shareholders’ value for the corporation? The basic principle of “accountability” for effective governance answers the following questions positively, except a. Does the board recognize and manage risk? b. Does the board lay solid foundations for management oversight? c. Does the’ composition mix of board membership ensure an appropriate range and risk of expertise diversity, knowledge added value? d. Does the board promote objective, ethical and responsible decision making? “Transparency and full disclosure” principle advocates the following except a. Sound disclosure policies and practices b. Solid foundations for management oversight c. Meeting the information needs of investment communities d. Safeguards integrity in financial reporting, The ‘rights of shareholders can be effectively upheld through the following measures except, : a. Byestablishing an audit committee ee b. By designing and disclosing a communications strategy to promote affective communication with shareholders. : c. By encouraging active Participation at general meetings. d, By requiring the external auditor to attend the annual general meeting and to answer questions about the audit.1 Chapter Shs My OE ei To safeguard integrity in financial reporting, the business firm should do the following except a, Establish an audit committee b. Request the external auditor to atten ¢. Disclose the functions reserved to tl management ue d. Disclose the policy concerning trading in company securities by directors, officers and employees. d the annual general meeting he board and those delegated to To encourage enhanced performance by the board and management, it is recommended that the following should be adopted except Disclosure of the process for performance evaluation of the board, its committees, individual directors and by executives. b. A remuneration committee c. Distinguish between non-executive director’s remuneration from that of executives. Establish policies on risks oversight and management @ The characteristic of good governance where fair legal framework are enforced impartially is a. Participation b. Rule of Law c. Equity d. AccountabilityChapter CORPORATE GOVERNANCE RESPONSIBILITIES AND ACCOUNTABILITIES Expected Learning Outcomes After studying the chapter, you should be able to... 1. Explain the relevance of good governance, to both large publicly-listed companies and SMEs 2. Know the relationship between shareholders or owners and other stakeholders 3. Identify the parties involved in Corporate Governance 4. Describe the respective broad rate and specific responsibilities of the different parties in a corporate setting QWBSCHAPTER 2 CORPORATE GOVERNANCE RESPONSIBILITIES AND ACCOUNTABILITIES INTRODUCTION Many of the characteristics of good governance described in Chapter | are relevant to both SME's and large listed public companies. As an organization grows in size and influence, these issues become increasingly important. However, it is also important to recognize that good corporate governance is based on principles underpinned by consensus and continually developing notions of good practice, There are no absolute rules which must be adopted by all organizations. "There is no simple universal formula for good governance". Instead emphasis is many localities, has been to encourage organizations to give appropriate attention to the principles and adopt approaches which are tailored to the specific needs of an organization at a given point in time. When corporate governance is discussed, it is often spoken of in terms of a company's corporate governance framework. The key elements within an effective governance framework, and the issues relating to each element, are set out on the following pages and are relevant to organizations large and small, in both the private and the public sectors. The table provides a useful structure for any company to consider its own approach to corporate governance and the matters which may assist it to achieve its strategic objectives. Many of the matters listed may not be directly relevant in all situations and some may not, in particular circumstances, be within the board's control, but it provides a useful context in which any organization can consider its governance needs so that they might be most appropriately addressed. The essence of any system of good corporate governance is to allow the board and management the freedom to drive their organization forward and to exercise that freedom within a framework of effective accountabilityCorporate Governance ki sand Accoumabilities RELATIONSHIP BETWEEN § : eRe ER(S) AND OTHER STAKEHOLDERS RA REHOLDERS / OWNER(S) AN The relationshi S| eae between the shareholders / owners, management and other stakeholders in a corporation is shown below. Public Corporation Stakeholders Board of Shareholders / Directors Owners Executive External Delegate Management Have Auditors ‘Shareholders 7 Owners . i Responsibiities | [— Operational || Accountabiliies| [Regulators Management Internal Society and Auditors Others [isi poe yea Dee Governance starts with the shareholders/owners delegating responsibilities through an elected board of directors to management and, in turn, to operating units with oversight and assistance from internal auditors. The board of directors. and its audit committee oversee management and, in that role, are expected to protect the shareholders’ rights. However, it is important ‘to recognize that management is part of the governance framework; management can influence who sits on the board and the audit committee as well as other governance controls that might be put into place. In return for the responsibilities (and power) given to management and the board, governance demands accountability back through the system to the shareholders. However, the accountabilities do not extend only to the shareholders. Companies also have responsibilities to other stakeholder ‘Stakeholders can be anyone who is influenced, whether directly or indirectly, by the actions of a company. Management and the board have responsibilities to act within the laws of society ements of creditors, employees and the stakeholders. and to meet various requir18 Chapter? A broad group of stakeholders has an interest in the quality of corporate governance because it has 2 relationship to economic performance and the quality of financial reporting. For example, it is likely that many employees have significant funds invested in pension plans. Those pension plans are designed to protect the financial interests of those employees in their retirement. We use the word society in the diagram to indicate those broad interests. In a similar fashion, employees and creditors have a vested interest in the organization and how it is govemed. Regulators are a response to society's wishes to. ensure that organizations, in their pursuit of returns for their owners, act responsibly and operate in compliance with relevant laws. ss to various parties within the While shareholders / owners delegate respons ni corporation, they also require accountability as to how well the resources “that have been entrusted to management and the board have been used. For example, the owners want accountability on such things as: © Financial performance * Financial ransparency — financial statements that are clear with full disclosure and that reflect the underlying economics of the company. * Stewardship, including how well the company protects and manages the resources entrusted to it. > Quality of internal control * Composition of the board of directors and the nature of its activities, including information on how well management incentive systems are aligned with the shareholders’ best interests. The owners want disclosures from management that are accurate and objectively verifiable. For instance, management has 4 respensibility to provide financial reports, and in some cases, reports on internal control effectiveness, Management bas always had the primary responsibility for the accuracy and completeness of an organization's financial statements. From a financial Teporting perspective, it is management's responsibility to: * Choose which accounting principles best Portray the economic substance of company transactions. * Implement a system of internal contro! that assures completeness and accuracy in financial reporting. * Ensure that the financial statements contain accurate and complete disclosure.ie Corporate Governance Responsibilities and Accountabilities 19 PARTIES INVOLVED IN CORPORATE GOVERNANCE: THEIR RESPECTIVE BROAD ROLE AND SPECIFIC RESPONSIBILITIES Corporate governance and financial reporting reliability are receiving considerable attention from a number of parties including regulators, standard setting bodies, the accounting profession, lawmakers and financial statement users. Party E Overview of Responsibilities 1. Shareholders ‘Broad Role: Provide effective oversight through election of board members, approval of rigjorinitialves such as buying or selling stock, annual reports on management compensation, from the board, 2. Board of Directors Broad Role: The major representative of stockholders to ensure thatthe organization is run according to the organization's charter and that there is proper accountability. ‘Specific activities include among others: 4. Overall Operations Establishing the organization's vision, mission, values and ethical standards. ‘© Delagating an appropriate level of authority to management. Demonstrating leadership. ‘© Assuming responsibilty for the business relationship with CEO including hs or her appointment, succession, performance remuneration and dismissal. © Overseeing aspects of the employment ofthe management team including management remuneration, performance and succession planning Recommending auditors and new directors to shareholders. © Ensuring effective communication with shareholders other stakeholders, + Crisis management. Appointment of the CFO and corporate secretary.20 Chapter 2 2, Performance mi © Ensuring the organization's long term viability and enhancing the financial position. ; Formulating and overseeing Implementation of corporate strategy. H Approving the plan, budget and corporate policies. Agreeing key performance indicators (KPIs) Monitoring / assessing assessment, performance of the organization, the board itself, management and major projects. Overseeing the risk management framework and monitoring business risks. i Monitoring developments in the industry and the operating environment. © Oversight of the and organization, including its control and accountability systems, * Approving and monitoring the progress of major capital expenditure, capital management and acquisitions and divestitures. 3. Compliance / Legal Conformance — Understanding and protecting the organization's financial position, © Requiring and monitoring legal and regulatory + compliance including compliance with accounting Standards, unfair trading legislations, occupational health and safely and environmental standards, + Approving annual financial reports, annual feports and other public documnents / sensitive reports, ‘e Ensuring an effective system of internal controls exists and is operating as expected, 3. Non-Executive or Independent Directors Broad Role: The same as the broad role of the entire board of directors Specific activities include among others: « to understand the organization, its business, its operating environment and its financial position, * lo.apply expertise and skils in the organization's best interests, * lo assist management to keep performance objectives at the top of its agenda,Corporate Governance Responsibilities and Accountabilities a © fo understand that his/her role is not to act as auditor, nor to act as a member of the management team, : © torespect the collective, cabinet nature of the board's decisions, to prepare for and attend board meetings, ‘© to seek information on a timely basis to ensure that he/she is in a position to contribute to the discussion when a matter comes before the board, or alert the chairman in advance to the need for further information in relation to a particular matter, and © _ to.ask appropriate questions relative to operations. 4, Management Broad Role: Operations and accountability. Manage the organization effectively; provide accurate and timely reports to shareholders and other stakeholders. Specific activities include among others: recommend the strategic direction and translate the strategic plan into the operations ofthe business manage the company’s human, physical and financial resources to achieve the organization's objectives — run the business assume day to day responsibly for the organization's conformance with relevant laws and regulations and its compliance framework develop, implement and manage the organization's risk management and internal control frameworks ; develop, implement and update policies and procedures be alert to relevant trends in the industry and the organization's operating environment provide information to the board ‘act as conduit between the board and the organization developing financial and other reports that meet public, stakeholder and regulatory requirements.22_ Chapter 2 5. Audit Committees of the Board of Directors Broad Role: Provide oversight of the internal and external audit function and the process of préparing the annual financial statements as well as Public reports on internal control. Specific activities include among others: © — Selecting the external audit firm ‘© Approving any non-audit work performed by the audit firm © Selecting and / or approving the appointment of the Chief Audit Executive (Internal Auditor) ‘* Reviewing and approving the scope and budget of the internal audit function * Discussing audit findings with internal auditor and extemal auditor and advising the board (and management) on specific actions that should be taken 6. Regulators a. Board of Accountaricy Broad Role: Set accounting and auciting standerds dictating underlying financial reporting and auciting concepts; set the expectations of audit quality and accounting quality. Specific activities include among others: * Conducting CPA Licensure Board Examinations ‘* Approving accounting principles © Approving auditing standards ¢ Interpreting previously issued standards implementing quality control processes to ensure audit quality Educating members on audit and accounting requirements .b. Securtios and i Exchange Commission Corporate Governance Responstbilittes and Accountabllities 23 Brood Rolo: | Ensure the accuracy, timeliness and fairness of public repeating of financial and other information for public companies. Specific activities include among others: © Reviewing flings vith the SEC + Interacting with the Financial Reporting Standards Council in setting accounting standards * Specifying independence standards required of auditors that report on public financial staternents * Identity corporate frauds, investigate causes, and suggest remedial actions 7. External Auditors Broad Role: Perform audits of company financial statements to ensure that the statements are free of material misstatements including misstatements thal may be due to fraud, ‘Specific activities include among others: + Audit of public company financial statements ‘© Audits of nonpublic company financial statements «Other services such as tax of consulting 8. Internal Auditors Broad Role: Perform audits of companies for compliance with company policies and laws, audits to evaluate the efficiency of operations, and periodic evaluation and tests of controls. Specific activities include among others: ‘© Reporting results and analyses to management (including operational management) and audit committees + Evaluating internal controls24 Chapter 2 REVIEW QUESTIONS Questions bk uw “Small business enterprises do not need good governance Do you agree? Explain. Does good governance require absolute rules that must be adopted by all organizations? What is the essence of any system of corporate governance? Where does the board of directors derive its authority? To whom is the board of directors accountable? On what aspects do shareholders demand accountability from the board of directors? What is management’s responsibility as far.as financial reporting is concerned? Describe the broad role of the shareholders in a corporation. Describe the broad role of the Board of Directors. 10. What are the specific activities of the board of directors? Multiple Choice Questions Approving annual financial reports and other public documents ‘are specific responsibilities of a. Management b. Board of directors c. Shareholders d. EmployeesCorporate Governance Responsibilities and Accountabililies 25 2. Providing oversight of the internal and external audit function, the Process of preparing the annual financial statements and public reports on internal control are the responsibility of a. Board of directors b. Chief executive officer ¢. Chief financial officer d. ‘Audit committee of the board of directors Who is responsible for ensuring the accuracy, timeliness of public Teporting of financial and other information for public companies? a. External auditors— b. Securities and exchange commission c. Shareholders d. Board of Accountancy we 4. Who performs audit of companies for compliance with company policies and laws, audits efficiency of operations and periodic evaluation and tests of controls? a, External auditors b. Internal auditors c, Commission on audit d. Chief accountant 5. An independent director is expected to a. Apply expertise and skills in the corporations best interest b. Asset management to keep performance objectives at the top of its agenda c. Respect the collective, cabinet nature of the board’s decision d. Act as conduit between the board and the organizationSECURITIES AND EXCHANGE COMMISSION (SEC) CODE OF CORPORATE GOVERNANCE Expected Learning Outcomes After studying the chapter, you should be able to... 1. Understand the need for the Gode of Governance for publicly-listed companies. 4s i 2. Know the sixteen (16) governance responsibilities of the Board of Directors of publicly-listed companies. . Explain the meaning of "comply and explain” approach. 4. Describe the three aspects of the Code, namely * Principles * Recommendations * Explanations 5. Know what constitutes a competent board and how can it be established. 6. Understand the composition, functions and Tesponsibilities of the board committees that can be established such as the * Audit Committee * Corporate Governance Committee * Board Risk Oversight Committee * Related Party Transaction Committee 7. Know how the directors can show full commitment to the company 8. Understand how independence and objectivity of the board can be reinforced and enhanced. 9. Describe how the performance and effectiveness of the board can be assessed. LUYBCHAPTER 3 SEC CODE OF CORPORATE GOVERNANCE FOR PUBLICLY-LISTED COMPANIES (“CG Code for PLCs”) Securities and Exchange Conimission SEC MC No. 19, Series of 2016 * On November 10, 2016, the Securities and Exchange Commission approved the Code of Corporate Governance for publicly-listed companies. Its goal is to help companies develop and sustain an ethical corporate culture and keep abreast with recent develépments in corporate governance. One of its salient provisions is for publicly-listed companies to establish a code of business conduct and submit a new manual on Corporate Governance that would “provide standards for professional and ethical behavior as well as articulate acceptable and unacceptable conduct and practices”. The Board of Directors is required to implement the code and make sure that management and employees comply with the internal policies set. While many companies have already developed their Code of Business Conduct and Ethics, the real challenge, is in its implementation and monitoring compliance. The SEC Code of Corporate Governance is published in this book, not only to acquaint readers particularly future professionals and businessmen of these rules and regulations but also to serve as reference and guidelines to currently existing publicly-listed corporations. (Source: www.sec.gov.ph)28 Chapter} IRPORATE GOVERNANCE FOR CODE OF CC PUBLICLY-LISTED COMPANIES PONSIBILITIES THE BOARD'S GOVERNANCE LANE Principle 1: Principle 2: Principle 3: Principle 4: Principle 5: Principle 6: Principle 7: by a competent, working board f the corporation, and to sustain n a manner consistent with 5 of its ‘The company should be headed to foster the long-term success o} its competitiveness and profitability in c its corporate objectives and the long-term best interes shareholders and other stakeholders, ‘The fiduciary roles, responsibilities and accountabilities of the Board as provided under the law, the company’s articles and by- laws, and other legal pronouncements and guidelines should be clearly made known to all directors as well as to stockholders and other stakeholders. ible to Board committees should be set up to the extent pos support the effective performance of the Board’s functions, particularly with respect to audit, risk management, related party transactions, and other key corporate governance concerns, such as nomination and remuneration. The composition, functions and responsibilities of all committees established should be contained in a publicly available Committee Charter. To show full commitment to the company, the directors should devote the time and attention necessary to properly and effectively perform their dutics and responsibilities, including sufficient time to be familiar with the corporation’s business. The Board shauld endeavor to exercise objective and independent judgment on all corporate affairs, ‘The best measure of the Board’s effectiveness is through an assessment process. The Board should regularly carry out evaluations (0 appraise its performance as a body, and assess whether it possesses the right mix of backgrounds and competencies, Members of the Board are duty-bound to apply high ethical standards, taking into account the interests of all stakeholders.SEC Code of Corporate Governance _29 DISCLOSURE AND TRANSPARENCY Principle 8: - le: The company should establish corporate disclosure policies and Procedures that are practical and in accordance with best Practices and regu! latory expectations. Principle 9: The company should establish standards for the appropriate selection of an external.auditor, and exercise effective oversight of the same to strengthen the external auditor’s independence and enhance audit quality. Principlel0: The company should ensure that material and reportable non- financial and sustainability issues are disclosed. Principle 11: The company should maintain a comprehensive and cost- efficient communication channel for disseminating relevant information. This channel is crucial for informed decision- making by investors, stakeholders and other Interested users. INTERNAL CONTROL SYSTEM AND RISK MANAGEMENT FRAMEWORK Principle 12: To ensure the integrity, transparency and proper governance in the conduct of its affairs, the company should have a strong and effective internal control system and enterprise risk management framework. CULTIVATING A SYNERGIC RELATIONSHIP WITH SHAREHOLDERS fe oss any should treat all shareholders fairly and equitably, Principles: TD en recognize, protect and facilitate the exercise of thelr rights.30 Chapter 3 DUTIES TO STAKEHOLDERS Principle 14: The rights of Principle 15: A mechanism for employee partici f stakeholders established by law, by eee relations and through voluntary commitments must be respected. Where stakeholders’ rights and/or interests re at stake, stakeholders should have the opportunity to obtain prompt effective redress for the violation of their rights. pation should be developed to create a symbiotic environment, realize the company’s goals and participate in its corporate governance processes. The company should be socially responsible in all its dealings Principle 16: : with the communities where it operates. It should ensure that | its interactions serve its environment and stakeholders in a positive and progressive manner that is fully supportive of its comprehensive and balanced development. INTRODUCTION 1. The Code of Corporate Governance is intended to raise the corporate governance standards of Philippine corporations to a level at par with its regional and global counterparts. The latest G20/OECD1 Principles of Corporate Governance and the Association of Southeast Asian Nations Corporate Governance Scorecard were used as key reference materials in the drafting of this Code. . The Code will adopt the “comply or explain” approach. This approach combines voluntary compliance with mandatory disclosure. Companies do not have to comply with the Code, but they must state in their annual corporate governance reports whether they comply with the Code provisions, identify any areas of non- compliance, and explain the reasons for non-compliance. The Code is arranged as follows: Principles, Recommendations and Explanations. The Principles can be considered as high-level statements of corporate governance good practice, and are applicable to all companies. iSEC Code of Corporate Governance 31 ae Recommendations are objective criteria that are intended to identify the specific features of corporate governance good practice that are recommended -for companies operating according to the Code. Alternatives to a Recommendation may be justified in Particular circumstances if good governance can be achieved by other means. When a Recommendation is not complied with, the company must disclose and describe this non-compliance, and explain how the overall Principle is being achieved. The alternative should be consistent with the overall Principle. Descriptions and explanations should be written in’ plain language and in a clear, complete, objective and precise manner, so.that shareholders and other stakeholders can assess the company's governance framework. . The Explanations strive to provide companies with additional information on the recommended best practice. This Code does not, in any way, prescribe a “one size fits all” framework. It is designed to allow boards some flexibility in establishing their corporate governance arrangements. Larger - companies and financial institutions would generally be expected to follow most of the Code’s provisions. Smaller companies may decide that the costs of some of the provisions outweigh the benefits, or are less relevant in their case. Hence, the Principle of Proportionality is considered in the application of its provisions. The Code of Corporate Governance for publicly listed companies is the first of a series of Codes that is intended to cover all types of corporations in the Philippines under supervision of the Securities and Exchange Commission (SEC). |. Definition of Terms: Corporate Governance ~ the system of stewardship and control to guide organizations in fulfilling their long, term economic, moral, Tegal and social obligations towards their stakeholders. Corporate governance is a system of direction, feedback and control Going regulations, performance standards and ethical guidelines to hold the Board and senior management accountable for ensuring ethical behavior — reconciling long-term customer satisfaction with shareholder value — to the benefit of all stakeholders and society.32 Chapter 3 Its purpose is to maximize the organization’s long-term se creating sustainable value for its shareholders, stakeholders and the nation. Board of Directors - the governing body elected by the stockholders that exercises the corporate powers of a corporation, conducts all its business and controls its properties. iven the authority by the Management — a group of executives ) 7 jes it has laid down in the Board of Directors to implement the pol conduct of the business of the corporation. Independent director - a person who is independent of management and the controlling shareholder, and is free from any business or other relationship which could, or could reasonably be perceived to, materially interfere with his exercise of independent judgment in carrying out his responsibilities as a director. Executive director —a director who has executive responsibility of day-to-day operations of a part or the whole of the organization. Non-executive director — a director who has no executive responsibility and does not perform any work related to the operations of the corporation. Conglomerate — a group of corporations that has diversified business activities in varied industries, whereby the operations of such businesses are controlled and managed by a parent corporate entity. Internal control — a process designed and effected by the board of directors, senior management, and all levels of personnel to provide reasonable assurance on the achievement of objectives through efficient and effective operations; reliable, complete and timely financial and management information; and compliance with applicable laws, regulations, and the organization’s policies and procedures. ae Ea Organization for Economic Co-operation and DevelopmentSEC Code of Corporate Governance _33. Enterprise Risk Management — a process, effected by an entity’s Board of Directors, management and other personnel, applied in strategy setting and across the enterprise that is designed to identify Potential events that may affect the entity, manage risks to be within its risk appetite, and provide reasonable assurance regarding the achievement of entity objectives.” Related Party — shall cover the company’s subsidiaries, as well as affiliates and any party (including their subsidiaries, affiliates and special purpose entities), that the company exerts direct or indirect control over or that exerts direct or iridirect control over the company; the company’s directors; officers; shareholders and related interests (DOSRI), and their close family members, as well as corresponding persons in affiliated companies. This shall also include such other person or juridical entity whose interest may pose a potential conflict with the interest of the company. Related Party Transactions — a transfer of resources, services or obligations between a reporting entity and a related party, regardless of whether a price is charged. It should be interpreted broadly to include not only transactions that are entered into with related parties, but also outstanding transactions that are entered into with an unrelated party that subsequently becomes a related party. Stakeholders — any individual, organization or society at large who can either affect and/or be affected by the company’s strategies, policies, business decisions and operations, in general. This includes, among others, customers, creditors, employees, suppliers, investors, as well as the government and community in which it operates. ——$—<————— re am 7 Committee uf Sponsoring Organizations of the Tread way Commission (COSO Framework)34 Chapter 3 THE BOARD'S GOVERNANCE RESPONSIBILITIES 1. ESTABLISHING A COMPETENT BOARD Principle The company should be headed by a competent, working board to foster the long-term success of the corporation, and to sustain its competitiveness and profitability in a manner consistent with its corporate objectives and the long-term best interests of its shareholders and other stakeholders. a Recommendation 1.1 The Board should be composed of directors with a collective working knowledge, experience or expertise that is relevant to the company’s industry/sector. The Board should always ensure that it has an appropriate mix of competence and expertise and that its members remain qualified for their positions individually and collectively, to enable it to fulfill its roles and responsibilities and respond to the needs of the organization based on the evolving business environment and strategic direction. Explanation Competence can be determined from the collective knowledge, experience and expertise of each director that is relevant to the industry/sector that the company is in. A Board with the necessary knowledge, experience and expertise can properly perform its task of overseeing management and governance of the corporation, formulating the corporation’s vision, mission, strategic -objectives, policies and Procedures that would guide its activities, effectively monitoring management’s performance and supervising the Proper implementation of the same. In this regard, the Board sets qualification standards for its members to facilitate the selection of potential nominees for board seats, and to serve as a benchmark for the evaluation of its performance.SEC Code of Corporate Governance _35 Recommendation 1.2 The Board should be composed of a majority of non-executive directors who possess the necessary qualifications to effectively participate and help secure objective, independent judgment on corporate affairs and to substantiate proper checks and balances. Explanation The right combination of non-executive directors (NEDs), which include independent directors (IDs) and executive directors (EDs), ensures that no director or small group of directors can dominate the decision-making process. Further, a board composed of a majority of NEDSs assures protection of the company’s interest over the interest of the individual shareholders. The company determines the qualifications of the NEDs that enable them to effectively participate in the deliberations of the Board and carry out their roles and responsi Recommendation 1.3 The Company should provide in its Board Charter and Manual on Corporate Governance a policy on the training of directors, including an orientation program for first-time “directors and relevant annual continuing training for all directors. Explanation The orientation program for first-time directors and relevant annual continuing training for all directors aim to promote effective board performance and continuing qualification of the directors in carrying-out their duties and responsibilities. It is suggested that the orientation program for first-time directors, in any company, be for at least eight hours, while the annual continuing training be for at least four hours. {All directors should be properly oriented upon joining the board. This .w members are appropriately apprised of their duties and before beginning their directorships. The orientation program covers SEC-mandated topics on corporate governance and an preoduction to the company’s business, Articles of Incorporation, and Code of Conduct. It should be able to meet the specific needs of the ensures that ne responsibilities,36 Chapter 3 nd aid any new director company and the individual directors 4! crrectively performing his or her functions. her hand, makes rmed of the developments including emerging risks on corporate governance it, internal controls, risk is encouraged that The annual continuing training program, on the ot! certain that the directors are continuously infor in the business and regulatory environments, relevant to the company. It involves courses OF ant to the company, including audit matters relev: m | in ie management, sustainability and strategy. 2 companies assess their own training and -development needs in ir continuing training: program. determining the coverage of thei Recommendation 1.4 ‘The Board should have a policy on board diversity. Explanation Having a board diversity policy is a move ensure that optimal decision-making is achieved. A board diversity policy is not limited to gender diversity. It also includes diversity in age, ethnicity, culture, skills, competence and knowledge. On gender diversity policy, a good example is to increase the number of female directors, including female independent directors. to avoid groupthink and Recommendation 1.5 The Board should ensure that it is assisted in its duties by a Corporate Secretary, who should be a separate individual from the Compliance Officer, The Corporate Secretary should not be a member of the Board of Directors and should annually attend a training on corporate governance. Explanation The Corporate Secretary is primaril il 1 ly responsible to the corporati its shareholders, and not to the Chairman or President of th ca ap and has, among others, the following duties and responsibilities: ari a ase the Board and the board committees in the conduct of their jeetings, including preparing an annual schedule of Board andSEC Code of Corporate Governance _37 committee meetings and the annual board calendar, and assisting the chairs of the Board and its committees to set agendas for those meetings; Safekeeps and preserves the integrity of the minutes of the meetings of the Board and its committees, as well as other official records of the corporation; Keeps abreast on relevant laws, regulations, all governance issuances, relevant industry developments and operations of the corporation, and advises the Board and the Chairman on all relevant issues as they ari Works fairly and objectively with the Board, Management and stockholders and contributes to the flow of information between the Board and management, the Board and its committees, and the Board and its stakeholders, including shareholders; Advises on the establishment of board committees and their terms of reference; Informs members of the Board, in accordance with the by-laws, of the agenda of their meetings at least five working days in advance, and ensures that the members have before them accurate information that will enable them to arrive at intelligent decisions on matters that require their approval; ‘Attends all Board meetings, except when justifiable causes, such as illness, death in the immediate family and serious accidents, prevent him/her from doing so; Performs required administrative functions; Oversees the drafting of the by-laws and ensures that they conform with regulatory requirements;, and Performs such other duties and responsibilities as may be provided by the SEC.38__ Chapter 3 Recommendation 1.6 The Board should ensure that it is assisted in its duties by a Compliance Officer, who should have a rank of Senior Vice President | or fd equivalent position with adequate stature and ae ite corporation. The Compliance Officer should not bea mem id Board of Directors and should annually attend a training on corporal governance. Explanation . The Compliance Officer is a member Of the company’s management team in charge of the’ compliance function. Similar to the Corporate Secretary, he/she is primarily liable to the corporation and its shareholders, and not to the Chairman or President of the ‘company. He/she has, among others, the following duties and responsibilities: a. Ensures proper onboarding of new directors (i.e., orientation on the company’s business, charter, articles of incorporation and by-laws, among others); b. Monitors, reviews, evaluates and ensures the compliance by the corporation, its officers and directors with the relevant laws, this Code, rules and regulations and all governance issuances of regulatory agencies; ¢. Reports the matter to the Board if violations are found and recommends the imposition of appropriate disciplinary action; d. Ensures the integrity and accuracy of all documentary submissions to regulators; ¢. Appears before the SEC when summoned in relation t ., with this Code; ion to compliance f. Collaborates with other departments to Properly address compliance issues, which may be subject to investigation; g. Identifies possible areas of compliance issues and work: i ‘Ss resolution of the same; oeSEC Code of Corporate Governance _39 Ensures the attendance of board members and key officers to relevant trainings; and Performs such other duties and responsibilities as may be provided by the SEC. 2. ESTABLISHING CLEAR ROLES AND RESPONSIBILITIES OF THE BOARD Principle The fiduciary roles, responsibilities and accountabilities of the Board as provided under the law, the company’s articles and by-laws, and other legal pronouncements and guidelines should be clearly made known to all directors as well as to shareholders and other stakeholders. Recommendation 2.1 The Board members should act on a fully informed basis, in good faith, with due diligence and care, and in the best interest of the company and all shareholders. Explanation There are two key elements of the fiduciary duty of board members: the duty of care and the duty of loyalty. The duty of care requires board members to act on a fully informed basis, in good faith, with due diligence and care. The duty of loyalty is also of central importance; the board member should act in the interest of the company and all its shareholders, and not those of the controlling company of the group or any other stakeholder. Recommendation 2.2 The Board should oversee the development of and approve the “= business objectives and strategy, and monitor their compan: ~ r the rat in order to sustain the company’s long-term viability implementation, and strength.40 Chapter 3 Explanation According to the OECD, the Board should review and suide corpornip strategy, major plans of action, risk management Pp procedures, annual budgets and business plans; ii a aealapon objectives; monitor implementation and corporate a ae ear oversee major capital expenditures, acquisitions and divest - es: ooo strategic policies and objectives translate to the comps Be oie identification and prioritization of its goals and guidance o achieve them. This creates optimal value to the corporation Recommendation 2.3 The Board should be headed by a competent and qualified Chairperson. Explanation The roles and responsibilities of the Chairman include, among others, the following: a. Makes certain that the meeting agenda focuses on strategic matters, including the overall risk appetite of the corporation, considering the developments in the business and regulatory environments, key governance concerns, and contentious issues that will significantly affect operations; b. Guarantees that the Board receives accurate, timely, relevant, insightful, concise, and clear information to enable it to make sound decisions; c. Facilitates discussions on key issues by fostering an environment conducive for constructive debate and leveraging on the skills and expertise of individual directors; d. Ensures that the Board sufficiently challenges and inquires on reports submitted and representations made by Management; e. Assures the availability of proper orientation for first-time directors and continuing training opportunities for all directors; and f. Makes sure that performance of the B ii t ‘oard is evaluated at | a year and discussed/followed up on. aoaCode of Corporate Governance _41 Recommendation 2.4 ue Les should be responsible for ensuring and adopting an effective iene pl anne program for directors, key officers and management This sh an and a continued increase in the shareholders’ value. should include adopting a policy on the retirement age for directors and key officers as part of management succession and to promote dynamism in the corporation. Explanation The transfer of company leadership to highly competent and qualified individuals is the goal of succession planning. It is the Board’s responsibility to implement a process to appoint competent; professional, honest and highly motivated management officers who can add value to the.company. ‘A good succession plan is linked to the documented roles and responsibilities for each position, and should start in objectively identifying the key knowledge, skills, and abilities required for the position. For any potential candidate identified, a professional development plan is defined to help the individuals prepare for the job (e.g, training to be taken and cross experience to be achieved). The process is conducted in an impartial manner and aligned with the strategic direction of the organization. Recommendation 2.5 ‘The Board should align the remuneration of key officers and board members with the long-term interests of the company. In doing so, it Should formulate and adopt a policy specifying the relationship between remuneration and performance. Further, no director should participate in discussions or deliberations involving his own remuneration. Explanation Companies are able to attract and retain the services of qualified and competent individuals ifthe level of remuneration is sufficient, in line with the business and risk strategy, objectives, values and incorporate measures to prevent conflicts of interest. Remuneration policies promote sound risk culture in which risk-taking behavior is appropriate. Theyann nny 42 Chapter 3 also encourage employees to act in the long-term interest of the company as a whole, rather than for themselves or their business lines only. Moreover, it is good practice for the Board to formulate and adopt a policy specifying the relationship between remuneration and performance, which includes specific financial and non-financial metrics, to measure performance and set specific provisions for employees with significant influence on the overall risk profile of the corporation. Key considerations in determining proper compensation include the following: (1) the level of remuneration is commensurate to the responsibilities of the role; (2) no director should participate in deciding on his remuneration; and (3) remuneration pay-out schedules should be sensitive to risk outcomes over a multi-year horizon. For employees in control functions (e.g,, risk, compliance and internal audit), their remuneration is determined independent of any business line being overseen, and performance measures are based principally on the achievement of their objectives so as not to compromise their independence. Recommendation 2.6 The Board should have and disclose in its Manual on Corporate Governance a formal and transparent board nomination and election policy that should include how it accepts nominations from minority shareholders and reviews nominated candidates. The policy should also include an assessment of the effectiveness of the Board's processes and procedures in the nomination, election, or replacement of a director. In addition, its process of identifying the quality of directors should be aligned with the strategic direction of the company. Explanation It is the Board’s responsibility to develop a policy on board nomination, which is contained in the company’s Manual on Corporate Governance. The policy should encourage shareholders’ participation by including procedures on how the Board accepts nominations from minority shareholders. The policy should also promote transparency of the Board’s nomination and election process.Code of Corporate Governance 43 The nomination and election process also includes the review and evaluation of the qualifications of all persons nominated to the Board, including whether candidates: (1) possess the knowledge, skills, experience, and particularly in the case of non-executive directors, independence of mind given their responsibilities to the Board and in light of the entity's business and risk profile; (2) have a record of integrity and good repute; (3) have sufficient time to carry out their responsibilities; and (4) have the ability to promote a smooth interaction between board members. A good practice is the use of professional bay firms or external sources when searching for candidates to the ‘oard. In addition, the process also includes monitoring the qualifications of the directors. The qualifications and grounds for disqualification are contained in the company’s Manual on Corporate Governance. The following may be considered as grounds for the permanent disqualification of a director: a. Any person convicted by final judgment or order by a competent judicial or administrative body of any crime that: (a) involves the purchase or sale of securities, as defined in the Securities Regulation Code; (b) arises out of the person’s conduct as an underwriter, broker, dealer, investment adviser, principal, distributor, mutual fund dealer, futures commission merchant, commodity trading advisor, or floor broker; or (c) arises out of his fiduciary relationship with a bank, quasi-bank, trust company, investment house or as an affiliated person of any of them; b. Any person who, by reason of misconduct, after hearing, is permanently enjoined by a final judgment or order of the SEC, Bangko Sentral ng Pilipinas (BSP) or any court or administrative body of competent jurisdiction from: (a) acting as underwriter, broker, dealer, investment adviser, principal distributor, mutual fund dealer, futures commission merchant, commodity trading advisor, or floor broker; (b) acting as director or officer of a bank, quasi-bank, trust company, investment house, or investment company: (c) engaging in or continuing any conduct or practice in any of the capacities mentioned in sub-paragraphs (a) and (b) above, or willfully violating the laws that govern securities and. banking activities.44 Chapter 3 The disqualification should also apply if (a) such person Is the subject of an order of the SEC, BSP or any court or administrative body denying, revoking or suspending any registration, license or permit issued to him under the Corporation Code, Securities Regulation Code or any other law administered by the SEC or BSP, or under any rule or regulation issued by the Commission or BSP; (b) such person has otherwise been restrained to engage in any activity involving securities and banking; or (c) such person is the subject of an effective order ofa self-regulatory organization suspending or expelling him from membership, participation or association with a member or participant of the organization; Any person convicted by final judgment or order by a court, or competent administrative body of an offense involving moral turpitude, fraud, embezzlement, theft, estafa, counterfeiting, misappropriation, forgery, bribery, false affirmation, perjury or other fraudulent acts; ‘Any person who has been adjudged by final judgment or order of the SEC, BSP, court, or competent administrative body to have willfully violeted, or willfully aided, abetted, counseled, induced or procured the violation of any provision of the Corporation Code, Securities Regulation Code or any other law, rule, regulation or order administered by the SEC or BSP; ‘Any person judicially declared as insolvent; Any person found guilty by final judgment or order of a foreign court or equivalent financial regulatory authority of acts, violations or misconduct similar to any of the acts, violations or misconduct enumerated previously; Conviction by final judgment of an offense punishable by imprisonment for more than six years, or a violation of the Corporation Code committed within five years prior to the date of his election or appointment; and Other grounds as the SEC may provide._SEC Code of C jpponecuane wenn onerer en rerenre porate Governance 48 In addition, the following may be grounds for temporary disqualification of a director: a, Absence in more than fifty percent (50%) of all regular and special meetings of the Board during his incumbency, or any 12-month period during the said incumbency, unless the absence is due to illness, death in the immediate family oF serious accident. The disqualification should apply for purposes of the succeeding election; b. Dismissal or termination for cause as director of any publicly-listed company, public company, registered issuer of securities and holder of a secondary license from the Commission. The disqualification should be in effect until he has cleared himself from any involvement in the cause that gave rise to his dismissal or termination; c.f the beneficial equity ownership of an independent director in the corporation or its subsidiaries and affiliates exceeds two percent (2%) of its subscribed capital stock. The disqualification from being elected as an independent director is lifted if the limit is later complied with; and d. If any of the judgments or orders cited in the-grounds for permanent disqualification has not yet become final. \ Recommendation 2.7 The Board should have the overall responsibility in ensuring that there is a group-wide policy and system governing related party transactions (RPTs) and other unusual or infrequently occurring transactions, particularly those which pass certain thresholds of materiality. The policy should include the appropriate review and approval of ‘material or significant RPTs, which guarantee fairness and transparency of the transactions. The policy should encompass all entities within the group, taking into account their size, structure, risk profile and complexity of operations. Explanation Ensuring the integrity of related party transactions is an important fiduciary duty of the director. It is the Board’s role to initiate policies and measures geared towards prevention of abuse and promotion ofi i id regulations to ansparency, and in compliance with ap} je laws and | ‘ poet the interest of all shareholders. One such eer is ihe reauted ratification by shareholders of material or significant 's appl ved by the Board, in accordance with existing laws. Other measures inc ensuring that transactions occur at market prices, at ann engl is and under conditions that protect the rights of all shareholders. plicabl The following are suggestions for the content of the RPT Policy: Definition of related parties; Coverage of RPT policy; Guidelines in ensuring arm’s-length terms; Identification and prevention or management of potential or actual conflicts of interest which arise; . Adoption of materiality thresholds; ‘ + Internal limits for individual and aggregate exposures; + Whistle-blowing mechanisms, and . + Restitution of losses and other remedies for abusive RPTs. In addition, the company is given the discretion to set their materiality threshold at a level where omission or misstatement of the transaction could pose a significant risk to the company and influence its economic decision. The SEC may direct a company to reduce its materiality threshold or amend excluded transactions if the SEC deems that the threshold or exclusion is inappropriate considering the company’s size, risk profile, and risk management systems, Depending on the materiality threshold, approval of management, the RPT Committee, the Board or the shareholders may be required. In cases where the shareholders’ approval is required, it is good practice for interested shareholders to abstain and let the disinterested parties or majority of the minority shareholders decide. Recommendation 2.8 The Board should be primarily responsible for ay it i NH ving th and assessing the performance of the Management led by the Chie? Executive Officer (CEO), and control functions led by their respective heads (Chief Risk Officer, Chi : Baca isk Officer, Chief Compliance Officer, and Chief AuditSEC Code of Corporate Governance _47 Explanation fe the responsibility of the Board to appoint a competent management at all times, monitor and assess the performance of the management team based on established performance standards that are consistent with the company’s strategic objectives, and conduct a regular review of the company’s policies with the management team. In the selection process, fit and proper standards are to be applied on key Personnel and due consideration is given to integrity, technical expertise and experience in the institution’s business, either current or planned. Recommendation 2.9 The Board should establish an effective performance management framework that will ensure that the Management, including the Chief Executive Officer, and personnel’s performance is at par with the standards set by the Board and Senior Management. Explanation Results of performance evaluation should be linked to other human resource activities such as training.and development, remuneration, and succession planning, These should likewise form part of the assessment of the continuing fitness and propriety of management, including the Chief Executive Officer, and personnel in carrying out their respective duties and responsibilities. Recommendation 2.10 ‘The Board should oversee that an appropriate internal control system is in place, including setting up a mechanism for monitoring and managing potential conflicts of interest of Management, board members, and Shareholders. The Board should also approve the Internal Audit Charter. Explanation In the performance of the Board’s oversight responsibility, the minimum internal control mechanisms may include overseeing the implementation of the key control functions, such as risk management, compliance and internal audit, and reviewing the corporation's human resource policies,48 Chapter 3 f ‘ d conflict of interest situations, compensation program for employees an management succession plan. Recommendation 2.11 The Board should oversee that a sound enterprise risk management (ERM) framework is in place to effectively identify, monitor, assces and manage key business risks. The risk management framework S) ci guide the Board in identifying units/business lines and enterprise Tevé risk exposures, as well as the effectiveness of risk management strategies. Explanation Risk management policy is part and parcel of a corporation’s corporate strategy. The Board is responsible for defining the company’s level of risk tolerance and providing oversight over its risk management policies and procedures. : Recommendation 2.12 The Board should have a Board Charter that formalizes and clearly states its roles, responsibilities and accountabilities in carrying out its fiduciary duties. The Board Charter should serve as a guide to the directors in the performance of their functions and should be publicly available and posted on the company’s website. Explanation The Board Charter guides the directors on how to di i I te jischarge their functions. It provides the standards for evaluating the perfortancs of the Board. The Board Charte i $b areas, erie Clie jarter also contains the roles and responsibilitiesSEC Code of Corporal 3. ESTABLISHING BOARD COMMITTEES jovernance 49 Principle poor corals should be set up to the extent possible to support the is eu Rana of the Board’s functions, particularly with respect a management, related party transactions, and other key corporate governance concems, such as nomination and remuneration. The composition, functions and responsibilities of all committees bli should be contained in a publicly available Committee r. Recommendation 3.1 The Board should establish board committees that focus on specific” board functions to aid in the optimal performance of its roles and responsibilities. Explanation Board committees such as the Audit Committee, Corporate Governance Committee, Board Risk Oversight Committee and Related Party Transaction Committee are necessary to support the Board in the effective performance of its functions. The establishment of the same, or any other committees that the company deems necessary, allows for “specialization in issues and leads to a better management of the Board’s serkload, The type of board committees to be established by a company would depend on its size, risk profile and complexity of operations. However, if the committees are not established, the functions of these committees may be carried out by the whole board or by any other committee. Recommendation 3.2 ‘The Board should establish an Audit Committee (0 enhance its oversight capability over the company’s financial reporting, internal control system. internal and external audit processes, and compliance with lations. The committee should be composed of applicable laws and regu! Id bec at least three appropriately qualified non-executive directors, the majority of whom, including the Chairman, should be independent. All of the members of the committee must have relevant background,50 Chapter 3 knowledge, skills, and/or experience in the areas of accounting auditing and finance. The Chairman of the Audit Committee sI chairman of the Board or of any other committees. Explanation The Audit Committee is responsible for overseeing ee acolo management in establishing and maintaining an adequate, ¢! ed efficient internal control framework. It ensures that syste! it processes are designed to provide assurance in areas rsa ring monitoring compliance with laws, regulations and ea p : . efficiency and effectiveness of operations, and safeguarding of assets. The Audit Committee has the following duties and responsibilities, among others: a. Recommends the approval the Internal Audit Charter (IA Charter), which formally defines the role of Internal Audit and the audit plan as well as oversees the implementation of the IA Charter; Through the Internal Audit (IA) Department, monitors and evaluates the adequacy and effectiveness of the corporation’s internal control system, integrity of financial reporting, and security of physical and information assets. Well-designed internal control procedures and processes that will provide a system of checks and balances should be in place in order to (a) safeguard the company’s resources and ensure their effective utilization, (b) prevent occurrence of fraud and other inregularities, (c) protect the accuracy and reliability of the company’s financial data, and (d) ensure compliance with applicable laws and regulations; s ¢. Oversees the Internal Audit Department, and recommends the appo intment and/or grounds for approval of an internal audit head or Chief Audit Executive (CAE). The Audit Committee should also approve the terms and conditions for outsourcing internal audit services; Establishes and identifies the reporting li it i ig line of the Internal Auditor to enable him to’prorerly fulfill his duties and responsibi i this purpose, he should directly report to the Audit ComSEC Code of Corporate Governance 51 Reviews : ‘Anders ty Monitors Management's responsiveness to the Internal indings and recommendations; Prior pg the commencement of the audit, discusses withthe External Prope ae nature, scope and expenses of the audit, and ensures thé Per Coordination if more than one audit firm is involved in the: activity to secure proj ee ede er efforts, Proper coverage and minimize duplication of g. Evaluates and determines the non-audit work, if any, of the External Auditor, and periodically reviews the non-audit fees paid to the External Auditor in relation to the total fees paid to him and to the corporation’s overall consultancy expenses. The committee should disallow any non-audit work that will conflict with his duties as an External Auditor or may pose a threat to his independence3. The non-audit work, if allowed, should be disclosed in the corporation’s Annual Report and Annual Corporate Governance Report; h. Reviews and approves the Interim and Annual Financial Statements before their submission to the Board, with particular focus on the following matters: Any change/s in accounting policies and practices ‘Areas where a significant amount of judgment has been exercised Significant adjustments resulting from the audit Going concern assumptions Compliance with accounting standards Compliance with tax, legal and regulatory requirements Reviews the disposition of the recommendations in the External Auditor’s management letter; functions over the corporation’s Internal and External Auditors. It ensures the independence of Internal and External Auditors, and that both auditors are given unrestricted access to all records, properties and personnel to enable them to rm their respective audit functions; Performs oversight perfor k. Coordinates, monitors and facilitates compliance with laws, rules and regulations; Ts defined under the Code of Ethics for Professional Accountantscommends to the Board the ointment, reappointment, pina feed ofthe External Auditor, duly aoe. 7 Ha Commission, who undertakes an independent he it eee corporation, and provides an objective assurance on c cm i by which the financial statements should be prepared and presented to the stockholders; and ve a Board Risk Oversight ‘actions Committee, performs provided under m. In case the company does not ha Committee and/or Related Party Trans: the functions of said committees as Recommendations 3.4 and 3.5. The Audit Committee meets with the Board at least every quarter without the presence of the CEO or other management team members, and periodically meets with the head of the internal audit. Recommendation 3.3 The Board should establish a Corporate Governance Committee that should be tasked to assist the Board in the performance of its corporate governance responsibilities, including the functions that were formerly assigned to a Nomination and Remuneration Committee. It should be composed of at least three members, all of whom should be independent directors, including the Chairman. Explanation The Corporate Governance Committee (CG Committee) is tasked with ensuring compliance with and proper observance of corporate governance principles and practices. It has the followi i functions, among others: erence ane a. Oversees the implementation of the corporate govert framework and periodically reviews the said framework to ia that it remains appropriate in light of material changes a tha corporation's size, complexity and business strate; . Il ois business and regulatory environments: oes b. Oversees the periodic performance evaluation of the Board and its committees as well as executive i fe mana; ‘a annual selfevaluation ofits performances” 4 Conducts: anSEC Code of Corporate Governance 53 c. Ensures that the results of the Board evaluation are shared, discussed, and that conerete action plans are developed and implemented to address the identified areas for improvement; qd. Recommends continuing education/training programs for directors, assignment of tasks/projects to board committees, succession plan for the board members and senior officers, and remuneration packages for corporate and individual performance; Adopts corporate governance policies and ensures that these are reviewed and updated regularly, and consistently implemented in form and substance; f. Proposes and plans relevant trainings for the members of the Board; g. Determines the nomination and election process for the company’s directors and has the special duty of defining the general profile of board members that the company may need and ensuring appropriate knowledge, competencies and expertise that complement the existing skills of the Board; and h. Establishes a formal and transparent procedure to develop a policy for determining the remuneration of directors and officers that is consistent with the corporation’s culture and strategy as well as the business environment in which it operates. ‘The establishment of a Corporate Governance Committee does not preclude companies from establishing separate Remuneration or Nomination Committees, if they deem necessary. Recommendation 3.4 Subject to a corporation’s size, risk profile’ and complexity of operations, the Board should establish a separate Board Risk Oversight Committee (BROC) that should be responsible for the oversight of a company's Enterprise Risk Management system to ensure its Fonctionality and effectiveness. The BROC should be composed of at lenst three members, the majority of whom should be independent Ufrectors, including the Chairman. The Chairman should not be the Chairman of the Board or of any other committee. At least one member Gf the committee must have relevant thorough knowledge and experience on risk and risk management.S4 Explanation Chapter 3 The establishment of a Board Risk Oversight oan OT is generally for conglomerates and companies with a high risk to an effective corporate fa company's value creation { the Board in Enterprise risk management is integral governance process and the achievement of a ¢« $ objectives. Thus, the BROC has the responsibility to assis = ensuring that there is an effective and integrated risk Hite process in place. With an integrated approach, the Board an op management will be in a confident position to make well-informe decisions, having taken into consideration risks related to significant business activities, plans and opportunities. The BROC has the following duties and responsibilities, among others a. Develops a formal enterprise risk management plan which contains the following elements: (a) common language or register of risks, (b) well-defined risk management goals, objectives and oversight, (c) uniform processes of assessing risks and developing strategies to manage prioritized risks, (d) designing and implementing risk management strategies, and (¢) continuing assessments to improve risk strategies, processes and ‘measures; b. Oversees the implementation of the enterprise risk management plan through a Management Risk Oversight Committee. The BROC conducts regular discussions on the company’s prioritized and residual risk exposures based on regular risk management reports and assesses how the concerned units or offices are addressing and managing these risks; c. Evaluates the risk management plan to ensure its continued relevance, comprehensiveness and effectiveness, The BROC revisits defined risk management strategies, looks for emerging or changin material exposures, and stays abreast of significant develo, cheats that seriously impact the likelihood of harm or loss; m d. joe the Board on its risk appetite levels and risk tolerance imits;SEC Code of Corporate Governance 55 Padi at least annually the company’s risk appetite levels and risk folerance limits based on changes and developments in the business, the regulatory framework, the extemal economic and business environment, and when major events occur that are considered to have major impacts on the company; f. Assesses the probability of each identified risk becoming a reality and estimates its possible significant financial impact and likelihood of occurrence. Priority areas of concern are those risks that are the most likely to occur and to impact the performance and stability of the corporation and its stakeholders; g. Provides oversight over Management’s activities in managing credit, market, liquidity, operational, legal and other risk exposures of the corporation. This function, includes regularly receiving, qnformation on risk exposures and risk management activities from Management; and h. Reports to.the Board on a regular basis, or as deemed necessary, the company’s material risk exposures, the actions taken to reduce the risks, and recommends further action or plans, as necessary. Recommendation 3.5 Subject to 2 corporation’s size, risk profile and complexity of operations, the Board should establish a Related Party Transaction (RPT) Committee, which should be tasked with reviewing all material related party transactions of the company ‘and should be composed of at least three non-executive directors, two of whom should be independent, including the Chairman. Explanation Examples of companies that may have. 8 separate RPT Committee are tes. and universalieommercial banks in recognition of the slomer: pa ‘tude of RPTs in these kinds of corporations. potential magnit‘The following are the functions of the RPT Committee, among others: a. Evaluates on an ongoing basis existing relations between and among businesses and counterparties to ensure that all related part continuously identifi RPTs are monitored, and sub: changes in relationships with counterparties (from non-related to related and vice versa) are captured, Related parties, RPTs and changes in relationships should be.reflected in the relevant reports to the Board and regulators/supervisors; Evaluates'all material RPTs to ensure that these are not undertaken on more favorable economic terms (e.g. price, comm inlerest rates, fees, tenor, collateral requirement) to such related parties than similar transactions with non-related parties under similar circumstances and that no corporate or business resources of the company are misappropriated or misapplied, and to determine any potential reputational risk issues that may arise as a result of or in connection with the transactions, In evaluating RPTs, the Committee takes into account, among others, the following: 1. The related party's relationship to the company and interest in the transaction; 2. The material facts of the proposed RP aggregate value of such transaction: 3. The benefits to the corporation of the proposed RP" 4, The availability of other sources of comparable products or services; and : 5. An assessment of whether the proposed RPT is on terms and conditions that are comparable to the terms generally available Fr cluding the proposed to an unrelated party under similar circumstances. The company should have an effective price discovery system in place and exercise due diligence in determining a fair price for RPTs: c. Ensures that appropriate disclosure is made, and/or information is provided to regulating and supervising authorities relating to the company’s RPT exposures, and policies on conflicts of interest or potential conflicts of interest. The disclosure should include information on the approach to managing material conflicts of interest that are inconsistent with such Policies, and conflicts that could arise as a result of the company’s affiliation or transactions with other related parties;SEC Code of Corporate Governance _ 57 Reports to the Board of Directors on a regular basis, the status and aggregate exposures to cach related party, as well as the ie amount of exposures to all related parties; e. Ensures that transactions with related parties, including write-off of exposures are-subject to a periodic independent review or audit process; and f. Oversees the implementation of the system for identifying, monitoring, measuring, controlling, and reporting RPTS, including @ periodic review of RPT policies and procedures. Recommendation 3.6 All established committees should be required to have Committee Charters stating in plain terms their respective purposes, memberships, structures, operations, reporting processes, resources and other relevant information. The Charters should provide the standards for evaluating the performance of the Committees. It should also be fully disclosed on the company’s website: Explanation The Committee Charter clearly defines the roles and accountabilities of each committee to avoid any overlapping functions, which aims at having a more effective board for the company. This can also be used as basis for the assessment of committee performance. 4, FOSTERING COMMITMENT Principle To show full commitment to the company, the directors should devote the time and attention necessary to properly and effectively perform their duties and responsibilities, including sufficient time to be familiar with the corporation’ business.Recommendation 4.1 . The directors should attend and actively participate in Satie the Board, Committees, and Shareholders in person or tl rove ete Videoconferencing conducted in accordance with the rules i requlations of the Commission, except when justifiable causes, suc - iliness, death in the immediate family and serious acciden's, Preven them from doing so. In Board and Committee monica the director should review meeting materials and if called for, ask the necessary questions or seek clarifications and explanations. Explanation A director's commitment to the company is evident in th amount of time he dedicates to performing his duties and responsibilities, which includes his presence in all meetings of the Board, Committees and Shareholders. In this way, the director is able to effectively perform his/her duty to the company and its shareholders. The absence of a director in more than fifty percent (50%) of all regular and special meetings of the Board during his/her incumbency is a ground for disqualification in the succeeding election, unless the absence is due to illness, death in the immediate family, serious accident or other unforeseen or fortuitous events. Recommendation 4.2 The non-executive directors of the Board should concurrently serve as directors to a maximum of five publicly listed companies to ensure that they have sufficient time: to fully prepare for meetings, challenge Management’s proposals/views, and oversee the long-term strategy of the company. id Explanation Being a director necessitates a commitment to the corporation. Hence, there is a need to set a limit on board directorships. This ensures that the members of the board are able to effectively commit themselves to perform their roles and_ responsibilities, regularly ‘update their knowledge and enhance their skills, Since sitting on the board of too many companies may interfere with the optimal performance of board members, in that they may not be able to contribute enough time to keepSEC Code of Corporate Governance 59 bas st of the corporation's operations and to attend and actively participate during meetings, a maximum board seat limit of five directorships is recommended. Recommendation 4.3 A director should notify the Board where he/she is an incumbent irector before accepting a directorship in another company: Explanation The Board expects commitment from a director to devote sufficient time and attention to his/her duties and responsibilities. Hence, it is important that a director notifies his/her incumbent Board before accepting 4 directorship in another company. This is for the company'to be able to assess if his/her present responsibilities and commitment to the company will be affected and if the director can still adequately provide what is expected of him/her. 5, REINFORCING BOARD INDEPENDENCE Principle ‘The board should endeavor to exercise an objective and independent judgment on all corporate affairs. Recommendation 5.1 The Board should have at least three independent directors, or such number as to constitute at least one-third of the members of the. Board, whichever is higher- Explanation ‘The presence of independent directors in the Board is to ensure the exercise of independent judgment oh corporate affairs and proper oversight of managerial performance, including prevention of conflict of interests and balancing of competing demands of the corporation. There ig increasing global recognition that more independent directors in the Board lead to more objective decision-making, particularly in conflict of interest situations. In addition, experts have recognized that there are60 Chapter 3 spel | Potato 2 i inde ent directors in the ing opini + optimal number of independent direc d Ce eS a veal ir rom one-third to a substantial board, However, the ideal number ranges fi majority. Recommendation 5.2 endent directors possess the The Board should ensure that its indep cAOTS he disqualifications for an necessary qualifications and none of u independent director to hold the position. Explanation ss a good general understanding of is worthy to note that independence hand. It is therefore important that possess the Independent directors need to posse: the industry they are in. Further, it i and competence should go hand: the non-executive directors, including independent directors, qualifications and stature that would enable them to effectively and objectively participate in the deliberations of the Board. ‘An Independent Director refers to a person who, ideally: a. Is not, or has not been a senior officer or employee of the covered company unless there has been a change in the controlling ownership of the company; b. Is not, and has not been in the three years immediately preceding the* election, a director of the covered company; a director, officer, employee of the covered company’s subsidiaries, associates, affiliates or related companies; or a director, officer, employee of the covered company’s substantial shareholders and its related companies; c. Has not been appointed in the covered its subsidiaries, associates, affiliates or related companies acca ee ois “Ex-Officio” Directors/Officers or Members of any Advisor Board, or otherwise appointed in a capacity to assist the Board in the performance of its duties and responsibilities within th i immediately preceding his election; ec ereSEC Code of Corporate Governance 61 Is i i us an owner of more than two percent (2%) of the outstanding s of the Covered company, its subsidiaries, associates, affiliates or related companies; |s not a relative of a director, officer, or substantial shareholder of the covered company or any of its related companies or of any of its substantial shareholders. For this purpose, relatives include spouse, at child, brother, sister and the spouse of such child, brother or rs Is not acting as a nominee or representative of any director of the covered company or any of its related companies; Is not a securities broker-dealer of listed companies and registered issuers of securities. “Securities broker-dealer” refers to any person holding any office of trust and responsibility in a broker-dealer firm, which includes, among others, @ director, officer, principal stockholder, nominee of the firm to the Exchange, an associated person or salesman, and an authorized clerk of the broker or dealer; Is not retained, either in his personal capacity or through a firm, as a professional adviser, auditor, consultant, agent or counsel of the covered company, any of its related companies or substantial shareholder, or is otherwise independent of Management and free fiom any business or other relationship within the three years immediately preceding the date of his election; Does not engage or has not engaged, whether by himself or with other persons of through a firm of which he is a partner, director or substantial shareholder, in any transaction with the covered company or any of its related companies or substantial shareholders, other than such transactions that are conducted at arm’s length and Could not materially interfere with or influence the exercise of his independent judgment; Is not affiliated with any non-profit organization that receives significant funding from the covered company of any of its related Companies or substantial sharcholders; and executive officer of another company where Is not employed as an ic I pany’s executives serve as directors. any of the covered com62_ Chapter 3 Related companies, as used in this section, refer to (a) the coe + entity’s holding/parent company; (b) its subsidiaries; and (c) subsidiaries of its holding/parent company. Recommendation 5.3 The Board’s independent directors should serve for a maximum cumulative term of nine years. After which, the independent director should be perpetually barred from re-election as such in the same compaiy, but may continue to qualify for nomination and election as a non-independent director. In the instance that a company wants to retain an independent director who has served for nine years, the Board should provide meritorious justification/s and seek shareholders’ approval during the annual shareholders’ meeting. Explanation Service in a board for a long duration may impair a director’s ability to act independently and objectively. Hence, the tenure of an independent director is set to a cumulative term of nine years. Independent directors (IDs) who have served for nine years may continue as a non- independent director of the company. Reckoning of the cumulative nine- year term is from 2012, in connection with SEC’Memorandum Circular No. 9, Series of 2011. Any term beyond nine years for an iD is subjected to particularly rigorous review, taking into account the need for progressive change in the Board to ensure an appropriate balance of skills and experience. However, the shareholders may, in exceptional cases, choose to re-elect an independent director who fias served for nine years, In such instanees the Board must provide a meritorious justification for the re- election. Recommendation 5.4 The positions of Chairman of the Board and Chief Executive Officer should be held by separate individuals and each should have clearly defined responsibilities.SEC Code of Corporate Governance _ 63 Explanation To avoid conflict or a split board and to foster an appropriate balance of poet imereased accountability and better capacity for independent ecision-making, it is recommended that the positions of Chairman and Chief Executive Officer (CEO) be held by different individuals. This {ype of organizational structure facilitates effective decision making and good governance. In addition, the division of responsibilities and accountabilities between the Chairman and-CEO is'clearly defined and delineated and disclosed in the Board Charter. ‘The CEO has the following roles and responsibilities, among others: a. Determines the corporation’s strategic direction and formulates and implements its strategic plan on the direction of the business; b. Communicates and implements the corporation’s vision, mission, values and overall strategy and promotes any organization or stakeholder change in relation to the same; c. Oversees the operations of the corporation and manages human and financial resources in accordance with the strategic plan; d. Has a good working knowledge of the corporation’s industry and market and keeps up-to-date with its core business purpose; e. Directs, evaluates and guides the work of the key officers of the corporation; £ Manages the corporation’s resources prudently and ensures a proper balance of the same; Provides the Board with timely information and interfaces between the Board and the employees; h. Builds the corporate culture and motivates the employees of the corporation; and the link between internal operations and external i, Serves as stakeholders. The roles and responsibilities of the Chairman are provided under Recommendation 2.364 Chapt Recommendation §, The Board should designate a lead director among, the independent directors if the Chairman of the Board is not independent, including if the positions of the Chairman of the Board and Chief Executive Officer are held by one person, In cases where the Chairman is not independent and where the roles of and CEO are combined, putting in place proper mechanisms ires independent views and perspectives, More importantly, it avoids the abuse of power and uli, and potential conflict of interest. A suggested mechanism is the appointment of a strong “lead director” among the independent directors. ‘This lead director has sufficient authority to lead the Board in cases where management has clear conflicts of interest. The functions of the lead director include, among others, the following: a. Serves as an intermediary between the Chairman and the other directors when necessary; b, Convenes and chairs meetings of the non-executive directors; and c. Contributes to the performance evaluation of the Chairman, as required, . Recommendation 5.6 A director with a material interest in any transaction affecting the corporation should abstain from taking part in the deliberations for the same. Explanation The abstention of a director from participating in a meeting when related party transactions, self-dealings or any transactions or matters on which he/she has a material interest are taken up ensures that he has no influence over the outcome of the deliberations, The fundament i principle to be observed is that a director does not use his position to profit or gain some benefit or advantage for if . related interests. ° himself and/or his/herSEC Code of Corporate Governance _ 65 Recommendation 5.7 The non-executive directors (NEDs) should have separate periodic, meetings with the external auditor and heads of the internal audit, compliance and risk functions, without any executive directors present to ensure that proper checks and balances are in place within the Corporation. The meetings should be chaired by the lead independent director. : Explanation NEDs are expected to scrutinize Management’s performance, particularly in meeting the companies? goals and objectives. Further, it is their role to satisfy themselves on the integrity of the corporation’s internal control and effectiveness of the risk management systems. This role can be better performed by the NEDs if they are provided access to the external auditor and heads of the internal audit, compliance and risk functions, as well as to other key officers of the company without any executive directors present. The lead independent director should lead and preside over the meeting. 6. ASSESSING BOARD PERFORMANCE ASSESSING BOARD PERFORMANCE Principle The best measure of the Board’s effectiveness is through an assessment process. The Board should regularly carry out evaluations to appraise its performance as a body, and assess whether it possesses the right mix of backgrounds and competencies. Recommendation 6.1 The Board should conduct an annual self-assessment of its performance, including the performance of the Chairman, individual members and committees. Every three years, the assessment should be supported by an external facilitator.06 Chyrer $ Eyptanation we their The Boant assessment helps the dirvetors to thoroughly i performance and understand their roles aud rospon. lit ic periodic review and assessment of the Board’s performance as « my the boant committees, the individual directors, and the Cc Manele flies how the aforementioned should perform their responsi ll it es efectively, In addition, it provides a means (0 assess a director’ attendance at board and committee meetings ticipation in boardroom discussions and manner of voting on material issues. The use of an external facilitator in the assessment progess increases the objectivity of the same, The external facilitator can be any independent third party such as, but not limited to, a consulting firm, academic institution or professional organization, Recommendation 6.2 The Board should have in place a system that provides, at the minimum, criteria. and process to determine the performance of the Board, the individual directors, committees and such system should allow for a feedback mechanism from the shareholders. Explanation Disclosure of the criteria, process and collective results of the assessment ensures transparency and allows shareholders and stakeholders to determine if the directors are performing their responsibilities to the company. Companies are given the discretion to determine the assessment criteria and process, which should be based on the mandates, functions, roles and responsibilities provided in the Board and Committee Charters, In establishing the criteri attention is given to the values, principles and skills required for the company. The Corporate Governance Committee oversees the evaluation process.SEC Code of Corporate Governance _67 7, STRENGTHENING BOARD ETHICS Principle Member of the Board are duty-bound to apply high ethical standards; ing into account the interests of all stakeholders. Recommendation 7.1 The Board should adopt a Code of Business Conduct and Ethics, which would provide standards for professional and ethical behavior, as well as articulate acceptable and unacceptable conduct and practices in internal and external dealings. The Code should be properly disseminated to the Board, senior management and employees. It should also be disclosed and made available to the public through the company website. Explanation- A Code of Business Conduct and Ethics formalizing ethical values is an important tool to instill an ethical corporate culture that pervades throughout the company. The main responsibility to create and design a Code of Conduct suitable to the needs of the company and the culture by which it operates lies with the Board, To ensure proper compliance with the Code, appropriate orientation and training of the Board, senior management and employees on the same are necessary. Recommendation 7.2 ‘The Board should ensure the proper and efficient implementation and monitoring of compliance with the Code of Business Conduct and Ethics and internal policies. Explanation ‘The Board has the primary duty to make sure that the internal controls are in place to ensure the company’s compliance with the Code of Business Conduct and Ethics and its internal policies and procedures. Hence, it needs to ensure the implementation of said internal controls to rantee compliance. This includes efficient which aid and encourage employees, creditors to raise concerns on potential support, promote and guat communication channels, customers, suppliers and$8_Cha unethica/unlawfil behavior without fear of retribution. A company’s ethics policy can be made effective and inculcated in the company culture through a communication and awareness campaign, continous training to reinforce the code, strict monitoring and inp nN a ft setting in place proper avenues where issues may be rais addressed without fear of retribution. DISCLOSURE AND TRANSPARENCY 8. ENHANCING COMPANY DISCLOSURE POLICIES AND PROCEDURES Principle 8 The company should establish corporate disclosure policies and procedures that are practical and in accordance with best practices and regulatory expectations. Recommendation 8.1 The Board shoutu establish corporate disclosure policies and procedures to ensure a comprehensive, accurate, reliable and timely report to shareholders and other stakeholders that gives a fair and complete picture of a company’s financial condition, results and business operations. Explanation Setting up clear policies and procedures on corporate disclosure that comply with the disclosure requirement as Provided in Rule 68 of the Securities Regulation Code (SRC), Philippine Stock Exchange Listing and Disclosure Rules, and other regulations such as those required by the Bangko Sentral ng Pilipinas, is essential for comprehensive and timely reporting. Recommendation 8,2 Fee onbany should have a policy requiring all directors and officers to disclose/report to the company any dealings j ma f s in the company’: within three business days, " pany’s sharesSEC Code of Corporate Governance 69 Explanation pee aften have access to material inside information on the i civaiitage art to reduce the tisk that the directors might take policy re ic this information, it is crucial for companies to have a with Aue iring directors to timely disclose to the company any dealt es diéclosur Sa: shares. It is emphasized that the policy is on internal ihe ’e to the company of any dealings by the director in company res. This supplements the requirement of Rules 18 and 23 of the Securities Regulation Code. Recommendation 8.3 The Board should fully disclose all relevant and material information on individual board members and key executives to evaluate their experience and qualifications, and assess any potential conflicts of interest that might affect their judgment. Explanation A disclosure on the board members and key executives’ information is prescribed under Rule 12 Annex C of the SRC. According to best practices and standards, proper disclosure includes directors and key officers’ qualifications, share ownership in the company, membership of other boards, other executive positions, continuous trainings attended and identification of independent directors. Recommendation 8.4 The company should provide a clear disclosure of its policies and procedure for setting Board and executive remuneration, as well es the fevel and mix of the same in the Annual Corporate Governance Repor. _ Algo, companies should disclose the remuneration on an individual basis, including termination and retirement provisions. Explanation Disclosure of remuneration policies and procedure enables investors t© renderstand the link between the remuneration paid to directors and Key tnanagement personnel and the company's performance,10 Chapter 3 The Revised Code of Corporate Governance requires only a disclosure of all fixed and variable compensation that may be paid, directly or indirectly, to its directors and top four management officers during the preceding fiscal year. However, disclosure on board and executive remuneration on an individual basis (including termination and retirement provisions) is increasingly regarded as good practice and is now mandated in many countries. Recommendation 8.5 The company should disclose its policies governing Related Party Transactions (RPTs) and other unusual or infrequently occurring transactions in their Manual on Corporate Governance. The material or significant RPTs reviewed and approved during the year should be disclosed in its Annual Corporate Governance Report. Explanation ‘A full, accurate and timely disclosure of the company’s policy governing RPTs and other unusual or infrequently occurring transactions, as well as the review and approval of material and significant RPTs, is regarded as good corporate governance practice geared towards the prevention of abusive dealings and transactions and the promotion of transparency. These policies include ensuring that transactions occur at market prices and under conditions that protect the rights of all shareholders. The said disclosure includes directors and key executives reporting to the Board when they have RPTs that could influence their judgment. Recommendation 8.6 The company should make a full, fair, accurate and timely disclosure to the public of every material fact or event that occurs, particularly on the acquisition or disposal of significant assets, which could adversely affect the viability or the interest of its shareholders and other stakeholders. Moreover, the Board of the offered company should appoint an independent party to evaluate the fairness of the transaction price on the acquisition or disposal of assets.Code of Corporate Gov Explanation The disclosure on the ' acquisition or disposal of -significant assets includes, among others, r if the rationale, effect on operations and approval fe Meetings with independent directors present to establish sparency and independence on the transaction. ‘The independent e i i ic i Valuation of the faimess of the transparent price ensures the protection of the rights of shareholders. Recommendation 8.7 The company’s corporate governance policies, programs and procedures should be contained in its Manual on Corporate Governance, which should be submitted to the regulators and posted on the company’s website. Explanation Transparency is one of the core principles of corporate governance. To ensure the better protection of shareholders and other stakeholders’ rights, full disclosure of the company’s corporate governance policies, programs and procedures is imperative. This is better done if the said policies, programs and procedures are contained in one reference document, which is the Manual on Corporate Governance. The submission of the Manual to regulators and posting it in companies’ websites ensure easier access by any interested party. 9, STRENGTHENING THE EXTERNAL AUDITOR’S INDEPENDENCE AND IMPROVING AUDIT QUALITY Principle 9 ‘The company should establish standards for the appropriate selection of an external auditor, and exercise effective oversight of the same to Strengthen the external auditor’s independence and enhance audit quality. Recommendation 9.1 ‘The Audit Committee should have a robust process for approving and recommending the appointment, reappointment, removal, and fees of the external auditor. The appointment, reappointment, removal, and fees ofn Chapter 3 he Pe the external auditor should be recommended by the Audit Committee, approved by the Board and ratified by the shareholders. For removal of the external auditor, the rei for removal or change should be disclosed to the regulators and the public through the company website and required disclosures Explanation ‘The appointment, reappointment and removal of the external auditor by the Board’s approval, through the Audit Committee’s recommendation, and shareholders’ ratification at shareholders’ meetings are actions regarded as good practices. Shareholders’ ratification clarifies or emphasizes that the external auditor is accountable to the shareholders or to the company as a whole, rather than to the management whom he may interact with in the conduct of his audit. " Recommendation 9.2 The Audit Committee Charter should include the Audit Committee’s responsibility on assessing the integrity and independence of external auditors and exercising effective oversight to review and monitor the external auditor’s independence and objectivity and the effectiveness of the audit process, taking into consideration relevant Philippine professional and regulatory requirements. The Charter should also contain the Audit Committee’s responsibility on reviewing and monitoring the external auditor’s suitability and effectiveness on an annual basis. \ Explanation The Audit Committee Charter ‘includes a disclosure of its responsibility on assessing the integrity and independence of the external auditor. It establishes detailed guidelines, policies and Procedures that are contained in a separate memorandum or document. Nationally and internationally recognized best practices and standards of external auditing guide the committee in formulating these Policies and procedures. Moreover, establishing effective communication with the external auditor and requiring them to report all relevant matters help the Audit Committee to efficiently carry out its oversight responsibilities,SEC Code of Corporate Governance _73 Recommendation 9,3 Wy company should disclose the nature of non-audit services performed y its extemal auditor in the Annual Report to deal with the potential conflict of interest. The Audit Committee should be alert for any Potential conflict of interest situations, given the guidelines or policies on non-audit services, which could be viewed as impairing the external auditor's objectivity. Explanation The Audit Committee, in the performance of its duty, oversees the overall relationship with the external auditor. It evaluates and determines the nature of non-audit services, if any, of the external auditor. Further, the Committee periodically reviews the proportion of non-audit fees paid to the external auditor in relation to the corporation’s overall consultancy expenses. Allowing the same auditor to perform non-audit services for the company may create a potential conflict of interest. In order to mitigate the risk of possible conflict between the auditor and the company, the Audit'Committee puts in place robust policies and procedures designed to promote auditor independence in the long run. In formulating these policies and procedures, the Committee is guided by nationally and internationally recognized best practices and regulatory requirements or issuances.STIONS AND EXERCISES REVIEW QU Multiple Choice Questions 1. Audit committee activities and responsibilities include which of the following? a. Selecting the external audit firm. b. Approving corporate strategy. c. Reviewing management performance and compensation. d. None of the above. determining Which of the following audit committee responsibilities has the SEC v mandated? a. Obtaining each year a report by the internal auditor that addresses the company’s internal control procedures, any quality control or regulatory problems, and any relationships that might threaten the independence of the internal auditor. b. Discussing in its meetings the company’s earnings press releases, as well as financial information and earnings guidance provided to analysts. Reviewing with the internal auditor any audit problems or difficulties that they have had with management. d. Allof the above. Exercises Exercise 1 Below is a summary of the SEC corporate governance requirements of companies publicly-listed in the stock exchange. For each requirement, state how it is intended to help to address the risk of fraud in publicly traded organizations. a. Boards need to consist of at least 3 independent di board which is higher. ee Ce Sette b. Boards need to hold regular executive sessi i ‘ sessions of inde i without management present. Pendent directorsSEC Code of Corporate Governance _75 Boards must have a / corporate governance committee composed at least of independent directors, ahs Corporate governance committee must have a written charter that ig resses the committee's purpose and responsibilities, and there must e annual performance evaluation of the committee. Boards “must have an audit committee with a minimum of three independent members, The audit committee must have a written charter that addresses the committees purpose and responsibilities, and the committee must produce an audit committee report; there must also be an annual performance evaluation of the committee. Exercise 2 Below is a summary of the SEC listing requirements for audit committee responsibilities of companies listed on this stock exchange. For each requirement, state how it is intended to help to address the risk of fraud in publicly traded organizations. Obtaining each year a report by the external auditor that addresses the company’s internal control procedures, any quality control or regulatory problems, and any relationships that might threaten the independence of the external auditor 5 Discussing the company’s financial statements with management and the external auditor Discussing in its meetings the company’s earnings press releases, as well as financial information and earnings guidance provided to analysts, policies with respect to risk assessment and Discussing in its’ meetit risk management Meeting separately with management, internal aifditors, and the external auditor on a periodic basis Reviewing with the external auditor any audit problems or difficulties that they had with management Setting clear hiring policies for employees or former employees of the external auditors Reporting regularly tothe board of directorsChapter SEC CODE OF CORPORATE GOVERNANCE, CONTINUED Expected Learning Outcomes ° After studying the chapter, you should be able to... i Understand how the ethical behavior of the board can be strengthened. Describe how the company disclosure policies and procedures can be enhanced. Appreciate how the external auditor's independence can be strengthened and how audit quality can be enhanced. Understand how a company could increase focus on non- financial and sustainability reporting. Explain how a company can promote a comprehensive and cost- efficient access to relevant information. Understand how integrity, transparency and proper governance of a company could be ensured through effective internal control system and enterprise risk management framework. Describe briefly how a synergic relationship with shareholders could be cultivated and promoted. Explain how the rights of stakeholders could by respected and how to institute effective redness for the violation of their rights. QUBSCHAPTER 4 SEC CODE OF CORPORATE GOVERNANCE, CONTINUED 10. INCREASING FOCUS ON NON-FINANCIAL AND SUSTAINABILITY REPORT! Principle 10 The company should ensure that the material and reportable non- financial and sustainability issues are disclosed. Recommendation 10.1 The Board should have a clear and focused policy on the disclosure of non-financial information, with emphasis on the management of economic, environmental, social and governance (EESG) issues of its business, which underpin sustainability. Companies should adopt a globally recognized standard/ramework in reporting sustainability and non-financial issues. Explanation ‘As-external pressures including resource scarcity, globalization, and access to information continue to increase, the way corporations respond acoemistainability challenges, in addition to financial challenges, fletermines their long-term viability and competitiveness. One way to respond to sustainability challenges is disclosure to all shareholders and other stakeholders of the company’s strategic (long-term goals) and operational objectives (short-term goals), as well as the impact of a wide range of sustainability issues. Disclosures can be made using standards/frameworks, such as the G4 Framework by the Global Reporting Initiative (GRIN, the Integrated Reporting Framework by the International Integrated Reporting Council (IIRC) and/or the Sustainability Accounting Standards Board (SASB)’s Conceptual Framework.78 Chapter 4 ENSIVE AND COST-EFFICIENT, 11. PROMOTING A COMPREI ACCESS TO RELEVANT INFORMATION Principle 11 1 comprehensive and cost-efficient minating relevant information. This decision-making by investors, The company should maintain communication channel for d channel is crucial for informed stakeholders and other interested users. Recommendation 11.1 eROlt of Medio in dissemination of The company should include me of communication to ensure the time’ public, material and relevant information to its shareht investors. information dia and analysts” briefings as channels ly and accurate dissemination of jolders and other Explanation The manner of disseminating relevant information to its intended users is as important as the content of the information itself. Hence, it is essential for the company to have a strategic and well-organized channel for reporting. These communication channels can provide timely and up-to-date information relevant to investors’ decision-making, as well as to other interested stakeholders. INTERNAL CONTROL SYSTEM AND RISK MANAGEMENT FRAMEWORK 12, STRENGTHENING THE INTERNAL CONTROL SYSTEM AND ENTERPRISE RISK MANAGEMENT FRAMEWORK . Principle To ensure the integrity, transparency and proper governance in the conduct of its affairs, the company should have a strong and effective internal control system and enterprise risk management framework.SEC Code of Corporate Governance, Continued _79 Recommendation 12.1 The Company should have an adequate and effective internal control system and an enterprise risk management framework in the conduct of its business, taking into account its size, risk profile and complexity of operations. Explanation An adequate and effective internal control system and an enterprise risk management framework help sustain safe and sound operations as well as implement management policies to attain corporate goals. An effective internal control system embodies management oversight and control culture; risk recognition and assessment; control activities; information and communication; monitoring activities and correcting deficiencies. Moreover, an effective enterptise risk management framework typically includes such activities as the identification, sourcing, measurement, evaluation, mitigation and monitoring of risk. Recommendation 12.2 The Company should have in place an independent internal audit function that provides an independent and objective assurance, and consulting services designed to add value and improve the company's operations. Explanation ‘A separate internal audit function is essential to monitor and guide the implementation of company policies. It helps the company accomplish its objectives by bringing a systematic, disciplined approach to evaluating and improving the effectiveness of the company’s governance, risk management and control functions. The following are the functions of the internal audit, among others: Provides an independent risk-based assurance service to the Board, Audit Committee and Management, focusing on reviewing the effectiveness of the governance and control processes in (1) promoting the right values and ethies, (2) ensuring effective performance management and accounting in the organization, (3) communicating risk and control a.80 Chapters pace oordinating the activities and information internal auditors, and information, and (4) e among the Board, external and Management; audit as contained in the annual b.. Performs regular and spe ; ' he company’s risk assessment, audit plan and/or based on th Performs consulting and advisory services related to governance and control as appropriate for the organization; of relevant laws, rules and and other commitments, the organization; d. Performs compliance audit regulations, contractual obligations which could have a significant impact on # e. Reviews, audits and assesses the efficiency and effectiveness of the internal control system of all areas of the company; rograms to ascertain whether results f, Evaluates operations or pr are consistent with established objectives and goals, and ut as whether the operations or programs are being carried o1 planned; g. Evaluates specific operations at the request of the Board or Management, as appropriate; and h. Monitors and evaluates governance processes. ‘A company’s internal audit activity may ve a fully resourced activity housed within the organization or may be outsourced to qualified independent third party service providers. Recommendation 12.3 Subject to a company’s size, risk profile and complexity of operations, it should have a qualified Chief Audit Executive (CAB) appointed by the Board. The CAE shall oversee and be responsible for the internal audit acti _of the organization, including that portic.. that is outsourced to a third party service provider. In case of a fully outsourced internal audit activity, a qualified independent executive or senior management personnel should be assigned the responsibility for managing the fully outsourced internal audit activity.SEC Code of Corporate Governance, Continued 81 Explanation 4 ‘The CAE, in order to achieve the necessary independence to fulfill his/her responsibilities, directly, reports functionally to the Audit Committee and administratively to the CEO. The following are the responsibilities of the CAE, among others: a. Periodically reviews the internal audit charter and presents it to senior’ management and the Board Audit Committee for approval; b. Establishes a risk-based internal audit plan, including policies and procedures, to determine the priorities of the internal audit activity, consistent with the organization’s goals; cc. Communicates the internal audit activity’s plans, resource requirements and impact of resource limitations, as well as significant interim changes, to senior management and the Audit Committee for review and approval; 4. Spearheads the performance of the internal audit activity to ensure it adds value to the organization; e. Reports periodically to the Audit Committee on the internal audit activity’s performance relative to its plan; and f. Presents findings and recommendations to the Audit Committee and pives advice to senior management and the Board on how to improve internal processes. Recommendation 12.4 Subject to its size, risk profile and complexity of operations, the company should have a separate risk management function to identify, assess and monitor key risk exposures. Explanation ‘The risk management function involves the following activities, among others: a. Defining a risk management strategy;82__Chapuer 4 b. Identifying and analyzing key risks exposure relating ‘2 economic, environmental, social and governance (EESG) factors and the achievement of the organization’s strategic objectives; Evaluating and categorizing each identified risk using the company’s predefined risk categories and parameters; Establishing a risk register with clearly defined, prioritized and residual risks; Developing a risk mitigation plan for the most important risks to the company, as defined by the risk management strategy; Communicating and reporting significant risk exposures includimg business risks (i,¢., strategic, compliance, operational, financial and reputational risks), control issues and risk mitigation plan to the Board Risk Oversight Committee; and Monitoring and evaluating the effectiveness. of the organization's risk management processes. Recommendation 12.5 In managing the company’s Risk Management System, the company should have a Chief Risk Officer (CRO), who is the ultimate champion of Enterprise Risk Management (ERM) and has adequate authority, stature, resources and support to fulfill his/her responsibilities, subject to a company’s size, risk profile and complexity of operations. Explanation The CRO has the following functions, among others: a. Supervises the entire ERM process and spearheads the development, implementation, maintenance and continuous improvement of ERM Processes and documentation; Communicates the top risks and the status of implementation of risk management strategies and action Plans to the Board Risk Oversight Committee;SEC Code of Corporate Governance, Continued 83. ©. Collaborates with the CEO in updating and making recommendations to the Board Risk Oversight Committee; 4. Sugeess ERM policies and related guidance, as may be needed; an ©. Provides insights on the following: © Risk management processes are performing as intended # Risk measures reported are continuously reviewed by risk owners for effectiveness; and «Established risk policies and procedures are being complied with. There should be clear communication between the Board Risk Oversight Committee and the CRO. CULTIVATING A SYNERGIC RELATIONSHIP WITH SHAREHOLDERS 13. PROMOTING SHAREHOLDER RIGHTS Principle ‘The company should treat all shareholders fairly and equitably, and also recognize, protect and facilitate the exercise of thelr rights, Recommendation 13.1 ‘The Board should ensure that basic shareholder rights are disclosed in the Manual on Corporate Governance and on the company's website. Explanation It is the responsibility of the Board to adopt policy informing the shareholders of all their rights. Shareholders are encouraged to exercise their rights by providing clear-cut processes and procedures for them to f follow. Shareholders’ rights relate tothe following, among others: © Preemptive rights; Dividend policies;84 Chapter 4 i ‘a i i d to include Right to propose the holding of meetings an agenda items ahead of the scheduled Annual and Special Shareholders’ Meeting; - E Right to nominate candidates to the Board of Directors; > Nomination process; and 4 * Voting procedures that would govern the Annual an Special Shareholders’ Meeting. The right to propose the holding of meetings and items for inclusion in the agenda is given to all shareholders, including minority and foreign shareholders. However, to prevent the abuse of this right, companies Tay require that the proposal be made by shareholders holding a specified percentage of shares or voting rights. On the other hand, to ensure that minority shareholders are not effectively prevented from exercising this right, the degree of ownership concentration is considered in determining the threshold. Further, all shareholders must be given the opportunity to nominate candidates to the Board of Directors in accordance with the existing laws. The procedures of the nomination process are expected to be discussed clearly by the Board, The company is encouraged to fully and promptly disclose all information regarding the experience and background of the candidates to enable the shareholders to study and conduct their own background check as to the candidates’ qualification and credibility. . Shareholders are also encouraged to participate when given sufficient information prior to voting on fundamental corporate changes stich’ as: (1) amendments to the Articles of Incorporation and By-Laws of the company; (2) the authorization on the increase -in authorized capital stock; and (3) extraordinary transactions, including the transfer of all or substantially all assets that in effect result in the sale of the company. In addition, the disclosure and clear explanation of the voting procedures, as well as removal of excessive or unnecessary costs and other administrative impediments, allow for the effective exercise of the shareholders’ voting rights. Poll Voting is highly encouraged as opposed to the show of hands. Proxy Voting is also a good practice, including the electronic distribution of proxy materials. The related shareholders’ rights and relevant company policies should » be contained in the Manual on Corporate Governance,—_— * Code of Corporate Governance, Continued 8S Recommendation 13,2 es should encourage active shareholder participation by sending he Notice of Annual and Special Shareholders" Meeting with sufficient and relevant information at least 28 days before the mecting. Explanation Required information in the Notice include, among others, the date, location, meeting agenda and its rationale and explanation, and details of issues to be deliberated on and approved or ratified at the meeting. Sending the Notice in a timely manner allows sharcholders to plan their participation in the meetings. It is good. practice to have the Notice sent to all shareholders at least 28 days before the meeting and posted on the company website. Recommendation 13.3 “The Board should encourage active shareholder participation by making the result of the votes taken during the most recent Annual or Special Shareholders’ Meeting publicly available the next working day. In addition, the Minutes of the Annual and Special Shareholders’ Meeting Should be available on the company website within five business days from the end of the meeting. Explanation pusclosed Voting results include a breakdown of the approving and dissenting votes on the matters raised during the Annual or Special Stockholders’ Meeting. When a substantial number of votes have been cast against a proposal made by the eompany, it may make an analysis of the reasons ro the same and consider having a dialogue with its shareholders. “The Minutes of Meeting include the following matters: (1) A description ‘of the voting and the vote tabulation procedures used; (2) they opportunity given to shareholders to ask questions, as well as a record of the questions and the answers receiveds (3) the matters discussed and the resolutions reached; (4) a record of the voting results for each agenda item; (5) a list of the directors, officers and shareholders who attended ‘and (6) dissenting opinion on any agenda item that is the meetings i i P ficant in the discussion process. considered signi86 Chapter 4 : = Recommendation 13.4 n of a shareholder, an te disputes in an included in the The Board should make available, at the option alternative dispute mechanism to resolve intra-corpora! amicable and effective manner. This should be company*s Manual on Corporate Governance. Explanation It is important for the shareholders to be well-informed of the company’s processes and procedures when seeking to redress the violation of their rights. Putting in place proper safeguards ensures suitable remedies for the infringement of shareholders’ rights and prevents excessive litigation. The company may also consider adopting in its Manual on Corporate Governance established Alternative Dispute Resolution (ADR) procedures. Recommendation 13.5 The Board should establish an Investor Relations Office (IRO) to ensure constant engagement with its shareholders. The IRO should be present at every shareholders’ meeting. Explanation Setting up an avenue to receive feedback, complaints and queries from shareholders assure their active participation with regard to activities and policies of the company. The IRO has a designated’ investor relations officer, email address and telephone number. Further, creating an Investor Relations Program ensures that all information regarding the activities of the company are properly and timelh i ee. ‘ ely communicated toSEC Code of Corporate Governance, Continued _87 DUTIES TO STAKEHOLDERS 14. RESPECTING RIGHTS OF STAKEHOLDERS AND EFFECTIVE SS FOR VIOLATION OF STAKEHOLDER’S. RIGHTS Principle The rights of stakeholders established by Inw, by contractual relations and through voluntary commitments must be respected. Where stakeholders’ rights and/or interests are at stake, stakeholders should have the opportunity to obtain prompt effective redress for the violation of their rights. Recommendation 14.1 ‘The Board should identify the company’s various stakeholders and promote cooperation between them and the company’ in creating wealth, growth and sustainability. Explanation Stakeholders in corporate governance include, but are not limited to. customers, employees, suppliers, shareholders, investors, creditors, the community the company operates in, society, the government, regulators, competitors, external auditors, etc. In formulating the company’s strategic and operational decisions affecting its wealth, growth and sustainability, due consideration is given to those who have an interest in the company and are directly affected by its operations. Recommendation 14.2 sald establish clear policies’ and programs to provide a The Board sho : he fair treatment and protection of stakeholders. mechanism on tl Explanation When stakeholders’ interests are not legislated, companies” nts ensure the protection of the stakeholders’ rights. yolunterypany's Code of Conduct ideally includes provisions on the Tempany's policies and procedures on dealing with various comp anjers., "The company's stakeholders. include its customers In instances whe voluntary commitmer88 Chapter 4 ity in which it operates. e community In which it a ls I as clear, timely and resource providers, creditors Iders ensure their fair Fair, professional and objective dealings as iat regular communication with the various stakehol treatment and better protection of their rights. Recommendation 14.3 rk and process that allow rent framewol 4 The Board should adopt a transpat and to obtain redress for stakeholders to communicate with the company the violation of their rights. Explanation The company’s stakeholders play a role in its growth and long-term viability. As such, it is crucial for the company to maintain open and easy communication with its stakeholders. This can be done through stakeholder engagement touchpoints in the company, such as the Investor Relations Office, Office of the Corporate Secretary, Customer Relations Office, and Corporate Communications Group. 15. ENCOURAGING EMPLOYEES’ PARTICIPATION Principle A mechanism for employee participation should be developed to create a symbiotic environment, realize the company’s goals and participate in its corporate governance processes. Recommendation 15.1 The Board should establish policies, programs and procedures that encourage employees to actively participate in the realization of the company’s goals and in its governance. Explanation The establishment of policies and 7 t ie Programs cov following: (1) health, safety and welfare; (2) training _ and (3) reward/compensation for employ perform better and motivates them to tak ‘ a take a more dynami i aed . mi e corporation. Active participation is further fostered ‘ition theese ie pan cover among others, the (2) training and development;SEC Code of Corporate Governance, Continued 99 recognizes the contribution. in cert firm-specific skills of its employees and their potential ain key decision ny Bovernance, The employees’ viewpoint in throigh wae ets May also be considered in governance processes Councils or employee representation in the board. Recommendation 15.2 e ean should Set the tone and make a stand against corrupt practices by adopting an anti-corruption policy and program in its Code of Conduct. Further, the Board should disseminate the policy and program to employees across the organization through trainings to embed them in the company’s culture. Explanation The adoption of an anti-corruption policy and program endeavors to mitigate corrupt practices such as, but not limited to, bribery, fraud, extortion, collusion, conflict of interest and money laundering. This encourages employees to report corrupt practices and outlines procedures on how to combat, resist and stop these corrupt practices. Anti-corruption programs are more effective when the Board sets the tone and leads the company in their execution. Recommendation 15.3 - The Board should establish a suitable framework for whistleblowing that allows employees to freely communicate their’ concerns about illegal or unethical practices, without fear of retaliation and to have direct access to an independent member of the Board or a unit created to handle whistleblowing concerns, The Board should be conscientious in establishing the framework, as well as in supervising and ensuring its enforcement. Explanation A suitable whistleblowing framework sets up the procedures and safe- harbors for complaints of employees, either personally or through their representative bodies, concerning illegal and unethical behavior. One essential aspect of the framework is the inclusion of. safeguards to secure the informer and to ensure protection from nfidentiality of a p.,proteeut slistich. Further, part of the framework is granting individuals or90 Chapter 4 o _ sik 5 ee access to either an independent whistle blowing concerns. nan to deal with complaints il facilities to receive representative bodies confidential direct director or a unit designed to deal with Companies may opt to establish an ombudsm and/or established confidential phone and e-ma! allegations. 16. ENCOURAGING SUSTAINABILITY AND SOCIAL . RESPONSIBILITY Principle The company sliould be socially responsible in all its dealings with the communities where it operates. It should ensure that its interactions serve its environment and stakeholders in a positive and progressive manner that is fully supportive of its comprehensive and balanced development. Recommendation 16.1 The company should recognize and place an importance on the interdependence between business and society, and promote a mutually beneficial relationship that allows the company to grow its business, while contributing to the advancement of the society where it operates. Explanation The-company’s value chain consists of inputs to the production process, the production process itself and the resulting output. Sustainable development means that the company not only complies with existing regulations, but also voluntarily employs value chain processes. that takes into consideration economic, environmental, social and governance issues and concerns. In considering sustainability concerns, the company plays an indispensable role alongside the governmene ana civil society in contributing solutions to complex global challenges like ‘poverty, inequality, unemployment and climate change. .SEC Code of Corporate Governance, Continued "91 REVIEW QUESTIONS Questions lh 10. Assume that management had determined that its organization’s audit committee is not effective. How do the weaknesses in audit committee affect management’s evaluation of internal control over financial reporting? Would an ineffective audit committee constitute a material weakness in internal control over financial reporting? State the rationale for your response. Why is there @ need for a corporation to maintain a comprehensive and cost-efficient communication channels to shareholders and other investors? - What is the objective of the company in having a, strong and effective’ internal control system? What is the purpose of having an independent internal audit function in a publicly-listed corporation? Give at least four (4) responsibilities of the Chief Audit Executive. Enumerate the activities of the Risk Management department in a publicly-listed corporation. To what may the shareholders’ rights relate? How may participation of employee in corporate governance be encouraged? reporting includes voluntary corporate ives, plans, and associated True or False. Sustainabi disclosures about sustainability ini outcomes. True or False. The terms non-financial reporting, corporate social respons reporting, and mriple bottom-line reporting are each sustainability-related terms.92 Chapter 4 1 . Define the terms nonfinancial reporting, corporate social responsibility reporting, and triple bottom-line reporting. How do these terms relate to sustainability reporting? . What factors have driven the demand for sustainability reporting? . Why is there a demand for independent assurance on sustainability reporting? . In unethical for a company to provide a sustainability report, but provide no assurance on the reliability of the information contained therein?UNIT BUSINESS ETHICS Chapter 5 6 10 Introduction to Ethics Business Ethics Common Unethical Practices of Business Establishments Ethical Dilemma Advocacy Against Corruption Initiatives to Improve Business Ethics and Reduce CorruptionChapter - INTRODUCTION TO ETHICS Expected Learning Outcomes After studying the chapter, you should be able to... 1. Define Ethics, 2. Enumerate.and describe the basic characteristics and values associated with ethical behavior. 3. Appreciate why ethical behavior in personal, professional and business dealings is necessary. 4. Understand the.reasons why people act unethically. 5. Give and explain the categories of ethical principles . 6. Give and describe the ethical principles related to a) Personal ethics b) Professional ethics c) Business ethics 7. Explain why professional ethics is importa conduct should be adopted portant and why a code of LassCHAPTER 5 INTRODUCTION TO ETHICS INTRODUCTION Ethics can be defined broadly as a set of moral principles or values that govern the actions and decisions of an individual or group. While personal ethics vary from individual to individual at any point in time, most people within a society are able to agree about what is considered ethical and unethical behavior. In fact, a society passes laws that define what its citizens consider to be the more extreme forms of unethical behavior. Each of us has such a set of values, although we may or may not have considered them explicitly. Philosophers, religious organizations, and other groups have defined in various ways ideal sets of moral principles or values. Examples of prescribed sets of moral principles or values at the implementation level include laws and regulations, church doctrine, code of business ethics for professional groups such as CPAs, and codes of conduct within individual organizations. Ethies is a topic that is receiving a great deal of attention throughout our society today. This attention is an indication of both the importance of ethical behavior to maintaining a civil society, and a significant number of notable instances of unethical behavior. Much of what is considered unethical in a particular society is not specifically prohibited. So how do we know whether we are acting ethically? Who decides what standards of conduct are appropriate? Is any type of behavior “ethical” as long as it does not violate a law or a rule of one’s profession? ‘on for people to differ in their moral principles or values. Even if two on the’ ethical principles that determine ethical behavior, it is Patikety that they will agree on the relative importance of each principle. These differences result from all of our life experiences. Parents, teachers, friends and employers are known to influence our values, but so do television, team sports, Tife suecesses and failures, and thousands of other experiences. It is comm people agree96 _ Chapter 5 [CAL CHARACTERISTICS AND VALUES ASSOCIATED WITH ETHI BEHAVIOR fc iptes i istics and values The following list of ethical principles incorporates the characteristic: that most people associate with ethical behavior. Integrity . Be principled, honorable, upright, courageous and act on eonictionss ee Hl be twofaced or unscrupulous, or adopt an end-justifies-the means philosophy that ignores principle. Honesty Be truthful, sincere, forthright, straightforward, frank, candid; do not cheat, steal, lie, deceive or act deviously. Trustworthiness and Promise Keeping Be worthy of trust, keep promises, full commitments, abide by the spirit as well as the letter of an agreement; do not interpret agreements in an unreasonably technical’ or legalistic manner in order to rationalize noncompliance or create excuses and justification for breaking commitments. Loyalty (Fidelity) and Confidentiality Be faithful and loyal to family, friends, employers, client and country; do not use or disclose information learned in confidence; in a professional context, safeguard the influences and conflicts of interest. Fairness and Openness Be fair and open-minded, be willing to admit error and, where appropriate change positions and beliefs, dethonstrate a commitment to jaaieee eon treatment of individuals, and tolerance for acceptance of divin dene overreach or take advantage of another's mistakes or diversities, °° °° Caring for Others Be caring, kind, and compassionate; share, be givi : : help those in need and avoid harming others. ©" P¢ OF service to others;Introduction to Ethics 97 Respect Demonstrate respect for human dignity, privacy. and the right to self determination of all people: be courteous. prompt, and decent: provide others with the information they need to make informed decisions about their own lives: do not patronize, embarrass, or demean. Responsible Citizenship Obey just laws; if all law unjust, openly protest it; exercise all democratic rights and privileged responsibly by participation (voting and expressing informed views), social consciousness, and public service; when in a position of leadership or authority, openly respect and honor democratic processes of decision making, avoid unnecessary secrecy or concealment of information, and assure that others have all the information they need to make intelligent choices and exercise their rights. Pursuit of Excellence Pursue excellence in all matters; in meeting your personal and professional responsibilities, be diligent, reliable, industrious and committed; perform all tasks to the best of your ability, develop and maintain a high degree of competence, be well informed and well prepared; do not be content with mediocrity; do not “win at any cost Accountability Be accountable, accept responsibility for decisions, for the foreseeable consequences of actions and inactions, and for setting an example of others. Parents, teachers, employers, many professionals and public officials have a special obligation to lead by example, to safeguard and advance the integrity and reputation of their families, companies, professions and the government itself; an ethically sensitive individual avoids even the appearance of impropriety, and takes whatever actions are necessary to correct or prevent inappropriate conduct of others.98 Chapter $_ eS WHY IS ETHICAL BEHAVIOR NECESSARY? fe i ion i derly manner. It ary for a society to function in an or is the g/ve that holds a society together. What would happen if for example we could not depeid on the people we deal with to be ings, co-workers and friends all honest. If parents, teachers, employees, sibl , pedis consistently lied, it would be almost impossible for effective communication to occur. Ethical behavior is nee can be argued that ethi portant that many commonly held laws dealing with driving citizenship and respect duct, it can be held The need for ethics in society is sufficiently imy ethical values are incorporated into laws. For example, while intoxicated and selling drugs concern responsible for other. Similarly, if a company sells a défective pro accountable if harmed parties choose to sue throughout the legal system. A considerable portion of the ethical values of a society cannot be incorporated into laws because of the judgmental naturé of certain values. Looking at the honesty principle, it is practical to have laws that deal with cheating, stealing, lying, or deceiving others. It is far more difficult to establish meaningful laws that deal with many aspects of principles such as integrity, loyalty and pursuit of excellence. That does not imply that these principles dre less important for an orderly society. Business decisions influence employees, customers, suppliers and competitors, while company operations affect communities, governments and the environment. 4 WHY DO PEOPLE ACT UNETHICALLY? Most people define unethical behavior as conduct that differs from the way they believe would have been appropriate given the circumstances. Each of us decides or ourselves what we consider unethical behavior, both for ourselves and other. It is important to understand what causes people ‘to act it : decide is unethical. ee oe There are two primary reasons why people act unethically: - the person's ethical standards are different from those of soci a rent fir ' se of society as 2. the person chooses to act selfishly.Introduction to Ethics__99 In many instances, both reasons exist. Person's Ethical Standards differ from General Society Extreme examples of people whose behavior violates almost everyone's ethical standards are drug dealers, bank robbers, and larcenists. Most people who commit such acts feel no remorse when they are apprehended, because their ethical standards differ from those of society as a whole. There are also many far less extreme examples when violate our ethical values. When people cheat on their tax returns, treat other people with hostility, lie on employment applications, or perform below their competence level as employees, most of us regard that as unethical behavior. If the other person has decided that this behavior is ethical and acceptable, there is a conflict of ethical values that is unlikely to be resolved. The Person Chooses to Act Selfishly A. considerable portion of unethical behavior results from selfish behavior. The Pork Barrel Scam and the other political scandals resulted from the desire for political power and wealth; cheating on tax returns and expense reports is motivated by financial greed; performing below one’s competence and cheating on tests are typically due to laziness. In each case, the person knows that the behavior is inappropriate, but chooses to do it anyway because of the personal sacrifice needed to wet ethically. CATEGORIES OF ETHICAL PRINCIPLES Principles of Personal Ethics include among others B Respect for the right of others Concem for the right of others Concem for the well-being on welfare of others justice, fairness Benevolence, trustworthiness, honesty Compliance with the law100 Chapter 5 Professional Ethics include among others Integrity, impartiality, objectivity ¢ Professional competence © Confidentiality * Professional behavior * Avoidance of potential or apparent conflict of interest Business Ethics include among others © Fair competition * Global as well as domestic justice © Social responsibility © Concern for environment The focus of this book is on Business Ethics. The Need for Professional Ethics To understand the importance of a Code of Ethics to professionals, one must understand the nature of a profession as opposed to other vacation. There is no universally accepted definition of what constitutes a profession; yet, for generations, certain types of activities have been recognized as professions while others have not. Medicine, law, engineering, architecture and theology are examples of disciplines long accorded professional status. Public accounting is relatively new as far as the ranking of the professions is concerned but it has achieved widespread recognition in recent decades. All the recognized professions have several common characteristics. The most important of these characteristics are: (1) a responsibility to serve the public (2) a complex body of knowledge (3) standards of admission to the profession (4) aneed for public confidenceIntroduction to Ethics 101 Careless a Cartes ork or lack of integrity of a professional may la! the public to.0 ‘confidence ‘of the cae entire profession. All’ professionals must have public different professi Public to be successful. Consequently, the members of the ions act in unison by deriving their respective code of conduct. Code of Good Governance for the Profession in the Philippines (E.0. No. 220, June 23, 2003) This Code This Codes adopted by the Professional Roglaten Commission (PRC) ard te 12 Professional perform their tasks, While ch environment of good governance in which all Flipino professionals shall ‘of ethics, itis generall profession may adopt and enforce is own cade of good governance and code ‘which covers the eal eee, tee gavel ‘commonality among the various codes. This Code ; wn ; wrhesoice ota CMA tinct tie aetrn, professions could be used by all General Principle of Professional Conduct Professionals are required not only o have an ethical commitment, a i . . a personal resolve to act ‘athically, but also hare crt atic evarenes ee ebie compelney_ Ei axaness refers to the ability 10 disoem i rong, whi ‘competency jins to the ability to in sound moral reasoni ‘and consider carefully the apeaioeo onus cae. oe ° oi ‘Specific Principle of Professional Conduct 4. Service to Others Professionals are committed to life of service to others. They protect Ife, propery, and public welfare. To serve others, they shall be prepared for heroic sactiice and genuine selflessness in carrying out their professional duties even al the expense of personal gain. 2. Integrity and Objectivity To maintain and broaden pubic confidence, professionals shall perform their responsibiliies wth the highest sense of integrity and imbued with nafonaism and spival vaues. nthe penance of any professional Servce they shal at al mes, main object, bere of coils of interes, and refrain om engaging in any sett thet would prejudice their ais to cary out their dus eticaly, They shal acid making any representation that would likely cause a reasonable person to misunderstand oro be deceived 43, Professional Competence stain level of competence is necessary, ie, knowledge, technical skis, In providing professional services, a ce In providing er xevince, Professionals shal, therfore, undertake ony those proessona satin: thal they ata ey dever wi rctessional competence. Coal this thi exress bose to keep up ca aetaowedge and tactniqus in tht fit, coninualy rprove ts, sis ‘and upgrade thir level of ‘competence and take part in alfelong ‘continuing education program. 4, Solidarity and Teamwork 1 ruture and support one organization forall ts members. Though @ deep spit of oo ee erbet Mould put the broader interest ofthe profession above one's personal ambition and cay, pugh teamwork win a cohesive professional ganze”, 6) ‘member shal effectively eo ra pecices ind pursue continuing professional development as well as deepen one's social and civic responsibil. 5, Social and Civic Responsibility i carryout ther professional duties with due consideration of the broader interest of Prleeson e aerr, oar ner-censlomployers andthe publics wih profesional cencem and in a ; gs fo sogely. As responsible Flipnocizens, they shall actively ‘a manner consistent with their respon el are tothe attainment ofthe countrys national objectives.102 Chapter 5 Every fecal dele fed world, He or she shall Every professional shall remain open to challenges of a more dynamic interconnect He fise up 10 global slandars ant maintain levels of protessonal practoes fully aned wih gobal best practices, 7. Equality of All Professions ets ali Al professionals shall treat their colleagues with respect and shall strive to be fair in their dealin another. No one group of professionals is superior or above others. All professionals aan ‘an equally important, yet distinct, service to socialy. In the eyes of the PRC, all professions are equal and, therefore, ‘every one shall reat one other professionals with respect and faimess. Examples of Code of Conduct and Ethics for Professionals are shown in: Appendix A — For Professional Teachers Appendix B —For Internal Auditors Appendix C ~ For Management Accountants Examples of Code of Business Conduct and Ethics for Private Enterprises are presented in: Appendix D ~Telecommunications Company Appendix E — Manufacturing Company Appendix F - Commercial Bank REVIEW QUESTIONS Questions Define “Ethics”. 2. What is the basic purpose of a code of ethics for a profession? 3. Name and explain the characteristics and values associated with ethical behavior. 4. Explain why ethical behavior is necessary. 5. What are some of the reasons why people act unethically? 6. Describe some the principles and or values that are related to a. Personal ethics b. Professional ethics c. Business ethics 7. Explain why ethical behavior is necessary’ in th ; i profession. ry in the practice of one’sBUSINESS ETHICS Expected Learning Outcomes After studying the chapter, you should be able to... 4. Explain what business ethics is 2. Discuss the purposes of business ethics 3. Describe the scope and impact of business ethics on a) the economy b) society c) ‘environment d) business managers 4. Explain the ethical challenges in today's world QUBBCHAPTER 6 BUSINESS ETHICS BASIC CONCEPT OF BUSINESS ETHICS Business ethics refers to standards of moral conduct, behavior and judgment in It involves making the moral and right decisions while engaging in such business activities as manufacturing and selling a product and providing a service to customers. Business ethics is an area of corporate responsibility where businesses are legally bound and socially: obligated to conduct business in an ethical manner. Business ethics is based on the personal values and standards of each person engaged in business. PURPOSES OF BUSINESS ETHICS Main Purpose The main purpose of business ethics is to help business and would-be business to determine what business practices are right and what are wrong. Hopefully, they are going to use this knowledge to guide them in making the right business decisions. Special Purpose There are other purposes which are corollary to the main purpose, These purposes include the following: 1. To make businessmen realize that they cannot employ double standards to the actions of other people and to their own actions. Nv To show businessmen that common practices which they have thought to be right because they see other businessmen doing it, are really wrong. 3. To serve as a standard or ideal upon which business conduct should be based. .Busin ae fe some country's organizations, professionals which have formulated plemented their Code of Eth the business world today does not have one universal standard code of ethics, Each man has to evaluate a situation according to his own belief. Often, because there is no code of ethics to guide them, businessmen take actions that may be wrong, Therefore, one of the specific purposes of business ethics is to assist the business world in formulating codes of conduct — personal, company and professional — which can be used as. guide in formulating business plans and strategies and in making business decisions. SCOPE AND IMPACT OF BUSINESS ETHICS Business ethics covers all conduct, behavior and judgment in business. This -includes the slightest deviation from what is right to illegal and dishonest acts that are punishable by law. It involves making the right choices while engaging in such business activities as manufacturing and selling a product or selling and rendering a service. Generally, actions that are not forbidden by law are ethical. In some cases, however, what is legal (not forbidden by law) may be unethical. Business ethics therefore covers even acts that may be legal but which are wrong because they violate ethical principles. Business ethics is based on the personal values and standards of each person engaged in business. Since individual values differ, what is ethical or unethical in raking. profit also varies from person to person. And here lies the problem. Trareis still no uniform standards of right and wrong from which all business may base their actions. The businessman who provides fair business competition is’ the most likely to observe the business ethical rules of conduct, behavior and judgment. Fair business competition means achieving success solely by offering better products, services and terms than the competitor. It is a form of business competition where success is gained by the merits of one's goods or services.106 Chapter 6 Economic Impact A business has an economic impact on society through the wages it pays to its employees, the materials that it buys from their suppliers and the prices it charges its customers. It would have a positive social impact on its employees if they are paid fair living wages and benefits. It will have a positive effect on its suppliers that they paid fairly and on time for their supplies. The effect on its customers positive if the business gives them good value for the price they pay for the products and services. Social Impact The social impact of corporate governance contributes to the ethical climate of society. If businesses offer bribes to secure work or other benefits, engage in accounting fraud or breach regulatory and legal limitations on their operations, the ethics of society suffer. In addition to a deteriorating ethical environment, such as corruption may unfairly raise the price of goods for consumers or the quality of the product or service compromised. Environmental Impact Environmental protection is a key area of business influence on society. Businesses that implement good environmental policies to use energy more efficiently, reduce waste and in general lighten their environmental footprint can reduce their internal costs and promote a positive image of their company. The environmental initiatives of a business leader often force competitors to take similar action for an increased beneficial effect‘on the environment. Impact on Business Managers The concepts and principles for the ethical conduct in business are relegated to the managers of the business enterprise. Thus, although the manager is expected to act in the best interest of the business, he cannot be expected to act in a manner that is contrary to the law or to his conscience. In particular, a manager should: * acknowledge that his role is to serve the business enterprise and the community; ¢ avoid all abuse of executive power for personal gain, advantage or prestige;Business Ethics 107 reveal the fact to his superior whenever his personal business of financial interests conflict with those df the company; be actively concerned with the difficulties and problems of subordinates, ee fairly and by example, lead them effectively, assuring to all ._ the right of reasonable access and appeal to superiors; ° recognize that his subordinates have a right to information on matter affecting them, and make provision for its prompt communication unless such communication is likely to undermine the security and efficiency of the business; © fully evaluate the likely effects on employees and the community of the business plans for the future before taking a final decision and © cooperate with his colleagues and not attempt to secure personal advantage at their expense. ETHICAL CHALLENGES IN TODAY’S WORED In an article, “Ethical Challenges in Today’s World” written by Ms. Mercedes B. Suleik published in the Business Mirror on February 13, 2018 the author expressed her insights on “Business Ethics” where an inherent conflict between ethics and the pursuit of profit is more pronounced, Cited in this article is the message of Pope Francis in his Ecumenical,’ Evangeli Gaudium “Humanity is experiencing a turning point in its history as can be seen from the advances occurring in the sciences and technology. We are in tage of knowledge and information and that this has led to new and often conymous kinds of power. We have today an economy of exclusion and inequality”. “In a system that idolizes increased profit, everything that stands in its way is ‘pushed aside. Behind this attitude lurks a rejection of ethics. vtithics has come to be viewed with derision as being counterproductive. Ethics is felt to be a threat because it condemns the manipulation and debasement of the person and that ethics leads to a call for a committed response, which is outside ofthe categories of the marketplace.”108 Chapter 6 She also quoted Pope Benedict XVI's Encyclical Caritas in Veritate "Humanity has a mission and the means to transform the world in justice and love in human relations, even in the social and economic field. Market economics must be underpinned by commitments to particular moral goods and a certain version of the human person if it is to serve than undermine humanity's common good. The economy needs rather cono? : ics in order to function correctly — not an ethics which is people- el oriented.” REVIEW QUESTIONS Questions lL 2. What does business ethics mean? What is the main objective of observing ethical behavior in business? Name the other purpose of business ethics. What is the scope of business ethics? Explain the economie impact of observing business ethics, What is the impact of business ethics to society in general? Explain how business managers could act ethically. Describe the inherent conflict between ethics and pursuit of profit.Chapter COMMON UNETHICAL PRACTICES OF BUSINESS ESTABLISHMENTS Expected Learning Outcomes After studying the chapter, you should be able to... a To familiarize yourself of the comm: i i i .on unethical practices of business establishments such as P Misrepresentation and e Over-Persuasion Describe how direct misrepresentation is committed by business firms such as a) deceptive packaging b)_misbranding or mislabeling ¢) false and misleading advertising d) adulteration e) weight understatement f)_ measurement understatement g) quantity understatement Describe how indirect misrepresentation is done by: business firms such as a) caveat emptor b) deliberate withholding of information c) passive deception pescribe how over-persuasion becomes unethical: Desoribe some unethical corporate practices of the a) board of directors by executive officers and lower level manager c) employees WussCHAPTER 7 COMMON UNETHICAL PRACTICES OF BUSINESS ESTABLISHMENTS COMMON UNETHICAL PRACTICES OF BUSINESS ESTABLISHMENTS Unethical problems in business ethics occur in many forms and types. The most common of these unethical practices of business establishments are misrepresentation and over-persuasion. Misrepresentation may be classified into two types: direct misrepresentation and indirect misrepresentation. Direct Misrepresentation is characterized by actively misrepresenting about the product or customers. This includes: Deceptive Packaging. Deceptive packaging takes many forms and is of many types. One type is the practice of placing the product in containers of exaggerated sizes and misleading shapes to give a false impression of its actual contents. An example of this type of deceptive packaging is slack-fill packaging where containers like cartons, tin cans and certain plastics are filled only up to eighty-five to ninety-five percent of their capacity. Misbranding or Mislabeling. Misbranding. is the practice of makin ig false statements on the label of a product or making its container similar to a well-known product for the purpose of deceiving the customer as to the quality and/or quantity of a product being sold. False or Misleading Advertising. Advertising serves a useful purpose if it conveys the right information. It is the principal means by which people are informed about the availability, nature and uses of old and new products, However, advertising does not always tell the "whole truthCommon Unethical Practices of Business Establishments 11N on nothing but the truth" if it greatly exaggerates the virtues ofa product and tells only half of the truth or else sings praises to its non- existent virtues. If advertising does not provide a useful service anymore to - customers, it can become the agent of misrepresentation. Examples are: a. Advertisements with pictures or statements that conyey exaggerated impression of the product’s reliability or quality. b. Advertisement that claims that the product is: the "fastest selling brand" or the "product of the year". c. Advertisements using fictitious or obsolete testimonials. Adulteration. Adulteration is the unethical practice of debasing a pure or genuine commodity by imitating or counterfeiting it, by adding something, to increase its bulk or volume, or by substituting an inferior product for a superior one for the purpose of profit or gain. It is unethical because an inferior product is passed off as a superior one. This does not meet the standard for fair service, that is achieving success by offering better service (in the form of a superior product and terms of payment) than the competitor. Weight understatement or Short weighing. In short weighit 1g, the mechanism of the weighing scale is tampered with or something is unobtrusively attached to it so that the scale registers more than the wretual weight. An example is a foot pedal with a concealed string tied to the weighing scale. The modus operandi of sellers is to use two sets of scales one which gives the correct weight and has been sealed by the Authorities and another which looks identical but registers more weight than the ‘product. Short weighing is practiced in selling products where prices depend on the weight such as SuBar, meat, fish, vegetables, fruits, nails, etc. Measurement understatement or Short measurement. In short measurement, the measuring stick oF standard is shorter than the real Tength or smaller in volume than the standard. This unethical practice is found in selling situations where the price of the product depends on its aes eiling cloth or textiles, electric cords or wires or on its length such si fn as selling rice by the sack. volume suc!112 Chapter 7 Quantity understatement or Short numbering. \n this unethical praetee the seller gives the customer less than the number asked for or pai i me Short numbering is often practiced in selling situations where the pro i being sold is in such a shape or is packed in a manner that would make counting the product difficult or inconvenient. For example, a ati who is not vigilant may receive less quantity than what he eel : when buying toilet paper, bond paper, carbon paper, paper clips, thum| tacks, matches and toothpicks which are sold by the box or package. Indirect Misrepresentation is characterized by omitting adverse or unfavorable information about the product or service. Among the most common practices involving indirect misrepresentations are caveat emptor, deliberate withholding of information and business ignorance. Caveat emptor is a practice very common among salesmen. Translated, caveat emptor means "let the buyer beware". Under this concept, the seller is not obligated to reveal any defect in the product or service he is selling. It is responsibility of the customer to determirie for himself the defects of the product. Caveat emptor is indirect misrepresentation and unethical because a seller is a witness for the goods he is selling, He testifies to its nature, features, uses and qualities. As a witness, it is his obligation to "tell the truth and nothing but the truth" about his product. What makes caveat emptor unethical is the willingness of the seller to generate profit by taking advantage of the buyer's lack of information. This is passive deception which is also lying. Deliberate Withholding of Information. Following the argument that caveat emptor is unethical, the deliberate withholding of significant information in a business transaction, is also unethical. No business transaction is fair where one of the parties does not exactly know what he is giving away or receiving in return.” Passive deception, Direct misrepresentation gives business a bad name while indirect misrepresentation or passive deception is not as obvious, it nonetheless contributes to the impression that businessmen are liars and are out to make a fast buck. Business ignorance is passive deception because the businessman is unable to provide the customer with the complete information that the latter needs to make a fair decision.Common Unethical Practices of Business Establishments 113 Over-Persuasion Pessation the protesofapealing ote mains of prospective customer dnd Recessary in the nan item of merchandise he needs. Persuasion is legitimate persuading him to get ing of goods if it is done in the interest of a buyer such as Perm eton mecee hospitalization insurance policy. However, persuasio® sas bieher ts et eaten: sf selling a product without considering the interest of following examples: |. The common instances of over-persuasion include the 1. Urging a customer to satisfy a low priority need for merchandise. 2. Payee upon intense emotional agitation to convince a person to uy. 3. Convincing a person to buy what he does not need just because he has the capacity or money to do so. CORPORATE ETHICS Unethical Practices of Corporate Management ement that involve ethical considerations may be Practices of corporate manags classified into two: practices ‘of the Board of Directors and practices of executive officers. In many cases, the practices may apply to both categories of corporate management and the only dividing line is in the financial magnitude and implications of a particular corporate management practice. Some Unethical Practices of the Board of Directors 1. Plain Graft Some of the Board of Directors help themselves to the earnings that otherwise would go other stockholders. This is done by voting for themselves and the executive officers huge per diems, large salaries, big bonuses that do not ‘commensurate to the value of their services. They can also reduce the earnings going to the other shareholders by hhases of goods and services for the company’s use at a authorizing pure’ x md ser S price higher than ormal, in consideration of a certain percentage of the purchase value OF commission accruing to them.14 Chapter 7 2. Interlocking Directorship Interlocking directorship. is often practiced by a person who holds directorial positions in two or more corporation that do business with each other. This practice may involve conflict of interest and can result to disloyal selling. Disloyal selling happens when this person is compelled to decide which of the two corporation’s interest should be protected or upheld. Thus, whatever decisions the person makes, he betrays the trust reposed on him by the shareholders of either of the two companies. 3. Insider Trading Insider trading occurs when a broker or another person with access to confidential information uses that information to trade in shares and securities of a corporation, thus giving him an unfair advantage over the other purchasers of these securities. 4. Negligence of Duty A more common failure of the members of the Board of Directors than breach of trust is neglect of duties when they fail to attend board meetings regularly. It is only in regular attendance that they can protect the rights and interests of the shareholders and their non-attendance of board meetings could result to betrayal of trust of the parties who elected them to their positions. Some Unethical Practices of Executive Officers and Lower Level Managers To the activities they are also capable of en; because of certain limits to their at a lesser extent, executive officers may also guilty of unethical practices. All unethical practices of the members of the Board of Directors discussed are gaging in though perhaps to a lesser degree tuthority. Unethical practices that are more common to executive officers and lower level managers are: 1. Claiming a vacation trip to be a business trip. The President or a Vice President reports his personal vacation in Europe or in the United States as a business trip so he can get reimbursement for his expenses including those of his family’s.2. Common Unethical Practices of Business Establishments 11S Having employees do work unrelated to the business. Executive officers and lower managers ask company employees to do personal things for them on company time such as having the company janitors water and mow their lawns, having the maintenance men do house or appliance * repairs for them, and having subordinate employees secure a license or type letters pertaining to their other businesses. Loose or ineffective controls. Managers do not provide adequate controls to remove temptation and to prevent or discourage employees from engaging in unethical practices. A manager has the moral obligation to provide the proper control atmosphere so that his subordinates will not be tempted to commit dishonest acts. A manager indirectly betrays the trust placed on him by higher executive officers if the administrative and accounting controls in his office are so weak or effective that employees are given the opportunity to misappropriate funds or engage in petty thievery. Unfair labor practices. The labor code lists the following as unfair labor practices committed by an employer on employees or a group of employees who have organized themselves into a union. a. To interfere with, restrain or coerce employees in the exercise of their right to self-organization; b. To require as a condition of employment that a person or an employee shall not join a labor organization or shall withdraw from one to Which he belongs; To contract out services or functions being performed by union members when such will interfere with, restrain or coerce employees in the exercise of their rights to self organization; d, To initiate, dominate, assist or otherwise in with the formation or administration of any labor organization, including the giving of financial or other support to it; To discriminate with regard to wages, hours of work, and other terms of conditions of employment in order to encourage or discourage membership in any labor organization. f£. To dismiss, discharge, or otherwise prejudice or discriminate, against an employee for having given or being about to give testimony under the Labor Code:116 Chapter 7 g. To violate the duty to bargain collectively a prescribed by the Labor Code; h. To pay negotiation or attorneys fees to the union or its officers or agents as part of the settlement of any issue in collective bargaining or any other dispute: i. To violate or refuse to comply with voluntary arbitration awards or decisions relating to the implementation or interpretation of a collective bar gaining agreement; j. To violate a collective bargaining agreement. Making false claims about losses to free themselves from paying the compensation and benefits provided by law. There are employers who claim non-existent losses s0 they can be exempted from paying the minimum wage and emergency-cost-of-living allowances required by law. Making employees sign documents showing that they are receiving fully what they are entitled to under the law whem in fact they are only receiving a fraction of what they are supposed to get. . Sexual Harassment. Work, education or training-related sexual harassment is committed by an employer, employee, manager, supervisor, agent of the employer, teacher, instructor, professor, coach, trainer or any other person who, having authority, influence or moral ascendency over another in a work or training or education environment, demands, requests or otherwise requires sexual favor from the other, regardless of whether the demand, request or requirement for submission is accepted or not by-the object.Common Unethical Practices of Business Establishments 7 Some Unethical Practices of Employees There are some employees who are not mindful of their moral obligations to their employers. They take advantage of their position and the trust of their employees by committing unethical practices harmful to their employers’ interest these unethical practices may be classified into conflict of interest and dishonesty. LL Conflicts of Interest A conflict of interest arises when an employee who is duty bound to protect and promote the interests of his employer violates this obligation by getting himself into a situation where his decision or actuation is influenced by what he can gain personally from it rather than what his employer can gain from it. Some common examples of conflicts of interest are: a. An employee who holds a significant interest or shares of stock of a competitor, supplier, customer or dealer favors this party to the prejudice of his employer. b. The employee accepts.cash, a gift or a lavish entertainment or a loan from a supplier, customer, competitor or contractor. In this situation, the decision or action of the employee is influenced by his being indebted for a favor or loan from a party with whom the company is doing business. He, therefore, cannot act impartially. c. The employee uses or discloses confidential company information for his or someone else's personal gain. An example is revealing his employer's formula or menu fora well-liked food to a competitor. 4. The employee engages in the same type of business as his employer. He may attend to his business only after office hours because he has somebody t0 mind it for him but itis still unethical, An example is ta auditor employed full-time in a public accounting firm but maintains his own auditing office where he works after office hours. ‘The employee uses for his own benefit « business opportunity in hich his employer has or might be expected to have an interestM18 Chapter 7 2. Dishonesty i i ith outside Business ethics is not just limited to business transactions with o parties. It also covers employee-employer relationship, se respect to an employee’s honesty as he carries out his aapigye the office. Examples of dishonest acts of employees are: a. Taking office supplies home for personal use. : b. Padding an expense account through the use of fake receipts when claiming reimbursements. c. Taking credit for another employee’s ideaCommon Unethical Practices of Business Establishments 119 REVIEW QUESTIONS Questions 1. What are the two most common types of unethical practices of business establishments as far as the products or customers are concerned? Give and explain briefly at least three ways of directly misrepresenting products. 3. How is indirect misrepresentation of a product undertaken? 4. What does “caveat emptor” mean? 5. When does over-persuasion become unethical? 6. What is “interlocking directorship” and why could it lead to unethical actions of a member of the board of directors? 7. Insider trading is considered an unethical practice. Why? 8. What are some of the unethical practices that executive officers may be guilty of? 9. Cite some unethical practices of employees to their employers. 10. Distinguish between direct misrepresentation indirect misrepresentation. Multiple Choice Questions 1. Examples of direct misrepresentation about the product include the following except a. False advertising b. Deceptive packaging c. Mislabeling d. Caveat emptor