Governance

#. Definition of Corporate Governance (CG)

Corporate Governance refers to the systems, principles, and processes by
which companies are directed and controlled. It encompasses the
relationships among the various stakeholders involved, including
shareholders, management, the board of directors, and other stakeholders.
Good corporate governance ensures accountability, fairness, and
transparency in a company's relationship with its stakeholders.
Importance of Corporate Governance
Corporate governance is crucial for several reasons:
• Accountability: It holds management accountable to shareholders and
other stakeholders.
• Risk Management: Effective governance helps identify and mitigate
risks that could affect the company's performance.
• Trust: Good governance builds trust among investors, which can lead to
better access to capital.
• Sustainability: It promotes ethical behavior and long-term
sustainability of the company.
#. Agency Theory explains the relationship between principals (shareholders)
and agents (managers). Shareholders delegate decision-making authority to
managers but must monitor their actions to ensure they align with
shareholder interests, as managers may prioritize personal goals over
maximizing shareholder value. This potential misalignment leads to agency
costs, including expenses for monitoring, auditing, and incentivizing
managers.
#. Stewardship Theory
What It Is: Stewardship Theory suggests that managers act as stewards who
prioritize the organization’s success over personal interests. Unlike agency
theory, which assumes managers may prioritize their own gains, stewardship
theory focuses on trust, collaboration, and shared goals. It assumes that
managers are dedicated to the company’s success and will work hard to
achieve its objectives.
#. Transaction Cost Theory focuses on the costs involved in economic
exchanges, such as searching for suppliers, negotiating contracts, and
monitoring performance. It suggests that businesses aim to minimize these
"transaction costs" to operate more efficiently. When these costs are high,
companies may choose to handle activities internally (vertical integration),
while low costs often make it better to rely on external suppliers. Essentially,
this theory helps businesses decide whether to "make" products themselves
or "buy" them from others by considering all related costs.
#. Stakeholder theory argues that companies should consider the interests
of all stakeholders, not just shareholders. Stakeholders include employees,
customers, suppliers, the community, and the environment. According to this
theory, companies have a responsibility to create value for all stakeholders
and not just focus on maximizing profits. Companies that follow stakeholder
theory engage in activities like reducing environmental impact, promoting
social responsibility, and supporting local communities.
#. Resource dependence theory highlights the importance of external
resources for a company’s survival and success. Companies rely on
resources like capital, technology, and skilled employees, which they often
obtain from external parties. This theory suggests that companies should
build strong relationships with suppliers, investors, and other organizations to
secure these resources. Board members can play a crucial role in providing
access to important resources through their networks and connections,
ensuring the company remains competitive and resilient.
#. Managerial hegemony theory suggests that managers hold the real power
in a company, even more than the board of directors. This can be a concern if
managers prioritize their own interests over those of shareholders. To prevent
this, companies need strong governance mechanisms to ensure that
managers are accountable for their actions and do not misuse their power.
Governance practices like regular audits, performance evaluations, and
independent oversight can help maintain balance and prevent abuse of
power.
#. Corporate governance systems can be categorized into two main types:
insider systems and outsider systems.
An insider system is common in countries like Germany and Japan. In this
system, a small group of major shareholders, often family members or banks,
holds a significant portion of the company’s shares and has direct control
over management. This system provides stability and allows shareholders to
influence management decisions easily. However, it can also lead to a lack of
transparency and discrimination against minority shareholders.
An outsider system is more common in countries like the United States and
the United Kingdom. In this system, shareholdings are widely dispersed, and
there is a clear separation between ownership and management. Companies
in this system rely on formal governance mechanisms, such as regulatory
frameworks and external audits, to ensure accountability. This system
promotes transparency and reduces conflicts of interest but can also
increase costs and make it harder for shareholders to influence management
decisions directly.
#. Corporate Governance Elements
Corporate governance consists of various elements that can be classified into
internal and external mechanisms:
Internal Mechanisms
Internal mechanisms are tools and processes within a company to keep it
running smoothly, safely, and in the best interests of its stakeholders.
1. Board of Directors:
o A group of people who guide and oversee the company’s
management.
 o They make sure the company is working toward its goals and
acting responsibly.
2. Management Controls:
o Rules and systems inside the company to prevent mistakes or
fraud.
o Examples: Dividing responsibilities and keeping accurate financial
records.
3. Internal Audit:
o A team that checks how well the company follows its rules and
manages risks.
o They also give advice to make things better.
4. Risk Management:
o Identifies what might go wrong and plans to reduce those risks.
o For example, setting up a team to watch for and handle risks.
5. Executive Compensation:
o Pay plans for managers, like bonuses or stock options, that
encourage them to work for the company’s long-term success.
6. Ethical Codes and Policies:
o Guidelines for proper behavior, such as a company’s code of
conduct.
o Includes systems for reporting wrongdoing (like whistleblowing).

External mechanisms in corporate governance are the outside factors that

help keep companies accountable and ensure they follow the rules. These
include:
 • Regulatory Frameworks: These are laws and rules made by
governments and organizations. They set standards for how companies
should behave and make sure companies follow them by doing checks
and giving penalties when needed.
• External Auditors: These are independent professionals who check a
company’s financial records. They make sure that the company is
honest about its finances and help reduce the risk of fraud. They also
check if the company’s internal controls are working properly.
• Shareholders: These are the people who invest in the company. They
have the right to vote on important decisions, take part in meetings, and
make sure that the company’s managers are doing a good job. Some
shareholders, called activist shareholders, push for changes to improve
the company.
• Market Forces: This means competition from other companies.
Companies need to have good governance to attract investors and
customers. If a company has poor governance, it can lose trust and
damage its reputation.
• Takeover Threats: If a company is not performing well, it may face the
risk of a hostile takeover. This motivates companies to improve their
governance to avoid being taken over by others.
• Media and Public Opinion: What people see in the media and how the
public views the company can affect its behavior. If a company gets
negative publicity, it can lose customers and investors.
These mechanisms work together to make sure companies are transparent,
ethical, and responsible. They help companies build trust with their
stakeholders and operate in a fair way.
#. Agency Cost
Definition: Agency cost refers to the expenses incurred due to conflicts of
interest between the owners of a company (the shareholders) and the people
who manage it (the executives). This conflict arises because the managers
may not always act in the best interests of the shareholders.
What It Means: When shareholders hire managers to run the company, they
expect these managers to make decisions that maximize profits and
shareholder value. However, conflicts of interest may arise when the directors
prioritize their own interests over those of the shareholders. This is called the
agency problem.
Examples of Agency Costs:
1. Monitoring Costs: Expenses incurred by shareholders to monitor the
directors' actions (e.g., audit fees, costs of attending meetings).
2. Bonding Costs: Costs incurred by directors to reassure shareholders
that they are acting in the shareholders' best interest (e.g., providing
reports, disclosures).
3. Residual Loss: The loss in value that occurs when management's
decisions do not align with shareholder interests.
#. Power and Interest (Mendelow’s Matrix)

Definition: The concept of power and interest helps to map the influence of
different stakeholders in an organization. Mendelow’s Matrix is a tool that
classifies stakeholders based on their level of power (ability to influence the
company) and interest (likelihood of being concerned about the company’s
actions).

Diagram: Mendelow’s Matrix

A. Low Power, Low Interest (Monitor): These stakeholders have minimal
influence and interest in the project. They require minimal attention and can
be monitored passively.
• Examples: General public, competitors (in some cases).
B. Low Power, High Interest (Keep Informed): These stakeholders are highly
interested in the project but have limited ability to influence it. Keeping them
informed and consulted can maintain their support and gather valuable
insights.
• Examples: Local communities, environmental groups, media.
C. High Power, Low Interest (Keep Satisfied): These stakeholders have
considerable influence but are less directly involved in the project. It's crucial
to keep them informed and satisfied to avoid potential opposition.
• Examples: Banks, government agencies, industry associations.
D. High Power, High Interest (Key Players): These stakeholders hold
significant influence and are deeply concerned about the project's outcome.
They require close involvement and active management.
• Examples: Major shareholders, key customers, regulatory bodies.
This diagram helps companies understand how to prioritize their
communication and engagement strategies with different stakeholders.
#. Independent Director
Definition
An independent director is a board member who does not have any significant
financial, business, or personal ties with the company. They are selected to
bring objective judgment to the board. Their primary role is to ensure the
board makes fair and unbiased decisions that align with shareholders'
interests.
Key Characteristics of Independent Directors:
1. Financial and Personal Independence:
 o Holds less than 1% of the company's total paid-up shares.
o Has no financial or business relationships with the company or its
related entities, including sponsors and directors.
2. No Past Employment:
o Was not an executive of the company in the last two financial
years.
3. Legal and Ethical Integrity:
o Not convicted of financial defaults or crimes of moral turpitude.
4. Limited Other Engagements:
o Cannot serve as an independent director in more than five listed
companies.
5. Professional Qualifications:
o Must have experience in areas like law, business, finance, or
management.
Role of Independent Directors:
• Ensure Compliance: They ensure the company complies with financial
laws and corporate governance codes.
• Monitor Management: They provide unbiased oversight of the
management's actions.
• Protect Shareholders' Interests: They act in the best interest of
minority shareholders.
• Risk Management: They contribute valuable perspectives on risk
assessment and management.
Tenure: An independent director’s term is usually three years and can be
extended for another term.
#. Audit Committee
Definition: An audit committee is a special group within a company's board of
directors. Its main job is to oversee the company's financial reporting process,
internal controls, and external audits to ensure everything is accurate and
transparent.
Composition of the Audit Committee
• Members: The audit committee must have at least three members.
• Non-Executive Directors: All members must be non-executive
directors, meaning they do not work for the company in day-to-day
operations.
• Independent Director: At least one member must be an independent
director, which means they have no personal ties to the company that
could influence their judgment.
• Financial Literacy: All members should understand financial matters,
and at least one member must have a background in accounting or
finance.
Functions of the Audit Committee
1. Oversee Financial Reporting: The committee ensures that the financial
statements accurately reflect the company's situation and are fair to
shareholders.
2. Monitor Internal Audits: It reviews the internal audit processes to make
sure they are effective and well-resourced.
3. Oversee External Audits: The committee manages relationships with
external auditors, including appointing them, reviewing their
performance, and discussing their findings.
4. Review Compliance: It checks that the company follows all relevant
laws and regulations.
 5. Prevent Fraud: The committee establishes systems to prevent and
detect fraud within the organization.
Responsibilities
• Meeting Frequency: The audit committee must meet at least four times
a year to discuss its responsibilities and findings.
• Chairperson: The chairperson of the audit committee must be an
independent director to ensure unbiased oversight.
• Reporting Issues: The committee is responsible for reporting any
significant issues it finds to the board of directors.
In summary, the audit committee plays a critical role in ensuring that a
company's financial practices are transparent, accurate, and compliant with
laws. It helps protect the interests of shareholders by providing oversight of
financial reporting and internal controls.
#. Principal and Rule-Based Approach
Principles or Rules?
Corporate governance can follow two main approaches:
• Principles-based approach – Focuses on broad guidelines and general
principles.
• Rules-based approach – Provides strict, detailed rules that companies
must follow.
The key debate is whether governance should rely on principles (allowing
flexibility) or strict rules (ensuring uniformity).
• Principles-based approach is flexible and allows companies to adapt
governance to their needs. However, it can lead to inconsistencies if
companies interpret principles differently.
 • Rules-based approach ensures consistency but may lead to "box-
ticking," where companies follow rules without focusing on their true
purpose.

Characteristics of a Principles-Based Approach

1. Flexibility: Companies can follow the principles in a way that works

best for their business. They aren’t forced to follow strict rules.
2. Focus on Intent: The main focus is on doing the right thing based on the
principles, not just following every small detail.
3. Encourages Innovation: Companies are free to come up with creative
and new ways to meet their governance goals.
4. Justification Required: If a company decides not to follow specific
guidelines, they need to explain why and show how they are still
meeting the principles.

Example: The UK Corporate Governance Code uses this approach.

Companies either "comply" with the code or "explain" how their own
practices achieve the same goals.

Characteristics of a Rules-Based Approach

1. Strict and Clear: Companies have to follow specific rules, no

guesswork allowed.
2. Consistent for Everyone: All companies follow the same standards, so
it’s fair.
3. Less Flexible: There’s not much room for companies to adjust things to
suit their unique needs.
4. Easy to Check: Regulators can quickly spot if a company isn’t following
the rules.

Example: The Sarbanes-Oxley Act (SOX) in the US has strict, detailed

requirements that companies must meet.

Advantages of a Principles-Based Approach

1. Flexibility – Adaptable to different industries and company sizes.
 2. Encourages Best Practice – Companies focus on good governance, not
just following rules.
3. Encourages Innovation – Allows for creative governance solutions.
4. Focus on Stakeholders – Decisions often consider shareholders,
employees, and other stakeholders.

Advantages of a Rules-Based Approach

1. Clear and Consistent: Everyone knows exactly what to do, and there’s
no confusion.
2. No Misunderstandings: The rules are straightforward, so it’s hard to
misinterpret them.
3. Easy for Auditors: Regulators can quickly check if a company is
following the rules.
4. Accountability: Companies can’t easily justify bad behavior by saying,
“We didn’t know.”

#. Duty to Avoid Conflict of Interest

Directors have a big responsibility to act in the company’s best interest and
not mix their personal interests with the company’s affairs.
Key Points:
• Be Open About Personal Interests: If a director has any personal
connection (like owning shares in a company the business deals with),
they must let the company know.
• Step Back from Decisions: If a director has something to gain
personally from a decision, they shouldn’t be involved in making that
decision.
• Give Back Any Unfair Gains: If a director makes money or benefits
because of a conflict, they might have to return those benefits to the
company.
Example:
Imagine a director owns shares in a supplier bidding for a company contract.
They need to tell the board about their shares and shouldn’t vote or be
involved in choosing the supplier.
#. Role of Managing Director (MD) and Chairman
The Chairman and the Managing Director (MD) have different jobs to make
sure everything runs smoothly and fairly in a company.
Key Points:
• Separate Jobs:
o The Chairman leads the board of directors, makes sure meetings
go well, and oversees governance.
o The MD handles the daily work, like running the business and
carrying out the board’s plans.
• Non-Executive Chairperson: The Chairman shouldn’t be directly
involved in running the business. They should be more like a guide or
advisor.
• Why Separate Roles?
o It keeps one person from having too much power.
o It helps with checks and balances, so no one can misuse their
position.
o It improves transparency, making the company more trustworthy.
#. External Auditor
External auditors are independent experts who check a company’s financial
records to make sure they’re accurate and honest.
Key Responsibilities:
 • Check the Books: Auditors review financial reports to confirm there are
no mistakes or fraud.
• Stay Independent: They must remain unbiased and shouldn’t have
personal relationships with the company.
• Report to Shareholders: Their job is to ensure shareholders can trust
the company’s financial statements.
Why Independence is Important:
• Auditors shouldn’t have close ties to the company or provide extra
services (like consulting) that might make them less impartial.
• Independence ensures their review is fair and reliable.
Example:
When an external auditor checks a company’s accounts, they’re making sure
everything is accurate so shareholders can make informed decisions.
#. OECD Principles
The OECD Principles of Corporate Governance are guidelines developed by
the Organisation for Economic Co-operation and Development (OECD) to
promote good corporate governance practices worldwide. These principles
help governments and companies to improve their legal, institutional, and
regulatory frameworks for corporate governance. These principles also help
ensure that companies are fair, transparent, and accountable to their
shareholders and stakeholders. The key points include:
• Rights of Shareholders: Companies should protect the rights of
shareholders and ensure they can vote, receive dividends, and access
information.
• Equitable Treatment of Shareholders: All shareholders, including
minority and foreign shareholders, should be treated equally.
 • Role of Stakeholders: Companies should recognize the rights of other
stakeholders (such as employees, customers, and the community) and
cooperate with them.
• Disclosure and Transparency: Ensuring that companies provide
accurate and timely information to stakeholders.
• Board Responsibilities: The board of directors should guide the
company, oversee management, and be accountable to shareholders.
These principles serve as a framework for effective governance, promoting
trust and confidence among investors and stakeholders.
#. Driving Force of Corporate Governance:
The development of corporate governance has been driven by several
important factors over time. Here’s a simplified explanation of the key
reasons:
1. Internationalization and Globalization
• As businesses expand globally, investors demand better
governance practices to protect their interests.
2. Investor Concerns
• Sometimes, local and foreign investors were treated differently.
They wanted equal rights and fair rules to stop big shareholders
from having too much control.
3. Quality of Financial Reporting
• Investors lost trust in financial reports because of unclear or
dishonest practices.
• Better rules, like stopping companies from hiding debts (off-
balance sheet financing), made financial information clearer and
reduced risks for investors.
4. National Differences
 • Each country’s unique culture and values influenced how
corporate governance developed.
5. Corporate Scandals
• High-profile scandals have highlighted the need for stronger
governance codes, prompting regulatory changes to prevent
future failures.
Corporate governance was created to make businesses more honest, fair, and
trustworthy, especially as global markets grew and problems were uncovered.
#. What is Ethics?
Ethics is a set of rules or principles that guide people on what is right and
wrong. It helps individuals make decisions that are fair, honest, and respectful
to others. In business, ethics ensures that companies operate in a responsible
way by considering the impact of their actions on employees, customers, and
the community.
Example:
• Not cheating customers.
• Treating employees fairly.
• Avoiding harm to the environment.
#. What is Ethical Behavior?
Ethical behavior means acting in a way that is morally right. It involves doing
the right thing, even when it is not required by law. Ethical behavior builds
trust and respect among people and promotes a positive reputation for
businesses.
Characteristics of Ethical Behavior:
• Honesty: Telling the truth and not misleading others.
• Integrity: Doing the right thing, even when no one is watching.
 • Fairness: Treating everyone equally and without discrimination.
Example:
• A company paying its workers fairly and on time.
• A business being honest with its customers about product quality.
#. What is Behavior?
Behavior refers to how a person or group acts in different situations. It
includes actions, words, and decisions made by individuals. Behavior can be
influenced by culture, values, and personal beliefs.
Types of Behavior:
• Positive Behavior: Helping others, being honest, and following rules.
• Negative Behavior: Lying, cheating, and harming others.
Example:
• Positive behavior: An employee helping a new colleague learn the job.
• Negative behavior: An employee stealing from the company.
#. What is Corporate Social Responsibility (CSR)?
Corporate Social Responsibility (CSR) is when a company takes
responsibility for its actions and works to make a positive impact on society
and the environment. It goes beyond making profits and focuses on doing
good for the community.
Key Areas of CSR:
1. Environmental Responsibility: Reducing pollution, saving energy, and
using sustainable resources.
2. Social Responsibility: Treating employees fairly, supporting local
communities, and promoting human rights.
3. Economic Responsibility: Ensuring ethical business practices and
contributing to the economy.
Example:
• A company donating a portion of its profits to charity.
• A business reducing its carbon emissions to protect the environment.
Why CSR is Important:
• Builds a positive reputation.
• Increases customer loyalty.
• Attracts responsible investors.
#. What is Business Ethics?

Business ethics means doing the right thing in business. It is about making
sure a company treats people fairly, follows the law, and acts honestly.
Businesses with good ethics care about their workers, customers, and the
environment.

Why Business Ethics Matters:

• It helps a company build trust.

• It keeps the company out of legal trouble.
• It makes people want to work with the company.

Examples:

• A business telling the truth about its products.

• Paying employees on time and treating them with respect.
• Not polluting the environment or harming animals.

#. Why Should Managers Behave Ethically?

Managers should behave ethically because:
• Trust and Reputation: Ethical behavior builds trust with customers,
employees, and investors.
• Legal Compliance: Acting ethically helps avoid legal problems and
penalties.
 • Long-Term Success: Ethical companies often perform better in the long
run.
• Employee Morale: Ethical leadership boosts employee satisfaction and
productivity.
• Public Goodwill: The public respects and supports ethical businesses.
#. Some Effects of Ethical and Unethical Behavior.

#. Internal Control and Risk

Internal control is a process designed to ensure the efficiency and
effectiveness of operations, reliability of financial reporting, and compliance
with applicable laws and regulations. It involves everyone in an organization,
from the board to operational managers and staff.
The COSO (Committee of Sponsoring Organizations of the Treadway
Commission) framework is widely used for internal control and risk
management. Key components include:
• Internal Environment – This is the foundation of the framework,
reflecting the organization’s culture and ethical values.
• Objective Setting – Ensuring objectives align with the organization's
mission.
• Event Identification – Identifying risks that could impact the
organization.
• Risk Assessment – Analyzing risks to determine their likelihood and
impact.
• Risk Response – Determining how to address the risks (accept, avoid,
reduce, or share).
• Control Activities – Implementing policies and procedures to mitigate
risk.
• Information and Communication – Effective communication channels
are essential so that everyone understands their roles in maintaining
controls.
• Monitoring – Continuous monitoring is crucial to evaluate whether
internal controls are working effectively.
#. Economic Argument for CSR
CSR helps companies make more money and stay successful by building
trust and a good reputation. Customers are loyal to responsible businesses,
and investors prefer companies that follow ethical practices. CSR also
prevents costly problems like fines or lawsuits and encourages innovation,
making businesses more efficient. Happy employees also work better when
they feel their company does good for society.
#. Rational Argument for CSR
CSR helps companies avoid risks and future problems. By acting
responsibly, businesses can avoid strict government rules or public criticism.
CSR also protects against negative media and boycotts, keeping the
company’s reputation safe. Responsible businesses stand out from
competitors and are better prepared for future changes.
#. Moral Argument for CSR
Companies should do good because it’s the right thing to do. Businesses
benefit from society, so they should give back by treating workers fairly,
protecting the environment, and supporting social causes. Acting ethically
builds goodwill and trust from customers and employees.
#. Why is CSR Increasingly Relevant Today?
CSR is more important today because people care more about ethical
behavior and the environment. With social media, bad company actions
spread quickly, putting pressure on businesses to act responsibly. Climate
change and globalization also make CSR essential for long-term success and
public trust.
#. Growing Affluence
Wealthy people expect companies to behave well. They are ready to spend
more money on products that are good for the environment and made
ethically. Richer communities also want companies to be more honest and
responsible. This pushes businesses to follow CSR (Corporate Social
Responsibility) practices.
#. Ecological Sustainability
Companies need to protect the environment by reducing pollution and saving
resources. Businesses that ignore environmental issues can lose customers
and face penalties. On the other hand, sustainable practices save money and
improve efficiency, benefiting both the company and the planet.
#. Globalization
Globalization refers to the process by which businesses, cultures, and
economies become interconnected and interdependent on a global scale. It
involves the exchange of goods, services, information, and ideas across
international borders.
Companies today operate in many countries around the world, which makes
doing business more complicated. They must follow different laws, respect
various cultures, and understand local customs. This also means companies
have more people (stakeholders) to answer to, and their needs may
sometimes conflict.
While working globally can help companies save money by producing goods in
different countries, it also increases the risk of bad publicity if the company
doesn’t treat local communities well. With globalization, any mistake can
quickly become known worldwide.

#. Free Flow of Information

Free flow of information" in the context of CSR (Corporate Social
Responsibility) means that companies should be open and transparent about
their social and environmental impact. It's about sharing information willingly
and making it easy for people to access it. This builds trust, promotes
accountability, and allows people to make informed decisions. It's a key part
of being a responsible and sustainable business.
 Previous Mid
1. How could you differentiate the governance of companies from public
sector organizations?

2. Define Accountability' and 'Fiduciary duty'.

Accountability:
• The obligation of an agent (such as a company director) to explain and
justify their actions to stakeholders or principals. The agent must report
how resources are used and disclose any profits gained through their
position
Fiduciary Duty:
• Fiduciary Duty means someone in a trusted position must act in the
best interest of the company or person they work for. They must be
honest, avoid personal gain, and make decisions that benefit the
organization, not themselves.
3. Describe how 'Mendelow Matrix' used for managing stakeholders of
organizations.
Mendelow Matrix for Managing Stakeholders
• Mendelow’s Matrix: A tool used to map stakeholders based on their
power and interest in the organization.
o High Power, High Interest (Key Players - D): Engage directly;
their support is crucial.
o High Power, Low Interest (C): Keep satisfied; they can become
key players.
o Low Power, High Interest (B): Keep informed; they can influence
others.
o Low Power, Low Interest (A): Monitor with minimal effort.
4. Distinguish between insider systems and outsider systems of
ownership.
5. Mention the major reasons of 'Enron Scandal'.
Major Reasons for Enron Scandal in Easy English:
1. Accounting Fraud:
o Enron hid debt and inflated profits using fake companies.
2. Lack of Oversight:
o The Board failed to monitor financial activities and risky practices.
3. Conflict of Interest:
o Auditors ignored problems to keep Enron’s business.
4. Greed and Pressure:
o Executives broke rules to gain quick profits.
5. Lack of Transparency:
o Enron misled investors by hiding information.
6. Poor Culture:
o Risky, unethical behavior was encouraged.
7. Weak Regulation:
o Fraud went undetected due to poor enforcement.
6. Mention the key features of internal control systems.
Key components include:
• Internal Environment – This is the foundation of the framework,
reflecting the organization’s culture and ethical values.
• Objective Setting – Ensuring objectives align with the organization's
mission.
• Event Identification – Identifying risks that could impact the
organization.
 • Risk Assessment – Analyzing risks to determine their likelihood and
impact.
• Risk Response – Determining how to address the risks (accept, avoid,
reduce, or share).
• Control Activities – Implementing policies and procedures to mitigate
risk.
• Information and Communication – Effective communication channels
are essential so that everyone understands their roles in maintaining
controls.
• Monitoring – Continuous monitoring is crucial to evaluate whether
internal controls are working effectively.
7. Differentiate between fundamental Risk and Particular risk.
• Fundamental Risk: This type refers to risks that affect an entire market
or economy (e.g., natural disasters, economic downturns). These risks
are generally beyond individual control.
• Particular Risk: These are risks specific to an individual company or
entity (e.g., management decisions, operational failures). They can
often be managed or mitigated through internal controls.
8. What the duties that a director would perform to avoid conflict of
interest?
Directors have a big responsibility to act in the company’s best interest and
not mix their personal interests with the company’s affairs.
Key Points:
• Be Open About Personal Interests: If a director has any personal
connection (like owning shares in a company the business deals with),
they must let the company know.
 • Step Back from Decisions: If a director has something to gain
personally from a decision, they shouldn’t be involved in making that
decision.
• Give Back Any Unfair Gains: If a director makes money or benefits
because of a conflict, they might have to return those benefits to the
company.

Example:
Imagine a director owns shares in a supplier bidding for a company contract.
They need to tell the board about their shares and shouldn’t vote or be
involved in choosing the supplier.