Chapter 9

Governance and ethics

Introduction
Learning outcomes
Syllabus links
Assessment context
Chapter study guidance

Learning topics
1 What is governance?
2 Perspectives on corporate governance
3 Stakeholders’ governance needs
4 Symptoms of poor corporate governance
5 What is meant by ‘good practice’ in corporate governance?
6 The effect of types of financial system on governance
7 Governance structures
8 Ethics, business ethics and an ethical culture
Summary
Further question practice
Technical references
Self-test questions
Answers to Interactive questions
Answers to Self-test questions
 Introduction

Learning outcomes
• State the reasons why governance is needed and identify the role that governance plays in the
management of a business
• Identify the key stakeholders and their governance needs for a particular business
• Specify how differences in legal systems and in national and business cultures affect corporate
governance
• Specify the nature of ethics, business ethics, sustainability and corporate responsibility
• Specify the policies and procedures a business should implement in order to promote an ethical
culture
Specific syllabus references are: 4c, 4d, 4f, 4h, 4i
9

Syllabus links
Governance is developed further as a topic in Audit and Assurance and Financial Accounting and
Reporting at the Professional level, and at the Advanced level. Ethics are a continuing theme in all
assessments.
9

Assessment context
Questions on governance and ethics will be set in the assessment in either MCQ or multiple
response format. They will be either straight tests of knowledge or applications of knowledge to a
scenario.
9

Chapter study guidance

Use this schedule and your study timetable to plan the dates on which you will complete your study
of this chapter.

Topic Practical significance Study approach Exam approach Interactive

questions

1–4 Governance, Approach Questions on IQ1: Corporate

stakeholders’ needs Read through governance and ethics governance is a
and poor sections 1 to 4 quickly are almost certain to useful question
governance and then again more appear in your exam. to test your
Governance and slowly, making sure Questions are likely to understanding
ethics have become you understand the be set in a scenario of the meaning
major issues in idea that there is a context, though of corporate
recent years and fundamental tension knowledge-type governance.
ones which have a between questions are also
direct impact on shareholders and likely on particular
many areas in which directors that needs definitions and
professional to be addressed via principles.
accountants operate, corporate Essential points are:
especially audit and governance.
financial reporting. • agency theory:
Stop and think information and
What does the word accountability
‘governance’ mean to • perspectives on
you? How is it corporate
different to governance
‘management’? Who
governs a business – •

306 Business, Technology and Finance ICAEW 2023

Topic Practical significance Study approach Exam approach Interactive
questions

shareholders or • symptoms of poor

directors/managers? corporate
And who is it governance
governed for?

5 What is meant by Approach This section is likely to

‘good practice’ in Study section 5 very be examined using
corporate closely, learning the application type
governance? key elements of good questions relating to
Accountants are governance. Learn good governance or
required to advise the definitions knowledge-based
companies on many relating to natural question about the
areas, including capital, and definitions.
governance. You sustainability and Essential points are:
must understand the learn the UN • areas that good
importance of good sustainable practice is
governance before development goals concerned with
going on to discuss (SDGs).
the Wates Principles • key elements of
Stop and think good corporate
later in this chapter,
and the UK Are you aware of any governance
Corporate recent high profile • a business’s
Governance code in corporate failures? responsibilities in
the chapter Was the failure due to relation to natural
Corporate poor practice in capital,
governance. corporate sustainability and
governance? corporate social
responsibility.

6 The effect of types Approach Questions on this area IQ2: Risk Tests
of financial system Next, read section 6 tend to focus on: your
on governance on financial systems, • the characteristics understanding
You may come national culture and of market-based of the risk
across different legal systems, making and bank-based attitudes of a
approaches to sure you can see why financial systems. market based
corporate the importance of financial
• Hofstede’s Cultural system.
governance if you institutional dimensions and
have clients with shareholders derives their impact on
businesses outside from the nature of the governance
the UK. It is UK financial system, systems
important to and why in some
appreciate the other countries banks
reasons for the dominate
different Stop and think
approaches.
Try to analyse the UK
culture using the
table and consider if
the UK approach to
governance is what
you would expect.

7 Governance Approach This is a popular area

structures Learn the OECD for questions, which
This section deals Principles, the will tend to test your
with some aspects of distinction between knowledge of
codes other than the unitary and dual particular codes:

ICAEW 2023 9: Governance and ethics 307

 Topic Practical significance Study approach Exam approach Interactive
questions

UK code (which is board structures, and

dealt with in the the outline of the Essential points are:
chapter Corporate overall UK
governance). governance structure, • OECD Principles –
including the Wates what are the six
principles. principles?
Stop and think • unitary v dual
boards – what do
What impact would these terms mean?
each of the Wates
Principles have on the • UK legal
success of an requirements
organisation? relating to
corporate
governance
• Wates Principles

8 Ethics, business Approach There may well be IQ3: Ethical

ethics and an ethical Read very carefully questions dealing with pressures
culture section 8 on business the relevance of ethics encourages you
ICAEW members values and ethics, and in business. to think about
and students are the ways in which an Essential points are: why it may be
required to comply ethics-based culture difficult in
• ethical principles – practice for
with the ICAEW’s can be promoted. such as the Nolan
code of ethics. This businesses to
Stop and think Principles – what do always behave
code does not apply they mean?
to businesses other Could a company that ethically
than member firms adopts poor ethical • meaning of
of the ICAEW. behaviour, such as business ethics and
However, employing workers examples of what
accountants working on very low wages, are the minimum
in business have a prosper in the long acceptable
role to play in term? business ethics
ensuring that the • the meaning of
businesses they corporate
work for operate in responsibility
an ethical manger. • what is included in
a corporate code of
ethics?

Once you have worked through this guidance you are ready to attempt the further question practice
included at the end of this chapter.

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 1 What is governance?
Section overview

• Governance is the system by which an organisation is directed and controlled so that its
objectives are achieved in an acceptable and sustainable manner.
• Agency theory states that managers and directors act as shareholders’ agents when managing the
company.
• Managers and directors should reflect the interests of shareholders, not their own interests.
Historically, they were able to pursue their own interests because they had better information than
shareholders and were not held accountable to them.

Management is essentially a very practical matter: ‘getting things done’. It should not be confused
with a term that is frequently used interchangeably with management, which is governance.
Governance incorporates concepts of ethics, risk management and stakeholder protection,
extending way beyond management alone. Governance is not the same thing as managing a
business and running business operations. It is concerned with exercising overall control, to ensure
that the objectives of the company are achieved in an acceptable and sustainable manner. If a
business is properly led, directed and controlled then it should be able to get things done properly
and should be sustainable in the long term.

Interactive question 1: Corporate governance

You have probably heard a great deal about ‘good corporate governance’ in the press and maybe in
the office too. What do you think it means? Why is it an important issue?

See Answer at the end of this chapter.

1.1 Why is governance an important issue?

In getting things done, a business’s managers can lose sight of:
• whom they are seeking to benefit; and
• the fact they should not harm others.
This is often referred to as the agency problem.

1.2 Agency problem: shareholders and management

Managers of a company are there to ensure that the interests of the shareholders, who in large
companies are not usually also the managers, are looked after. Managers therefore effectively act as
the ‘agents‘ of the shareholders when managing the company, though not in the full legal sense. This
means that:
• ownership and control are separated; and
• conflicts arise between the interests of those in control of the company and those who own it
These issues are known together as agency theory or stewardship theory.
Historically, when managers ran a company in a way that suited their own interests, without due
regard to the interests of the shareholders, they often got away with it because:
• they had better information than the shareholders about what was going on; and
• they were not sufficiently accountable for their stewardship, decisions and actions

1.2.1 The importance of information

Shareholders make decisions to invest in the company’s shares, and/or to hold onto the shares,
largely on the basis of information supplied by managers in the company’s name. The value of a
shareholder’s investment can therefore be at risk from receiving inadequate information to judge
what is happening.

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1.2.2 The need for accountability
Shareholders also rely on managers to account to them for their stewardship of the company’s
resources. Through a combination of withholding information, failing to report to shareholders as
required (basically, hiding information) and making decisions that are in their own rather than the
company’s interests, managers and company directors have historically been able to avoid true
accountability to shareholders.

Professional skills focus: Applying judgement

You could potentially be asked what would be the best governance structure for a particular
organisation. All corporate governance structures try to solve the agency problem but recognise that
there may be different principals (the different stakeholders) who have different levels of influence
and power.

2 Perspectives on corporate governance

Section overview

• Corporate governance is the set of relationships between a company’s management, board,

shareholders and other stakeholders that provides the structure through which the company’s
objectives are set, attained and monitored. It specifies the distribution of rights and
responsibilities between stakeholders, and establishes rules and procedures for making decisions
about the company’s affairs.
• Three governance all emphasise shareholders but the public policy and stakeholder perspectives
place more emphasis on non-shareholders, and on the need to balance the interests of all
stakeholders.

Definitions
Corporate governance: ‘A set of relationships between a company’s management, its board, its
shareholders and other stakeholders…that provides the structure through which the objectives of
the company are set…attained…and monitored’ (OECD, 2015).
Corporate governance: ‘The system by which companies are directed and controlled’ (Cadbury
Committee, 1992).

2.1 What is corporate governance?

There are four broad perspectives on what the objectives of corporate governance should be.

2.1.1 The public policy perspective on corporate governance

Some would argue that the aim of corporate governance is to ensure that the company meets:
• the objectives of its shareholders;
• the interests of other individuals and groups with a direct ‘stake‘ in the company; and
• the interests of the public at large
South Africa’s King Report on corporate governance is South Africa’s equivalent of the UK Corporate
Governance Code. It was first published in 1994 and is now in its fourth incarnation.
King IV sets out voluntary corporate governance principles which are to be achieved, by careful
application of recommended practices.
Core aspects of the King Report are leadership, sustainability and good corporate citizenship. The
report considers all three aspects to reflect the interests of the public at large. For example,
companies with good leaders are more likely to be successful and therefore employ more people
and offer better job security. Sustainability benefits the public through reduced environmental

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 impact of business operations (such as cleaner air). Good corporate citizenship offers potentially a
multitude of benefits depending on what the business decides to do. For example, it may offer
support to local families in need, provide sponsorship to local amenities or allow staff time off to
work on charitable projects. Therefore, the report is an example of the public policy perspective on
corporate governance.
This perspective acknowledges that companies don’t act in isolation but are an integral part of
society and should therefore be accountable to current and future stakeholders.

2.1.2 The stakeholder perspective on corporate governance

Taking a narrower ‘stakeholder view’, corporate governance means a balance between economic
and social goals and between individual and communal goals. The framework of corporate
governance should therefore:
• encourage the efficient use of resources through efficient investment;
• require accountability from the company’s senior management (its board of directors) to
shareholders for the way it has managed and taken care of those resources; and
• aim to align the interests of shareholders and companies with those of other stakeholders

2.1.3 The corporate perspective on corporate governance

We normally think of the aim of a company as being to maximise the wealth of the shareholders,
provided it conforms to the rules of society (its laws and customs). This means that a company’s
senior management should balance the interests of shareholders with those of other stakeholders in
order to achieve long-term sustained value for shareholders.

2.1.4 The stewardship perspective on corporate governance

Probably the narrowest view of corporate governance is to take the approach that the law requires
directors to act in the best interests of the company when acting as ‘stewards’ of the company’s
resources. This is called the stewardship approach or perspective, and it is related most directly to
solving the agency problem outlined above.

2.2 Definitions of corporate governance

Whether a corporate, public policy or stakeholder perspective is taken, rather than the OECD’s
definition set out above, we could use the following:

Definition
Corporate governance: A structured system for the direction and control of a company that:
• specifies the distribution of rights and responsibilities between stakeholders, such as the
shareholders, the board of directors and management; and
• has established rules and procedures for making decisions about the company’s affairs

3 Stakeholders’ governance needs

Section overview

• Governance extends beyond management to take explicit account of stakeholders.

• Stakeholders’ interests can often be in conflict, and it is not enough simply to let the most
powerful (the shareholders) ‘win’.
• Stakeholders need the company’s corporate governance to ensure that: their interests and
expectations will be reflected in the company’s objectives; the scope for conflict of interests is
reduced; the company follows good practice in corporate governance and business ethics.

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 3.1 Conflicts between stakeholders’ interests
No company can exactly meet all the expectations of all its stakeholders all of the time. There is often
a conflict of interests between different stakeholder groups, with each group wanting different
things, in order to achieve incompatible objectives. In most cases the company will set itself a
strategy that at least attempts to balance these conflicting interests while acknowledging that the
interests of shareholders are dominant.
Occasionally however there will be a serious conflict of interests.

3.1.1 What are the symptoms of a serious conflict of interests?

There is no standard way in which a serious conflict of interest becomes apparent. It may become
evident by:
• financial collapse without warning, as in the case of US energy corporation Enron in 2002
• directors trying to disguise the true financial performance of the company from shareholders by
‘dressing up’ the published financial statements so shareholders cannot judge properly the
condition of their investment
• disputes over directors’ remuneration such as huge salaries, bonuses, pension schemes, share
options, golden hellos and golden goodbyes and other benefits and, in general, directors’
rewards that do not vary according to the company’s performance and the benefits obtained for
the shareholders
• decisions taken by a board of directors to satisfy their own wish for power and rewards rather than
to boost the interests of shareholders, such as recommendations on shareholders accepting
certain takeover bids and offers

3.2 Stakeholders’ governance needs

• For their interests and expectations to be reflected in the company’s objectives
• For the scope for conflicts to be reduced
• For the company to adhere to good practice in corporate governance
• For the company to adhere to good business ethics

4 Symptoms of poor corporate governance

Section overview

• There is a range of symptoms that, alone or together, may indicate poor corporate governance in
an organisation.

The following symptoms can indicate that there is poor corporate governance:
• domination of the board by a single individual or group, with other board members merely
acting as a rubber stamp
• no involvement by the board, for example meeting irregularly, failing to consider systematically
the organisation’s activities and risks, or basing decisions on inadequate information
• inadequate control function, for instance no internal audit, or a lack of adequate technical
knowledge in key roles, or a rapid turnover of staff involved in accounting or control
• lack of supervision of employees
• lack of independent scrutiny by external or internal auditors
• lack of contact with shareholders
• emphasis on short-term profitability, leading to concealment of problems or errors, or
manipulation of financial statements to achieve desired results
• misleading financial statements and information

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 Worked example: Poor corporate governance
TechPoint plc is a medium sized public company that produces a range of components used in the
manufacture of computers. The board of directors consists of Chair Max Mallory, Chief Executive
Richard Mallory, and Finance Director Linda Mallory, all of whom are siblings. There are five other
unrelated executive directors. All directors receive bonuses based on sales. The company’s sales are
made by individual salesmen and women each of whom has the authority to enter on the company’s
behalf into contracts unlimited in value without the need to refer to a superior or consult with other
departments. It is this flexibility that has enabled the company to be very profitable in past years.
However, a number of bad contracts in the current year have meant that the Finance Director has re-
classed them as ‘costs’ to maintain healthy sales and to protect the directors’ bonuses.
Requirement
What are the corporate governance issues at TechPoint plc?

Solution
The main corporate governance issues are:
• domination by a small group: all the key directors are related which gives them power over the
other executives.
• short-term view: directors’ bonuses are based on short-term sales and caused the manipulation
of accounts to achieve them.
• lack of supervision: the sales force can tie the company into large loss-making contracts without
any checks. There is no authorisation or communication with other departments which means the
company may take on contracts that it cannot fulfil. The company has been hit hard with bad
contracts in the current year.

5 What is meant by ‘good practice’ in corporate

governance?
Section overview

• Good practice in corporate governance is concerned with: risk management; ethical and
sustainable behaviour; transparency; integrity; accountability; reducing the potential for conflict;
reconciling the interests of shareholders and directors.
• Key elements in corporate governance: the board (executive and non-executive directors, and
committees); senior management; shareholders; external auditors; internal auditors.

Good practice in corporate governance is concerned with:

• risk management and reduction, and good internal controls
• ethical and sustainable pursuit of the business’s strategy in a way which safeguards against
misuse of resources, physical or intellectual and which aims at ensuring success over the long
term
• openness and transparency: disclosure of information
• integrity and probity: applying the spirit of the law as well as its letter, and being honest in all
dealings
• accountability: monitoring and judging directors’ performance based on the returns that the
company has achieved under their stewardship
• reducing the potential for conflict
• reconciling the interests of shareholders and directors as far as possible
Key elements of good corporate governance are as follows:
• the board of directors

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 – executive directors of a very high standard in terms of their decision-making and of the culture
that they create in the company
– non-executive directors (NED) who are independent of the executives yet who accept that they
have collective responsibility with the rest of the board for corporate governance
– committees of the board of directors as a whole that are properly constituted and have the
power and resources to make the decisions delegated to them by the main board.
• Senior management of high quality and able to:
– put into effect the decisions of the board; and
– ‘whistleblow‘ on the activities of the company should the need arise
• shareholders who are proactive at meetings and generally ensure that the board is acting in their
best interests and within the spirit of good corporate governance
• external auditors working on behalf of the shareholders totally independently of the directors
when reaching a conclusion as to whether the company’s financial statements show a true and fair
view
• internal auditors who are independent of the directors as far as possible, reporting to the Audit
Committee of the board or to some other committee dominated by non-executives
• corporate values and culture which are very important due to their effect on how individuals
behave (ie, do the values and standards of behaviour expected in an organisation encourage
people to behave ethically?)
• the workforce, which makes up the majority of the organisation in terms of individuals, is highly
important in terms of fulfilling the objectives of the organisation’s corporate governance policies.
It is important that the policies and practices towards its workforce support its long-term success,
and part of this means organisations need to engage with their employees. However, it is equally
important that employees are able to raise concerns they have (not least because this could help
to alert management to potential ethical problems within an organisation.)

5.1 Natural capital, sustainability and corporate responsibility

Throughout this workbook, the importance of sustainability and working to eliminate climate change
has been discussed. Good corporate governance also implies taking account of wider areas of
corporate responsibility, such as its impact and dependency on the natural environment, how far its
strategy is sustainable in terms of the world’s resources in the long term, its management of its
human resources, how well it manages risk, the extent of its charitable support, and how far it goes
beyond complying with just the minimum standards required by laws and regulations.
The use by organisations of natural capital (for example fossil fuels, air, water, plants, trees and
animals) is increasingly under public scrutiny as more and more people become concerned about
the impact of humans on the planet.

Definitions
Natural capital: The stock of renewable and non-renewable natural resources that combine to yield a
flow of benefits or ‘services’ to people (eg, biodiversity as plants and animals, air, water, soils,
minerals).
The flows can be ecosystem services or abiotic services; which provide value to business and to
society.
Natural capital is one of the capitals included in the integrated reporting framework that was
discussed in the chapter The finance function and financial information.
Ecosystem services: The benefits to people from ecosystems, such as timber, fibre, pollination, water
regulation, climate regulation, recreation, mental health, and others.
Abiotic service: Benefits to people that do not depend on ecological processes but arise from
fundamental geological processes and include the supply of minerals, metal, and oil and gas, as well
as geothermal heat, wind, tides and the annual seasons.
Biodiversity: Biodiversity is critical to the health and stability of natural capital as it provides resilience
to shocks like floods and droughts, and it supports fundamental processes such as the carbon and
water cycles as well as soil formation. Therefore, biodiversity is both a part of natural capital and also
underpins ecosystem services. (Natural capital coalition (2016))

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 The idea of natural capital is closely associated with sustainability and corporate responsibility.
From the introduction to sustainability in the chapter Introduction to business, we can see that
sustainability concerns the use of both of the following:
• tangible resources such as natural capital (such as raw materials) and energy; and
• intangible resources such as human/intellectual capital, and relationships with stakeholders

Definition
Corporate responsibility: Corporate responsibility is about the impact an organisation makes on
society the environment and the economy. (CIPD)

Corporate responsibility concerns the organisation’s ideas and values on how to use resources, such
as natural capital, promoting the positive impacts of their use and reducing the impact of any
negative impacts.
Corporate governance, in its widest sense, is therefore about far more than the agency problem of
motivating managers to act in the best interests of the shareholders. It is about the problem of
ensuring that in pursuing their objectives, organisations act responsibly, both in terms of their social
impact and their environmental impact. Investors and customers in particular are increasingly
expecting organisations to take these issues seriously, and organisations that fail to do this will lose
customers and find it difficult to raise finance, so will fail to achieve their financial objectives.

5.2 UN Sustainable Development Goals

The UN established 17 Sustainable Development Goals (SDGs) that aim to improve the world for
everyone. In 2015, world leaders signed up to them.
The purpose of the Goals is to focus and help governments, businesses organisations, society and all
individuals to come together and build a better future for everyone.
The overall aims of the Goals are to end poverty, fight inequality and stop climate change. The UN
Global Compact is an organisation that supports the SDGs by obtaining commitments from
businesses to meet the principles and support the Goals.
This is a list of the 17 UN SDGs:

Goal Meaning

1. No poverty End poverty in all its forms, everywhere

2. Zero hunger End hunger, achieve food security and improved nutrition,
and promote sustainable agriculture

3. Good health and wellbeing Ensure healthy lives and promote wellbeing for all at all ages

4. Quality education Ensure inclusive and equitable quality education and

promote lifelong learning opportunities for all

5. Gender equality Achieve gender equality and empower all women and girls

6. Clean water and sanitation Ensure availability and sustainable management of water
and sanitation for all

7. Affordable and clean energy Ensure access to affordable, reliable, sustainable and
modern energy for all

8. Decent work and economic Promote sustained, inclusive and sustainable economic
growth growth, full and productive employment and decent work
for all

9. Industry, innovation and Build resilient infrastructure, promote inclusive and

infrastructure sustainable industrialisation, and foster innovation

10. Reduced inequality Reduce inequality within and among countries

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 Goal Meaning

11. Sustainable cities and Make cities and human settlements inclusive, safe, resilient
communities and sustainable

12. Responsible consumption and Ensure sustainable consumption and production patterns
production

13. Climate action Take urgent action to combat climate change and its impacts

14. Life below water Conserve and sustainably use the oceans, seas and marine
resources for sustainable development

15. Life on land Protect, restore and promote sustainable use of terrestrial
ecosystems, sustainably manage forests, combat
desertification, halt and reverse land degradation and halt
biodiversity loss

16. Peace, justice and strong Promote peaceful and inclusive societies for sustainable
institutions development, provide access to justice for all and build
effective, accountable and inclusive institutions at all levels

17. Partnerships for the goals Strengthen the means of implementation and revitalise the
global partnership for sustainable development

6 The effect of types of financial system on governance

Section overview

• The type of financial system in an economy affects the type of corporate governance that prevails.
• There are two broad types of financial system: bank-based and market-based. Which one
operates in a particular economy depends on: household preference re saving; degree of
financial intermediation; balance of debt and equity in business finance.
• Which system is in place depends on: whether there is instability associated with financial
markets; how far government intervenes in and regulates the system; how effective markets as
opposed to intermediaries are at allocating resources; how far markets are limited by market
imperfections, such as transaction costs, insider dealing and asymmetric information.
• In bank-based financial systems, bank lending is the most important source of business finance,
after retained earnings, and banks and businesses are highly integrated.
• In market-based financial systems, markets are more important than banks for long-term finance.
This means that the dominant force in external finance for businesses is represented by
institutional shareholders.
• The increasing influence of institutional shareholders means that there is increasing pressure on
companies: to conduct themselves well; to respond to the requirements of active or ‘engaged’
institutional shareholders; to provide good information via financial reporting.

In the chapter Business finance, we looked at the UK financial system and its role in business finance.
We now need to determine why the type of financial system overall influences so profoundly the
approach taken to corporate governance.

6.1 Types of financial system

There are two broad types of financial system:
• bank-based systems
• market-based systems
Whether a system favours banks or the markets is determined by how the factors we saw in the
chapter Business finance are balanced, namely:

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 • how households prefer to hold their assets
• the degree of dominance of the system by financial intermediaries and therefore by indirect
investment as opposed to direct investment
• how businesses are financed, that is the balance of retained earnings, debt and equity
In turn, many of these preferences in a system are determined by its attitude to some of the
problems inherent in any system that is designed to ensure the flow of funds from savers to
borrowers:
• instability associated with financial markets
• the degree of government intervention in and regulation of the system (government activity has
become increasingly discredited)
• how effective markets as opposed to intermediaries are at allocating resources (in economic
terms, markets are perceived as being better at this)
• how far markets are limited by market imperfections, such as:
– transaction costs;
– insider trading; and
– asymmetric information.
Market imperfections are covered in the chapters The economic environment of business and
finance and External regulation of business of this Workbook.

6.2 Bank-based financial systems

We can characterise a bank-based financial system as follows:
• households prefer to bear little risk and so allocate more of their financial assets to cash and cash
equivalents ie, deposits with banks
• households have less access to investments in physical assets such as housing ie, less choice
• where households do invest in securities, this is primarily done via intermediaries such as pension
and mutual funds, so institutional shareholders are influential
• there is comparatively more government regulation, often as a result of historic financial
catastrophes
• banks are highly concentrated and integrated in terms of providing both banking (deposit-
taking) and non-banking (insurance, etc) services
• bank lending is the most important source of business finance, after retained earnings
• banks and businesses are highly integrated: banks have a long-term relationship with the
businesses they lend to, usually cemented by the bank:
– holding equity in the business as well as debt
– having equity held by the business (a ‘cross-holding‘)
– having access to detailed management information so there is less risk that their lending will be
jeopardised by undesirable activities
– being involved in the business’s strategic decisions, often by having seats on the board
– becoming actively involved if there are financial problems
• Markets are volatile and speculative because companies are dependent on bank finance and
thus have high gearing
Together these factors mean that the dominant force in external finance for businesses is
represented by banks. However, most bank-based systems are becoming increasingly market
oriented, with less regulation and a higher profile for financial markets.

Interactive question 2: Risk

In the UK households hold proportionately more of their assets in the form of equity than in many
other countries. What does this say about UK households’ attitude to risk?

See Answer at the end of this chapter.

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6.3 Market-based financial systems
We can characterise a market-based financial system as follows:
• households bear more risk and so hold proportionately more equity and proportionately fewer
deposits with banks
• households have greater access to investments in physical assets such as housing ie, more choice
• high levels of indirect investment via intermediaries such as pension and mutual funds mean that
institutional shareholders have a great deal of influence
• markets are more important than banks for long-term finance, though retained earnings remain
the most important source of funds
• they are comparatively unregulated
• banks are more fragmented with less integration of banking and non-banking services (though
this has changed to a large degree)
• banks have less close relationships with the businesses they lend to, not holding equity and not
being involved in decision making
Together these factors mean that the dominant force in external finance for businesses is
represented by institutional shareholders.

6.4 Financial intermediation and the importance of information

In both types of system financial intermediation is of increasing importance, because intermediation
is seen as the way to overcome market imperfections, especially that of asymmetric information.
While lending banks in bank-based systems have access to information about companies that is not
shared with investors in the financial markets, so too have institutional shareholders in market-based
systems historically been kept better-informed than the general public about the affairs of the
business in which the intermediary holds debt and equity.
The increasing influence of institutional shareholders means that there is increasing pressure on
companies:
• to conduct themselves well (good corporate governance);
• to respond to the requirements of institutional shareholders; and
• to provide good financial information via financial reporting

6.5 National culture and legal systems

Every nation has a different culture and therefore a different set of values and even ethics. This leads
to a difference in corporate governance approaches around the world, because of different opinions
on the meaning of ‘good governance’. The UK Corporate Governance Code is only one example of
an approach.
Research has shown that different types of culture (as categorised by Hofstede’s Cultural
Dimensions) have influenced certain aspects of corporate governance codes.
The table below summarises Hofstede’s Cultural Dimensions and how they might affect corporate
governance.

Masculinity v A masculine culture means a fact-based, aggressive or ‘hard’ decision-

Femininity making style. For corporate governance:
• the focus is on money and achievement
• diversity is less likely to be advocated (eg, may be expected that CEO
will be male)
• gender roles are more clearly defined
A feminine culture is an intuitive, consultative style. In terms of corporate
governance:
• ‘feminine’ cultures tend to favour policies on quality of life
• more balance and gender diversity in boards

Individualism v

318 Business, Technology and Finance ICAEW 2023

 Collectivism Some cultures place a high value on the performance of individuals,
others place more value on team performance. In corporate governance:
• cultures that value individualismencourage debate and expression of
ideas and therefore support a diverse mix of directors
• collectivism tries to maintain harmony and therefore is less likely to
support strong, diverse opinions

Power distance (PD) The PD dimension reflects the degree to which a person’s position and
status is valued. Cultures with a high PD score encourage bureaucracy
and respect for authority and a person’s rank in an organisation.
• They believe that power should be concentrated in a small group.
• There will be less emphasis on separating out the roles of the CEO
and chair and less need for independent non-executive directors
(NEDs).
Cultures with a low PD score encourage flatter organisational structures
and more value is placed on personal responsibility and autonomy.
• There will be more emphasis on separating the role of CEO and chair
and on the need for independent NEDs.

Long-term This relates to how different cultures view time horizons in terms of
orientation appraising business success, for example in regards to business planning
and measuring performance.
Cultures that take a short-term view will seek to reward directors for
short-term performance (such as bonuses based on annual performance)
Cultures that take long-term view will encourage rewards based on long-
term performance, such as share options that can only be exercised after
a specific period of time.

Uncertainty This dimension reflects the different attitudes to risk-taking. Cultures with
avoidance low levels of uncertainty avoidance will tolerate more risk and are not
afraid to take chances and make changes. Cultures with higher levels of
uncertainty avoidance prefer lower levels of risk and seek the protection
of rules, analysis of data and the establishment of roles and
responsibilities.
In terms of corporate governance, cultures with low uncertainty
avoidance will not seek to restrict or control risk-taking to the same
degree as cultures with high uncertainty avoidance.
Cultures with higher levels of uncertainty avoidance promote internal
controls, risk management and other rules and procedures to mitigate
business risk to an acceptable level, and to make life as predictable and
controllable as possible.

Indulgence v Highly indulgent cultures seek personal gratification of basic and natural
Restraint human drives related to enjoying life and having fun. Cultures that desire
the opposite – restraint – suppress personal gratification and place more
emphasis on regulation of people’s conduct and behaviour and
establishing social norms.
In terms of corporate governance, indulgent cultures are unlikely to
restrict personal gratification or anything that promotes it (such as
frivolous spending on corporate hospitality). Cultures that are more
restrained are more likely to control such spending.

For example, cultures categorised as being highly masculine, rather than feminine oriented are
unlikely to promote gender diversity amongst board members. However, the reverse is true in
cultures that are highly oriented towards individualism, because boards are seen to have more
legitimacy if they reflect a broader range of people. Similarly, in countries which have high ‘power
distance’ scores – with a recognition that power is concentrated in the hands of a small minority – the
rationale for separating the role of chief executive officer (CEO) and chair, and the need for

ICAEW 2023 9: Governance and ethics 319

 independent non-executive directors (NEDs) on a board, might be less apparent than in countries
with lower ‘power distance’ scores.
Legal systems also have an impact on corporate governance codes. For example, countries such as
the UK with common-law legal systems that evolve over time as legal cases are heard, often have a
different approach to corporate governance to countries with civil-law legal systems in-which the
laws are codified.

Professional skills focus: Structuring problems and solutions

You may be required to demonstrate understanding of the wider context in considering whether
proposed solutions (eg, proposed governance structures) are appropriate. Culture should always be
taken into account.

7 Governance structures
Section overview

• A governance structure is the set of legal or regulatory methods that has been put in place to
ensure good corporate governance. It may comprise both direct regulation and non-statutory
codes of practice.
• The OECD’s principles on corporate governance are: promotion of transparent and fair markets;
protection of shareholders’ rights; equitable treatment of shareholders; recognition of the rights
of shareholders; timely and accurate disclosure of information; an effective board.
• A board of directors may be unitary or have a dual (management and supervisory) structure.
• The UK’s governance structure emphasises shareholders, especially institutional shareholders:
insurance companies, pension funds, investment trusts and their investment managers.
• The UK’s governance structure incorporates: statute (the Companies Act 2006); a code of practice
(the FRC’s UK Corporate Governance Code); the FCA rules (for listed companies); and the Wates
principles.

7.1 What is a governance structure?

Definition
Governance structure: The set of legal or regulatory methods put in place in order to ensure
effective corporate governance.

There are two basic governance structures:

• statutes
• codes of practice
Different countries use different combinations of statutes and codes of practice, depending in part
on whether they have principles-based or a shareholder-led approach to governance structures.

7.2 Principles-based approach to governance structures

In most countries the approach to governance structure is determined initially by the desire to
adhere to certain principles of good corporate governance, as set out in the OECD‘s Principles of
Corporate Governance (revised in 2015).
The OECD Principles cover:
(a) Ensuring the basis for an effective corporate governance framework. This framework should
promote transparent and fair markets, and the efficient allocation of resources. It should be
consistent with the rule of law and support effective supervision and enforcement.

320 Business, Technology and Finance ICAEW 2023

 (b) The rights and equitable treatment of shareholders and key ownership functions.
(c) The company’s relationships with Institutional investors, stock markets and other intermediaries.
(d) The rights of stakeholders in corporate governance, including the importance of creating
sustainable and financially sound companies that in turn create wealth and jobs.
(e) Accurate and timely disclosure and transparency regarding financial performance and position,
ownership and governance.
(f) The responsibilities of the board to guide the company, to monitor its management and to be
accountable to shareholders.
Principle V enshrines in particular:
• The need for and status of the external audit
• The need for an effective approach to the provision of analysis or advice by analysts, brokers,
rating agencies and others, that is:
– relevant to decisions by investors; and
– free from material conflicts of interest that might compromise the integrity of their analysis or
advice

7.3 Shareholder-led approach to governance structures

In the UK in particular, greater emphasis has been placed on the role of shareholders in governance
structures. This is because they are market-based financial systems where institutional shareholders
have very high levels of investment in the shares of leading companies.
Institutional shareholders is a broad term for organisations which invest money on behalf of other
people (their beneficiaries). In the UK they comprise:
• insurance companies
• pension funds
• investment trusts
• investment managers who act as agents of the above bodies, eg, unit trusts
Good corporate governance is greatly helped when institutional shareholders have an agenda for
dialogue with boards of directors and follow that up so they can secure their own interests and those
of their beneficiaries. Where this is the case, as in the UK, determining the appropriate governance
structure is said to be a shareholder-led process rather than a principles-based one.

7.4 Possible structures for the board of directors

There are two types of structure for the board of directors as a whole:
• a unitary board is responsible for both management of the business and reporting to the
shareholders, via the financial statements and shareholder meetings. This is the basic system
under UK statute.
• a dual or supervisory board structure, as is seen in Germany for instance, with roles split between:
– the management board, with responsibility to manage the company using similar powers to
the unitary board; and
– the supervisory board: an independent separate board elected by the shareholders and the
employees, often comprising a series of committees with delegated powers. In Germany the
supervisory board has powers to:
◦ appoint and remove members of the management board;
◦ request information from members of the management board;
◦ receive formal reports on policy, financial performance, the state of the company’s affairs and
exceptional occurrences;
◦ approve or not approve the statement of profit or loss and other comprehensive income, the
statement of financial position and dividends declared;
◦ inspect books and records;
◦ perform independent reviews; and
◦ convene shareholder meetings

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7.4.1 Workers and the board
Under the UK Governance Code, boards are required to consider the interests of stakeholders,
particularly workers, when making decisions.
Effective engagement procedures are required to achieve this, and the UK Corporate Code provides
that, in order to ensure engagement with the workforce, companies should do one or more of the
following:
• appoint a director from the workforce
• establish a formal workforce advisory panel
• have a non-executive director designated to specialise in workforce issues

7.5 The governance structure of the UK

In the UK company law sets out a great many of the rules on corporate governance, especially with
regard to:
• the board of directors (a unitary board is required)
• directors’ powers and duties
• the relationship of the company with directors, such as loans to directors and the interests of
directors in company contracts
• accountability for stewardship and financial reporting via the financial statements
• rules on meetings and resolutions
Statutory provisions on corporate governance are outside the scope of the Business, Technology and
Finance syllabus.
In addition to these statutory rules, large companies (both UK and overseas companies) that have a
premium listing in the Main Market of the London Stock Exchange are regulated by the FCA’s listing
rules. They must:
• comply with the main principles of the FRC’s UK Corporate Governance Code contained in the
FCA’s Listing Rules (see the chapter Corporate governance); and
• comply with the supporting provisions of the Code; or
• explain why they have not so complied
As mentioned in the chapter The business’s finance function, the FRC has stated that boards of UK
companies have a responsibility to consider their impact on the environment, and the likely
consequences of any business decision.
Finally, the board is subject to the shareholders in general meeting as well as to laws and
regulations.

Context example: Gender pay gap

Under the Equality Act 2010 (Gender Pay Gap Information) Regulations 2017, all businesses with
over 250 employees must publish and report on the difference between the average earnings of
their male and female employees. These regulations help to demonstrate the UK’s system of
corporate governance which consists of a combination of legal and non-legal rules, regulations and
codes.
The main two sources are the non-legal Corporate Governance Code and the legal Companies Act
2006. However, the system extends beyond these two sources and includes other sources such as
the gender pay gap regulations.
One of the cornerstones of UK corporate governance is transparency. This means that business
organisations should not use rules and regulations to hide or give a misleading picture of a particular
situation. The gender pay gap regulations support transparency by forcing large organisations to
publicly share information on the average salaries of their male and female employees separately,
whereas before, publicly available salary information was a combination of the two.

We saw above that companies should display integrity and probity, and also that one of the key
governance needs of stakeholders is for the company to adhere to good business ethics. We shall
look at these points, and the related idea of an ethics-based culture in a company now, and then
return to the UK Corporate Governance Code in the chapter Corporate governance.

322 Business, Technology and Finance ICAEW 2023

7.5.1 Companies (Miscellaneous Reporting) Regulations
In 2018, the UK government introduced The Companies (Miscellaneous Reporting) Regulations.
These are aimed at larger private companies, which are not required to comply with the UK
Corporate Governance Code (because they are private). The requirements were issued in
recognition of the fact that large companies have a significant impact on the interests of many
stakeholder groups, even if they are private.
The regulations require companies to include a statement in their annual reports that discloses their
corporate governance arrangements. The regulations apply to companies that meet one or more of
the following limits:
• more than 2,000 employees globally; or
• a turnover of over £200 million globally; or
• a balance sheet total (total assets) of over £2 billion

7.5.2 Wates Principles

The Wates Principles are a voluntary code that aim to help large private companies meet the
Companies (Miscellaneous Reporting) Regulations. The code is followed using an ‘apply and
explain’ approach, whereby companies have to follow the six principles and explain how they have
done so. They were developed by a coalition of interested groups set up by the FRC including the
Institute of Directors and the Trades Union Congress and several private companies (the Coalition
group). The code consists of six principles:

Number Principle

1 Purpose and leadership An effective board develops the purpose of a company, and
ensures that its values, strategy and culture align with that
purpose.

2 Board composition A board should include an effective chair, and a balance of

skills, backgrounds, experience and knowledge, with individual
directors having sufficient capacity to make a valuable
contribution.

3 Directors’ The board and individual directors should have clear

responsibilities understanding of their accountability and responsibilities. The
board’s policies and procedures should support effective
decision-making and independent challenge.
This principle also includes the requirement to establish formal
and robust internal control systems.

4 Opportunity and risk A board should promote the long-term sustainable success of
the company by identifying opportunities to create and
preserve value, and establishing oversight for the identification
and mitigation of risks.

5 Remuneration A board should promote executive remuneration structures

aligned to the long-term sustainable success of a company,
taking into account pay and conditions elsewhere in the
company.

6 Stakeholder Directors should foster effective stakeholder relationships

relationships and aligned to the company’s purpose. The board is responsible for
engagement overseeing meaningful engagement with stakeholders,
including the workforce, and having regard to their views when
taking decisions.

The Wates Principles ‒ is a voluntary code. If companies follow the principles, it will satisfy their
requirements under the Companies (Miscellaneous Reporting) Regulations to disclose their
corporate governance requirements. A company that chooses to follow the Wates Principles should
apply the six principles, paying attention to the guidance that accompanies them. Unlike the UK
Corporate Governance code (see the chapter Corporate governance) there are no additional
provisions within the principles. The guidance is therefore less detailed than the full UK code.

ICAEW 2023 9: Governance and ethics 323

 Companies that choose not to follow the Wates Principles have no requirement to disclose non-
compliance with the code or its principles. They may still have an obligation to disclose their
corporate governance arrangements under the Companies (Miscellaneous Reporting) Regulations,
but do not need to mention if they have applied the Wates Principles or not.

Professional skills focus: Concluding, recommending and communicating

Questions may test your ability to apply technical knowledge to support your conclusions. It is
important to know who is required to follow the codes mentioned above, and be aware of the
comply or explain principle.

8 Ethics, business ethics and an ethical culture

Section overview

• Acceptable business values may include: integrity, objectivity, accountability, openness, honesty,
truth, transparency, fairness, responsibility and trust.
• Business ethics are the ethical standards that society expects of businesses.
• An ethical culture can be promoted by: ethical leadership from the board; corporate codes of
ethics; supporting policies and procedures.
• An ethical profile produced by means of an ethical audit measures the consistency of a company’s
values base.

8.1 What is an ethical culture?

Definition
Ethical culture: A business culture where the basic values and beliefs in a company encourage
people within the company to behave ethically.

Every organisation has a different set of beliefs and values, which together make up its culture, as we
saw in the chapter Managing a business. The importance of ethical values in a company’s culture is
that they underpin both policy and behaviour throughout the company, from top to bottom.

8.1.1 The ethical organisation

Organisations do not become ethical by chance; it is a conscious decision made by the owners or
directors of the business to develop an ethical culture.
Many companies are founded for ethical reasons by an entrepreneur who has specific ethical beliefs.
For example, the Body Shop was founded by an individual who was passionately against the use of
animals in testing beauty products. Such organisations often attract like-minded employees and
therefore an ethical culture develops naturally.
However, other organisations may wish to develop an ethical culture for other reasons. For example,
there may be pressure from shareholders or other stakeholders to become more ethical.
Alternatively, other organisations within an industry may be moving towards a more ethical stance
and therefore there is a competitive reason to change; or organisations may see an opportunity to
differentiate themselves from their competitors on the basis of their ethical organisation credentials
and wish to take advantage of that.
These organisations may not naturally have an ethical culture and therefore one must be developed,
promoted and communicated through the organisation.
Regardless of the reasons why the organisation wishes to have or maintain an ethical culture,
employees are expected to adhere to certain expectations. (We shall consider corporate ethical
codes later in this chapter). The starting point for the ethical culture must, however, come from
corporate values and the directors.

324 Business, Technology and Finance ICAEW 2023

 Ethical values are promoted in the company by the board of directors which should be committed
to:
• openness and transparency in decisions and use of resources;
• promoting good relationships wherever possible; and
• high standards in their own personal behaviour, especially preparing adequately for and
attending meetings, and being involved in decision making
Stakeholders, including customers, employees, investors, government and regulators, increasingly
exert pressure on companies about their values and their business ethics.

8.1.2 Ethical principles and values

Some of the Nolan Principles established by the Committee for Standards in Public Life are a useful
starting point for ethical values in a company as a whole:
• Integrity
• Objectivity
• Accountability
• Openness
• Honesty
The Institute of Business Ethics lists further ethical values:
• Respect
• Transparency
• Fairness
• Responsibility
• Trust
Along with the ethical values listed above are statutory requirements of all companies:
• Equality for all
• No discrimination on any grounds
• Freedom of information

8.2 What are business ethics?

Definition
Business ethics: The application of ethical values to business behaviour and functions. Ethics goes
beyond the legal requirements for a business and is, therefore, about discretionary decisions and
behaviour guided by values. (Institute of Business Ethics, n.d.)

Acceptable business ethics may comprise as a minimum:

• paying staff decent wages and pensions
• providing good working conditions for staff
• paying suppliers in line with agreed terms
• sourcing supplies carefully
• using sustainable or renewable resources
• being open and honest with customers
The important point to note, however, is that society’s expectations, which can and do change,
mould business ethics. Expectations have an effect at three levels:
• at the overall level of ‘what is the role of business in society?’
• at the level of a specific company, and what it can do to manifest business ethics
• at the level of individuals within the company
Corporate responsibility is a related concept, which extends the importance of business ethics to the
business making a commitment to all its stakeholders.

ICAEW 2023 9: Governance and ethics 325

 Definition
Corporate responsibility: The commitment the business makes to its stakeholders to increase its
positive impacts and decrease its negative ones (Institute of Business Ethics, n.d.)

Corporate responsibility is a measure of how far a company exceeds the minimum obligations it
owes to stakeholders and society by virtue of regulations and corporate governance. In particular, it
is concerned with the company’s obligations to those stakeholders which are unprotected by
contractual or business relationships with the company, namely local communities, consumers in
general and pressure groups.

Interactive question 3: Ethical pressures

In what areas of a business would you say there were the greatest pressures not to behave ethically,
and from what source does this pressure come?

See Answer at the end of this chapter.

8.3 How can an ethical culture be promoted?

An ethical culture can be promoted by a combination of:
• ethical leadership from the board of directors;
• codes of ethics or business conduct; and
• policies and procedures to support ethical behaviour

8.3.1 Ethical leadership from the board of directors

Most of the scandals which created so much interest in corporate governance and business ethics
since the first years of this century centred on the fact that the company involved was being led by
unethical directors: it had an unethical ‘tone at the top‘. The degree of their unethical behaviour may
range from criminal dishonesty to a simple failure to accept responsibility. Such behaviour
undermines trust.
The board should provide ethical leadership to the company: it should lead by example and set an
ethical tone at the top. Boards should also set the foundations for an open culture in their
organisation. They should foster a support and reporting network so that staff feel that they are able
to raise issues, that their concerns will be heard without fear of retribution and that their contributions
are valued.
The Institute of Business Ethics identifies the following attributes and behaviours of ethical leaders:

Attributes Behaviours

Openness Be open minded and willing to learn, and encourage others to learn

Courage Be determined and direct; actively stamp out poor behaviour

Ability to listen Be aware of what is going on and know that doing the right thing is the right
thing to do

Honesty Be considerate and cautious in managing expectations

Fair mindedness Be independent and willing to challenge the status quo

In its 2016 report ‘Corporate culture and the role of boards’, the FRC made the following
observations on ethical corporate culture:

Observation Comment

Demonstrate leadership Leaders, in particular the chief executive, must embody the
desired culture, embedding this at all levels and in every aspect
of the business. Boards have a responsibility to act where
leaders do not deliver.

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 Observation Comment

Recognise the value of culture A healthy corporate culture is a valuable asset, a source of
competitive advantage and vital to the creation and protection
of long-term value. It is the board’s role to determine the
purpose of the company and ensure that the company’s values,
strategy and business model are aligned to it. Directors should
not wait for a crisis before they focus on company culture.

Be open and accountable Openness and accountability matter at every level. Good
governance means a focus on how this takes place throughout
the company and those who act on its behalf. It should be
demonstrated in the way the company conducts business and
engages with and reports to stakeholders. This involves
respecting a wide range of stakeholder interests.

Embed and integrate The values of the company need to inform the behaviours
which are expected of all employees and suppliers. Human
resources, internal audit, ethics, compliance, and risk functions
should be empowered and resourced to embed values and
assess culture effectively. Their voice in the boardroom should
be strengthened.

Assess, measure and engage Indicators and measures used should be aligned to desired
outcomes and be material to the business. The board has a
responsibility to understand behaviour throughout the
company and to challenge where they find misalignment with
values, or need better information. Boards should devote
sufficient resource to evaluating culture and consider how they
report on it.

Align values and incentives The performance management and reward system should
support and encourage behaviours consistent with the
company’s purpose, values, strategy and business model. The
board is responsible for explaining this alignment clearly to
shareholders, employees and other stakeholders.

Exercise stewardship Effective stewardship should include engagement about

culture and encourage better reporting. Investors should
challenge themselves about the behaviours they are
encouraging in companies and reflect on their own culture.

8.3.2 Corporate codes of ethics

There is no general ethical code, such as the UK Corporate Governance Code, which companies can
use as their own corporate code of ethics. Instead, each company should draw up their own code of
ethics which is suited to their own unique situation, values and culture.

Definition
Corporate code of ethics: A formalisation of principles, values, responsibilities and obligations.

Organisations have several reasons for introducing corporate codes of ethics.

• Communication: codes of ethics communicate the standard of behaviour expected of employees.
• Consistency of conduct: with the message effectively communicated, the behaviour of employees
can be standardised or made consistent across all its operations and locations. Customers,
suppliers and other stakeholders will receive similar treatment wherever they are.
• Risk reduction: standardised behaviour reduces the risk of unethical actions as employees who
are unethical will ‘stand out’ and can be dealt with. This reduces the risk of a few employees
irrevocably damaging the reputation of the organisation and the trust people have in it.
The functions of a corporate code of ethics are:

ICAEW 2023 9: Governance and ethics 327

 • to tell the world at large what the company is striving to achieve in terms of ethical conduct
• to communicate a guide for the company as a whole to follow in its dealings with third parties
• to provide guidance for individuals within the company as to how to act
• to describe what the company aims to do in the event that an employee highlights unethical
behaviour and abuse within the company
A company should have three objectives for a corporate code of ethics in mind:
• To improve behaviour
• To build the company’s reputation and the trust of stakeholders in the company
• To improve performance and build value

8.3.3 Whistleblowing and complaints systems

A key way for organisations to support ethical behaviour is by introducing (and making employees
aware of) a whistleblowing or complaints system to help identify and deter unethical behaviour. The
purpose of such systems is to enable employees to draw the organisation’s attention to
unprofessional or unethical behaviour that has occurred, or is currently occurring in the workplace.
Reporting can be facilitated in a number of ways, but a common approach is to set up an employee
helpline for employees to call if they have any concerns. Such helplines are especially useful because
they allow employees who have concerns regarding their line manager (or other senior managers
above them) to report their unethical behaviour to someone outside of their immediate managerial
hierarchy.

8.4 ICAEW members and business ethics

There is no requirement on ICAEW’s members in business to implement ICAEW’s Code of Ethics for
the business itself, nor to implement policies and procedures such as a unique code of ethics for the
business, or an ethical audit. However, members in business are encouraged by ICAEW to promote
an ethics-based culture as far as possible, and of course must apply the Code in relation to their own
conduct.
The Code recognises that the extent to which members in business will be able to encourage and
promote an ethics-based culture depends on their seniority withing the organisation. As examples,
the Code suggests members could introduce, implement and oversee:
• ethics education and training programs
• ethics and whistleblowing policies
• policies and procedures designed to prevent non-compliance with laws and regulations

8.4.1 Ethics in business functions

One of the key sources of ethical issues facing accountants is the prospect of business strategies
being proposed which conflict with ethical principles.
The table below briefly summarises some of the ways in which ethics affects different business
functions (and therefore where there is potential for conflict between ethics and business strategies).

Business function Impact of ethics

Marketing Targeting of marketing efforts

Is it ethical to target children or vulnerable people?

Operations Production processes

Should the organisation use the cheapest method of production, rather
than more expensive, but more environmentally friendly alternatives?

Procurement Sourcing of materials

Is it ethical to source meat and animal products from cheap suppliers with
low standards of animal welfare?
Should the organisation use overseas suppliers that exploit workers with
poor pay and conditions, or which pollute their local environments?

328 Business, Technology and Finance ICAEW 2023

 Business function Impact of ethics

HR Terms of employee contracts

Are zero hours contracts and low pay rates ethical?

IT Privacy and security of data

As well as a legal obligation, organisations have an ethical obligation to
collect, store and manage data in a way that is in the best interests of those
that the data concerns.

Finance Paying suppliers

Should large organisations take advantage of small suppliers by forcing
down prices, or by demanding long credit periods, as a way of improving
their cash operating cycle?
Tax strategy
Should multinational companies structure their business so that profits are
taxed in countries with low tax rates? Minimising tax costs will help to
maximise the value a company can deliver to its shareholders, but is it ‘fair’
to deprive governments of tax revenue which could help fund public
services such as healthcare and education?

Professional skills focus: Assimilating and using information

This skill includes recognising key ethical issues for accountants undertaking work in accounting and
reporting, so the information above about accountants working in business is relevant to this skill.

ICAEW 2023 9: Governance and ethics 329

Summary

Governance:
Direction and control of company

Agency problem:

Managers have better ...shareholders,

information than and who own the
are not accountable to... company

Conflicts of Corporate governance Perspectives

interest • Distribution of rights/responsibilities • Corporate
between shareholders and managers • Public policy
Stakeholders’ governance • Sets rules for procedures for making • Stakeholder
needs: decisions for the company
• Stewardship
• Interest and expectations
reflected in objectives
• Scope for conflict of
interest to be reduced
• Good practice in • Natural capital
Good practice in corporate governance
corporate governance • Sustainability
• Openness/transparency
• Good business ethics (2/2) • Corporate
• Integrity/accountability
responsibility
• Reducing potential for conflict
• Reconciling shareholders'/directors' interest

Key elements:
Unitary • Board of directors
(exec and non-exec, Which type of governance?
Dual committees) Affected by:
• Senior management
• Shareholders
• External auditors
Type of governance Type of financial National culture and
• Internal auditors structure system legal systems
• Corporate values and culture
• The workforce

OECD Shareholder- Market- Bank-

Principles led based based

Code of
Statutory
practice

UK governance structure
• Company law
• UK Corporate Governance Code
• Wates Principles

330 Business, Technology and Finance ICAEW 2023

 'How we should behave'

Business values
• Integrity • Respect
Promoted by board • Objectivity • Transparency
of directors
'ethical leadership' • Accountability • Fairness
• Openness • Responsibility
• Honesty • Trust

Business ethics
'How the company should behave'
Ethical
culture • Transparent • Trustworthy
• Open • Accepting of responsibility

Business conduct

Whistleblowing
and complaints
systems

ICAEW 2023 9: Governance and ethics 331

 Further question practice

1 Knowledge diagnostic
Before you move on to question practice, confirm you are able to answer the following questions
having studied this chapter. It not, you are advised to revisit the relevant learning from the topic
indicated.

Confirm your learning

1 Do you know the meaning of ‘governance’ and ‘agency theory’? (Topic 1)

2 Do you know the four broad perspectives on what the objectives of corporate
governance should be? (Topic 2)

3 Can you list at least five possible symptoms of poor corporate governance? (Topic 4)

4 What are the key elements of good corporate governance and what is their role in it?
(Topic 5)

5 Can you understand the meaning of natural capital, sustainability and corporate
responsibility and do you know their relevance for corporate governance? (Topic 5)

6 Do you know how the differences between bank based and market-based financial
systems? (Topic 6)

7 Do you know Hofstede’s Cultural Dimensions and can you discuss the impact of each
dimension on the approach to corporate governance? (Topic 6)

8 Do you know what is meant by a principles-based approach to corporate governance?

(Topic 7)

9 Do you know the governance structure in the UK? (Topic 7)

10 Can you list the six principles of the Wates code? (Topic 7)

11 How many of the 13 ethical principles and values listed in Topic 8 can you remember?
(Topic 8)

12 Do you know what is meant by business ethics and corporate responsibility? (Topic 8)

13 Can you list the functions of a corporate code of ethics? (Topic 8)

2 Chapter Self-test question practice

Aim to complete all self-test questions at the end of this chapter. Once completed, attempt all
questions in the Governance and ethics chapter of the Business, Technology and Finance Question
Bank. Refer back to the learning in this chapter for any questions which you did not answer correctly
or where the suggested solution has not provided sufficient explanation to answer all your queries.
Once you have attempted these questions, you can move on to the next chapter, Corporate
governance.

332 Business, Technology and Finance ICAEW 2023

Technical references

• Cadbury Committee (1992) Report of the committee on the financial aspects of corporate
governance. London, Gee.
• FRC (2018) The Wates Corporate Governance Principles for Large Private Companies. London,
FRC.
• ICAEW (2020) ICAEW Code of Ethics. London, ICAEW.
• Institute of Business Ethics (n.d.) What is business ethics. [Online]. Available from:
www.ibe.org.uk/knowledge-hub/what-is-business-ethics.html [Accessed 20 April 2021].
• OECD (2015) G20/OECD Principles of Corporate Governance. Paris, OECD Publishing.
• World Forum on Natural Capital (2018) What is natural capital? [Online]. Available from:
https://naturalcapitalforum.com/about/ [Accessed 20 April 2021].
• Report of the World Commission on Environment and Development: Our Common Future
Available from https://sustainabledevelopment.un.org/content/documents/5987our-common-
future.pdf [Accessed 20 April 2021].
• CIPD Corporate responsibility: an introduction [Online]. Available from:
https://www.cipd.co.uk/knowledge/strategy/corporate-responsibility/factsheet#gref [Accessed
20 April 2021].
• Natural Capital Coalition (2016) Natural Capital Protocol [Online]. Available from:
https://capitalscoalition.org/capitals-approach/natural-capital
protocol/?fwp_filter_tabs=training_material [Accessed 20 April 2021].
• Un.org Sustainable development goals [Online]. Available from:
https://www.un.org/sustainabledevelopment/ [Accessed 14 June 2022]

ICAEW 2023 9: Governance and ethics 333

 Self-test questions

Answer the following questions.

1 The agency problem concerns the misalignment in interests and conflicts of interest between:
A banks and financial markets
B regulators and professional bodies
C government and industry
D directors and shareholders
2 In a company with weak corporate governance managers may be able primarily to pursue their own
rather than the company’s interests because, in relation to shareholders:
A they have more information and high levels of accountability
B they have less information and high levels of accountability
C they have more information and low levels of accountability
D they have less information and low levels of accountability
3 In comparison with the corporate and the public policy perspectives on corporate governance, the
stakeholder perspective places least emphasis on:
A accountability
B alignment of interests of shareholders and other stakeholders
C good information
D efficient use of resources
4 Good practice in corporate governance requires that openness and transparency should be
supported by:
A reducing the potential for conflicts of interest
B disclosure of information
C reconciling the interests of shareholders and directors
D judging performance of directors on the basis of return on investment
5 In countries with a dual board structure, the supervisory board is elected by:
A shareholders only
B employees only
C shareholders and employees only
D shareholders, employees and members of the management board
6 Business ethics are primarily moulded by the expectations of:
A directors
B customers
C government
D society

Now go back to the Introduction and ensure that you have achieved the Learning outcomes listed for
this chapter.

334 Business, Technology and Finance ICAEW 2023

Answers to Interactive questions

Answer to Interactive question 1

Good corporate governance is more than good management and effective leadership: it is about
directing and controlling a company so that it meets the objectives that have been agreed with
stakeholders, particularly shareholders, and so that it meets the needs of users and the markets for
information, accountability and good behaviour. This should ensure that the company has a
sustainable future in the long term.

Answer to Interactive question 2

Equity is a riskier form of investment than cash and cash equivalents so it would appear that UK
households are less risk averse than households in other countries.

Answer to Interactive question 3

The pressure not to behave ethically in business mainly derives from the need to gain commercial
advantage in a fiercely competitive world. Areas where unethical behaviour often occurs are:
• procurement – bribe taking, exploitation of suppliers
• excessive client and supplier entertainment
• inflated directors’ expenses
• engaging in conflicts of interests
• disclosing or using confidential information

ICAEW 2023 9: Governance and ethics 335

 Answers to Self-test questions

1 Correct answer(s):
D directors and shareholders

2 Correct answer(s):
C they have more information and low levels of accountability

3 Correct answer(s):
C good information

4 Correct answer(s):
B disclosure of information

5 Correct answer(s):
C shareholders and employees only

6 Correct answer(s):
D society

336 Business, Technology and Finance ICAEW 2023