Session 3

[Vivienne]

1. Explain the 'Rules' and 'Principles' based aproach to Corporate Governance describing the advantages of each approach.

2.Explain and explore the nature of the principal-agent relationship in the context of Corporate Governance.

[Vivienne]

1. There are two distinct approaches to CG ,these are the rules based and principles based approach.

1.1 Rules based approach

A rules based approach focuses on the box ticking rather tahn 'spirit of the law' eg the Sarbanes Oxley.it has the following characteristis

1.1.1 its a quick way of ensuring compliance
1.1.2 its easy to see that entity is complying.
1.1.3 its possible to misinterpret rules.
1.1.4 difficult to set rules to cover all situations

Advantages
1.the acceptability of behavious is clearly defined
2.compliance is likely to be prevalent
3.reduces the descretion of managers/auditors

Disadvantages
1.its ill equiped for new circumstances
2.the compliance is punitive to SMEs

1.2 Principles based approach
in the principles based approch CG is regulated by principles in codes of best practice.Compliance with principles is voluntary

Characteristics
2.1 easy to see that entity is complying
2.2 directors required to work in the entity's best interests
2.3 more flexible and therefore better able to deal with 'new' situations

Advantages
1. Can deal with new circumstances

Disadvantages

2.1 non compliance difficult to enforce

Developments of principles based CG

Cadbury 92 - General CG
Greenbury 95 - Directors perks
Hampel 98 - General CG
Smith 03 - Audit committee
Higgs 03 - NEDS
Turnbull 98 - Internal controls


2.0
An agent is a party that performs a task on behalf of another.A principle is a party that employs an agent to perform a task on their behalf.Therefore an agent is accountable to the principal

Fiduciary responsibility
an agent is a trustee of the principal and therefore
1.must act in best interest of principal
2.should not make a secret profit.

The main agency relationship in a company are Principal -Shareholder,agent-auditorsand agent-directors

some recent corporate failures have been due to
1. disfunctional principal-agent relationship
2. conflict of interest between principal and agent causes the principal -agent problem eg (Enron collapse)

CG codes and statutory regulations are intended to solve the principal agent problem

other theories that underpin agency theory are
1.directors are accountable to all stakeholders
2.goverment,employees,customers,suppliers also have a say in a company creating principal agent relationship.

[Marvellous]

1. Explain the 'Rules' and 'Principles' based aproach to Corporate Governance describing the advantages of each approach.

2.Explain and explore the nature of the principal-agent relationship in the context of Corporate Governance.

1. Rules Based Aprroach
This resulted from the high profile scandals in the US such as Worldcom, Enron.
It was passed by the Sarbanes Oaxley Act.
It adopts a checklist approach which shows a clear distinction between compliance and non-compliance

Advantages
a. It is a quick way of ensuring compliance.
b. Easy to see that entity is complying
c. Same rules apply to all
d. It has reduced suspicion that auditors,bankers and corporate officers are colluding
e. Improved standards of corporate reporting
f. It is designed to prevent problems before they arise. Eg Speed limits are there to avoid accidents

2.Principles Based Approach
Mainly in the UK. The approach is shareholder - led. Probably because of the increased number of institutional shareholders compared to the US.
a.It adopts the comply or explain. An explanation should be available for non-compliance
b.There are no hard and fast rules
c.It meets the expectations of the stakeholders
d.It applies the spirit of the law and not the letter

Advantages
a. It is flexible and is tailored to meet particular needs of the entity
b.It can deal with new situations
c.it is easy to justify breach of principles



2.Explain and explore the nature of the principal-agent relationship in the context of Corporate Governance.

The principal agent relationship is one in which one party ( the principal - shareholders) engages another party ( the agent - management) to perform some service on their behalf by delegating some decision making authority to the agent.

Principals are shareholders who cannot run management because they may have a lack of interst due to limited risk and liability, have wide ownership base or have short term motive of capital gains in stock market

Agents are employed by the principal to manage the company. they are delegated the task to run the company and more interested in their remuneration than prifit maximisation.
This usually leads to agency problems and results in agency costs.
Agency costs are incurred by the principals to monitor the work of the agents.

In an agency relationship accountability and fiduciary responsibilities are required.

Accountability is the need to explain and justify any failure to fulfil responsibility. An agent is accountable to the principal when he accepts to undertake the task given to him.

Fiduciary responsibility demands extreme loyalty and personal interests shold be subordinate to duty. the agent must not profit from their position as a fiduciary unless with the principals consent. It is highlighted by good faith, loyalty and trust

[helen0804]

THAT IS VERY USEFUL, :THANKS