Essay: Corporate governance and positive accounting theory

1.0 Introduction and Purpose
The purpose of this report is to review the aspects of the corporate governance as commissioned by the chair of Australian Securities Exchange Corporate Governance Council. The report will examine what current research deduces about firm’s actions in relation to corporate governance by applying Positive accounting theory and agency relationship concepts and discuss its impact on society.
The research examined explores mechanisms which are used to avoid the agency problems with a firm. Agency theory explains the gap between the manager and the shareholders. It also explains the factors which influence the decision making of the top management. The management does not always make decision in the best interest of the Capital contributors.
The report will begin with an overview of the corporate governance introduction and its need. It will further explain the relationship between corporate governance and positive accounting theory. It then discusses how board composition is determined and what role does executive officers remuneration plays in the overall performance of the firm. Finally, overall effects of all the factors have on the corporate governance of the firms in UK.
2.0 Corporate Governance
The following sections will look at the relationship between board remuneration and its effects on firm’s performance in relation to the corporate governance and positive accounting theory concepts.
2.1 Corporate Governance and its importance
Corporate Governance is a structure designed with the procedures and process which specifies the distribution of rights and responsibilities among the organization and sets the rules for decision making (Rankin et al. 2018). There’s a need of good corporate governance in a firm to protect the interest of shareholders and the public from the biased and self-interests of the management, also to bring an end to the problems and issues derived from the gap between Capital contributors and the management (Rankin et al. 2018).
2.2 Corporate Governance and Positive accounting theory
Due to the separation between managers and the shareholders, most of the problems arise within the corporate governance (Rankin et al. 2018). Shareholders appoint managers as the agents to work in their best interests within the firm which binds the managers to act in good faith (Rankin et al. 2018). However, even though managers are expected to make decisions in the favor of maximizing company’s wealth, the personal interests of the manager derived by the incentives attached to firm’s performance can influence the decisions made which are not in favor of the Capital contributors
(Rankin et al. 2018).
Seven control mechanisms are suggested to provide incentives to managers and to reduce the agency problems between managers and shareholders (Agrawal & Knoeber 1996). Managers are monitored by the board members, but the question arises who is going to monitor the board members (Agrawal & Knoeber 1996). It is suggested in many research papers that the board members should not only have internally appointed board members but also externally appointed board members (Agrawal & Knoeber 1996). Internally appointed board members may not work in the best interests of the shareholders due to their self-interest too. The greater use of externally appointed directors will lead to more efficient internal monitoring (Agrawal & Knoeber 1996).
The seven control mechanisms tested are insider shareholdings, institutional shareholdings, shareholdings by block holders, the use of outsiders on the board of directors, debt financing, the external labor market for managers, and the market for corporate control (Agrawal & Knoeber 1996). Out of all the suggested mechanisms, four of them are used depending on the decisions made by internal decision makers of the firm whereas the other three mechanisms are used by the decisions made by outside parties (Agrawal & Knoeber 1996).
2.3 Board of Director Composition and misleading financial statements
Beasley’s (1996) research emphasizes on the “…importance of including outside directors on the board for purposes of monitoring management in acute agency settings other than those involving financial statement fraud.” In many researches it has been predicted that the firms who tend to have financial statement frauds are the firms with less proportion of outside members on board than the no-fraud firms (Beasely 1996). There is very less amount of knowledge about the board processes which includes specifically that how the activities of board are affected by distinct level of boards composition (Beasely 1996). Board tasks like types of issues, data represented to board, and meeting time checklist are handled by the directors which further contribute towards already existing knowledge (Beasely 1996). For preventing the financial reports fraud, the outcome never agrees to previous advices which supports the importance of audit committees (Beasely 1996). For better understanding of the issues linked to nature and methods specific to adult committees, a further thorough study is necessary (Beasely 1996). This type of study will help to understand the processes by which the audit committees work effectively to fulfill their oversight responsibilities of financial reporting (Beasely 1996).
“…CEO plays a large role in choosing the board of directors (Hermalin & Weisbach 1988).”
The further research in Hermalin’s and Weisbach’s paper discusses the possible components which might help in understanding the process of choosing the directors on board (Hermalin & Weisbach 1988). It emphasizes on the importance of the CEO for a firm which further leads to the selection of the members on board (Hermalin & Weisbach 1988). It is a crucial process to understand Corporate Governance and how effectively the board plays its role (Hermalin & Weisbach 1988). Due to the culture that follows within the firms at the retirement or resignation of the current CEO of a firm, the next CEO is promoted internally (Hermalin & Weisbach 1988). The selection of the next CEO is entirely based on the performance of the possible candidates within the firm (Hermalin & Weisbach 1988). However, it is argued that the selection of an internally selected CEO is due to the motive of carrying the old lobbying practices existent within the firm than because of the fact that the internally appointed candidate is already exposed to the various issues within the firm which is often referred as ‘grooming process’ (Hermalin & Weisbach 1988). The change of a CEO who has led the company for a significant period and helped in the major performance of the firm in the market can also affect the departure of internal board members (Hermalin & Weisbach 1988). If a firm isn’t performing good in the market, then the change of the CEO might question the certainty of the jobs for the current board members (Hermalin & Weisbach 1988). Due to the new CEO not ready and will need the good counselling and advices to run the firm effectively, he might not fill the vacant board positions with internal possible candidates (Hermalin & Weisbach 1988).
2.4 Top management remuneration, Board governance and firm valuation
The compensation and salary paid to the top management of the company has been of significant argument between different authors. It has been argued in many researches that CEO shouldn’t play any role in the evaluation of their own pay (Conyon & Peck 1998). As discussed earlier, the importance of outside members on the board to keep the balance within the board to receive better benefits and counselling in the functioning of a firm. It has also been suggested to appoint a remuneration committee to discuss and decide the remuneration of a firm’s CEO which is not biased and is truly independent Conyon & Peck 1998).
The members on the remuneration committee are suggested to be majority of or only non-executive directors who act in the best interests of the shareholders or the owners of the company (Conyon & Peck 1998). Adding further to the discussion above, the outside directors are believed to be more experienced in internal organizational control and monitoring the top management of the firms (Conyon & Peck 1998). However, it has been argued that the outside directors may not be completely independent if they were former part of the management (Conyon & Peck 1998). If the directors are appointed internally then there’s a high chance of board members to work in the best interests of the CEO to enhance their future career paths (Conyon & Peck 1998). It is believed that the executives’ pay, and governance are linked with each other. They are supposedly expected to work in the best interests of the shareholders in regard to their pay. The research in past is evident to believe that if there’s no remuneration committee involved in the determination of the executives’ pay, there’s an opportunity waiting for them to reward themselves with pay which is higher than their expertise and skills (Conyon & Peck 1998). It all comes back to the performance of a firm, is the executives’ pay acceptable in comparison to the firm’s performance in the market? There have been contradicting evidences in past where executives’ pay scale has been witnessed to rise continuously in relation to the firm’s downfall in the market (Conyon & Peck 1998).
The board of the company is held responsible for the governance of their firms. In a survey done by Hermalin and Weisbach (2010), the boards responsibility has been questioned. Various board members were asked about what role they play in their companies and their duties performed as the member of the board.
Shaukat and Trojanowski’s (2018) research is broadly explained considering all the major factors related with Board’s decisions and CEO’s remuneration within UK. The companies are managed and controlled by a system called corporate governance and the board of director are held accountable for management of the companies the initial responsibilities towards company’s strategic aims and providing the methods to make these strategies successful relies on managers. Whereas, the responsibilities like decision making relies upon outside directors. The approach to governance in UK and other countries which is favoured by the regulators handover the ability to choose their matrix and composition to the cooperate board when they feel appropriate in respect to time for example the chair positions and the position of CEO are combined together to make the leadership structure effective. Strengthening of board independence and cutback of duality are commonly interlinked with higher effectiveness of board oversight function. Consequently, powerful monitoring capacity is linked with superior oversight function which further results in better operating performance. The top managerial power and information asymmetry are linked to reduction in the board governance index. When the independence of board monitoring committee tends to deteriorate (specifically audit committee and remuneration), Board governance index is also affected negatively. Although, the corporate board is recognized as the ultimate internal monitor. Whereas, it also regains the position at the centre of governance reforms in UK. Some studies found that by empowering the managers decision making gets speed up with the help of duality. Whereas, other believes empowering managers results in mutual entrenchment which further contributes to weak governance and moderate performance. The people who are at CEO’s position from longer time and greater company equity ownership doesn’t fully agree with code recommendations of dividing CEO chair roles. Several research confirms that the board structure is strongly influenced by the powerful CEO’s. The monitoring capacity of boards of the specifically listed companies in UK are being strengthened by sticking to code’s voluntary recommendations, companies at some time also reacted opportunistically and mistreated the flexibility of code’s.
 
Conclusion