Chapter 5

Governance and
Integrity System

Chicago Business Press Copyright © 2009 by Chicago Business Press. All rights
 LEARNING OBJECTIVE
At the end of this lecture, student should be able to understand:

• Definition of corporate governance

• Components of corporate governance
• Company Directors Code of Ethics
• Malaysian Code on Corporate
Governance
Definition of corporate governance

• Corporate mainly refers to large corporations, i.e. public listed corporations/companies (PLCs).
• ‘Governance comes from the Greek word gubernare, which means “to steer”’ (Tricker, 1984).
• Corporate governance (CG) refers to how a board of directors steers a corporation on behalf
of its shareholders.
– board of directors is an agent to the shareholders and it is their responsibilities to makse sure the
company being manage properly.

• The Malaysian Code on Corporate Governance (2000) defines CG as

‘The process and structure used to direct and manage business and affairs of the company
towards enhancing business prosperity and corporate accountability with the ultimate
objective of realizing
long term shareholder value, whilst taking into account
the interests of other stakeholders.’
it clearly stated that, eventhough the main objective is to fulfill or maximize the shareholder values
but the responsibilities towards other stakeholders should be look into account. One of the
example is responsibilities towards environment-recycle activities and so on.
 Theory related to corporate
governance
• Stakeholder theory
This theory argues that corporations should serve a broader agenda
of maximizing wealth for shareholders (investors) and protecting
the welfare of stakeholders.

• Agency theory
Proposes that corporate governance problems exist due to the
selfish tendencies of the professional managers that prompt them
to engage in conflict of interest situations.
• For example; high/excessive remuneration, misleading
accounting information
• Why does CG mainly concerns PLCs?
– PLCs have many shareholders – impossible to run the business on their own
– So, they hire professional managers to control the business
– Hence, shareholders own the business but control is surrendered to managers
– *however the demands for good corporate governance also implies to every types of
company'organization regardless wether the company is public or private company.
• However, in private company where one director is now can be incorporated under CA 2016,
the issues on corporate governance can be minimalized. it is because, In private firms, owners
manage their own firm – goals of owners are the same as the goals of firm.
• In PLCs, owners delegate power to professional managers to manage firms – goals of
managers might not be in line with goals of owners. the shareholders invest money and give
the responsibility to the directors to manage the company. However, the directors may have
different agenda which is to fullfil their owh personal interest.
 CORE COMPONENTS OF CG
1. Fairness -
protection of shareholder rights (i.e. rights of minority and foreign
shareholders). Rights can be strengthened by ensuring the
enforceability of contracts made by the providers of capital.Fairness
is very important to ensure everyone been treated equally.

2. Transparency -
by the timely disclosure of adequate, clear and comparable
information concerning corporate performance, governance and
ownership.
the board also should encourage employees to report genuine
concern sin relation to breach of a legal obligation in the workplace
regardless if it involves top management.
3. Accountability -
by clarifying governance roles and responsibilities and by
means of voluntary efforts to ensure the meeting of
managerial and shareholder interests as monitored by the
board of directors.
regular review of the division of responsibilities should be
conducted to ensure the company is able to adapat to
changing business circumstances.

4. Responsibility -
by ensuring corporate compliance with other laws and
regulations reflecting the existing society’s values.
they can review, challenge and decide on management of the
company and monitor its implementation by the
management. Directors also must make sure that strategic
planning of the company supports long term value creations
and including strategies on sustainability.
 PILLARS OF CORPORATE
GOVERNANCE
• According to UNESCAP (no date) good governance has 8
major characteristics of good governance.
• It is participatory, consensus, oriented, accountable,
transparent, responsive, effective and efficient, equitable and
inclusive and follows the rule of law.
• It assures that corruption is minimized, the views of minorities
are taken into account and that the voices of the most
vulnerable in society are heard in decision-making. It is also
responsive to the present and future needs of society.

(Retrieved August, 15, 2016 from http://www.unescap.org/pdd/prs/ProjectActivities/Ongoing/gg/governance.asp)

 Corporate Governance and PLCs

11

• Managers and shareholders have conflicting goals (interest).

• Shareholders want maximization of profit and wealth.they want
returns from their investment to the company. ( Dividend)
• However, the personal interests of managers may not be in line
with shareholders’ interests – Conflict of interest.

 CG is needed to reduce the extent of conflict of interest

between shareholders and managers to protect the
former and make everyone happy.
 Concentrated Ownership–
Malaysian PLCs

• Implications of concentrated ownership

– A few large shareholders and minority shareholders
– The nature of agency conflict differs from PLCs with diffused
ownership
Between managers and shareholders – principal
Type I and agent conflict

Type II Between large shareholders and minority

shareholders – principal-principal conflict
 Type I still exists but to a lesser extent than Type II.
 In this type of ownership environment, CG is meant to reduce
Type II conflict to protect minority shareholders.
 Development of Corporate
Governance in Malaysia

• Started off during Asian financial crisis in 1997–1998: many PLCs

experienced financial trouble.
• Poor CG was one of key causes of financial crisis due to blatant
power abuse and questionable business and financial transactions.
• The government established a committee in 1999 to investigate CG
in PLCs and to recommend improvement measures.
• Significant outcome – Malaysian Code on Corporate Governance
(MCCG) launched in year 2000. It later been revised three times in
year 2007,2012 and finally in year 2017.
• MCCG sets out principles and best practices aimed at enhancing
the quality of CG in PLCs.
Corporate Governance Mechanisms

To monitor activities and behaviour of controllers

to align their interest with those of shareholders
OBJECTIV

and to protect welfare of stakeholders.

To ensure board of directors fulfill fiduciary duty.
ES

To contribute to improve corporate performance

and to create long-term shareholder value.

• Can be classified into internal and external mechanisms – known

as monitors.
• To be effective, these mechanisms need to be put in place
together, as opposed to a piecemeal basis.
 Corporate Governance
Mechanisms (continued)
 The Board of Directors

• The board of directors is the most important mechanism – it is the

shareholders’ first line of defence.
• Accountable directly to shareholders and main task to ensure
professional managers do not engage in self-interest activities.
• Prior corporate scandals show that when boards failed in their
duties, it is highly likely that the company failed or was in financial
trouble.
• A board has both leadership and control roles.
• Leadership role: supervises formulation and implementation of
business strategy.
• Control role: monitors performance and activities of professional
managers.
 The Board of Directors
(continued)

• The board of directors enjoy independence from influence and

control of professional managers. This is achieved by:
– Leadership structure: different individuals holding Chairman
and CEO posts, which will prevent unfettered powers in one
person
– Appointing sufficient number of independent directors
– Chairman should be an independent director
• The board of directors should also establish independent board
committees.
• They must also ensure that remuneration of professional managers
are based on performance and they do not set their own pay
package.
• They should also ensure all directors attend induction and regular
training.
Corporate Governance Mechanisms

Internal Control: a system established by

boards to protect assets and investment
against risk exposure and expropriation.
Internal Audit: an independent process to
help boards to verify reliability and
effectiveness of internal control.
External Audit: an independent process to
assist shareholders to verify accuracy and
Shareholder Activism: shareholders
reliability of financial reports.
actively monitor the development in their
company by exercising voting rights during
general meetings
Regulation: regulate
and corporate
through abehaviour
two-way
dialogue.
so that the public has confidence in the
business environment – mandatory
compliance.
 Objective of internal control

• To ensure the orderly and efficient conduct of

business in respect of systems being in
place and fully implemented.
• To safeguard the asset of the business.
• To prevent and detect fraud.
• To ensure the completeness and accuracy of
accounting records.
• To ensure the timely preparation of financial
information.
• Any other relevant points.
 Ethical Issues in Corporate
Governance

Financial
manipulation Inflated Excessive Poor
directors business risk communication
Most common remuneration taking, lack of of information
issue as evidenced risk control
by previous Excessive Shareholders are
corporate remuneration; Managers pursue kept ‘in the dark’
scandals, e.g. reward not based risky strategy about affairs and
fictitious sales to on performance. without proper performance of
inflate profit and assessment and company, which
use of creative management of results in the latter
accounting to hide risks involved. being unable to
huge debts in make informed
balance sheet. decisions.
Types of communication channels that can
be used by board of directors with its
shareholders to improve poor
communication of information
• The annual reports and accounts
• The dialogue during annual general meeting
• Electronic communication such as an interactive company website and email
• Establish a dedicated investor relations department to handle enquiries.
• Engage in regular dialogue with institutional shareholders
 A NEW STRUCTURE ON MCCG 2017

• MCCG 2012 -the structure divided into

– principles, recommendations and the commentary to eachrecommendation.

• MCCG 2017-NEW STRUCTURE WHICH SETS OUT:

– principles:actions, procedures or processes which companies are expected to adopt.
– intended outcome:provides companies with the lines of sights on what they will
achieve through the practices.
– practice: with some Step Up practices for large companies
– guidance:assist companies in appplying the Practice to achieve the intended
outcome.
• the important element is CARE. c=comprehend, a=apply and RE=report.
 MALAYSIAN CODE OF
CORPORATE GOVERNANCE
• PRINCIPLES2017* new slide
A : BOARD LEADERSHIP AND EFFECTIVENESS.
– Board responsibilities
– Board composition
– Remuneration

• PRINCIPLES B : EFFECTIVE AUDIT AND RISK MANAGEMENT

– Audit Committee
– Risk management and internal control framework

• PRINCIPLES C: INTEGRITY IN CORPORATE REPORTING AND

MEANINGFUL RELATIONSHIP WITH STAKEHOLDERS.
– Communication with stakeholders
– Conduct of general meeting
• The latest version, MCCG 2021, was released on January 26, 2021, and includes
several updates and enhancements to the previous version. Here's a summary of
the key changes:
• Board of Directors: MCCG 2021 places greater emphasis on the role and
responsibilities of the Board of Directors in overseeing corporate governance. It
recommends that the Board should have a balanced composition of independent
and non-independent directors, with the Chairman and CEO roles being separate.

• Stakeholder Engagement: MCCG 2021 encourages companies to engage with

stakeholders, including employees, customers, and the community, to understand
their interests and concerns.

• Board Diversity: MCCG 2021 highlights the importance of diversity on boards,

including gender diversity, and recommends that companies set targets to improve
diversity.

• Risk Management: MCCG 2021 emphasizes the need for companies to have
effective risk management frameworks in place, and recommends that risk
management be integrated into the company's strategy.

• Sustainability: MCCG 2021 recognizes the importance of sustainability and

encourages companies to adopt sustainable practices, including the disclosure of
sustainability-related information.

• Remuneration: MCCG 2021 introduces more comprehensive guidelines on

executive remuneration, including the disclosure of performance metrics and the
adoption of clawback provisions.
Code of Ethics for Company Directors

• The business environment and laws will continue to

become more complex and this has imposed a greater
demand for reasonable competence amongst
company directors.
• It is important to establish a standard of competence
for corporate accountability which includes standards
of professionalism and trustworthiness in order to
uphold good corporate integrity.
 PURPOSE

• This Code of Ethics is formulated to enhance the

standard of corporate governance and corporate
behaviour with the intention of achieving the following
aims:
• 1. To establish a standard of ethical behaviour for
directors based on trustworthiness and values that can
be accepted, are held or upheld by any one person.
• 2. To uphold the spirit of responsibility and social
responsibility in line with the legislation, regulations
and guidelines for administrating a company.
 CODE OF ETHICS
In the performance of his duties, a director should at all
times observe the following codes:

• 1. Corporate Governance
– 1.1 Should have a clear understanding of the aims and purpose, capabilities and capacity of the company;
• 1.2 Should devote time and effort to attend meetings and to know what is required of the board and each of its
directors, and to discharge those functions;
• 1.3 Should ensure at all times that the company is properly managed and effectively controlled;
• 1.4 Should stay abreast of the affairs of the company and be kept informed of the company's compliance with the
relevant legislation and contractual requirements;
• 1.5 Should insist on being kept informed on all matters of importance to the company in order to be effective in
corporate management;
• 1.6 Should limit his directorship of companies to a number in which he can best devote his time and effectiveness;
each director is his own judge of his abilities and how best to manage his time effectively in the company in which
he holds directorship;
• 1.7 Should have access to the advice and services of the company secretary, who is responsible to the board to
ensure proper procedures, rules and regulations are complied with;
• 1.8 Should at all times exercise his powers for the purposes they were conferred, for the benefit and prosperity of
the company;
• 1.9 Should disclose immediately all contractual interests whether directly or indirectly with the company;
• 1.10 Should neither divert to his own advantage any business opportunity that the company is pursuing, nor may
he use confidential information obtained by reason of his office for his own advantage or that of others;
• 1.11 Should at all times act with utmost good faith towards the company in any transaction and to act honestly
and responsibly in the exercise of his powers in discharging his duties; and
• 1.12 Should be willing to exercise independent judgment and, if necessary, openly oppose if the vital interest of
the company is at stake
 Con’t

• 1.13 Relationship with Shareholders, Employees, Creditors and Customers

– 1.13.1 Should be conscious of the interest of shareholders, employees, creditors and customers of
the company;
– 1.13.2 Should at all times promote professionalism and improve the competency of management
and employees; and
– 1.13.3 Should ensure adequate safety measures and provide proper protection to workers and
employees at the workplace.
• 1.14 Social Responsibilities and the Environment
– 1.14.1 Should ensure that necessary steps are taken in accordance with the law to properly wind-
up or strike off the company register if the company has not commenced business or
has ceased to carry on business and is not likely to commence business in the future
or resume business as the case may be;
– 1.14.2 Should adopt an objective and positive attitude and give the utmost cooperation for the
common good when dealing with government authorities or regulatory bodies;
– 1.14.3 Should ensure the effective use of natural resources, and improve quality of life by
promoting corporate social responsibilities;
– 1.14.4 Should be more proactive to the needs of the community and to assist in society-related
programmes in line with the aspirations of the concept of 'Caring Society' in Vision 2020; and
– 1.14.5 Should ensure that the activities and the operations of the company do not harm the interest
and well-being of society at large and assist in the fight against inflation.
 REFERENCES

• Khalidah Khalid Ali, Zulkufly Ramly, &

Lau Teck Chai. (2014). Business Ethics.
Shah ALam: Oxford Fajar Sdn Bhd.
• https://www.sc.com.my/wp-content/
uploads/eng/html/cg/cg2012.pdf
• https://www.ssm.com.my/en/code-ethics-
company-directors
 Introduction

• Many companies have not implemented effective business ethics

programs.

• Ethics and compliance program create good system to manage

organizational conduct

• Ethics program include not only the need for top executive leadership
but also responsibility by boards of directors for corporate governance

• Unethical and illegal business conduct occurs, even in organizations

that have ethics program

• Customized ethics programs may help many organizations provide

guidance for employees from diverse backgrounds
 The need for organizational ethics
program
• Companies must assess their ethical risks and develop values and
compliance system to avoid legal and ethical mistakes that could
damage the organization

• Corporations can be held accountable, fined and even receive the

death penalty when they are operating in a manner inconsistent with
major legal requirements

• Fostering ethical decisions within an organization requires eliminating

unethical behavior and improving the firm’s ethical standards

• Organizations can foster unethical corporate cultures not because

individuals within them are bad, but because the pressure to succeed
create opportunities that reward unethical decisions.
• In the case of an unethical corporate culture, the organization must
redesign its ethical standards to conform to industry and stakeholder
standards of acceptable behavior.

• Therefore, in order to be socially responsible and promote legal and

ethical conduct, an organization should develop an organizational
ethics program by communicating and monitoring ethical values and
legal requirements that characterize the organization’s history,
culture, industry and operating environment.

• Without such program it is difficult for employees to determine what

behaviors are acceptable within a company
• A strong ethics program includes a written code of conduct, an ethics
officer to oversee the program, care in the delegation of authority,
formal ethics training, auditing, monitoring, enforcement and revision
of program standards

• In the absence of such programs and standards, employees generally

will make decisions based on their observations of how their
coworkers and managers behave

• No universal standards exist that can be applied to organizational

ethics programs, but most companies develop codes, values or policies
for guidance

• Ethics programs are developed as organizational control system of

which aims to create predictability in employee behavior
• Two types control system
• Compliance orientation
– Create order by requiring that employees identify with and commit to
specific required conduct. It uses legal terms, statues and contracts that
teach employees the rules and penalties for noncompliance

• Values orientation
– Strives to develop shared values. Although penalties are attached, the
focus is more on an abstract core of ideals such as respect and
responsibility. Instead of relying on coercion, the company’s values are
seen as something to which people willingly aspire

• The goal of an effective ethical program is to get employees to report

wrongdoing when they become aware
•Compliance Strategy

• This strategy is based on three interrelated components:

• Rules: Compliance strategies are centered around strict codes of ethics composed of
rules that set forth minimum thresholds of acceptable behaviour. The use of rules to
structure employee action does run into problems due to the gap between rule and
application, the appearance of novel situations, and the impression that it gives to
employees that obedience is based on conformity to authority.

• Monitoring: The second component consists of monitoring activities designed to ensure

that employees are conforming to rules and to identify instances of non-compliance.
Monitoring is certainly effective but it requires that the organization expend time, money,
and energy. Monitoring also places stress upon employees in that they are aware of
constantly being watched. Those under observation tend either to rebel or to
automatically adopt behaviours they believe those doing the monitoring want. This
considerably dampens creativity, legitimate criticism, and innovation.

• Disciplining Misconduct: The last key component to a compliance strategy is

punishment. Punishment can be effective especially when establishing and enforcing
conduct that remains above the criminal level. But reliance on punishment for control
tends to impose solidarity on an organization rather than elicit it. Employees conform
because they fear sanction. Organizations based on this fear are never really free to
pursue excellence.
•Values Strategy

• To facilitate comparison, three correlative but different elements to Values-Based or aspirational approaches will be
identified.
• Development of Shared Values: Using a process similar to the one described above, a company develops a
Statement of Shared Values. These provide guidelines that replace the hard and fast rules of a compliance code.
Statements in values-oriented codes play a different logical function than statements in compliance codes. "Principles
of Professional/Organizational Conduct" in compliance codes specify circumstances of compliance: time, agent, place,
purpose, manner, etc. These provide sufficient content to set forth principles of professional conduct as rules that can
be violated. This, in turn, allows them to be backed by punishment for violation. "Ideals of the Profession" (or
organization) set forth a community's shared aspirations. These are pitched at a level well above and beyond the
minimum. Communities can and should define themselves as much by their aspirations as by their threshold
standards.

• Support for Employees: Since Statements of Values set forth excellences or aspirations, the role of the organization
changes from monitoring and then punishing misbehaviour to finding ways of opening avenues for employees to
realize key values in their day to day activity. Excellence is not something to be reached overnight. It requires
rethinking basic motivations, attitudes, beliefs, and goals. Companies need to identify obstacles to achieving ideals
and then develop support structures to help those who seek to realize ideals. Values-based approaches change from
punishing conduct that falls below the minimum to providing collective support to those who strive for the excellent.

• Locking in on Continual Improvement: The philosopher, John Dewey, characterizes moral responsibility as the drive
to better ourselves. The particular twist in Dewey's approach is to find ways of folding what has been learned from the
past into meeting new challenges that arise in the future. This involves changing habits and, ultimately, changing
character. Continual improvement is the ultimate goal of corporations oriented toward excellence. The values these
"moral ecologies" identify structure and channel this endeavor. What is needed at this stage is to develop concrete
programs and strategies for identifying obstacles to excellence, removing them, and remaining on track for excellence.
To summarize, some companies identify a compliance strategy where they set
forth rules that establish minimum levels of acceptable conduct, monitor
compliance, and punish non-compliance. Others, value-oriented or aspiration-
oriented companies, identify core values or aspirations (by reflecting on
community values and finding them embedded in extant codes of ethics), develop
programs and structures to support those who strive for these values, and work to
lock in a program of continual improvement or betterment.

Something to think about. Compliance approaches work best in what of

company, organization or moral ecology. (Think about this in terms of the central
or core commitments such as those in finance-, customer-, and quality-driven
companies.) Values-based approaches work best in what kind of company,
organization or moral ecology? How does one transition from compliance to
values-based approaches? How does one integrate the two?
 Codes of Conduct

• Because of diversity it cannot be assumed that they know how to

behave appropriately when they enter a new organization or job

• Codes of conduct (also called codes of ethics) are formal statements

that describe what an organization expects of its employees.

• A code od conduct has to reflect the board of directors’ and senior

management’s desire for organizational compliance with the values,
mission, rules and policies that support an ethical dilemma.

• Development of a code of ethics should involve the board of directors,

chairman/president and senior managers with the attendance of legal
staff as to ensure the code has correctly assessed key areas of risk and
that potential legal problems are buffered by standards in the code
Developing and implementing Code
of Ethics
• Codes of conduct may address a variety of situations, from internal
operations to sales presentations and financial disclosure practices.

• Research ahs found that corporate codes of ethics often have five to
seven core values or principles :
• Trustworthiness
• Respect
• Responsibility
• Fairness
• Caring
• Citizenship

• These values will not be effective without distribution, training and the
support of top management

• A code of ethics will be useless if it is not communicated effectively

 Ethics Officers

• Organizational ethics programs also must have oversight by a high

tanking person known to respect and understand legal and ethical
standards.

• He/she is referred as an ethics officer

• Many corporations are now appointing chief compliance officer and

ethics and business conduct professional to develop and oversee
corporate compliance programs

• Ethics officer usually responsible for companywide disciplinary system,

implementing all disciplinary actions the company takes for violations
of its ethical standards.

• Many companies includes ethical compliance in their employee

performance appraisals
• The financial reporting requirements of the Sarbanes-Oxley Act put
more pressure on ethics officer to monitor financial reporting as well
as reporting of sales and inventory movements to prevent fraud

• Building an ethics program and hiring an ethics officer to avoid fines

will not be effective alone

• But it takes the involvement and commitment of top management and

the board.

• Ethics offices are responsible for knowing about thousands of pages of

regulations as well as communicating and reinforcing values that build
an ethical corporate culture
 Ethics training and communication

• Instituting a training program and a system to communicate with and

educate employees about the firm’s ethical standards is a major steps
in developing and effective ethics program

• Training programs can make employees aware of available resources,

support system, and designated personnel who can assist them with
ethical and legal advice

• It also can help empower employees to ask tough questions and make
ethical decisions by the training from ethics officers.

• Ethics training must be customized to the specific nature of employees

in the organization and risk they face in order to understand why it is
conducted, how it fits into the organization and what is their own role
in its implementation
• Top corporate executives must communicate with managers at the
operations level and enforce overall ethical standards within the
organizations.

• It is crucial to help employees identify ethical issues and give them the
means to address and resolve such issues and offered direction

• Effective ethics program can reduce criminal, civil and administrative

consequences including fines, penalties, judgments, debarment etc.
Factors crucial to ethics training
• Business ethics programs need to educate employees about formal
ethical frameworks and models for analyzing business ethics issues

• Training and communication should reflect the unique of an

organization( its size, culture, values, management style and employee
base)

• Involvements from all staff are important including managers,

executives that relate to actual situations.

• Behavioral simulation or role-play is relatively new training in which

they are assigned roles

• Learning objectives of simulation include increase awareness,

development of analytical skills and exposure to the complexity of
ethical decision
• A growing number business deliver “learning-management” system
software and content to train and certify employees by e learning to
ensure the computerized training elements of such system provide
consistency of content and delivery to all locations and allow for
customization of languages and to cultures

• Ethical decision making is influenced by organizational culture,

coworkers and supervisors and by the opportunity to engage in
unethical behavior.

• Key goals is to make employees aware the risks associated with jobs,
industry, stakeholders, provides understanding of the culture and
expectation, create accountability and the behavior that is acceptable
in the organiozation