Importance of Independence in Importance of Independence in Corporate GovernanceCorporate Governance

What is Corporate What is Corporate Governance?Governance?

Corporate GovernanceCorporate Governance

Corporate Governance is a relationship among Corporate Governance is a relationship among stakeholders that is used to determine and stakeholders that is used to determine and control the strategic direction and performance of control the strategic direction and performance of organizationsorganizations

Concerned with identifying ways to ensure that Concerned with identifying ways to ensure that strategic decisions are made effectivelystrategic decisions are made effectively

Used in corporations to establish order between Used in corporations to establish order between the firm’s owners and its top-level managersthe firm’s owners and its top-level managers

Corporate Governance PartiesCorporate Governance Parties

Shareholders – those that own the Shareholders – those that own the companycompany

Directors – Guardians of the Company’s Directors – Guardians of the Company’s assets for the Shareholdersassets for the Shareholders

Managers who use the Company’s assetsManagers who use the Company’s assets

Four Pillars Four Pillars of Corporate Governanceof Corporate Governance

AccountabilityAccountability

FairnessFairness

TransparencyTransparency

IndependenceIndependence

Accountability Accountability • Ensure that management is accountable to the Ensure that management is accountable to the

BoardBoard• Ensure that the Board is accountable to Ensure that the Board is accountable to

shareholdersshareholders

FairnessFairness• Protect Shareholders rightsProtect Shareholders rights• Treat all shareholders including minorities, Treat all shareholders including minorities,

equitablyequitably• Provide effective redress for violationsProvide effective redress for violations

TransparencyTransparency• Ensure timely, accurate disclosure on all Ensure timely, accurate disclosure on all

material matters, including the financial material matters, including the financial situation, performance, ownership and situation, performance, ownership and corporate governancecorporate governance

IndependenceIndependence• Procedures and structures are in place so as to Procedures and structures are in place so as to

minimise, or avoid completely conflicts of minimise, or avoid completely conflicts of interestinterest

• Independent Directors and Advisers i.e. free Independent Directors and Advisers i.e. free from the influence of othersfrom the influence of others

Elements of Corporate GovernanceElements of Corporate Governance

Good Board practicesGood Board practices

Control EnvironmentControl Environment

Transparent disclosureTransparent disclosure

Well-defined shareholder rightsWell-defined shareholder rights

Board commitmentBoard commitment

Why Corporate Governance?Why Corporate Governance?

Better access to external financeBetter access to external finance Lower costs of capital – interest rates on Lower costs of capital – interest rates on

loansloans Improved company performance – Improved company performance –

sustainabilitysustainability Higher firm valuation and share Higher firm valuation and share

performance performance Reduced risk of corporate crisis and Reduced risk of corporate crisis and

scandalsscandals

Why Corporate Governance?Why Corporate Governance?

In 2002, L Klapper and I Love from the World In 2002, L Klapper and I Love from the World Bank found evidence that improving a company’s Bank found evidence that improving a company’s corporate governance has proportionately greater corporate governance has proportionately greater impact in countries with weak legal impact in countries with weak legal environments. environments.

They have suggested that companies can They have suggested that companies can partially compensate for ineffective laws and partially compensate for ineffective laws and enforcement by establishing good corporate enforcement by establishing good corporate governance at the company level and providing governance at the company level and providing credible investor protectioncredible investor protection

‘‘Independence’ as a conceptIndependence’ as a concept

An essential component of professionalism and An essential component of professionalism and professional behavior.professional behavior.

Refers to the avoidance of being unduly Refers to the avoidance of being unduly influenced by a vested interest and to being free influenced by a vested interest and to being free from any constraints that would prevent a correct from any constraints that would prevent a correct course of action being taken.course of action being taken.

Ability to make the correct and uncontaminated Ability to make the correct and uncontaminated decision on a given issue.decision on a given issue.

ExampleExample

If an auditor is a longstanding friend of a client, If an auditor is a longstanding friend of a client, the auditor may not be sufficiently independent of the auditor may not be sufficiently independent of the client. Given that it is an auditor’s job to act the client. Given that it is an auditor’s job to act on behalf of shareholders and not the client, the on behalf of shareholders and not the client, the friendship with the client may compromise the friendship with the client may compromise the auditor’s ability to effectively represent the auditor’s ability to effectively represent the interests of the shareholders. He may be interests of the shareholders. He may be influenced to give the benefit of a doubt to the influenced to give the benefit of a doubt to the client when he should not be doing so.client when he should not be doing so.

IndependenceIndependence

In corporate governance, independence is In corporate governance, independence is therefore important in a number of contexts. It is therefore important in a number of contexts. It is vital that vital that external auditors are independent of external auditors are independent of their clientstheir clients, that , that internal auditors are internal auditors are independent of the colleagues they are auditingindependent of the colleagues they are auditing, , and that and that non-executive directors have a degree of non-executive directors have a degree of independence from their executive colleagues on independence from their executive colleagues on a board.a board.

External Auditors to be External Auditors to be independent independent

Why?Why?• Act on behalf of the owners of the business, normally Act on behalf of the owners of the business, normally

the shareholder.the shareholder.• Report on the financial statements prepared by Report on the financial statements prepared by

management for the benefit of shareholders.management for the benefit of shareholders.

If External Auditors are not independent:If External Auditors are not independent:• their ability to form an objective opinion on the financial their ability to form an objective opinion on the financial

statements will be impaired.statements will be impaired.• the owners of the business will not have confidence in the owners of the business will not have confidence in

the audit reports that the audits issue.the audit reports that the audits issue.

Phar-MorPhar-Mor

declared bankrupt in the year 1995.declared bankrupt in the year 1995. Factor related to independent contributing to the Factor related to independent contributing to the

fraud:fraud:• Familiarity threatFamiliarity threat

Phar-Mor’s fraud team was made up of several former auditors, Phar-Mor’s fraud team was made up of several former auditors, including at least one former auditor who had worked for Coopers including at least one former auditor who had worked for Coopers on the Phar-Mor auditon the Phar-Mor audit

Coopers checks only 4 stores out of 129.Coopers checks only 4 stores out of 129. they knew in advance which stores will be checked and what the they knew in advance which stores will be checked and what the

auditors were looking forauditors were looking for

Internal auditors to be Internal auditors to be independent independent

Internal auditing is an advisory functionInternal auditing is an advisory function Independence and objectivity of internal auditors Independence and objectivity of internal auditors

must exist in both appearance and in fact; must exist in both appearance and in fact; otherwise the credibility of the internal auditing otherwise the credibility of the internal auditing work product is jeopardized.work product is jeopardized.

Internal auditors have to be independent from the Internal auditors have to be independent from the activities they audit so that they can evaluate activities they audit so that they can evaluate them objectively.them objectively.

Non-Executive DirectorsNon-Executive DirectorsTHE CODE OF CORPORATE GOVERNANCE FOR THE CODE OF CORPORATE GOVERNANCE FOR

MAURITIUSMAURITIUSIndependent director Independent director - a director who is non-executive and who:- a director who is non-executive and who:

(a) is not a representative or member of the immediate family (spouse, child, parent, (a) is not a representative or member of the immediate family (spouse, child, parent, grandparent or grandchild) of a shareholder who has the ability to control or grandparent or grandchild) of a shareholder who has the ability to control or significantly influence the board or management. This would include any director who significantly influence the board or management. This would include any director who is appointed to the board (by virtue of a shareholders’ agreement or other such is appointed to the board (by virtue of a shareholders’ agreement or other such agreement) at the instigation of a party with a substantial direct or indirect agreement) at the instigation of a party with a substantial direct or indirect shareholding in the company; shareholding in the company;

(b) has not been employed by the company or the group of which the company (b) has not been employed by the company or the group of which the company currently forms part, in any executive capacity for the preceding three financial currently forms part, in any executive capacity for the preceding three financial years; years;

(c) is not a professional advisor to the company or the group other than in a director (c) is not a professional advisor to the company or the group other than in a director capacity; capacity;

(d) is not a significant supplier to, debtor or creditor of, or customer of the company (d) is not a significant supplier to, debtor or creditor of, or customer of the company or group, or does not have a significant influence in a group related company in any or group, or does not have a significant influence in a group related company in any one of the above roles;one of the above roles;

(e) has no significant contractual relationship with the company or group; (e) has no significant contractual relationship with the company or group;

(f) is free from any business or other relationship which could be seen to materially (f) is free from any business or other relationship which could be seen to materially impede the individual’s capacity to act in an independent manner; impede the individual’s capacity to act in an independent manner;

(g) in the case of banks, the Bank of Mauritius’ definition of independent applies.(g) in the case of banks, the Bank of Mauritius’ definition of independent applies.

Non-Executive DirectorsNon-Executive Directors

The primary purpose of a NED is to bring The primary purpose of a NED is to bring objective scrutiny on behalf of the shareholdersobjective scrutiny on behalf of the shareholders

Independence, when it comes to boards, allows a Independence, when it comes to boards, allows a director to be objective and evaluate the director to be objective and evaluate the performance and well being of the company performance and well being of the company without any conflict of interest or the undue without any conflict of interest or the undue influence of interested parties.influence of interested parties.

Having a majority of independent directors (or at Having a majority of independent directors (or at least a critical mass) allows outside directors to least a critical mass) allows outside directors to feel they have support in raising contrary points feel they have support in raising contrary points of view.of view.

Non-Executive DirectorsNon-Executive Directors

A board with a majority of independent directors, A board with a majority of independent directors, can bring expertise and objectivity whichcan bring expertise and objectivity which• Assures owners that the company is being run legally, Assures owners that the company is being run legally,

ethically, effectively and in the best interest of its ethically, effectively and in the best interest of its ownersowners

• And that they have “representatives” who are objective And that they have “representatives” who are objective and have no “ax to grind”and have no “ax to grind”

• Who will look at issues with no vested interest or Who will look at issues with no vested interest or “hidden agendas.”“hidden agendas.”

Non-Executive Directors in Non-Executive Directors in Family BusinessFamily Business

For a family business, independence is even more For a family business, independence is even more important. The independent director can help important. The independent director can help with issues where the family tends to lacks with issues where the family tends to lacks objectivity and independence such as:objectivity and independence such as:• Hiring, firing, promoting, and compensating family Hiring, firing, promoting, and compensating family

members as well as determining succession plans;members as well as determining succession plans;• Bringing expertise and perspective to a business which Bringing expertise and perspective to a business which

is run on tradition and sentimental loyalty (“this is the is run on tradition and sentimental loyalty (“this is the way dad did it”) rather than by current best business way dad did it”) rather than by current best business practices;practices;

• Acting as a neutral bridge between family owners and Acting as a neutral bridge between family owners and non-family managers.non-family managers.

Non-Executive DirectorsNon-Executive Directors

Some of the main arguments for having Some of the main arguments for having independent directors are the following:independent directors are the following:• Selected to provide specialist skills;Selected to provide specialist skills;• Add diversity to the board, thereby modifying the Add diversity to the board, thereby modifying the

culture of a unitary Board; culture of a unitary Board; • Provide independent appraisal – separation of ownership Provide independent appraisal – separation of ownership

and control;and control;• Corporate experience and leadership qualities;Corporate experience and leadership qualities;• Provide expertise, explicitly to support the CEO;Provide expertise, explicitly to support the CEO;• To provide leadership and vision; andTo provide leadership and vision; and• Status and credibility  of the  governance  model  – to Status and credibility  of the  governance  model  – to

 represent  the  public  face  of  the  business. represent  the  public  face  of  the  business.

CONCLUSIONCONCLUSION

Independence is an essential quality in a number Independence is an essential quality in a number of situations in corporate governance and in of situations in corporate governance and in professional behaviour. Independence is professional behaviour. Independence is sometimes enhanced and underpinned by sometimes enhanced and underpinned by regulation and legislation, but over and above regulation and legislation, but over and above that, it is expected of every professional person that, it is expected of every professional person and of every professional accountant.and of every professional accountant.

THANK YOUTHANK YOU