Chapter 1

Review Questions
1. What is the primary goal of corporate governance?
To create a balance of power-sharing among shareholders, directors, and
management to enhance shareholder value and protect the interests of other
stakeholders.
2. What is the primary mission of a public company?
To create sustainable and enduring shareholder value.
3. What is the role of a corporate governance gatekeeper?
To align managements interests with those of long-term shareholders and to
protect investors from misleading financial information published in public
filings.
. Corporate governance reforms an! best practices re"uire the establishment of
what four key gatekeepers to !eal with the perceive! agency problems of
asymmetric information between management an! investors an! to improve the
"uality of public financial information?
(1) Independent and competent board of directors (!) independent and competent
e"ternal auditor (#) ob$ective and competent legal counsel and (%) ob$ective and
competent financial advisors and investment bankers.
#. $ow !oes an effective corporate governance structure improve investor
confi!ence?
It ensures corporate accountabilit&, enhances the reliabilit& and 'ualit& of public
financial information, and enhances the integrit& and efficienc& of the capital
market.
%. What is the primary intent of corporate governance reforms?
To improve(
The reliabilit&, integrit&, transparenc&, and 'ualit& of financial reports.
The effectiveness of internal controls over financial reporting and related risk
management assessment.
The credibilit& of the e"ternal audit function.
The independence and ob$ectivit& of other gatekeepers such as legal counsel
and financial anal&sts.
)hareholder monitoring and democrac&.
&. What benefits are obtaine! by the proper implementation of '()?
Improved corporate governance.
*nhanced 'ualit&, reliabilit&, and transparenc& of financial information.
Improved audit ob$ectivit& and effectiveness in lending credibilit& to
published financial statements.
*. $ow can the boar! of !irectors influence the corporate culture?
)et an appropriate +tone at the top,, promoting personal integrit& and
professional accountabilit&.
-eward high-'ualit& and ethical performance.
.iscipline poor performance and unethical behavior.
/aintain the compan&s high reputation and stature in the industr& and the
1
business communit&.
+. What is the intention of organi,ational co!es of business ethics an! con!uct?
0odes of business ethics and conduct are intended to govern behavior, but the&
cannot substitute for moral principles, culture, and character.
1-. Corporate governance !epen!s on what three practices to be effective?
0ompliance with state and federal statutes.
0ompliance with listing standards.
Implementation of best practices suggested b& investor activists and
professional organi1ations.
11. Why is there no universal !efinition of corporate governance?
The scope covers a vast arra& of distinct economic phenomena and it is often
described from a shareholders view.
12. $ow have '() provisions. '/C0relate! rules. an! listing stan!ar!s influence!
the corporate governance structure?
2uditors, anal&sts, and legal counsel who were not traditionall& considered
components of corporate governance are now brought into the realm of
internal governance as gatekeepers.
The legal status and fiduciar& dut& of compan& directors and officers have
been more clearl& defined and significantl& enhanced.
0ertain aspects of state corporate law were preempted and federali1ed.
13. What business entities are currently affecte! by '()?
)34 applies e'uall& to and is intended to benefit all publicl& traded companies,
although man& provisions are also relevant to private and not-for-profit
organi1ations.
1. What is the !ifference between a sharehol!er an! a stakehol!er?
)hareholders are individuals or groups who are traditionall& the primar& users of
the compan&s financial reports, which reflect the compan&s financial condition
and the results of operations. The& also have greater rights of involvement with
decisions and monitoring of a compan&. )takeholders are individuals or groups,
including shareholders, creditors, customers, emplo&ees, suppliers, competitors,
governmental entities, environmental agencies, and social activists, who affect the
compan&s strategic decisions, operations, and performance.
1#. What are the primary !ifferences between financial reporting an! corporate
accountability reporting?
5inancial -eporting 0orporate 2ccountabilit& -eporting
6egal re'uirement. 7ot a legal re'uirement.
8repared based on a set of generall&
accepted accounting principles and
standards.
7o single set of standards which are
widel& agreed upon.
2udit is re'uired. 7o mandator& assurance report.
9uidelines specif& the t&pe and
level of assurance.
7o guidelines specif& the t&pe and
level of assurance.
8repared primaril& for shareholders. 8rovided to a broad range of
stakeholders with different and
often competing interests.
!
1%. What is the relationship between corporations an! stakehol!ers. an! what is the
corporations1 role in that relationship?
There is a contractual relationship between corporations and their stakeholders.
The corporations role is to create and protect the value of that contract.
1&. What is the primary !ifference between the first an! secon! tier of the
stakehol!er hierarchy?
The first tier is the shareholders and owners of the corporation. The& are absent in
the dail& operations. The second tier consists of those involved in the operations
of the corporations.
1+. 2o whom are corporations accountable?
0orporations are accountable to all internal and e"ternal stakeholders in a
corporation. This can lead however to agenc& problems.
1+. /3plain the relationship between corporations an! the capital markets in the
4nite! 'tates.
The capital markets provide funds to corporations and thus monitor their
corporate governance to align the interests of management with the interests of
investors. 3n the other hand, corporations provide relevant financial information
to the capital markets, which facilitates the efficienc& and li'uidit& of the capital
markets.
5iscussion Questions
1. 6n your own wor!s. briefly e3plain the concepts of value creation an! value
protection.
The value creation goal of corporate governance focuses on shareholder value
creation and enhancement through the development of long-term strategies to
ensure sustainable and enduring operational performance. The value protection
goal of corporate governance concentrates on the accountabilit& of the wa& a
compan& is managed and monitored to protect the interests of shareholders and
other stakeholders. These two concepts should be considered within ever&
compan&.
2. $as 'arbanes0(3ley thus far ha! a positive. negative. or neutral effect on public
companies? 5efen! your answer.
The )arbanes-3"le& 2ct has had an overall positive effect on public companies.
:ithin the areas of financial reporting and corporate accountabilit&, )34 has
encouraged management to effectivel& formulate and implement a strong s&stem
of internal control and financial reporting such that errors and fraud are materiall&
prevented, detected, and corrected. )34 has increased the cost of compliance
with federal regulations, particularl& with )ection %;%, but these costs are
outweighed b& the benefits of robust financial reporting, increased scrutin& of
managements dealings within the organi1ation, and increased investor
confidence. 2dditionall&, measures are being taken to decrease the costs of )34,
such as proposed 2uditing )tandard 7o. < b& the 8023=.
3. 5iscuss the following "uote from 7ori 8. Richar!s. the '/C1s 5irector of the
(ffice of Compliance 6nspections an! /3aminations9
:6t1s not enough to have policies. 6t1s not enough to have proce!ures.
6t1s not enough to have goo! intentions. 8ll of these can help. ;ut to
#
be successful. compliance must be an embe!!e! part of your firm1s
culture.<
In addition to policies and procedures designed to promote effective corporate
governance, organi1ations must create and reinforce a consistent, positive
corporate culture which complements such measures. /embers of the
organi1ation, starting with the e"ecutives, must lead b& e"ample in their efforts to
encourage others to compl& with applicable policies and procedures. The norms
and values embraced b& the organi1ation as its corporate culture should be
consistent with its policies and procedures otherwise behavior inconsistent with
those policies and procedures will result. 0ompliance $ust for the sake of
compliance and the development of a +check bo", mentalit& is not enough.
0orporations should create an ethical culture that encourages all corporate
governance participants including directors, officers, auditors, financial advisors,
emplo&ees, and others to do the right thing and understand that this is vital to the
compan&s sustainable financial performance.
. What are the benefits of an =;7 approach?
/=6 reporting forces organi1ations to consider the effects of man& aspects of
their operations in addition to financial reporting, such as environmental, social,
ethical, and governance performance. )ince the effects of organi1ations in these
areas can be significant, man& stakeholders benefit from the fact that /=6
reporting makes organi1ations accountable for the effects of their operations in
man& different areas.
#. Who are first0tier. secon!0tier. an! thir!0tier stakehol!ers. an! why are they
significant to the organi,ation?
The first tier of stakeholder hierarch& consists of investors or shareholders who
own the compan&. )hareholders are the primar& stakeholders>without them the
compan& would not e"ist. /an& argue that the primar& purpose and responsibilit&
of the compan& is to ma"imi1e shareholder wealth b& creating sustainable and
enduring shareholder value. Thus, the compan&s corporate governance structure
should reduce the agenc& costs raised from the separation of ownership and
control b& aligning the interests of management with those of the shareholders.
6enders and creditors are considered as the second-tier stakeholders in the
compan&. .ebtholders ma& have significant power in situations in which the
organi1ation is funded largel& b& debt. The third tier of stakeholders consists of
emplo&ees, suppliers, governments, customers, and societ&. This tier should be
important to the organi1ation, as the collective actions of such a large base of
stakeholders could significantl& affect the organi1ation.
%. What is the significance of "uality financial statements an! other financial
reporting information?
%
5inancial statements are a vital source of information to the capital markets and
their participants. The 'ualit& of investment and voting decisions b& investors
depends on the accurac&, completeness, and reliabilit& of financial information
disseminated to them b& public companies. Thus, high-'ualit& financial
information improves investor decisions and in turn the efficienc&, li'uidit&, and
safet& of the capital markets, which ma& result in prosperit& and economic growth
for the nation. Therefore, 'ualit& financial statements and other financial reporting
information is important to the strength of capital markets.
&. What are the responsibilities of corporate governance gatekeepers?
The board of directors is charged with overseeing managements strateg& and
performance. The e"ternal auditor is responsible for providing a high level of
assurance regarding the reliabilit&, 'ualit&, and transparenc& of the financial
reports of public companies. 6egal counsel is charged with providing legal advice
and ensuring more than mere technical compliance with applicable laws,
regulations, rules, and standards. The financial advisors and investment bankers
are responsible for advising compan& management and the board in conducting
legitimate business affairs and transactions that have a valid economic purpose.
2ll gatekeepers must be competent in order to be effective in promoting strong
corporate governance.
*. What shoul! the boar! of !irectors !o to promote a positive corporate culture?
The engaged board of directors can significantl& influence the corporate culture
b&( (1) setting an appropriate +tone at the top,, promoting personal integrit& and
professional accountabilit& (!) rewarding high-'ualit& and ethical performance
(#) disciplining poor performance and unethical behavior and (%) maintaining the
compan&s high reputation and stature in the industr& and the business
communit&. =& taking these actions, the board of directors helps to promote a
culture within the organi1ation that is consistent with corporate governance
ob$ectives.
+. Will compliance with applicable laws. rules. an! regulations ensure effective
corporate governance? /3plain your answer.
/ere compliance with applicable laws, rules, and regulations will not guarantee
effective corporate governance, since those measures cannot change the culture
within an organi1ation. Thus, companies should integrate the best practices
suggested b& investor activists and professional organi1ations into their corporate
governance structure. *ffective corporate governance can onl& be achieved when
all participants( (1) add value to the compan&s sustainable long-term
performance (!) effectivel& carr& out their fiduciar& dut& and professional
responsibilities (#) are held accountable and personall& responsible for their
performance and (%) develop a practice of not onl& compl&ing with applicable
regulations, but also committing to doing the right thing, observing ethical
principles of professional conduct in avoiding potential conflicts of interest, and
acting in the best interests of the compan& and its shareholders.
1-. What are some reasons for integrating corporate governance an! business ethics
e!ucation into the business curriculum?
The following are reasons for integrating corporate governance and business
education into the business curriculum( (1) reported financial scandals (e.g.,
<
*nron, :orld0om, 9lobal 0rossing, 2delphia, ?west) underscore the importance
of vigilant corporate governance and ethical conduct b& corporations (!) the
)arbanes-3"le& 2ct of !;;! ()34) is intended to improve corporate governance
b& enforcing more accountabilit& for public companies and re'uiring adoption of
a code of ethics for their e"ecutives (#) anecdotal evidence and academic studies
suggest that corporate governance and business ethics are not properl& integrated
into business education, and coverage of these issues should be increased
(%) teaching and research in corporate governance and business ethics have been
strongl& recommended and encouraged (<) there is an inventor& of support
materials for teaching business ethics and corporate governance in the post-*nron
era. There are sufficient resources (te"tbooks such as this book, published articles,
Internet :eb sites, videos) to offer a stand-alone course or integrate business
ethics and corporate governance modules throughout accounting courses (@) it is
easier to obtain administrative support to offer business ethics and corporate
governance courses in the post-)34 era (A) several business schools have
developed innovative strategies for engaging students in the challenge of
providing ethical leadership b& focusing on both positive and negative e"amples
of ever&da& conduct in business (B) there is an increasing trend toward
incorporation of business ethics and corporate governance education into the
business curriculum worldwide (C) accounting programs should integrate
provisions of )34 on corporate governance, financial reporting, and audit
functions into the curriculum (1;) corporate governance has evolved from
compliance re'uirements to a business imperative (11) the 7ational 2ssociation
of )tate =oards of 2ccounting (72)=2), in its *"posure .raft of Dniform
2ccounting -ules <-1 and <-! regarding 72)=2 1<;-hour education,
emphasi1ed the need for si" semester credit hours in ethical and professional
responsibilities and (1!) the 2ssociation to 2dvance 0ollegiate )chools of
=usiness International (220)=) has promoted the integration of business ethics
and corporate governance into the business curriculum.
11. 8s note! in the te3t. corporate governance has no universally accepte!
!efinition. 5efine corporate governance an! e3plain your !efinition.
:ithin a dispersed ownership structure, corporate governance is a process
affected b& legal, regulator&, contractual, and market-based mechanisms and best
practices to create substantial shareholder value while protecting the interests of
other shareholders. In a capital structure where there is a concentrated ownership
and a small group of shareholders can e"ercise ownership control, corporate
governance should ensure alignment of the interests of controlling shareholders
with those of minorit& or individual shareholders.
12. 2he following is a list of eight entities an! conventional systems that shape
corporate governance. >rovi!e e3amples of how or what they have !one.
a. ?e!eral legislation
-ules and regulations set forth b& 0ongress provide guidance as to the operation
of corporate governance in publicl& traded companies. 2n e"ample would be the
)arbanes-3"le& 2ct of !;;!, which dramaticall& affected corporate governance
guidelines both in the Dnited )tates and around the world.
b. 'tate statutes
@
)tate statutes affect the wa& public organi1ations e"ecute corporate governance
within a particular state. In con$unction with federal guidelines, state statutes can
provide additional guidance on corporate governance through corporate charters.
c. '/C regulation
The )*0 rules and regulations provide guidance for publicl& traded companies in
corporate governance. The )*0, in con$unction with the 8ublic 0ompan&
2ccounting 3versight =oard (8023=), provides these guidelines to increase the
effectiveness of corporate governance.
!. 2he courts
The courts ma& at times set legal precedents through the interpretation of those
rules and regulations set forth b& 0ongress, the )*0, and the 8023=. These
courts, in effect, give publicl& traded companies guidance on how to adhere to
corporate governance rules and regulations.
e. 7isting stan!ar!s
6isting standards of national stock e"changes also provide guidance on corporate
governance for organi1ations attempting to list on those e"changes. 3ften, an
organi1ation must adhere to certain corporate governance guidelines set forth b&
the stock e"change before the organi1ation would be eligible to list on that
e"change.
f. 6nvestor activists
Investor activists fight for investor rights and serve as watchdogs to ensure that
organi1ations are protecting those rights. Investor activists ma& push certain
corporate governance practices in order to increase the 'ualit& of corporate
governance within an organi1ation.
g. 6nvestors
Investors, like investor activists, ma& aid in monitoring the operations of a
compan&. 2nd similar to investor activists, investors ma& push certain corporate
governance practices in order to increase the 'ualit& of corporate governance
within an organi1ation.
h. (ther corporate governance participants
3ther corporate governance participants, such as corporate governance
gatekeepers, ma& aid in monitoring the corporate governance practices within an
organi1ation. These participants ma& aid the others in influencing man& aspects of
corporate governance within different organi1ational settings.
13. 2he book mentions many e3amples of the give0take relationship between
corporations an! society. What are some other e3amples of the
corporation@society relationship? >rovi!e a minimum of three e3amples.
3ne e"ample of this relationship could be found in a manufacturing plant
environment in which the manufacturing process is such that ha1ardous emissions
are released into the atmosphere. The corporation is able to suppl& $obs for those
in the area, but the& ma& have to live close to the plant and be sub$ect to harmful
emissions. 2nother e"ample can be found in the pricing polic& of man&
corporations. 0orporations ma& need to price a certain product high enough to
cover costs, but this price ma& make the product unavailable to those who need it
most. )hould the corporation decrease its price, it could become insolvent. )hould
it maintain its price, those who need the product most ma& have to do without it.
A
Eet another e"ample of the give-take relationship between corporations and
societ& is the compensation polic& of management within an organi1ation. )uch
compensation should be high enough to attract highl& 'ualified individuals, but
should not be so e"orbitant that it becomes a detriment to the shareholders of the
organi1ation.
1. 5iscuss the significance an! importance of investors Asharehol!ersB as the first
tier of the stakehol!er hierarchy.
)hareholders are the primar& stakeholders without them the compan& would not
e"ist. /an& argue that the primar& purpose of the compan& is to ma"imi1e
shareholder wealth. Thus, the compan&s corporate governance structure should
reduce the agenc& costs raised from the separation of ownership and control b&
aligning the interests of management with those of shareholders. )hareholders
provide capital to the compan& in return for sustainable return on their investment
in terms of periodic dividends and stock price appreciations. 8a&ment of
dividends reduces the amount of discretionar& funds available to management
and, thus, can be used as a deterrent to opportunistic managerial behavior and as a
vehicle for controlling management actions. )hareholders participate and shape
the compan&s corporate governance structure b& e"ercising their voting rights to
elect the members of the board of directors who are directl& responsible to protect
their interests and are ultimatel& accountable to them for the compan&s business
affairs.
2rue@?alse
1. Investors are taking a more active role in their financial future through private
investments in the securities markets.
!. The involvement of the board of directors, audit committee, management, and
auditors is considered a value-adding function.
#. Investors should not and do not rel& on financial reports for decision making
purposes.
%. The board of directors is elected b& shareholders and is responsible for hiring the
appropriate management to operate the dail& compan& operations.
<. -ecent accounting scandals helped to boost the publics confidence and trust in
financial disclosures presented in financial reports.
@. 2 corporate gatekeeper is assigned to ensure that onl& authori1ed individuals are
allowed in the corporate offices.
A. 0ompanies with a well-defined corporate governance structure are more likel& to
restate their earnings than companies with no corporate governance structure.
B. 0orporate governance has one worldwide accepted definition, +To promote corporate
fairness, transparenc&, and accountabilit&.,
C. /arket correction mechanisms are preventive measures initiated prior to abuse and
loss.
1;. 0orporate governance regulations will continue to be a leading discussion among
polic& makers, stakeholders, and corporate activists even as changes are made.
11. )arbanes-3"le& applies to both public and private companies with annual revenues
F1; million or greater.
1!. Integrit& in the e'uit& market and restored investor confidence are both primar&
B
purposes of the )arbanes-3"le& 2ct.
1#. 0ompliance is compliance and a compan& does not need to establish a compliant
culture from the top down.
1%. 5inancial markets pla& an important role in creating safe, efficient, and the most
competitive capital markets to ensure economic growth, low costs of capital,
entrepreneurship, innovation, and $ob creation.
1<. The preservation of the integrit&, reputation, and efficienc& of the capital markets is
not the responsibilit& of all capital market participants.
1@. The free enterprise s&stem in the Dnited )tates is characteri1ed b& a dispersed capital
ownership structure.
1A. -ecent reported financial scandals prove that market mechanisms b& themselves ma&
not be ade'uate to monitor, control, and discipline business affairs, and corporate
governance reforms are needed to correct the perceived failures of market
mechanisms.
1B. The improvement in public trust and investor confidence in corporate 2merica, its
financial reports, and capital markets is of no concern or priorit& to public companies.
1C. )hareholders who invest capital in D.). companies are often close b& distance or
knowledge to those managing corporations.
!;. 0orporations in the Dnited )tates are viewed as creators of value for all concerned
stakeholders.
!1. 2ll stakeholders are provided with incentives and opportunities to reward
corporations for good performance and discipline them for poor performance.
!!. The first tier of stakeholder hierarch& is investors or shareholders who own the
compan&.
!#. The e"tent to which an organi1ation derives its funding from e'uit& or debt does not
significantl& affect the business decisions of the compan&.
!%. The sustainabilit& and financial health of public companies, public trust, and investor
confidence in financial reports pla& a crucial role in the integrit& and efficienc& of the
capital markets and the economic growth and prosperit& of the nation.
!<. -eliabilit&, accurac&, and transparenc& of financial information do not pla& a vital
role in the efficienc&, integrit&, and safet& of the capital markets.
!@. The primar& role of all corporate governance participants, as defined in this book,
should center around the fundamental theme of protecting shareholders, restoring
investor confidence, and supporting strong and efficient capital markets.
!A. 2 compliance culture re'uires the establishment and implementation of proper
programs, policies, and procedures to effectivel& compl& with applicable regulations,
laws, rules, standards, and best practices.
!B. 0ompanies that are well governed will usuall& outperform poorl& governed
companies and will be able to attract investors to help finance further growth.
!C. )hareholders are a t&pe of stakeholder.
#;. The board of directors is held personall& liable for all damages caused b& decisions
that resulted in unsuccessful conclusions.
#1. 0orporations in the Dnited )tates are viewed as destro&ers of value for all concerned
stakeholders.
#!. The relationship between corporations and societ& is contractual and is demonstrated
C
b& a giveGtake scenario.
2rue@?alse
1. True
!. True
#. 5alse
%. True
<. 5alse
@. 5alse
A. 5alse
B. 5alse
C. 5alse
1;. True
11. 5alse
1!. True
1#. 5alse
1%. True
1<. 5alse
1@. True
1A. True
1B. 5alse
1C. 5alse
!;. True
!1. True
!!. True
!#. 5alse
!%. True
!<. 5alse
!@. True
!A. True
!B. True
!C. True
#;. 5alse
#1. 5alse
#!. True
=ultiple Choice
1. Which of the following is not crucial to the integrity an! efficiency of capital
markets an! economic growth?
a. )ustainabilit& and financial health of public companies.
b. 8ublic trust.
c. High stock prices.
d. Investor confidence.
2. 6nvestors shoul! rely on which of the following to make rational. informe!
investment !ecisions?
1;
a. 2ccurate financial statements and reports.
b. 5ormer emplo&ees.
c. Internet +blogs, and message boards.
d. Insider information.
3. >C8(; stan!s for9
a. 8opular 0ompan& 2ccounting 3versight =oard.
b. 8ublic 0ompan& 2ccounting 3versight =oard.
c. 8ublic 0ompan& 2ccounting 3versight =ulletin.
d. 8opular 0ompan& 2ccounting 3versight =ulletin.
. Conflicts of interest among corporate governance participants are referre! to
as an9
a. +2n&thing &ou can do, I can do better, problem.
b. 2lignment problem.
c. 2genc& problem.
d. There are no conflicts of interest among corporate governance participants.
#. 2he primary mission of a public company is to9
a. /ake mone& now without planning for the future.
b. Ieep management happ&.
c. 0reate sustainable and enduring corporate value.
d. -emain idle and complacent with current performance.
%. >ublic companies are re"uire! to comply with all of the following except9
a. 5ederal and state laws and regulations.
b. 6isting standards of their respective e"change.
c. =est practices of leading competitors.
d. 2ll of the above re'uire compliance.
&. Which of the following woul! be an e3ample of a corporate gatekeeper?
a. Independent and competent board of directors.
b. Independent and competent e"ternal auditor.
c. 3b$ective and competent legal counsel or financial advisor.
d. 2ll of the above would be an e"ample of a corporate gatekeeper.
*. 2he improvement of corporate governance an! financial reporting by '()
shoul! a!! the following benefits except9
a. Improved investor confidence.
b. Increased firm value.
c. .ecreased cost of capital.
d. Increased audit fees.
+. 2he ?e!eral 'entencing Cui!elines re"uire9
a. )wift and harsh penalties.
b. 0ompliance and ethics training.
c. 0ompanies to eliminate incentives for ethical performance.
d. /artha )tewart treatment for all financial statement frauds.
1-. 2he elements of a multiple bottom line A=;7B approach are economic. social.
ethical. an!9
a. *'uit&.
b. *nvironmental.
c. *ccentricit&.
11
d. 7one of the above.
11. 8 compliance culture can be promote! through the establishment of a
centrali,e!9
a. 0hief e"ecutive officer.
b. 0hief governance officer.
c. 0hief compliance officer.
d. =oard of directors.
12. =ultiple0bottom0lines focus on9
a. Improving internal control over financial reporting.
b. *nhancing organi1ational disclosures concerned with social, environmental,
and ethical issues.
c. 0reating and sustaining effective corporate structure.
d. -eporting on the man& ventures in which the organi1ation is involved.
13. Congress passe! the 'arbanes0(3ley 8ct of 2--2 to9
a. *nhance the burden of financial reporting.
b. *stablish a new regime of investor protection.
c. Increase the workload of auditors of public companies.
d. 8rovide more protection to the managers of public companies.
1. Which of the following !oes not effectively characteri,e the post0'() era9
a. 2 change in the regulator& framework for the auditing profession through the
establishment of the 8023=.
b. The move toward more transparent and timel& financial reports.
c. 2 redefining of roles and responsibilities of those who are directl& or indirectl&
involved in the financial reporting process.
d. The reduction of the importance and role of ethics within publicl& traded
companies.
1#. 'uppliers an! customers rewar! goo! corporate performance by9
a. 2ctivel& and favorabl& doing business with the compan&.
b. Investing in the compan& at the lower desired rate of return of investment.
c. .isinvesting or demanding a higher rate of return on their investment.
d. 9iving e"tra benefits to the management of the compan&.
1%. 2he primary mission of public companies is regar!e! as9
a. -eporting increasing revenues.
b. .ecreasing unemplo&ment rates.
c. 0reating sustainable and enduring value.
d. .ecreasing costs.
1&. 2he primary stakehol!ers are9
a. 0ustomers.
b. )uppliers.
c. )hareholders.
d. 0reditors.
1*. 'harehol!ers own corporations an! the DDDDDDDDDDDDDD is electe! to make
business !ecisions on behalf of sharehol!ers.
a. 0hief e"ecutive officer.
b. =oard of directors.
c. 0hief compliance officer.
1!
d. 6egal counsel.
1+. Which of the following are consi!ere! to be the secon!0tier stakehol!ers in the
company?
a. 6enders and creditors.
b. 0ustomers and suppliers.
c. )hareholders.
d. 9overnmental oversight bodies (e.g., 8023=, )*0).
2-. Which of the following are not consi!ere! thir!0tier stakehol!ers?
a. *mplo&ees.
b. 0ustomers.
c. )uppliers.
d. 0reditors.
21. Which of the following is not a key corporate gatekeeper?
a. =oard of directors.
b. *"ternal auditor.
c. 9overnmental oversight bodies (e.g., 8023=, )*0).
d. 6egal counsel.
22. Catekeepers shoul!9
a. =e emplo&ees of the compan& and use their internal insight to effectivel& monitor
corporate governance practices.
b. 2ccept the representations of management on full faith.
c. =e full& independent from the compan&.
d. 5ulfill their professional responsibilit& to the management of the compan&.
23. /ffective corporate governance !oes all of the following e3cept9
a. *nsure corporate accountabilit&.
b. *nhance the integrit& and efficienc& of the capital market.
c. *liminate the prospect of fraud within an organi1ation.
d. *nhance the reliabilit& and 'ualit& of public financial information.
2. With the DDDDDDDDDDD the primary goal is to achieve economic performance.
while proper consi!eration is given to other measures inclu!ing social. ethical.
an! environmental A'//B issues.
a. /ultiple bottom lines (/=6) ob$ectives.
b. 8023= 2uditing )tandards.
c. )*0 5inal )tatements.
d. 9enerall& 2ccepted 2ccounting 8rinciples (9228).
2#. 2he goal of corporate governance an! business ethics e!ucation is to9
a. Teach students their professional accountabilit& and to uphold their personal
integrit& to societ&.
b. 0hange the wa& in which ethics is taught to students.
c. 0reate more ethics standards b& which corporate professionals must operate.
d. Increase the workload for accounting students.
2%. 2he relationship between public companies an! sharehol!ers. cre!itors.
au!itors. etc. is9
a. /arital.
b. 0ontractual.
c. 6egall& nonbinding.
1#
d. There is no relationship.
2&. 8n a!vantage of a corporation is9
a. 6imited liabilit& for the owners.
b. Dnlimited life of the corporation.
c. *ase of transferabilit& of ownership interests.
d. 2ll are advantages of a corporation.
2*. 2he secon! tier of the stakehol!er hierarchy consists of all of the following
e3cept9
a. 0reditors.
b. *mplo&ees.
c. )hareholders.
d. )uppliers.
2+. C88> stan!s for9
a. 9enerall& 2ccepted 2ccounting 8rocedures.
b. 9enerall& 2bnormal 2ccounting 8rocedures.
c. 9enerall& 2ccepted 2ccounting 8rinciples.
d. 9enerall& 2bnormal 2ccounting 8rinciples.
3-. 2he ultimate responsibility for maintaining an appropriate balance between
management an! the owners rests with9
a. =oard of directors.
b. /anagers.
c. )hareholders.
d. -egulating entities.
=ultiple Choice
1. c.
!. a.
#. b.
%. c.
<. c.
@. c.
A. d.
B. d.
C. b.
1;. b.
11. c.
1!. b.
1#. b.
1%. d.
1<. a.
1@. c.
1A. c.
1B. b.
1C. a.
!;. d.
!1. c.
1%
!!. c.
!#. c.
!%. a.
!<. a.
!@. b.
!A. d.
!B. c.
!C. c.
#;. a.
Chapter 2
Review Questions
1. What are the three :legs< of the corporate governance structure !iscusse! in
Chapter 2?
0orporate governance aspects, corporate governance principles, and corporate
governance functions.
2. What is the un!erlying focus of the sharehol!er aspect of corporate governance?
Jalue creation for the shareholder through corporate governance effectiveness.
3. What types of managerial failures prevent management from acting in the best
interest of the sharehol!ers?
5ailure of managerial competence resulting from unintentional mistakes or
negligence in discharging fiduciar& duties.
5ailures of managerial integrit& caused b& willful or opportunistic behaviors
(fraudulent activities, fabrications, embe11lement, illegitimate earnings
management) that have detrimental effects on the value of the firms assets.
. Ealue protection is the goal of which corporate governance aspect?
)takeholder corporate governance aspect.
#. What is corporate governance resilience an! how is it maintaine!?
0orporate governance resilience is the abilit& of a corporation to sustain and
recuperate from setbacks and abuses. It is maintained through the internal and
e"ternal mechanisms that the corporate governance structure of a compan&
implements to prevent, detect, and correct such setbacks and abuses.
%. What is corporate governance responsiveness?
0orporate governance responsiveness is the compan&s timel& and appropriate
response to the concerns, re'uests, or desires of investors, customers, emplo&ees,
auditors, suppliers, social responsibilit& activists, and other stakeholders.
&. /3plain corporate governance transparency.
Transparenc& is the notion that a compan& is openl& and coherentl& disclosing to
the public relevant corporate information.
*. What are the seven essential corporate governance functions?
The seven essential corporate governance functions are oversight, managerial,
compliance, internal audit, advisor&, e"ternal audit, and monitoring.
+. What are the roles an! responsibilities of insi!e an! outsi!e !irectors?
Inside directors usuall& provide e"ecutive services considered to be important in
improving the compan&s financial performance, whereas outside directors
1<
provide monitoring services, which are also important in aligning managements
interests with those of shareholders.
1-. What items are likely to be recor!e! in a corporate governance report?
0orporate governance reporting ideall& would include(
The compan&s vision, strategies, and missions in creating stakeholder value.
The board of directors composition, independence, involvements, functions,
and evaluation.
5inancial, economic, social, and environmental indicators.
11. What is the basic cause of corporate agency problems?
The separation of control and ownership is the basic cause of corporate agenc&
problems.
5iscussion Questions
1. What are the versions of corporate governance mechanisms? $ow are they
effective? $ow can they be ineffective?
Internal and e"ternal corporate governance mechanisms e"ist to aid and improve
corporate governance. Internal mechanisms are designed to manage, direct, and
monitor corporate activities in order to create sustainable and enduring
stakeholder value. *"amples of internal governance mechanisms are the board of
directors, particularl& independent directors, the audit committee, management,
internal controls, and internal audit functions. *"ternal governance mechanisms
are intended to monitor the compan&s activities, affairs, and performance to
ensure that the interests of insiders (management, directors, and officers) are
aligned with the interests of outsiders (shareholders and other stakeholders).
*"amples of e"ternal mechanisms are the capital market, the market for corporate
control, and the labor market, as well as state and federal statutes, court decisions,
shareholder proposals, and best practices of investor activists. These mechanisms
ma& be helpful in aligning management incentives with shareholder interests, and
also controlling management behavior. 0orporate governance mechanisms ma&
be ineffective in situations in which independence is removed, or in which
corporate governance participants fail to perform their duties.
2. 6!entify an! !efine the three aspects of corporate governance.
The shareholder aspect of corporate governance is the concept that the
corporation e"ists for the benefit of shareholders, and therefore, emphasi1es
shareholder value creation and enhancement as the primar& ob$ective of
corporations. The shareholder aspect of corporate governance is based on the
premise that shareholders provide capital to the corporation which e"ists for their
benefit. It supports the agenc& theor& that fiduciar& duties of corporate directors
and e"ecutives are to shareholders who have a residual claim on the compan&s
residual assets and cash flows. )hareholders (principals) provide capital to the
compan&, which is run b& management (agent). The principal-agent problem
e"ists because corporations are separate entities from their owners>management
needs ph&sical capital (investment funds) and investors need skilled human
capital to run the compan&. The stakeholder aspect of corporate governance is the
premise that a compan&s success depends on the contributions of investors and
1@
other ke& groups and how well it manages the relationships with those groups
which consist of shareholders, creditors, emplo&ees, supplies, customers, and
communities. The stakeholder model of corporate governance focuses on a
broader view of the compan& as a ne"us of contracts among all corporate
governance participants with the common goal of creating value. The emerging
model concentrates on ma"imi1ation for all stakeholders, including(
(1) contractual participants such as shareholders, creditors, suppliers, customers,
and emplo&ees and (!) social constituents including the local communit& societ&
and global partners local, state, and federal governments and environmental
matters. Dnder this view, public companies must be sociall& responsible>good
citi1ens granted the use of the nations ph&sical and human capital, managed in
the public interest. The integrated aspect of corporate governance focuses on both
shareholder value creation and enhancement and stakeholder value protection.
/odern corporate governance emphasi1es both financial aspects of increasing
shareholder value and an integrated approach that considers the rights and
interests of all stakeholders. 0orporate governance should be viewed as a d&namic
and integrated approach of addressing financial, social, environmental, and
economic concerns of all stakeholders.
3. What entities or groups of in!ivi!uals are responsible for the oversight.
managerial. an! monitoring functions. an! what are their basic responsibilities
an! !uties?
The oversight function is the responsibilit& of the board of directors, which is
charged with the fiduciar& dut& of overseeing the managerial function in the best
interests of the compan& and its shareholders. The managerial function is the
responsibilit& of management, which is charged with the responsibilit& of running
the compan& and managing its resources, operations, and disclosures of relevant
and reliable financial and nonfinancial information. The monitoring function is
the responsibilit& of shareholders, particularl& institutional shareholders, who are
empowered to elect and, if warranted, remove directors. )hareholders can
influence corporate governance through their proposals and nominations to the
board of directors. )hareholders elect directors, and directors appoint officers to
manage the compan&. 3ther stakeholders such as creditors, emplo&ees, financial
anal&sts, and investor activists can also affect corporate policies and practices.
. Compare an! contrast the internal an! e3ternal au!it functions.
The internal audit function provides both assurance and consulting services to the
compan& in the areas of operational efficienc&, risk management, internal
controls, financial reporting, and governance processes. The e"ternal audit
function is performed b& e"ternal auditors in e"pressing an opinion that financial
statements trul& and fairl& represent, in all material respects, the compan&s
financial position and the results of operations in conformit& with 9228.
*"ternal auditors lend credibilit& to the compan&s financial reports and thus add
value to its corporate governance through their integrated audit of both internal
control over financial reporting and financial statements. =oth parties provide
assurance and both ma& aid in the audit of financial statements. However, e"ternal
auditors are independent and work to provide assurance to shareholders, while
internal auditors are not independent, and work to provide assurance to
1A
management.
#. 2he te3t notes that corporate governance reforms have re!uce! many potential
conflicts of interest among corporate governance participants inclu!ing
!irectors. management. au!itors. financial analysts. corporate counsel. an!
investors. What conflicts of interest are possible among these groups?
0onflicts of interests ma& arise among directors, management, auditors, financial
anal&sts, corporate counsel, and investors in instances in which personal goals of
such participants are at odds with those of others. 5or e"ample, conflicts of
interest ma& arise among management and shareholders or the board of directors
as to the operation of the organi1ation. 2lso, management ma& e"perience
conflict with corporate gatekeepers acting on behalf of the shareholders, such as
auditors, corporate counsel, and the board of directors.
%. 8s an investor. woul! you fin! use in corporate governance reports? /3plain.
0orporate governance reporting reports the effectiveness, responsiveness, and
credibilit& of an organi1ations corporate governance measures. 0orporate
governance measures and performance indicators that could be included in 09-
are( (1) descriptions of an organi1ations culture, appropriate tone at the top,
board of directors, internal controls, and commitment to economic, social, and
environmental goals (!) ma$or risks facing the organi1ation in achieving its
economic, social, and environmental goals and measures taken to address such
risks (#) the percentage of the board of directors who are independent and
none"ecutive directors (%) the e"istence of an audit committee comprising all
independent and financiall& literate directors (<) the ade'uac& of internal
controls (@) corporate governance principles and mechanisms to which the
organi1ation adheres and (A) the status of the organi1ations compliance with
applicable laws, rules, regulations, and standards, and disclosure of areas of
noncompliance. 2ll of these reported phenomena would be helpful in assessing
the future viabilit& of the organi1ation.
&. 4se your research skills to search the 6nternet for information regar!ing the
most recent C=6 ratings. 5o the ratings show an improvement in corporate
governance proce!ures? ;riefly comment on your fin!ings.
Information on recent 9/I ratings ma& be found at www.gmiratings.com or via
the use of a popular Internet search engine.
*. =any :best practices< are mentione! in the te3t. Which three best practices !o
you agree with an! which three best practices !o you !isagree with? /3plain.
2nswers will var&. 0orporate governance best practices suggested b& professional
organi1ations and investor activists are nonbinding corporate governance
guidelines intended to improve corporate governance policies and practices of
public companies above and be&ond state and federal statutes and listing
standards.
+. 6n your own wor!s. what is honesty?
2nswers will var&. Honest& means telling the truth at all times, regardless of the
conse'uences. Honest& is important in establishing a trusting relationship among
all corporate governance participants. This also means that corporate
communications with both internal and e"ternal audiences, including public
financial reports, should be accurate, fair, transparent, and trustworth&. 2
1B
reputation for honest& can be earned over time through truthful and transparent
corporate communication, and it can be easil& destro&ed through lies, deceptions,
malfeasance, concealments, and fraud.
1-. $ypothetically. what are the agency problems that e3ist in your work an! school
environment?
2nswers will var&. 8ossible agenc& problems ma& arise between corporate
governance participants with differing goals and ob$ectives. 2genc& problems
within a school ma& arise from differing goals and ob$ectives between those
funding the school and those actuall& running the da&-to-da& operations in the
school.
11. >erform an 6nternet search for the 'ecurities 8cts of 1+33 an! the 'ecurities
/3change 8ct of 1+3. What are some of the key provisions of these acts?
Internet information on these acts of legislation ma& be found at
sec.gov/about/laws.shtml. These 2cts are primaril& disclosure-based statutes that
re'uire public companies to file a periodic report with the )*0 and disclose
certain information to their shareholders to make investment and voting decisions.
12. 8re internal or e3ternal corporate governance mechanisms more influential to
the effectiveness of corporate governance? 5efen! your answer.
2 proper balance between internal and e"ternal corporate governance
mechanisms must be present in order to ensure the effectiveness or corporate
governance. Internal mechanisms are designed to manage, direct, and monitor
corporate activities in order to create sustainable and enduring stakeholder value.
:ithout proper internal mechanisms, lack of vigilance b& the board of directors
ma& result. *"ternal governance mechanisms are intended to monitor the
compan&s activities, affairs, and performance to ensure that the interests of
insiders (management, directors, and officers) are aligned with the interests of
outsiders (shareholders and other stakeholders). :ithout proper e"ternal
mechanisms, investors ma& not be ade'uatel& protected.
13. Which approach !o you prefer9 principles0base! or rules0base!? Why?
2nswers will var&. The principles-based approach emphasi1es operating within
the +spirit of the law,, whereas the rules-based approach emphasi1es abiding b&
the +letter of the law., The rules-based approach ma& be useful in promoting
uniformit& and clarit& in the application of regulations pertaining to corporate
governance, but ma& be inconclusive in some areas and allow sub$ects to deviate
from the principle of the law without violating the letter of the law. The
principles-based approach promotes the principles upon which organi1ations
should base their corporate governance, but ma& be less clear and provide less
uniformit& between firms than rules-based regulation.
1. 'earch the 6nternet for the '/C1s comments on which metho! they prefer.
Internet information on the )*0s comments regarding rules-based and
principles-based regulation ma& be found at( sec.gov. The )*0 seems to largel&
embrace the principles-based approach for creating legislation. In this manner, the
principles of the law are promoted so that organi1ations will not $ust have a
+check-bo", compliance mentalit&. 3rgani1ations ma& be prone to follow the
principles underl&ing regulations in a principles-based regulation than in a rules-
based counterpart.
1C
1#. 5iscuss the a!vantages an! !isa!vantages of both a regulatory0le! an! a
sharehol!er0le! approach to corporate governance.
In the D.)., corporate governance reforms are influenced b& a combination
of state laws, federal laws, and regulations, listing standards of national stock
e"changes, and best practices of professional organi1ations. This approach to the
development of corporate governance reforms is often referred to as a regulator&-
led s&stem. )tate laws govern the internal mechanisms of corporate governance
including directors duties and shareholder rights whereas polic&makers,
regulators, stock e"changes, and best practices pla& an important role in the
governance of listed companies. This regulator&-led approach has a tendenc& of
promoting a rules-based approach to corporate governance reforms. The
advantages of this approach are( (1) more enforceable compliance procedures and
(!) 'uicker regulator& response to assess and correct corporate governance
ineffectiveness and breakdowns.
In the D.I., the government allows the market to establish corporate
governance best practices, leading to the development of the 0ombined 0ode
which re'uires a +compl&-or-e"plain, approach to corporate governance. This
approach is referred to as a shareholder-led approach to good corporate
governance primaril& because shareholders pla& an active role in its development.
The primar& advantage of this approach is that it is regarded as a principles-based
or a self-regulator& approach to good governance with the main theme of compl&-
or-e"plain with lower compliance costs. The primar& disadvantage is that it is less
enforceable and mainl& relies on the abilit& of shareholders to monitor boards
through rights accorded to them in compan& legislation. 2 regulator&-led
approach can be effective in building overall market confidence, whereas a
shareholder-led approach promotes more scalable corporate governance.
2rue or ?alse
1. 2ll public companies have the same structure for their corporate governance.
!. *"amples of e"ternal governance mechanisms are the board of directors, the audit
committee, management, internal controls, and internal audit functions.
#. The three aspects of corporate governance are integrated, shareholder, and
stakeholder.
%. Jalue creation is the primar& goal of the stakeholder aspect.
<. )hareholders are a t&pe of stakeholder.
@. The integrated aspect combines the shareholder and stakeholder aspects but puts
emphasis on the shareholder aspect.
A. Honest& means telling the truth when it is most beneficial to the compan&.
B. )hareholders are primaril& responsible for the monitor& function of corporate
governance.
C. 2n important principle of effective corporate governance is its transparenc& of not
onl& financial information, but also operations and structures.
1;. The board of directors is held personall& liable for all damages caused b& decisions
that resulted in unsuccessful conclusions.
11. 0orporate governance reporting is now re'uired b& all public companies due to the
!;
)arbanes-3"le& act of !;;!.
1!. 9overnance rating agencies ma& be held liable for investors decisions and be
re'uired to pa& damages.
1#. )eparation of control and ownership is the primar& cause of agenc& problems.
1%. 2n e"ample of a market correction mechanism would be a dissatisfied shareholder
selling off his or her shares in a corporation.
1<. -ules-based corporate governance is considered the +spirit of the law, approach.
1@. )ecurities laws set minimum re'uirements for companies offering securities to the
public and re'uire investors to be presented with accurate, relevant, and useful
financial information.
1A. /70s are onl& influenced b& the home countr& when evaluating and developing their
corporate governance structure.
1B. There is no universall& accepted definition of corporate governance primaril& because
its concept is not well defined, it covers various distinct economic phenomena, and it
is often described from the shareholders view.
1C. The primar& purpose of corporate governance is to create and enhance long-term,
endurable, and sustainable management value.
!;. 0orporate governance has evolved from its role of reducing agenc& costs to creating
long-term shareholder value, and, recentl&, to increasing sustainable and enduring
value for all stakeholders.
!1. The shareholder aspect of corporate governance focuses on shareholder value creation
and the enhancement goal of corporate governance.
!!. The integrated aspect concentrates on both the shareholder value creation and
stakeholder value protection goals of corporate governance.
!#. The agenc& problem e"ists when the desires and interests of management and
shareholders are in accord and when there are no difficulties in verif&ing management
activities.
!%. In the real world, the agenc& problem can never be perfectl& solved, and agenc& costs
cannot be totall& eliminated.
!<. The 0*3, as representative of investors, has direct authorit& and responsibilit& to
govern business affairs and is accountable to investors for the compan&s strategic
performance.
!@. *"ecutive compensation should be linked to performance, be established and
approved b& the management of the compan&, and be given the advisor& approval of
the 0*3.
!A. There is no globall& accepted corporate governance structure.
!B. There is no globall& accepted set of corporate governance principles that can be
applied across a broad range of board structures, business practices, and legal,
political, and economic environments.
!C. Transparenc& means that the compan& is not hiding relevant information, and
disclosures are fair, accurate, reliable, and understandable b& average stakeholders.
#;. The use of ma$orit& voting as apposed to pluralit& voting substantiall& reduces the
abilit& and influence of shareholders over who is actuall& elected to the board.
!1
#1. The oversight function is granted to the board of directors with the fiduciar& dut& of
overseeing management in the best interests of the compan& and its shareholders.
#!. The managerial function is given to the board of directors in order to run the compan&
and manage its resources and operations.
##. The monitoring function is e"ercised b& shareholders (and particularl& institutional
shareholders who are empowered to elect, and if warranted, remove directors).
2rue or ?alse
1. 5alse
!. 5alse
#. True
%. 5alse
<. True
@. True
A. 5alse
B. True
C. True
1;. 5alse
11. 5alse
1!. 5alse
1#. True
1%. True
1<. 5alse
1@. True
1A. 5alse
1B. True
1C. 5alse
!;. True
!1. True
!!. True
!#. 5alse
!%. True
!<. 5alse
!@. 5alse
!A. True
!B. True
!C. True
#;. 5alse
#1. True
#!. 5alse
##. True
=ultiple Choice
1. 2he corporate governance structure of a company reflects the in!ivi!ual
companies19
!!
a. 0ultural and economic s&stem.
b. 6egal and business s&stem.
c. )ocial and regulator& s&stem.
d. 2ll of the above.
2. /3ternal governance mechanisms such as the capital market an! state an!
fe!eral regulations are !esigne! to9
a. Ieep companies from providing a large earnings-per-share.
b. 2lign the interests of insiders with the interests of outsiders.
c. 8rohibit corporate takeover efforts.
d. *nsure management makes budget.
3. Which of the following statements is not true concerning corporate governance
mechanisms?
a. The effectiveness of corporate governance mechanisms also depends on the cost-
benefit trade-offs among these mechanisms.
b. 0orporate governance mechanisms create effective s&stems of checks and
balances.
c. Internal and e"ternal mechanisms work best when used independentl& of the
other.
d. 7one of the above are true statements.
. 8ll of the following !escribe agency problems an! costs except9
a. The agenc& problem e"ists when the desires of management and shareholders are
not in accord.
b. 2genc& costs arise where there is +information as&mmetr&, between management
and shareholders.
c. 2genc& problems can be perfectl& solved and agenc& costs can be totall&
eliminated.
d. The agenc& problem e"ists when the compan&s board of directors fails to fulfill
their assigned oversight role.
#. Ealue protection is inten!e! to protect the interests of all stakehol!ers. 'uch
interests inclu!e9
a. 9overnment>ta" revenue.
b. *mplo&ee>$ob securit&.
c. )hareholder>wealth (stock appreciation and dividends).
d. 2ll of the above.
%. 8 well0balance! implementation of the seven corporate governance functions
shoul! not result in9
a. -esponsible corporate governance.
b. -eliable financial reports.
c. Harm to the compan&.
d. 0redible audit services.
&. Which of the following statements best !escribes the compliance function?
a. The compliance function is composed of a set of laws, regulations, rules, and
standards established b& state and federal legislators which are followed onl&
when beneficial.
b. 0ompliance is following &our internal b&laws and regulations.
c. The compliance function is composed of a set of laws, regulations, rules, and
!#
standards established b& state and federal legislators which must be followed
regardless of the cost.
d. 0ompliance is a nuisance that deters from the compan&s main goal of making
mone&.
*. 2he internal au!it function is least effective when the !epartment9
a. Is nonindependent.
b. Is competent.
c. Is ob$ective.
d. *"hibits integrit&.
+. Which of the following statements is true?
a. 2n e"ternal audit can be performed b& an&one with an accounting degree.
b. 2n e"ternal audit is re'uired for an& compan& with annual revenues greater than
F< million.
c. 2n e"ternal audit is designed to prove that the financial statements are wrong.
d. 2n e"ternal audit must be performed b& an independent, public accounting firm.
1-. Which of the following woul! be consi!ere! the least effective an! appropriate
best practice of a public company?
a. *"ecutive compensation programs should be designed and implemented to ensure
alignment of interest with the long-term interests of shareowners.
b. The 0*3 and chairperson of the board should be the same individual to allow for
the congruence of management and director interests.
c. The board of a publicl& owned corporation should have a substantial degree of
independence from management.
d. The board does not impose term limits, as this could unnecessaril& interfere with
the continuit&, diversit&, developed e"perience and knowledge, and long-term
outlook the board must have.
11. Corporate governance reports are recommen!e! to inclu!e all of the following
!isclosures except9
a. The compan&s vision, strategies, and missions in creating stakeholder value.
b. The board of directors composition, independence, involvements, functions, and
evaluation.
c. 0ompetitive trade secrets and research reports.
d. The compan&s financial, economic, social, and environmental indicators.
12. Which of the following is false concerning market mechanisms?
a. /arket mechanisms are used to monitor, control, and discipline business affairs.
b. /arket mechanisms are effective as the onl& control structure.
c. /arket mechanisms re'uire additional corporate governance reforms to provide
ade'uate controls.
d. /arket mechanisms were discussed as earl& as 1AA@.
13. 2he 'arbanes0(3ley 8ct of 2--2 provi!e! gui!ance for all of the following
except9
a. *"ecutive certifications of internal controls and financial statements.
b. 6imits on e"ecutive and director pa&.
c. 2udit committee oversight of financial reporting and audit activities.
d. .irector independence.
!%
1. Which of the following woul! be consi!ere! principles0base!?
a. )tep-b&-step directions for a temp worker.
b. =est practices.
c. D.). 9228.
d. )hareholder voting procedures.
1#. Corporate governance in the 4nite! 'tates is influence! by9
a. )tate and federal statutes.
b. 0ourt decisions.
c. 6isting standards and best practices.
d. 2ll of the above.
1%. 2he Combine! Co!e is the lea!ing corporate governance !irective for9
a. The Dnited )tates.
b. 9erman&.
c. The Dnited Iingdom.
d. Kapan.
1&. 2he corporate governance structure is shape! by9
a. Internal governance mechanisms.
b. External governance mechanisms.
c. Policy interventions through regulations.
d. All of the above.
18. An e3ample of an internal governance mechanism is aAnB9
a. )hareholder activist.
b. )hareholder proposal.
c. 2udit committee.
d. 5ederal statute.
1+. 2he ownership structure that may best characteri,e a situation in which a
typical sharehol!er may have little power to control the company1s affairs
beyon! voting power to elect members of the boar! of !irectors is9
a. 0entrali1ed ownership structure.
b. .ispersed ownership structure.
c. Two-tier ownership structure.
d. None of the above.
20. Un!er the DDDDDDDDDDDDD. both internal an! e3ternal corporate governance
mechanisms are inten!e! to in!uce managerial actions that ma3imi,e profit an!
sharehol!er value.
a. )hareholder theor&.
b. 2genc& theor&.
c. )takeholder theor&.
d. 0orporate governance theor&.
21. Which of the following is not a primary source of corporate governance in the
U.S.?
a. Federal securities laws.
b. Best practices.
c. Listing standards.
d. All of the above are primary sources of corporate governance in the U.S.
22. One of the obFectives of the 'arbanes0(3ley 8ct was to9
!<
a. Increase the cost of compliance with federal regulations.
b. 5orce foreign companies to delist from D.). capital market e"changes.
c. Improve the 'ualit& and transparenc& of financial reporting.
d. Increase the compliance burden for small companies.
23. Which of the following is false?
a. 8ublic companies do not usuall& report their corporate governance activities.
b. 0orporate governance reporting reports the effectiveness, responsiveness, and
credibilit& of an organi1ations corporate governance measures.
c. 0orporate governance reports are re'uired to be prepared in con$unction with the
annual 1;-k filed with the )*0.
d. 0orporate governance standards should be developed to assess, attest to, and
report on the 'ualit& and effectiveness of corporate governance.
2. Which of the following is not an aspect of corporate governance
reporting@!isclosures?
a. 5inancial position and earnings anal&sis.
b. 0ompensation polic& for directors and officers.
c. /aterial information on multiple bottom lines sustainabilit& performance.
d. /a$or share ownership and voting rights.
=ultiple Choice
1. d.
!. b.
#. c.
%. c.
<. d.
@. c.
A. c.
B. a.
C. d.
1;. b.
11. c.
1!. b.
1#. b.
1%. b.
1<. d.
1@. c.
1A. d.
18. c.
1C. b.
20. b.
21. d.
22. c.
!#. c.
!%. a.
Chapter 3
!@
Review Questions
1. What are the three ethical classifications an! their purposes !iscusse! by the
author?
/etaethics(
5ocus on ethical theories, their evolution, and the social, religious,
spiritual, and cultural influences shaping those theories.
7ormative ethics(
*mphasi1e the practical aspects of ethics b& providing principles of
appropriate behavior and guidance for what is right and wrong, good or
bad in behavior (e.g. principles of $ustice, honest&, social benefits, and
lawfulness).
2pplied ethics(
.eal with the application of moral principles and reasoning as well as
codes of conduct for a particular profession or segment of the societ& (e.g.
business ethics, environmental ethics, and medical ethics).
2. What factors can lea! to a company engaging in corporate miscon!uct of
misrepresenting their financial position?
8erformance is below their industr&s average performance.
8erformance is significantl& above their own past performance.
Their 0*3 receives a high proportion of total compensation as stock options.
3. /3plain the terms of the phrase :organi,ational ethical culture.<
3rgani1ation is defined as a group of individuals or entities bound to achieve
a shared goal.
*thics are honorable behavior conforming to the norm of the group.
0ulture is a pattern of shared beliefs adopted b& the group in dealing with its
internal and e"ternal affairs.
. ?rom start to finish. what are the steps re"uire! to make an ethical !ecision?
The process of making ethical decisions starts with the commitment to do the
right thing b&( (1) recogni1ing the relevant issue, event, or decision (!) evaluating
all alternative courses of action and their impacts on ones well-being as well as
the well-being of others possibl& affected b& the decisions (#) deciding on the
best course of action available (%) consulting appropriate ethical guidance
(<) continuousl& assessing the conse'uences of the decision and adopting
appropriate changes and (@) implementing the decision.
#. What are situational ethics?
)ituation ethics are a moral pattern allowing circumstances to overrule principle
and allegiance where principle means definable moral, criminal, or civil law and
allegiance means group lo&alt&.
%. What are the attributes of an ethical culture?
sense of emplo&ee responsibilit&.
freedom to raise concerns without fear of retaliation.
managers modeling ethical behavior and e"pressing the importance of
integrit&.
an understanding b& leadership of the pressure points that drive unethical
!A
behavior.
processes to find and fi" these areas of pressure.
&. What is meant by the term ethics sensitivity?
It is the moral principles, workplace factors, gamesmanship, lo&alt&, peer
pressure, and $ob securit& that influence ones ethical decisions and are derived
from the organi1ations ethical culture.
*. /3plain the sources of incentives for ethically base! behavior.
individual-based incentives.
organi1ation-based incentives.
market-based incentives.
profession-based incentives.
regulator&-based incentives.
+. /3plain organi,ation0base! incentives an! profession0base! incentives.
3rgani1ation-based incentives(
0ome from setting an appropriate tone at the top and establishing,
maintaining, and enforcing ethical behavior throughout the organi1ation.
9o be&ond promoting corporate values of integrit&, fairness, and honest&.
Include a set of principles that re'uire ethical behavior.
8rofession-based incentives(
8rofession-based incentives are defined b& a professional affiliation of
individuals.
8rofessional codes of conduct serve as a reference and a benchmark for
individuals, establish rules of conduct relevant to the profession, and provide a
means of facilitating enforcements of rules and standards of conduct.
1-. What is meant by the term :ethical behavior<?
It is the process of recogni1ing ethical issues, considering all alternative courses
of action, referring to ethical incentives to guide the best actions, evaluating the
conse'uences of ethical decisions, and proceeding with confidence.
11. What are the si3 principles of business ethics an! con!uct?
0ompl& with a written code of business conduct.
8rovide sufficient training to all personnel within their organi1ation regarding
personal responsibilit& under the code.
*ncourage internal reporting of violations of the code with the promise of no
retaliation for such reporting.
)elf-govern their activities b& implementing controls to monitor compliance
with all applicable laws and regulations.
)hare their best practices in implementing the .II principles through
participation in an annual =est 8ractices 5orum.
=e accountable to the public, particularl& through the completion of an annual
8ublic 2ccountabilit& ?uestionnaire.
5iscussion Questions
1. What are ethics? /3plain.
*thics are broadl& described in the literature as moral principles about right and
!B
wrong, honorable behavior reflecting values, or standards of conduct. Honest&,
openness, responsiveness, accountabilit&, due diligence, and fairness are core
ethical principles. *thics are a branch of philosoph& with no clear-cut definition
of what behaviors are ethical and which are unethical when $udging ones
behavior. There is no general or global consensus for defining ethical behavior for
individuals, as it ma& change from time to time and from one place to another
place. There is no universal measure or standard as to what constitutes ethical
behavior. =usiness ethics are most simpl& described as( a process of promoting
moral principles and standards that guide business behavior.
2. 5o you believe moral principles an! ethics are a part of family values which
cannot be taught? 'ubstantiate your answer.
=usiness ethics can be promoted and taught to improve professional reputation,
accountabilit&, integrit&, $udgment, and other 'ualities of the business decision-
making process. )etting the appropriate +tone at the top, promoting ethical
organi1ation, culture, and policies can effectivel& influence individuals behavior.
Teaching business ethics should provide incentives, opportunities, and
rationali1ation for individuals, particularl& professionals, to uphold their personal
integrit& and professional accountabilit&.
3. Companies that !o not have a co!e of ethics must either establish such a co!e or
!isclose why they have not implemente! a co!e. What factors woul! lea! a
company to not !evelop a co!e of ethics?
8ublic companies that do not have a code of ethics must establish a code that
meets the re'uirements of the )*0 final rule. 8ublic companies with an e"isting
code of ethics must ensure that their e"isting code satisfies )*0 re'uirements or
otherwise revise their code to meet the re'uirements if not, the& must be prepared
to disclose wh& the& have not adopted a 'ualif&ing code of ethics. Inabilit& to set
the right +tone at the top,, improper corporate culture, and disregard for ethical
behavior ma& be factors that would lead a compan& to not develop a code of
ethics.
. 5o you feel a company shoul! provi!e incentives an! opportunities for the
maFority of ethical in!ivi!uals to maintain their honesty an! integrity an! at the
same time provi!e measures for the unethical in!ivi!uals to be monitore!.
punishe!. an! correcte! for their unethical con!uct? /3plain why.
Ees, because ethics in business has an important underl&ing postulate that the
ma$orit& of business leaders, managers, and other personnel are honest and ethical
in conducting their business and the minorit& who engage in unethical conduct
will not prevail in the long term.
#. 6n what ways can !oing what is right contrast with establishe! principles an!
proce!ures?
)ituation ethics +is a moral pattern allowing circumstances to overrule principle
and allegiance. 8rinciple here is interpreted as definable moral, criminal, or civil
law. 2llegiance refers to group lo&alt&., This suggests that individuals should do
what is right rather than compl& with specific principles when facing ethical
challenges. 0ircumstances ma& arise in which actions prescribed b& various rules
and regulations ma& conflict with doing what is right, or conduct ma& take place
which is contradictor& with the +spirit of the law, and &et allowed b& the various
!C
rules and regulations.
%. 8re people motivate! more by incentives to !o what is right or by the self0pri!e
of !oing what is right? /3plain.
In most cases, people ma& be motivated more b& incentives to do what is right
than the self-pride of doing what is right. Individuals within the compan& tend to
act according to incentives provided to them in terms of rewards and the
performance-evaluation process. 8eople usuall& would rather take pride in the
rewards and benefits received b& established incentives than simpl& b& the fact
that the& have done what is right.
&. $as the ethical !ownfall of maFor corporations ultimately helpe! buil! a more
ethical business worl!? 5efen! your answer.
The ethical downfall of ma$or corporations has alerted man& regulators (among
others) to the need for ethical behavior in the corporate environment. This has
prompted swift legislation (e.g. )arbanes-3"le&) designed to promote ethics and
propriet& in the workplace. *thics, as a result, is no longer practiced as a
seemingl& voluntar& process. 6egislation that promotes ethical practice ma& now
aid in building a more ethical business world. 2nother result of the ethical
downfall of ma$or corporations is the increased vigilance of corporate
stakeholders. 0orporations know that, since the& are now scrutini1ed to a larger
degree, the& must at least provide the appearance of ethical behavior. If the& do
not, the& ma& face even more scrutin& b& various stakeholders. Thus, the ethical
downfall of ma$or corporations has alerted societ& to the need for increased
regulation and vigilance designed to promote ethical behavior. This has, in turn,
helped build a more ethical business world.
2rue or ?alse
1. 2n appropriate code of ethics is the backbone of effective corporate governance.
!. /an& tragedies and scandals are directl& related to the ethical behavior of
individuals involved and their activities.
#. 0odes of business ethics and conduct can be effective substitutes for moral principles,
character, and culture of individuals and organi1ations.
%. /anagement has a fiduciar& responsibilit& for stakeholder value creation.
<. 2ccording to the )*0, the established code of ethics best describes the compan&s
policies and procedures for internal reporting of code violations.
@. Individuals should follow specific principles rather than what is right while facing
ethical challenges.
A. The 7E)* listing standards recommend that each listed compan& determine its own
business conduct and ethics policies.
B. *thics in the workplace is more important in the emerging corporate governance
reforms.
C. Individual-based incentives relate to personal integrit& and are the primar& driver of
ethical behavior.
1;. .efense contractors are e"empted from accountabilit& to the public as stated in
the .efense Industr& Initiatives on =usiness *thics and 0onduct (.II).
#;
2rue or ?alse
1. True
!. True
#. 5alse
%. True
<. True
@. 5alse
A. True
B. True
C. True
1;. 5alse
=ultiple Choice Questions
1. Which of the following is@are the key componentAsB of an organi,ation1s control
environment as set forth in both reports of the Committee of 'ponsoring
(rgani,ations of the 2rea!way Commission AC('(B?
a. Integrit&.
b. *thical conduct.
c. =oth (a) and (b).
d. 7either (a) nor (b).
2. Which of the following is not a factor that can lea! to companies
misrepresenting their financial position?
a. 8erformance is below their industr&s average performance.
b. 8erformance is significantl& above their own past performance.
c. The compan& has an established and well-defined code of corporate ethics.
d. Their 0*3 receives a high proportion of total compensation as stock options.
3. >ublic companies must make their co!e of ethics publicly available through9
a. )*0 annual reports.
b. 0orporate :eb sites (if available).
c. Hard copies (upon re'uest).
d. 2ll of the above.
. 2he Web site !isclosure re"uire! for amen!ments an! waivers to the co!e of
ethics must be maintaine! online for which of the following9
a. 1! months or otherwise be retained for at least five &ears.
b. !% months or otherwise be retained for at least five &ears.
c. < months or otherwise be retained for at least five &ears.
d. 1! months or otherwise be retained for at least two &ears.
#. 2he increasing tren! towar! more involvement of the boar! of !irectors in the
company1s ethics program is influence! by9
a. 0onse'uences of reported financial scandals.
b. 2uditors of low-profile companies.
c. .evelopment of corporate governance reforms in promoting ethical conduct.
d. =oth (a) and (c).
%. Companies nee! ethics an! business programs in or!er to effectively an!
efficiently perform which of the following functions?
a. .iversif& personnel services.
#1
b. )atisf& the e"pectations of the public and their stakeholders.
c. 0ompl& with applicable laws, regulations, rules, standards, and guidelines.
d. 2ll of the above.
&. 8n organi,ation1s appropriate tone at the top promoting ethical con!uct is an
e3ample of9
a. *thics sensitivit&.
b. *thics incentives.
c. *thical behavior.
d. 0onse'uentialist.
*. 2he two broa!ly !efine! an! commonly accepte! ethical theories are9
a. 0onse'uentialism and nonconse'uentialism.
b. *goism and utilitarianism.
c. 0onse'uentialism and egoism.
d. 0onse'uentialism and utilitarianism.
+. 8 conse"uence of re!ucing costs by lowering the "uality of pro!ucts an! services
is an e3ample of9
a. -egulator&-based incentives.
b. /arket-based incentives.
c. 3rgani1ation-based incentives.
d. Individual-based incentives.
1-. 'ignatory companies. as part of their public accountability process. are re"uire!
to9
a. 0onduct internal audits.
b. 2ssess compliance of internal audits.
c. 8rovide officer certifications.
d. 2ll of the above.
=ultiple Choice Questions
1. c.
!. c.
#. d.
%. a.
<. d.
@. d.
A. b.
B. a.
C. b.
1;. d.
Chapter
Review Questions
1. What is the !ifference between !ecision management an! !ecision control?
.ecision management is managements responsibilit& of initiating and
implementing strategies, and decision control is the board of directors fiduciar&
dut& of ratif&ing and monitoring strategies.
#!
2. ;riefly e3plain the business Fu!gment rule an! the benefit it provi!es to !irectors.
2 court will refuse to review the actions of a corporations board of directors in
managing the corporation unless there is some allegation of a violation of the
directors fiduciar& duties or the decisions of the directors lack a rational basis.
The business $udgment rule eases the liabilit& and pressure on directors.
3. What is the relationship between the supervisory an! management boar!s of a
two0tiere! boar! system?
The supervisor& board has as its primar& ob$ective the dut& and responsibilit& to
appoint, dismiss, and oversee the management board.
. Why are investors in favor of separation of the positions of C/( an!
chairperson?
)eparation is perceived as strengthening the boards independence and reducing
potential conflicts of interest.
#. What is a financial e3pert?
2 person who has an understanding of generall& accepted accounting principles
and financial statements e"perience appl&ing generall& accepted accounting
principles e"perience preparing or auditing financial statements e"perience with
internal controls and procedures for financial reporting and an understanding of
audit committee functions.
%. Why is it important for a company to have an appropriately si,e! boar! of
!irectors?
The si1e of the board can affect the efficienc& and effectiveness of the board of
directors.
&. ;riefly !iscuss the benefits of small an! large boar! si,es.
2 small board is considered to be efficient because the process of deliberation
becomes time consuming and unwield& with large boards. 2 large board can be
more effective in monitoring managerial actions primaril& because b& increasing
the number of directors involved with monitoring, management ma& decrease the
opportunit& for wrongdoing and collusion becomes more difficult.
*. What are the !irect responsibilities of the boar! of !irectors?
The board of directors is directl& responsible for defining the compan&s
ob$ectives establishing policies and procedures to ensure achievement of defined
ob$ectives monitoring the established policies and procedures assuming ultimate
accountabilit& for the compan&s business and affairs and ensuring that the
compan& is conducting its business in the utmost ethical, legal, and professional
manner to create long-term shareholder value while protecting the interests of
other stakeholders.
+. ;oar! in!epen!ence is essential for what purposes?
The independence of the compan&s board of directors is important because it has
a significant impact on its effectiveness and is essential to the proper and
ob$ective functioning of the board.
1-. What responsibility !oes the compensation committee have towar!s the
remuneration of boar! members?
The compensation committee should determine the amount and percentage of
e"ecutive stock ownership that will motivate them to align their interests with
those of shareholders.
##
11. $ow !oes the boar! of !irectors oversee corporate governance?
The board of directors( (1) monitors management plans, decisions, and activities
(!) acts as an independent leader who takes initiatives that create shareholder
value (#) establishes guidelines or operational procedures for its own functioning
(%) meets periodicall& without management presence to assess compan& and
management performance and strateg& (<) evaluates its own performance to
ensure that the board is independent, professional, and active and (@) establishes
the audit committee that oversees the financial reporting process, internal control
structure, and audit functions.
5iscussion Questions
1. 5iscuss the importance an! obFectives of !irectors1 fi!uciary !uties to the
company.
The fiduciar& dut& means that, as shareholders guardians, directors are
trustworth&, acting in the best interest of shareholders, and investors in turn have
confidence in the directors actions. 5iduciar& duties of boards of directors are
mandated b& the laws of the state of incorporation, are generall& specified in the
compan&s charter and b&laws, and are often interpreted b& courts when there are
allegations of breach of fiduciar& duties. .irectors should reali1e that their
primar& dut& is to be the corporate gatekeeper b& protecting investors and
working towards the achievement of shareholder value creation and enhancement
while protecting the interests of other stakeholders.
2. What are possible situations that coul! Feopar!i,e a !irector1s !uty to avoi!
conflicts of interest?
)ituations that ma& create potential conflicts of interest are when a director(
(1) receives material gifts or benefits from a third part& that is doing business with
the compan& (!) either directl& or indirectl& enters into a transaction or
arrangement with the compan& (#) obtains substantial loans from the compan&
or (%) engages in backdated stock options.
3. 5o you support C/( !uality in a public company? 5efen! your response.
2nswers ma& var&. 8roponents of the dual 0*3 position have argued that no
gains will be achieved b& separating the 0*3 and chairperson positions on the
grounds that e"isting corporate governance reforms have alread& addressed the
0*3s potential conflicts of interest b& re'uiring that( (1) the independent
compensation committee monitor 0*3 compensation and (!) the board of
directors, particularl& the lead director, control the 0*3s power in situations
where the 0*3 encounters conflicts of interest, the 0*3 is aggressive, or where
there is a long-term and gradual failure of the compan&s business plan. The
potential benefits of the separation of the 0*3 and chair positions are( (1) such
separation aligns D.). corporate governance with that of other countries (!) 0*3
accountabilit& is improved (#) 0*3 potential conflicts of interest are reduced
(%) having two individuals in the corporate leadership role should improve
corporate governance and operations and (<) the board responsibilit& to oversee
management for shareholders benefit would be more effective when the chair of
the board assumes no e"ecutive role.
. Why is it important for the members of the boar! of !irectors to have business
#%
knowle!ge an! financial e3pertise?
2de'uate business knowledge and financial e"pertise allow members of the board
of directors to effectivel& fulfill its fiduciar& duties. =oard members ma& not be
able to perform their fiduciar& duties in the absence of such business knowledge
and financial e"pertise.
#. 6n your opinion. who shoul! be allowe! to serve as a !irector of a public
company?
2nswers ma& var&. =oard members should possess the technical skills, financial
e"pertise, e"periences, and other 'ualifications to effectivel& fulfill their fiduciar&
responsibilities. The& should be competent and independent of management in
order to assure effective corporate governance.
%. 6s a boar! that meets more often for shorter perio!s of time more effective an!
efficient than a boar! that meets less fre"uently but for a longer perio! of time?
/3plain.
2nswers ma& var&. )hort, fre'uent meetings ma& be $ust as effective as long,
infre'uent meetings and vice-versa. The board of directors is re'uired to meet
regularl& to discuss the compan&s business affairs and financial reports with and
without the presence of management. The effectiveness of board meetings
depends largel& on the leadership abilit& of the chairperson of the board to set an
agenda and direct discussions. The leadership st&le and abilit& of the chair
determines whether the meetings will be short or length&, formal or informal,
friendl& or adversarial, rela"ed or tense, efficient or inefficient, productive or
nonproductive, responsive or nonresponsive, relevant or irrelevant, decisive or
indecisive, and predetermined or deliberative.
&. 5iscuss the impact of the ;usiness Gu!gment Rule on !irectors1 ability to fulfill
their fi!uciary !uties.
There are some variations in director fiduciar& duties as compan& law differs from
one state to another. However, directors are empowered to manage the affairs of a
compan&, and directors must e"ercise their powers in the best interests of the
compan& and its shareholders. In fulfilling their fiduciar& duties of care and
lo&alt&, directors are governed b& the business $udgment rules of e"ercising their
best $udgments in aligning management interests with those of shareholders and
in creating shareholder value. The business $udgment rule is intended to protect
directors from undue liabilit& when making business decisions in good faith and
in the best interests of the compan& and its shareholders.
*. Compare an! contrast the roles an! responsibilities of e3ecutive an! none3ecutive
!irectors.
The ma$orit& of directors in the post-)34 period should be independent
none"ecutive directors who work collectivel& with e"ecutive directors in the best
interests of the compan& and its shareholders. The primar& responsibilit& of the
board of directors is to hire a competent and ethical management team to run the
compan& effectivel&. *"ecutive directors are t&picall& engaged in strategic
decision making, planning, and e"ecution of plans whereas none"ecutive directors
advise and oversee managerial plans, decisions, and actions without
micromanaging.
#<
+. 5escribe both a!vantages an! !isa!vantages of C/( !uality.
0*3 dualit& means that the roles of the chair of the board and 0*3 are combined.
The primar& advantage of 0*3 dualit& is more control of the compan&s affairs
b& the 0*3 in bringing more uniform leadership into the boardroom. 2dvantages
of separation of the roles of the chair and the 0*3 are( (1) providing guidance
and advisor& services to the 0*3 (!) pla&ing a leadership role in influencing the
boards agenda and facilitating board meetings (#) overseeing the performance of
the 0*3 and (%) creating a more open and candid boardroom that promotes
constructive and frank discussion.
1-. 5iscuss how the levels of e3ecutive compensation shoul! be !etermine!.
*"ecutive compensation is normall& composed of a basic salar&, annual bonus,
long-term awards including stocks and share options, pension benefits, and perks.
2s a general rule, e"ecutive compensation should be linked directl& to the
compan&s long-term performance to ensure alignment of e"ecutives interests
with sustainable shareholder value creation. *"ecutive compensation, however, in
practice is determined in relation to the market rate of pa& and the level of pa& in
companies of similar si1e, comple"it&, and industr&. )ignificant drivers of
e"ecutive compensation are the compan&s long-term performance, shareholder
returns, and abilit& to create sustainable shareholder value.
2rue or ?alse
1. .ecision management duties are the responsibilit& of management and are the
ratification and monitoring of strategies.
!. The board of directors should not be involved in managerial and operational decisions.
#. The dut& of care re'uires directors to e"ercise due diligence and prudence in carr&ing
out their oversight function.
%. 2 one-tier board model consists of onl& outside directors.
<. 2ll public companies are re'uired to have a board of directors but are not re'uired to
have a chairperson.
@. 0*3 dualit& implies that the compan&s 0*3 holds both the position of chief
e"ecutive and the chair of the board of directors.
A. 2 permanent or rotating lead director is used as an alternative to separating the 0*3
and chairperson positions.
B. The board of directors for all public companies must have at least three members.
C. .irectors ma& onl& serve as a director on one board per &ear.
1;. -esources available to the board consist of legal, financial, and information resources.
11. .irectors of all public companies are re'uired to own shares in their compan&.
2rue or ?alse
1. 5alse
!. True
#. True
%. 5alse
#@
<. 5alse
@. True
A. True
B. 5alse
C. 5alse
1;. True
11. 5alse
=ultiple Choice
1. 2he primary responsibilities of the boar! of !irectors inclu!e all but which of
the following9
a. .efine the compan&s mission and goals.
b. *stablish or approve strategic plans and decisions to achieve these goals.
c. 2ppoint senior e"ecutives to manage the compan& in accordance with the
established strategies, plans, policies, and procedures.
d. /ake managerial decisions that will increase the compan&s stock price.
2. 2he oversight function of the boar! of !irectors consists of9
a. -epresenting shareholders and protecting their interests.
b. 2pproving the compan&s ma$or operating, investing, and financial activities.
c. Holding the board, its committees, and its directors accountable for the fulfillment
of the assigned fiduciar& duties and oversight functions.
d. 2ll of the above.
3. 8 !irector who notifies the company of a possible investment opportunity
instea! of acting upon it himself is !emonstrating the9
a. .ut& of obedience.
b. .ut& of lo&alt&.
c. .ut& of care.
d. .ut& of fair disclosure.
. Ratification of management !ecisions an! minimal liability !efines which best
practices boar! structure?
a. 0ertif&ing board.
b. 3perating board.
c. 8assive board.
d. Intervening board.
#. =anagement1s implementation of boar! strategies an! the boar! serving as the
key !ecision maker are best associate! with9
a. 0ertif&ing board.
b. 3perating board.
c. 8assive board.
d. Intervening board.
%. 2he chairperson of the boar! of !irectors an! C/( shoul! be lea!ers with9
a. Jision and problem solving skills.
b. The abilit& to motivate.
c. =usiness acumen.
d. 2ll of the above.
&. 2he !irector position that is utili,e! in C/( !uality situations to keep the boar!
#A
obFective an! in!epen!ent of management is the9
a. 6ead director.
b. 0overing director.
c. 8rime director.
d. 7one of the above.
*. Which of the following can be !iversification classifications?
a. 2ge.
b. 9ender.
c. *thnicit&.
d. 2ll of the above.
+. 2he structure of a public company1s boar! of !irectors is establishe! by its9
a. 2rticles of incorporation.
b. =&laws.
c. 0orporate governance policies.
d. 2ll of the above.
1-. ?inancial resources are ma!e available to the boar! for all of the following
e3cept9
a. 0ompensating directors.
b. -eimbursing personal e"penses.
c. Hiring e"ternal auditors.
d. 3btaining legal council.
11. 8n in!epen!ent !irector is one who9
a. .id not attend a school supported b& the compan&.
b. .oes not have outside relationships with other directors.
c. .oes not have an& other relationships with the compan& other than his or her
directorship.
d. 2ll of the above.
12. 8 boar! that is electe! in a classifie! system is known as a9
a. .iversified board.
b. )taggered board.
c. -otating board.
d. .eclassified board.
13. 6nsurance payable to the !irectors an! officers of a company if they get sue! for
something that happene! while they were with that company is known as9
a. .uties L obligations insurance.
b. .isaster L occurrence insurance.
c. .irector L officer insurance.
d. .ut& L opportunit& insurance.
=ultiple Choice
1. d.
!. d.
#. b.
%. c.
<. b.
@. d.
#B
A. a.
B. d.
C. d.
1;. b.
11. c.
1!. b.
1#. c.
Chapter #
Review Questions
1. What are the key functions of the nominating. au!it. governance. an!
compensation committees?
The nominating committee is responsible for(
-eviewing the performance of the current directors.
2ssessing the need for new directors.
Identif&ing and evaluating the skills, background, diversit&, and knowledge of
candidates for the board.
Having an ob$ective nominating process for 'ualified candidates to the board.
2ssisting in the election of 'ualified new directors.
The audit committee is responsible for(
3verseeing the financial reporting process.
/onitoring the choice of accounting policies and principles.
/onitoring the internal control process.
3verseeing the hiring and performance of e"ternal auditors.
The corporate governance committee is responsible for(
*stablishing the agenda for the board of directors to determine what the board
should discuss with management and to what e"tent.
The compensation committee is responsible for(
*valuating the performance of directors.
*valuating the performance of e"ecutives.
.esigning and implementing compensation plans for directors and e"ecutives.
.isclosing the work of the compensation committee.
2. What actions must be taken to make the compensation committee effective?
The compensation committee should be composed of independent outside
directors with sufficient human resources e"perience in compensation and related
issues. 2lso this committee should hire outside compensation advisors that report
directl& to and are compensated b& the committee to ensure ob$ectivit&.
3. 7ist the principles an! practices for ensuring the effectiveness of the
compensation committee as recommen!e! by 2he Council of 6nstitutional
6nvestors AC66B.
)tructure.
8ro"& statement disclosure.
-esponsibilities.
#C
. ;riefly !iscuss the criteria or benchmarks use! by the compensation committee
in the evaluation process.
Inowledge, e"perience, and e"pertise.
Teamwork and leadership abilit&.
/aturit&, ob$ectivit&, $udgment, and independence.
Jalue-added contribution to the compan&s welfare.
Dnderstanding of the compan&s business and industr& including legal and
financial literac&.
5irm commitment and dedication to working towards the achievement of the
compan&s goals.
)afeguarding of the compan&s assets, ensuring integrit& of its financial
reports, and protecting the interest of shareholders.
0reating long-term shareholder value.
8rotecting the interests of all stakeholders.
)etting an appropriate tone at the top in promoting ethical conduct.
#. What are the responsibilities of the corporate governance committee?
0ontrol the agenda and the meeting.
-eview past agendas and minutes of meetings to ensure ade'uate time and
discussion were devoted to each issue.
-evise the agenda as necessar& and set priorities for meetings.
%. 7ist the issues the nominating committee shoul! consi!er in the evaluation
process.
The gender and ethnic diversit& of the board in creating a right balance to
address the current and future challenges of the business while being challenging
&et supportive of the top management team, as appropriate.
The e"perience necessar& to operate board committees.
5uture e"pertise needs of the board.
-egular refreshment of the board.
2 right mi" of director 'ualifications and behavioral characteristics.
&. What characteristics !efine a goo! !irector?
2sks the difficult 'uestions.
:orks well with others.
Has industr& e"perience and awareness.
8rovides valuable input.
Is available when needed.
Is alert and in'uisitive.
Has business knowledge.
0ontributes to committee work.
2ttends meetings.
)peaks out appropriatel& at board meetings.
8repares for meeting.
2ssures responsibilit& and accountabilit&.
%;
Is familiar with or willing to learn about emerging corporate governance
reforms and applicable regulations and best practices.
0ommunicates effectivel& with all corporate stakeholders.
)upports the compan&s economic, ethical, social, and environmental
measures.
*. 7ist any two functions of following committees9
Hominating committee
-ecommends, nominates, and elects directors.
8u!it committee
3versee internal controls, risk management, financial reporting, and audit
activities.
Covernance committee
2dvises, reviews, and approves management strategic plans, decisions, and
actions in effectivel& managing the compan&.
Compensation committee
Implements and supports the oversight function of the board particularl& in areas
relevant to the design and review of director and e"ecutive evaluation and
compensation schemes.
+. What is nee!e! for the oversight function of au!it committees to be effective?
Independence, due diligence, proper authorit&, resources, corporate culture,
governance structure, attitude, philosoph&, and practices of management and the
entire board of directors.
1-. 5escribe the relationship that shoul! e3ist between the au!it committee an!
management.
The audit committee should interact with management b& asking appropriate
'uestions pertaining to the compan&s corporate governance structure, internal
controls, financial reporting, audit activities, risk assessment, codes of ethics, and
whistleblower programs.
11. =embers of the au!it committee must be vigilant. effective. an! informe!. What
are some characteristics that contribute to these traits?
(1) 9eneral understanding of the compan&s ma$or economic, business, operating,
and financial risk (!) a broad knowledge of the interrelationship of the
compan&s operations and financial reporting (#) a clear understanding of the
difference between the compan&s decision-making function delegated to
management and its oversight function assumed b& the audit committee (%) the
abilit& to formulate and ask probing 'uestions about the compan&s operations,
business, internal control, financial reporting process, and audit activities and
(<) courage to challenge management when necessar&.
12. What are some "ualities or actions that can impe!e the effectiveness of an au!it
committee?
2 lack of true independence from management.
Infre'uent or ineffective meetings.
2 lack of sufficient understanding of the compan&s business and
operations.
Inade'uate understanding of internal controls, audit scope, plan, policies and
procedures, and financial reporting practices.
%1
2 lack of proper communication with management, the internal auditor, and
e"ternal auditors.
Inade'uate resources including access to legal counsel and advisors.
Insufficient staff support.
6ack of e"ercising due diligence.
Dnclear mission and undefined authorit& in the committee charter.
Insufficient number of 'ualified committee members.
Inade'uate compensation to demand high-'ualit& performance.
6ack of accountabilit& for committee performance.
13. 2he te3t !iscusses the "ualifications an! characteristics of an au!it committee
financial e3pert. 6n your own wor!s. !efine what a financial e3pert shoul! be.
2nswers ma& var&. The )*0 final rules define an audit committee financial
e"pert as a person who has all of the following attributes(
2n understanding of 9228 and financial statements.
The abilit& to assess the general application of such principles in connection
with the accounting for estimates, accruals, and reserves.
*"perience preparing, auditing, anal&1ing, or evaluating financial statements
that present a breadth and level of comple"it& of accounting issues that are
generall& comparable to the issues that can be raised b& the registrants financial
statements, or e"perience activel& supervising one or more persons engaged in
such activities.
2n understanding of internal controls and procedures for financial reporting,
and an understanding of audit committee functions.
1. What are the positives an! negatives of the C/( an! e3ecutive management1s
atten!ance at au!it committee meetings?
It can signal the commitment of senior e"ecutives to the achievement of effective
audit committee oversight functions as well as underscore the importance of those
meetings. 3n the other hand, it ma& prevent open and candid dialogue between
the independent auditor and the audit committee or undermine the authorit& of the
committee chair.
1#. What !isclosures must the au!it committee make in its report to sharehol!ers?
2 description of audit committee responsibilities, its activities and
accomplishments, and its self-assessment of how well it has discharged its
assigned responsibilities. The committee should also indicate in its report to
shareholders whether it has(
-eviewed and discussed the audited financial statements with management.
.iscussed with the independent auditor those matters re'uired to be
communicated in accordance with generall& accepted auditing standards
(922)).
-eceived from the independent auditor the independent disclosures and
discussed with the independent auditor the matters relevant to auditor
independence.
-ecommended to the compan&s board of directors, based on discussions
with management and the independent auditor, that audited financial statements
%!
be included in the annual report on 5orm 1;-I or 5orm 1;-I)= be filed with
the )*0.
5iscussion Questions
1. 2o be effective. the compensation committee shoul! be in!epen!ent. 6s the given
statement true or false? 'ubstantiate your answer.
The compensation committee is responsible for establishing director and
e"ecutive pa&. Thus, if the committee were not independent from management,
the committee members might be motivated to increase management
compensation above levels that would have otherwise been stipulated.
2. 5iscuss the common0sense e3ecutive compensation program.
The program consists of salar&, annual bonus, long-term e'uit& compensation,
severance, and disclosure recommendations designed to protect the interest of
shareholders.
)alar&>The 0*3s salar& should be based on the mean of salaries paid at
peer group companies, not e"ceeding F1 million annuall&, and no senior
e"ecutive can be paid more than the 0*3.
2nnual bonus>The annual bonus paid to senior e"ecutives should be linked
to performance determined based on both 'uantitative (financial) and 'ualitative
(nonfinancial) measures as a percentage of salar& capped at 1;; percent.
6ong-term e'uit& compensation>6ong-term e'uit& compensation to senior
e"ecutives should( (1) be in the form of restricted shares, not stock options
(!) be based on $ustifiable performance criteria and challenging performance
benchmarks (#) contain a vesting re'uirement of at least three &ears (%) re'uire
e"ecutives to hold all shares awarded under the program for the duration of their
emplo&ment and (<) ensure that the value of a restricted share grant does not
e"ceed F1 million on the date of the grant.
)everance>The ma"imum severance pa&ment to a senior e"ecutive should
be capped at one &ears salar& and bonus.
.isclosure>Ie& components of the e"ecutive compensation plan should be
specified in the compensation committees report to shareholders.
3. /3plain the key features of an effective succession planning process.
(1) a continuous process (!) proper oversight and approval b& the board (#) 0*3
input, involvement, and collaboration as appropriate without dominating the
committee (%) an easil& e"ecutable and adaptable procedure in the event of a
crisis (<) succession re'uirements aligned with the compan&s strategic plans
(@) aims to find the right leader at the right time (A) the development of talent
pools at lower levels (B) a program in place to identif& and professionall&
develop internal candidates and (C) avoidance of a +horse race, mentalit& that
ma& lead to loss of ke& deputies upon the appointment of the new 0*3.
. /3plain the views of e3ecutive compensation. Which one !o you agree with?
Why? /3press your views on reasons for higher compensation for C/(s.
2nswers ma& var&. 2cademic studies present two distinct views on e"ecutive
compensation. The dominant view is that the design of an optimal compensation
package ma& encourage management to enhance long-term shareholder value.
%#
The second view is that e"ecutives have considerable influence over the design
and amount of their own pa&, thus enabling them to e"tract rents. This suggests
there is no relationship between e"ecutive compensation and performance
primaril& because managerial power determines e"ecutive compensation. Higher
compensation for 0*3s ma& be implemented to attract well-'ualified, motivated
individuals to run the compan&. )uch compensation, however, ma& be viewed as
e"cessive b& shareholders and other stakeholders.
#. 2he te3t lists the characteristics that !efine a goo! !irector. 5o you agree with
these? Woul! you a!! any other characteristics? 5efen! your answer.
0haracteristics of a good director include the abilit& to( (a) ask the difficult
'uestions (b) work well with others (c) utili1e industr& e"perience and
awareness (d) provide valuable input (e) be available when needed (f) be alert
and in'uisitive (g) use business knowledge (h) contribute to committee work
(i) attend meetings ($) speak out appropriatel& at board meetings (k) prepare for
meetings (l) make long-range planning contributions (m) provide overall
contributions (n) assure responsibilit& and accountabilit& (o) learn about
emerging corporate governance reforms and applicable regulations
(p) communicate effectivel& with all corporate stakeholders and (') support the
compan&s economic, ethical, social, and environmental measures. 2nswers will
var& on whether these characteristics are agreed with, or if an& additional
characteristics would be added. :hile this list ma& not be comprehensive, it does
detail several of the characteristics of good directors.
%. 'earch the library or 6nternet for the te3t of 'arbanes0(3ley. What !oes it
re"uire regar!ing the au!it committee?
The )arbanes-3"le& 2ct of !;;! e"tended audit committee responsibilit& and
defines this responsibilit& as oversight of financial reporting and accounting
processes of the compan&, and financial statement audits of the compan&.
)ection #;1 of )34 also holds the audit committee directl& responsible for hiring,
firing, compensating, and overseeing the audit work of e"ternal auditors. 2
summar& of )34 ma& be found online at fmcenter.aicpa.orgG-esourcesG)arbanes-
3"le&M2ctG)ummar&MofMtheM8rovisionsMofMtheM)arbanes-
3"le&M2ctMofM!;;!.htm, while the full te"t ma& be found at
sec.govGaboutGlawsGsoa!;;!.pdf.
&. ;riefly !iscuss the reasons that the au!it committee nee!s effective working
relationships with the boar! of !irectors. management. internal au!itors. an! the
e3ternal au!itors.
The audit committee assists the board of directors in fulfilling its responsibilities
b& bringing speciali1ation and e"pertise to the board in the areas of financial
reporting, internal controls, risk management, and audit activities. 2s an
independent committee of the board of directors, the audit committee must ensure
that organi1ational oversight is successful. )enior e"ecutives should inform the
audit committee of significant events and transactions that substantiall& affect the
compan&s risk appetite, and thus management must be able to communicate
successfull& with the audit committee. The audit committee is responsible for
hiring, overseeing, compensating, and firing the head of the internal audit
department, and internal auditors are ultimatel& accountable to the audit
%%
committee. This aids in creating robust corporate governance. 3pen and candid
communication between the audit committee and e"ternal auditors should
preserve the independence of e"ternal auditors and better enable the audit
committee to discharge its oversight responsibilities. Therefore, an effective
working relationship with the e"ternal auditors is also necessar& to improve
organi1ational oversight.
*. 7isting stan!ar!s re"uire that au!it committees be compose! solely of
in!epen!ent !irectors. 5o you agree or !isagree with this? Why?
-ecent corporate governance reforms have promoted director independence as
the most important attribute to improve committee effectiveness. In the pre-)34
period( (1) audit committee members were not totall& independent, with a
significant portion of +gre&, directors (!) independent audit committee members
were most likel& to support the auditors position and (#) there was a positive
relationship between audit committee independence and the proportion of outside
directors, suggesting that the independence of committee members was largel&
affected b& the independence of the board of directors. 2udit committee
independence can induce substantial benefits in terms of( (1) improving the
'ualit& of financial reports b& assisting in reducing financial reporting problems
(!) increasing interactions with internal auditors and (#) improving the 'ualit& of
financial statement audits b& engaging higher 'ualit& auditors.
+. ;est practices recommen! ten au!it committee principles. 6!entify five that you
agree or !isagree with an! e3plain your reasoning.
2nswers will var&. The ten audit committee principles identified b& the author
include( (1) formation (!) independence (#) member 'ualifications
(%) authorit& (<) funding (@) oversight function (A) accountabilit& (B) charter
(C) agenda and (1;) orientation, training, and continued education. These audit
committee principles provide guidance designed to promote effective and
efficient audit committees.
2rue or ?alse
1. 2 special committee of independent directors ma& be formed to conduct an
independent investigation if director and officer wrongdoings are alleged.
!. The number and si1e of board committees depend on the number of directors on the
compan&s board.
#. The nominating committee is responsible for establishing director and e"ecutive pa&
designed to set compensation contracts that retain good directors and managers while
motivating optimal performance that creates shareholder value.
%. To be effective, the compensation committee should be independent from
management.
<. The remuneration of none"ecutive directors should be determined b& the chair of the
board and e"ecutive directors.
@. 5inance committee responsibilities include developing, approving, monitoring, and
disclosing the compan&s e"ecutive pa& philosoph&.
A. 2 proper evaluation process selected b& the compensation committee to assess the
performance of directors does not depend on the independence of the board from the
0*3 and corporate governance structure.
%<
B. The purpose of e"ecutive evaluation is to identif& areas of concern and poor
e"ecutive performance.
C. 6ong-term e'uit& compensation to senior e"ecutives should be in the form of stock
options.
1;. The dominant view is that the e"ecutives have considerable influence over the design
and amount of their own pa&, which enables them to e"tract rents.
11. The governance committee is usuall& responsible for identif&ing, evaluating, and
nominating a new director to the board.
1!. The move toward ma$orit& voting for the election of directors has received a
tremendous amount of attention and support from institutional investors on the grounds
that it will make the corporate board more accountable to and representative of
shareholders.
1#. 2lthough the directors positions on the board are not tenured, there are usuall& no
term limits in the b&laws.
1%. Ie& features of an effective succession planning process include that the ma$orit& of
directors are independent and do not have financial or personal ties to management.
1<. In a situation when the compan&s 0*3 is also serving as the chair of the board of
directors, an outside directors committee can be formed to maintain the boards
independence.
1@. 2udit committees are nonessential participants in corporate governance due to
decreased fiduciar& and accountabilit& responsibilities.
1A. The audit committee charter should provide the audit committee with primaril&
management duties and responsibilities.
1B. The audit committee can be described as a client to the e"ternal auditor.
1C. 2udit committees are effectivel& +one-si1e-fits-all, entities.
!;. The audit committee should be ultimatel& accountable to the board of directors as
representative of all stakeholders particularl& shareholders.
!1. The audit committee can have no more than three members.
!!. 2 ke& responsibilit& of the audit committee is to oversee the financial reporting
process and internal controls.
!#. The )*0 rules regarding audit committee duties are designed to provide the
committee with more influence in managerial decisions regarding strategic planning.
!%. 2 whistleblower program is one designed to allow individuals to safel& and
confidentiall& inform the audit committee and board of directors of potential financial
malfeasance.
!<. The audit committee is onl& re'uired to meet once a &ear and can perform all re'uired
duties in that meeting.
!@. )arbanes-3"le& states, +the compan&s board of directors is responsible for
evaluating the performance and effectiveness of the audit committee.,
2rue or ?alse
1. True
!. True
#. 5alse
%. True
%@
<. True
@. 5alse
A. 5alse
B. True
C. 5alse
1;. 5alse
11. 5alse
1!. True
1#. True
1%. 5alse
1<. True
1@. 5alse
1A. 5alse
1B. True
1C. 5alse
!;. True
!1. 5alse
!!. True
!#. 5alse
!%. True
!<. 5alse
!@. 5alse
=ultiple Choice Questions
1. Which of the following is not among the three boar! committees re"uire! by the
listing stan!ar!s of national stock e3changes?
a. 2udit committee.
b. 7ominating committee.
c. 5inance committee.
d. 0ompensation committee.
2. Which of the following committees approves management strategic plans?
a. 9overnance committee.
b. 2udit committee.
c. 0ompensation committee.
d. 2ll of the above.
3. 2he minimum number of boar! members on certain committees as suggeste! by
the '/C an! re"uire! by some professional organi,ations is9
a. Two.
b. Three.
c. 5our.
d. 7one of the above.
. 2he boar! committee with the responsibility of approving the company1s policy
for authori,ing claims for e3penses from the C/( an! other e3ecutives is the9
a. 2udit committee.
b. 0ompensation committee.
c. 7ominating committee.
%A
d. 7one of the above.
#. (f the following. which are criteria use! by the compensation committee for the
evaluation of !irectors when !etermining an! reevaluating !irector compensation
an! benefits?
a. Inowledge, e"perience, maturit&, ob$ectivit&, independence, and e"pertise.
b. Teamwork, leadership, and abilit& to set an appropriate tone at the top in
promoting ethical conduct.
c. Dnderstanding of the compan&s business and industr& including legal and
financial literac&.
d. 2ll of the above.
%. 2he common0sense e3ecutive compensation program shoul! inclu!e all of the
following components e3cept9
a. 2nnual bonus.
b. )everance.
c. 6ong-term e'uit&.
d. 8erformance.
&. 2he 4.I. Combine! Co!e recommen!s all of the following maFor concepts of
share0base! incentive plans e3cept9
a. 8a&outs or grants under all incentive plans should be linked to performance
measures reflecting the compan&s ob$ectives.
b. )hareholders should approve an& proposed long-term incentive plans.
c. 9rants under incentive plans should normall& be phased rather than awarded in
one block.
d. Jesting of awards should be conditional on meeting the compan&s specified
performance measures.
*. Which of the following is a function of the nominating committee?
a. -eviewing the performance of e"ternal auditors and assisting in the
implementation of the audit plan.
b. -eviewing the performance of current directors and assessing the need for new
directors.
c. *stablishing methods and procedures for implementation of a whistleblower
program.
d. 2ll of the above.
+. Which of the following woul! be consi!ere! a key feature of an effective
succession plan?
a. 0*3 input, involvement, and collaboration as appropriate without dominating the
committee.
b. *asil& e"ecutable and adaptable procedure in the event of a crisis, aimed at
finding the right leader at the right time.
c. The development of talent pools at lower levels.
d. 2ll of the above.
1-. 8ccor!ing to the author. which of the following is not among the often re"uire!
types of committees to be establishe! by any company?
a. 9overnance committee.
b. 7ominating committee.
c. 5inance committee.
%B
d. 0ompensation committee.
11. Which of the following committees approves management strategic plans9
a. 9overnance committee.
b. 7ominating committee.
c. )pecial committee.
d. 2udit committee.
12. Which of the following criteria are not use! by the compensation committee in
the evaluation process9
a. Jalue-added contribution to the compan&.
b. Teamwork and leadership.
c. /aturit& and ob$ectivit&.
d. .irectors oversight function.
13. /ffective oversight functions of au!it committees contribute to9
a. /ore effective corporate governance.
b. 2 reliable reporting process.
c. 0redible audit functions.
d. 2ll of the above.
1. 2he :tone at the top< promotes all of the following i!eals e3cept9
a. *thical conduct.
b. Dnlawful behavior.
c. 8rofessional accountabilit&.
d. 8ersonal integrit&.
1#. 2he au!it committee works with which of the following boar! committees to
fulfill the boar!1s fi!uciary !uties to sharehol!ers an! stakehol!ers9
a. *ntertainment.
b. 0ompensation.
c. Travel.
d. 7one of the above .
1%. What is the relationship between the e3ternal au!itor an! the au!it committee?
a. The e"ternal auditor is hired, fired, and overseen b& the audit committee.
b. The audit committee assembles the compensation package for the e"ternal auditor
and should approve all audit services.
c. *"ternal auditors are held accountable to the audit committee, evaluate the
effectiveness of the audit committee, and consider ineffective audit committees as
material weaknesses in internal control.
d. 2ll of the above.
1&. 8ll members of the au!it committee shoul! be financially literate with one
member !esignate! as a financial e3pert. 2his re"uires that one member has all of
the following e3cept9
a. 2n understanding of 9228 and financial statements.
b. *"perience preparing or auditing financial statements.
c. Inowledge of how to make mone& in the stock market.
d. *"perience with internal controls and procedures for financial reporting.
1*. 2he au!it committee is grante! which of the following authoritative powers?
a. The authorit& to hire, fire, and compensate management.
b. The authorit& to engage independent counsel and other advisors.
%C
c. The authorit& to conduct an& investigations deemed necessar& to cover up fraud.
d. 2ll of the above.
1+. Which of the following statements is incorrectly state! as a !eterminant of an
effective au!it committee?
a. 2ll members of the audit committee should be financiall& literate and at least one
member should be designated as and meet the re'uirements of a financial e"pert.
b. /embers of the audit committee should be held personall& liable for actions
causing corporate damages that were in accordance to their fiduciar& duties of
obedience, due care, lo&alt&, and fair disclosure.
c. The audit committee should have open and candid communications with
management, the board of directors, internal auditors, legal counsel, and e"ternal
auditors.
d. The audit committee must have ade'uate financial resources to pa& the audit fee,
hire advisors to fulfill its oversight functions, and have access to management,
internal auditors, and e"ternal auditors.
2-. 2he au!it committee shoul! be compose! of in!epen!ent. none3ecutive. outsi!e
!irectors. 6n!epen!ence is characteri,e! by the '/C as9
a. 7ot receiving an& compensation from the compan& other than that as a board
member.
b. 7ot having been emplo&ed b& the compan& or its affiliates within the past five
&ears.
c. 7ot having been a member of the immediate famil& of the compan&s e"ecutives
or its affiliates within the past five &ears.
d. 2ll of the above.
21. =embers of the au!it committee shoul! e3hibit all of the following
characteristics e3cept9
a. 6ack of trust and confidentialit&.
b. )ufficient financial reporting understanding.
c. 0ommitment in terms of time and effort.
d. Independence, integrit&, and ob$ectivit&.
22. 8ll of the following are responsibilities of the au!it committee e3cept9
a. 3verseeing the financial reporting process and internal controls.
b. Hiring, firing, compensating, and overseeing the audit work of e"ternal auditors.
c. *nsuring the compan& meets or e"ceeds estimated 'uarterl& earnings.
d. 8reapproving all services provided b& the independent auditor to the compan& or
its subsidiaries.
23. Which of the following is not a man!atory au!it committee report?
a. -eports or minutes of its meetings to the compan&s board of directors.
b. 5ormal 'uarterl& report to the compan&s shareholders and board of directors.
c. 5ormal annual report to the compan&s shareholders and board of directors.
d. 2ll of the above are mandator& audit committee reports.
<;
=ultiple Choice Questions
1. c.
!. a.
#. b.
%. b.
<. d.
@. d.
A. d.
B. b.
C. d.
1;. c.
11. a.
1!. d.
1#. d.
1%. b.
1<. b.
1@. d.
1A. c.
1B. b.
1C. b.
!;. d.
!1. a.
!!. c.
!#. b.
Chapter %
Review Questions
1. What are the a!vantages of having a former C?( as C/(?
053s tend to focus more on shareholder value creation and enhancement b&
considering all aspects of the business whereas 0*3s with more marketing or
operations backgrounds have the tendenc& to focus on growth and cost efficienc&.
053s pa& close attention to metrics and focus on economic value-added
activities and wa&s to improve performance and generate a return that e"ceeds the
compan&s cost of capital.
053s ma& be regarded as investor-friendl& because of their financial and
market-anal&sis e"perience and attention to investor return on investment and
stock price indicators.
053s are better e'uipped to identif& business risk associated with the
compan&s events and transactions and to assess the challenges and opportunities
presented b& the business risk.
2. What are the basic components of e3ecutive compensation?
)alar&.
2nnual incentive compensation.
<1
6ong-term compensation.
)tock option awards.
*mplo&ment contracts, severance, and change of control pa&ments.
3. What !oes transparency in conte3t to the "uality of the financial report mean?
Transparenc& means that companies provide all information needed b& their
shareholders to make decisions.
. What is an offJbalance sheet transaction?
2n offNbalance sheet transaction is an& transaction or contract with an
unconsolidated entit& under which the compan& has(
2n& obligation associated with certain guarantee contracts.
2 retained or contingent interest in assets transferred to an unconsolidated
entit&.
2n& obligation including a contingent obligation under a material variable
interest held in an unconsolidated entit&.
#. What are the two aspects of critical accounting policies an! practices re"uire! as
!isclosures by the '/C1s Strengthening the Commissions Requirements Regarding
Auditor Independence?
2ccounting estimates made b& a compan& as part of its accounting policies
including 'uantitative anal&sis of sensitivit& to different assumptions.
The initial adoption of an accounting polic& that has a material effect on the
presentation of financial statements.
%. What is a non0C88> financial measure?
2 numerical measure of a registrants historical or future financial performance,
financial position, or cash flows that are included in the most directl& comparable
measure calculated and presented in accordance with 9228.
&. What are the steps taken by public companies an! internal au!itors to fulfill
their internal control re"uirements?
0ooperation efforts between management and independent auditors in
documenting I05- while preserving auditor independence.
2doption of a suitable evaluation framework for I05- (e.g. 03)3
framework).
*ffective oversight function of I05- b& the audit committee.
*stablishment of ade'uate disclosures for reporting on I05-.
*. What are the types of costs associate! with 'ection - compliance?
Two t&pes of costs are associated with )ection %;% compliance. The first categor&
is the cost of compliance of )ection %;%, )*0 implementation rules, and 8023=
auditing standards to bring internal control effectiveness in line with these
re'uirements. These costs are viewed as one-time start-up costs that have been
significant for companies with inade'uate and ineffective internal control
structure, causing them to spend substantial financial and human resources in
designing, implementing, and operating the re'uired internal controls. The second
categor& of costs relates to the initial assessment, documentation, attestation, and
reporting on compliance with both )ections #;! and %;%. The second categor&
consists of costs pertaining to ongoing, &ear-after-&ear, continuous monitoring of
both the design and operation of internal controls and the continuous
<!
documentation, assessment, testing, and reporting re'uirements.
+. /3plain the steps involve! in continuous process of improving the effectiveness of
corporate internal control over financial reporting.
-emediation( ensures progress from +'uick manual fi"es, to building long-
term sustainable solutions including an automated, streamlined continuous
process.
)ustainabilit&( focuses on sustaining compliance in an ever-changing business
and regulator& environment.
3ptimi1ation( leverages knowledge and e"perience with )ection %;%
compliance to optimi1e other critical business processes.
Integration( integrate )ection %;% compliance process with other business
processes to improve efficienc& and effectiveness of operations and decision
making.
1-. /3plain the term enterprise risk management.
2 process, affected b& an entit&s board of directors, management, and other
personnel, applied in strateg& setting and across the enterprise, designed to
identif& potential events that ma& affect the entit&, and manage risks to be within
its risk appetite, to provide reasonable assurance regarding the achievement of
entit& ob$ectives.
11. What are the four obFectives of enterprise risk management?
)trategic.
3perations.
-eporting.
0ompliance.
12. What are the maFor provisions of the Working ?amilies 2a3 Relief 8ct
AW?2R8B?
Ta" brackets.
0hild ta" credits.
2lternative minimum ta".
?ualified child.
13. What are the characteristics of abusive ta3 shelters?
6ack of meaningful economic risk of loss or potential for gain.
Inconsistent financial and accounting treatment.
8resence of ta"-indifferent parties.
0omple"it& without a reasonable business purpose.
Dnnecessar& steps or novel investments.
8romotion or marketing of ta" benefits as a central component.
0onfidentialit&.
High transaction costs.
-isk reduction arrangements.
1. What are the ta3 services provi!e! for an au!it client that can lea! to an
impairment of au!itor in!epen!ence?
Ta" planning or advice involving potentiall& abusive ta" transactions
including listing transactions or confidential transactions under Treasur&
<#
regulations.
Ta" services pertaining to planning or opinion on a transaction based on an
aggressive interpretation of applicable ta" rules, laws, and regulations.
Ta" compliance and planning services provided to the audit clients senior
officers who oversee the compan&s financial reporting.
1#. What are the "ualities of a C?(?
)trategic sense.
2ccounting e"pertise.
=udgeting and planning abilit&.
/anagement skill.
0apital market knowledge.
1%. /3plain the a!vantages of the having a C?( with C>8 certification.
082s have a renewed commitment to the public interest and have worked
diligentl& to develop public trust and investor confidence in financial
reporting and their profession.
The& have a longer histor& of public trust and a well-deserved reputation for
ob$ectivit& and honest&.
The& have valued continuing education and ac'uired new knowledge and
skills to meet demands of the workplace and their profession.
The& are committed to a high level of professional competence and standards
of ethical conduct and integrit&.
The& are trusted professionals with the 'ualifications necessar& to add value
to corporate governance.
5iscussion Questions
1. 5iscuss the possible relationship between C/( performance an! their
compensation? 8re they overpai! or un!erpai!?
2necdotal evidence indicates that corporate e"ecutives are highl& compensated
regardless of their compan&s performance, and even when the& are forced out of
their positions due to poor performance, the& are still paid generousl&. *"ecutive
compensation is linked to short-term performance instead of long-term
sustainable performance.
2. :/3ecutives shoul! be given proper motivation an! be pai! for their goo!
performance to create sufficient incentives for outstan!ing performance. an! not be
pai! e3cessively for poor or un!erperformance.< 5o you agree with this philosophy?
'ubstantiate your answer.
*"ecutives should not be paid e"cessivel& for poor corporate performance, and proper
incentives should be given to e"ecutives to lead the compan& in the right direction.
Their compensation should be linked to the compan&s sustainable performance in
creating shareholder value.
3. /3plain the importance of the !etermination of C/( compensation
reasonableness an! its link to the company1s sustainable performance in the areas
of economic. social. ethical. an! environmental activities in general an! creation of
sharehol!er value in particular.
<%
The compan&s board of directors and its representative, the compensation
committee, should develop an effective, rewarding, and reasonable e"ecutive
compensation program tailored to achieving the compan&s mission and strategic
goals, sustainable and enduring performance, and industr& considerations. The
contrasting views of investors and directors on reasonableness and relevance of
e"ecutive pa& suggest( (1) despite recent corporate governance reforms,
management decides who gets on the board and thus directors have incentives to
support pa& arrangements that favor senior e"ecutives (!) directors are more
aligned with 0*3s than with shareholders and (#) outsi1ed e"ecutive pa& will
continue to grow until shareholders are empowered to easil& replace directors.
The culmination of these contrasting views between investors and directors ma&
result in further regulation and increased shareholder activism. =oth of these
reactions ma& have various economic, social, and ethical implications.
. What. accor!ing to you. shoul! be !one to face the conse"uences of the
retirement of the baby0boom generation of financial e3ecutives?
2nswers ma& var&. /easures ma& be taken to ensure that the ne"t generations of
e"ecutives are competent and ethical in their duties. *ducational and ethical
programs within the compan&, review of corporate governance programs to
promote their effectiveness, and appointing highl& 'ualified individuals all would
help to improve the competence and ethical awareness of the ne"t generation of
e"ecutives.
#. /3plain the role of management in the presentation of true financial statements
in conformity with C88>. /3plain the a!vantages an! !isa!vantages of incentives
use! by the management of any company.
/anagement is primaril& responsible for providing a true and fair presentation of
financial statements in conformit& with 9228. In the post-)34 era, management
certifies both internal control reports and financial statements, and is responsible
and legall& liable for inaccurac& or incompleteness of financial reports.
/anagement ma& have incentive to manage earnings and when provided with the
opportunit& ma& engage in illegitimate and fraudulent earnings management
schemes. Incentives for earnings management can be related to( (1) market
incentives for meeting or e"ceeding anal&sts forecasts to prevent significant
stock price declines following announcements that missed earnings estimates
(!) contractual incentives of ma"imi1ing managerial compensation or avoiding
violation of debt covenants particularl& when bonus plans and debt agreements
are based on accounting information (#) regulator& incentives of manipulated
earnings to influence regulator& decisions (deflating earnings to avoid sanctions
for potential antitrust violations) and (%) income smoothing incentives of
reporting steadil& increasing earnings to ma"imi1e stock prices particularl& when
e"ecutives are compensated through stock options.
%. /3plain how !isclosure of financial statements can affect sharehol!ers1 wealth.
The disclosure of financial statements allows shareholders and other interested
parties to obtain information regarding the financial position of the organi1ation
as of the report date. )hareholders ma& use this information to help make
investment decisions regarding the organi1ation and to obtain a better
understanding of the industr& in which the organi1ation operates.
<<
&. /3plain the importance of converging 6?R' an! C88>.
0onvergence of I5-) and D.). 9228 should benefit the global capital market
primaril& because such convergence reduces the differences in global accounting
policies and practices. 0onvergence in financial reporting standards should
benefit global investors and lenders when global consolidated financial statements
are more comparable.
*. 5o you think enterprise risk management is gaining importance in to!ay1s
economy?
2nswers ma& var&. *nterprise risk management has recentl& received
considerable attention and interest from public companies, the business
communit&, and the accounting profession. 5inancial scandals of the earl& !;;;s
and recent world events including the )eptember 11
th
terrorist attacks have
generated more interest in the issue of overall *-/ including traditional risks
(e.g., strategic, financial, operational, information securit&, and reputational).
+. What is meant by the term ta3 shelter? Can they help investors? 6s it right on
the part of the corporation to provi!e abusive ta3 shelters to corporations an!
in!ivi!uals? /3plain your point of view.
2nswers ma& var&. 2 ta" shelter is a legal method of minimi1ing or decreasing
ta"able income and, therefore, ta" liabilit&. Ta" shelters can range from
investments or investment accounts that provide favorable ta" treatment to
activities or transactions that lower ta"able income. Ta" shelters not onl& have
detrimental effects on ta" collections, but the stock and the cost of debt prices can
also be affected.
2rue or ?alse
1. 5inancial statements should be prepared from the perspective of shareholders.
!. The relationship between 0*3 pa& and their skills is positive and stronger when the
firm does not have a large ma$orit& of shareholders.
#. The primar& responsibilit& of the 053 is stewardship over the compan&s finance.
%. The responsibilit& of 053s is to ensure the effectiveness of internal control over
financial reporting.
<. The establishment of and material amendments to the compan&s long-term incentive
plans re'uire shareholder approval.
@. )tock option awards are classified as long-term incentive plans.
A. )ection %;% of )34 re'uires the principal e"ecutive and financial officers of the
compan& to certif& each periodic report filed with the )*0.
B. )*0 rules do not re'uire public companies to disclose the aggregate of offNbalance
sheet arrangements in categories that increase understanding and discussion of important
effects of the total arrangement.
C. 8ublic companies are re'uired to provide a 'ualitative and 'uantitative discussion in
the financial statements of an& material changes made to accounting estimates during the
past three &ears.
1;. )ection #;! of )34 authori1es the )*0 to issue rules re'uiring public companies to
make public disclosure on a +rapid and current basis, of their financial information.
<@
11. )34 re'uires public companies to design and maintain ade'uate and effective
internal controls.
1!. The strategic ob$ective of *-/ is to obtain effective and efficient use of the entit&s
resources.
1#. -evenue recognition is one of the financial reporting challenges identified b&
5inancial *"ecutives International (5*I).
2rue or ?alse
1. True
!. 5alse
#. 5alse
%. True
<. True
@. True
A. 5alse
B. 5alse
C. True
1;. 5alse
11. True
1!. 5alse
1#. True
=ultiple Choice Questions
1. Corporations have a management team consisting of which of the following9
a. 0*3.
b. 053.
c. 0ontroller.
d. 2ll of the above.
2. Which of the following is@are responsible for promoting effective functioning.
ethical con!uct. an! professional behavior throughout the company?
a. 0*3.
b. /anagement.
c. =oard of directors.
d. 2ll of the above.
3. C/( pay is negatively relate! to skill when9
a. There is no large shareholder to monitor management.
b. The 0*3 has been paid largel& in options and stocks.
c. The firm has a large shareholder.
d. 7one of the above.
. Which of the following is@are special retirement arrangements ma!e available to
senior e3ecutives?
a. .eferred compensation plans.
b. )upplemental retirement plans.
c. -etirement packages.
d. 2ll of the above.
<A
#. 'ection 3-2 e3ecutive certification is signe! by(
a. 053.
b. 0*3.
c. =oth the 0*3 and 053.
d. 7either the 053 nor the 0*3.
%. 8ccor!ing to 'ection 3-2. C?(s an! C/(s are responsible for9
a. *stablishing and maintaining the compan&s disclosure controls and procedures.
b. 2ssessing the effectiveness of the compan&s disclosure controls.
c. 8resenting in the /.L2 their conclusions about the effectiveness of disclosure
controls and procedures.
d. 2ll of the above.
&. =arket incentives for meeting or e3cee!ing analyst1s forecasts. contractual
incentives of ma3imi,ing managerial compensation. an! income smoothing
incentives are all forms of9
a. *arnings management incentives.
b. )tock price incentives.
c. -egulator& incentives.
d. Insider trading incentives.
*. 6ncentives for earnings management can be relate! to which of the following9
a. -egulator& incentives.
b. /arket incentives.
c. =oth (a) and (b).
d. 7either (a) nor (b).
+. Which of the following is not a feature of a high0"uality financial report?
a. -elevance.
b. Dsefulness.
c. -eliabilit&.
d. 3pa'ueness.
1-. '() !irecte! the '/C to e3amine the last DDDDDDD of its accounting an! au!iting
enforcement actions A88/8sB to i!entify areas of financial reporting that are most
susceptible to frau!. abuse. manipulation. an! earnings management.
a. < &ears.
b. ! decades.
c. 1; &ears.
d. % &ears.
11. '/C rules re"uire public companies to !isclose which of the following items
about their offJbalance sheet arrangements an! their possible effects?
a. The nature and purpose of the compan&s offNbalance sheet arrangements.
b. The relevance and importance of the identified offNbalance sheet arrangements
reasonabl& likel& to result in a termination or material reduction.
c. The likelihood of an& known event, demand, commitment, trend, or uncertaint&.
d. 2ll of the above.
12. 8ccor!ing to the '/C. accelerate! filers are those public companies that have a
public float of at least K&# million an! have been subFect to the '/C perio!ic
reporting re"uirement for at least9
a. 1! months.
<B
b. B months.
c. C months.
d. 7one of the above.
13. Which of the following '() sections are consi!ere! !irections to the '/C
re"uiring the issuance of rules regar!ing con!itions for the use of non0C88>
financial measures?
a. )ection %;1.
b. )ection %;C.
c. )ections %;1 and %;C.
d. 7either )ection %;1 nor %;C.
1. Which of the following '() sections re"uire management an! au!itors to test
an! report on the effectiveness of internal controls?
a. )ection %;%.
b. )ection #;!.
c. )ection %;1.
d. )ection %;C.
1#. 2he effectiveness of /R= !epen!s on9
a. The ade'uac& and effective functioning of its components.
b. -eporting and compliance.
c. The variet& of electronic representational media available.
d. The assessed level of inherent risk of a corporation.
1%. C('(1s /R= framework is !evelope! base! all of the following e3cept9
a. 2ligning risk appetite and strateg&.
b. *nhancing risk response decisions.
c. -educing operational surprises and losses.
d. .ecreasing deplo&ment of capital.
1&. 8ll of the following are components of enterprise risk management i!entifie! by
C('( e3cept9
a. -isk response.
b. -isk assessment.
c. Internal environment.
d. 2ll of the above are components of enterprise risk management identified b&
03)3.
1*. Which of the following is not helpful in transparency of financial reporting?
a. :orking with the audit committee and management.
b. 8roviding assurance on financial information used b& the compan&s
management.
c. 8articipating in the development of nonfinancial measures with other participants
in the financial reporting process (e.g. customers, suppliers).
d. 2ll of the above.
=ultiple Choice Questions
1. d.
!. a.
#. a.
%. d.
<C
<. c.
@. d.
A. a.
B. c.
C. d.
1;. a.
11. d.
1!. a.
1#. c.
1%. a.
1<. a.
1@. d.
1A. d.
1B. b.
Chapter &
Review Questions
1. /3plain the categories of the fun!amental provisions of the 'arbanes0(3ley 8ct
of 2--2.
0orporate governance.
5inancial reporting.
2udit functions.
5ederal securities law enforcement.
3thers (e.g., legal counsel, financial anal&sts).
2. /3plain the financial reporting provisions of '() an! '/C0relate! rules.
0ertification of financial statements and internal controls b& 0*3s and 053s.
.isclosure of offNbalance sheet transactions.
.isclosure pertaining to the use of non-9228 financial measures.
.isclosure of material current events affecting companies.
/andator& internal control reporting b& management.
2 stud& of principles-based accounting standards.
0onvergence of accounting standards.
-ecognition of ade'uate funding for the 52)= as an accounting standard-
setting bod&.
3versight function of the 52)= b& the )*0.
3. What is one fun!amental obFective of '()?
3ne of the fundamental ob$ectives of )34 is to restore investor confidence in
corporate 2merica, its financial reporting, and capital markets b& enhancing the
reliabilit& and integrit& of audit functions and the audit process as well as the
credibilit& of audit reports.
. /3plain the ?air ?un!s >rovision of '().
It empowers the )*0 to obtain civil penalties resulting from enforcement cases
and add them to disgorgement funds to compensate investors who suffer losses
due to securities law violations.
@;
#. What are the four !ivisions of the '/C?
The .ivision of 0orporate 5inance.
The .ivision of /arket -egulation.
The .ivision of Investment /anagement.
The .ivision of *nforcement.
%. /3plain the blackout perio!.
The blackout period is defined as an& period of more than three consecutive
trading da&s during which the abilit& of at least <; percent of the participants or
beneficiaries of the compan&s account plans to trade (purchase, sell, ac'uire, or
transfer) an& e'uit& securit& of the plans is temporaril& suspended b& the
compan& or b& a fiduciar& of the plans.
&. /3plain the composition of the >C8(;.
The 8023= functions under )*0 oversight, consisting of five members where
two of them are certified public accountants (082s), chaired b& a member who
has not practiced as a 082 for at least five &ears prior to appointment.
*. What is '8' Ho. ++ an! what are its re"uirements?
)2) 7o. CC titled Consideration of Fraud in a Financial Statement Audit
provides risk factors broken into the fraud p&ramid of incentivesGpressures,
opportunities, and attitudesGrationali1ations. )2) 7o. CC states that +absolute
assurance is not attainable and thus even a properl& planned and performed audit
ma& not detect a material misstatement resulting from fraud., )2) 7o. CC
re'uires auditors to(
2pproach ever& audit with professional skepticism.
.iscuss among the audit team members regarding the risks of material
misstatement due to fraud.
Identif& fraud risk and management incentives, opportunities, and abilit& to
rationali1e occurrence of fraud.
.esign audit tests responsive to the risks of fraud.
)2) 7o. CC re'uires that auditors place an increased emphasis on discovering
financial statement fraud.
+. What are some of the a!vantages of complying with '()?
The mentioned benefits of compliance with )34 in the order of importance are(
(1) stronger internal controls (!) improved accountabilit& of individuals involved
in operations and financial reports (#) reduced risk of financial statement fraud
and better fraud safeguards (%) reduced errors in financial operations and
financial statements (<) improvements in the accurac& of financial reports
(@) empowerment of boards of directors, particularl& audit committees and
(A) enhancements of investors view of public companies.
1-. What is the obFective behin! cooperation an! coor!ination of the '/C an!
C/'R?
Identif& and address emerging risks in the *D and D.). markets at an earl&
stage.
.iscuss potential regulator& pro$ects to facilitate converging wa&s of
addressing common issues.
@1
)et priorities for discussion and collaboration between the two bodies
including market structure issues, the role and responsibilit& of credit rating
agencies and anal&sts, and mutual fund regulation.
11. /3plain the role of courts in corporate governance. 8lso e3plain the two views on
the role of courts.
The role of courts in corporate governance and corporate internal affairs is
determining and interpreting fiduciar& duties of its participants, particularl&
directors and officers.
The contractarianists view the corporations as a ne"us of contracts that
establishes a set of private contractual relationships among all corporate
governance participants including providers of capital and services.
2nticontractarianists argue that a corporation is not a t&pical contract sub$ect
to e"tensive government regulation and view the corporation as a concession of
the state.
5iscussion Questions
1. What !o you think about this perception that the maFority of corporate
e3ecutives believe that the emerging corporate governance reforms. inclu!ing
'(). provi!e stan!ar!s an! measures for corporate compliance. but there is no
a!e"uate training. e!ucation. or stan!ar!s for in!ivi!uals who carry out
compliance? 'ubstantiate your answer.
-egulators understand that provisions cannot be too e"haustive, due to the
d&namic nature and diversit& of the man& public companies under such
provisions. 2s corporate governance reforms continue to follow a more
principles-based approach to regulation as opposed to a rules-based approach,
organi1ations should consider adopting some of the corporate governance best
practices outlined b& the 0onference =oard, 2merican 6aw Institute, 2merican
=ar 2ssociation, and institutional investors. 2dopting corporate governance best
practices ma& aid an organi1ation to compl& with various corporate governance
reforms. In addition, corporate e"ecutives ma& find it beneficial to engage the
services of outside counsel to compl& with reforms. These two measures ma&
allow the organi1ation to understand various provisions, and therefore be able to
compl& more ade'uatel& with those provisions.
2. :2he recent wave of financial scan!als in!icates that regulators are often slow in
respon!ing to those scan!als. bringing enforcement actions against corporate
wrong!oers. an! preventing wi!esprea! effects of aversion towar!s the scan!al.<
5o you agree with the given statement? Why?
-egulators are often slow in responding to corporate scandals because of the
political and regulator& bureaucratic process involving these scandals. In these
situations, the state attorne& general can be ver& effective in the earl&
investigation of corporate wrongdoing. 5or e"ample, the timel& activities of 7ew
Eork 2ttorne& 9eneral *liot )pit1er had a significant impact on the mutual fund
industr& and its operations. T&picall&, following the announcement b& )pit1er
regarding possible investigation, the concerned companies would agree to pa&
fines for bad practices and correct their operations (e.g., !;;! /errill 6&nch
anal&sts practices). )pit1ers investigation into the mutual fund industr& began in
@!
late !;;#, but it was not until earl& !;;% that the )*0 issued independence rules
for mutual funds that were subse'uentl& appealed b& the industr&. 0ongress then
re'uested that the )*0 revisit its mutual fund rules.
3. 5o you feel the concept of best practices helps the effectiveness of corporate
governance? /3plain how.
=est practices can be used as benchmarks to determine the best wa& to improve
business processes and corporate governance b& following the means b& which
leading organi1ations achieve e"cellence performance. 0orporate governance ma&
become more robust as a result of the adoption of best practices designed to
improve corporate governance structure and operation.
. Can '() an! other corporate governance provisions be beneficial for nonpublic
companies even though they are not obligate! to comply with such provisions?
/3plain your answer.
)34 and other corporate governance provisions can be ver& beneficial to private
companies that have no intention of going public. 5urthermore, )34 has become
so pervasive that man& stakeholders of private companies demand that the&
conform to some of the provisions of )34. )ome of the less cumbersome
provisions of )34 relevant to nonpublic companies are( (1) improving their
corporate governance b& creating an appropriate balance of power-sharing
between owners, management, and auditors (!) improving the 'ualit& of their
financial reports (#) strengthening their code of business conduct (%) prohibiting
loans to their officers (<) enhancing their communications with their shareholders
and other constituencies through holding conference calls, meeting with them, or
distributing periodic 'uarterl& and annuall& financial statements (@) increasing
the effectiveness of the board oversight function through establishing an
independent audit committee to oversee financial reporting, internal controls, and
audit activities and (A) improving their I05- b& implementing some of the ke&
provisions of )34 %;% including internal control reports b& management and
audit reports b& the independent auditor.
#. $ow !o companies encourage compliance with rules an! regulations establishe!
by regulatory bo!ies within the corporate governance structure?
0ompanies should compl& with comprehensive, transparent, and fair rules,
regulations, and standards enforce these rules, regulations, and standards and
impose e'uitable penalties for their violations. 2n effective compliance function
reduces incentives for misconduct, reduces conflicts of interest, and encourages
ethical and professional conduct.
%. $ow !oes the regulatory an! legal environment of a country shape the corporate
governance structure?
:hen market correction mechanisms are ineffective, government intervention is
necessar&. 9overnment intervention can be endorsed on several levels( local,
regional (state), and federal (in all three branches( e"ecutive, $udicial, and
legislative). 2 countr&s regulator& and legal environment shapes how these
reforms are mandated.
@#
&. 5escribe the impact of regulatory conflicts an! overloa! on the long0term
attractiveness an! global competitiveness of the 4.'. capital markets.
The D.). approach to corporate governance is regarded as a regulator&-led s&stem
that provides high standards of protections for investors influenced b& polic&
makers, regulators, stock e"change listing standards, and state law. These
regulations must be cost-effective, efficient, and scalable to promote best
practices of corporate governance. 2n& regulator& conflicts or overregulations can
significantl& increase compliance costs, have detrimental effects on the long-term
attractiveness of D.). capital markets, and put the markets at a global competitive
disadvantage. 5or foreign companies, with a low number of D.). e'uit&
shareholders, the compliance costs with strict regulations can outweigh the
benefits of listing on D.). capital markets and cause these companies to
deregister.
2rue or ?alse
1. Section 1103 of SOX authorizes the SEC to obtain a temporary order to escrow
extraordinary payments by the company to its directors and officers.
2. One of the goals of the SEC is to foster informed investment decision making.
3. The Division of Corporate Finance establishes and maintains standards for fair,
orderly, and efficient capital markets.
4. The rules established by the SEC do not have a significant impact on the corporate
governance structure of public companies, but do have an impact on that of the private
companies.
5. The SEC does not have any powers to bring civil enforcement actions against the
individuals who violate its rules and securities laws.
6. The SEC requires each of the self-regulatory organizations (SROs), including the
NYSE and Nasdaq, to review the adequacy of their governance practices.
7. The PCAOB does not have any powers to investigate registered public accounting
firms and their personnel for potential violations of applicable laws, rules, and
regulations.
8. The U.S. Sentencing Commission (USSC) guidelines have been used by companies
as a benchmark for reducing the risk of significant penalties if a violation of a law
occurs.
9. The SEC requires mutual funds to establish certain governance practices.
10. Investment protection principles (IPPs) do not require broker/dealers who trade
securities on the funds behalf to establish a monitory process to ensure compliance with
the IPPs.
11. IPPs require investment managers to disclose the amount of commission paid to
broker/dealers.
12. Courts play a role in corporate governance by interpreting implications and
applicability of corporate governance measures.
13. One corporate governance recommendation is that the board of directors should
develop a structure that establishes an appropriate balance of power-sharing between the
0*3 and the independent directors.
@%
14. Shareholder activism can increase agency costs by promoting effective corporate
governance principles and monitoring compliance with corporate governance best
practices.
2rue or ?alse
1. True
2. True
3. False
4. False
5. False
6. True
7. False
8. True
9. True
10. False
11. True
12. True
13. True
14. False
=ultiple Choice Questions
1. 2he primary focus of '() was to improve the DDDDDDDDD of public financial
reports.
a. -eliabilit&.
b. ?ualit&.
c. Transparenc&.
d. 2ll of the above.
2. 2he >C8(; functions un!er the '/C oversight consist of9
a. Two 082s, chaired b& a member who has not practiced as a 082 for at least five
&ears prior to appointment.
b. 3ne 082, chaired b& a member who has not practiced as a 082 for at least five
&ears prior to appointment.
c. 7o 082s, but chaired b& a member who has not practiced as a 082 for at least
five &ears prior to appointment.
d. 7one of the above.
3. >C8(; governance. bu!get. an! operations are !esigne! in such a manner to
maintain its9
a. .ependence on public accounting firms and the federal government.
b. Independence from public accounting firms and the federal government.
c. *ither independence or dependence on public accounting firms and the federal
government.
d. 7either independence nor dependence on public accounting firms or the federal
government.
@<
. 2he >C8(; is authori,e! to register9
a. 3nl& D.). public accounting firms auditing D. ). public companies.
b. 3nl& non-D.). public accounting firms auditing D.). public companies.
c. =oth D.). and non-D.). public accounting firms auditing D.). public companies.
d. 7either D.). nor non-D.). public accounting firms auditing D.). public
companies.
#. 6nspection reports inclu!ing violations may be ma!e available to the public if
concerns an! issues inclu!e! in the reports are not properly a!!resse! by the
accounting firm within9
a. @ months after the date of the inspection report.
b. 1! months after the date of the inspection report.
c. 1; da&s after the date of the inspection report.
d. Immediatel& after the date of the inspection report.
%. ;y launching its new accounting culture. the 86C>8 plays which of the following
roles9
a. 2 standard-setting role.
b. 2 fraud prevention and detection liaison role.
c. 2n educational role.
d. 2ll of the above.
&. 2he ?8'; has been critici,e! for which of the following9
a. =eing too slow to respond to emerging changes in the business environment.
b. .eveloping broad accounting concepts.
c. 8roviding standards for financial reporting.
d. 8roviding guidance on the implementation of standards.
*. 2he primary responsibility of the C/'R is to9
a. Issue standards and guidance.
b. 8romulgate standards.
c. Issue implementation guidance.
d. 2ll of the above.
+. Which of the following is@are the !uty@!uties of the '/C9
a. *nforce rules and laws.
b. Interpret federal securities laws.
c. =oth (a) and (b).
d. 7either (a) nor (b).
1-. 2he investment protection principles re"uire broker@!ealers who tra!e securities
on the ?un!1s behalf to9
a. )ever the link between compensation for anal&sts and investment banking.
b. 8rohibit investment banking contribution (input) into anal&st compensation.
c. *stablish a review committee to approve anal&sts research recommendations.
d. 2ll of the above.
11. 2he effectiveness of corporate governance !epen!s on9
a. 0ompliance with state and federal statutes.
b. 0ompliance with listing standards.
c. 0ompliance with best practices recommended b& investor activists and
professional organi1ations.
d. 2ll of the above.
@@
12. 6nstitutional investors may not fully e3ercise their corporate governance
oversight function an! monitoring controls because9
a. 8ension fund managers are t&picall& the ultimate beneficiaries of the wealth
generated b& corporations.
b. The& ma& have strong incentives to engage in monitoring of the compan&s
affairs.
c. )uch monitoring engagements are with costs.
d. 5und managers ma& be reluctant to incur these monitoring costs.
=ultiple Choice Questions
1. d.
!. a.
#. b.
%. c.
<. b.
@. d.
A. a.
B. d.
C. c.
1;. d.
11. d.
1!. d.
Chapter *
Review Questions
1. What are the recommen!ations ma!e by the 668 to the '/C an! the >C8(; in
improving the effectiveness of 'ection - compliance?
0onsideration of the importance of enterprise-wide risk management in
improving corporate governance rather than $ust I05-.
/ore-detailed guidance regarding managements assessment of internal
controls.
/ore-detailed guidance on the 'uarterl& )ection #;! management assessment
process and reporting on management corrections of reported material
weaknesses.
0larification of +principal evidence, and additional guidance regarding ke&
issues such as a vigilant board of directors and management overrides.
Increasing the cost effectiveness of compliance with provisions of )34 b&
clarif&ing )*0 implementation rules and providing better communication
between the audit committee, e"ternal auditors, and management.
0reation of appropriate balance between the focus on compliance with )ection
%;% and other enterprise-wide risks affecting all aspects of corporate governance.
2. What !oes the Conference ;oar! recommen! regar!ing the establishment of an
internal au!it function in an organi,ation?
2ll public companies should have an internal audit function.
@A
3. Why is the establishment an! maintenance of an internal au!it function crucial
to the effectiveness of a company1s corporate governance in achieving its goal of
creating sharehol!er value an! protecting stakehol!er interests?
The internal auditors add value and improve an organi1ations governance. The
)arbanes-3"le& 2ct, )*0 related-rules, listing standards, and professional
organi1ations all directl& or indirectl& recogni1e the important role of the internal
audit.
. What are the areas in which '/C rules permit internal au!it outsourcing to the
client1s in!epen!ent au!itor?
3perational internal audits that are not related to internal accounting controls,
financial s&stems, or financial statements.
7onrecurring assessment of discrete items or other programs unrelated to
outsourcing of the internal audit function.
#. What are the factors to be consi!ere! by the internal au!itors when supporting
an! consulting management to comply with 'ection 3-2 an! -?
0onsulting management on internal control activities compliance does not
impair the internal auditors independence and ob$ectivit&.
/aking ke& management decisions in the compliance process impairs the
internal auditors ob$ectivit& and independence.
Having responsibilit& for specific operations or participation in directing ke&
management decisions impairs the internal auditors ob$ectivit& and
independence.
The design, implementation, and drafting procedures for internal controls to
compl& with )ections #;! and %;% impair the internal auditors independence and
ob$ectivit&.
-ecommendation of standards for internal controls or review of internal
control procedures does not impair the internal auditors ob$ectivit& and
independence.
.evoting a significant amount of effort to consult with management on
)ections #;! and %;% compliance can deplete internal auditors resources and
deviate their attention from other value-adding activities.
%. /3plain the steps involve! for the establishment or improvement of an effective
internal au!it function.
2ppoint the right person to be the chief audit e"ecutive (02*). The audit
committee of the board of directors is directl& responsible for the
appointment, compensation, and, when necessar&, the dismissal of the
compan&s 02*.
*stablish a written audit charter. The internal audit charter should specif& the
purpose, authorit&, and responsibilit& of the internal audit function as an
integral component of corporate governance in adding value to the compan&s
sustainable performance.
.evelop an audit strateg&. The internal audit function should have a sound
audit strateg& that adds value to the compan&s operations in risk
management, financial reporting, internal controls, and governance processes.
@B
Implement the audit strateg&. *ffective implementation of the internal audit
strateg& re'uires proper audit plans, sufficient resources including ethical,
highl& speciali1ed, and competent staff, commitment from senior
management, and approval of the audit committee.
*stablish 'ualit& assurance and performance evaluation. To ensure a high-
'ualit& internal audit function it should be evaluated annuall&.
&. 5iscuss the responsibilities of the internal au!it function.
The internal audit function is responsible for providing assurance that the
compan&s operations, risk assessment, internal controls, financial reports, and
governance processes as designed and implemented b& management are ade'uate
and effective to ensure(
/anagement operations are efficient.
=oth operational and financial risks are identified, managed, and monitored.
8roper communication and interactions e"ist between all corporate
governance participants.
Ie& operational, managerial, and financial information is accurate, timel&,
and reliable.
The compan& is in compliance with applicable laws, regulations, rules, and
standards.
*mplo&ees adhere to internal policies as well as e"ternal regulations.
-esources are safeguarded and used efficientl&.
/anagerial programs, plans, and ob$ectives are effectivel& achieved.
The internal audit function uses appropriate risk-based audit methodolog&.
The established annual audit plan is effectivel& implemented.
2 professional internal audit staff is maintained with ade'uate skills,
knowledge, education, certification, and e"perience.
2n appropriate 'ualit& assurance program is established to assess the
effectiveness of the internal audit function.
2 continuous improvement process is implemented.
*"ternal and internal audit activities are properl& coordinated to ensure
ade'uate coverage and prevent duplication.
0odes of corporate ethics are complied with.
The audit committee receives periodic reports on internal audit activities and
significant financial and internal control processes.
*. /3plain the three sets of man!atory stan!ar!s for >rofessional >ractice of
6nternal 8u!iting A'>>68B.
2ttribute standards specif&ing appropriate features of individual auditors or
audit functions performing internal auditing.
8erformance standards regarding the performance of internal audit
engagements.
Implementation standards describing attribute and performance standards and
how the& can be applied to the specific t&pes of audits.
+. What are the best practices that shoul! be implemente! by organi,ations
accor!ing to >ricewaterhouseCoopers?
@C
8w0 suggests that internal auditors best practices include the following(
=uild an ade'uate internal audit staff to support the needs of business.
)tructure the internal audit function on a fluid and fle"ible framework.
.esign an enterprise-with-riskNbased audit program.
=roaden audit scope to address third-part& and vendor risk.
0ombat fraud b& advocating ethical conduct throughout the organi1ation.
/anage information s&stems risk proactivel&.
1-. What purpose !oes the written au!it charter serve for the company?
The internal audit charter should specif& the purpose, authorit&, and responsibilit&
of the internal audit function as an integral component of corporate governance in
adding value to the compan&s sustainable performance.
11. What authoritative rights shoul! be grante! to the internal au!it function an!
the C8/?
5ull and free access to the compan&s audit committee.
Dnrestricted access to the compan&s records, documents, propert&, and
personnel.
2uthorit& to determine the scope, nature, e"tent, and timing of internal audit
activities.
2ccess to plans that have alread& been approved b& the audit committee.
2uthorit& to review risk assessment, internal controls, compliance, financial
reporting, and governance processes.
2uthorit& to provide consulting services to corporate governance participants
including directors, e"ecutives, and ke& financial personnel.
2uthorit& to assist the audit committee in its oversight responsibilities relevant
to financial reporting and audit activities.
2uthorit& to discuss initiatives, policies, and procedures regarding risk
assessment, internal controls, compliance, financial reporting, and governance
processes with management and other corporate governance participants.
5iscussion Questions
1. 8 close working relationship between the au!it committee an! internal au!itors
can improve the effectiveness of corporate governance. 5o you agree with this
statement? 'ubstantiate your answer.
2nswers ma& var&. 5irst, the independence and ob$ectivit& of internal auditors
can be enhanced when the& report their findings directl& to the audit committee.
The internal audit function should be independent in the sense that auditors
maintain their( (1) planning independence in determining scope and audit
planning( (!) investigating independence in conducting the audit and performing
audit procedures and (#) reporting independence in communicating audit findings
to senior management and the audit committee. )econd, the prestige and status of
internal auditors can be strengthened when the& work with management at all
levels. Third, internal auditors have the potential to be a significant source of
assistance to the audit committee to effectivel& fulfill their oversight
A;
responsibilities in functions such as financial reporting, internal controls, risk
management, e"ternal audit, whistleblowing, ethics, and ta"es.
2. $ow can an au!it committee contribute to the success an! effectiveness of
internal au!itors an! the achievement of their value0a!!ing activities?
=& ensuring that internal auditors have(
)ufficient independence from management b& reporting to and being held
accountable to the audit committee.
2de'uate resources, competence, and focus to assess the compan&s internal
controls and enterprise risk management.
8roper knowledge of the compan&s corporate governance, internal control,
financial reporting, and audit activities.
The mechanisms and confidence to bring forward controversial financial
reporting issues.
2 process for communicating directl& with the compan&s audit committee on
a regular and timel& basis.
2ccess to the audit committee to discuss concerns related to management
activities, financial reporting risk, and fraudulent financial reporting.
3. 6n your opinion. why are there no regulations that re"uire internal au!it
assurance reports?
2nswers ma& var&. Internal auditors provide information to management based
on the information needs of e"ecutives and decision makers within the
organi1ation. If such a process were regulated, then the information provided b&
internal auditors could become more standardi1ed to compl& with applicable laws.
This, in turn, could cause such information to be less effective for managers.
Thus, regulation in the internal audit process ma& not be helpful to effective
decision making within the organi1ation, especiall& since regulations are alread&
in place for e"ternal reporting and independent audit behavior.
. 6n what ways !oes the internal au!it !epartment a!! value to an organi,ation?
Internal auditors ma& improve the effectiveness of their organi1ations
governance b& assisting management in assessing internal controls and enterprise
risk management, identif&ing their material weaknesses, and making suggestions
to management for their improvements.
#. What factors have le! to the transformation of the 6681s !efinition of :internal
au!iting<? Research your answer.
Internal auditors have made impressive progress during the past several decades.
The focus of internal auditing shifted awa& from appraisal and compliance
activit& toward ob$ective assurance and consulting activities. There was a shift
from +serving management, to +serving the organi1ation, to +corporate
governance., The role of internal auditors changed from providing management
with input and ob$ective feedback to participating directl& in decision making.
%. What are the benefits an! negative results of outsourcing the internal au!it
function?
2nswers ma& var&. )ome benefits from outsourcing ma& include( increased
competenc& of the internal audit function enhanced independence of internal
auditors and competitive performance from the internal audit firm. 7egative
results of outsourcing ma& include( privac& concerns control over information
A1
lack of fle"ibilit& and lack of positive e"ternalities e"perienced in other areas of
the organi1ation due to in-house internal audit services.
&. 2he role of internal au!itors has evolve! from performing tra!itional appraisal
activities an! au!it functions of evaluating internal controls to being consi!ere! an
important component of corporate governance by a!!ing value to organi,ations by
improving operations. 6s the given statement true or false? 'ubstantiate your
answer.
2nswers ma& var&. Internal auditors now focus on adding value to their
organi1ations in performing a variet& of assurance-related functions b& providing
assistance to( (1) the audit committee in effectivel& discharging its oversight
responsibilities (!) management in making business decisions, assessing
enterprise risk management, certif&ing internal controls and financial statements,
and identif&ing and preventing problems and potential risks and (#) the
independent auditor in performing their assurance and integrated audit functions.
Thus, the given statement is true.
*. /3plain how internal au!itors1 e3pertise in internal control can ensure
effectiveness of the corporate governance structure.
Internal auditors can identif& areas within the organi1ation that ma& need
corporate governance improvement, suggest means for improving corporate
governance in those areas, and evaluate the efforts of management in improving
the effectiveness of corporate governance.
2rue or ?alse
1. The purpose of performance evaluation is to improve the 'ualit& of the internal audit
function and provide a basis for promotion, advancement, and compensation.
!. .evelopment and practice aids usuall& offer training and education on emerging
developments in internal auditing consisting of courses, research reports, and continuing
education seminars.
#. The internal audit function under the direct oversight of the audit committee is
responsible for providing assurance that the compan&s operations, risk assessment,
internal controls, financial reports, and governance processes as designed and
implemented b& management are ade'uate and effective to ensure ke& operational,
managerial, and financial information is accurate, timel&, and reliable.
%. Independent auditors are prohibited from performing internal auditing outsourcing
services for nonpublic compan& audit clients.
<. The 0onference =oard recommends that all public companies have an internal audit
function.
@. The decision of whether to establish and maintain an internal audit function or
outsource the internal audit function should be made b& the compan&s shareholders,
audit committee, management, legal counsel, and independent auditor.
A. The internal auditors role is regarded as a value-adding function to improve
managerial and emplo&ee performance while preserving their independence and
ob$ectivit&.
B. Internal audit activities should be viewed as a value-added function within the
organi1ations corporate governance with sufficient resources to carr& out their assigned
responsibilities.
A!
C. )34 directl& addresses internal auditor responsibilities or internal audit functions.
1;. The success of corporate governance depends on the effectiveness of all corporate
governance functions.
11. Dnder )ections #;! and %;% of )34, management is authori1ed to delegate its
responsibilities to the internal auditors.
1!. The term +service, mentioned in definitions of internal auditing as provided b& the
II2 initiall& in 1C%A, and subse'uentl& in 1CB1 and 1CCC, implies that internal auditing is
a line activit& rather than a staff within the organi1ation.
1#. The ma$orit& of D.). /70s rated securit& and privac&, timing and timeliness,
control, and abilit& to deal with compliance issues as important and highl& effective in
making decisions to outsource financial functions.
1%. Jalue driver identification including gathering information about value drivers of
internal audit is the third phase in the four-phase plan suggested b& 8w0.
2rue or ?alse
1. True
!. True
#. True
%. 5alse
<. True
@. 5alse
A. True
B. True
C. 5alse
1;. True
11. 5alse
1!. 5alse
1#. True
1%. 5alse
=ultiple Choice Questions
1. Which of the following is the secon! step in the process of establishment or
improvement of an effective internal au!it function?
a. *stablish 'ualit& assurance and performance evaluation.
b. .evelop an audit strateg&.
c. *stablish a written audit charter.
d. 2ppoint the right person to be the 02*.
2. Which of the following statements is true regar!ing the internal au!it functions
of a publicly hel! company?
a. 6isting standards re'uire an internal audit function.
b. The internal auditor ma& also be the e"ternal auditor.
c. The internal audit department onl& reports to the audit committee.
d. 2ll of the above.
3. Which of the following is not a step in establishing or improving an effective
internal au!it function?
A#
a. *stablish 'ualit& assurance and performance evaluation.
b. .evelop an audit strateg&.
c. *stablish a verbal audit charter.
d. 2ppoint the right person to be the 02*.
. What is the primary purpose of the C8/?
a. *ffectivel& supervise and administer the internal audit.
b. )ociali1e with the e"ternal auditors to ensure positive reporting.
c. =e the sounding board of the audit committee.
d. Hire and fire the accounting personnel of the compan&.
#. What is foun! in the au!it strategy?
a. )cope, nature, procedures, and timing of all internal audit activities.
b. 8rocedures and timing of all internal audit activities and the fees associated with
the audit.
c. )cope and nature of all internal audit activities and the fees associated with the
audit.
d. 5ees associated with the audit.
%. 2he four principles of the 668 co!e of ethics are9
a. Integrit&, ob$ectivit&, confidentialit&, and competenc&.
b. Integrit&, ob$ectivit&, independence, and competenc&.
c. Integrit&, independence, confidentialit&, and authorit&.
d. Integrit&, ob$ectivit&, confidentialit&, and independence.
&. 2o maintain their in!epen!ence an! obFectivity. internal au!itors shoul! refrain
from9
a. /aking decisions on behalf of management.
b. 5inancial reporting.
c. 8roviding consulting services.
d. 0ompliance with applicable laws, rules, and regulations.
*. Which of the following statement !oes not a!e"uately !escribe the 668?
a. The II2 is a well-recogni1ed organi1ation representing more than 1;!,;;;
members throughout the world.
b. The II2 is viewed as the national voice of internal auditors through its issuance of
the International )tandards for the 8rofessional 8ractice of Internal 2uditing.
c. The II2 has pla&ed an important role in improving corporate governance, internal
control, and financial reporting.
d. The II2 has adopted a 8rofessional 8ractices 5ramework (885) that includes new
and updated internal auditing standards.
+. Which one of the following is not a recommen!ation issue! by the 668 to the
'/C?
a. The consideration of the importance of enterprise-wide risk management in
improving corporate governance rather than $ust internal control over financial
reporting.
b. /ore-detailed guidance regarding managements assessment of internal controls.
c. /ore-detailed guidance on the 'uarterl& )ection #;! management assessment
process and reporting on management corrections of reported material
weaknesses.
A%
d. Dntil all )34 implementation issues have been effectivel& +ironed-out,, there
should be a decrease in the communication among management, audit committee,
and e"ternal auditors.
1-. Which of the following is not an element of internal au!iting as !efine! by the
668?
a. )ervice.
b. 5ocus on ob$ectivit&.
c. The role of internal auditors.
d. 5inancial reporting.
11. '() prohibits in!epen!ent au!itors from performing which services for their
client?
a. 5inancial reporting.
b. 8roviding certain internal auditing outsourcing activities contemporaneousl& with
audit services.
c. Improving the internal audit function.
d. *stablishing and maintaining an internal audit function.
12. Which of the following is not rate! as important an! highly effective in making
!ecisions to outsource financial institutions?
a. Timing and timeliness.
b. )ecurit& and privac&.
c. 2bilit& to deal with compliance issues.
d. 7one of the above.
13. 8u!it committees shoul! utili,e internal au!itor services in fulfilling their
oversight responsibilities over9
a. 5inancial reporting.
b. Internal controls.
c. 2udit activities.
d. 2ll of the above.
1. 2he 6681s 2-- >osition >aper suggests which of the following activities of
internal au!itors to support their company1s proFect to comply with 'ections 3-2
an! -?
a. 8ro$ect oversight.
b. 0onsulting and pro$ect support.
c. 3ngoing monitoring and testing.
d. 2ll of the above.
1#. >ricewaterhouseCoopers suggests that internal au!itors1 best practices shoul!
inclu!e all of the following e3cept9
a. =uild an ade'uate internal audit staff to support the needs of business.
b. )tructure the internal audit function on a fluid and fle"ible framework.
c. 7arrow the audit scope to address third-part& and vendor risk.
.esign an enterprise-with-riskNbased audit program.
=ultiple Choice Questions
1. c.
!. a.
#. c.
%. a.
A<
<. a.
@. a.
A.a.
B. b.
C. d.
1;. d.
11. b.
1!. d.
1#. d.
1%. d.
1<. c.
Chapter +
Review Questions
1. $ow can an effective au!it function be achieve!?
2n effective audit function is achieved b& improving the following(
2uditor selection and client acceptance processes.
2udit 'ualit& and its relation to audit fees.
*vidence-gathering procedures.
Integrated audit approach.
2uditor independence.
2udit and nonaudit services.
2udit opinion.
2. /3plain the term :e3pectation gap< in au!iting.
*"pectation gap is the difference between what the investing public and other
users of audited financial statements believe the responsibilities of auditors are
and what auditors are willing to assume as responsibilities according to their
professional standards.
3. /3plain the initiatives to be taken to improve au!it "uality as well as the
transparency of the au!it process an! report.
8ublication of audit engagement letters.
)hareholder rights to 'uestion auditors.
8ublication of auditor resignation statements.
6ead partners signature on audit reports.
2nnual shareholder annual ratification of the audit firm.
. What are the structural factors of accounting that provi!e opportunities for bias
to influence Fu!gment?
2mbiguit&.
2ttachment.
2pproval.
#. What is the un!erlying basis of au!it firm rotation?
To reduce the likelihood of economic ties and friendship with clients, public
accounting firms must be rotated and clients must be prohibited from rehiring the
accounting firm at the end of the contract for a given period of time.
A@
%. /3plain the :pass@fail< approach utili,e! by the current au!iting mo!el.
The passGfail approach states whether financial statements are presented fairl& in
conformit& with 9228 (pass) or not (fail) without providing an& information
regarding the 'ualit& of audited financial statements.
&. What are the three categories in which internal control !eficiencies are classifie!
accor!ing to 8u!iting 'tan!ar! Ho. 2?
Inconse'uential deficiencies.
)ignificant deficiencies.
/aterial weaknesses.
*. /3plain the !ifferent types of opinions on internal control over financial
reporting.
Dn'ualified opinion>2n un'ualified opinion can be rendered when there are
no identified material weaknesses in I05- and no scope limitations.
2dverse opinion>2n adverse opinion should be rendered when there are
significant deficiencies in the compan&s I05- that result in one or more
material weaknesses.
?ualifiedGdisclaimer opinion>2 disclaimer of opinion should be given when
there is a scope limitation and the auditor cannot e"press an opinion on
managements assessment of the effectiveness of the compan&s I05-.
+. What are the four tests use! to classify ta3 planning as aggressive?
The auditor provides an& service related to the plan or opinion.
The idea was not initiated b& the client.
2 significant purpose of the idea was to avoid ta"es.
The plan has a less than <;-<; chance of prevailing if challenged b& the I-).
1-. /3plain several of the steps followe! by the >C8(; for its inspection process.
)electing the audit clients based on the 8023=s assessment of the likelihood
of material misstatements or significant audit deficiencies.
-eviewing aspects of the selected audits b& each firm.
0hoosing the engagements to review according to the 8023=s criteria.
-etraining the accounting firm to limit or influence the engagement selection
process or an& other aspect of inspection review.
-eviewing the selected audit clients financial statements and certain )*0
filings.
11. /3plain the importance of the inspection report.
It improves audit effectiveness b& identif&ing and re'uiring resolution of audit
failures.
It identifies and properl& addresses emerging and common accounting and
auditing issues.
It improves the audit firms s&stem of 'ualit& control and evidence-gathering
procedures.
It assists the 8023= in establishing appropriate auditing, 'ualit& control, and
ethics standards.
It enhances public trust and investor confidence in the auditing profession.
12. $ow are >C8(; enforcement investigations coor!inate! with those of the '/C?
AA
The 8023= staff meets fre'uentl& with the )*0 staff.
The 8023= staff attends )*0 testimon& of auditors.
The )*0 staff sits in on 8023= testimon& without asking 'uestions.
13. When !oes the au!it committee monitor au!itor in!epen!ence an! why?
The committee monitors auditor independence during(
The appointment process b& being directl& responsible for hiring, firing,
compensating, and overseeing the work of the auditor.
The planning stages of the audit to ensure that management is not influencing
the audit plan or scope of the audit.
The evidence-gathering phase of the audit to ensure that the auditor has access
to all information, records, schedules, and financial statements, and the scope
of the audit was not limited.
The reporting phase to ensure auditor $udgment and opinion were not
influenced b& management or a sense of lo&alt& to the compan&.
1. $ow can the au!it committee ensure proper !isclosures of au!itor
in!epen!ence?
The committee ensures proper disclosures b& receiving auditor independence
confirmation from the compan&s independent auditor prior to the filing and
distribution of audited financial statements.
1#. /3plain the term au!itor in!epen!ence an! the principles it is base! on.
2uditor independence is defined as freedom from those pressures and other
factors that compromise, or can reasonabl& be e"pected to compromise, an
auditors abilit& to make unbiased and ob$ective audit decisions. It is based on
three basic independence principles(
2uditors cannot be part of management or its team.
2uditors cannot audit their own works.
2uditors cannot serve in advocac& roles as specified b& the )*0.
1%. /3plain the !ual testing of controls an! substantive tests.
It is an integrated audit approach in which auditors test controls at both the entit&-
level and the transaction-level along with substantive tests.
1&. What are the four aspects of the financial reporting process that are targete! by
'() as nee!ing improvement?
/isstatements or omissions in financial statements.
Internal control deficiencies.
2ccounting estimates.
5raud.
1*. What are the si3 steps for the effective assessment of company0level controls?
*ngage in gap remediation and continuous improvements.
Test the effectiveness of compan&-level controls.
.ocument and assess compan&-level controls.
3btain input on the design and operation of compan&-level controls.
=uild an assessment structure for compan&-level controls.
.efine the pro$ect plan and ke& milestones.
AB
1+. Which three boar!s in the 4nite! Iing!om look after the au!iting profession
an! au!iting stan!ar!s?
8rofessional 3versight =oard (83=), formerl& 8rofessional 3versight =oard
for 2ccountanc& (83=2).
2uditing 8ractices =oard (28=).
2ccountanc& Investigation and .iscipline =oard (2I.=).
2-. /3plain 8u!iting 'tan!ar! Ho. 39 8u!it 5ocumentation.
2) 7o. # governs audit documentation b& re'uiring the auditor to prepare and
maintain>for at least seven &ears>audit documentation in sufficient detail to
support the conclusion reached in their reports.
21. What is the >C8(; propose! stan!ar! on au!itor in!epen!ence an! what
circumstances consi!er au!itor in!epen!ence impairment?
The 8023= proposed standard on auditor independence identifies four
circumstances that would be considered an impairment of auditor independence
when performing ta" services for their audit clients. These circumstances are(
-egistered auditors perform ta" services on contingent fee arrangements for
their audit clients.
2uditors provide aggressive ta" planning.
2uditors perform aggressive ta" shelters.
2uditors provide ta" services to top e"ecutives of audit clients.
5iscussion Questions
1. :2he public trust in au!itors1 Fu!gments an! reputation is vital in regar!ing the
au!it function as value0a!!e! services that len! cre!ibility to publishe! financial
reports.< 5o you agree or !isagree with the given statement? /3plain your answer.
The audit function is considered value-added when it lends credibilit& to
published financial statements b& reducing the information risk associated with
those statements. :hen auditors provide assurance services, the& are providing
their opinion b& utili1ing their professional $udgment. 8ublic trust in such a
$udgment depends on the reputation of the auditor and the firm with which he or
she is emplo&ed. If the public does not trust the reputation of the firm or the
$udgment of the auditor, 'uestions ma& arise regarding the accurac& of the ob$ect
of assurance. Thus, if the auditor or firm is considered to be untrustworth&, their
services ma& not be considered value-added or helpful to the organi1ation or its
stakeholders.
2. 8ccor!ing to the author. an au!itor has two responsibilities9 to e3press an!
opine on the true an! fair presentation of financial statements in conformity with
C88>. an! at the same time. to assess the "uality of the reports. 5o you feel it is
possible for an au!itor to !ischarge both !uties? /3plain your answer.
This audit function can be achieved b& improving the following( (1) the auditor
selection and client acceptance process (!) audit 'ualit& and its relation to audit
fees (#) evidence-gathering procedures (%) the integrated audit approach
(<) auditor independence (@) audit and nonaudit services and (A) the audit
opinion.
AC
3. Confi!ence an! public trust in au!itors have been re!uce! !ue the concern that
au!itors serve the interests of management who write their checks rather than the
sharehol!ers who eventually pay their fees. 5o you agree or !isagree? /3plain your
answer.
The wave of financial scandals along with financial restatements b& high-profile
public companies and related audit failures eroded public trust and investor
confidence in financial reports and audit functions. /an& concerns have been
raised regarding the challenges confronting the accounting profession in the
aftermath of these scandals and the related regulator& responses. )ince the
passage of )34, the audit committee is responsible for compensating the audit
firm rather than management. Hopefull& this and other measures will improve
corporate governance and thus boost investor confidence and public trust in
auditors.
. /3plain the importance of public accounting firms in a capital market.
2uditors attest to the statements of management, within material respects, giving
credibilit& to managements statements and allowing stakeholders to make
decisions regarding with reasonabl& accurate management representations. If the
representations of management were not seen as credible, investors and other
stakeholders could not rel& on information from management. This would lead to
inefficient markets and a volatile econom&. Thus, the services of public
accounting firms are important to the function of the markets and the econom&
through reducing information risk associated with the information disseminated to
the capital markets.
#. 5o you think it is right to eliminate incentives that cause au!itor self0serving
biases in or!er to improve the "uality of the au!it? 'ubstantiate your answer.
*liminating an& conflicts of interest the auditor ma& e"perience is helpful in
improving the 'ualit& of the audit. This improves the auditors ob$ectivit&, and
also aids in establishing the auditors credibilit&. :hen auditor ob$ectivit& is
enhanced, the 'ualit& of the audit is improved.
%. 6s there any !ifference between ta3 planning an! abusive ta3 shelters? /3plain
your point of view.
There is no standard or law defining the term +ta" shelter, or differentiating
between +ta" planning,, which is a legitimate means of reducing ta" liabilit&, and
+abusive ta" shelter,, which is illegal. 7onetheless, abusive ta" shelters are
characteri1ed as +transactions in which a significant purpose is the avoidance or
evasion of federal, state, or local ta" in a manner not intended b& the law.,
&. /3plain why au!itor in!epen!ence is backbone of the au!iting profession.
2uditor independence lends credibilit& to the auditor and maintains a solid
reputation for the firm in which he or she is emplo&ed. If auditor independence is
impaired, the reputation of the auditor and the auditing firm could be placed in
$eopard& due to legal actions taken b& regulator& bodies against the firm and
decreased confidence in audit reports issued b& the firm.
*. /3plain how internal au!itors are important in performing the integrate! au!it.
B;
*ffective communication between the audit committee, internal auditors, and
other corporate governance participants is an important part of the integrated audit
process. The audit committee should meet with the compan&s 053, internal
auditor, independent auditor, and legal counsel to discuss the integrated audit of
annual financial statements, including managements assessment of the
effectiveness of I05-, auditor report on managements assessment, and audit of
annual financial statements, to evaluate the overall integrit& and 'ualit& of
financial reports before the& are filed or distributed.
+. 5o you think au!itors are solely responsible for any au!it failure? What steps
woul! you. as an au!itor. take to ensure that you are minimally blame! for a
business failure?
2uditors ma& not alwa&s be solel& to blame for audit failures, since unethical
behavior and earnings management schemes ma& sometimes be kept hidden from
auditors even when due diligence is used in the audit process. However,
sometimes auditors ma& look the other wa& when fraud is perpetrated b&
members of the audited organi1ation. In such cases, the auditors would be
responsible for the audit failure. 2uditors can practice due diligence and take
steps to enhance independence from the client to decrease the occurrence of
possible audit failures.
1-. :Critics argue that any contractual provisions that limit the e3ternal au!itor1s
liability or re"uire waiving the right to a Fury trial may have !etrimental effects on
au!itor impartiality. obFectivity. an! "uality.< /3press your views on the given
statement.
)ome ma& argue that auditor liabilit& should be limited on the grounds that such a
limitation could protect auditors from the conse'uences of auditing an
organi1ation that has engaged in fraudulent activities or unethical behavior
without catching such activit&. 3thers ma& argue that a limitation of auditor
liabilit& would result in decreased audit 'ualit&, since the conse'uences of
providing the wrong opinion are lessened.
11. 5iscuss briefly the steps establishe! by the >C8(; for its inspection process.
The inspection process consists of( (1) selecting audit clients based on the
8023=s assessment of the likelihood of material misstatements or significant
audit deficiencies (!) reviewing aspects of the selected audits b& each firm
(#) choosing the engagements to review according to the 8023=s criteria
(%) retraining the accounting firm to limit or influence the engagement selection
process or an& other aspect of inspection review (<) reviewing the selected audit
clients financial statements and certain )*0 filings (@) selecting certain higher-
risk areas for review (e.g. revenue recognition, confirmation) (A) reviewing the
selected areas of revenues, reserves or estimated liabilit&, income ta"es, related
part& transactions, derivatives, supervision of work performed b& foreign
affiliates, internal control assessment and documentation, and risk assessment
(B) anal&1ing end-of-the &ear closing and ad$usting entries, particularl&
ad$ustments that were suggested b& the auditor and were not booked b& the client
(C) reviewing written communications between the auditor and the clients
management (1;) reviewing written communication between the auditor and the
clients audit committee (11) conducting an interview with the chairperson of the
B1
audit committee of the selected audit client (1!) discussing unresolved aspects of
the inspection process with the personnel from the firms national offices if the
issues cannot be resolved through review of work papers and discussion with the
engagement team (1#) selecting additional audits if necessar& to follow leads to
the root of audit deficiencies (e.g., other audits performed b& the same audit
partner or engagement team) (1%) reviewing other work performed b& internal
reviewers who missed the reviewed partners errors (1<) identif&ing and
resolving audit deficiencies and problems earl& in their development (1@) inviting
the public accounting firm to comment on the discovered potential material
accounting errors and significant audit deficiencies (1A) discussing the
discovered audit problems with audit firm representatives including members of
the engagement team, the firm representative responsible for the inspection
process, national office e"perts, the managing partner, or the firms 0*3
(1B) addressing audit problems, lack of performing necessar& audit procedures,
and 'ualit& control re'uirements (1C) disclosing the public portion of the
inspection report on the 8023= :eb site and (!;) disclosing the nonpublic
portion of the inspection report primaril& regarding the firms 'ualit& control
s&stem and other 8023= communication to the audit firm and out of public view
unless the firm fails to take proper action to correct the identified audit failures in
due time.
12. /3plain the importance of au!itor in!epen!ence in the au!iting profession an!
to society an! the investing community.
2uditor independence establishes and maintains the credibilit& of the auditing
profession, and instills confidence in the investing communit& and societ&
regarding the work of audit professionals. 0onfidence in the work of audit
professionals ma& dwindle if such independence were impaired, calling into
'uestion the value-adding nature of such audit services.
13. $ow !o e3ternal au!itors len! cre!ibility to the corporate governance structure?
The independent auditor assurance function provides reasonable assurance that
financial statements are free from material misstatements due to error and fraud,
and e"presses an opinion on the fair presentation of financial statements in
conformit& with 9228. -egistered auditors are also re'uired to e"press an
opinion on managements assessment of the effectiveness of the design and
operation of I05- as well as an opinion on the effectiveness of internal control
itself. The auditor assurance function is intended to lend credibilit& to financial
reports and reduce information risk that financial reports are biased, misleading,
inaccurate, or incomplete.
2rue or ?alse
1. 2ccording to modern compan& law, effective reporting and accounting are essential
for effective governance.
!. The )ecurities *"change 2ct of 1C#% re'uires that companies offering stock to the
public in raising capital must have their financial statements audited b& an independent
public accountant.
#. 0orporate governance reforms do not mandate e"ternal auditors to be independent.
%. The I22)= defines reasonable assurance as absolute in nature.
B!
<. Technical competencies are considered to be the auditors knowledge of relevant
professional standards, rules, laws, and regulations.
@. -eporting competencies are the auditors abilit& to choose appropriate evidence-
gathering procedures.
A. :hen considering the audit function as a value-added service, public trust in auditors
$udgments and reputation is ver& important.
B. 3ne of the primar& purposes of corporate governance reforms is to improve the
'ualit& and credibilit& of financial statement audits and audit reports.
C. 3ne of the missions of the 08025 is to provide leadership through sponsoring public
forums and periodic meetings with interested groups.
1;. *thics education is sufficient to have an impact on bias.
11. The nature and e"tent of managements documentation of internal controls in
providing reasonable support for managements assessment pla&s an important role in
performing tests of controls.
1!. 8023= standards allow public accounting firms to provide ta" shelter services to
their audit clients that impair their independence.
1#. 0onducting an interview with the chairperson of the audit committee of the selected
audit client is part of the inspection process followed b& the 8023=.
1%. The audit committee is directl& responsible for hiring and compensating the
compan&s independent auditor.
1<. Independent auditors can gather information not provided b& management through
in'uiries of the audit committee.
1@. 0ommunications from the audit committee to the independent auditor do not include
formal approval of audit and permissible nonaudit services.
1A. )34, )*0-related rules, and 8023= standards are intended to strengthen auditor
independence b& linking audit partner compensation to audit 'ualit& and not to revenues
received.
1B. The evidence-gathering phase re'uires an auditor to review work papers to ensure
that the audit was conducted in accordance with 8023= audit standards.
1C. The materialit& concept has an important role in assessing the reasonableness of
accounting estimates.
!;. 8ublic companies are e"empted from filing the 11-I report with the )*0.
21. When an independent auditor issues an adverse opinion indicating that there is a
material weakness in internal control, a stand-alone audit engagement may be desired.
2rue or ?alse
1. True
!. True
#. 5alse
%. 5alse
<. True
@. 5alse
A. True
B. True
C. True
B#
1;. 5alse
11. True
1!. 5alse
1#. True
1%. True
1<. True
1@. 5alse
1A. True
1B. True
1C. True
!;. 5alse
21. True
=ultiple Choice Questions
1. 6n!epen!ent au!itors are re"uire! to !ocument their assessment of reasonable
assurance through the use of9
a. The materialit& concept.
b. The audit risk model.
c. =oth (a) and (b).
d. 7either (a) or (b).
2. /3ternal au!itors are not an! shoul! not be e3pecte! to provi!e absolute
assurance regar!ing reliability of financial statements primarily because of9
a. The nature and limitation of evidence-gathering procedures.
b. /anagement assertions and financial representations that are not certain b&
nature.
c. The possibilit& of false documentation.
d. 2ll of the above.
3. 8ccor!ing to aca!emic stu!ies con!ucte! for au!it "uality. which of the
following statementAsB is AareB correct9
a. =ig accounting firms are perceived as more likel& to disclose a discovered error.
b. There is a negative relationship between auditor tenure and the discover& of
material misstatements for the earl& &ears.
c. 5inancial reporting 'ualit& is negativel& affected b& having a large audit firm
audit financial statements.
d. 2ll of the above.
. '() a!!s stipulations surroun!ing employee affiliation between clients an!
au!itors. ?or e3ample. the au!it staff is prohibite! from accepting a key financial
position with the au!it clients for at least9
a. 5ive &ears.
b. Three &ears.
c. Two &ears.
d. 3ne &ear.
#. 8n a!vantage of the pass@fail au!it approach is that(
a. It does not reflect the 'ualit& of the financial statements.
b. It does not provide relevant or useful information to investors regarding the
'ualit& of the compan& as an investment or credit risk.
B%
c. It is standard passGfail language that provides uniformit& and improves
comparabilit&.
d. It focuses on fair presentation rather than true and accurate presentation of
financial position and results of operations.
%. 8 company1s ability to initiate. measure. authori,e. an! report financial
information in accor!ance with C88> is affecte! by9
a. )ignificant deficiencies in internal control.
b. Inconse'uential deficiencies in internal control.
c. /aterial weaknesses in internal control.
d. 7one of the above.
&. >C8(; 8' Ho. 3 re"uires au!itors to prepare an! maintain au!it
!ocumentation in sufficient !etail for at least9
a. Three &ears.
b. 5ive &ears.
c. 5our &ears.
d. )even &ears.
*. 8u!it firms are permitte! to perform which of the following ta3 services for
their au!it clients?
a. -outine ta" return preparation and ta" compliance.
b. 9eneral ta" planning and advice.
c. *mplo&ee personal ta" services.
d. 2ll of the above.
+. 'ections 2-1 an! 2-2 of '() re"uire that all au!it an! permissible nonau!it
services performe! by the company1s in!epen!ent au!itor must be approve! by the9
a. 2udit committee.
b. =oard of directors.
c. 0*3.
d. 7one of the above.
1-. Rotation re"uirements for au!it partners other than the lea! an! concurring
partners involve! in an engagement are9
a. /a"imum of seven &ears on and sub$ect to a two-&ear timeout.
b. /a"imum of two &ears on and sub$ect to a seven-&ear timeout.
c. /a"imum of five &ears on and sub$ect to a one-&ear timeout.
d. /a"imum of three &ears on and sub$ect to a two-&ear timeout.
11. 2he >C8(; propose! stan!ar!s an! 'ection 2-1 on au!itor in!epen!ence
prohibit registere! au!itors from participating in which of the following activities?
a. 5inancial information s&stem design and implementation.
b. Internal auditing outsourcing engagements when acting as e"ternal auditor.
c. /anagerial duties.
d. 2ll of the above.
12. 'ection 2-% of '() prohibits9
a. 2uditors from performing an audit where the 0*3 or other senior financial
e"ecutive was emplo&ed b& the auditor during the preceding &ear.
b. 2uditors from providing an& nonaudit services to the compan&
contemporaneousl& with audit services.
B<
c. 6ead audit or concurring partner and reviewing partner from rotating off the audit
ever& five &ears.
d. 2uditors from reporting to the audit committee all critical accounting policies
and practices used.
13. 8u!itor in!epen!ence provisions along with listing stan!ar!s of national stock
e3changes an! au!iting best practices are !esigne! to supply which of the following
benefits to corporate governance?
a. -educe potential conflicts of interest between auditors and their clients
management.
b. -eplace self-regulation and peer reviews.
c. 6imit the t&pe of nonaudit services public accounting firms can perform.
d. 7one of the above.
1. 2he evi!ence0gathering activities of an integrate! au!it engagement consist of9
a. Tests of controls performed on I05-.
b. )ubstantive tests performed on account balances and transactions.
c. =oth (a) and (b).
d. 7either (a) nor (b).
1#. 2ren! in earnings use! by au!itors to establish planning materiality is an
e3ample of which of the following?
a. ?uantitative factor.
b. ?ualitative factor.
c. 2llocation factor.
d. 7one of the above.
1%. 6f a !etecte! misstatement is consi!ere! to be material then the au!itor shoul!9
a. 2sk management to correct the misstatement.
b. Dse 'uantitative anal&sis to solve to problem.
c. 8erform tests of controls.
d. .ecide on the materialit& of the detected misstatements.
1&. Controlling the !etection risk is the primary responsibility of the9
a. /anagement.
b. 2uditor.
c. 0*3.
d. 0ontroller.
1*. Company0level controls i!entifie! by C('( are relate! to the company1s9
a. 0ontrol environment.
b. =oard of directors effectiveness.
c. /anagement competenc&.
d. 2ll of the above.
1+. Which of the following is AareB gui!elines provi!e! by the >C8(;?
a. 0ommunication with audit clients regarding internal control issues should be
minimi1ed.
b. Dse of a bottom-up approach of focusing on compan&-level controls should be
implemented.
c. 2udits of internal control and financial statements should be integrated.
d. 2ll of the above.
B@
2-. /stablishing an! overseeing an in!epen!ent 8u!it 6nspection 4nit is the
responsibility of which of the following boar!s?
a. 8rofessional 3versight =oard (83=), formerl& 8rofessional 3versight =oard
for 2ccountanc& (83=2).
b. 2uditing 8ractices =oard (28=).
c. 2ccountanc& Investigation and .iscipline =oard (2I.=).
d. =oth 28= and 2I.=.
21. 6n!epen!ent au!itors are subFect to which of the following liabilities?
a. 0ivil liabilit&.
b. 0riminal liabilit&.
c. =oth civil and criminal liabilities.
d. 7either civil nor criminal liabilit&.
22. 2he a!opte! 6nterim >rofessional 'tan!ar!s are e3isting stan!ar!s promulgate!
by the 86C>8 an! are classifie! by the >C8(; into five categories out of which
rule 33--2 stan!s for9
a. Interim 2ttestation )tandards.
b. Interim ?ualit& 0ontrol )tandards.
c. Interim *thics )tandards.
d. Interim 2uditing )tandards.
=ultiple Choice Questions
1. c.
!. d.
#. a.
%. d.
<. c.
@. a.
A. d.
B. d.
C. a.
1;. a.
11. d.
1!. a.
1#. a.
1%. c.
1<. b.
1@. a.
1A. b.
1B. d.
1C. c.
!;. a.
!1. c.
!!. a.
Chapter 1-
BA
Review Questions
1. What are the interrelation factors on which the effectiveness of the monitoring
an! control function by investors is base!?
8ropert& rights established b& law or contractual agreement that define the
relations between a compan&s investors and its management, as well as
the e"istence of such relations between different t&pes of investors.
5inancial s&stems facilitating the suppl& of finances between households,
financial intermediaries, and corporations.
7etworks of intercorporate competition and cooperation establishing
relations between corporations in the marketplace.
2. /3plain the two alternative mo!es of financial me!iation between househol!s
AinvestorsB an! corporations.
The first mode is bank-based finance where banks take deposits from
households and channel this savings into loans made to companies.
The second mode is market-based finance in which households, directl& or
indirectl& through retirement plans, invest in e'uit& or debt securities issued
b& corporations.
3. 5iscuss the five rules that the ;R2 recommen!s for fair an! respectful
treatment of shareowners an! their views.
8ublic companies should have procedures for shareholders to communicate
with the board and for directors to respond to shareholders concerns.
2ll communications with shareholders should be consistent, fair, transparent,
clear, and candid.
The established shareholder communication procedures should be readil&
available to shareholders.
The compan&s board should be notified of all shareholder proposals and the
board or its corporate governance committee should oversee the compan&s
response to shareholder proposals.
.irectors should attend the annual meeting of shareowners and should
respond or ensure that management responds to all relevant 'uestions.
. What are the policies an! proce!ures that shoul! be establishe! by the
nominating committee to better enhance the viability of sharehol!ers1 nominations?
-eceive shareholders nominations for board candidates and proposals for
significant strategic decisions.
0onsider nominees and proposals received from small individual
investors.
0ommunicate with shareowners.
#. What situations can lea! to institutional investor intervention with the investe!
company?
Intervention ma& occur in situations where there are concerns about strateg&,
operational performance, mergers and ac'uisitions strateg&, inade'uate oversight
function b& independent directors, reported material weaknesses in internal
controls, inade'uate succession planning, noncompliance with corporate
governance reforms, inappropriate e"ecutive compensation plans, lack of
BB
commitment to social, environmental, and ethical issues, material financial
restatements, and corporate malfeasance and fraud.
%. $ow can institutional investors participate in the corporate governance of the
company?
*"ercise their right to elect directors.
-aise their concerns about the compan&s governance b& either selling their
shares or voicing their dissatisfaction.
Improve the efficienc& of the capital markets b& transmitting private
information the& obtain from management to the financial markets.
-educe agenc& problems b& possessing resources and e"pertise to monitor the
managerial and oversight functions as well as reduce information as&mmetr&
between management and investors.
&. /3plain the a!vantages of employee participation in corporate governance.
Through ownership of compan& shares emplo&ees have more incentives to
align their interests with those of shareholders.
*mplo&ee involvement in corporate governance is a learning process for
emplo&ees to advance their position and improve the compan&s operational
efficienc&.
*mplo&ee participation in corporate governance can be regarded as an internal
mechanism to monitor managerial performance and prevent management
opportunistic conduct.
5iscussion Questions
1. What factors an! opportunities have le! to the movement of !irect in!ivi!ual
ownership of stocks to a more institutional ownership structure?
5actors contributing to this change are the move toward institutionali1ation of
financial markets through financial institutions, privati1ation of pension plans,
and individual investors preference toward long-term investments.
2. 2he author states that investors shoul! also share some of the blame for
reporte! financial scan!als for their lack of monitoring of their companies1
governance. 5o you agree or !isagree with this statement? Why?
2nswers ma& var&. The publici1ed financial scandals of the earl& !;;;s
originated from the use of aggressive accounting and earnings management
practices of the late 1CC;s. 5inancial irregularities and earnings management
practices of man& companies definitel& sent strong signals of forthcoming
financial scandals. 7onetheless, investors either did not want to ask tough
'uestions about their governance or did not care as long as the stock prices were
going up. *arnings management practices of prominent companies were reported
in the press but investors did not raise man& concerns about the irregularities of
these companies that were making profit for them. The economic downturn, stock
market plunges of !;;; and !;;1, failures of *nron, :orld0om, 2delphia,
9lobal 0rossing, and others, and ineffectiveness of their corporate governance
made investors angr& where the roots of these problems trace back to the capital
market inefficienc& of the 1CC;s. The two biggest corporate bankruptcies in D.).
histor&, *nron and :orld0om, and the failures of other high-profile companies
BC
primaril& caused b& fraud, which cost investors and pensioners over F<;; billion,
made investors take notice and demand corporate accountabilit&.
3. 2ra!itionally. the accountability an! transparency between the boar! an!
sharehol!ers have not been effective in the sense that the boar! was not informe! of
what sharehol!ers were e3pecting of it an! sharehol!ers were not aware of the
boar!1s activities an! its effectiveness. What shoul! be !one about this
communication gap? 'ubstantiate your answer.
2nswers ma& var&. )hareholders have voting rights to elect directors as their
agents however, individual directors have no direct responsibilit& or
accountabilit& to shareholders. Traditionall&, public companies have used a
pluralit&-vote s&stem to elect corporate directors. Dnder a pluralit&-vote s&stem,
directors can be elected b& the vote of a single share unless the& are opposed b& a
dissident director. 0onversel&, a ma$orit&-vote s&stem empowers shareholders to
elect the most 'ualified outside directors. The nominating committee can pla& an
important role in promoting ma$orit& voting and developing an efficient
mechanism for shareholders to nominate or endorse director candidates. This ma&
give shareholders more responsibilit& in selecting directors to the board, which
ma& in turn alleviate the communication gap between the board of directors and
shareholders.
. 6nvestors may think they live in the 4nite! 'tates of 8merica but when it comes
to electing corporate !irectors. sharehol!ers1 inten!e! watch!ogs in the
boar!rooms. they are !efinitely back in the 4.'.'.R. Compare or contrast this
statement with your own views.
The abilit& of shareholders to vote against or fire underperforming directors is
limited under the commonl& used pluralit&-vote s&stem. )hareholders do not have
access to their compan&s pro"& materials and are not empowered to nominate
their candidates for the board. The increase in corporate governance awareness
ma& result in improved shareholder democrac&, giving investors a stronger voice
in relation to corporate operations.
#. 5o you feel the e3tent of sharehol!ers1 participation in the election of !irectors is
limite! to the rubber0stamp process of affirmation? /3plain the given statement.
)hareowners are empowered under state corporate statutes to elect directors to
oversee management, but in realit&, the& have no real voice in the nomination and
election process. The real election appears to be cast in the boardroom due to the
fact that even if the ma$orit& of shareholders oppose a corporate-sponsored
nominee, that person will still be elected as a director. Dntil ver& recentl&,
0*3sGchairs of the board had significantl& influenced the nomination and election
of new directors. The re'uirement for the establishment of a nominating
committee composed solel& of independent directors has provided some structure
to the nomination and election process even though in man& cases independent
directors still serve at the will of the 0*3s and other e"ecutive directors.
%. /laborate on the following statement9 :6n mo!ern corporations. particularly in
the era of technological a!vances. labor resources are becoming an important part
of corporate governance as capital resources.<
The balance of power and association between propert& rights, managerial
control, and emplo&ee participation rights can pla& an important role in the
C;
effectiveness of corporate governance. *mplo&ee participation in corporate
governance can influence managerial control and authorit&, and can influence
emplo&ee cooperation in the implementation of decisions. The shape and e"tent of
emplo&ees participation in corporate governance is a function of the emplo&ee
level of investment in the compan&s stock through retirement plans and whether
their skills are firm-specific. In a situation in which emplo&ees invest in skills
specific to their compan& and their retirement funds and pensions are tied to the
compan&s stock, their incentives to participate in corporate governance are
greater. 2lternativel&, when emplo&ees skills are portable across companies and
their investments in the compan& are insignificant, the& ma& prefer strategies of
e"it over voice in response to dissatisfaction and grievances. Thus, emplo&ees
interests in corporate governance are shaped b& their economic, investment, and
emplo&ment ties to the compan&, as well as their participation in managerial
decisions.
&. 2he Council of 6nstitutional 6nvestors AC66B recommen!s si3 sharehol!er voting
rights. 'earch the 6nternet for e3amples of organi,ations that implement those
recommen!ations.
The following are the shareholder voting rights recommended b& the 0ouncil of
Institutional Investors (0II)( (1) access to the pro"& (!) one share, one vote
(#) confidential voting (%) voting re'uirements (<) broker votes and (@) bundled
voting. The student can search the business press, an applicable database, or a
search engine to find information related to these recommendations as well as
e"amples of organi1ations implementing such recommendations.
*. 5iscuss sharehol!ers1 participation in monitoring their companies1 affairs.
!ecisions. an! corporate governance.
Investors, particularl& institutional investors, should be engaged activel& in
monitoring their companies corporate governance and fundamental decisions.
Investors should participate in important affairs and engage with companies
where value can be added to their investments. =& virtue of their influence and
power, institutional investors should intervene when ineffectiveness or
breakdowns in corporate governance occur to assist in protecting sustainable
shareholder value. Individual shareholders can change managerial directions and
decisions b& selling their shares when there is corporate underperformance, and if
the ma$orit& of shareholders follow suit, management will be forced to act. In the
case of institutional investors where funds are inde"ed with limited abilit& to sell,
institutional engagement in corporate governance is the onl& wa& to correct
ineffectiveness in corporate governance.
+. 5escribe how sharehol!er proposals can influence corporate governance.
The compan&s board normall& communicates with shareholders in obtaining
their approvals on resolutions. )hareholders are also given the opportunit& to
address issues of their interests through specific shareholder proposals.
Traditionall&, shareholder proposals have been nonbinding and therefore the
board could choose to ignore them even if the& received a ma$orit& of favorable
votes. In realit&, for these proposals to influence corporate governance, the&
should be binding. -ecentl&, pro"& voting advisors, such as 9lass 6ewis L 0o.
C1
and Institutional )hareholder )ervices (I))), have pla&ed an important role in
influencing board agendas and the pro"& process.
2rue or ?alse
1. 2merican households are more likel& to have direct ownership of public compan&
stock now than in 1C<;.
!. )hareowners with significant ownership positions theoreticall& have more incentives
and opportunities to engage in the monitoring function.
#. The publici1ed financial scandals of the earl& !;;;s originated from the use of
conservative accounting and earnings management practices of the late 1CC;s.
%. 8ropert& rights establish the legal relations between a compan&s investors and its
management as well as the relations among different t&pes of investors.
<. =ank-based finance is a mode of financial mediation where banks take deposits from
households and channel this savings into loans made to companies.
@. The use of pluralit& voting rather than ma$orit& voting substantiall& increases the
abilit& and influence of shareholders over who is actuall& elected to the board.
A. Involvement of institutional investors in the monitoring function of corporate
governance limits agenc& problems associated with the separation of ownership and
control in public companies.
B. The chief compliance officer is accountable to the mutual funds board and can be
terminated b& the board or a shareholder coalition.
C. .ue to the rash of financial scandals of high-profile companies, investors have become
more active in monitoring the corporate governance of companies.
1;. *mplo&ee participation in corporate governance can be regarded as an e"ternal
mechanism to monitor managerial performance and prevent management opportunistic
conduct.
11. /utual funds must either establish a code of ethics or disclose in their annual report
wh& the& have not adopted such a code.
2rue or ?alse
1. 5alse
!. True
#. 5alse
%. True
<. True
@. 5alse
A. True
B. 5alse
C. True
1;. 5alse
11. 5alse
=ultiple Choice Questions
1. Which of the following groups typically own the most public corporation shares?
C!
a. .irectors, officers, emplo&ees.
b. Individual outside shareholders.
c. 5inancial institutions.
d. 2ll of the above t&picall& own a similar amount.
2. DDDDDDD establishAesB the legal relations between the investors of a corporation
an! its management.
a. The articles of incorporation.
b. 8ropert& rights.
c. The corporate charter.
d. 8ro"& statements.
3. DDDDDDD provi!e a means of financing an! corporate ownership that
fun!amentally constitutes the supply si!e of capital markets.
a. 8ropert& rights.
b. Intercorporate networks.
c. 5inancial s&stems.
d. 7one of the above.
. 2he relation between the company an! other corporations or organi,ations is
!etermine! by9
a. Intercorporate networks.
b. The structure of power and opportunit&.
c. 0orporate governance.
d. 7one of the above.
#. >rovi!ing timely access to information. enhancing sharehol!ers1 rights. an!
promoting sharehol!er !emocracy can result in9
a. 8ositive effects on corporate governance.
b. 7egative conse'uences such as directors challenging the 0*3s preferences.
c. 2n increase in the likelihood that a merger or ac'uisition will ensue.
d. 2ll of the above.
%. Which of the following woul! be consi!ere! a metho! of institutional investor
intervention?
a. /eeting with directors, particularl& independent directors, lead directors, or the
chairperson of the board.
b. /aking a public statement in advance of annual shareholder meetings.
c. )ubmitting resolutions and proposals for vote at shareholders meetings.
d. 2ll of the above.
&. 2he first level of agency problems is associate! with9
a. 8otential conflicts of interest between individual investors and their trustees and
fiduciaries.
b. 8otential conflicts of interest between professional mone& managers and
corporations and their corporate clients.
c. 3wnership societ&.
d. /onitoring public companies governance, affairs, and business.
*. Which one of the following is among the plans consi!ere! by the '/C9
a. )tandardi1e e"change governance b& re'uiring D.). stock e"changes to file
'uarterl& reports with regulators.
b. *nsure that a ma$orit& of directors are not independent.
C#
c. *nsure that members of the nominating, governance, audit, compensation, and
regulator& committees are not entirel& independent.
d. 6imit e"change members ownership interest to #< percent.
+. 2he core principles !o not provi!e consi!erations for9
a. =oard independence L leadership.
b. =oard processes L evaluation.
c. Individual director characteristics.
d. )hareowner rights.
1-. /mployee performance of an assigne! Fob shoul! be compensate! through9
a. )alar&-based pa&.
b. )tock ownership to encourage emplo&ees to devote and retain these skills in the
compan&.
c. )tock options.
d. 5ringe benefits.
11. 'harehol!er rights are enhance! by provi!ing means for9
a. 2sking 'uestions and raising concerns.
b. Tabling resolutions.
c. Joting in absentia.
d. 2ll of the above.
12. (nly large shareowners an! particularly institutional sharehol!ers have
incentives an! resources to monitor companies1 governance an! other sharehol!er
benefits because9
a. 0orporate ownership in the Dnited )tates is highl& dispersed and diffused.
b. The incentives and opportunities for individual investors to monitor the
compan&s governance are ver& remote.
c. Individual investors cannot afford the high costs of monitoring.
d. 2ll of the above.
=ultiple Choice Questions
1. c.
!. b.
#. c.
%. a.
<. a.
@. d.
A. a.
B. a.
C. d.
1;. a.
11. d.
1!. 2ll of the above.
C%
Chapter 11
Review Questions
1. $ow !oes a legal counsel play an important role in corporate governance?
6egal counsel pla&s an important role in presenting and anal&1ing relevant
information as well as providing valuable advice to the compan&s board of
directors, committees, officers, and emplo&ees in effectivel& discharging their
assigned responsibilities. 6egal counsel pla&s an important role in corporate
governance b& providing professional advice to the compan&s directors, officers,
and other ke& emplo&ees, and ensuring that the compan& is in compliance with all
applicable laws, regulations, and rules.
2. What is the purpose of the legal counsel serving as a!visors to management?
The purpose is to identif& financial reporting risks for management and an&
noncompliance with regulations in financial disclosures to investors.
3. Why is reliable an! transparent information a necessity to operate an efficient
market?
Investors need reliable and transparent information to make rational investment
decisions and to allocate their capital properl&.
. What is :Regulation 8C<?
The )*0 final rule Regulation Analyst Certification (-egulation 20) addresses
concerns regarding the independence of research from investment banking and the
anal&sts perceived conflicts of interest. -egulation 20 re'uires brokers, dealers,
and certain other associated persons to incorporate into their research reports
certification b& the research anal&st.
#. What are the stan!ar!s of best practices governing the relationship between
corporations an! their analysts?
Information flow.
2nal&st conduct.
0orporate communications and access.
-eviewing anal&st reports or models.
Issuer-paid research reports.
5iscussion Questions
1. 7ist e3ternal participants in corporate governance who help monitor the
corporate governance structure an! provi!e a!vice to internal participants.
8rofessional, legal counsel, financial advisors, investors, securities anal&sts,
institutional investors, investment bankers, pension funds, credit-rating agencies,
and the media.
2. 'houl! attorney0client privileges be waive! in certain situations? /3plain.
2nswers ma& var&. The issue of attorne&-client privilege has been controversial
and unresolved in the post-)34 period. 0orporate attorne&s have been pressured
to waive the privilege in connection with government ()*0) investigations. In
.ecember !;;@, the .epartment of Kustice revised its guidelines for prosecuting
corporate fraud. The new guidelines promote the preservation of corporate legal
privileges and establish new re'uirements for prosecutors who seek privileged
C<
information from companies. 8rosecutors must obtain approval from the D.).
2ttorne& and prove a legitimate need before re'uesting waivers of corporate
privileged information unless the compan& voluntaril& waives such privileges.
8rosecutors also refrain from considering in their charging decision whether a
compan& advances legal fees to former or current emplo&ees who are sub$ects of
an investigation. Thus, prosecutors are restricted but not prohibited from seeking
corporate privilege waivers. This includes re'uest waivers of attorne&-client or
work product protections when there is a legitimate need for the privileged
information. The new guidelines, however, provide greater protection for the
attorne&-client privileged communication.
3. With respect to attorneys. will the imposition of '/C rules relating to ethics
positively impact behavior?
2nswers ma& var&. It is e"pected that )*0 rules will lead to more ethical law&ers
who contribute to the achievement of business ethics. 6aw&ers pla&ed a role in
financial scandals b& either facilitating management impropriet& or not detecting
and preventing management misconduct. The general understanding is that when
management and accountants are attempting to break the law, it is the
professional responsibilit& of legal counsel to detect and prevent the wrongdoing
rather than act as facilitators or enablers of wrongdoing.
. What has contribute! to the improvement of information since the '/C
implemente! :Regulation 8nalyst Certification< ARegulation 8CB?
2nswers ma& var&. )everal factors ma& have contributed to the improvement of
the information environment after the implementation of -egulation 20. 5irst,
-egulation 20 ma& have improved the credibilit& and integrit& of anal&st
research reports b& reducing potential conflicts of interest. )econd, investor
confidence in anal&st research reports ma& have improved because of mere
certifications of those reports. 5inall&, companies ma& have increased the 'ualit&
and 'uantit& of information provided to anal&sts or disseminated through public
disclosures.
2rue or ?alse
1. The Task 5orce of the 2=2 recommends regular and periodic e"ecutive session
meetings between their general counsel and the committee of independent directors.
!. )ection <;1 of )34 directs the )*0 to establish rules of professional conduct for
law&ers appearing and practicing before the commission.
#. The )*0 has issued numerous rules that govern the standards of professional conduct
for attorne&s appearing and practicing before the )*0 on behalf of public issuers.
%. The compan&s chief legal officer (063) is responsible for determining if alleged
material violations have occurred or are likel& to occur.
<. 2 'ualified legal compliance committee, under the )*0 rule, is a committee that is
composed of at least two members of the compan&s audit committee and two or more
independent directors.
@. )*0 rules re'uire investment advisors to establish policies and procedures to guide
their pro"& voting in the best interest of their clients.
C@
A. )ecurities anal&sts are hired b& brokerage firms to anal&1e financial performance of
the corporations the& follow, assess the 'ualit& of the compan& as an investment, and
make recommendations for investment opportunities based on their anal&sis.
B. )ection #;A of )34 directs the )*0 to issue rules addressing securities anal&st
conflict-of-interest issues.
C. =oth 72). -ule !A11 and the amended 7E)* -ule %A! are designed to manage,
monitor, and disclose research anal&sts conflicts of interest in connection with research
reports on e'uit& securities and public appearance.
1;. 2n increase in the ob$ectivit& and credibilit& of anal&st reports and forecasts will lead
to a higher consensus among anal&sts and lower forecast dispersion.
11. 8ublic companies usuall& retain numerous outside law&ers.
1!. 2cademic research documents investors react more strongl& to forecast revisions of
anal&sts with high prior forecasting accurac&.
2rue or ?alse
1. True
!. 5alse
#. True
%. True
<. 5alse
@. True
A. True
B. 5alse
C. 5alse
1;. True
11. True
1!. True
=ultiple Choice Questions
1. 2he corporate legal structure consisting of both the internal lawyers an!
e3ternal legal team shoul! work together an! synchroni,e their obFectives an!
responsibilities as9
a. 0ounselors to the board, its committees, and its directors.
b. 2dvisors to management.
c. 9atekeepers to ensure compliance.
d. 2ll of the above.
2. What are the approval responsibilities that the boar! of !irectors has to the legal
counsel?
a. 2ppointment, retention, and compensation.
b. 2ppointment and retention.
c. -etention and compensation.
d. 0ompensation and appointment.
3. 2o effectively promote a culture of compliance within the company9
a. 6aw&ers should bring legal compliance issues to the attention of appropriate
authorities.
CA
b. 6aw&ers should pla& an important role in presenting and anal&1ing relevant
information.
c. -etained outside law&ers should not communicate with emplo&ed inside law&ers.
d. 7one of the above.
. Casual communication of key legal issues from the legal counsel to the boar! of
!irectors may create which of the following relationships?
a. 2n independent relationship between the compan&s directors and its officers.
b. 2n increasing relationship between the compan&s directors and its officers.
c. 2n adverse relationship between the compan&s directors and its officers.
d. 2 positive relationship between the compan&s directors and its officers.
#. 2he 2ask ?orce of the 8merican ;ar 8ssociation makes which of the following
suggestionAsB to a company1s general counsel?
a. The compan&s general counsel should establish policies and procedures for
outside law&ers to communicate with the general counsel regarding material
violations.
b. The compan&s general counsel should have no communication with outside
law&ers to maintain independence and confidentialit&.
c. The compan&s general counsel should establish rules of professional conduct for
law&ers.
d. The compan&s general counsel should report corporate misconduct to the
compan&s shareholders or 0*3.
%. 2he '/C re"uires that the "ualifie! legal compliance committee be compose! of
what minimum member structure?
a. 3ne member of the audit committee and two independent directors.
b. Two members of the audit committee and one independent director.
c. Two members of the audit committee and two independent directors.
d. 3ne member of the audit committee and one independent director.
&. 'ection #-1 of '() !irects the '/C to issue rules that pertain to what corporate
governance subFect?
a. )ecurities anal&st conflicts of interest issues.
b. Internal control reporting.
c. 2uditor rotation.
d. 7one of the above.
*. Which of the following is the inten!e! purpose of Regulation 8C?
a. To decrease the ob$ectivit& and credibilit& of anal&st reports and forecasts.
b. To decrease consensus among anal&sts.
c. To improve the ob$ectivit& and credibilit& of anal&st reports and forecasts.
d. To decrease the 'ualit& and 'uantit& of information provided to anal&sts.
+. 8mong the stan!ar!s of best practices. information flow means that analysts
shoul!9
a. 0onduct their research and recommendations with utmost ob$ectivit&,
independence, fairness, and unbiased opinion.
b. 7ot discriminate among recipients of the information disclosed based on the
recipients prior research, recommendations, earnings estimates, conclusions, and
opinions.
CB
c. 7ot disrupt or threaten to disrupt the free flow of information between
corporations, investors, and anal&sts.
d. 3nl& accept cash compensation for their research work.
=ultiple Choice Questions
1. d.
!. a.
#. a.
%. c.
<. a.
@. a.
A. a.
B. c.
C. c.
Chapter 12
Review Questions
1. $ow !oes 62 serve as a benefit an! tool for the overall obFectives of corporate
governance?
IT can pla& an important role in corporate governance as a tool to improve the
efficienc& and effectiveness of corporate governance. IT is an essential
component of corporate governance as an effective means of delivering timel&
and accurate information for planning, monitoring, and reporting purposes. The
effectiveness of all corporate governance functions depends on the 'ualit& of
support received from the IT function. The IT function enables other corporate
governance functions to operate in real-time, online processes facilitating
simultaneous decision making, continuous monitoring, instantaneous assessment
electronic reporting, and continuous auditing.
2. $ow !o public companies benefit from electronic communication? $ow !o
sharehol!ers benefit from electronic communication?
0ompanies can(
)ave the substantial costs of paper-based production and dissemination of
annual pro"& and financial statements.
Improve the timeliness and transparenc& of communications with
shareholders.
)hareholders can(
Dse electronic means in communicating with their companies.
8articipate in meetings that might otherwise be inaccessible or difficult to
attend because of the constraints of time or location.
3. What is e0commerce? What are the !ifferent e0commerce strategies?
*-commerce is defined as conducting business affairs, transactions, and
communications over the Internet or through private online networks.
*-commerce strategies are classified into( (1) business to business (=!=)
(!) business to consumer (=!0) (#) consumer to consumer (0!0) (%) business to
CC
government (=!9) (<) government to government (9!9) and (@) government to
consumers (9!0).
. What is information infrastructure? /3plain how it is influence! by the boar! of
!irectors an! top management.
Information infrastructure determines the wa& financial information is generated,
processed, anal&1ed, audited, and used in making business and investment
decisions. It is influenced b& directors in overseeing the financial reporting
process, internal controls, and audit activities, and b& the top management team in
designing sound accounting and internal control s&stems and in certif&ing its
financial statements and I05-.
#. What is '()0>ro?
)34-8ro is a dual-purpose solution with some elements designed to track
documents and provide access control, auto-alerts, continuous monitoring, and
management reports to compl& with )ections #;! and %;%, and other elements
designed to provide internal network securit& management.
%. 5iscuss the meaning an! purpose of the :6nternal ?rau! Eulnerability
8ssessment 2ool< A6?E82B.
I5J2T is used b& auditors to assess internal control weaknesses as part of
compliance re'uirements with provisions of )34, particularl& )ection %;%. It
uses a standard risk assessment methodolog& to determine the likelihood of fraud
and its possible impacts b& asking more than #;; 'uestions and measuring risk for
the most common internal fraud schemes including skimming, inventor& and
e'uipment theft, corruption, and financial statement fraud.
&. /3plain the function of the e)tensible ;usiness Reporting 7anguage A);R7B.
It enables business reporting information to be transferred automaticall& between
different computer platforms and applications and allows the selection, anal&sis,
storage, and e"change of tagged data that can be displa&ed automaticall& in
various formats.
*. What are the inten!e! purposes of );R7?
To enhance users abilit& to search the filings database.
To e"tract and anal&1e financial information.
To perform financial comparisons within industries.
To facilitate the )*0s review of filings.
+. What are the purposes of the );R70C7 technology?
4=-6-96 enables the development of a standardi1ed vocabular& for(
*fficient communication between accountants.
*"pressing information from business documents that flow into financial
reports.
/oving information between accounting s&stems, spreadsheets, and service
providers.
1-. What are the a!vantages of );R70C7?
-eporting independence.
)&stem independence.
0onsolidation.
5le"ibilit&.
1;;
11. What is continuous au!iting? /3plain the benefits of continuous au!iting.
0ontinuous auditing is a comprehensive electronic audit process that enables
auditors to provide some degree of assurance on continuous information
simultaneousl& with, or shortl& after, the disclosure of the information. The
benefits are(
-educing the cost of an audit engagement b& enabling auditors to test a larger
sample of a clients transactions.
-educing the amount of audit resources needed to manuall& perform tests of
controls and substantive tests.
Increasing the 'ualit& of financial statement audits b& allowing auditors to use
the integrated audit approach of understanding the client corporate-level
controls.
)pecif&ing transaction selection criteria to choose transactions or transaction
c&cles and perform integrated audits.
12. What is an );R7 instance !ocument?
2n 4=-6 instance document is a stand-alone document of a machine-readable
format of financial information consisting of numerous data points and their
corresponding 4=-6 tags that ma& be published using email, a :eb site, or other
electronic distribution means.
5iscussion Questions
1. 5iscuss the impact that the 6nternet. globali,ation. an! regulations are having on
corporate governance reforms.
The Internet has allowed man& different people, groups, and organi1ations to
e"change information regarding corporations and their business practices. This
makes users of information more informed to make better decisions. The
emergence of the Internet has also had an impact on corporate financial
information dissemination via :eb sites. 9lobali1ation has aided in the
convergence of corporate governance and financial reporting standards
worldwide, ushering in related governance reforms. -egulations impact the
structure of governance within countries and their organi1ations, leading to
corporate governance reforms related to those changes.
2. $ow have mo!ern vi!eo conferencing an! other metho!s of telecommunications
impacte! the corporate governance of public companies?
/odern video conferencing, or +:eb cam, technolog&, enables companies to
conduct their meetings electronicall& without re'uiring ever&one to be ph&sicall&
present. This allows individuals, both inside and outside of organi1ations, to more
effectivel& communicate with each other regarding man& issues (including
corporate governance matters).
3. Research current business literature or the 6nternet for e3amples of the si3
e0commerce strategies.
2nswers ma& var&. *-commerce strategies are classified into( (1) business to
business (=!=), the online e"changes of products, services, and business
transactions between businesses and suppliers (!) business to consumer (=!0),
conducting business online with consumers (#) consumer to consumer (0!0),
1;1
where consumers trade among themselves (%) business to government (=!9),
e"changing transactions between business and governmental entities
(<) government to government (9!9), consisting of online programs and
activities between governmental agencies and (@) government to consumers
(9!0), where online transactions are e"changed between governmental entities
and consumers. *"amples ma& be found using a search engine or database.
. :2he business framework has transforme! from Lbrick0an!0mortar1 to a Lbrick0
an!0click1 infrastructure.< Compare this statement with your views an! cite some
e3amples.
2nswers ma& var&. 2lmost all traditional retailers have established online trades.
*lectronic commerce (e-commerce) has become an integral component of
business strategies and has altered the wa& organi1ations conduct their dail&
operations.
#. What are the four factors that can !ifferentiate the corporate governance
structure from one country to another?
6egal infrastructure, regulator& environment, information infrastructure, and
market infrastructure.
%. What factors help shape the corporate governance structure of multinational
corporations?
The host and home countries legal, political, cultural, and regulator& s&stems, the
business practices and historical patterns of countries, global capital, labor, and
managerial markets, global institutional investors, and boards of directors.
2rue or ?alse
1. :hile compl&ing with )ections %;% and B;! of )34, the use of IT solutions for
timel& access to secure and complete business documents is necessar&.
!. *"isting corporate laws permit the use of electronic communications as a means of
shareholder communication.
#. 9overnment to government (9!9) strateg& involves online transactions that are
between governmental entities and consumers.
%. The information infrastructure of corporate governance is not affected b& the
compan&s legal counsel.
<. )ection %;C re'uires public companies to rapidl& report events that could affect their
performance.
@. Dsing the standard 4=-6 format, investors have access to the same information as
anal&sts.
A. 4/6-tagged data cannot be sent across the Internet in a universal, platform-
independent language.
B. 2n& suspicious or fraudulent activities can be monitored b& anal&tics software.
C. 5-227I enables organi1ations to integrate accounting numbers with other financial
information publicl& available on the Internet, including stock 'uotes and anal&st
earnings forecasts.
1;. .ata integration consists of the capabilit& to provide for the seamless e"change and
aggregation of financial data.
1;!
2rue or ?alse
1. True
!. 5alse
#. 5alse
%. 5alse
<. True
@. True
A. 5alse
B. True
C. True
1;. True
=ultiple Choice Questions
1. What challenges are intru!ing upon the corporate governance structures of the
twenty0first century?
a. Internet.
b. 9lobali1ation.
c. -egulations.
d. 2ll of the above.
2. ;y using electronic communication. companies can !o which of the following?
a. Increase costs.
b. Improve the timeliness and transparenc& of communications.
c. 8articipate in virtual meetings.
d. 7one of the above.
3. 2he business0to0business A;2;B strategy is best !efine! by which of the
following?
a. 0onducting businesses online with consumers.
b. 3nline transactions e"changed between governmental entities and consumers.
c. 3nline e"changes of products, services, and business transactions between
businesses and suppliers.
d. 3nline programs and activities between governmental agencies.
. 2he "uality of public financial information is increase! by which of the
following9
a. 0ompetence and integrit& of providers of information.
b. )oundness of accounting principles.
c. *ffectiveness of the related internal controls.
d. 2ll of the above.
#. 'ections 3-2 an! - of '() re"uire public companies to9
a. .isclose controls, procedures, management assessment, and reporting on internal
control over financial reporting.
b. -eport in a timel& manner events that could affect their performance.
c. 3ffer complete, secure, and timel& access to documents.
d. 7one of the above.
%. Which of the following is@are benefits of using );R70tagge! !ata system?
1;#
a. 4=-6 data changes from the time and place of origination to their eventual
designation and use.
b. 4=-6 can be used on an& computer hardware e'uipment or operating s&stem to
store data.
c. =oth (a) and (b).
d. 7either (a) nor (b).
&. Wi!esprea! application of the );R7 format will only be successful upon9
a. the acceptance and re'uirement of 4=-6-tagged data for financial reporting.
b. the acceptance and re'uirement of 4=-6-tagged data for ta" purposes .
c. the development of appropriate 4=-6 ta"onomies for all industr& segments.
d. 2ll of the above.
*. );R7 ta3onomy is best !escribe! as9
a. Ta"es levied against certain advanced technological uses.
b. /echanisms for describing, naming, and classif&ing items of business
information.
c. 2dvanced procedures for identif&ing uses of computer hardware.
d. 7one of the above.
+. Which of the following is an a!vantage of );R70C7?
a. -eporting independence.
b. )&stem independence.
c. 0onsolidation.
d. 2ll of the above.
1-. Which of the following is a benefit provi!e! by continuous au!iting?
a. -eduction of the cost of an audit engagement b& enabling auditors to test a larger
sample of a clients transactions.
b. Increase in the amount of audit resources needed to manuall& perform tests of
controls and substantive tests.
c. .ecrease in the 'ualit& of financial statement audits b& allowing auditors to use
the integrated audit approach of understanding the client corporate-level controls.
d. 2ll of the above.
11. Corporate law. tort law. an! bankruptcy law are all items that help sustain the9
a. 6egal infrastructure.
b. -egulator& environment.
c. Information infrastructure.
d. /arket infrastructure.
12. Which of the following stan!ar!s boar!s have interrelate! !efinitions of the
financial statement elements9 assets. liabilities. e"uity. revenue. an! e3penses?
a) 52)=.
b) I2)=.
c) =oth I2)= and 52)=.
d) 7either I)2= nor 52)=.
13. 8uthentication technologies inclu!e9
a. The hardware and software procedures and processes to protect a persons privac&
and identit& from internal and e"ternal threats.
b. .J., electronic document storage, and network attached storage (72)).
1;%
c. Transfer of voice or data from one device to another through the airwaves without
ph&sical connectivit&.
d. 2ll of the above.
=ultiple Choice Questions
1. d.
!. b.
#. c.
%. d.
<. a.
@. b.
A. d.
B. b.
C. d.
1;. a.
11. a.
1!. c.
1#. a.
Chapter 13
Review Questions
1. What are the !ifferent types of H>(s?
)tate and local governments.
Healthcare organi1ations.
0olleges and universities.
0haritable organi1ations.
2. What is the primary purpose of H>(s?
To serve the public, achieve philanthropic purposes rather than ma"imi1ing
shareholder wealth like for-profit companies.
3. 5iscuss the role of the >anel on the Honprofit 'ector.
To demonstrate the role of charitable organi1ations in 2merican life and to
strengthen the accountabilit&, transparenc&, and governance of 783s.
. What are the principles !evelope! by the >anel on the Honprofit 'ector an! why
were they establishe!?
The panel developed eight principles regarding the role of charitable
organi1ations, the responsibilities of the charitable communit&, and the need for
balanced government oversight. The suggested principles are(
2 vibrant charitable communit& is vital for a strong 2merica.
The charitable sectors effectiveness depends on its independence.
The charitable sectors success depends on its integrit& and credibilit&.
0omprehensive and accurate information about the charitable sector must
be available to the public.
2 viable s&stem of self-regulation and education is needed for the
charitable sector.
1;<
9overnment should ensure effective enforcement of the law for charitable
organi1ations.
9overnment regulation should deter abuse in the charitable sector without
discouraging legitimate charitable activities.
0ompliance with applicable laws and high standards of ethical conduct
should be re'uired and commensurate with the si1e, scale, and resources of
the organi1ation.
#. /3plain how whistleblower programs help public companies.
:histleblower programs facilitate emplo&ees voicing their concerns and reporting
corporate wrongdoing to authorities without the risk of retaliation or losing their
$ob.
%. /3plain the role of the governing boar! in an H>(.
The governing board is directl& responsible and ultimatel& accountable for the
organi1ations affairs and, in large 783s, provides more of an oversight function
rather than the managerial function of directl& making decisions. In small 783s,
the governing board ma& perform both managerial and oversight functions.
&. /3plain the role of internal governance in H>(.
2ssess performance, reward good performance, and discipline poor performance.
*. $ow can H>( !irectors or trustees avoi! conflicts of interest?
783 directors or trustees avoid conflicts of interest b&( (1) not engaging in
material transactions with the 783 and (!) not serving as an attorne&, or
providing other services for substantial fees.
+. /3plain the three maFor fi!uciary !uties of the boar! of !irectors.
.ut& of obedience, which re'uires directors and trustees to carr& out their
assigned responsibilities.
.ut& of care, which re'uires directors and trustees to e"ercise due care,
diligence, and skill.
.ut& of lo&alt&, which re'uires directors and trustees to carr& out their
activities in pursuing the best interests of the organi1ation b& avoiding self-
dealing and self-serving activities.
1-. What are the "ualities of an effective boar! member?
Jision.
6eadership.
)tewardship.
)kill.
.iligence.
0ollegialit&.
11. What are the governance !ocuments of H>(s?
/ission statement.
0ode of conduct.
0harter.
=&laws.
1;@
5iscussion Questions
1. 2he >anel on the Honprofit 'ector has ma!e a long list of recommen!ations
calling for improvement within the nonprofit sector. more effective oversight. an!
changes in the law. Review the recommen!ations an! !iscuss the recommen!ations
that you agree or !isagree with.
2nswers ma& var& based on which recommendations are agreed or disagreed
with.
*ffective oversight of the charitable sector re'uires vigorous enforcement of
federal and state law.
2nnual information returns filed to the I-) (5orms CC;, CC;-*O, and CC;-85)
should be improved.
0ongress should implement a new periodic review s&stem to verif& that
charitable organi1ations continue to meet the 'ualifications for ta" e"emption.
0ongress should re'uire charitable organi1ations with annual revenues of
between F!<;,;;; and F1 million to have an annual financial statement audit
and those with more than F1 million to have their financial statements be
reviewed 'uarterl& and audited annuall& b& independent auditors.
0haritable organi1ations should provide more-detailed information about their
operations and performance to the public through annual reports, a :eb site,
or other means.
-egulations governing donor-advised funds should be strengthened to ensure
that donors and related parties do not receive inappropriate benefits from
those funds.
*ver& supporting organi1ation should be re'uired to reveal on its 5orm CC;
whether it is operating as a T&pe I, II, or III supporting organi1ation with
particular limitations for activities of T&pe II organi1ations.
Ta"-e"empt organi1ations are sub$ect to the same re'uirements as ta"able
entities with regard to reporting their participation in potentiall& abusive
+listed, or other +reportable, ta" shelter transactions with applicable penalties
for engaging in aggressive ta" shelters.
0ongress should strengthen the rules for the appraisals ta"pa&ers can use to
substantiate deductions claimed or propert& donated to charitable
organi1ations and for the violation of these rules.
0haritable organi1ations should be discouraged from providing compensation
to their board members, and when such compensation is provided the amount,
reason, and method of determination should be full& disclosed.
0haritable organi1ations should be re'uired to disclose clearl& the
compensation paid to their 0*3, other +dis'ualified persons, determined b&
the I-), and the five highest-compensated emplo&ees.
0haritable organi1ations should establish and enforce appropriate travel
e"pense policies to pa& for or reimburse travel e"penses of board members,
officers, emplo&ees, consultants, volunteers, or others traveling to conduct the
business of the organi1ation.
1;A
0haritable organi1ations should have a minimum of three members on its
governing board to be 'ualified as a <;1(c)(#) ta"-e"empt organi1ation, and at
least one-third of the governing board members should be independent to
'ualif& as a public charit& rather than a private foundation.
0haritable organi1ations should include individuals with some financial
literac& on their boards of directors and those whose financial statements are
audited should consider establishing a separate audit committee of the board.
0haritable organi1ations should adopt and enforce a conflict of interest polic&
and the I-) should re'uire them to disclose on their 5orm CC; series whether
the& have such a polic&.
2. Compare an! contrast California1s Honprofit 6ntegrity 8ct of 2-- to the
'arbanes0(3ley 8ct of 2--2.
0alifornias 7onprofit Integrit& 2ct of !;;% has several similarities with )34,
including reporting re'uirements and governance of organi1ational operations
developed to deter fraudulent activit&. The main difference between 0alifornias
7onprofit Integrit& 2ct of !;;% and )34 is the target of the legislation.
0alifornias 2ct applies to charities, commercial fundraisers, fundraising
counsels, unincorporated associations, and trusts while )34 applies to public
companies.
3. 'everal provisions of '() shoul! be applicable to private companies an!
nonprofit organi,ations. Which of these !o you most agree with? Why?
8rovisions that are more applicable to private companies and even 783s are
re'uirements for( (1) more vigilant and independent directors (!) audit
committees (#) improvements in the financial reporting process (%) risk
management and internal controls (<) audit 'ualit& (@) codes of conduct
(A) whistleblower programs and (B) restriction against document destruction.
. 2here are 1# primary responsibilities of the boar! of !irectors@trustees of H>(s.
Which of those !o you feel are the most effective. efficient. an! necessary?
2nswers ma& var& on which responsibilities are considered to be the most
effective, efficient, and necessar&. The primar& responsibilities are to(
*stablish the organi1ations mission and goals.
.evelop strategies to achieve these goals.
2ppoint officers and e"ecutives to run the organi1ation.
.etermine the compensation of e"ecutives, oversee their work, and
evaluate their performance.
-eview the organi1ations programs and services.
3versee financial reporting, internal controls, and audit activities.
3versee compliance with applicable laws, rules, and regulations,
particularl& ta" rules.
8romote ethical behavior and accountabilit& throughout the organi1ation.
*nsure ade'uac& and effective use of resources.
*valuate the boards performance.
2pprove directorGtrustee compensation, if an&.
2ssess board vacanc& and recruit new board members.
*nsure e"ecutives and staff provide the board with relevant and timel&
information to effectivel& carr& out its fiduciar& duties.
1;B
)et an appropriate +tone at the top, promoting ethical conduct throughout
the organi1ation.
*nsure that all board members participate in orientation and continuing
education programs.
#. :Hot0for0profit organi,ations are create! to serve the publicMoften in!ivi!uals
other than organi,ations.< 5o you agree or !isagree with this statement? 'upport
your answer with points regar!ing transparency. governance. an! accountability of
charitable organi,ations.
9overnance of 783s is important in managing and monitoring their activities and
balancing their budgets. To serve the public successfull&, 783s should be
transparent and accountable for their actions, and have an effective corporate
governance structure.
%. 5iscuss the skepticism among !onors an! the public at large with respect to the
governance an! accountability of H>(s. keeping in min! the following two
statements9
A1B :2here are concerns that charitable organi,ations are becoming too
business0like an! not focusing on passion an! commitment to their
mission.<
A2B :>ublic confi!ence in charities !epen!s on whether they have !one a
goo! Fob helping people an! spen!ing money.<
783s, particularl& charities, have been under e"tensive scrutin& regarding their
governance, financial integrit&, stewardship of resources, and appropriateness of
compensation schemes. )uch scrutin& ma& result in skepticism among donors and
the general public regarding the abilit& of 783s to ade'uatel& control their
resources and fulfill their mission. )uch skepticism ma& be suppressed for 783s
with a proven reputation for operating effectivel&.
&. /3plain how the role of C/( in a company is relate! to role of presi!ent in an
H>(. 'ubstantiate your answer with e3amples.
In the business sector, the 0*3 manages the compan& in 783s, the 0*3 ma& be
called e"ecutive director, president, general manager, superintendent, or director-
general. The board grants its authorit& to the 0*3. *"ecutive directors in both
public and not-for-profit organi1ations are charged with making decisions related
to the operation of the organi1ation. *"amples of both public and not-for-profit
e"ecutive directors ma& be found utili1ing a search engine or business press.
2rue or ?alse
1. 7ot-for-profit organi1ations are ta"-free entities that benefit from 1ero ta"es on all
generated revenue.
!. Ta" is imposed on ta"-e"empt organi1ations for the revenue generated from
engagement in a trade or business unrelated to their philanthropic purposes.
#. 0alifornias 7onprofit Integrit& 2ct of !;;% re'uires charities with gross revenues of
less than F! million to establish and maintain an audit committee.
%. 7ot-for-profit organi1ations are t&picall& owned b& their members, their communities,
or their constituencies.
1;C
<. 7ot-for-profit organi1ations are managed t&picall& b& a 0*3 whose authorit& is
granted b& the state 783 council.
@. -isk management assessment and internal controls pla& an important role in the
success of private companies and 783s.
A. The advisor& board of an 783 t&picall& provides advice, gives counsel, and engages in
governing the organi1ation.
B. The internal control s&stem of 783s should ensure that appropriated funds are spent
on the designated programs.
C. The directors or trustees of 783s are t&picall& volunteers or appointed b& the
sponsoring organi1ation.
1;. The development and fundraising committees are responsible for the organi1ation and
oversight of fundraising events and capital campaigns.
11. The audit committee is composed of officers and committee chairs that can act on
behalf of the entire board between board meetings if circumstances re'uire.
1!. 3ne of the most important attributes of audit committees for 783s is that all
members of the committee should be independent.
1#. 2 mission statement is a legal document describing an organi1ations reasons for
e"istence and its goals.
2rue or ?alse
1. 5alse
!. True
#. 5alse
%. True
<. True
@. True
A. 5alse
B. True
C. True
1;. True
11. 5alse
1!. True
1#. 5alse
=ultiple Choice Questions
1. Hot0for0profit organi,ations receive their operating bu!gets from which of the
following sources?
a. 9overnment grants.
b. )takeholder contributions.
c. /embership dues and fees.
d. 2ll of the above.
2. 8ccor!ing to the recommen!ations of the >anel on the Honprofit 'ector. to be
"ualifie! as a #-1AcBA3B ta30e3empt organi,ation. an organi,ation shoul! have which
of the following governing boar! structures?
a. 2 minimum of three members on its governing board.
11;
b. 2 minimum of two members on its governing board.
c. 2 ma"imum of three members on its governing board.
d. 7one of the above.
3. 2he Honprofit 6ntegrity 8ct of 2-- passe! by Californian legislators re"uires
charitable organi,ations to have au!it committees an! au!ite! financial reports
when gross revenues amount to which of the following values?
a. F! million or more.
b. F!.< million or more.
c. F# million or more.
d. F#.< million or more.
. Hot0for0profit organi,ations have begun to a!opt many of the '() provisions
re"uire! for public companies to improve an! sustain their9
a. 0orporate governance.
b. 5inancial reporting.
c. Internal control.
d. 2ll of the above.
#. 6n a small H>(. the governing boar! performs the following functions9
a. 3versight function.
b. /anagerial function.
c. =oth (a) and (b).
d. 7either (a) nor (b).
%. Hot0for0profit organi,ations shoul! have an a!e"uate an! effective internal
control system to ensure which of the following obFectives?
a. The organi1ation is performing efficientl& within given budgets.
b. The organi1ation is achieving its program results.
c. The organi1ations financial reports are reliable and transparent.
d. 2ll of the above.
&. Which of the following committees is usually not prevalent to H>(s?
a. 2udit committee.
b. 7ominating committee.
c. 8ersonnel committee.
d. 2pproval committee.
*. 2he primary responsibilities of the boar! of !irectors@trustees of H>(s inclu!e9
a. *stablishing the organi1ations mission and goals.
b. .etermining compensation of e"ecutives.
c. -eviewing the organi1ations programs and services.
d. 2ll of the above.
+. 2eamwork an! respect of colleagues most completely !efine which "uality of an
effective boar! member?
a. 0ollegialit&.
b. Stewardship.
c. Leadership.
d. Diligence.
1-. Which of the following attributes is specifie! in the 86C>8 au!it committee
charter matri3 for government organi,ations?
a. 2udit committee members should be appointed b& the board of directors.
111
b. 2t least two members of the audit committee should have financial e"perience.
c. The audit committee should meet at twice a &ear or more as deemed necessar&.
d. 2udit committees should have the authorit& to hire professional consultants as
necessar&.
11. Rules an! proce!ures for the selection of !irectors an! appointment of officers
are !evelope! by the organi,ation1s9
a. 0harter.
b. =&laws.
c. /ission statement.
d. 0ode of conduct.
=ultiple Choice Questions
1. d.
!. a.
#. a.
%. d.
<. c.
@. d.
A. d.
B. d.
C. a.
1;. d.
11. b.
Chapter 1
Review Questions
1. What are the primary responsibilities of the supervisory boar! in the Cerman
boar! structure?
The supervisor& board is merel& a token board with the responsibilities of hiring
and firing management board members, shaping the remuneration packages for
management board members, and overseeing the work of the management board
members but not instructing them on how to do their $ob.
2. ;riefly !escribe the boar! structure in Gapanese corporations.
=oards of directors in Kapanese corporations are primaril& composed of insiders
who are usuall& top e"ecutives of companies with no outside directors
representing small individual investors. =oards of directors do not t&picall& have
a monitoring function.
5iscussion Questions
1. 5iscuss the global corporate governance structure.
There is no globall& accepted corporate governance structure. .ifferences in
corporate governance structure are primaril& driven b& a countr&s statutes,
corporate structure, and culture. 5or e"ample, corporate governance reforms in
the D.). are t&picall& regulator-led whereas reforms in *uropean countries are
11!
normall& shareholder-led. 7onetheless, the 3*0. has established a set of
corporate governance principles that have received global acceptance.
2. /3plain the three commonly use! approaches to regulatory reforms in terms of
their effectiveness an! conte3t.
The three regulator& reforms are( (1) a race to the bottom (!) a race to optimalit&
and (#) a race to the top. The race to the bottom concept suggests that global
securities regulators, in an effort to attract issuers, deregulate the points that
provide issuers with ma"imum fle"ibilit& for their operations at the e"pense of not
providing ade'uate protections for investors. The race to the top concept suggests
that global securities regulators provide ma"imum protection for investors
through rigid regulations and highl& scrutini1ed enforcement at the e"pense of
putting companies in the global competition at a disadvantage with nonNcost-
$ustified regulations. The race to optimalit& concept is a h&brid of the first two
concepts, in which both issuers and investors prefer a regulator& regime and
$urisdiction that provide cost-$ustified investor protection.
3. 5iscuss the primary aspects of corporate governance in the 4nite! Iing!om.
The primar& aspects of corporate governance in the D.I. pertaining to the board
of directors are( (1) a single board collectivel& responsible for the success of the
compan& (!) separation of the position of the 0*3 and the chairman of the
board (#) a proper balance of e"ecutive and none"ecutive directors (%) strong
independent audit and remuneration committees (<) emphasis on ob$ectivit& of
directors in the interests of the compan& (@) transparenc& of appointments and
remuneration (A) annual evaluation b& the board of its performance and
(B) effective rights for shareholders.
. 5escribe the new initiatives taken in Gapan to improve the infrastructure of its
capital markets.
These initiatives are( (1) establishing a cross-sectional framework of a wide range
of financial instruments and services (e.g., broadening the definitions of
investment schemes including financial instruments) (!) strengthening the 'ualit&
of independent audits of financial statements (#) enhancing protections for
investors (%) improving disclosures through 'uarterl& reporting (<) reporting to
management and auditors on internal controls (@) providing for self-regulator&
structures and (A) increasing penalties against market fraud.
#. 8re you e3pecting many changes in corporate governance reforms in the =i!!le
/ast an! 8sia?
Ees. 2fter man& decades of *uropean and 2merican domination of global
markets, trades and investments are now flowing between the /iddle *ast and
2sia. :ith oil prices riding high, /iddle *astern countries and their investors and
companies have funds to invest and 2sian countries have the capabilities to attract
such investments. It is inevitable that governments in both 2sia and the /iddle
*ast will create a more hospitable business and investment climate for
investments to reach their global potentials.
%. /3plain the types of boar! systems worl!wi!e.
The three commonl& used board s&stems are(
a. 2 unitar& board s&stem where the board of directors and management are
the same (e.g. )ingapore board s&stem).
11#
b. 2 two-tier board s&stem where there are two boards, supervisor& and
management, and the supervisor& board has oversight over the
management board. The *uropean two-tiered model of corporate
governance consists of an e"ecutive board and a supervisor& board. The
e"ecutive board is composed of senior e"ecutives and inside directors, and
is primaril& responsible for managing the compan&. The supervisor&
board, on the other hand, is t&picall& composed of outside directors who
represent shareholders, emplo&ers, and lenders, and appoints and oversees
the activities of the e"ecutive board.
c. 2n oversight board s&stem where the board of directors appoints
management and oversees its activities (D.).).
&. Compare an! contrast rules0base! versus principles0base! approaches of
corporate governance.
The rules-based approach to corporate governance is where corporate governance
reforms and listing standards are ver& rigid and applicable to all listed companies,
detailing re'uirements for compliance and prescribed to a set of rules. 3n the
other hand, the principles-based approach is where corporate governance
principles establish benchmarks and norms for good governance practices but
companies establish their own corporate governance rules tailored to their
circumstances with ade'uate fle"ibilit& to set their own rules. The principles-
based approach ma& create more room for manipulation and even noncompliance
with minimum standards.
2rue or ?alse
1. 0*3 and chairperson dualit& can best prevent agenc& problems and help reinforce the
independent nature of the board of directors.
!. 0orporations affected b& the 0ombined 0ode are re'uired to conform and e"plain
their compliance or noncompliance to shareholders.
#. The 9erman board of directors consists of two boards( the management board and the
supervisor& board.
%. Hostile takeovers are more likel& to occur in 9erman& versus the Dnited )tates.
<. Kapanese corporate culture is dominated b& a single organi1ation, the Ieiretsu.
@. 6ifelong emplo&ment is a characteristic of the labor market in Kapan.
A. 0anadian corporate ownership is much like the Dnited )tates in that ownership is
widel& held b& man& investors.
2rue or ?alse
1. 5alse
!. True
#. True
%. 5alse
<. 5alse
@. True
A. 5alse
11%
=ultiple Choice
1. 2he network of organi,ations that shapes the business structure an! !ominates
business practice in Gapan is the9
a. Iinkai-to-secchi-kaisha.
b. Ieiretsu.
c. )hinobu.
d. )ikko&aku.
2. 2he goal of unifying 4.'. C88> an! 6?R' is referre! to as9
a. 0omparabilit&.
b. 0ongruence.
c. 0onvergence.
d. 0ontainment.
3. 8 two0tier boar! of !irectors system consisting of a management boar! an! a
supervisory boar! best !escribes the governance structure of9
a. The Dnited )tates.
b. 9erman&.
c. The Dnited Iingdom.
d. Kapan.
. Corporate governance reforms clearly separate the boar!1s oversight function
from managerial functions in9
a. The Dnited )tates.
b. 9erman&.
c. The Dnited Iingdom.
d. Kapan.
#. 5irectors are responsible for the preparation of financial statements an! review
of internal controls in9
a. 9erman&.
b. 0anada.
c. The Dnited Iingdom.
d. 7one of the above.
%. ?inancial institutions play the largest role in corporate governance structure an!
monitoring in9
a. The Dnited )tates.
b. Kapan.
c. The Dnited Iingdom.
d. Iorea.
=ultiple Choice
1. b.
!. c.
#. b.
%. a.
< c.
@. b.
11<
Chapter 1#
Review Questions
1. What are the four levels of legislation process set forth by the ?inancial 'ervices
8ction >lan A?'8>B?
6evel 1( 5ramework principles that are initiated b& the *0 and adopted into
legislation b& both the 0ouncil /inisters and *uropean 8arliament.
6evel !( 0ommunit& legislation that is adopted b& the *D based on technical
advice b& the 0ommittee of *uropean )ecurities -egulators (0*)-) and
approval of member states.
6evel #( .a&-to-da& implementation through 0*)-s guidance.
6evel %( -eview b& the *0 to ensure compliance with *D legislation b&
member states.
2. What is the purpose of the financial markets regulatory global !ialogue that has
been establishe! between the /uropean Commission an! the 4nite! 'tates?
:orking towards a more efficient transatlantic financial market to enhance
sustainable economic growth in the D.). and *urope.
8romoting integration of global financial markets.
3. What is the benefit to institutional investors in supporting the e0pro3y?
It would make challenging nomination campaigns more feasible and affordable.
. What are the areas of business practices of private companies in which '() has
le! to improvements?
)tock markets are up since the passage of )34 in Kul& !;;!.
/ergers and ac'uisitions have substantiall& increased.
Initial public offerings (I83s) have increased.
7ew listings on the 7E)* have increased.
7ew listings on 7asda' have increased.
/arket capitali1ation on the 7E)* and 7asda' increased.
The loan markets have significantl& improved since !;;!.
8ublic compan& bankruptcies have dropped substantiall&.
#. What is the /nhance! ;usiness Reporting Consortium A/;RCB?
It is in the process of tr&ing to develop a voluntar&, global disclosure framework
for *=- that will provide structure for the presentation of financial and
nonfinancial I8Is.
%. /3plain how the ?8'; an! the 68'; have ma!e convergence of accounting
stan!ar!s possible to a certain e3tent.
2greeing to conduct their ma$or accounting standard pro$ects $ointl&.
0onvincing the )*0 to allow foreign companies to use I5-) to raise capital in
the Dnited )tates without having to reconcile them to D.). 9228.
&. What !o you mean by internal control over financial reporting?
2 process to provide reasonable assurance regarding the reliabilit& of financial
reporting and the presentations of financial statements for e"ternal purposes in
accordance with 9228.
11@
*. /3plain the obFective of an integrate! au!it on );R70generate! financial
statements.
The effectiveness of both the design and operation of internal controls over
4=-6-generated financial reports.
5air presentation of 4=-6-generated financial statements in conformit&
with the selected 4=-6 ta"onom&.
+. What are the emerging au!iting issues in the post0'() perio!?
The e"pectation gap.
2uditor switches.
2uditor independence.
2uditor resignation.
2uditor liabilit&.
Integrated audit approach.
*ngagement letters.
2udit failure.
0onfirmations.

5iscussion Questions
1. 6!entify an! !iscuss the key emerging corporate governance issues.
9lobal market and investor confidence.
The corporate governance structure including shareholder democrac& and director
independence.
Internal controls and risk management including )ection %;% compliance.
5inancial reporting including convergence in standards and stock option
e"pensing, pension liabilit& recognition, electronic financial reporting, and
financial reporting disclosure.
2udit function including an integrated audit approach, liabilit& caps, and auditing
for fraud.
2. Ieeping in min! the number of scan!als that have come up in recent years. !o
you think regulators worl!wi!e coming together an! working to enhance the
integrity an! efficiency of global markets will help? /3plain your answer.
*rosion in investor confidence worldwide has been attributed to the fear of
terrorist attacks, the economic downturn in man& countries, instabilit& in the
governments of some countries, and the bad news of pervasive global financial
scandals. 2ccurate and reliable financial information assists investors to make
informed and sound investment decisions whereas inaccurate financial
information is likel& to mislead them into making wrong decisions. Initiatives
taken to restore investor confidence in capital markets and financial reports are(
(1) more emphasis on corporate codes of ethics (!) more effective internal
control s&stems (#) more focus on long-term performance that creates sustainable
shareholder value (%) linking e"ecutive compensation to long-term performance
and (<) improving the 'ualit& and ob$ectivit& of audit services.
11A
3. Clobal corporate governance can be classifie! into three general categories of
:close.< :open.< an! :hybri!.< 5iscuss the characteristics of these three categories.
The close model of corporate governance is characteri1ed b&( (1) concentration of
ownership of both e'uit& capital and debt capital (!) a long-term financing
relationship with a few borrowers and lenders (#) less dependence on capital
markets for financing activities (%) more direct control and management b& a few
ma$or investors such as banks, insurance, or individuals (<) more direct and close
oversight function b& monitoring bodies such as supervisor& boards (@) a well-
balanced distribution of control rights and information rights (A) less information
as&mmetr& between management, the supervisor& board, and ma$or investors and
(B) more focus on internal information flows and controls. 2n e"ample of a close
model, which is also referred to as +insider control,, is 9erman corporate
governance.
The open model of corporate governance, better known as the +market-
based, or +outsider, model, is characteri1ed b&( (1) total reliance on capital
markets for sources of financing activities (both e'uit& capital and debt capital)
(!) less concentration of ownership in the hands of a few ma$or investors (#) an
oversight function b& the board of directors (%) less regulation of corporate
governance and corporate activities (<) total separation of the managerial
function and oversight function (@) e"istence of a market-based s&stem of checks
and balances (A) information as&mmetr& between management, the board of
directors, and investors and (B) more focus on e"ternal information flows and
controls. 2 purel& market-based corporate governance model does not e"ist from
a practical perspective or in a real-world environment. The h&brid model
encompasses a combination of market-based mechanisms, internal mechanisms,
and regulator& mechanisms. The closest to the market-based model is the
corporate governance model in the D.). In realit& the D.). corporate governance
model is a h&brid model based on market-based mechanisms with proper
monitoring b& governmental regulations.
The h&brid model is a set of both internal and e"ternal mechanisms
designed to manage, monitor, control, reward, and discipline arrangements among
all stakeholders to create sustainable and enduring value and to protect their
interests. )takeholders are broadl& defined as those who have contractual
relationships with the compan&, such as investors, creditors, suppliers, customers,
emplo&ees, and those who affect or are affected b& the compan&s business affairs
including social constituents, the communit&, societ& at large, local, state, and
federal governments, and environmental interests. 0ompanies that do not adopt an
effective corporate governance structure would presumabl& be inefficient and in
the long term would be disciplined b& the capital markets. Thus, there is no need
for polic& or governmental interventions because market mechanisms correct an&
corporate governance inefficiencies. However, recent financial scandals
demonstrate that market-correction mechanisms were not ade'uate b& themselves
to solve the market failure arising from as&mmetric information and potential
conflicts of interest among corporate governance participants. /arket failures and
resulting financial scandals provide $ustifiable grounds for polic& intervention to
prevent management from adopting a suboptimal level of corporate governance.
11B
Thus, an effective corporate governance structure depends on a well-balanced
relation between internal mechanisms, e"ternal mechanisms, and polic&,
regulator&, and legal re'uirements.
. 2he framework of corporate governance reporting an! assurance is suggeste! by
the Clobal Reporting 6nitiatives ACR6B. 5escribe the CR6 gui!elines for corporate
governance reporting.
9-I guidelines consist of five components( (1) the introduction which describes
the motivation for and benefits of sustainabilit& reporting (!) part two which
provides basic information regarding the nature of the guidelines, their
documentation, design, and reporting e"pectations (#) part three consisting of
reporting principles which describe the principle of sustainabilit& performance
(%) part four consisting of reporting content, providing detailed information about
the content of a 9-I report and (<) the final part consisting of glossar& and
anne"es, giving background information about the 9-I and supplemental
information pertaining to the preparation of 9-I reports and assurance provided
on such reports.
#. /3plain why the tren! towar! emphasis on social. ethical. an! environmental
issues will continue to increase.
There has been a growing interest in social, ethical, and environmental ()**)
measures and performances in addition to economic performance. 0ompanies
worldwide disclose whether their board has( (1) recogni1ed the significance of
)** matters (!) considered the significant risks and opportunities provided b&
appropriate responses to )** matters (#) obtained ade'uate information to assess
the importance of )** matters (%) established appropriate policies to manage
risks to short- and long-term value resulting from )** issues and (<) provided
sufficient measure of the compan&s )** performance.
%. 6!entify an! !escribe factors that may influence the future of financial reporting.
The current financial reporting s&stem based on a rules-based approach in
measuring, recogni1ing, and disclosing financial information has less value-
relevance to investors and is more complicated and costl& than it should be.
)everal drivers of an enhanced future financial reporting process are(
1. 9lobali1ation>The move toward convergence in accounting and auditing
standards and globall& accepted accounting principles in compliance with
I5-). (The )*0 is alread& accepting financial statements prepared in
conformit& with I5-) for foreign private issuers without the need for
reconciliation to D.). 9228.)
!. Technological advances>The use of 4=-6 format in financial reporting.
#. Investors need for more sustainable information on both financial and
nonfinancial I8Is.
a. )top 'uarterl& earnings guidance which forces management to focus
on short-term performance at the e"pense of long-term sustainable
performance.
b. 5ocus on value drivers and /=6 performance in the areas of
economic, governance, social, ethical, and environmental activities.
c. 5ocus on forward-looking financial information.
11C
d. 6ink reasonable e"ecutive compensation to long-term strategic and
sustainable performance.
%. Integrated reporting of financial statements and internal controls.
<. Intangibles including the value of the compan&s brand and its relationship
with emplo&ees, suppliers, and customers that drive value creation, which
should be properl& measured, recogni1ed, and disclosed.
@. 5ewer rules and better $udgments for accruals and estimates.
&. 5iscuss the e3tent to which convergence between 4.'. C88> an! 6?R' is
possible.
I5-) is viewed as principles-based re'uiring fair and true presentation of
financial reports compared with D.). 9228, which is regarded as rules-based and
re'uiring fair presentation of financial reports. 0ompliance with D.). 9228 b&
public companies is re'uired b& the 1C#% )ecurities *"change 2ct. 0onvergence
in accounting standards means that standard setters (e.g., 52)=, I2)=)
worldwide agree to eliminate differences in how similar transactions are
processed with the keen ob$ective of establishing confidence in the 'ualit& of
global financial reporting. 8rogress has been made toward reconciliation and
harmoni1ation of accounting standards worldwide, and short-term pro$ects are
being undertaken to remove a variet& of differences between I5-) and D.).
9228. The )*0 has recentl& eliminated reconciliation re'uirements to D.).
9228 for foreign registrants that compl& with I5-) and is considering an
initiative to allow even D.). companies to compl& with I5-) for their )*0 filing
purposes. These are positive steps toward complete convergence between D.).
9228 and I5-).
*. 5iscuss the possibility of convergence in au!iting stan!ar!s.
0onsolidated financial statements of )*0-registered companies are re'uired to be
audited b& an independent auditor in accordance with auditing standards
established b& the 8023=. *uropean countries compl& with International
)tandards on 2uditing (I)2s) issued b& the International 2uditing and 2ssurance
)tandards =oard (I22)=). It is e"pected that both auditing standards and audit
regulations throughout the world will remain on a national level.
2rue or ?alse
1. 0orporate governance reporting changes companies one-dimensional financial
reporting to multidimensional bottom lines.
!. )ustainabilit& reports are uniform with assurance provided on their completeness and
reliabilit&.
#. 2ccording to anecdotal evidence improvements in corporate governance are not
associated with improvements in corporate performance.
%. =efore an issuing compan& registers with the )*0, regulations prohibit the compan&
from conducting promotions that ma& boost its stock price.
<. *-pro"& ma& result in lower costs for investor-to-investor communications.
@. 2 promanagement summar& postcard has the potential of driving down turnout or
encouraging automatic +&es, voting in contentious annual general meetings.
A. In the post-)34 era, the representation of members of racial minorities and women in
management positions is still disproportionabl& low.
1!;
B. 2ccording to the 8rotection against *"ecutive 0ompensation 2buse 2ct shareholder
approval is not re'uired for the compan&s e"ecutive compensation plan.
C. )ection 1@!(m) of the 1CC# ta" code allowed companies to deduct e"ecutive
compensation in e"cess of F1,;;;,;;; for federal ta" purposes unless it is performance-
based.
1;. 8rivate companies are currentl& re'uired to compl& with corporate governance and
financial reporting.
11. 5inancial restatements are a ma$or contributing factor in eroding investor confidence
and public trust in public financial information.
1!. The *D 2ccounts /odernisation .irective (*D 2/.) re'uires decreasing the
comparabilit& between *uropean companies through a common reporting framework.
1#. 2ntifraud prevention and detection controls and assessments addressed b& )34 are
relevant onl& to financial statement fraud.
1%. 2udit failure of not discovering and reporting material misstatements in financial
statements can increase the chance of reporting failure of misstating financial statements.
2rue or ?alse
1. True
!. 5alse
#. 5alse
%. True
<. 5alse
@. True
A. True
B. 5alse
C. True
1;. 5alse
11. True
1!. 5alse
1#. True
1%. True
=ultiple Choice Questions
1. CR6 focuses on three sustainability !imensions of9
a. *conomic.
b. *thical.
c. 9overnance.
d. 7one of the above.
2. 2he structure of corporate governance of companies in terms of the percentage
of ownership of blockhol!ers an! outsi!e !irectors on the boar! can change9
a. :hen the compan& files the I83.
b. 2fter the compan& is past the I83 stage.
c. :hen the stock prices go high.
d. :hen it decides to go public.
3. Which of the following is not allowe! by the '/C propose! pro3y access rule9
1!1
a. 2llowing small shareholders of shareholder groups access to companies pro"&
statements to nominate their director candidates.
b. *nabling selected shareholders to nominate their candidates.
c. 9ranting shareholders access and the right to nominate directors under
circumstances in which a +triggering event, has occurred.
d. 7one of the above.
. 6n which of the following circumstances is !emocratic voting not practice!9
a. :hen directors are elected despite an overwhelming ma$orit& of opposing votes.
b. :hen brokers can vote for management in place of silent shareholders.
c. =oth (a) and (b).
d. 7either (a) nor (b).
#. Which if the following is not a feature of plurality voting9
a. 7ominated candidates can vote for themselves.
b. 2 single affirmative vote is not sufficient for a director to be elected.
c. The nominating committee provides shareholders with the option of voting for
nominees or choosing not to vote at all.
d. The ma$orit& of shareholders, up to CC percent, can vote against a nominee and he
or she can still be elected.
%. =ost in!ivi!ual@retail investors !o not want e0pro3y because of9
a. )ecurit& concerns of financial information over the Internet.
b. The ease of reading materials on a computer screen.
c. Having Internet access at all times.
d. 7one of the above.
&. =ore effective sharehol!er !emocracy can affect which of the following9
a. Increase market mechanisms for corporate control.
b. Increase management entrenchment devices.
c. 7o power to elect independent directors.
d. 2ll of the above.
*. 2o increase accountability in the boar!room an! improve the effectiveness of
boar! committees. companies are changing their compensation policies an!
practices by9
a. 8a&ing per meeting fees to members of board committees.
b. Increasing the use of restricted and deferred stock.
c. =oth (a) and (b).
d. 7either (a) nor (b).
+. 'ection -* of '() re"uires the '/C to review financial reports file! with the
commission by public companies at least every9
a. 5our &ears.
b. Two &ears.
c. Three &ears.
d. 5ive &ears.
1-. 6nternational ?inancial Reporting 'tan!ar!s are regar!e! as9
a. 8rinciples-based standards.
b. -ules-based standards.
c. =oth (a) and (b).
d. 7either (a) nor (b).
1!!
11. Which of the following sections of '() re"uires public companies to !isclose
their financial reports on a rapi! an! current basis9
a. )ection %;C.
b. )ection #;!.
c. )ection 1@!.
d. )ection %;1.
12. 6ntegrate! au!it covers the au!it of9
a. Internal control over financial reporting.
b. Internal control over audit of financial statements.
c. Internal control over financial reporting and financial statements.
d. Internal control neither over financial reporting nor over audit of financial
statements.
13. Which of the following sections of '() !irects the Covernment 8ccountability
(ffice AC8(B to stu!y the factors contributing to consoli!ation in public accounting
firms in the 1+*-s an! 1++-s in the 4nite! 'tates9
a. )ection %;1.
b. )ection #;!.
c. )ection %;C.
d. )ection A;1.
=ultiple Choice Questions
1. a. .
!. b.
#. a.
%. c.
<. b.
@. a.
A. a.
B. c.
C. c.
1;. a.
11. a.
1!. c.
1#. d.
1!#