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Chapter 5 – Corporate Governance and Sarbanes Oxley Act
Instructor Manual
➢ An Overview Of Corporate Governance. The purpose of corporate governance is
to encourage the efficient use of resources and to require accountability of those
resources. The aim is to balance the interests of individuals, corporations and the
the corporate leaders.
➢ Participants In The Corporate Governance Process. The participants in the
corporate governance process are stakeholders, a term for all of the different people
who have some form of involvement or interest in the business. Some stakeholder
groups have a direct effect on corporate governance while other groups are affected
by corporate governance.
External stakeholders are people and organizations outside the corporation who
have a financial interest in the corporation. External auditors lend credibility to the
financial statements because they are responsible for evaluating whether or not the
company’s financial information is prepared according to established accounting
rules. Governing bodies are important stakeholders in the corporate governance
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interest in the company or who consider obtaining an ownership share. Customers
and suppliers are involved with the company on a day to day basis by buying and
selling, respectively.
➢ The Functions Within The Corporate Governance Process. The system of
checks and balances that comprise corporate governance includes several
interrelated functions, including management oversight, internal controls and
compliance, financial stewardship, and ethical conduct.
o Management Oversight. Management oversight encompasses the policies
and procedures in place to lead the directorship of the company. The
directorship of a company is generally considered to be its supervisors,
managers, officers, and directors. Every level of management within a company
o Internal Controls And Compliance. The control mechanisms that are
necessary for good corporate governance are: those that dictate the manner in
which rights and responsibilities are assigned to different people within the
organization; and those that ensure that the company is fulfilling its obligations
with respect to adherence to accounting conventions and regulatory
requirements. The goal of corporate governance, with respect to internal
controls and compliance, is to ensure that financial information is accurate and
transparent. Accuracy relates to the correctness of the information presented; it
o Financial Stewardship. Managers and directors have a fiduciary duty to the
shareholders of the company. In the corporate environment, fiduciary is a term
that means that management has been entrusted with the power to manage the
assets of the corporation which belong to shareholders. The financial affairs of a
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corporation are expected to be managed in such a way as to maximize
shareholders’ wealth. Since the business is owned and financed by the
in such a way as to shed more favorable light on the company or its
management. Earnings management is unethical because it involves stretching
the rules beyond their intended bounds.
o Ethical Conduct. Because of its widespread relevance, ethical conduct is often
valued as the most important part of corporate governance. Good corporate
➢ The History Of Corporate Governance. Corporate governance has changed over
the years as the focus of the business world changed, and changes in legislation
have had a big impact on corporate governance. The origin of the corporate
governance concept coincides with in the establishment of the SEC and enactment
of the securities laws in the 1930s. The Securities Act of 1933 requires full
disclosure of financial information through the filing of registration statements before
securities can be sold in the financial markets. The Securities Exchange Act of 1934
➢ The Sarbanes-Oxley Act Of 2002. There are eleven titles (or categories) in
Sarbanes-Oxley, each with several sections. Selected sections are relevant to
corporate governance.
Section 201 – Services outside the scope of practice of auditors. Auditors of public
companies are now prohibited from providing non-audit services to their audit
clients. In the past, it was customary for auditors to perform many of these non-audit
services. However, each of these services is now prohibited because of its
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Section 301 – Public company audit committees. Public companies must have an
audit committee as a sub-committee of the board of directors. The auditors report
directly to the audit committee on all matters related to the audit. The members of
the audit committee cannot be affiliated with the company, its employees or its
subsidiaries (other than through their service on the audit committee). In order to
remain independent, members of the audit committee may not receive
compensation for their service to the company.
Section 906 – Failure of corporate officers to certify financial reports. If an officer of
a public company does not comply with the requirements of Section 302 or if the
officer certifies financial statements that are known to be misleading, stiff penalties
may apply. Fines and/or prison terms may be imposed up to $5,000,000 and 20
years, respectively.
Section 401 – Disclosures in periodic reports. The Act introduces new requirement
that a company must disclose any off-balance sheet transactions, including
obligations or arrangements that may impact the financial position of the company.
This requirement is intended to prevent repeated incidents like the problems
encountered at Enron, where special-purpose entities were used to conceal off–
balance sheet transactions.
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systems. If there are any weaknesses in internal controls, they must be disclosed in
this report. In addition to management’s increased responsibility regarding internal
controls, there are also new requirements for the auditors of public companies
regarding the internal control structure of its clients. As part of their audit
procedures, auditors must now attest to the internal control report prepared by
management.
Section 409 – Real-time disclosures. The Act requires that certain issues must be
reported immediately if they involve information necessary to protect investors. This
requirement allows for better and more timely information to be provided to the
public regarding important corporate events such as bankruptcy, new contracts,
acquisitions and disposals, changes in control, etc. Such events must be reported
within four business days following their occurrence.
Section 806 – Protection for employees of publicly traded companies who provide
evidence of fraud. This section is often referred to as the fiwhistleblower protection”
provision of the Act. A whistleblower is someone who reports instances of
wrongdoing or assists in a fraud investigation. To protect a whistleblower from
retaliation by the company or its employees, the Act prohibits any form of ridicule or
harassment, demotion, discrimination, or termination of employment against a
person who has provided such information in a lawful manner.
➢ The Impact Of The Sarbanes-Oxley Act On Corporate Governance.
Management oversight – The Act changes management’s focus from one of
strategic decision-making and risk management to overall accountability. With the
and compliance – The Act is forcing companies to comply with a wide range of new
management and financial reporting requirements. In order to comply with this
provision, it is essential that public companies have in place financial reporting
systems that can provide current information in real-time concerning its operations
and financial condition. The goal of Section 404 is to require companies to monitor
Oxley Act is to improve ethical conduct. Nearly every title and section within the Act
has a tie to the company’s foundation of ethical behavior.
➢ The Importance Of Corporate Governance In The Study Of Accounting
Information Systems. CEOs and corporate managers must now be more in tune
with the ever-changing financial picture of the company. IT departments are
value. As such, accounting information is key to the corporate governance process,
as well as the overall economic health of the company.
➢ Ethics And Corporate Governance. The most challenging ethical issue within
corporate governance is the potential conflict of interest for management in its role
as financial stewards of the corporation. It may become difficult for managers to
the company’s workforce. In times of trouble, changes may be needed in the
workforce, and management may be placed in the painstaking position of firing and
reorganizing personnel. An ethical approach to this difficult task is important.
Another concept that is extremely significant to corporate governance and ethical
conduct is independence. The audit committee must maintain independence in
order for it to perform its duties. The audit committee is responsible for financial