Introduction

In Chapter 11 we discussed corporate governance in the US, the UK, New Zealand, Canada, South Africa and India. They are some of the major traditional Anglo-American corporate governance jurisdictions. There are among them some fundamental differences in approach. In this chapter the focus is on corporate governance developments in countries where the two-tier board system is used. The number of EU member states with different corporate law systems makes corporate governance harmonisation quite difficult, but also leads to very interesting and dynamic discussion within the EU. The OECD Principles cover board structures. Germany has a two-tier board structure with employee representatives forming part of the supervisory board. Elements of the German corporate governance model influenced the original Japanese corporate governance model, but Anglo-American influence emerged after World War II. China has a unique corporate governance model because Chinese corporations were traditionally state-owned and many major corporations are still either state-owned or statecontrolled. Nevertheless, elements of both the German model and the Anglo-American model, especially as far as independent, non-executive directors for listed companies are concerned, have influenced the Chinese corporate governance model. Indonesia also has a two-tier board model, originally based on the Dutch model, but is now developing its own corporate governance principles based on international best practices. Indonesia is of course important for Australia, because of its close proximity and the potential for expanding economic and commercial ties between the countries, especially in light of the extensive ongoing negotiations regarding the Indonesia-Australia Comprehensive Economic Partnership (IA-CEPA).

European Union (EU)

Enhancing corporate governance

The European Commission (EC) represents the interests of the EU as a whole. It proposes new legislation to the European Parliament and the Council of the European Union, and it ensures that EU law is correctly applied by member countries.

Introduction: The audit role and where it fits into corporate governance

Overview of the audit role

Auditing is defined as an assurance service that objectively gathers evidence and communicates it to third parties. Companies that are required to prepare a financial report for a financial year must have their financial report audited and obtain an auditor's report. Thus all large proprietary companies and public companies must appoint an auditor. Small proprietary companies, and small companies limited by guarantee, are not required to prepare a financial report in normal circumstances and hence need not appoint an auditor. However, they must do so in a limited range of circumstances, namely where members holding at least 5 per cent of the votes in a general meeting require preparation of accounts and ask for an auditor.

Broadly, the function of an auditor is to conduct a review and verification of the financial affairs of the company and to ascertain whether the financial report provided by the company complies with relevant legal requirements and accounting principles, and gives a true and fair account in all material respects of the company's financial affairs. The audit role has several objectives. The main one is to provide reasonable assurance that the financial information reported by the company is free from material misstatement. In the process, auditors provide a barrier of protection against careless or dishonest company officers. In order to fulfil this role, the auditor must have suitable skills and expertise, and must be independent of the company.

The main auditing requirement is to provide a report to the members, within the financial report, for a financial year. This is laid before the annual general meeting and lodged with the Australian Securities and Investments Commission (ASIC).

It is important to note that the auditor's role is essentially procedural, not substantive, in nature. More particularly, pursuant to sections 307 and 308 of the Corporations Act 2001 (Cth), the auditor's report to members must set out a number of matters in relation to the financial report for a financial year.

Higher community expectations of directors

Initially low standards of care, skill and diligence expected of directors

Directors’ statutory duties and liability are discussed in greater detail in Chapter 9. It is, however, important to first make a few observations regarding the higher community expectations of directors.

Based on antiquated English precedents, it has been accepted that directors are not liable for a breach in their duty of care, skill and diligence if they merely acted negligently. One of the first indications that more than ordinary negligence was required is found in an English case decided in 1872, where it was held that directors are liable only for a breach of their duty of care, skill and diligence if they acted with crassa negligentia (gross negligence). This rule was confirmed in a later case (1899) by Lord Lindley MR, one of the most famous English commercial Lords:

Introduction

The Australian Securities and Investments Commission (ASIC), as the primary corporate regulator, has had some spectacular successes, as well as failures, in enforcing the civil penalty provisions underpinning breach of directors’ duties under the Corporations Act 2001 (Cth) (Corporations Act). ASIC has played an active role in enforcing civil penalty provisions against directors and officers.

Introduction

One only has to scan the daily newspaper or follow a newsfeed to find plentiful examples of corporations being criticised for unethical conduct. It would take little more time to find businesses or business leaders who have suffered significant reputational damage, enforcement actions or damages claims. Since the 1970s, a considerable academic and practical literature has developed that considers and explores the field of business ethics, drawing on theory, practice and empirical data. Subjects that consider business ethics have become standard within university business courses. There can be no doubt that the conduct of corporations attracts considerable public interest. For a corporation, the consequences of perceived unethical activity can be profound: they include significant penalties for breaches that amount to regulatory infringements. It can also lead to calls for enhanced regulation and broader scrutiny of corporate activity. In this context the management of a corporation's ethical climate and conduct is increasingly seen as critical to its success, and a matter with which the senior management and the board should be deeply concerned. No book on corporate governance would, therefore, be complete without canvassing this topic.

The modern corporation knows few bounds – its widespread use in business and the corporatisation of essential services means that it permeates almost every aspect of our daily lives. It is companies, small and large, that drive economies and that can create economic prosperity for countries. However, all is not bright and shining; companies, especially large multinational public companies, have been the cause of considerable harm to the environment and society generally because of pollution, exploitation of employees and not providing safe working environments. There are too many examples in too many countries to name them all, but as this book originated in Australia, the James Hardie case, where many suffered tremendously because of exposure to asbestos, with little or no respect by the company for those who suffered, is a prime example of why it is of considerable importance that companies are governed properly. We discuss the James Hardie case in detail in Part 2.4.2, as well as in Part 14.2.3 from a business ethics perspective. Principles of corporate governance have a vital role to play in protecting consumers, shareholders, creditors, the environment and society, and in ensuring that companies act responsibly as well as legally.

Since the appearance of the first edition of Principles of Contemporary Corporate Governance in 2005, developments have gained velocity, and the volume of materials on corporate governance has grown exponentially. This made the appearance of a second edition in 2011 inevitable. The global financial crisis that emerged in about 2008 and global financial uncertainties in the European Union (since 2008) made us predict in 2011 (in the Preface to the second edition of this book) that the discipline of corporate governance would retain its prominence in future. That has indeed been the case, and it was a main motivation for us to bring out the third edition and now this fourth edition of Principles of Contemporary Corporate Governance.

Again we looked at the book in its entirely and asked how we could keep it relevant and contemporary. We decided not to simply add more materials to the book and make it a monstrous work. Rather, we decided to stick to our original approach of focusing on the fundamental and contemporary principles of corporate governance. However, we also wanted to include more of the corporate governance themes and issues that have become particularly prominent in recent years.