Asian Financial Statement Analysis: Detecting Financial Irregularities

CHAPTER 6

EVALUATING CORPORATE GOVERNANCE AND RELATED-PARTY ISSUES

This chapter examines the impact of weak corporate governance on reported results. Weak corporate governance provides opportunities for the activities presented in previous chapters by permitting managers or majority shareholders to engage in related-party transactions to enrich themselves at the expense of other shareholders. The chapter provides a checklist of things to look for when evaluating corporate governance issues.

When an investor is also the manager, there is an automatic alignment of interests. The owner would run the business in its best interests and would be disincentivized to enter into transactions that detract from this mission. In today's large public companies, this alignment is harder to achieve due to a separation of ownership and control. The investors provide capital to the business, which is in turn run by its management. With the investor base being very fragmented, no single investor is able to exercise oversight to ensure that the owners’ interests are looked after. Good corporate governance can overcome the issues associated with a separation of ownership and control.

According to the CFA Institute:

Corporate governance is the system of internal controls and procedures by which individual companies are managed. It provides a framework that defines the rights, roles, and responsibilities of various groups—management, board, controlling shareowners, and minority or non-controlling ...