Corporate Governance and Business Ethics Education

1. Corporate Governance and Business Ethics Education By Zabi Rezaee Ph.D., CPA, CMA, CIA, CFE, CGFM Thompson-Hill Chair of Excellence & Professor of Accountancy Fogelman College of Business and Economics The University of Memphis 1

2. The Cost of “Bad Press” The Arthur Andersen partner was on his cell phone when he said, “Ship the Enron documents to the feds,” But his secretary heard, “Rip the Enron documents to shreds.” It turns out that it was all just a case of bad cellular. The Clear Alternative to Cellular TM 2

3. Pepper . . . and SaltOctober 2, 2007 3

4. Financial Statement Fraud: Prevention and Detection • Review in Journal of Accountancy,December 2002, pp. 89−90: • “Financial Statement Fraud is a good reference for understanding some of the current corporate financial statement problems in making sure that financial statements are correct.” • Review in Internal Auditing May/June 2002, • p. 46−47: • “This professional reference is highly recommended reading for all internal auditors and should be included in all internal auditing libraries and used in internal auditing training programs. This book should hit the bestseller lists rather quickly.” by Zabihollah Rezaee, published by John Wiley & Sons, March 2002 4

5. Cooks Recipes EndResults FSF = Crime Incentives Monitoring Cooking the Books = FSF = CRIME Financial Statement Fraud Formula Cooks + Recipes + Incentives + Monitoring (lack of) + End Results = CRIME 5

6. Corporate Governance Post-Sarbanes-Oxley: Regulations, Requirements, and Integrated Processes Lynn Turner writes, “Corporate Governance Post-Sarbanes-Oxley appropriately provides the reader with a useful discussion of emerging and contemporary issues confronting those involved with corporate governance including those in the monitoring function, as well as those in the growing field of not-for-profit organizations. And it adds an international flavor to its pages, which is unquestionably important and useful as today’s largest investors as well as accomplished management teams and directors come from a multitude of countries.” Michael McCauley, Director of Corporate Governance for the Florida State Board of Administration, wrote, “Corporate Governance Post-Sarbanes-Oxley offers one of the most comprehensive examinations available. Dr. Rezaee achieves an in-depth, thorough review of today’s corporate governance landscape and provides a sound perspective for the reader. His systematic description offers a practical guide for any investor interested in the role of governance within the capital markets. An excellent book.” by Zabihollah Rezaee, published by John Wiley & Sons, 2007 6

7. Introduction The demand for ever-improving corporate governance and accountability for business organizations appears to be a global trend in the post-SOX era. • Business schools should provide higher education with relevant curriculum. Two areas that have recently received long-awaited attention are business ethics and corporate governance. Business schools play an important role in preparing the next generation of business leaders, who will experience lifelong training in acting with integrity, upholding the highest level of ethical conduct, and carrying the heavy burden of public trust. • There is little background data available with respect to the integration of corporate governance and business ethics education into the business and accounting curriculum. 7

8. Definitions • Business Ethics: The moral principles and ethical standards that guide business behavior. • Professional Ethics: The National Association of State Boards of Accountancy (NASBA) defines education in ethical and professional responsibilities as “a program of learning that provides potential professional accountants with a framework of professional values, ethics and attributes for exercising professional judgment and for acting in an ethical manner that is in the best interest of the public and the profession” (NASBA, 2005). • Corporate Governance: An ongoing process of managing, controlling, and assessing business affairs to create shareholder value and protect the interests of other stakeholders. 8

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10. Why Teach Corporate Governance and Business Ethics? • Reported financial scandals (e.g., Enron, WorldCom, Global Crossing, Adelphia, Qwest) underscore the importance of vigilant corporate governance and ethical conduct by corporations. • The Sarbanes-Oxley Act of 2002 (SOX) is intended to improve corporate governance by enforcing more accountability for public companies and requiring adoption of a code of ethics for their executives. • Anecdotal evidence and academic studies suggest that corporate governance and business ethics are not properly integrated into business education, and coverage of these issues should be increased. 10

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12. There is an inventory of support materials for teaching business ethics and corporate governance in the post-Enron era. There are sufficient resources (published articles, Internet Web 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-SOX era. • There is an increasing trend toward incorporation of business ethics and corporate governance education into the business curriculum worldwide. • Corporate governance has evolved from compliance requirements to a business imperative. 12

13. PwC’s 2003 survey indicates that ethics is not properly integrated into accounting education and encourages academicians to increase the coverage of ethics and ethical issues in the classroom. • Business schools have been alleged for ethics violations that “range from widespread cheating by students to faculty who have falsified data and manipulated research findings” (AACSB 2004). • Business schools have been criticized for teaching “students to bend the rules to make the numbers” or encourage students to bypass policies, procedures, and even the law, to ensure favorable financial results (AACSB 2004). • A KPMG 2007 study confirms that ethics training should tackle employee fraud and theft. 13

14. KPMG conducted a survey of about 7,000 employees of companies and found significantly more positive support for ethical behavior in organizations with compliance ethical programs (CEP). • The Association to Advance Collegiate Schools of Business International (AACSB) has promoted the integration of business ethics and corporate governance into the business curriculum. • AACSB in its task force report promotes the coverage of business ethics and corporate governance in the business curriculum. • This report identifies the four important areas viewed by the AACSB as the “cornerstones of a comprehensive and viable ethics education curriculum in business schools”: • responsibility of business in society; • ethical decision making; • ethical leadership; and • corporate governance. 14

15. The AACSB, however, stopped short of requiring accredited schools to offer specific ethics or corporate governance courses. • It is left up to business schools to determine whether and how to provide corporate governance and business ethics education to business students either in a single course or integrated across the curriculum on a module-basis. • NASBA recommends that the process of ethics education start with a discussion of broad ethical theories and concepts and their applications to the accounting and business environment. • NASBA initially recommended that ethics education programs contain: (1) three semester credit hours in ethical and professional responsibilities of CPAs. (2) three semester hours in ethical foundations and applications in business. These recommendations were subsequently tabled. 15

16. Ethics Sensitivity Business Ethics Ethical Behavior Ethics Incentives Ethics Triangle Ethics sensitivity: Moral principles, workplace environment, gamesmanship, loyalty, peer pressure, and job security that influence one’s ethical decisions. Ethics incentives: Rewards, punishments, and requirements for ethical behavior (e.g., tone at the top, AICPA code of professional ethics). Ethics behavior: Doing “the right thing” rises above a rules-based mindset that asks, “is this legal,” and adopts a more principles-based approach that asks, “is this right?” 16

17. The established codes of conduct and ethics programs address the following: • Avoidance and resolution of conflicts of interest between the company and employee. • Compliance with all applicable regulations. • Emphasis on customer relations to enhance the company’s reputation. • Avoidance of improper use of the company’s confidential information. • Encouragement of whistleblowers to reveal dishonesty, wrongdoings, and improper behavior. 17

18. 1. A KPMG 2007 study confirms that ethics training should tackle employee fraud and theft. 2. Federal Sentencing Guidelines require ethics and “code of conduct” training for employees covering the following: a. The rules against theft, no matter how small the asset. b. The early warning signs of employee misconduct (isolation, refusal to provide information to management, a sudden change in spending habits. c. Educating employees about whistleblower programs, hotlines. 3. A corporate culture must promote ethical behavior at all levels. 18

19. Sources of Corporate Governance The primary sources of corporate governance in the United States are corporate law, securities law, listing standards, and best practices. • Corporate laws: State corporate law establishes standards of conduct for corporations and defines fiduciary duties, authorities, and responsibilities of shareholders, directors, and officers. • Federal securities laws: Federal securities laws are passed by Congress and are intended to protect investors and improve investor confidence in the integrity and efficiency of the capital markets. • The two fundamental federal securities laws pertaining to public companies are the Securities Act of 1933 and the Securities Exchange Act of 1934. 19

20. SOX expanded the role of federal statutes in corporate governance by providing measures to improve corporate governance, financial reports, and audit activities. • Listing standards:Listing standards adopted by national stock exchanges establish corporate governance standards for listing companies to promote high standards of shareholder democracy, corporate responsibility, and accountability to shareholders and monitor the operation of securities markets. • Best practices:Corporate governance best practices suggested by professional organizations are nonbinding corporate governance guidelines intended to improve corporate governance policies and practices above and beyond state and federal statutes and listing standards. 20

21. Global Convergence in Corporate Governance • There are no globally accepted corporate governance reforms and best practices. • Differences are mainly driven by the country’s statutes, corporate structures, and culture. • The United States and United Kingdom operate under common law with the purpose of aligning the interests of management with those of shareholders compared to countries under code law (e.g., Germany) with the purpose of protecting the rights of minority shareholders. • Corporate governance reforms in the United States are typically regulator-led being established by the SEC to protect investors, whereas reforms in the United Kingdom are normally shareholder-led indicating that investors are responsible for safeguarding their interests. 21

22. Corporate and Capital Structure • Corporate governance in a dispersed share ownership (U.S.) is designed to align the interests of management with those of shareholders. • In a concentrated ownership (Germany) corporate governance creates a right balance between the interests of minority and majority shareholders. • The primary purpose of corporate governance in the U.S. is to enhance shareholder value creation while protecting the interests of other stakeholders (creditors, employees, suppliers, customers, government), whereas in Germany the focus is more on protecting creditors as banks play an important role in financing companies. 22

23. The Board System • In one-tier boards in the U.S., directors are elected to oversee management in running the company. • In the two-tier board system in Germany, the supervisory board advises, appoints, and supervises the management board in managing the operation of the company. • Japan’s companies operate through a complex system of committees, and these committees oversee and run the company. • Cultural and political differences can also influence corporate governance as some cultures are more collective and risk averse than others (e.g., German compared to U.S.). 23

24. SOX Impact on Corporate Governance & Ethics Section 406 of SOX and SEC rules require public companies to disclose whether they have adopted a code of ethics for their senior executives and make it publicly available by: (1) filing their code of ethics as an exhibit to their SEC annual reports; (2) posting their rules of ethics on their Web site; and (3) disclosing in their annual reports that a copy of their code of ethics is available without charge upon request. SOX is reported to have a positive impact on business codes. However, SOX is only one element in the complex corporate culture that determines the ethical conduct of participants (directors, officers, auditors, employees) in the current corporate business model. The other elements require changes in corporate culture in promoting competency and integrity among all corporate governance participants. A 2007 survey conducted by Grant Thornton indicates that about two-thirds of CFOs feel they could intentionally misstate their financial statements to auditors. 24

25. Corporate Governance Functions • The seven essential corporate governance functions are oversight, managerial, compliance, internal audit, advisory, external audit, and monitoring. Corporate governance participants fulfill their responsibility when their role in corporate governance is viewed as a value-added function. • Three of these functions, however, are crucial to the achievement of sustainable corporate performance: • the oversight function assumed by the board of directors. • the managerial function delegated to management. • the monitory function exercised by shareholders. 25

26. CORPORATE GOVERNANCE FUNCTION OVERSIGHT MANAGERIAL Board of Directors Audit Committee MONITORING Management Stakeholders Public Trust and Investor Confidence COMPLIANCE Governing Bodies EXTERNAL AUDIT Corporate Governance Effectiveness External Auditors INTERNAL AUDIT ADVISORY Internal Auditors Legal Counsel Financial Analysts 26

27. Corporate Governance Survey of AACSB-Accredited Schools in the U.S. Of 494 accredited schools surveyed, 212 responded (43%). • 8 percent of bachelor’s and 11 percent of MBA programs currently require a corporate governance course. • 11 percent of bachelor’s and 22 percent of MBA programs currently offer corporate governance as an elective. 27

28. CG education is relatively new to business schools. 50% 45% 40% 35% 30% Percent of respondents 25% 20% 15% 10% 5% 0% Before 1980 1980 to 1989 1990 to 1999 2000 to 2002 2002 or after Year in which corporate governance was first introduced into the undergraduate or MBA curriculum 28

29. Motivation for Corporate Governance Education 100% 90% 80% 70% 60% 50% Percent of respondents 40% 30% 20% 10% 0% SOX or equivalent COSO reports or equivalent Corporate fraud Events motivating inclusion of corporate governance in the curriculum (last two years only) 29

30. Exposure of Graduates to Corporate Governance Topics > 90% 50%−90% Percent of respondents 10%−49% < 10% Five years ago Currently Five years from now 30

31. Impact of Corporate Governance Education • 70 percent agree that educating all business graduates in corporate governance can deter corporate fraud in the future. • 75 percent agree that Sarbanes-Oxley will improve corporate governance. • 49 percent believe that corporate fraud will decrease in the next five years. 31

32. Methods and Procedures Two methods are used in gathering data pertaining to corporate governance and business ethics education. • First, we perform a content analysis of a sample 52 corporate governance and business ethics course syllabi from business schools’ Web sites. We found out that a limited number of business schools offer a separate corporate governance course including The University of Delaware, Oklahoma State University, Claremont University, and Bryant University. However, many law schools teach corporate governance. • The primary focus of studied syllabi is on the role of the board, management, and investors in corporate governance with limited attention to the roles and responsibilities of other corporate governance participants (external auditors, internal auditors, legal council, financial advisors, regulatory bodies, standard setters). 32

33. Topics Covered • Theory of the Firm • Role of Law • International Corporate Governance • Board Composition and Control • Compensation of Executives • Investor Protection • Role and Performance of Management • Role of Regulators • Role of Institutional Investors • Financial Scandals • Internal Control and Accountability 33

34. Second, we conduct a nationwide survey of accounting academicians and practicing CPAs to determine the demand, benefits, coverage, and delivery of corporate governance and business ethics education. • A random sample of 1,000 accounting professors, teaching primarily auditing and financial accounting, is selected from Hasselback’s 2007−2008 Accounting Faculty Directory. • A random sample of 1,000 practicing CPAs, primarily partners and managers of public accounting firms, is purchased from the AICPA. 34

35. Do you expect future demand and interest in business ethics and corporate governance to: Do you expect future demand and interest in business ethics and corporate governance to: 35

36. Perceived Benefits of Business Ethics and Corporate Governance 36

37. Perceived Obstacles in Integrating Ethics and Corporate Governance Education 37

38. Business Ethics Topical Content: Comparison of Academicians vs. Practitioners 38

39. Corporate Governance Topical Content: Comparison of Academicians vs. Practitioners 39

40. Both groups agreed on the importance of the role of standard-setting and regulatory bodies (SEC, FASB, etc.). Practitioners place more importance on most of the topics compared to academicians. • Practitioners place more importance on the following: • Corporate governance and the code of corporate or professional conduct. • Antifraud education and training programs. • Investigating potential disciplinary ethical issues. • Due ethical assessment process. • Ethics enforcement programs and procedures. 40

41. Conclusion Two areas that have recently received long-awaited attention are business ethics and corporate governance. This next generation of business leaders must understand the importance of ethical conduct and corporate governance to our society and the complexity or new accountability and responsibility of financial reporting. Thus, business curriculum must reflect the promotion of ethical behavior, professional accountability, and personal integrity taught to business students. Corporate governance and business ethics including accountability, integrity, and transparency must be integrated throughout the business curriculum. 41

42. Forthcoming Book Title:Corporate Governance & Ethics Author: Zabi Rezaee Publisher: John Wiley & Sons Publication date: May 2008 42

43. Book Contents • Part I: Private Enterprise and Public Trust • Chapter 1: The Free Market System and Business • Chapter 2: Corporate Governance • Chapter 3: Introduction to Business Ethics • Part II: Roles and Responsibilities of Corporate Governance Participants • Chapter 4: Board of Directors’ Roles and Responsibilities • Chapter 5: Board Committees’ Roles and Responsibilities • Chapter 6: Roles and Responsibilities of Management • Chapter 7: Roles and Responsibilities of Regulatory Bodies and Standard Setters • Chapter 8: Internal Auditors’ Roles and Responsibilities 43

44. Book Contents....Continued • Chapter 9: External Auditors’ Roles and Responsibilities • Chapter 10: Stakeholders’ Roles and Responsibilities • Chapter 11: Roles and Responsibilities of Other Corporate Governance Participants Part III: Contemporary Issues in Business Ethics and Corporate Governance • Chapter 12: Technology and Corporate Governance • Chapter 13: Corporate Governance in Not-for-Profit Organizations • Chapter 14: Corporate Governance in Transition • Chapter 15: Corporate Governance Emerging Issues 44