Which of the following is an internal mechanism that seeks to ensure ethical corporate governance?

Corporate governance is the combination of rules, processes and laws by which businesses are operated, regulated and controlled. The term encompasses the internal and external factors that affect the interests of a company's stakeholders, including shareholders, customers, suppliers, government regulators and management.

The board of directors or corporate executive board is responsible for creating a framework for corporate governance that best aligns business conduct with corporate objectives. Good corporate governance involves establishing principles of security, transparency, equity, compliance, reliance and accountability.

Importance of corporate governance

Corporate governance is critical for the proper functioning of an organization. Demonstrating good corporate governance is important for maintaining a company's reputation.

Corporate governance is based on a set of rules, bylaws, policies and procedures to ensure company accountability. When done correctly, it establishes a framework for attaining a company's objectives in all spheres of management. It also recognizes the importance of shareholders. Shareholders elect the company's members of the board, fund company operations and have a direct say in the operation of the business.

Good governance ensures a company's integrity, overall direction, risk management and success planning. This, in turn, helps companies stay financially viable and build strong community, shareholder and investor relations and trust. Demonstrating good corporate governance is often considered as important as profitability for businesses.

Bad corporate governance can lead to a host of negative outcomes, such as the following:

• failure to reach company goals;
• loss of support from stakeholders and community;
• financial losses; and
• collapse of the company.

Principles of corporate governance

While corporate governance structures may vary, most organizations incorporate the following key elements:

• Fair and equitable treatment. All shareholders, customers, employees and other stakeholders should be treated equally and fairly. Part of this is making sure shareholders are aware of their rights and how to exercise them.
• Accountability. Legal, contractual and social obligations to both shareholders and nonshareholders must be upheld. Organizations should define a code of conduct for board members; board committees, such as the audit committee and compensation committee; and senior executives. New individuals joining those ranks must meet those established standards.
• Diversity. The board of directors must maintain a commitment to ensure diversity within corporate governance and the company overall.
• Oversight and management. Board members must also possess the adequate skills necessary to review management practices.
• Transparency. All corporate governance policies and procedures should be disclosed to relevant stakeholders. This includes regularly and consistently communicating pertinent information to employees, customers, investors, vendors and members of the community.

Conflict management in corporate governance

One purpose of corporate governance is to implement a checks-and-balances system that minimizes conflicts of interest between various stakeholders and with any individual party.

Conflicts arise when two parties have opposing opinions or goals on the way business should be conducted. Conflicts of interest can also arise when individual stakeholders might gain personally from a corporate action or decision they have a say in. The board of directors should provide a nonbiased way to handle these sorts of conflicts.

Conflicts can occur when executives disagree with shareholders. For example, the shareholders may want to pursue goals that generate greater profits, while the chief executive officer might want to invest in better employee engagement efforts. Another type of conflict could arise if multiple shareholders disagree with each other.

Personal conflicts of interest or conflicts among directors, audit plan administrators and company executives are typically disclosed in proxy statements. A proxy statement is a document that shareholders use to evaluate the qualifications and compensation of the board of directors and key senior management staff.

Public companies are required by the Securities and Exchange Commission to release proxy statements. They are shared during annual meetings when a company is soliciting shareholder votes on a given matter, such as nominating a new member to the corporate boards.

Examples of corporate governance

Specific processes that can be outlined in corporate governance may include the following:

• action plans;
• performance measurement;
• environmental, social and governance principles;
• disclosure practices;
• executive compensation decisions;
• dividend policies;
• decision-making practices;
• procedures for reconciling conflicts of interest; and
• explicit or implicit contracts between the company and stakeholders.

An example of good corporate governance practices is a well-defined and enforced structure that works for the benefit of everyone concerned by ensuring that the enterprise adheres to accepted ethical standards, best practices and formal laws.

Alternatively, bad corporate governance is poorly structured, ambiguous and noncompliant approaches to running a business. All of these approaches can damage the image or financial health of a business.

The Enron scandal is an example of poor corporate governance. Enron Corp. declared bankruptcy in 2001 -- just months before it was one of the largest companies in the U.S. Enron falsely reported its revenue by a wide margin and used fraudulent methods to hide debts and toxic assets from investors and regulators to avoid accountability. This scandal had a lasting effect on Wall Street and led the government to pass new regulations on corporate accountability and governance.

Good corporate governance often goes unnoticed in the public sphere. One example of a company with a reputation for good corporate governance is PepsiCo. In its 2020 proxy statement, the company outlined its leadership structure and changes to the compensation program, as well as input from investors in the following areas:

Regulation of corporate governance

Corporate governance has received increased attention because of high-profile scandals involving abuse of corporate power or alleged criminal activity by corporate officers. To counteract those activities, various laws and regulations have been passed to address the components of corporate governance guidelines, including the following:

• Basel II. This business standard minimizes the financial effect of risky operational decisions. Basel II includes the rights of shareholders, thus affecting corporate governance.
• Gramm-Leach-Bliley Act. This act, also known as the GLB Act, regulates the ways that financial institutions handle private information. It requires that companies include how they oversee financial organizations and stakeholders in their corporate governance strategy.
• Sarbanes-Oxley Act. Also known as SOX, this act was passed after it was found that high-profile companies and their executives were committing fraud -- specifically, Enron and WorldCom. As a result, emphasis was placed on corporate governance as a way to restore faith in public companies.

Good corporate governance depends on complying with various regulations, both general and industry-specific. Learn the top cloud compliance standards and how cloud companies can use them.

Internal controls are the mechanisms, rules, and procedures implemented by a company to ensure the integrity of financial and accounting information, promote accountability, and prevent fraud.

Besides complying with laws and regulations and preventing employees from stealing assets or committing fraud, internal controls can help improve operational efficiency by improving the accuracy and timeliness of financial reporting.

• Internal controls are the mechanisms, rules, and procedures implemented by a company to ensure the integrity of financial and accounting information, promote accountability and prevent fraud.
• Besides complying with laws and regulations, and preventing employees from stealing assets or committing fraud, internal controls can help improve operational efficiency by improving the accuracy and timeliness of financial reporting.
• Internal audits play a critical role in a company’s internal controls and corporate governance, now that the Sarbanes-Oxley Act of 2002 has made managers legally responsible for the accuracy of its financial statements.

Internal controls have become a key business function for every U.S. company since the accounting scandals in the early 2000s. In their wake, the Sarbanes-Oxley Act of 2002 was enacted to protect investors from fraudulent accounting activities and improve the accuracy and reliability of corporate disclosures. This has had a profound effect on corporate governance, by making managers responsible for financial reporting and creating an audit trail. Managers found guilty of not properly establishing and managing internal controls face serious criminal penalties.

The auditor’s opinion that accompanies financial statements is based on an audit of the procedures and records used to produce them. As part of an audit, external auditors will test a company’s accounting processes and internal controls and provide an opinion as to their effectiveness.

Internal audits evaluate a company’s internal controls, including its corporate governance and accounting processes. They ensure compliance with laws and regulations and accurate and timely financial reporting and data collection, as well as helping to maintain operational efficiency by identifying problems and correcting lapses before they are discovered in an external audit. Internal audits play a critical role in a company’s operations and corporate governance, now that the Sarbanes-Oxley Act of 2002 has made managers legally responsible for the accuracy of its financial statements.

No two systems of internal controls are identical, but many core philosophies regarding financial integrity and accounting practices have become standard management practices. While internal controls can be expensive, properly implemented internal controls can help streamline operations and increase operational efficiency, in addition to preventing fraud.

Regardless of the policies and procedures established by an organization, only reasonable assurance may be provided that internal controls are effective and financial information is correct. The effectiveness of internal controls is limited by human judgment. A business will often give high-level personnel the ability to override internal controls for operational efficiency reasons, and internal controls can be circumvented through collusion.

The U.S. Congress passed the Sarbanes-Oxley Act of 2002 to protect investors from the possibility of fraudulent accounting activities by corporations, which mandated strict reforms to improve financial disclosures from corporations and prevent accounting fraud.

Internal controls are typically comprised of control activities such as authorization, documentation, reconciliation, security, and the separation of duties. And they are broadly divided into preventative and detective activities.

Preventive control activities aim to deter errors or fraud from happening in the first place and include thorough documentation and authorization practices. Separation of duties, a key part of this process, ensures that no single individual is in a position to authorize, record, and be in the custody of a financial transaction and the resulting asset. Authorization of invoices and verification of expenses are internal controls. In addition, preventative internal controls include limiting physical access to equipment, inventory, cash, and other assets.

Detective controls are backup procedures that are designed to catch items or events that have been missed by the first line of defense. Here, the most important activity is reconciliation, used to compare data sets, and corrective action is taken upon material differences. Other detective controls include external audits from accounting firms and internal audits of assets such as inventory.

Auditing techniques and control methods from England migrated to the United States during the Industrial Revolution. In the 20th century, auditors' reporting practices and testing methods were standardized.

Internal controls are the mechanisms, rules, and procedures implemented by a company to ensure the integrity of financial and accounting information, promote accountability, and prevent fraud. Besides complying with laws and regulations and preventing employees from stealing assets or committing fraud, internal controls can help improve operational efficiency by improving the accuracy and timeliness of financial reporting.

The Sarbanes-Oxley Act of 2002, enacted in the wake of the accounting scandals in the early 2000s, seeks to protect investors from fraudulent accounting activities and improve the accuracy and reliability of corporate disclosures.

Internal controls are broadly divided into preventative and detective activities. Preventive control activities aim to deter errors or fraud from happening in the first place and include thorough documentation and authorization practices. Detective controls are backup procedures that are designed to catch items or events that have been missed by the first line of defense. 

Separation of duties, a key part of the preventive internal control process, ensures that no single individual is in a position to authorize, record, and be in the custody of a financial transaction and the resulting asset. Authorization of invoices, verification of expenses, limiting physical access to equipment, inventory, cash, and other assets are examples of preventative internal controls.

Detective internal controls attempt to find problems within a company's processes once they have occurred. They may be employed in accordance with many different goals, such as quality control, fraud prevention, and legal compliance. Here, the most important activity is reconciliation, used to compare data sets, and corrective action is taken if there are material differences. Other detective controls include external audits from accounting firms and internal audits of assets such as inventory.