Corporate Governance and Financial Management

This article discusses the importance of corporate governance in financial management and the role of financial managers in maintaining ethical standards. It also explores the ASX Corporate Governance Principles and Recommendations in Australia and the impact of corporate governance on shareholder wealth maximization. The article uses the example of Westpac Bank to illustrate the role of financial managers in navigating the global marketplace and evaluating financial segments of a company. It also highlights the agency problem betwixt shareholders and management and how corporate governance can be used to minimize divergence of interests betwixt both parties.

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Financial management

Corporate governance
Part A: Risk and Return for Portfolios
2016 2017
Company A Company B
Company
A
Company
B
Sales ($
million) 10.7 13.9 11.6 14.6
EBIT ($ million) 5.7 7.4 6.2 8.1
Assets ($
million) 10.7 15.6 10.7 15.6
Debt ($ million) 5.8 9.3 5.8 9.3
Interest ($
million) 0.6 1 0.6 1
Equity ($
million) 4.9 6.3 4.9 6.3
PBT 5.1 6.4 5.6 7.1
Return on
Equity 1.04 1.02 1.14 1.13
Company A Company B
Change in EBIT 0.5 0.7
% change in EBIT 8.8% 9.5%
Change in Sales 0.9 0.7
% Change in
Sales 8.4% 5.0%
Operating
leverage 1.04 1.88
Return on assets 10% 20%
Net Operating
Assets 62 40.5
Financial Leverage 0.09 0.23
1. Operating leverage= %Change in EBIT/% change in sales
2. Return on equity= Net income/Equity
3. Assuming interest, debt and assets remain same in 2017
4. Return on assets= EBIT/Net Operating Assets
5. Financial Leverage= total debt/total assets
A high operating leverage shows the profit generating capacity of a company for a delta
change in sales. A higher operating leverage ratio is a positive sign. Hence, the operating
leverage of Company B is favorable.
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Corporate governance
However, a higher financial leverage ratio indicates an increased interest bearing of the
company which negatively affects the earnings per share of the company. Company A enjoys
a favorable financial leverage.
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Corporate governance
Part – B
Corporate governance is regarded as a set of procedures, rules, and laws that impact a
company’s operations and the decisions made by its managers. It involves balancing the
interests of various stakeholders like customers, shareholders, etc. Moreover, it is also a
relevant function of a public company. In Australia, the importance of corporate governance
is guided under ASX Corporate Governance Principles and Recommendations. When it
comes to financial managers, they have a far greater and better responsibility for maintaining
moral corporate governance measures in companies.
A financial manager undertakes a wide variety of functions associated with sustainability and
health of a company. He is responsible for the creation of financial reports, establishment of
strategies, direct investment activities, and policies for long-term financial objectives of a
company. Moreover, in relation to corporate governance, this is a pivotal role in the financial
success of a company. Financial managers are under an obligation to make sure that they
evaluate the financial segments of a company because it allows them fulfilling the
requirements of effective corporate governance (Deegan, 2011). In addition, such evaluation
comprises of understanding financial details in a way that proper information about the
operating results of a company can be easily facilitated (Harrison & Colle, 2010). This can in
turn allow adherence to the corporate governance principles of the company. For example,
considering the financial sector company Westpac of Australia, it can be seen that the
evaluation of financial information from the financial statements can assist the company in
safeguarding integrity for financial reporting throughout its operations. Nevertheless, it can
be said that the finance manager of Westpac is primarily responsible to assist the CEO of the
company in management of financial resources and in reviewing, drafting, and updating the
primary governance procedures and policies. Moreover, in relation to Westpac, it can be seen
that the financial manager should hit the ground running with accessible and ready expertise
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Corporate governance
to be used efficiently as the company’s Chief Financial Officer (CFO) or as a part of financial
experts’ team within the ranks of office of CFO. This is the reason why financial managers in
navigating the global marketplace efficiently, find themselves in a technology-oriented and
deluge of real time information that assists them in catering the knowledge demands of
investment bankers, investors, employees, traders, brokers, etc who are liable to know certain
companies, their goods and services, and the market wherein they function (Mudashiru et. al,
2014).
Financial managers are also responsible for maintaining ethical or moral standards in relation
to evaluation of financial aspects of a company. This is the reason why the CFO of Westpac
Ltd follow a strict guideline for complying with effective reporting requirements. Moreover,
as a financial professional, the managers are liable to themselves, their clients, and to the
public as well. This facilitates in the fulfilment of corporate governance principle of acting
ethically and responsibly on the part of the company. For example, the general manager
group audit of Westpac pursues a direct reporting line to the board audit committee’s
chairman and an administrative line to the company’s CFO (Westpac Bank, 2017).
It must also be noted that in bigger organizations like Westpac, a conflict of interest may
arise betwixt the shareholders and the management, thereby resulting in an agency problem.
In simple words, risk bearing ownership function and managerial control function are two
different functions undertaken by different parties and sometimes financial managers tend to
involve in activities that enhances their own return instead of others (Westpac Bank, 2017).
This facilitates in the principal-agent problem betwixt shareholders and financial managers
wherein considering the discretion of decision-making, such financial managers may engage
in non-value maximizing behaviour (Kruger, 2015). Therefore, it is the role of financial
managers to avoid such scenario because substantial costs emerge from such divergence of
interests betwixt two parties. This can be facilitated through corporate governance as it can
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Corporate governance
assist in reducing such costs. Besides, in public companies like Westpac, the problem of
principal-agent can be effectively accounted for by corporate governance as it facilitates in
acting as a device to safeguard the interests of investors and shareholders through contractual
connections with the company (Mudashiru et. al, 2014). Further, control strategies are
required to minimize divergence of interests betwixt both parties. Besides, corporate
governance can play a key role in becoming the widest control strategy for effective usage of
corporate resources (Kruger, 2015). It acts as a hybrid of both external and internal control
mechanisms with a perspective of attaining effective utilization of resources.
In order to remove the agency problem for maximization of wealth of shareholders, the most
effective and simple means of corporate governance measure can be attributed to the
structure of board of directors of a company. Such board of directors are responsible for
overseeing the strategic direction of the company with the primary goal of safeguarding the
interests of shareholders. Hence, board of directors is liable for setting corporate goals that is
aimed at enhancing long-term value for the shareholders (Goodstein, 2011). For such
purpose, the board is liable to monitor the progress of the company by reviewing the
management’s performance so that punishment or rewards can be offered to the management.
Hence, the success of the board in addressing its fiduciary duties and working with the
management can be expected to maximize the wealth of shareholders, thereby removing the
agency problem prevailing betwixt the management and shareholders (Edward & Moutchnik,
2013). Therefore, corporate governance can be easily adopted by public companies like
Westpac to get rid of agency problems for attaining shareholder wealth maximization.
Corporate governance plays a key role in enhancing the reputation and goodwill of
companies as it emphasizes use of ethical and moral measures for attainment of
organizational objectives. Besides, the agency problem persisting betwixt the management
and shareholders hamper the smooth flow of operations and corporate governance can be
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Corporate governance
easily implemented by companies to maximize shareholders’ wealth (Manoharan, 2011).
Moreover, the role played by financial managers in relation to corporate governance is also
crucial as they assist the Chief Executive Officer of a company in the management of
financial resources, thereby reflecting integrity in financial reporting.
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Corporate governance
References
Deegan, C. M. (2011) In Financial accounting theory. North Ryde, N.S.W: McGraw-Hill
Edward F & Moutchnik, A. (2013). Stakeholder management and CSR: questions and
answers. Oxford Press
Goodstein, E. (2011). Ethics and Economics, Economics and the Environment. Wiley
Harrison, W & Colle, D. (2010). Stakeholder Theory, State of the Art. Cambridge University
Press
Kruger, P., 2015, ‘Corporate goodness and shareholder wealth’, Journal of Financial
economics. [online]. 115(2), pp. 304-329. Available from:
https://EconPapers.repec.org/RePEc:eee:jfinec:v:115:y:2015:i:2:p:304-329 [Accessed 7 May
2018]
Manoharan, T.N. (2011). Financial Statement Fraud and Corporate Governance, The
George Washington University.
Mudashiru, A., Bakare, I.A. and Babatunde, Y. (2014) Good Corporate Governance and
Organisational Performance: An Empirical Analysis. International Journal of Humanities
and Social Science. [online]. 4(7), p. 170-178. Available from:
http://www.ijhssnet.com/journals/Vol_4_No_7_1_May_2014/22.pdf [Accessed 7 May 2018]
Westpac Bank. (2017) Westpac Bank Corporate governance Statement 2017 [online].
Available from: https://www.westpac.com.au/content/dam/public/wbc/documents/pdf/aw/ic/
2017_Westpac_Corporate_Governance_Statement.pdf [Accessed 7 May 2018]
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