April 8th, 2020

By Nurulhuda Noor Affendi, Nurayuni binti Hassan, and Azizah Abdullah

Abstract

In aligning the university’s practice with National Higher Education Strategic Plan, Universiti Teknologi MARA (UiTM) organizes the Invention, Innovation & Design Exposition (IIDEX) annually. Last year, IIDEX 2019 brought out great innovative ideas from the members of the Faculty of Accountancy (FACT). The innovations reflect the enthusiasm of the faculty members in embracing new business challenges particularly concerning financial and business sustainability. This article reviews six corporate governance-related innovations showcased by the FACT members at IIDEX 2019. This review aims to highlight the potential contributions of these innovative ideas towards promoting and facilitating effective corporate governance practices in business and public organizations.

Introduction

According to Terjesen, Aguilera, and Lorenz (2015), strong corporate governance has been proven to lessen agency problems and encourages managers to operate the business properly. Without strong corporate governance, companies are exposed to problems related to earnings management, financial misstatement, fraud, and corruption. There are four FACT innovations showcased in IIDEX 2019 which ideally aim to address these four shenanigans respectively - Earnings Management Predictor (EM-PRE), My Financial Guard (MyFinGuard), Fraud Prevention Mechanism Indicator (FPM-I) and C-BAROMETER. Apart from these four innovations, FACT innovators also acknowledge the importance of risk management and human capital as a support for strong governance, which is shown through the innovations of Dr. Risk Care (Your Risk Management Cure) and Human Governance Index (HGI).

Importance of Corporate Governance

Corporate governance is a structure that drives and controls a business in order to strike a balance between power and the authority of the company to provide transparency to shareholders and stakeholders (Daniri, 2005; Utami & Sutejo, 2019). A large body of literature from the 1980s has highlighted the importance of corporate governance and its influence on the likelihood of financial distress or bankruptcy (Lajili & Zéghal, 2010). According to the postulates of the agency theory, this is explained by the fact that conflict of interests in the relationship between management and other stakeholders, by delegating roles, is more severe in crisis because managers will choose a short-term strategy which will lead to higher private benefits in the hope of losing their jobs (Donker, Santen, & Zahir, 2009). The theory of the agency put forward the concept of conflicting agencies and the costs that arise from them (Jensen & Meckling, 1976). Agency costs are incurred to resolve agency conflicts and align the interests of ownership and management. A high level of agency cost shows inefficient monitoring activities and weak corporate governance (Jensen & Meckling, 1976; Shleifer & Vishny, 1997).

The increasing incidence of corporate fraud shows that organizations are prioritizing ineffective emphasis on fraud prevention and deterrence mechanisms (Razali & Arshad, 2014). Weak corporate governance mechanisms also make it possible for false financial statements to be released to the public (Hasnan, Rahman & Mahenthiran, 2014). According to Abdullah, Yusof & Nor (2010), corporate governance is known as one of the frameworks of public companies that could effectively protect the interests of the investors of a corporation. It is also seen as a means of ensuring an effective system of checks and balances, so that management acts in accordance with the interests of shareholders. Corporate governance, therefore, acts as a tool for managing discipline, supervising and monitoring the management.

Review of FACT Innovations Showcased in IIDEX 2019

            Earnings Management Predictor (EM-PRE)

Earnings management practices can be considered as unethical problems (Nasir, Ali, Razzaque, & Ahmed, 2018). These activities are motivated by management incentives, such as the ownership and management conflict (Man, Locke, & Wellalage, 2018). Referring to agency theory, Jiraporn, Miller, Yoon, and Kim (2008) suggest that agency conflicts could induce managers to exploit the flexibility in accounting policies to manage earnings. Therefore, it is important for the board of directors as the main vehicle for corporate governance to protect the interest of stakeholders.

This is where the Earnings Management Predictor (EM-PRE) designed to detect the likelihood of manipulation of earnings in the financial report. This tool incorporates both financial and non-financial measures. It can provide detection of financial statement manipulation, which leads to further investigation to be carried out by relevant enforcement agencies. This invention can guide stakeholders and the board of directors in making reliable and relevant decisions to financial reporting information. Hence, this will help to reduce agency costs.

            My Financial Guard (MyFinGuard)

My Financial Guard (MyFinGuard) is a tool invented to deal with issues of financial misstatement, financial distress, and poor corporate governance. It is useful to society as it is an effective way to be more proactive in the fight against financial misstatements. Financial statement fraud will not only affect the organizations but also their employees, creditors, and investors (Nasir et. al., 2018). In addition, the occurrence of financial statements fraud also decreases the integrity of corporate financial reports and financial market trust. The extent of financial statement fraud in manipulating accounting data has also affected users' ability to make decisions.

Megan Media Holding Berhad, Perwaja Steel Sdn. Bhd., OilcorpBerhad, Polymate Holdings Berhad, and Transmile Group Berhad are some examples of several companies in Malaysia that were alleged to have reported fraudulent financial reporting (Razali & Arshad, 2014). These organizational failures have raised questions about the legitimacy and accuracy of the financial report in the minds of various stakeholders.

By better understanding the determinants of misstatements, financial statements users should be in a better position to identify and curtail earnings management and fraudulent activity in the future. Thus, this innovation can be used by auditors and regulators as a tool to detect financial misstatements much sooner and stop it before it becomes material and creates financial damage. While for financial analysts and investors, it could be a tool for them to make a preliminary analysis of earnings quality and it can also be used as a stock selection signal and risk descriptor.

            Fraud Prevention Mechanism Indicator (FPM-I)

Fraud Prevention Mechanism Indicator (FPM-I) is another innovation that assists internal auditors in evaluating the effectiveness of fraud prevention mechanism. It can help to identify the most effective mechanism that could be used to minimize fraud risk in the organization. Its objectives include assists organizations to prioritize fraud prevention mechanism using Risk Assessment Matrix, assists organizations in evaluating the effectiveness of mechanisms prior and after implementation, identify the most effective mechanism that could be used to minimize fraud risks, and provide the suggestion for each evaluated mechanism whether it can be: i) proceeded (green); ii) improved (amber); iii) abandoned (red). Thus, it will create good corporate governance that will serve the company's shield against corporate fraud.

According to Belay (2007), the internal audit function is one of the strongest monitoring and promotion mechanisms in an organization's system of good governance. Furthermore, a study by Coram, Ferguson, and Moroney (2006) stated that internal audit is more efficient in identifying and reporting fraud rather than fully outsourcing the internal audit function. Hence, FPM-i can be commercialized to all business corporations and government agencies and bodies to evaluate their fraud prevention mechanism.

            C-BAROMETER

According to Shahid and Abbas (2019), quality corporate governance can enhance the reliability of financial information and efficiency of the capital market thus gain investor confidence. This is where another great invention which is C-BAROMETER designed to provide a corruption probability indicator for government-linked companies (GLCs) in Malaysia based on the characteristics of their corporate boards. It allows early detection of possible corruption, which would prevent the companies from going out of business, and hence reduce operational and litigation costs and reputational risks.

The agency theory suggests managers do not always act in the best interests of shareholders; they have incentives to expropriate the assets of the company, for example by undertaking self-profitable projects at the expense of the wealth of shareholders known as a moral hazard problem (Abdullah et. al., 2010). Thus, it is crucial to have good corporate governance since it enables the elimination of agency problems and improves the performance of companies thus maximize the shareholder’s wealth (Shahid & Abbas, 2019). C-BAROMETER is very useful to C-Suites including Chief Executives, Chief Integrity Officers, and Chief Risk Officers and investigators and researchers.

            Dr. Risk Care (Your Risk Management Cure)

Dr. Risk Care (Your Risk Management Cure) can be an important tool for corporate governance to measure the level of organizational risk based on the Enterprise Risk Management (ERM) Framework. Furthermore, this tool can assist an organization in identifying the strength and weaknesses of its risk management process and to take any corrective action to improve its risk management procedure. Since the early 2000s, corporate scandals such as Enron, WorldCom, and Merck, have drawn remarkable attention to the function of the board of directors. The US Sarbanes-Oxley Act, 2002, requires that the audit committee be composed entirely of independent directors and include at least one financially skilled member to strengthen the auditing function. While Section 303.07 (D) of the NYSE Listed Company Manual requires the audit committee “to discuss policies concerning risk assessment and risk management”.

According to agency theory, risk-neutral (diverse) shareholders and risk-averse executives have different risk preferences that require surveillance by the board (Jensen & Meckling, 1976; Subramaniam, McManus, & Zhang, 2009). Subsequently, without monitoring, risk-averse managers may reject profitable (but riskier) projects which are attractive to shareholders who prefer greater returns from greater risk levels. A study by Tao and Hutchinson (2013) has recommended the importance of corporate governance mechanisms as well as the management of risk. This research shows that it is essential to have compensation and risk committees with members who are independent of leadership, who have industry and board experience, who are professionally skilled and meet frequently.

As a result, Dr. Risk Care (Your Risk Management Cure) aims to act as an alarm and help an organization determines its level of organizational risk, and the quality of its risk management procedure. Besides, this tool can indicate the strengths and weaknesses of each level of ERM Framework and recommend suggestions to be undertaken by the organization to increase the efficiency of its risk management process.

            Human Governance Index (HGI)

Human Governance Index (HGI) is an indicator designed to measure human governance in any public and private entities. This is significant to assist the organization in enhancing talent comprises values, attitude, knowledge, competencies dimensions while governance that includes ethical leadership, work ethics and managing financial resources. Iqbal, Nawaz, and Ehsan (2019) pointed out that directors provide human and relational capital to a firm and therefore play an important part in improving overall firm performance.

The objective of the index is to act as an indicator of the level of human talent and governance expected in an organization that may assist the government and other institutions in strategizing their incentives pertaining to human talent and governance. Its usefulness where HGI provides impact measurement of the training modules provided by the organizations. While in the long run, the information presented by HGI can assist the government in crafting future strategies for human governance policy. The index proposes a platform for human governance reporting for the organization.

Conclusion

In conclusion, the innovations designed by the participants are inspiring and they are useful for many organizations, including government agencies. It also can help and assist organizations to improve their performance internally or externally especially in corporate governance. This exhibition event gives an insightful disclosure of real-life issues in the accounting field and provides an opportunity for the participants to share their innovations with the audience.