Governance scope and approaches: formula sheet

Key formulas

Agency relationship

Principal (shareholders) → delegates authority → Agent (directors)

Name both parties and what is delegated. In groups, the same logic applies between boards and subsidiary managers, or between shareholders and lenders.

Agency costs

Agency costs = monitoring costs + bonding/incentive costs + residual loss

Use all three headings when asked about agency costs. Give a scenario example under each.

Core cause of the problem

Conflict of interest + information asymmetry = agency problem

Both parts matter. Without the information gap, shareholders could easily check the agent.

Reducing the problem

Monitoring + Incentives (alignment of interests)

Link every recommendation to one of these two, then judge its limits.

Mendelow's matrix: high power, high interest

High power + High interest = Key players

Manage closely. Involve them in decisions and consult them early.

Mendelow's matrix: high power, low interest

High power + Low interest = Keep satisfied

Do not overload them with detail, but make sure they stay content. Their interest may rise.

Mendelow's matrix: low power, high interest

Low power + High interest = Keep informed

Communicate regularly. They may lobby or form coalitions that increase their power.

Mendelow's matrix: low power, low interest

Low power + Low interest = Minimal effort

Monitor only. Watch for changes in their position.

Stakeholder groupings

Internal | Connected | External; Primary | Secondary

Use these labels to organise a long list quickly, then pick the most important for the scenario.

Principles-based approach

Comply or explain = follow the provision, or disclose the departure and give reasons

Typical of the UK Corporate Governance Code. Enforced mainly through disclosure and shareholder pressure.

Rules-based approach

Comply or face legal penalty

Typical of Sarbanes-Oxley in the US. No option to explain a departure.

Key SOX features

Executive certification of accounts + management report on internal control + auditor attestation + PCAOB oversight + limits on auditor non-audit services

Use these as concrete evidence when you discuss a rules-based approach.

Evaluation frame

Strengths vs weaknesses, then apply to the scenario

Always give a reasoned conclusion, not just two lists.

OECD Principles (six areas)

Framework | Shareholder rights and equitable treatment | Institutional investors and intermediaries | Stakeholders | Disclosure and transparency | Board responsibilities

Use these as headings to organise an answer. They are guidance, not law.

Comply or explain

Comply with the provision, OR explain the departure

Explanations should be specific and reasoned. Shareholders judge them. It is not a licence to ignore the code.

Rules-based vs principles-based

Rules: mandatory, compliance enforced | Principles: flexible, judgement and explanation

Codes of best practice are usually principles-based. Legal requirements elsewhere may be rules-based.

Typical code features

Separate chair and CEO | Independent NEDs | Board committees (audit, remuneration, nomination) | Risk and control review | Performance-linked pay

These recur across most codes. Check the case for each one.

Core logic of governance failure

Weak oversight + strong incentive or pressure + opportunity = misreporting, fraud or poor decisions

A memory aid, not a formal rule. Use it to link scenario facts to causes.

Typical warning signs checklist

Dominant person | Weak board | Poor controls | Weak audit | Bad incentives | Poor culture

Use as a scanning list when reading a scenario. Not every case shows all six.

Answer structure for a failure question

Weakness (from scenario) → Why it matters → Recommended fix

Repeat for each point. This applies the facts and earns professional skills marks.

Value for money (three Es)

VfM = Economy + Efficiency + Effectiveness

Economy = cost of inputs; efficiency = output ÷ input; effectiveness = outcome achieved against objective. It is a framework, not a calculation.

Efficiency

Efficiency = Outputs ÷ Inputs

Example: cases handled per staff member, or cost per case. Compare against a target or benchmark.

Effectiveness

Effectiveness = Actual outcome achieved vs intended objective

Measure outcomes such as reduced waiting times or improved literacy, not just activity levels.

Accountability chain

Funders / public → Governing body → Management → Service delivery

Each link needs transparent reporting back up the chain.

Quick revision

• Corporate governance is the system by which organisations are directed, controlled and held to account.
• Agency problem: managers (agents) may act in their own interests rather than the owners' (principals).
• Agency problems are reduced through monitoring, incentives, disclosure and independent oversight.
• Stakeholder theory says the organisation has responsibilities to groups beyond shareholders.
• Judge stakeholders by their power and interest, and match your response to each.
• Rules-based approach: compliance is required and breaches are penalised; it is clear but can be box-ticking.
• Principles-based approach: flexible, with comply or explain; it needs judgement and sound disclosure.
• The OECD Principles are an international reference for governance frameworks, not a single binding code.
• Common failure causes: dominant leaders, weak or captured boards, poor controls, and short-term pay incentives.
• Public sector and not-for-profit bodies have no shareholders, so accountability runs to the public, funders and beneficiaries.
• In answers, link each governance point to a fact in the scenario and end with a clear recommendation.

Common mistakes

• Giving a textbook definition and nothing else. Fix: Keep the definition to one sentence. Spend the rest of your time applying it to facts in the scenario.
• Confusing governance with management. Fix: Governance directs, oversees and holds to account. Management runs operations. Say which one the issue belongs to.
• Writing a textbook definition of agency theory and stopping there. Fix: Give a one-line definition at most, then apply it to the people and facts in the scenario.
• Saying the agency problem is only about directors being dishonest. Fix: Explain it as a conflict of interest. Agents can act legally and still serve themselves, for example through empire-building or excess caution.
• Listing stakeholders without saying what they want. Fix: For each stakeholder, add a specific interest tied to the scenario and then link it to power and action.
• Placing stakeholders on the matrix with no justification. Fix: Give a reason from the case for both power and interest, such as the stakeholder's contract, voting rights, funding or ability to cause publicity.
• Writing a textbook list of strengths and weaknesses with no link to the scenario. Fix: Start from the scenario facts. Use only the points that fit and say why they fit.
• Saying principles-based means companies can ignore the code. Fix: State that departures must be disclosed and explained, and that shareholders can challenge poor explanations.
• Reciting the six OECD principles without applying them to the case. Fix: Use each principle only when a case fact supports it. Quote the fact, then link it to the principle.
• Treating the OECD Principles or a code as binding law. Fix: Say they are guidance. Binding force comes from national law or listing rules that adopt them.

Exam tips

• Define governance in one line, then move straight to the scenario. Marks come from application.
• Use the roles of directors, shareholders and other stakeholders as a checklist to structure your answer.
• Look for signals of weak governance in the case: dominant individuals, no independent directors, poor reporting or ignored stakeholders.
• End with a clear recommendation that matches the problem you identified. This supports your professional skills marks.
• Keep the language suited to the reader named in the requirement, such as a board member or investor.
• Always apply the theory to named people and facts in the case. Generic answers earn few marks, and scenario application is also part of professional skills.
• Check the requirement verb. 'Explain' needs cause and effect, 'evaluate' needs strengths and limits, and 'recommend' needs a clear action.
• Use the three agency cost headings to structure answers, and give one case example for each.