Financial Management · The nature and purpose of financial management

Corporate Governance and Ethical Issues in Financial Management

Updated 11 October 2026 · Fact-checked

Corporate governance is the system of rules, structures and processes that directs and controls a company. Ethics is the set of values behind decisions. Together they reduce agency problems, protect stakeholders and build trust. To answer exam questions, name the problem, link it to a governance control, and explain the financial impact.

Understand Corporate Governance and Ethical Issues

A company is owned by shareholders but run by directors. This split creates an agency problem. Managers may pursue their own goals, such as bonuses, status or job security, instead of shareholder wealth. Shareholders cannot watch every decision, so they need controls.

Corporate governance is that set of controls. It covers how the board is built, how directors are paid, how risk and internal control are managed, and how information is reported to shareholders. Good governance gives shareholders confidence that managers act in their interest. That confidence can lower the cost of raising finance and support the share price.

Typical governance features in codes of best practice include:

A separation of the roles of chair and chief executive, so power is not concentrated in one person.
A balanced board with a good number of independent non-executive directors (NEDs). NEDs bring outside judgement and challenge executives.
An audit committee made up of independent NEDs. It oversees financial reporting, internal control, internal audit and the relationship with the external auditor.
A remuneration committee of independent NEDs that sets executive pay, ideally linking it to long-term performance.
A nomination committee that leads board appointments.
Regular board evaluation, and a risk management and internal control system that the board reviews.

Ethics goes beyond legal compliance. A decision can be legal and still be unethical, such as aggressive earnings manipulation, or paying suppliers very late to flatter cash flow. Finance staff face pressure to hit targets. ACCA's ethical principles are integrity, objectivity, professional competence and due care, confidentiality, and professional behaviour.

Corporate social responsibility (CSR) means a company considers its effect on society and the environment, not only profit. It can protect reputation, reduce regulatory risk and attract customers and staff. It can also cost money in the short term. Financial managers must weigh these costs and benefits when setting objectives and appraising projects.

Good governance does not remove all conflict. Rules can be costly, and a board can follow the code in form but not in spirit. Stakeholders such as lenders, employees, customers and the community may also have goals that differ from shareholders.

Key rules to remember

Agency problem link: Separation of ownership and control → conflicting goals → agency costs; Use this chain to start any answer on why governance is needed.
Agency costs: Agency costs = monitoring costs + bonding costs + residual loss; Monitoring is cost of oversight such as audits. Bonding is cost of guarantees by managers. Residual loss is the value still lost.
ACCA ethical principles: Integrity, Objectivity, Professional competence and due care, Confidentiality, Professional behaviour; Learn these as a list to name the principle at risk in a scenario.
Key governance committees: Audit committee, remuneration committee, nomination committee; Each should be led by independent NEDs in good practice.

How to solve Corporate Governance and Ethical Issues questions

Use this method for scenario questions on governance, ethics or CSR, in objective tests and written answers.

1Read the scenario and identify who owns, who manages and who is affected.
2Name the problem: agency conflict, weak board structure, weak control, unethical behaviour or a CSR issue.
3Match it to the governance feature that addresses it, such as NEDs, audit committee, pay design or separate chair and chief executive.
4If ethics is involved, name the ACCA principle at risk and the threat, such as self-interest or intimidation.
5Explain the financial effect: cost of capital, share price, risk, reputation or legal penalties.
6Give a practical recommendation, and note any cost or limit of that recommendation.
7Check that each point is tied to the facts in the scenario, not generic.

Quickest way: Problem – Control – Impact

When to use it: Use when time is short, especially in a 2-mark objective question or a short written part.

Spot the problem in one phrase, for example: CEO is also chair.
Pick the matching control: separate the roles, or add independent NEDs.
State the impact in one line: better oversight, lower agency costs, more investor trust.
In objective tests, eliminate options that confuse executives with NEDs or that suggest governance guarantees performance.

Common mistakes in Corporate Governance and Ethical Issues

Saying governance removes the agency problem completely.
Students learn the benefits and overstate them.
Fix: Say it reduces or manages the problem. Controls cost money and can be bypassed.
Treating ethics and legal compliance as the same thing.
Both involve following rules.
Fix: State that an action can be legal yet unethical. Ethics relies on principles and judgement.
Listing governance features with no link to the scenario.
Students recall a memorised list.
Fix: Pick only the features that fix the problem in the question and explain why.
Confusing the roles of the audit committee and the external auditor.
Both deal with financial reporting.
Fix: The audit committee is a board sub-committee that oversees reporting, controls and the auditor. The external auditor gives an independent opinion on the financial statements.
Ignoring non-shareholder stakeholders in CSR questions.
Focus on shareholder wealth from earlier chapters.
Fix: Mention employees, lenders, customers and society, and show how their trust affects long-term value.
Assuming executive pay tied to short-term profit is always good.
It looks like it aligns goals.
Fix: Note that it can encourage short-term thinking and manipulation. Long-term share-based pay and clawback can help.

Worked examples

Example 1

Zeta Co's chief executive is also chair of the board. The board has two non-executive directors, both former employees. Executive bonuses are based only on this year's profit. Explain the governance weaknesses and suggest improvements. (6 marks)

Show the solution

Weakness 1: one person is chair and chief executive. Power is concentrated and the board may not challenge him or her. Improvement: separate the two roles.
Weakness 2: the NEDs are former employees, so their independence is doubtful. Improvement: appoint genuinely independent NEDs and form audit, remuneration and nomination committees from them.
Weakness 3: bonuses depend on one year's profit. This can encourage short-term decisions, cutting investment or manipulating profit. Improvement: link pay to long-term measures such as share price or shareholder return over several years, with deferred or share-based elements.
Impact: these changes reduce agency costs, improve investor confidence and may lower the cost of capital.
Limit: they add cost and cannot guarantee ethical behaviour.

Answer: Zeta Co has a combined chair and chief executive, doubtful NED independence and short-term bonuses. Separate the roles, appoint independent NEDs with committees, and tie pay to long-term performance. This reduces agency problems and builds shareholder trust.

Example 2

Which ONE of the following is the main role of the audit committee? A) Prepare the annual financial statements B) Oversee financial reporting, internal control and the relationship with the external auditor C) Set the salaries of executive directors D) Select the company's long-term strategy

Show the solution

A is the job of management, not the committee.
C is the job of the remuneration committee.
D is a matter for the full board and executives.
B matches the audit committee's oversight role, normally carried out by independent NEDs.

Answer: B

Exam tips

Always tie governance points to the scenario facts. Generic lists earn few marks in written answers.
In objective tests, watch for wording such as removes, guarantees or eliminates. These are usually wrong for governance.
Know which committee does what: audit for reporting and control, remuneration for pay, nomination for appointments.
For ethics scenarios, name the principle at risk and state a clear action, such as raising the matter with a senior person or seeking advice.
Link every governance or CSR point to a financial effect, such as cost of capital, risk or reputation.

Practice questions from The nature and purpose of financial management

Corporate Governance and Ethical Issues in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Corporate Governance and Ethical Issues: frequently asked questions

What is corporate governance in simple terms?

It is the system of rules and structures that directs and controls a company. It ensures managers act in the interests of shareholders and other stakeholders. It covers the board, pay, controls and reporting.

How do corporate governance rules reduce agency problems?

They add oversight and align interests. Independent NEDs challenge executives, committees review pay and reporting, and disclosure lets shareholders monitor. Long-term pay linked to shareholder return also aligns manager goals with owners.

What do non-executive directors and the audit committee do?

NEDs bring independent judgement and challenge executive decisions. The audit committee, made up of independent NEDs, oversees financial reporting, internal control, internal audit and the external auditor.

Is CSR part of financial management?

Yes. CSR affects reputation, regulatory risk, costs and long-term value. Financial managers must weigh its costs against benefits when setting objectives and appraising projects.