CIMA BA4 · Chapter 5
Corporate governance: principles and approaches MCQs with Answers
10 multiple-choice questions on Corporate governance: principles and approaches for CIMA BA4 Fundamentals of Ethics, Corporate Governance and Business Law. Try each one before revealing the answer and explanation.
Practise this chapter interactivelyQuestion 1
Which of the following best defines corporate governance?
- A) The process of preparing a company's financial statements
- B) The government's regulation of competition between companies
- C) The system by which companies are directed and controlled
- D) The day-to-day management of a company's production function
Show answer & explanation
Answer: C) The system by which companies are directed and controlled
Corporate governance is widely defined as the system by which companies are directed and controlled. Boards of directors are responsible for governance, and shareholders appoint the directors and auditors to satisfy themselves that an appropriate structure is in place. Financial reporting and operations are parts of what is governed, not the definition.
Question 2
In agency theory as applied to a listed company, who are the principals and who are the agents?
- A) Directors are principals and shareholders are agents
- B) Shareholders are principals and directors are agents
- C) Employees are principals and customers are agents
- D) Auditors are principals and directors are agents
Show answer & explanation
Answer: B) Shareholders are principals and directors are agents
Agency theory views shareholders (owners) as principals who delegate the running of the company to directors (agents). Because of the separation of ownership and control, the agents may pursue their own interests, and governance mechanisms aim to align the two.
Question 3
What does 'comply or explain' mean in the context of a principles-based governance code?
- A) Companies must comply with every provision or face criminal penalties
- B) Directors must explain every decision to shareholders before taking it
- C) Companies may ignore the code if they explain this verbally to the regulator
- D) Companies either follow the code's provisions or explain in their annual report why they have not done so
Show answer & explanation
Answer: D) Companies either follow the code's provisions or explain in their annual report why they have not done so
Under a comply-or-explain approach, such as the UK Corporate Governance Code for listed companies, companies disclose whether they have complied with the code and give reasons for any departure. Shareholders then judge whether the explanation is acceptable. It is not a criminal regime like a rules-based statute.
Question 4
Which of the following is an example of an agency cost?
- A) The cost of an external audit commissioned to monitor the directors' stewardship
- B) The cost of raw materials used in production
- C) The interest paid on a bank loan
- D) The cost of advertising a new product
Show answer & explanation
Answer: A) The cost of an external audit commissioned to monitor the directors' stewardship
Agency costs are costs incurred by principals to monitor and control agents, plus any loss from agents acting in their own interests. Audit fees, governance structures and incentive schemes are typical examples. Raw materials, interest and advertising are normal business costs not caused by the agency relationship.
Question 5
Which of the following is a characteristic of a rules-based approach to corporate governance, as exemplified by the US Sarbanes-Oxley Act?
- A) Companies are free to depart from requirements if they explain why
- B) Governance principles are voluntary guidance with no enforcement
- C) It relies mainly on shareholders deciding whether explanations are adequate
- D) Governance requirements are set in law and non-compliance can attract legal penalties
Show answer & explanation
Answer: D) Governance requirements are set in law and non-compliance can attract legal penalties
A rules-based approach makes governance requirements legally binding, so failure to comply can lead to penalties. The Sarbanes-Oxley Act in the US is the usual example. The other options describe a principles-based, comply-or-explain approach.
Question 6
Which of the following is an advantage of a principles-based approach to corporate governance compared with a rules-based approach?
- A) It gives investors certainty that every company follows identical practices
- B) It removes the need for any disclosure in the annual report
- C) It is flexible, allowing companies to adapt practices to their own circumstances
- D) It eliminates the risk that companies will give poor explanations for non-compliance
Show answer & explanation
Answer: C) It is flexible, allowing companies to adapt practices to their own circumstances
Principles-based codes are flexible and can be applied sensibly to companies of different sizes and circumstances. The drawback is less certainty and the risk of boilerplate or weak explanations. Disclosure is central to comply-or-explain, so it is not removed.
Question 7
An 'insider' system of corporate ownership, common in parts of continental Europe and Asia, is characterised by which of the following?
- A) Widely dispersed ownership by many small investors trading on a stock market
- B) Ownership concentrated in families, banks or other companies with close links to management
- C) Companies owned exclusively by their employees
- D) Companies owned and run by the state
Show answer & explanation
Answer: B) Ownership concentrated in families, banks or other companies with close links to management
Insider systems feature concentrated ownership by families, banks, other companies or founders who are close to management, which reduces some agency problems but can disadvantage minority shareholders. Outsider systems, typical of the UK and US, have widely dispersed shareholdings.
Question 8
Which of the following is NOT generally regarded as a stakeholder of a company?
- A) The shareholders of an unrelated company in a different industry, which has no dealings with the company
- B) Employees
- C) Suppliers
- D) The local community
Show answer & explanation
Answer: A) The shareholders of an unrelated company in a different industry, which has no dealings with the company
Stakeholders are groups or individuals who affect, or are affected by, the organisation's activities, such as employees, customers, suppliers, lenders, government and local communities. Shareholders of a company in an unrelated industry have no meaningful interest in or influence over the company.
Question 9
The OECD Principles of Corporate Governance include the equitable treatment of shareholders. Which practice would most clearly breach this principle?
- A) Issuing shares with different rights where the rights are disclosed to investors
- B) Holding a general meeting at which all shareholders may vote
- C) Publishing price-sensitive information to all shareholders at the same time
- D) Allowing directors to trade in the company's shares using undisclosed price-sensitive information
Show answer & explanation
Answer: D) Allowing directors to trade in the company's shares using undisclosed price-sensitive information
Equitable treatment requires that all shareholders, including minority and foreign shareholders, are treated fairly and that insider trading and abusive self-dealing are prohibited. Directors trading on undisclosed information benefit at other shareholders' expense. Disclosed differences in class rights, open meetings and simultaneous disclosure are consistent with the principle.
Question 10
A company has a two-tier board structure. Which statement correctly describes it?
- A) Executive and non-executive directors sit together on a single board with collective responsibility
- B) A supervisory board, which may include employee representatives, oversees a separate management board that runs the business
- C) The chair and chief executive are always the same person
- D) There are two boards with identical membership that meet on alternate months
Show answer & explanation
Answer: B) A supervisory board, which may include employee representatives, oversees a separate management board that runs the business
In a two-tier structure, common in Germany, a supervisory board (often including employee representatives) appoints and monitors a separate management board of executives. A single board of executive and non-executive directors is a unitary board, as used in the UK. The roles of the two tiers are distinct, so membership is not identical.