The Structure of Corporate Governance - Case Study Example

Corporate Governance of the of the Introduction History of Corporate Governance Corporate governance is referredto the regulatory framework that includes structure, conventions and obligations that directs and control organisations. It specifies the rights and duties of different members of an organisation including creditors, shareholders, directors, employees, auditors and other stakeholders (Luo, 2005). Corporate governance has been in existence for a long time but it surfaced and renewed interest in large corporations after the collapse of high-profile organisations such as Enron, WorldCom and others during 2001 and 2002 caused by accounting fraud; followed by global financial crisis of 2008. Corporate governance came in existence in early 20th century post the Wall Street Crash of 1929. Post World War II, large number of family-run companies surfaced and as a result corporate governance was dominated and controlled by Bureaucratic families, which caused biasness and inefficiency. However, massive bankruptcies of several companies in early 2000s and collapse of Lehman Brothers and other financial institutions worldwide triggered growing political concern in corporate governance (Chakrawal, 2006). Objective and importance Every organisation seeks growth, profit and maximisation of shareholders’ wealth and confidence. To achieve these, an organisation needs to frame policies relevant to the objectives of corporate governance. The main objectives of corporate governance are: A well-structured panel that is capable of independent decision making. The board members should be adequately responsible for the well-being and interest of all the stakeholders. Corporate governance ensures that transparency and credibility is maintained in the policies and adequate information is available to individuals The board should strictly monitor the activities of the management and undertake control whenever necessary. Corporate governance ensures fair practice in corporate affairs, accountability and transparency. The system facilitates policies and principles that govern corporations in the best interest of all stakeholders. It confirms adequate disclosure and effectiveness in activities as well as transparency in transactions. Moreover, it supports shareholders’ interest and protection, commitment to ethics and values and legal compliance. It ensures that no conflicting dilemma arises between personal and corporate funds available to management of a company (Luo, 2005). Structure and role of Corporate Governance The structure of corporate governance can be classified in two categories: Internal corporate governance controls and external corporate governance controls. These together provide an ideal control and monitoring system the regulated corporate objectives and goals and align internal and external stakeholder needs with it. Internal corporate governance controls Surveillance by top management: The legal authority along with the board of directors of the company manages and safeguards its human as well as monetary resources. Regular meetings help in identifying potential threats and its elimination. Internal control procedures: The internal control procedures include policies that are implemented by the board of directors, auditing committee and other management personnel to improve operational efficiency and provide reasonably reliable financial reporting. Balance of power: It defines that power should be appropriately distributed if not equally. Power of every individual should be utilised towards betterment of the organisations. Moreover, the balance of power should be maintained by classifying it in three major groups; one that proposes changes, another group that object the changes with valid reasons and third group that evaluate it with respect to the common interest. Remuneration: Remuneration can be in the form of cash and non-cash incentives but should be based on individual performance and should be proportionate to an individual’s earnings. Involvement of stakeholders: corporations should incorporate its stakeholders in decision-making process so that transparency is maintained with right degree of power to them to monitor the management (Myring & Shortridge, 2010). External corporate governance controls The external corporate governance controls includes control that are exercised by external stakeholders of an organisation such as competitors, debtors, acquisitions, government regulations and media. The board of directors is primarily responsible for satisfying the external stakeholders through financial reporting. Presently, to maintained integrity of reporting, International accounting standards are followed (Myring & Shortridge, 2010). Sarbanes-Oxley Act of 2002 The corporate scandals related to accountability and frauds in big corporations in 2001 and 2002 caused the United States federal government to pass the Sarbanes-Oxley Act of 2002, intending to refurbish public confidence in corporate governance. The act is also known as ‘Public Company Accounting Reform and Investor Protection Act. It was framed to protect investors from losing their money as a result of corporate failure. It created the Public Company Accounting Oversight Board that was responsible for supervision, regulation and control of accounting firms and auditors of public companies. It incorporated laws related to corporate responsibility, financial disclosures, interest conflicts, corporate and criminal fraud accountability, tax filing and several other corporate practices (Luo, 2005). Effects of corporate governance disclosure requirements on financial reporting worldwide (examples from different countries) Post 2002, countries all over the world involved themselves in implementing best practices as guideline towards better corporate governance. A number of reports were generated and acts were implemented in major countries that highlighted disclosure requirements on financial reporting and its effect. These reports include Cadbury report in United Kingdom, Sarbanes Oxley in United States, Vienot Report in France, King’s Report in South Africa, Cromme Code in Germany and Dey Report in Canada. To mitigate consequence of financial crises of different kind, continuous reviewing has been done to improve the quality of corporate governance and its impact on financial reporting (Chakrawal, 2006). According to Cohen, Krishnamoorthy & Wright (2004), corporate governance has increasingly become a major determinant of a corporation’s strength and activities. Moreover, it’s one of the major function is to ensure quality of financial reporting process. Financial reporting and corporate governance share an interesting relationship. The financial reporting relates all the people that are contributors of corporate governance such as board of directors, investors, creditors and stakeholders. It is a measure of company’s financial performance as well as act as a communication bridge between a company and its stakeholders. However, the integrity of financial and corporate reporting is highly dependent on corporate governance (issues related to conduct and ethics). The failure of corporate governance result in failure of financial reporting and cause availability of misleading information to external parties. The following section of the essay highlight corporate governance practices in different companies and countries and its effect on financial reporting (Chakrawal, 2006). Growing globalisation in financial and other commodity markets has resulted in increasing interest of consumers, market participants and regulators in quality of corporate as well as financial reporting. It has become pivotal to include corporate governance disclosures in reporting for monitoring corporate conduct and protecting shareholders. It was observed that growing openness to International Accounting Standards and foreign GAAP (generally Accepted Accounting Principles) would cause cost reduction to foreign firms that are interested in listing themselves in foreign stock exchanges and operate in foreign capital market. Keeping in view the financial crises of early 2000s, the market contestants are seeking standard quality financial information regarding a firm that would provide better picture of return and impact of market volatility on return (La Porta, et al., 2000). According to many authors, the quality of disclosure should be standard and should be a combination of transparency, timeliness and conservatism. Studies on American and European countries with large and active capital market suggest that disclosure requirements can be a powerful tool in influencing activities of corporations and protecting shareholders. Further, it was also observed a strong regime of disclosure helps in attracting capital and maintaining confidence of investors. Insufficient disclosure in financial reporting may disrupt the functionality of the market, increase cost of capital and improper allocation of resources. In the international business market, it was observed that appropriate disclosure helps in improving general (public) understanding of the organisational structure and its operations, policies and regulations and performance of the company while meeting environmental and ethical standards (Eng & Mak, 2003). Impact of corporate governance on disclosure by listed Jordanian companies This section discusses about impact of corporate governance on voluntary disclosures in annual report of various companies that are listed with Amman Stock Exchange for the period (2002 to 2011). The mentioned period is considered important because in 2002, Securities Law No. 76 was issued that supported introduction of voluntary disclosure and by 2011 annual reports became the main source of information for stakeholders in Jordan. Voluntary disclosure refers to public availability of financial and non-financial information related to operations of a corporation without any legal compliance. As a part of globalisation, the trend of preparing financial statements by various listed companies affected Jordan as well. Jordan realised the need of incorporating financial reporting to be at par with other countries. It is the first Arab country that joined the board of directors of the International Accounting Standards Committee and has been practicing International Accounting Standards ever since. In Jordan it was also observed that apart from corporate governance, ownership structure also affected the quality of financial reporting process. Various researchers employed dynamic panel GMM (Generalised Methods of Moments) to analyse the impact of corporate governance on disclosure in financial reporting. It was observed that different variables responsible for corporate governance have different effect. The board compensation and foreign ownership put greater thrust over disclosure of information while block holder ownership result in significant reduction in voluntary disclosure. Insignificant variable such as audit committee and executives and non-executive personnel also influence the decision relevant to disclosure. It was further observed that bigger corporations have a greater tendency to disclose information over small companies in Jordan (Alhazaimeh, Palaniappan & Almsafir, 2014). Impact on corporate reporting of Egyptian listed companies In Egypt, timeliness is considered as an important attribute of good reporting. Moreover, the companies in the country are more inclined towards integrated reporting as a result corporate reporting process is followed by majority of companies. A number of changes have been observed in the Egyptian business environment in recent years. One of the major changes is incorporation of corporate governance in the reporting of listed companies of Egypt. These have resulted in tremendous increase in trading in the Egyptian Stock Market. In Egypt, significant attention has been paid on impact of corporate governance on timeliness of disclosure of corporate reporting. Research studies show that various variables associated with corporate governance such as company size, ownership structure, board composition, liquidity, business activities and size of board have significant positive impact on timeliness disclosure of corporate reporting. It was observed that companies with diffused ownership structure (widely held companies) have a propensity to disclose more information than those with concentrated ownership structure (closely held companies). However, impact of board composition showed mixed trend in different Egyptian companies hence was not helpful in drawing inference. Further, it was observed that liquidity has a positive impact and encourages disclosure of greater share of information in the corporate reporting. Moreover, companies with extensive operations and profitability have a greater tendency towards disclosure of activities, events and other information in their reporting process.Egypt has undertaken several practices relevant to corporate governance to improve the disclosure requirements of its corporate reporting in recent years. As a result, it has become one of the important emerging markets in Middle East that has been attracting a greater share of foreign investments (Ezat & El-Masry, 2008). Effect of corporate governance on disclosure requirements in UK FTSE companies According to Lindsey & Shrives (2000), aggregate risk disclosures are greatly associated with size of a firm than that of risk level. In UK FTSE companies, it was observed that the emphasis is on risk disclosure more than that on mandatory disclosure requirements. Alongside, it was also observed that systematic and financing risk, risk-adjusted returns, board size, firm size, dividend-yield, number of non-executive directors as well as that of independent non-executive directors, close or open structure of ownership and effective audit environment affect both aggregated and voluntary risk disclosures positively, while impact of total risk is negative. In UK, the ICAEW (Institute of Chartered Accountants in England and Wales) illustrated the need of risk disclosure in corporate annual report and it emphasised on relating gain or losses to risk. It further ensures that the reporting includes both financial and non-financial risks along with accounting and non-accounting facts and figures. The principle themes that are addressed in disclosure requirements of financial reporting are contingencies, segment reporting, foreign exchange transactions, substance of transactions or investments, related party disclosures and derivatives. Apart from derivatives, all other themes are related to information about potential gain or loss while derivatives deal with disclosures related to liquidity, currency value, hedging of financial assets and liabilities, commodity contracts and other quantitative and qualitative risk disclosures. In the disclosure requirement it was observed that board size has an inverse impact on disclosure in financial reporting. The board composition also has strong (positive and negative) influence on disclosure requirements. Firms that have their CEO in the board have a greater tendency for less disclosure. It was observed that a closed ownership structure tends to disclose less information compared to open ownership structures. Another important element of corporate governance that influences disclosure requirements in UK firms is audit environment and a positive and direct association was observed in these firms (Lindsey & Shrives, 2000). Impact of corporate governance on disclosure by Australian listed companies This section explains the effect of corporate governance on the disclosure in financial reporting by top 50 companies listed with Australian Securities Exchange (ASX Top 50). The criteria that were considered in understanding the impact are mission and values, governance, key relationships, board structure, ethical conduct, integrity and policy and management. On an average, it was observed that the structure of board has a great positive impact on the disclosure in the financial reporting. Further, it was also observed among the 50 companies, Australia New Zealand Bank (ANZ) has secured the highest position in complying with disclosure requirements. However, based on individual criterion, it was observed that mission and values of corporation has highest influence on corporate disclosure of Westpac Banking Corporation. Moreover, at least ten companies showed that their disclosure requirements are driven by shareholder participation and engagement. It was also observed that board structure has a positive impact on almost all the companies. A number of companies exhibited positive response related to disclosure in reporting with respect to corporate governance criteria such as integrity and ethical decision making. Some of these companies are Qantas Airways Ltd, Oz Minerals Ltd, ANZ banking Group Ltd and Westpac Banking Corporation. The only indicator that exhibited low level of relationship with compliance of disclosure requirements is ‘adherence to code and guidelines’. These guidelines include OECD guidelines for multinational enterprises, UN global impact and GRI sustainability reporting guidelines (Collett & Hrasky, 2005). The relevant graphs have been provided in the appendix. Influence of corporate governance on disclosure requirements in reporting by listed companies in India With growing globalisation, Indian companies are no exception to incorporation of corporate governance. Various cases of malpractices, scams and fraudulent activities have resulted in inclusion of transparency and fair practices in the corporate sector of the country. The public undertakings of the countries are classified as Navratnas, Miniratnas and Maharatnas. The maharatna companies are highest rank holders among all the public-sector companies in India and include companies such as Coal India Ltd, Indian Oil Corporation, Steel Authority of India Ltd and others. The essay explains the impact of corporate governance on the disclosure practices of these companies. The corporate governance of the country has been illustrated in the Clause 49 of Listing agreement of Securities and Exchange Board of India (SEBI). It was observed that there is sufficient mention of company’s philosophy, structure of board, definition and selection criteria of independent directors in the disclosure requirements of corporate reporting. Moreover, majority of the companies have made disclosure about audit committee and report except for Steel India of India Ltd. It was further observed that general body meeting, shareholders’ interest and CEO/CFO certification have positive relation with respect to disclosure requirement in reporting (Dwivedi & Jain, 2005). After studying the impact of corporate governance on different countries it was observed that in different countries the elements varies to a great extent but the factors that have influenced them to incorporate corporate governance in their affairs are protection from fraudulent activities, public confidence and interest and company’s credibility. A number of companies include both financial as well as non-financial disclosures. The financial disclosure includes financial statements as well as information about the board watching over it. The non financial disclosure includes mission and objectives of the company, rights of its owners and shareholders, ethical code of conduct and governance structures and policies. The quality of financial disclosures depends on the efficiency of the members of the board and strength of the financial reporting standards. In financial reporting another inconvenience is caused by different reporting standards followed by different companies from different countries. To standardize the process, the International Accounting standards board framed the International Financial Reporting Standards (IFRS), which serves as a benchmark in this regard. Conclusion The existence of corporate governance dates back to the 20th century when Wall Street crashed in 1929. However, back then its application were extremely limited. After World War II, the corporate governance was mainly controlled by bureaucratic families as that period observed a tremendous growth of family-owned businesses. With time, the shape of corporate governance changed by it underwent a major change in the early 2000s. That period is defined by fraudulent practices and financial crises. The collapse of Lehman Brothers, Enron and WorldCom resulted in increasing importance of corporate governance. The collapse of Enron and WorldCom resulted in huge loss incurred by investors. It led to formulation of the Sarbanes Oxley Act in 2002 in United States and a number of other reports all over the world. Various countries expressed their concern towards involvement of corporate governance in disclosure requirement of financial reporting. The essay explains effect of corporate governance in different countries such as Egypt, Jordan, China, Australia and India. The Egyptian companies showed that the variable of corporate governance such as ownership structure and board structure has a positive impact on the timeliness of disclosure. In Jordan it was observed that board compensation and foreign ownership has a great influence on disclosure in reporting while concentrated ownership resulted in decline in disclosure. In Indian public companies role of corporate governance was worth appreciation while in China it was observed that privatisation results in better impact of corporate governance in disclosure. It was also observed that in some countries external and internal auditing has some impact on disclosure in financial reporting while in others countries it was considered relevantly insignificant. References Alhazaimeh, A., Palaniappan, R. & Almsafir, M. (2014). The Impact of Corporate Governance and Ownership Structure on Voluntary Disclosure in Annual Reports among Listed Jordanian Companies. Procedia - Social and Behavioral Sciences, 129, 341-348. Chakrawal, A. K. (2006). Corporate Governance and Accountability. Asia Pacific Business Review, 2(1), 88-97. Cohen, J., Krishnamoorthy, G. & Wright, A. (2004). The corporate governance mosaic and financial reporting quality. Journal of Accounting Literature, 87-152. Collett, P. & Hrasky, S. (2005). Voluntary disclosure of corporate governance practices by listed Australian companies. Corporate Governance: An International Review, 13(2), 188-196. Dwivedi, N. & Jain, A. K. (2005). Corporate governance and performance of Indian firms: The effect of board size and ownership. Employee Responsibilities and Rights Journal, 17(3), 161-172. Eng, L. L. & Mak, Y. T. (2003). Corporate governance and voluntary disclosure. Journal of accounting and public policy, 22(4), 325-345. Ezat, A. & El-Masry, A. (2008). The impact of corporate governance on the timeliness of corporate internet reporting by Egyptian listed companies. Managerial Finance, 34(12), 848-867. La Porta, R., Lopez-de-Silanes, F., Shleifer, A. & Vishny, R. (2000). Investor protection and corporate governance. Journal of financial economics, 58(1), 3-27. Linsley, P. & Shrives, P. (2000). Risk management and reporting risk in the UK. Journal of Risk, 3(1), 115–129. Luo, Y. (2005). Corporate governance and accountability in multinational enterprises: Concepts and agenda. Journal of International Management, 11(1), 1-18. Myring, M. & Shortridge, R. T. (2010). Corporate governance and the quality of financial disclosures. International Business & Economics Research Journal, 9(6), 103-109. Appendix Figure 1: Impact of Integrity on the top ten companies (Source: Collett & Hrasky, 2005) Figure 2: Impact of board structure on the top ten companies (Source: Collett & Hrasky, 2005) Read More