Applied Financial Management - Essay Example

?Applied Financial Management Contents Contents 2 Introduction 3 Concept of corporate governance 3 Different system of corporate governance 5 Anglo American system of corporate governance 5 Insider system of corporate governance 6 Convergence of corporate governance 7 Views in favour of convergence 7 Views against the convergence 8 Conclusion 8 Reference 9 Introduction Enron, a leading company of United States, which rose tremendously during 1990s and was rated as the most innovative company by fortune magazine, filed for bankruptcy in 2001. The main reason behind the collapse of the company was the non transparency of the financial statements. The financial statements did not provided proper information to the shareholders and the market analyst as a result they were unable to judge the performance of the company. The financial statements provided a favourable picture of the organization which was not true as a result the trust of the shareholders was affected with the exposure of the accounting frauds and with the collapse of the company all the stakeholder of the company were hugely affected. Another major corporate collapse was the fall of HIH Insurance which also fell due to the non transparent financial statements. The fall of a company affects not only its members but to every stakeholders which includes the economy too. The two major collapses indicated the importance of the corporate governance. Every country follow one or the other system of corporate governance but with the increase of operation of companies in different countries, should the different system of corporate governance should be converged or not is a matter of question. In this project the concept of corporate governance including the different systems of corporate governance has been discussed. With the era of globalization were different companies are operating around the globe; the topic of convergence of the different system of corporate governance has also been discussed. Concept of corporate governance Corporate governance can be defined as the relationship of the company with its stakeholders (Prasad, 2006, p.1). Corporate governance can be described as the rules, regulations, laws and the practices which signify how the business should be operated and should be controlled. Corporate governance provides a basic structure to the organisation on how it should be operated. It contains the ethical standards which should be followed by the organisation. Corporate governance contains the process which the company follows, the customs and the policies which are adopted by the company. The corporate governance specifies the company’s accountability to the different stakeholders of the organisation. It establishes the relationship between the various stakeholders of the organisation. The stakeholders include the shareholders, suppliers, fund providers, customers, government and the society in which the business is operating. The stakeholders also include the internal members of the organisation like the management, board of directors, employees etc. Corporate governance is also related with the corporate social responsibility of the company. The corporate scandals and the collapse of the two different corporate giant as mentioned in the above part signified the importance of adequate corporate governance. Every person whose interest lies on the operation of the company, directly or indirectly, is associated with the corporate governance. This makes the employees of the organisation also a member of corporate governance as they receive salary and other benefits for working in the company. The other members associated with the corporate governance are board of directors, managers, other company officials, auditors, shareholders, customers, suppliers and lenders. All these members are affected by the financial performance of the company. The corporate governance directs the management on the internal and the external factors of the organisation. The internal factors range from the remuneration, power, process of internal control etc. The external factors are competition, regulations of the government, financial risks, strategic decisions like mergers, takeovers etc. Different system of corporate governance Different countries practice different forms of corporate governance. Among all the two main system of corporate governance are the outsider system and the insider system. The outsider system of corporate governance is mainly America and Europe while the insider system is practised in Germany and Japan. Both the systems are very popular. Anglo American system of corporate governance The Anglo American system is also known as outsider system of corporate governance. As discussed earlier, this system is practiced in USA and UK. In this type of corporate governance system the owners of the organisation controls the management of the organisation indirectly by electing the representatives who will do the monitoring in the monitoring board. The ownership hierarchy of the organisations which have outsider system of corporate governance is flat this means that the real owner of the organisation directly own the company. The owners’ right on cash flows and control are interlinked (Braendle and Noll, 2005, p.2). This type of corporate governance has some unique characteristics. One of these characteristics is that the companies which follow this type of corporate governance have dispersed ownership. The companies also have large holdings. This type of system stresses on protecting the interest of the minor investors who have invested on the securities and is backed by various laws on investor protection. The disclosure requirements needed by the outsider system of corporate governance are stronger than the other type of models. Countries which follow this type of corporate governance system have various groups of investors which include both individuals and also the institutions. Generally the countries which follow this type of system have a history of equity investments. The institutional investors are the major holders of equity in these types of countries. United State of America itself has a large number of institutional investors owing equity shares (Nestor and Thomson, n.d., p.5). Insider system of corporate governance The insider system of corporate governance is also known as the Japanese- German system. This system is practiced in Japan, Germany, Austria, France, Switzerland and Italy. Unlike outsider system of corporate governance in this system the ownership is quite concentrated. The ownership structure of the organisations which practice this type of governance if not flat but have a pyramid structure. The owner of the organisations which practices this type of governance controls the management of the organisation directly. The insider system of corporate governance is made up of two different systems of corporate governance. The first one is known as the Germanic system and the second one is known as Japanese system. The Germanic system which is mainly practiced by the countries of Europe like France, Italy, and Germany etc has a unidirectional control system. This means that the flow of control is in one direction only. Suppose company P has controlling rights in company Q and also has a representative on the latter’s board then the company Q can have controlling rights on any company except company P. Thus the flow of control moves in one direction only. On the other hand in the Japanese system the companies are interrelated and interlinked through cross holding of shares and interlocked directorships. These types of interlinked companies are known as ‘Keiretsus’. The supervisory boards of these companies have representative of the bank which holds the shares of the group of companies (Braendle and Noll, 2005, p.4). Convergence of corporate governance Globalization has a major impact on the business of the organisations globally. Now, most of the companies operate from a number of countries and have offices and branches located around the globe. This has enabled the economies of the countries to be effected from the policies and other trade related matter of the other countries. Therefore due to globalization the corporate governance policies followed by one country also effect the economies of the other countries irrespective of the fact that the latter is following that particular policy or not. Here comes the question of convergence the systems of corporate governance followed in different countries to develop a unique system of corporate governance which can be followed by every country. There is different view related to the convergence of the governance system. Some scholars argue that the convergence should be done and some point out the barrier of convergence. Globalisation is the main reason behind the debate of having a unique system of corporate governance by convergence (Goergen, Martynova and Renneboog, 2005, p.2). Views in favour of convergence There are a number of reasons favouring the convergence of different corporate governance system. With globalisation the business activities across the borders has increased to a great extent. This has increased the need of convergence of the accounting policies and financial practices followed in the different countries. The increase in the international business transaction has resulted in the increase in the increase in convergence on the practices and policies of financial reporting. With the introduction of international financial reporting standards it can be said that the financial reporting procedures has converged. Financial reporting is a very important aspect of all corporate governance, therefore it can be said that the convergence of corporate governance is not impossible. International mergers and growth of institutional investor around the globe are also one of the main reasons behind the need of convergence. Mergers result in change of the board members and increase in the number of institutional investor which is better governed by the outsider system has increased the need of convergence. Companies in Japan are now following the single-tier structure of board which is followed by the US companies. The board structures of UK companies are also changing. This signifies that the convergence of system is possible (Braendle and Noll, 2005, p.5). Views against the convergence There are also a number of views against the convergence of the different models of corporate governance. As per M. F Guillen the convergence of governance system is not possible due to three reasons. Firstly, the corporate governance system followed by the country is related with the other regulatory and financial areas of the country like banking, taxation, laws related to the labour and competition etc. Secondly, the institutional factors are also related with the corporate governance of the country. The third factor is the government intervention in the corporate governance; this will act as a potential barrier for the convergence of the corporate governance systems. The corporate governance are generally formed on the basis of the various laws of the country like labour law, competition law etc. As these laws are different in different countries therefore convergence of the system is quite difficult. Moreover the institutional and the political factors also vary from country to country. This makes the convergence more difficult (Guillen, 1999, p.10). Conclusion Proper corporate governance in very important not only for every organisation but also for every country as the performance of the companies also influences the economies of the country. With the rise of international business and mergers there is a need of convergence of the corporate governance system. There are also many barriers of the convergence which should be dealt carefully so that at least partial convergence can be achieved which will make the process of mergers and international transactions more easier. Reference Braendle, U. C and Noll, J. (2005). On the Convergence of National Corporate Governance Systems. Retrieved on September 7, 2011. from http://poseidon01.ssrn.com/delivery.php?ID=125017092064000017111003020085113112041074054049036036007017121101098114006072107124124027025103026004058018111076015008119055084042023010021082071021080066090032049078125117081028080002081013028094&EXT=pdf. Goergen, M. Martynova, M. and Renneboog, L. (2005). Corporate Governance Convergence: Evidence From Takeover Regulation Reforms in Europe. Retrieved on September 7, 2011. from http://www.cepr.org/meets/wkcn/5/5528/papers/Goergen.pdf. Guillen, M. F. (1999). Corporate governance and globalization: Arguments and evidence against convergence. Retrieved on September 7, 2011. from http://knowledge.wharton.upenn.edu/papers/839.pdf. Nestor, S. and Thomson, J. K. (No Date). Corporate Governance Patterns in Oecd Economies: Is Convergence Underway. Retrieved on September 7, 2011. from http://www.oecd.org/dataoecd/7/10/1931460.pdf. Prasad, K. (2006). 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