Principles Underlying Corporate Governance and Its Importance - Essay Example

? Finance Principles Table of Contents Introduction 3 Principles underlying corporate governance and its importance 3 Combined on corporate governance 4 SOX on corporate governance 6 Conclusion 7 References 9 Bibliography 10 Introduction This paper deals with a detailed study on two acts of corporate governance and impact of these on improvement of corporate governance in UK and US based firms. These two acts are Combined Code 1998 and Sarbanes-Oxley (SOX) Act 2002. Combined code was prepared by Hampel committee in 1998. Corporate governance refers to a set of standard policies and principles through which a company is governed. This is developed to follow how the company will be directed and controlled so that it can fulfil objectives and goals along with can add value to the company and it’s all of its stakeholders’ interest in long term. Stakeholders include all individual and institutions that are financially and non financial associated with the company i.e. from board of directors and top management to shareholders, creditors, suppliers, employees, society and the environment (Ross, Westerfield, & Jordan, 2008, p.7). Corporate governance policies are developed and implemented by mainly the board of directors and top management of companies. Executive directors play important on this business activity. Many executive directors of leading firms of both UK and USA have been criticized for major corporate failure of their organizations. Few of these firms are WorldCom, Enron, Tyco, Fannie Mae, Northern Rock, Freddy Mac, Barings Bank, Royal Bank of Scotland. Principles underlying corporate governance and its importance Corporate governance is generally a set of principles developed by the companies to show its extent of confidence in terms of capability of the company to maintain sustainable interest of all the stakeholders. Main objective of corporate governance principles to conduct a business with integrity and fairness and the business should be transparent in all financial transactions. It should provide all necessary disclosure and discussions following all laws of the land and it should have responsibility and accountability towards its commitment to the stakeholders so that it can run a business with an ethical manner. Good corporate governance refers to standard level of confidence from a company through its positive commitment through corporate governance policies. The independent present in board leads to high confidence of the company in the market. It one of the important criteria on which the long term investors value a target company or an institutional investment decision is made by leading investment firms. Therefore, companies should have very clean, transparent and objective oriented corporate governance which would help to raise fund from both creditors and from market (Van Horne & Wachowicz, 2008, p.15). Combined Code on corporate governance Combined code is a popular corporate governance code of conduct that was derived from three different report of corporate governance. These are Hampel Committee’s Final Report, Greenbury report and Cadbury Report. The combined code was developed in 1988 and it is appended mandatory to the corporate governance policies of the companies listed in London Stock Exchange. Therefore, compliance of the combined code was mandatory to all the listed companies. The main constituents of combined code i.e. Cadbury report and Greenbury report were developed by Hample Committee and Greenbury Committee respectively in 1995. The main objective of combined code is to ensure that companies need to follow a standard set of corporate governance policies. The board of directors need to develop and maintain confidential corporate governance policies to safeguard the interest of the stakeholders’ interests. For this purpose the board need to have full control over the business activities so that shareholders’ investment and companies’ assets can generate adequate return for profitability of the companies as well as the shareholders (Block & Hirt, 2008, p.35). The directors should conduct review of effectiveness of policies implemented at least once a year or if possible in each quarter. They need to review the extent of control the company has over company’s assets and total capital invested. Internal control of the company includes financial, operating, legal compliances, risk management and financial and non financial disclosure to the shareholders. The code was divided into two major sections. First are the corporate governance principles of best business practice regarding provisions for companies and second is bets business practice for maintaining the monetary inte3rst of the shareholders of the shareholders who have invested huge amount in the company. Though compliance of code is not mandatory but this code was appended to the existing rules of London Stock Exchange which requires that the companies need to provide sufficient detailed financial and non financial information to the shareholders. The objective of this policy is that shareholders can access the extent of compliance of the companies where they have invested or willing to invest. Non-compliance instances need to be justified by the companies to the shareholders (Grinyer, 1986, p.77). First section of combined code is very much comprehensive that covers the operation and composition of the board, directors, remuneration, and corporate relationship with the shareholders, disclosure of information to the shareholders, accounting audit and financial accountability. The main fact of section 1 of the code is that corporate governance principles and provisions will combined together to develop a code that would be more powerful to be effected and also would be flexible enough for the companies to implement. Section 2 of combined code is very much specific compared to Section 1 and covers some corporate activities like shareholders voting rights and evaluation of corporate governance disclosure. Institutional investors invest on the companies on behalf of their shareholders they have responsibility to hold the companies account in which they already invested. The code recommends that the companies need to maintain good relationship with individual as well as institutional investors. The publication of three reports that consolidated into combined code of corporate governance in 1998 resulted major change in corporate governance policies by the companies. This leads to also change in their day to day business activity that further resulted sustainable growth and flawless ethical business activity by the companies in United Kingdom. SOX on corporate governance Sarbanes Oxley Act 2002 is also known as Public Company Investor protection and Accounting Protection Act. This Act of corporate governance was established to set enhanced standard for the corporate governance of public companies of United States. This Act was developed in response to the high profile WorldCom and Enron scandals to protect the interest of the shareholders and other stakeholders’ interests. Strictly mandated of this Act resulted reforms in financial disclosure by the companies for all stakeholders of the companies. It reduced fraudulent accounting activities which was the main objective of this Act. Two main provisions of Sarbanes Oxley Act are Section 302 and Section 404. Section 302 is a mandate that recommend senior management to clarify of financial reporting (Brounen, Jong, Koedijk, 2004, p.44). Section 404 recommends that auditors and top management need to have internal control on financial reputing techniques and methods. But, this Act is very costly to implement in public companies and it also maintain necessary control on financial reporting in higher extent that ensure any kind of non fraudulent financial reporting. The impact that Sarbanes-Oxley Act (SOX) and particularly its Section 404 on the corporate governance environment in the last one decade, results major change in corporate governance policies of US based companies. The author states in the beginning of the article that the SOX Act has been triumphant in averting some of the problems it was formulated to deal with. The positive impact of SOX in fortifying the business oversight has been widely accepted by professionals in the audit industry. The Act is believed to have unquestionably enhanced the audit quality, though its Section 404, which stressed on internal control besides the financials, has been widely considered to be premature. However, implementation of the Act had ensured that businesses made better decisions and in many cases even discovered superior competence resulting in cost savings. In the initial stage companies had to incur higher expenses to perform extensive audits of their internal control systems and consequently in the initial years of its implementation, there were reports of many companies going private as they could not afford the audits. In spite of cost involved and the complicated audit requirement, SOX has been able to fortify the function of autonomous audit committees in terms of superior corporate governance. SOX Act was developed on the need of evaluation and declaration of corporate organizations’ internal control efficiency. It emphasises that though SOX obligates a thorough evaluation of all financial reporting associated internal controls and hence requires a huge amount of resources, its positive impact on the quality of audit and corporate governance makes it highly beneficial and a necessity in the modern business environment. However, besides evaluation of internal controls, emphasis should be made on formulating controls around security of information (Brealey, Myers & Marcus, 2009, p.65). Conclusion Both Combines Code and Sarbanes Oxley Act have substantial impact on corporate governance policies of UK and US based listed companies. Combined Code resulted major reform in the role and responsibilities of board of directors and their enumeration while SOX leads to major reforms in to management of companies’ control over financial reporting. References Block, S.B., & Hirt, G.A. (2008). Foundations of financial management, 12th ed., New York, New York: McGraw-Hill/Irwin Brealey, R.A., Myers, S.C. & Marcus, A.J. (2009) Fundamentals of corporate finance. 6th ed., New York, New York: McGraw-Hill/Irwin. Brounen, D., de Jong, A., Koedijk, K. (2004). Corporate finance in Europe: confronting theory with practice, Financial Management, 33(4), 71-101 Grinyer, J.R. (1986). An alternative to maximization of shareholders’ wealth in capital budgeting decisions, Accounting & Business Research, 16(64), 319-326 Ross, S.A., Westerfield, R.W. & Jordan, B.D. (2008). Essentials of corporate finance, 6th ed., New York, New York: McGraw-Hill/Irwin Van Horne, J.C. & Wachowicz, Jr., J.M. (2008). 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