Corporate Governance and Accountability - Essay Example

PART I Introduction: Corporate Governance The issue of corporate governance has come to the fore in recent years due to the spate of scandals that have surfaced with relation to the corporates and their unethical behaviour. At stake is the way in which corporates are to be accountable to all stakeholders (note that the term stakeholder is used rather than shareholder as corporates have a basic responsibility towards all the different stakeholders) and that their behaviour must be worthy of emulation. The different stakeholders would be the shareholders, customers, employees and society at large that has an effect on the way the corporates behave. Hence, good governance is called for and indeed, demanded from the corporates. This part of the paper looks at the dimensions on which corporate governance can be analyzed by undertaking a literature review of the readings that have been assigned in different weeks of the course. The emphasis in this part is on a multidimensional and multi perspective look at some of the determinants of corporate governance. Executive Compensation and Corporate Governance The aspect of executive or senior management compensation and its effect on corporate governance is one of the frequently cited determinants (Forbes & Watson, 1993, 335). In view of the ongoing global economic crisis that was caused partly due to the excessive risk taking of bankers and the role played by incentives (flawed, in hindsight) in causing such amoral behaviour. Given the gap between executive compensation and the compensation of the lowest paid worker in many corporations (to take an extreme case, the ratio is said to be 300:1), it is indeed the case that the system of incentives and executive compensation needs to be relooked at (Main et al, 1996, 1638). To take the examples of banks that failed like Lehmann Brothers and the very recent case of MF Global, where the structure of executive compensation and the misaligned incentives directly led to their downfall, it is apparent that the role played by executive compensation needs to be addressed as quickly as possible. In fact, even auto majors and other companies in sectors that were traditionally more egalitarian have fallen prey to the disease of excessive compensation for the top management (Conyon & Leech, 1994, 238). Added to this is the fact of additional benefits in terms of bonuses, privileges and other perks that have resulted in the compensation system being skewed further to the advantage of the senior management and leading to severe issues of governance and behaviour (Conyon & Peck, 1998, 153). Presence of Outside Directors Board directors in firms are responsible for monitoring the behaviour of management and hence are custodians of shareholder trust. The issue of whether a certain proportion of directors on the boards of firms ought to be from outside of whether “inside directors” ought to be the norm has been the subject of research and study. It has been found that in firms where the boards have a higher proportion of outside directors, corporate governance is better as the outside directors can question and contradict the CEO’s and other management figures in a way that inside directors cannot (Jay Choi et al, 2007, 947). Hence, board independence has been found to be a significant determinant of corporate governance. The flip side of having outside directors is the issue of indifference and lack of operational knowledge and familiarity with the workings of the firm. However, this can be circumvented if directors are appointed according to their expertise and familiarity with the firms’ operational issues (Yermack, 2004, 2293). The point here is that the entire board need not be filled by outside directors. A healthy balance between outside directors and inside directors may be achieved through careful selection and the composition of the board can reflect the balance suitably. In fact, it has been mandated by law in many countries to have an equal portion of outside and inside directors and preferably foreigners as well (Cuervo, 2002, 88). Hence, it is suggested that firms in the UK and elsewhere take note of this and act accordingly. Role of Institutional Investors The role of institutional investors in enforcing good corporate governance has been studied extensively. It has been found that in firms where institutional investors hold significant equity, there tends to be better corporate governance because of the implicit and explicit pressure put on the firms to adopt better accounting practices. Further, large shareholders have the potential to minimize the agency problems that are the case with small shareholders and hence institutional investors play a significant role in achieving tangible results in terms of corporate governance. In fact, it has been found that because they have access to information that could have been obtained from management to other shareholders and they can pass on this information to other shareholders and in the process, benefiting all the shareholders (Koh & Laplante, 2007, 311). This is a clear example of how institutional investors can act in ways that benefit all shareholders without the accompanying costs. Since “agency problems” are at the root of many issues surrounding corporate governance, institutional investors because of their shareholding patterns can step in to resolve these problems. This has been the case in many countries across the world where the presence of FI’s (Financial Institutions) and FII’s (Foreign Institutional Investors) has been found to have a significant effect on the way institutional ownership and pay-for-performance systems are positively correlated. The discipline that is imposed on the firms because of shareholder activism is amplified when large investors are concerned (Hoitash, 2009, 840). Role of Regulatory Agencies In view of the scandals that erupted in many corporates, it has been suggested that one of the main reasons was the lack of adequate regulation and oversight from the auditors and regulators of these companies. Further, as the examples of Enron and WorldCom show, the unholy nexus between the senior management and the auditors of the company has been the culprit in causing these firm failures (Sikka, 2001, 757). Further, regulators tend to accept the word of the firms and their auditors at face value and as evidence from the ongoing global financial crisis shows; understaffed and overworked regulators might turn a blind eye to the goings on in many firms due to various reasons (Chirinko, 2004, 138). Hence, the role of regulatory agencies in determining good corporate governance is important. The aspect of whether “voluntary codes” of conduct are effective or whether laws should be passed to enforce good corporate behaviour has been debated at length. The evidence gleaned from a survey of the literature is that a mixture of compliance that is voluntary as well as enforcement of these codes of conduct through appropriate laws is the answer to bad corporate behaviour (Aguilera & Cuervo-Cazurra, 2009, 380). Hence, it is suggested that the UK follow other countries in making confederations of industry and commerce adopt voluntary codes of conduct (like Germany) and at the same time step up the enforcement of existing laws that regulate corporate governance (Goncharov, 2006, 442). Corporate Governance Mechanisms The discussion so far has concentrated on some determinants of good corporate governance. If we look at the way corporate governance mechanism work in various countries across the world, the survey of literature yields some interesting insights. First, corporate governance as it is practiced in the UK is based on close relationships between investors and managers where the former is in a position to significantly alter the behaviour of the latter (Parker, 2007, 51). Second, corporate governance when practiced as a market based system that engenders good corporate governance by making the markets monitor the firms is a good way to ensure that firms are responsible (Pendleton, 2005, 111). Third, there exists a two systems view of corporate governance that is based on informal networks and relationships and the other according to impersonal market transactions (Cornett et al, 2008, 368). The prevalence of these forms of corporate governance and which is effective as compared to the other has long been a bone of contention between researchers. Suffice to say that corporate governance ought to be situational, dependant on market and relationship mechanisms and finally, ought to be shareholder value maximizing and stakeholder fulfilment (Bauwhede, 2009, 509). The last two imperatives are the most important as maximizing shareholder value is the main reason why firms exist and in view of the recent trend towards corporate social responsibility, good corporate citizenship that ensures stakeholder fulfilment should be another factor in corporate governance (Sneller & Langendijk, 2007, 109). Hence, it is suggested that firms make optimal use of the corporate governance mechanisms that have been discussed and since the field is complex and subject to several variables, it is preferable if firms and their corporate conduct reflect the realities of modern day business imperatives and drivers (Bektas & Kaymak, 2009, 28). PART II Royal Bank of Scotland Plc RBS or Royal Bank of Scotland was in the news for all the wrong reasons because of its role in the subprime crisis and the way in which the bank mishandled the fallout of the slump in the housing market. The board was misled by the RBS traders who invested in sub-prime securities without the knowledge of the board leading to severe economic distress for the bank. Though the FSA took its time to launch an investigation, the rapidity with which economic events forced the bank to suffer losses and ask for a bailout from the government (Mail Online, 2009). This meant that the agency problems that are associated with managers becoming the decision makers and hence indulging in utility maximizing behaviour have manifested themselves in the case of RBS. The case also highlights the fact that the presence of outside board members as well as governmental representatives could have helped in corporate governance issues. Finally, the case highlights the failure of corporate governance mechanisms put in place by the board and this failure happened because of ineffective implementation of the norms of good governance and the failure of the “checks and balances” that are in place in the bank (Mail Online, 2009). Morrison Plc. The acquisition of Safeway by the Morrison group ran into issues related to poor business outcomes because of the acquisition. The way in which the acquisition was handled gave rise to suspicions of conflict of interest and crony capitalism considering the close linkages between the executive members of Morrison and those of Safeway. In fact, it has been suggested that the denigration of the code of corporate conduct by Morrison has been at the heart of the scandal that plagued the company and the way in which insider trading and close personal relationships were used to the advantage of the board members and the top management certainly justified some of these insinuations. The point is that at the time of the acquisition, there was not a single non-executive on the board of Morrison Plc and the board was dominated by the presence of Sir Ken Morrison as the executive chairman. This clubby atmosphere was the single most important reason for the resulting outcome. In fact, the outcome was distinctly unfavourable to the shareholders other than the Morrison family. There was no separation of ownership between owners and management and the Presence of all executive members on the board did not help matters (FRC UK, 2011). Mulberry Group Plc. When compared to the two companies surveyed so far, it is fair to say that Mulberry Group has been more or less better in terms of corporate governance and the way in which it has enhanced shareholder value to a certain extent is certainly commendable. The survey of corporate governance mechanism in this company suggests that the presence of outside directors did help the case of Mulberry as well as the role played by institutional investors was significant. Further, the percentage of insider trading was negligible as compared to the percentages of insider trading in RBS and Morrison which have raised grave questions about these companies. Mulberry Group, on the other hand, has managed its governance issues relatively well even with the presence of relations of executive members on the board. This shows that with a mix of members from across the spectrum on the board and diversity in the top management, good corporate governance can be achieved (Reuters, 2011). Savills Plc. This is another company that has a relatively effective corporate governance mechanism in place and the role of the institutional investors contributes in no small measure to the success of the governance mechanism. As the filings with the FSA and the press notes show, there is good representation on the board and the voting rights and the shareholder rights are adequately dispersed among minority, large and institutional shareholders. This has led to a relatively clean record for the company in matters of corporate governance. This is indeed a company that has delivered good shareholder value and though the results are not exceptional, it is a stable bet and a safe haven as far as shareholder interests is concerned (Savills, 2011). PART III Findings The findings from the survey of the four companies and their corporate governance mechanisms suggest that there is a real case for effective corporate governance and adherence to the code of conduct that has been agreed to by all these companies. The internal code of corporate governance as well as the code that is prescribed by the industry body has to be adhered to if there is to be creation of shareholder value and overall good corporate behaviour (Archambeault & DeZoort, 2008, 379). The aim of good corporate governance has to be to enhance and protect the shareholder value instead of lining the pockets of the directors and top management as happened in the case of Morrison Plc. Further, agency problems must be eliminated as far as possible as happened in the case of RBS where traders operated without informing the board. It is fair to state that poor governance procedures, philosophies and approaches can be correlated with poor business outcomes. The findings also indicate that the percentages of insider trades over a period of time suggested that asymmetries of information should not be used to the advantage of the top management and the board and instead, there must be effective checks and balances to regulate this trend that is growing by the day. Given the recent action against insider trading in the US, it is time for the regulators in the UK to consider stringent methods to check this pernicious and self serving practice (FRC UK, 2011). Finally, effective corporate governance is an ongoing process and should be person independent as far as possible. Only through institutionalizing the system of corporate governance and having ombudsmen to take care of concerns from whistleblowers can there be real corporate governance. The point here is that the gatekeepers must not bolt the gate after the horse has escaped and instead, must act in time to prevent corporate scandals. Comparison of Theory with Practice As the theoretical review in Part I and the survey of companies in Part II show, agency problems cannot be wished away. However, they can be minimized to a large extent. Further, the role of the regulatory agencies is indeed crucial as the case with RBS shows where the FSA was slow to react to the problem and because of poor oversight and inadequate regulation both from the board as well as from the independent agencies, the problems of RBS were exacerbated to the extent that it needed a bailout from the government. On the other hand, the relatively clean way in which Mulberry and Savills approached the issue of corporate governance is proof of the fact that the theoretical approaches outlined in Part I when followed properly can lead to better business outcomes. It is also the case that the governance mechanisms prescribed by internal codes and external codes of conduct need to be followed if there has to be effective corporate governance and to enhance shareholder value, transparency and accountability of the top management and the board has to be implemented (Bhat & Hope, 2006, 719). The theoretical approach is consistent with the findings to a large extent as the dimensions covered in Part I was echoed in the good and bad ways of corporate governance of the companies surveyed in Part II. Hence, the overall factors that were analyzed in both parts were relevant and similar. Of course, one aspect that received more attention in this part was the insider trading angle which can be lumped under the category of integrity of the board and which was not theorized separately in Part I. CG and Corporate Scandals It can be said that the press is right in attributing the recent business scandals as issues of corporate governance. The point here is that the buck stops with the senior management and the board and hence, there must be adequate control by and within the board. Though the press has a tendency to blow out of proportion certain scandals, it is a watchdog of public interest and hence a custodian of shareholder value as well. So, the press is certainly right in digging up issues related to corporate governance though they must not be selective in their approach. Only when they apply the same yardstick to all the companies can there be true reporting of issues related to corporate governance. Conclusion An aspect that has run through the paper as a theme is that of the debate between voluntary behaviour and enforced behaviour. It is certainly the case that as far as behaviour that is voluntary is preferred, the regulators must not hesitate to step in as and when required and in fact pre-emptively and preventively. Though voluntary compliance is the ideal, the practical considerations dictate that the regulation of companies be done and corporate governance methods enforced if the voluntary behaviour is found lacking (Talaulicar & Werder, 2008, 238). Further, with the recent trend of top honchos of the corporate world being held guilty or otherwise placed in suspicion of bad corporate behaviour, the watchdogs and the custodians of shareholder value must recognize that there are no holy cows anymore and hence all companies, irrespective of how big they are and who heads them must be treated equally and any suspicious activity monitored carefully. In conclusion, we are living in times where there is a transparency revolution underway and hence the first steps towards realizing these objectives and goals of transparency is to remove the opaqueness associated with corporate governance in the world. References 1. Aguilera, R. and Cuervo-Cazurra, A. 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