Governance and Risk in Finance - Case Study Example

GOVERNANCE AND RISK IN FINANCE Table of Contents 3 Content 4 Introduction 4 Purpose of study 5 Rationale 6 Issues 6 Method 7 Discussion andAnalysis 8 Event of a hostile takeover of Oracle vs. PeopleSoft 8 Corporate governance of Russia 9 Corporate governance of UK 9 Conclusion 11 Bibliography 13 Abstract Corporate Governance is necessary to be followed inside an organization to ensure good performance, having proper accountability to all stakeholders and mitigating any conflicts of interest. Good corporate governance ensures proper control over the risks concerning that organization. The business of any country may be affected by micro risk and macro risk factors. Micro risk factors are the factors which are within the control of firm and macro risk factors are factors which are beyond the control of firm. The macro risk factors can be political, economical, social and technological factors called PEST analysis. The macro economic variables generating macro risks are price indexes, exchange rates, commodity prices, variables of monetary policy etc. However, there are certain credit rating agencies who give credit rating to institutions from excellent to poor like A.M.Best, Dun & Bradstreet, Standard & Poor’s, Moody’s, and Fitch Ratings. The Standard & Poor gives rating scale ranging from AAA to BBB to CCC to D. Rating lower than BBB- is considered as junk or speculative bond. Sound corporate governance enables organizations to control risk beforehand. Hostile takeovers are often seen as from governance point of view as the threat of takeover is believed to exert pressure on managers to act protecting the interest of shareholders. Content Corporate governance can be referred to as the structure and processes through which the affairs and business of an institution are managed and directed in order to improve the shareholder value over long term through enhancement of accountability and corporate performance considering the interest of other stakeholders. Risk management is referred to as the assessment, identification and risk prioritisation. It refers to as the effect of uncertainty on objectives. Governance and risk in finance are closely related concerns. In fact, governance, risk and compliance (GRC) are integrated in terms of avoiding conflict and gaps within an organisation. It is interpreted in various organizations in different manner. It encompasses activities of corporate governance, corporate compliance with laws and regulations applicable and enterpriser risk management (ERM). Introduction Corporate governance does not provide any single, accepted definition. It implies the way in which a company can be managed to ensure all of its stakeholders so that they can get their fair share from the earnings of the business or from the firm’s assets. It provides the system of directing and controlling the companies. In present days, corporate governance not only encompasses the interest of shareholders but also many stakeholders. The reason underlying this fact is that interest of shareholders can only be satisfied by taking into account the interest of stakeholders as companies accountable to all of their stakeholders are more successful and prosperous over the long term. So, corporate governance rests on the perception of maximising value creation by companies over long term by discharging the accountability to all of their stakeholders and by optimizing the system of corporate governance. It is also based on the economic concept of maximising market value that underpaid shareholder capitalism as it frames rule to conduct business in accordance with the desires of shareholders and owner, requiring to make money as much as possible confirming to the basic rules of society as embodied in local customs and law. There are challenges in modern society to deal with risk appropriately and effectively manage it. International Risk Governance Council (IRGC) has given certain governance mechanisms to effectively deal with risks. Implementing such governance mechanisms calls for complying with corporate governance to have smooth running of an organization over longer periods. Purpose of study The purpose of study is to lay emphasis over the application of corporate governance inside an organization. How good corporate governance does enhance effective performance of an organisation over long term. The intersection of corporate governance and risk management has been depicted below. (Source: GARP, 2012) Rationale The rationale behind the corporate governance is that gives a systematic process by which a company is governed ensuring appropriate balances and checks. The essence of corporate governance is to ensure good organizational performance, mitigation of conflict of interest and proper accountability to all stakeholders. Good corporate governance can give a proper control over risk management enabling the organization to have a smooth functioning for long term. There is a broader and stakeholder oriented approach towards corporate governance implying a broader level of accountability to shareholders and other stakeholders. In the umbrella of corporate governance, companies are accountable to the world of future generations, society and the natural world. Issues There are four pillars of corporate governance. These are independence, fairness, transparency and accountability. The major elements of corporate governance include board commitment, functional and effective control environment, good board practices, well defined shareholder rights and disclosure of transparency. The strategies to manage risk includes avoiding risk, transferring risk to another party, reducing the probability or negative effect of risk, accepting all or some of the actual or potential consequences of a particular risk. Corporate governance and risk management should be integrated as good corporate governance gives proper control over risk management. Organizations not having good corporate governance can affect them adversely leading to job losses, reputation risk and collapse of company as in case of Enron, WorldCom, Lehman Brothers, Barclays Bank, Societe Generale. However, there is a perspective of hostile takeover as corporate governance. The notion of hostile takeover playing key role in corporate governance underlies financial sectoral reform proposals by bringing efficient financial market pressures to bear on poorly performing managers. Such reforms include making capital market trading free, raising shareholder primacy against other corporate stakeholders standing. Takeovers are taken to discipline and replace inefficient managers. The threat of takeover is believed to exert pressure on managers to act protecting the interest of shareholders. Method To test the role of takeover carefully, it is required to test a theory of takeover. The free cash flow hypothesis has been the most influential academic explanation for hostile takeovers. The theory argues that cash flow has been over retained by targets in relation to their profit opportunities. The free cash flow theory weaves several phenomena like apparent mismanagement of corporate, tightening competitive business environment and vigorous acquisition debt financing as part of movement towards efficient corporate restructuring. Attempts of hostile takeover become natural outcome if pre structuring management behaviour is entrenched as per free cash flow theory. Discussion and Analysis Event of a hostile takeover of Oracle vs. PeopleSoft Oracle was held at bay by PeopleSoft’s poison pill. In June 2003, Oracle Corp., the second largest U.S. software maker behind Microsoft made a $7.7 billion hostile bid for PeopleSoft Inc., its rival and third largest one. The back office software of both the firms were used for accounting function and supply management. The chief executive officer of Oracle, Lawrence Ellison, pursued PeopleSoft with the hostile takeover bid of his company. Oracle wanted to acquire PeopleSoft to become stronger in products. The focus of Ellison was on business application software, the programs that handle finance and accounting functions and customer relationship management. PeopleSoft specialized in this kind of software. But Oracle was weak in that software. Oracle intended to buy PeopleSoft to enhance its competitive position, to get new product, employees and customers to maintain its number two position behind SAP in enterprise software. The acquisition could provide benefit to Oracle shareholders by increased investment in innovation and giving superior solution to the needs of customers and lowering process. The consolidation will benefit as the joint company will have expanded brand reach, large consumer base and substantial business support. More customer base will increase the ability to invest more in applications development and support. On December 13, 2004, Oracle initiated a $10.3 billion bid for PeopleSoft. This acquisition struggled for about 18 months beginning from June 6, 2003. Oracle made its final offer on November 1, 2004, of $9.2 billion at $24 per share. PeopleSoft tried to convince its shareholders that $24 per share was less than real value but investors went to tender their shares to Oracle against the wishes of management. Oracle, after merger, emerged as the second largest manufacturer of business application software in world after SAP. Oracle continued deployment of PeopleSoft’s 8.9 applications and introduced the application of PeopleSoft’s 9.0. Oracle cut down the sales team of merged entity and made target towards the existing customers for sale of other applications. Corporate governance of Russia There has been a clear trend among the Russian companies to adhere to good corporate governance standards by complying with international accounting standards, increasing disclosure, placing independent directors on board. There has been an initiative from government, various private agencies and regulators to improve corporate governance. The Federal Financial Markets Service introduced the Code of Corporate Conduct. The characteristics of Russian corporate environment is high concentration of ownerships in firms, weak legal institutions, underdeveloped capital markets, significant involvement of state in business and segmented labour market. This feature substantially differentiates the Russian corporate governance from the economies of developed market especially Anglo Saxon countries. A large number of companies in Russia moved under state control, some have been accused for avoiding tax and received large claims of unpaid taxes from the authorities of tax, government excluded foreigners participation in large profitable businesses like oil extraction. Corporate governance of UK UK Corporate Governance Code was formerly known as the Combined Code. It sets out standards of good practice in relation to board effectiveness and leadership, accountability, remuneration and relation with shareholders. The UK is acknowledged generally as a world leader in the reforms of corporate governance. It was not a predetermined strategy but it was the result of growing interest in the issues of corporate governance within boardroom, the Government and the institutional investment community. In UK, all companies with a Premium Listing of equity shares are required under the Listing Rules to report on how they have applied the Code in their annual accounts and report. The Code encompasses more specific provisions and broad principles. All Listed companies are required to confirm that they have complied with Code’s provisions or wherever they have not complied need to be provided an explanation. Some of the Code’s provisions require disclosure to be made in order to comply with them. The initiatives taken by the country on corporate governance reforms are The Cadbury Report, 1992, The Greenbury Report, 1995, The Hampel Report, 1998, The Turnbull Report, 1999, The Higgs Report, 2003, The Smith Report, 2003, Redraft of the Combined Code, 2003. In July, 2003, a new draft of the combined code was approved by the Financial Reporting Council as intended from Hoggs Report, January 2003. This new code made certain recommendations like requiring at least half the board of directors to comprise independent non executive directors. A company’s chief executive should not be the chairman of the same company except in some exceptional circumstances. The chairman of a board at appointment should be independent. A senior independent director appointed should be available before the shareholders of the company if they have any unresolved concerns. The board is required to undertake a rigorous and formal evaluation of their own performance, especially considering the effectiveness and performance of its committees and individual directors. The companies should adopt formal, rigorous and transparent procedures while recruiting new directors. Box ticking should be avoided by institutional investors while assessing the corporate governance of investee companies. A non executive director should be reappointment only after six years of service following a particular rigorous review. Further, board should not agree to a full time executive director after accepting more than one non executive directorship in a top 100 company. Non executive directors can continue after nine years service followed by annual re-elections, they will be considered no longer as independent. Infact, one of the main targets of the redrafted code was readdressing executive remuneration, focussing on forcing companies to avoid excessive remuneration displaying little relation to corporate performance. It also emphasized on shareholder activism as means of proper implementation of transparency and corporate accountability. Conclusion There are several governance mechanisms which can ensure sound corporate governance like effective board of directors’ governance, ownership concentration, multidivisional organizational structure and market for corporate control. However, the role of ethics in corporate governance should be accounted for. It is important to serve the interests of multiple stakeholders group. A substantial increase in company’s valuation is achieved by building reputation and adhering to standards of good governance. There lies the demand for good corporate governance. Infact, it has also been found from research that good corporate governance and corporate social responsibility are linked significantly to good corporate financial performance is due to its link with management quality. Good corporate governance can not only provide competitive advantage in global market place but it also leads to improve the morale the employees resulting in higher productivity. It also provides growth and stability to organisation and builds confidence on adoption of good corporate practices, thereby reducing perceived risks and increasing returns consequently. Well governed companies can raise capital easily, widely and at lower cost. Better governance practices can also promote stability and sustenance of stakeholder’s relationship for long term. Adopting all these practices can create a good corporate citizen who can become an icon and can enjoy a position of pride in the society. Bibliography Goergen, M., 2012. International Corporate Governance. 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