The Corporate Governance Regulations - Term Paper Example

Effective Governance and Accountability Introduction 1. Corporate governance definition A framework of practices, rules and processes by which an organization is administrated, controlled and directed is defined as corporate governance. The principles that are set out within a company’s corporate governance framework enables mangers to maintain between the interests of various stakeholders of the company such as the shareholders, employees, customers, suppliers, community as well as the government (Ash-Edmunds, 2014). The code of corporate governance emphasizes on controlling the acts of people rather than organizational processes. The corporate governance regulations are meant to form a better management thereby reducing the occurrence of legal and ethical problems (Erkens, Hung and Matos, 2012). 1.2. Main underlying theories behind Corporate Governance Agency theory: The theory mainly emphasizes on resolving any issues of conflict between the principals and the agents (Coffee Jr, 2014). Agency theory was primarily introduced to address two critical problems. 1.) The issues that arise when the expectations and objectives of the principal and the agent are in conflict and the former does not possess any idea regarding the strategies that are being implemented by the latter. 2.) The difficulties arise only because of the fact that the risk forbearance level of the principal and the agent differ considerably from each other (Ingram, 2014). Stakeholder theory: The theory states that for any business to be successful it has to create value for customers, suppliers, employees, communities as well as financiers. It is responsibility of the management of an organization to figure out the ways in which the interests of all the stakeholders are aligned (Russo and Perrini, 2010). 1.3. Features of good corporate governance A good corporate governance structure in an organization will always enable managers to maintain a strong internal control within the working environment. The code of corporate governance emphasises on the fact that the board should be composed of people who are knowledgeable, experienced and highly skilled. A good corporate governance structure encourages companies to be more transparent in terms of reporting their business operations, strategies and financial position (Dallas, 2011). Companies should provide enhanced disclosure regarding all the aforementioned facts in order to makes sure that stakeholders have the opportunities to make informed decisions (Rezaee and Kedia, 2012). 1.4. Combined code of corporate governance The combined code of corporate governance, most recently known as the UK corporate governance code, is targeted primarily at publicly listed companies. However, certain non listed companies also choose to follow this code voluntarily. Published by the financial reporting council, the code was meant to encourage strong corporate governance and transparent corporate reporting. 2. Evolution of Combined Code of Corporate Governance The Combined Code of Corporate Governance 2003 came into emergence based on the report published by the Committee relating to the Financial Aspects of Corporate Governance. The report published by the committee was better known as the Cadbury Report of 1992. The Combined Code of Corporate Governance was formed based on a reviewing others recommendations related to Corporate Governance and thereby in bringing them under a common banner. The reviewing activities were carried out based on the stewardship of Sir Ronald Hampel (Financial reporting council, 2003). 3. Comply and explain provisions Before beginning the discussion regarding the Key Principles of the Combined Code of Corporate Governance, it is essential to put light upon the subject matter of comply and explain. As per the Listing Rules, a public listed firm is required to comply with the established and also explain in detail the areas of the code which could be complied with. Private companies are required to comply with the code but are however not required to explain the areas of compliance or non-compliance. Obligation towards explaining for private firm is low. The aspect of “comply and explain” is essential as it covers almost all major sections of the code. The Code comprises of more than 50 provisions. These provisions are set over 110 situations which guide firms, board members and others and specify the action they must and must not perform. However companies are not required to comply with all of these set provisions. Based on the organizational situation they may omit complying with some of the regulations by providing the required explanations. It is also essential that adequate and justifiable reasons are provided while explanations are provided for those corporate governance provisions which have not been followed by the firm. These explanations form a significant source of information to stakeholders. One of the important compliance norms is that non-executive directors must remain independent. Their independence is essential so that organizational operations do not influence the decisions taken by them and therefore effective corporate governance can be ensured. In case of a public listed, it is essential to disclose why independent status has not been provided to non executive directors (Financial reporting council, 2003). 4. The Key Principles of the Combined Code of Corporate Governance 2003-600 Firstly relating to the principle of Leadership, the Code requires every company to be effectively headed by a Board of Directors. The Board of Directors would be deemed to be responsible in a collective fashion for sustaining the success of the company for longer time periods. The second requirement relates to the division of responsibilities among the persons taken to head the company. The second principle of the Corporate Governance Code relates to the parameter of Effectiveness. Relating to the aspect of effectiveness, the board would be required to be composed of such individuals reflecting needed expertise, value, skill sets and knowledge to help in managing the affairs of the company. The appointment procedure of members to the board of directors is required to be conducted in a rigorous and formal fashion so as to help reflect needed transparency. The directors on being selected are required to rightly comply with the objectives of induction training. The third principle relates to the parameter of Accountability that aims to evaluate the level of understanding and assessment potentials of the directors relating to the financial and business position of the company. Further the board of directors are also required to reflect needed potentials in helping assess the risks relating to the conducting of the business and also in generating an effective mode of internal control. Accountability principles also focus on evaluating the methods pertaining to assessing of business risks and generating internal control to help in sustaining effective relationship with the auditors. Fourthly the principle of Remuneration tends to be evaluating whether the remuneration standards and policies are adequate to help in attracting and retaining an effective pool of directors for efficiently managing the affairs of the company. The remuneration levels are required to be decided based on the standards of individual and corporate level of performances. The remuneration policies are required to be generated in a formal and transparent fashion. The final main principle governs the relationship of the company with the shareholders. The board of directors are required to sustain an effective communication with the shareholders. Effectiveness in the communication between the boards with the shareholders is enhanced through rightly understanding the mutual objectives of the two groups. The board is required to help in generating the Annual General Meeting (AGM) to contribute in generating effective communication with the investors. This helps in encouraging the participation levels of the investors in company matters. 5. A Brief on Major Corporate Failures of the period 1900 to 2002 The failure of Robert Maxwell’s company highlights the loopholes that were present in the British accounting standards and the corporate governance codes. Robert Maxwell was known to follow a very ambiguous form of accounting which enabled him to conceal vital information related to company finances from the stakeholders. In the year 1991 the share price of Polly Peck international starting falling drastically following a raid conducted by the Serious Fraud Office at the company premises. The company’s chief Asil Ndir was accused of stealing millions of pounds from the shareholders. The chief executive demonstrated enormously high degree of authority over the company’s finances. This gave him the right to conduct transactions without any form of approval from another executive. Nadir was accused of stealing close to 150 million pounds from the shareholders through nearly 50 transactions executed illegally (Casciani, 2012). The individual was also accused off transferring money to a number of its subsidiaries through unauthorized transactions. However, later it was confirmed that the money was used to fulfil Nadir’s personal interest which involved fund transfers to trusts managed by the individual himself, family or other acquaintances (Casciani, 2012). There were series of events following this debacle such as the failure of Bank of Credit and Commerce International (BCCI). The bank was primarily accused for fraud and money laundering. Following this scandal, the Bank of England was sued by the creditors of BCCI as the company owed more than 10 billion pounds to the creditors. They will have to work within integrity as well place themselves in a position whereby they can challenge the actions of the higher authorities within their organization. The failure of corporate governance relating to Enron is based on the manipulation of the internal control mechanisms in place to help in generating benefits to the managers at the cost of the shareholders and investors of the company. The auditing committee of Enron is also observed to be largely ineffective in potentially countering the collapse of the company (ISDA, 2002). The evaluation of the corporate failure at WorldCom reflects that the same is caused owing to the existence of a greedy top management that focused on generating higher returns to meet their personal needs and wants. Similarly the internal control mechanism at place and the auditing activities of the organizations failed to rightly match the existing regulatory standards in place. Further WorldCom’s management is also observed to reflect on reduced level of earnings to help in reducing the chances of dividend generation. Similarly the ineffectiveness of the audit committee to enhance the parameter of internal controls contributed to the corporate failure of the company (Thornburgh, 2004). The corporate failure of Barings Bank is observed to have been largely caused owing to the lack of effective internal control mechanism and also the failure in meeting of the accountability parameters. Thus lack of accountability and commitment of the management in meeting the interests of the different stakeholders with also the incidence of corruptive practices is taken to generate the corporate failure in Barings (Bhugaloo, n.d.). The subprime mortgage crisis that happened in the year 2007-08 also highlights the partial failure of combined code of corporate governance. Practices like this highlights the loopholes that were present in the combined code of corporate governance which enabled companies to take the advantage of those loopholes and conduct business unethically. 6. Evaluation between the connection between 2003 Code and Corporate Failures In the first case greater power in the hands of the board of directors of the organizations tends to cause a dismal future for the employees and staffs in the organization. It also tends to affect the interest of the stakeholders. Secondly companies like Enron and WorldCom reflected inflated share prices and above average performance of the shares. This resulted in generating false prospects to the shareholders that incurred huge losses in the event of the collapse. The managers of these companies focused on gaining on higher returns at the cost of the shareholders of the organization. Thirdly the issue of generation of complex balance sheets and financial statements in companies like Enron made it easier for the management to conceal potential information pertaining to the increase in the debt value of the concern. Fourthly companies like Enron and WorldCom also reflected the lack of effective internal controls and needed potential of internal auditing functions. In that, the Combined Code for Corporate Governance 2003 also fails to generate needed stress on the independence of the auditor in generating non-auditing functions. Fifthly the companies like Enron and WorldCom also reflected the existence of lack of commitment and accountability of the board of directors to protect the interests of the society. The Combined Code of 2003 however reflects on the need for the board of directors to work in generation and enhancement of public trust. Thus the directors of these organizations failed to influence the actions of the executive and management body in helping generate greater accountability and trust of the organization towards the society. False and manipulative accounting practices were observed to be undertaken by the management of organizations like Enron and WorldCom. This issue thus highly affected the relationship of the company with the investors and shareholders of the business organization thereby generating corporate failure as indicated in the Code 2003 (Mellor, 2007). In the case of Barings Bank it was observed that the company was not able to comply with many of the internal control and governance policies laid down by the Combined Code for Corporate Governance 2003. The company had faulted a number of financial reporting requirements and could not effectively met the needs of stakeholders in terms of adequate reporting. Such failure had impacted the capital and investment procuring ability of the organization which had a direct impact on profits (Bhugaloo, n.d.) In the Polly Peck case study it was observed that the company’s authorities were unable to impose strict governance policies within the organization. This led to development of corrupt practises. The Combined Code for Corporate Governance 2003 clearly mentions that organizations are required to ensure fraudulent practices must be identified timely (Mellor, 2007). The Combined Code for Corporate Governance 2003 requires that organizations must take financial decisions diligently on the basis of the existing financial situation and careful analysis of future returns. In case of BCCI, the financial managers took many wrong decisions in terms of providing loans and making investments. This triggered loss of profits. The company had also manipulated the laws regarding complete disclosure of financial conditions to the stakeholders. This further impacted the goodwill of the firm making its share prices go down (Thornburgh, 2004). The underlying rationale behind establishment of the combined code of corporate governance was to ensure that the actions of higher authorities in organizations are regulated. This is precisely because a majority of failure that have been explained above are results of wreck less strategies adopted by mangers in order to fulfil their personal interest thereby putting the investments made by shareholders at risk. The Cadbury report along with the combined code of corporate governance make it mandatory for organizations to recruit non-executive directors who would be majorly responsible for enforcing restrictions on any such activity conducted by the managers. This explains the fundamental objective of the combined code of corporate governance which was to promote good governance and protect the interest of shareholders. 7. Adequacy of the 2003 Code in protecting the interests of shareholders The combined code of corporate governance 2003 was aimed at protecting the interest of shareholders as the code was written in a way that enabled companies to provide an enhanced disclosure to the shareholders regarding the way business is being carried out within the organizations. The code encouraged companies to provide a proper reflection of the company’s financial position to the shareholders as well as the stakeholders in order to help them make an informed judgement regarding whether or not to invest in the company. The code urged companies to maintain a stable relationship with the investors and provide them with intricate details regarding the financial aspects of the organization thereby enhancing the transparency of the business that is being conducted within the organization. Such rigidity that existed within the code enabled shareholders to have faith regarding the fact that their investments are being handled with utmost care and that the company is not indulging in any reckless activities that may put their investments in a risky situation. Te adequacy of the code can also be witnessed in its endeavour to make sure that authority and power is being channelized equivalently within organizational members and that is not being abused by any particular individual thereby safeguarding the right of the shareholders at all cost. Conclusion The field of c orporate governance has been researched considerably over the last few decades or so. Over the last five years, academic scholars have commented that the failure of corporate governance was evident from the occurrence of the global financial crisis in 2007-08 even though arguably the root causes of that crisis were not entirely failure of corporate governance frameworks. A considerable number of changes have been made in this combined code of corporate governance in order to make sure that the code encompasses every crucial aspect that ensures enhanced corporate governance structure. The underlying reason behind the modifications that were brought about in the combined code of corporate governance was that academies scholars, regulators and organizational leaders perceived the code to inept in terms of establishing a robust corporate governance framework. Alongside these new developments that have been brought about in the corporate governance codes, various modern accounting methods have also been introduced which have helped managers to still take advantage of the loopholes in the new corporate governance codes. That is why in order to ensure that such acts are kept at bay, regulators and legislators will have to give their optimum efforts in monitoring the performance of organizations and make sure that conduct business with utmost transparency. At the same time, the regulators will have to identify the inadequacies that are present in the corporate governance codes in so as to bring about constant development and prevent companies from indulging in any unethical practices at all cost. By doing so, regulators all around the world will be able to secure the future of the world economy and prevent occurrences of another financial crisis. Although the Corporate governance norms followed in the U.K and the U.S are varied, both have remained incapable of ensuring complete governance in corporate firms. Firms still lack the ability to monitor and control organizational activities and adhere to fraudulent practices for misinforming stakeholders. The necessity for uniform and sound corporate governance policies is essential for today’s business world. Reference List Ashe-Edmunds, S., 2014. The Advantages of Corporate Governance. [online] Available at: [Accessed 27 November 2014]. BBC, 2004. Britains biggest banking scandal. [online] Available at: [Accessed 29 November 2014]. Bhugaloo, S., no date. Commodities Trading: Nick Leeson, Internal Controls and the Collapse of Barings Bank. [pdf] Trade Futures. Available at [Accessed 24 November 2014]. Casciani, D., 2012. How Asil Nadir stole Polly Pecks millions. [online] Available at: [Accessed 29 November 2014]. Coffee Jr, J. C., 2014. What Caused Enron-A Capsule Social and Economic History of the 1990s. Cornell Law Review, 89(2), p. 1. Dallas, L. L., 2011. Short-termism, the financial crisis, and corporate governance. Journal of Corporate Literature, 37, p. 265. Erkens, D. H., Hung, M. and Matos, P., 2012. Corporate governance in the 2007–2008 financial crisis: Evidence from financial institutions worldwide. Journal of Corporate Finance, 18(2), pp. 389-411. Financial Reporting Council, 2003. The combined code on corporate governance. Available at: [Accessed 24 November 2014]. Ingram, D., 2014. The Agency Theory in Financial Management. [online] Available at: [Accessed 27 November 2014]. ISDA, 2002. Enron: Corporate Failure, Market Success. [PDF] ISDA. Available at: [Accessed 24 November 2014]. Mellor, J., 2007. The UK combined code of corporate governance and its application to smaller quoted companies. [pdf] Foundation GRE. Available at: [Accessed 24 November 2014]. Rezaee, Z. and Kedia, B. L., 2012. Role of corporate governance participants in preventing and detecting financial statement fraud. Journal of Forensic & Investigative Accounting, 4(2), pp. 176-205. Russo, A. and Perrini, F., 2010. Investigating stakeholder theory and social capital: CSR in large firms and SMEs. Journal of Business Ethics, 91(2), pp. 207-221. Thornburgh, D., 2004. A Crisis in Corporate Governance? The WorldCom Experience. [pdf] KL gates. Available at: [Accessed 24 November 2014]. Bibliography Arcot, S., Bruno, V., and Faure-Grimaud, A., 2010. Corporate governance in the UK: Is the comply or explain approach working?. International Review of Law and Economics, 30(2), pp. 193-201. Lütz, S., Eberle, D., and Lauter, D., 2011. Varieties of private self-regulation in European capitalism: corporate governance codes in the UK and Germany.Socio-Economic Review, 9(2), pp. 315-338. Okhmatovskiy, I., and David, R. J., 2012. Setting your own standards: Internal corporate governance codes as a response to institutional pressure.Organization Science, 23(1), pp. 155-176. Osemeke, L., and Adegbite, E., 2014. Regulatory multiplicity and conflict: towards a combined code on corporate governance in Nigeria. Journal of Business Ethics, pp. 1-21. Saad, N. M., 2010. Corporate governance compliance and the effects to capital structure in Malaysia. International journal of economics and finance, 2(1), pp. 105-114. Read More