Failures in Corporate Governance and Fraud - Literature review Example

FAILURES IN CORPORATE GOVERNANCE & FRAUD Name of the student Name of the institution Executive summary Corporate governance is a new concept in the business world brought about by continuous collapse by the companies and government corporation's couples' financial crisis. This paper discusses the process of risk management in reinforcing organizations management through existing infrastructure within the organization to help in curbing the fraud. The paper presents Parmalat case where the group had a complicated business structure, and there was no supervisory role among non-executive board members. The collapsed of this company has brought many questions on the completeness of FRS and accounting rules and regulations including the reliability of the Italian corporate governance system leading to the labeling the scandal as European Enron's. The paper emphasizes the role of none executive members, the internal control system and the IFRS. Introduction---background information on Parmalat Ellul (2015) states that risk management in business offer basis for building integrated management system which is coherent. Through this, it helps in generating well-organized risk management policies within the organization. The process of risk management reinforces organizations management through existing infrastructure within the organization. Scholars consider risk management to be an essential part of management within organization since the primary objective of management is danger identification, examination, and appraisal, with the sole determination of applying additional control actions that can result in risk reduction. In short, the aim of risk management is to reduce the organization's exposure with all-out competence. Jones (2014) defines risk as a situation which might result in adverse occurrence and cause loss to the business. While most governments are unable to develop stable political systems and adequate financial markets, they are in a position of developing an effective approach to identification, measurement and assessing risks and coming up with effective policy response. One of such approaches is effective enterprise risk management system (Epstein & Buhovac 2014). Good and all inclusive corporate management should be in place to help in improving performance of the organization by helping the board to discharge its duty in the best interest of shareholders and in case it ignores, the significance may well be susceptibility or unfortunate performance. Effective governance should be able to ease, effectual and commercial management that can deliver stockholders value over the lengthier term (Harford, Mansi & Maxwell 2012). Lam (2014) defines governance as the organizational the authority being exercised by the organization management to help in the integration of the business operation into one system using information and technology, it ensure the fusion of business with informatics. According to this definition, the main actor for effective management and governance process is information and technology. Notwithstanding the association between IT management and IT governance, the two concepts remain distinct. Management of IT is in charge of providing efficient IT services, with providing and administration of IT services and products. On the other hand, governance in mostly focuses on the performance and service delivery to transform that can assist in reaching the demands of customers and shareholders. IT governance is part of a much comprehensive concept of corporate governance (Acharya et al. 2013). They further say that the two major concepts and principles in information technology are effectiveness, transparency and accountability. It reflects broader organizational principles of governance while concentrating on the management and IT use to help in achieving corporate governance goals. Since the outcomes in most cases are not easy to measure, firms must allocate accountability for expected results and investigate how good they are achieved. IT management should not be considered in isolation since IT is related with other critical initiative assets thus IT governance might share devices with another set of the governance process thereby organizing enterprise-wide decision-making processes (Bromley & Meyer 2014). The risk management has to be included in any current and future planning of an organization. The objectives are as follows 1. To investigate principles of corporate governance 2. To establish measures, that can help in a reduction of corporate governance Failures 3. To determine areas of internal control system that can assist in curbing fraud. Case study---Parmalat In the year 2003 one of the world dairy food leaders, Parmalat group collapsed and entered into bankruptcy and this happened after management realized that billions of Euros were missing from the Company’s accounts. The collapsed of this Company has brought many questions on the soundness of the financial reporting standards and the soundness of the accounting standards including the reliability of the Italian corporate governance system leading to the labeling the scandal as European Enron’s (Harford & Maxwell 2012). This case illustrates old problem of shareholders who have failed in their oversight role in monitoring the Company’s managers instead, exploiting the Company on what was known as continental European governance structure. The Company’s management structure was quite open giving loopholes as compared with the Enron's, which was quite tight and well-designed (Harford & Maxwell 2012). The Company with all these weaknesses enjoyed good business with high-grade credit rating enabling it to borrow more and more from investors. Even though the Company was listed on the stock exchange, financial times indicate that the part of the Parmalat problem was that it was a family business that was operating in opaqueness. The economic issue of the Company can be traced years before its collapsed. The management, however, convinced other stakeholders that the group was healthy and operating efficiently. In as much, in the month following December 2003, several events unfolded raising concerns that had been expressed earlier concerning the Company’s operations. The Company had a complicated organization structure that comprised of over one hundred and seventy subsidiaries' (Acharya et al. 2013). The cash flow between the parent Company and the subsidiaries were quite much and this consisted of subsidiary in the Cayman Islands which is a tax heaven, further complicating monitoring the cash flow between the subsidiary and the parent company (Epstein & Buhovac 2014). An employee who failed to heed the instructions of destroying crucial documents assisted the investigators to unveil the mystery of the Company activities by handing over computer and disk containing the information. The investigation revealed that the Company had established several subsidiaries through which it had been able to channel huge financial resources to the administration of the Company who in turn failed to prove the full extent of the offshore transactions. The legal actions were extended to the bank officials who assisted the company to issue bonds and loans and investigation further established that the City group and Deutsche Bank were being pursued in relation to this fraud case (Acharya et al. 2013). In its financial statements, the Company overstated assets by recording nonexistent assets, understating its debts, overstating profit while diverting Company’s money to personal family account. For the Company to hit fatalities, Parmalat had to use various wholly owned entities among which included Bonlat in the Cayman Island subsidiary---which existed during the five final years and the Bank holder of America’s false account. The uncollected receivables from the company were all moved from the working corporations to the candidate objects, where their real worth was concealed. The Company management organized fictitious trades and monetary dealings to offset Company fatalities of operating subsidiaries and to expand assets and the Company income. Invoice duplication and securitization arrangements founded on the false trade receivables that were recurrently used to finance the group were other problems. The group modest its arrears in deceitful arrangements, recording non-existent repurchases of bonds, falsely describing non-recourse, in order to eliminate the obligations from the records. The Milan listing Stock Exchange's rules necessitate listed businesses to exemplify their corporate governance system and those who failed to follow these amended rules needed to justify why they have failed to do so. The Act recommended the appointment of independent director, one of the misunderstood concepts of governance (Franks et al. 2014). In 2001 report, the Parmalat declared that four out of thirteen directors were independent; however, they failed to disclose the relevant names of those directors giving the names in the following year (2002). There was no supervision of non-executive directors on the company managers. The group complex structure requires a substantial amount of work and financial understanding something which was lacking in the non-executive directors. They were further reluctant to dig deep into the group activities showing that they were not prepared to have the oversight role on the company activities (Franks et al. 2014) The corporate failures of the Company were a clear indication of lack of oversight authority as the non-executive directors failed in their role of monitoring the group activities. The case illustrates that the Company management did not only take benefit of the US accounting standards inadequacies to manage its incomes and the group balance sheet but the group financial statements did not conform to the existing US GAAP. There are several accounting issues that were found at the Parmalat giving very little evidence if the financial statements violated the letter of the adopted accounting standards; however, overall, the group violated the spirit of preparing financial statements. Product tampering, financial fraud and other violation of governance laws can also be considered as economic crime. Wintoki et al. (2012) argue that the possibility of the occurrence of such crimes usually depends on two main factors. First, the cost associated with committing the said crime and secondly the benefits which are derived from committing the fraud (Brown, Gao & Stathopoulos 2012). Gao & Stathopoulos further state that the higher the cost imposed on the crime culprit and the inferior the welfares related with the deception, the inferior the likelihood that the deception will be dedicated. Therefore, the management and the government should increase the cost of doing economic crimes as it will be a deterrent (Epstein & Buhovac 2014). The cost associated with committing a governance fraud typically depends on three major factors. The first one is the chances that the individual with deviant behavior will be discovered, which substantially depends upon the monitoring mechanism which has been put in place by the board of directors (Epstein & Buhovac, 2014). In the case of Parmalat scandal, the auditor general recommended the use of proper monitoring mechanism to be put in place and such scandals would have been reduced from happening from time to time since the greater the probability that the fraud can be discovered the less likely it would have been that the company management would commit the fraud hence proper monitoring mechanism was important in curbing fraud cases (Wintoki & Netter 2012). The second control mechanism to be put in place is to reduce the benefit associated with the fraud as a fraud depends on the utility function of the individual or group committing the fraud. The use of an integrated system is another way of putting control measures in an organization (Brown & Stathopoulos 2012). Information technology governance helps in putting control measures on the use of company resources. Governance regulations and principles both at national and international levels reflect the view that corporate governance, internal control, and risk management are quite interdependent factors. The boundaries of these concepts may appear narrow at times; however, it is not always clear whether the risk management is a sub-division of internal control or vice versa. Again, the dominant recurring theme is that risk organization is an integral part of the process of corporate governance. In the context of private sector, the primary responsibility of all the factors rests with the board of directors Epstein & Buhovac (2014) in their study concluded that information technology in the management of risk is the pillar of corporate governance; it is capable of achieving better and more efficient use of the organization resources and help in better management of projects. The arguments that are underlying the need for formal risk management control system may, therefore, appear to have strong similarities across both public and private institution (Franks et al. 2014) Discussion and Conclusion The Parmalat scandal is one of the largest known accounting frauds and it was thought to be a model of corporate governance. The group had one of the most reputable independent board and audit committee members. The Company was also listed in the stock exchange and some of its clientele included Fortune 500 companies. The company had won several awards and were respected Private Corporation, which was later listed to the public. The fraud in this cases and the disclosure of Parmalat scandal shocked not only the investors by the professional community at large. These scandals raised serious questions about the institutional arrangements for accounting, auditing and corporate governance in USA and Italy. The consequences triggered legal reforms and regulatory safeguards. Considering the greatness of the fraud, the discussion on the role of self-governing directors that followed was to expect an improvement in the audit committee diligence through more often audit committee meeting, increase in audit committee director attendance if the meetings with less busy board of directors will help in creating a more responsible monitoring body which can help in risk management within the company hence improvement of corporate governance. The case studies and the study have significant implications for the ongoing accounting and auditing reforms across the globe. The accounting standards in India are converging with international financial reporting standards (IFRS). They are usually based on the fair value, whereas the older GAAP were mostly based on the historical cost concept. More technical skills are necessary for the preparation of financial statements and auditors both internal and external should provide a clear and tighter control system to help in controlling the fraud both in private and public sector. The management should develop proper management system, establishing training programs for employees concerning good corporate governance. Good management system, like integrated information system, is very significance in helping the curbing fraud and another inherent risk in the organization. An effective risk management system should aim to anticipate and manage an uncertain future. Therefore, it is forward looking. The system should be able to provide appropriate disclosure to stakeholders about the risk being taken hence should be open. Effective management system should give opportunity management as well as any disaster management within the organization and should be strategic in nature and sustainable which is ability to evolve as the business evolves. The board of management should involve building a set of risk management activities which aim to align the company strategy, process, people, and technology and know how. The enterprise risk management, which is a dynamic environment through which the firms operates, enabling the firm to evaluate and control the uncertainties faced by it. In summary, the corporate governance is a wide topic to discuss fully in this single paper. Corruption in both private and public sector can only be managed with proper management, efficient control system is necessary to help in managing risk. Bibliography Acharya, V, Gottschalg, O, Hahn, M, & Kehoe, C 2013 Corporate governance and value creation: Evidence from private equity. Review of Financial Studies. 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