The Ideology of Corporate Governance - Coursework Example

Title: Corporate Governance Student’s Name: Instructor’s Name: Course Code and Name: Institution: Date of Submission: Corporate Governance The ideology of corporate governance has elicited much interest in the business and legal aspects, mostly following the collapse of large firms in the United States such as Enron and WorldCom following cases of poor governance and lack of accountability. Corporate governance refers to a combination of factors including processes, policies, customs, laws and institutions that affect the manner in which a company is administered, directed or controlled (Thomas & Marie, 2008). It is corporate governance that determines the firm’s level of success and hence the need to maintain proper governance structures and ground rules. Corporate governance is guided by a number of principles which mostly aim at enhancing integrity and reducing conflicts of interest within the organization. These principles are further guided by other elements including honesty, trust, accountability, openness, responsibility, performance orientation and accountability (OECD, 2004). The generally accepted principles include, firstly, equitable shareholder treatment which allows them to exercise their rights and have access to relevant information through enhancing communication channels. Secondly, recognizing the interest of other stakeholders including employees and customers is highly important. This is possible through realizing that the company has both legal and other obligations to satisfy for all the company’s legitimate stakeholders. Thirdly, the responsibilities and role of the board need to be well structured and clearly stated. The board also needs to have adequate skills and knowledge to enable them deal with various issues within the organization and be able to challenge the performance of the management. Fourthly, integrity and fostering of ethical behavior within the organization is highly imperative as it helps the company in reducing risk and minimizing lawsuits. Accordingly, good corporate governance requires the establishment of a company’s ‘code of conduct’. Lastly, disclosure and transparency are of great significance in corporate governance and companies are expected to ensure clarity, both in operations and responsibilities. The disclosure and transparency principle denotes that the management and the board should enhance integrity in financial reporting and factual information disclosure to company’s investors. Enhancing accountability is one of the major themes in corporate governance and which has received considerable attention. In order to enhance proper corporate governance, the company’s directors and employees must be accountable. In addition to enhancing integrity in financial reporting, the company must also establish procedures for independent verification of the financial reports through external auditing procedures (Denis & McConnell, 2003). This plays a significant role in enhancing business efficiency and continuity. The breakdown of good governance is bound to have deleterious effects on the organization as identified by Leung and Cooper (2003). Evidence of corporate governance failings include inappropriate compensation of the management, failure to exercise due diligence by manager and directors, inadequate regulation, account manipulation and non-independent audit functions, poor disclosure by directors, ineffective directors and board and lack of accountability from the management among others. Board composition In the recent past, the relevance of board composition in a company and the impact that this could have on profitability has received considerable attention. Nevertheless, it is imperative to select an effective board that will enhance the company’s continuity. Composition of the board should be based on the size of the firm and its objectives. In selecting the board, various criteria need to be considered as follows: Possession of a background in business and familiarity with the company’s financial affairs and complexities Education background and professional experience that can serve the company’s interest Possession of genuine interest in representing shareholders Willingness to spend necessary time as required by the company Possession of honesty and integrity Absence of any form of conflicts of interest with the company shareholders Ability to maintain independence as a director The concept of having an independent board has been a subject of discussion as far as board composition is concerned. In essence, an independent board is said to be effective in that it can identify various shortcomings in the company which the internal board may not be able to identify (Solomon & Solomon, 2004). It has been argued that an external board has no direct relationship with profitability (Stiles & Taylor, 2002). Responsibilities of the board The board serves an imperative role within the company; with the primary objective being the protection of shareholders’ interests and that the freedom of directors is contained to a large extent (Stiles & Taylor, 2002). The board of directors also protects the interests of employees as well as other stakeholders of the company (Cadbury, 1992). This means that the board must ensure that the corporate, social and political aspects of the company. The board of directors is considered the firm’s highest governing authority in the management structure; such that it is the board’s responsibility to ensure that all activities of the firm are conducted in a manner that seeks to gratify the shareholders while achieving the goals and objectives set (Thomas & Marie, 2008). The board is therefore responsible for the evaluation of the company’s activities and performance. The board is responsible for the selection or appointment of company directors and also determines their remuneration levels. The board also evaluates directors’ performance and may remove ineffective directors. The board makes an array of decisions regarding the company including approving the payment of dividends, assessing the attractiveness of the company in the stock exchange, recommending stock splits, overseeing the development of share repurchasing programs, recommending or discouraging changes in the company such as through mergers and acquisitions, approving of financial statements at the company and protecting the interests of the community and other stakeholders (Cadbury, 1992; Thomas & Marie, 2008). Role of NED A considerable level of literature views non-executive directors as having the role of monitoring the executive directors (Cadbury, 1992; Keasy, 1997). The more specific role however lies in the provision of an independent view on the company performance, corporate strategy, resources, standard of conduct and appointments (Solomon & Solomon, 2004). According to Keasy (1997), non-executive directors have an imperative role in questioning decisions and therefore have both the managerial and monitoring role. Non-executive directors provide external expertise that is often unbiased and are therefore considered important within the company. The main responsibilities of NED can be classified as follows (Rupert, 2003; Keasy & Hudson, 2002; Sherrer, 2003). Performance: NEDs are expected to scrutinize the management’s performance in achieving set goals and objectives. Where necessary, the NED is involved in succession planning and removal of ineffective management. Strategy: NEDs are expected to constructively contribute and challenge the company’s development strategy and thus make relevant suggestions in the formation of strategy. Risk: Non-executive directors must ensure that risk within the company is minimized through enhancing accurate financial information and ensuring that there are effective risk management systems. People: Non-executive directors are highly involved appointment of directors and in determining their remuneration levels. They are also involved in succession planning and removing senior management where necessary. A significant role of NED is that they protect the interests of shareholders in the company. This is because they are unlikely to have conflicting interests between the firm’s development and their own employment and advancement possibilities. It is worth noting that while the role of NED is considered independent, they rely significantly on the executive team to obtain knowledge and information regarding the company (Stiles & Taylor, 2002). Further, they must work closely with the executive because they have limited knowledge about the company due to limited time (Keasy et al, 2002). Director remuneration The issue of director remuneration has received a significant level of interest; mostly due to the importance associated with fair remuneration to directors. It is argued that the remuneration levels of directors ought to commensurate with the expertise and experience of the directors so as to increase the level of motivation. According to CCH (2005), a well remunerated director is expected to provide the company with exceptional services as opposed to where remuneration is poor. Unfortunately, a significant number of directors as indicated in a survey by Ernst and Young and AICAD in October 2003 consider themselves underpaid. Precisely, 63 percent of the respondents in the study were convinced that they were not paid enough to with regard to the risks and responsibilities that they undertake. The importance of motivation is apparent in the subject of director remuneration. It is generally agreed that directors are more likely to perform better if they are motivated and considerable levels of remuneration provide this form of motivation. It has been put forth that one of the greatest director performance incentive is the ownership of the company’s shares. This is because directors are more likely to work towards ensuring profitability of the firm when they have a stake in the ownership because it benefits them directly; as opposed to where they just expect their salary (Solomon & Solomon, 2003). On the contrary however, other studies have indicated that performance based on ownership of shares depends on the ownership level. Director remuneration plays a significant role in attracting highly qualified directors. Thomas and Marie (2008) note that as changes in corporate governance regulations and principles change, there is a rising demand for directors and that fair remuneration is expected to attract highly qualified candidates. Assessment of board performance As the corporate world becomes increasingly competitive, it is imperative for companies to constantly evaluate the performance of the board in order to ensure that they are performing the intended purpose (Thomas & Marie, 2008). Evidence of non-performance can then be used in making decisions for improvement or replacement of the current board of directors. There are various characteristics that are used in assessment as follows: Board size: The size of the board determines their overall effectiveness. This is because it determines the speed of making decisions and ability to have common views regarding the company. Business background: Board directors with a business background are preferred to those without because they can give valuable advice and also identify trends that may affect company performance. Age, education and professional background: Education and professional experience and qualifications play a significant role in determining the board’s performance. A board that consists of highly qualified members is expected to perform better. Further, the age determines the level of experience. Independence: The level of independence determines the ability of the board to effectively protect the shareholder’s interest. An independent board is therefore considered more effective in most circumstances. Attendance in board meetings: The board is more effective if most of the members are always present during meetings. A high rate of absenteeism may impact on the board’s performance. Other boards served: This mostly concerns the experience that board of directors have. On the contrary however, board members who are in competing firms may present conflicts of interest. References Cadbury, A. (1992). Report of the on the Financial Aspects of Corporate Governance. London, Gee & Co. CCH Australia Limited. (2005). Pay non-executive directors more - CGI report. Retrieved March 3, 2011 from http://www.cch.com.au/ Denis, D. K. & McConnell, J. J. (2003). International Corporate Governance. Journal of Financial and Quantitative Analysis, 38 (1): 1-36. Keasey, K. & Hudson, R. (2002). Non-executive directors and the Higgs consultation paper, 'Review of the role and effectiveness of non-executive directors'. Journal of Financial Regulation and Compliance, 10(4): 361-371. OECD. (2004). Principles of Corporate Governance. Paris: OECD Rupert, E. (2003). Non-Executive Directors. London: Profile Books Ltd. Scherrer, P. S. (2003). Director's responsibilities and participation in the strategic decision making process. Corporate Governance, 3(1): 86-90. Solomon, J. & Solomon, A. (2004). Corporate Governance and Accountability. West Sussex: John Wiley. Stiles, P. & Taylor, B. (2002). Boards at Work: How Directors view their Roles and Responsibilities. New York, NY: Oxford University Press. Thomas, C. & Marie, D. R. (2008). Fundamentals of Corporate Governance. London and Thousand Oaks, CA: SAGE. Read More