Corporate Governance in the United States - Assignment Example

?Introduction Corporate governance structures differ from one country to another. The United s and the UK both have evolved their corporate governance structures in response to scandals, while developing countries in the Asia have corporate governance structures which are tightly held. Managerial accountability is the same, however, due to two things – either managers are not accountable to shareholders, because there basically aren’t any shareholders, as is the case in developing countries; or managers are not accountable to shareholders because of shareholder apathy. Either way, the only time that accountability comes into play is when there is a crisis. In this way, managerial accountability issues are the same across jurisdictions. I. Corporate Governance in the United States Corporate governance and governance arrangements vary widely from country to country, and to illustrate this an in-depth examination will focus upon the UK and the United States. The first thing to understand about the United States’ corporate governance is that it evolved after the Enron and WorldCom scandals of the early 1990s to early 2000s. In order to understand why corporate governance in the UK and the United States evolved, one must under the precipitating factors in their evolutions, and that was the Enron and WorldCom scandals in the late 1990s-early 2000s. Corporate governance was different for the United States in the 1980s, because, during this period, hostile takeovers changed the way that corporations did business. 1 Leveraged buyouts were costly maneuvers, which made managers sensitive to the market price of their firm. This, in turn, led to great risks in inflating the stock prices. This was coupled with widespread deregulation and the rise of CEO pay.2 Since CEO pay was tied to the company’s performance, the CEO had reason to inflate the corporate numbers, because this, in turn, would inflate the salary of the CEO. The tie from the company’s performance to the CEO was further reason for the CEO to obsess about the day to day price of the firm. What this means was that, since the CEO pay was tied to the performance of the company, there was further reason for the CEO to inflate numbers, because it would also inflate his or her salary. Because of this tie from the performance of the company to the CEO pay, the CEO was given further reason to obsess over the day to day price of the firm. Moreover, there was a failure of accounting in catching the Enron and WorldCom debacles.3 Arthur Andersen, the accounting firm behind the Enron scandal, went from being one of the most well-respected professional firms in the world to a shamed company that was not only responsible for the Enron scandal, but securities frauds in Waste Management, Sunbeam, HBOCMcKesson, The Baptist Foundation and Global Crossing as well.4 While the U.S. has also traditionally believed in the power of the free market,5 in the wake of the scandals, the U.S. implemented a series of rules, as codified in the Code of Federal Regulations, by which corporations must abide. Some of these rules involve transparency in the disclosure of executive compensation.6 According to the SEC, all corporations must disclose any remuneration made to the CEO, CFO and the three most highly paid officers.7 The rules apply to the following disclosures: “(1) tabular disclosures regarding executive remuneration and director remuneration;(2) narrative description of other types of remuneration and any information material to an understanding of the tabular information, and (3) a Compensation Discussion and Analysis (“CD&A”)”8 . The way that all companies must disclose this information is through their annual proxy statement, which the SEC's website makes available on-line.9 Additionally, there are other regulations that are designed to increase transparency about executive and director compensation. For instance, there are regulations that require disclosure regarding “(i) beneficial ownership of public company securities by persons owning 5% or more of any class of the company’s voting securities and executives and directors;(ii) transactions between the company and related persons (generally defined to include officers, directors, 5% beneficial holders, and close family members of these individuals);and (iii) disclosure regarding a company’s processes and procedures for the consideration and determination of executive and director remuneration.” 10 Additionally, the United States instituted the Sarbanes-Oxley Act (SOX Act), which created a quasi-governmental agency, which created oversight over accounting firms, thus ending the reign of self-regulating principles.11 The Sarbanes Oxley Act was enacted after Enron, and the main point of the Act was to end self-regulation for auditors. It appointed five member of the Public Company Accounting Oversight Board, and two of these members must be certified public accountants, and they are to “register public accounting firms; (2) establish or adopt auditing, quality control, ethics, independence, and other standards relating to the preparation of audit reports for issuers; (3) conduct inspections of accounting firms; (4) conduct investigations and disciplinary proceedings, and impose appropriate sanctions; (5) perform such other duties or function as necessary or appropriate; (6) enforce compliance with the Act, the rules of the Board, professional standards, and the securities laws relating to the preparation and issuance of audit reports and the obligations and liabilities of accountants with respect thereto; and (7) set the budget and manage the operations of the Board and the staff of the Board.” 12 I. Corporate Governance in the UK The market structure of the UK is different from the United States, because of the UK has more firms than the United States, and each of these firms are smaller than typical US companies.13 As of 2005, the largest corporate voting block in the UK was under 10% of votes. This is contras to Austria, with 26%; Germany, with 27% and Italy with 20%.14 The UK may also be contrasted with the United States in that the UK firms have traditionally not had shareholders – in 1995, 84% of UK firms did not have any shareholders at all.15 While the U.S. had the Enron and WorldCom scandals, the U.K. dealt with scandals of her own. One was the collapse of Baring Bank, which was primarily due to one rogue trader, named Nick Leeson, who was making fraudulent transaction.16 Another scandal was the collapse of the Maxwell group, which was due to the ethics of Robert Maxwell.17 After the above scandals, the U.K. implemented different oversight regulations that were principle-based, in that these regulations stated broad principles that were to form the backbone of any corporate governance, but did not implement rules. Therefore, each individual corporation was free to implement the principles as they saw fit, but they had to implement some kind of governance that fit with the principles, and there was increased transparency to make sure that this occurred. This is in contrast with the United States, which implemented rules that their corporations must follow. This is a major difference in the oversight of corporate governance between these two countries. One of the changes that occurred was in the regulatory framework, which was already robust before the scandals, but needed to be reworked to placate the public.18 Since the Enron debacle was partially the fault of lax auditing procedures, the U.K. set up the Coordinating Group on Auditing and Accounting Issues, which focused on financial reporting, auditing, corporate governance and the structure of auditing and accounting oversight (CGAA). This review of the regulatory system led to regulations regarding auditor independence.19 Another major change dealt with the Board of Directors and their functions. The Board of Directors in the U.K., and the U.S., are elected to represent the interests of individual shareholders.20 They hold meetings about the direction of the corporation, and give reports to shareholders, and are responsible for directing the company while acting in the best interest of not only the shareholders but the corporation, and they deal not only with the business and financial issues of the company, but also issues such as corporate governance, corporate ethics and corporate social responsibility. They set the strategy for the corporations, along with the corporate structure, and establish the mission and values of the corporation.21 Therefore, presumably, if the Board of Directors are doing their jobs, scandals such as Enron, WorldCom, Barings Bank and Maxwell would not occur, because the Board oversight would catch these incidents before they could become scandals. Unfortunately, Gillespie & Zweig (2010) argue that Boards are often negligent, because they have a responsibility to the corporation and the shareholders to guide the company, but they do not do this, but become meek cheerleaders because they are beholden to the CEO who brought them aboard.22 Therefore, the U.K. set up principles by which the corporations’ Board of Directors must abide. The regulatory framework on corporations’ Boards is set out through the U.K. Corporate Governance Code, which implemented a set of principles by which Boards must follow, and the biggest principle is that Boards are to be robust and take their jobs seriously. Also, the CEO and the chairman of the board must be two different people. Boards must be balanced, in that the individuals on the board must represent a wide range of skills, experience, and knowledge. All board members must come up for re-election, procedures must be transparent, and must maintain sound risk management. The board must also maintain a dialogue with shareholders. The board must meet regularly, and each board member must continually update their skills. They must state in their annual report how the performance evaluation of the board has been conducted, and how they conducted their responsibility in preparing annual reports and accounts.23 These are just some of the principles that have been established to make the boards accountable to their shareholders, and force them to take their positions seriously. Further, the U.K. implemented procedures that increased transparency. These disclosures are related to corporate governance. It states that an issuer must have a body that is carrying out the functions mandated by disclosure and transparency rules, and at least one member of the body must be independent, and one must have expertise in auditing. The relevant body must monitor financial reporting, monitor the effectiveness of the internal control, internal audits and risk management; monitor the statutory audit; review and monitor the independence of the statutory auditor; and issue a corporate governance statement . The statement must reference the Corporate Governance Code and explain how the firm diverts from the Code, if this is the case. The corporate governance statement must also disclose the company’s internal controls and risk management system, in relation to the financial reporting process and must contain “a description of the composition and operation of the issuer’s administrative, management and supervisory bodies and their committees.”24 The annual report must also disclose such information as how the board operates,; how the board of directors was elected; how many meetings the board has had in the year; if a CEO is chairman of the board, why this is so; how performance evaluations of the board is conducted; if there is no internal audit function, why this is; and the steps that are taken to ensure that the board understands the views of the major shareholders of the company.25 The OECD has further instituted principles in response to the scandals. The principles are that shareholders should have more power to hold management accountable; that unfunded executive share options should be abolished; and that proper checks and balances should be put into place so that the corporate sector is strengthened, including the principle that accounting firms cannot also act as consultants.26 Although these are principles, not rules, they form the basis for the countries participating in the OECD to formulate their own rules that are based upon these principles. Therefore, corporate governance is different in the UK and the United States. Whereas the United States have large firms with many shareholders, the UK has smaller firms and fewer shareholders. The United States has rules that corporations must follow, while the UK has principles which form a foundation for a firm’s corporate governance. While the rules of the United States are hard and fast, the UK principles are more guidance-based, and firms do not necessarily have to follow them if they wish not to. I. Corporate Governance in Other Countries Meanwhile, corporate governance is different in emerging economies. McGee (2008) did an empirical study of Asian countries, excluding Japan and China, and found that many of the basic corporate governance principles were lax with these countries. In particular, corporations in the Asian countries had poor disclosure standards and poor auditing and accounting standards. Included in this is auditing procedures, and none of the countries observed the guidelines for independent audit.27 This is in contrast to both the UK and the United States, both of whom have adopted either rules or principles regarding accounting and auditing procedures. Sharif & Zaidansyah (2004) also state that, although Asian countries are developing better corporate governance procedures, the enforcement of such is often lacking. They give the example of Indonesia, which has put rules into place allowing shareholders to pierce the corporate veil when they have been wronged by a corporation, and they may bring action against a corporation who has caused them loss. However, because individuals in this country do not have faith in the judiciary, actions are rarely brought. Because of this, majority shareholders do not have incentive to comply with the rules. 28 Sharif & Zaidansyah thus recommends that Asian countries reform their regulatory frameworks and increase criminal penalties for non-compliance with rules.29 More, Claessens & Fan (2002) state that ownership structures are different from the United States in that firms are more likely to be closely held in Asian countries, and, in a typical Asian corporation, a family holds tightly held shares. This is because of the customs, social norms and legal system are different in these countries then other countries.30 Young et al. (2008) state that the effect of corporations being tight held by families results in principal-principal conflicts, which is often a conflict between controlling shareholders and minority shareholders. The tightly held nature of the Asian corporations means that ownership and control are not separate, as they are in developed countries that have a more diffuse structure. The countries with a more diffuse structure have conflicts between owner (principals) and managers (agents), because the ownership and control of the corporations are separate. 31 Chakrabarti (2007) singles out India in his review of corporate governance in Asian countries. Like the other Asian countries, there is an issue with the slow and inefficient judicial system, which means that enforcement of its rules is lax. Therefore, even though it has some of the best rules regarding investor protection in the world, since enforcement of these rules are lax, these rules have limited impact. As with the other Asian countries, corporations tend to be tightly held, and family business groups dominates. This is in contrast to Western countries. What is similar to Western countries is that India has excellent transparency rules and rigorous regulations. They have also enacted regulations similar to the Sarbanes-Oxley Act in the United States.32 I. Issues regarding electing and dismissing directors As corporate governance structures differ across the world, so do shareholder rights. Therefore, the ability to elect or dismiss directors differs across jurisdictions. Fairfax (2008) surveys these differences. According to her, the United States has traditionally had a system where a director may be elected by a plurality, which means that, even if 99% of the shareholder votes are against this person, he or she may still be elected to the board, as long as he or she has a single vote in his or her favour. This has been the default rule in US corporations until recently. It works the same way in director ousters – even if 99% of the shareholders vote to oust a director, the director may not be ousted if there is even one vote against the ouster. However, according to Fairfax, this has been changing, as shareholders have complained that these rules make it almost impossible to oust a director. Therefore, the directors are not accountable to shareholders in the plurality system, because they only need one shareholder on their side to avoid their ouster. The shareholder actions to change to a simple majority rule – where directors may be appointed or dismissed upon a simple majority – gained steam after shareholders could not oust Disney Chairman Michael Eisner because of the plurality rule. Fairfax states that these actions – to force corporations to adopt the majority rule – were the most popular shareholder actions in 2005 and 2006. Because of these actions, majority rule corporations have increased from just 30 corporations in 2004 to 55% of Fortune 500 companies adopting them in 2007. 33 The United States’ default rule of elections by plurality is unique in the world, according to Fairfax. For instance, in the UK, the directors are appointed by the board. However, shareholders must approve the directorial appointments, and this is by a simple majority. In France, not only must there be a majority to approve director appointments, but any votes in abstention count as a vote against that director. Other countries, such as Czech Republic, Germany, Poland and Russia have a two-tiered system, made up of a supervisor board and a management board. The supervisory board members are elected by a majority of shareholders, and the directors on the management board are elected by the members of the supervisory board. Meanwhile, Canada, which, like the United States, has traditionally had a default rule of plurality systems, has been changing to a plurality plus system – the power to remove or appoint directors is by a majority rule, then the board of directors approves the vote. Japan traditionally has had a 2/3 majority vote, where there must be a 2/3 majority to oust a director, and electing a director only requires 1/3 vote. However, in 2006, a Japanese law permitted companies to adopt a simple majority rule, and shareholders have increasingly demanded this.34 While there has been an increasing call by shareholders to have more power, there is some question whether, in practice, these changes will have any effect. This is because shareholders tend to be passive, and there is some thought that this is the most efficient way of things. The argument is that centralized power is more efficient than broad power exercised by shareholders. Fairfax (2008) states that, in the countries where majority voting has been the rule, most shareholders do not exercise their rights to vote to challenge directors. Fairfax states that these studies show that increased shareholder power may not make a difference in places like the United States, Canada and Japan, where movements to increase shareholder power have dominated the landscape. On the other hand, argues Fairfax, majority voting rules has encouraged boards to communicate more with shareholders. Moreover, shareholders do tend to exercise their rights in times of perceived crises. Another way that shareholders may impact corporate decisions, even if they are generally apathetic, is that corporations may take action when they see that there are a significant number of shareholders who do vote a certain way. This was the case with Disney, where shareholders cast “no” votes about CEO Michael Eisner’s severance package, yet were not successful because of the plurality rule in that corporation. The corporation saw the high number of dissenters and took action. Fairfax states that shareholder apathy actually makes corporations work the most efficiently, as the main goal of giving shareholders power is to increase the dialogue between the corporation and the shareholders, while ensuring that shareholders will take action in times of crisis. As the research shows that this is the practical effect of shareholder power, shareholder power works in the manner in which it was intended.35 Fairfax (2008) also states that, while in most countries increased shareholder power has not resulted in any changes in corporate governance, the exception to this rule has been the UK. Part of this reason is because the UK has given the shareholders an advisory opinion on executive pay, and that has not been the case in any other country. Because of this, the corporations in the UK have had more dialogue with shareholders then in the other countries, and executive pay has only risen 5 to 6% in the UK in the past five years. In other countries, executive pay has increased an average of 14% during this same time period. Moreover, there have been studies in the UK that show a strong positive correlation between shareholder activism and corporate value. Fairfax states that this shows, in the right circumstances, that shareholder activism and power can influence corporate matters and value.36 I. Underlying issues of managerial accountability – are they the same everywhere? In reviewing the different corporate governance structures and issues regarding shareholder power all over the world, the statement that “underlying issues of managerial accountability are the same everywhere” appears not to be true, on its face. In the developing Asian countries, which are closely held, the managers and the owners are often the same, or there are limited shareholders. In these countries, managers are not accountable because the power is so tightly clustered with a small group of individuals who do not seem accountable to anybody, or at least are accountable to a very small number of people. In Japan, shareholders traditionally have had limited power, due to its 2/3 vote rule. In Western countries, shareholders may have a great deal of power, such as in the UK and other European countries, or they may have limited power, as the traditional United States and Canada models show. This has been changing, in that the countries which have traditionally had structures which emphasize weak shareholder power are gradually converting to structures where shareholders have more power. This would presumably hold managers more accountable. Yet, this has not necessarily been the case, as shareholders continue to be, by and large, apathetic in these countries, even the countries which have afforded greater shareholder power. The only exceptions are in times of crisis, and this is where shareholders do seem to exercise their power. That said, perhaps this shows the truth of the statement – that managerial accountability issues are the same everywhere. Since shareholders, by and large, do not exercise the power that they are given, and this does not vary much from one country to another, managers are really not accountable to shareholders. The only exception is when there is a crisis, such as a company is going to go bankrupt or perhaps there is a takeover on the horizon. However, with day to day activity and decision-making, shareholders probably will not exercise their power. Therefore, perhaps the truth of the statement is that managers will be accountable to shareholders in a crisis, and this would be the case anywhere in the world, and not be accountable to shareholders when there is not a crisis. Thus, the managerial accountability issues will be consistent across countries for this reason. Conclusion Corporate governance structures differ from one country to another. The United States and the UK both have evolved their corporate governance structures in response to scandals, while developing countries in the Asia have corporate governance structures which are tightly held. Managerial accountability is the same, however, due to two things – either managers are not accountable to shareholders, because there basically aren’t any shareholders, as is the case in developing countries; or managers are not accountable to shareholders because of shareholder apathy. Either way, the only time that accountability comes into play is when there is a crisis. In this way, managerial accountability issues are the same across jurisdictions. Bibliography G. Benston & G. Kaufman, “The Appropriate Role of Bank Regulation,” (1996) 106 The Economic Journal 436. A. Cadbury, “Committeee on the Financial Aspects of Corporate Governance.” (1991) Accessed 1 December 2011. R. Chakrabarti, “Corporate Governance in India” Accessed 1 December 2011. S. Claessens & J. 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