The Study of Corporate Governance - Coursework Example

? Corporate Governance of the of the Corporate Governance Q. Enron, Worldcom and Parmalat have generated immense interest in the study of corporate governance and in identifying how board actions can be monitored more effectively. Discuss one way in which you would improve the current scenario in regard to corporate governance. Introduction The corporate world is full of stories and events- some good and some bad, some which make the news and some which never see the light of day. Competition, personal greed, pressure from stakeholders and other sources are some reasons why business managers, owners and CEOs indulge in bad and unethical business practices like embezzlement and misappropriation of funds, false accounting records, misleading valuations of assets and liabilities and a whole lot of other things that bring a bad reputation to themselves and the companies they represent. While these people are usually elected by the Board of Directors or hired based upon their past record, professional skills and business acumen- it is sad when they indulge in scandalous behavior that can lead a company to bankruptcy and closure. In recent years we have had corporate scandals involving such well known names as Enron and Worldcom in the USA and Parmalat in Italy. These widely recognized household names had a national or regional presence at least, with some even having business interests in various countries across the globe. This is what makes their demise all the more shocking. What is Corporate Governance? Broadly speaking, Corporate Governance may be defined as a set of laws, rules and principles by which a business is operated and controlled. Some of these rules are set down by law and common business practices and the culture of the land, while others are defined by the owners and those in the higher echelons of management of the enterprise. The rules of corporate governance are based on morality and integrity and fair play. There is an attempt to make all actions bonafide and above suspicion, so that the stakeholders as well as the general public are satisfied as to their genuineness. Corporate Governance has been defined by the OECD1 as ‘a set of relationships between a company’s board, its shareholders and other stakeholders. It provides the structure through which the objectives of the company are set, the means of attaining these and monitoring performance are determined’ (OECD, 1999, 1). This definition captures the entities of all who are involved as well as the working relationships among them with respect to the functions and responsibilities of corporate governance. The Need and Importance of Corporate Governance Quite simply, the stakeholders of a corporation-whether they be debtors, creditors, suppliers or distributors- as well as the general public would love to do business with a corporate entity or buy its products and services if they know that the management and the employees are a well reputed group and they can rely on the quality of the merchandise or service that is being provided to them. In other words the public perceives the corporate entity and its management and workers to be good and honest hardworking citizens, working hard to contribute to the good of the economy and society at large. Of course they price their goods to include profit as well as to cover the costs and expenses of running a business. But the exposure of bad and fraudulent business practices as well as dubious business activities will certainly make people think twice about the company and its bonafides- which have now fallen into disrepute It can be an audit team or the actions of a concerned whistleblower that exposes these activities2 (Wearing, 2005, 27). Once the beans have been spilled, the company usually comes under the investigation of the Securities and Exchange Commission and other Federal agencies such as FBI and law enforcement can also get involved. In the UK this would involve actions and investigations by the Home Department and the Metropolitan Police. Once the details are known, it is only a matter of time before corrective action is suggested and implemented. If the damage to the company’s reputation is not too deep, it may survive under new management and with new capital influx, but if the damage is widespread it is likely to go into bankruptcy if other organizations do not make an offer to take over the beleaguered company. This is what happened to Barings Bank in the UK after rogue trader Nick Leeson brought the bank down in the 1990s by overexposure and huge losses in derivative trading. The company was eventually bought by German firm ING and survives under the name of ING Barings today. Not so lucky was the House of Maxwell, where its founder Robert Maxwell apparently committed suicide in the UK- subsequent investigations uncovered that he had misused employee pension funds and the company which was financially weak had to close down. So in developed nations, any kind of business enterprise is expected to operate under the rules of Law of the land and it cannot escape punishment if it is found violating these rules and indulging in dubious business practices. Corporate Governance in the UK In the UK, efforts at framing a code for corporate governance started with the Cadbury Report, which was set up after corporate scandals of the 1980s. It recommended the establishment of an Audit Committee (for internal control), a Nomination Committee (to oversee Board appointments) and a Remunerative Committee (to recommend remunerations of directors). These initiatives were implemented in 1993 for all listed public limited companies. The Greenbury Committee was appointed in 1995 to consider whether remunerations to higher managements were justified. It suggested that Remuneration Committees be made up of wholly Non Executive Directors of the firm, who had been independently hired. This recommendation was also implemented in October 1995. Further work on corporate governance as recommended by the Smith, Turnbull and Higgs studies were consolidated into the Combined Code of Corporate Governance 2003 which was amended in 2006 and became the UK Code of Corporate Governance which every UK public listed company is required to comply with today3 (Solomon, 2007, 45-47). Corporate Governance in the USA The USA has unfortunately been the scene of most of the corporate scandals and errors of the last decade. Enron, World.com and Madoff Investments are some recent examples. While the Sarbanes-Oxley Act 2002 did make some good recommendations regarding separation of ownership and control, and the disclosures relating to directors of corporations, few failures were revealed by these measures. In consequence, calamities like the sub-prime mortgage crisis continue to unfold on Wall Street. A positive step is the enactment of the Wall Street & Consumer Protection Act signed in July 2010 under which it is proposed to have a Consumer Financial Protection Agency to regulate items of consumer credit such as car loans, credit card loans and mortgages. In this way it is hoped that continued changes and improvements in the laws of corporate governance would limit instances of corporate fraud and failure. The reason behind corporate governance laws is not only to prevent corporate failures but also to protect the rights and money of citizens who have invested in these businesses as stakeholders. The Case of Enron In the case of Enron, it was deliberate misreporting of profits and revenues and hiding losses through creative accounting practices like special purpose entities4 and marked to market trading5 that helped the company avoid detection until it was too late. CEO Ken Lay insisted that the public be shown a rosy picture and he hired Jeff Skilling and Andrew Fastow as CFOs to ensure that this was the case6. Even the auditors Arthur Andersen were paid to look the other way. The Case of World.com World.com’s merger with MCI made it the second largest communications company in the USA after AT&T. Then CEO Bernie Ebbers with the connivance of the CFO, Comptroller and Director General of Accounting engaged in underreporting of line costs and inflating revenues to paint a rosy picture of the company to the public and shareholders. It was estimated that assets were inflated by as much as $11 billion. But it all fell down like a house of cards and WorldCom was forced to file for bankruptcy in 2008. The Case of Parmalat Parmalat was a dairy and food products based company that had a presence in Europe, the Americas, Australia and South Africa. It was the world’s largest producer of UHT milk. However the company made some bad errors of judgment while expanding and sought to invest in derivatives to make good the losses- which made it even worse. The company’s debts were more than twice that reported on its balance sheet, and it filed for bankruptcy in 2003 with Euro 14 billion gap between liabilities and assets. It was Europe’s biggest bankruptcy7. Suggestions to Improve the Role of Corporate Governance in Organizations The present thinking recommends the idea of non-executive directors, who are preferably retired directors of public or private corporations with a record of integrity and service. These directors should be appointed with the sole purpose of looking at the ethics of what the business is doing and the way it is doing it. Any suspicious activity or fraudulent practice or attempt to mislead must be delved into by the auditors and the board of corporate governance and the true facts revealed. There must be no mercy shown to the miscreants. Non executive directors could be rotated every three years or so (www.cimaglobal.com). No one individual should be allowed to have too much power and all key decisions must be approved by a majority of the Board of Directors. There must be an adequate system of internal control not only for audit purposes but for management purposes as well. Employee and management feedback to Human Resources or directly to the Corporate Governance Board should be encouraged while their confidentiality ensured. The names and addresses and email contacts of the members of the Corporate Governance Board should be known and accessible to all stakeholders of the corporation and published in the financial reports. Laws such as Sarbanes Oxley Act of 2002 and the UK Code of Corporate Governance should be implemented in true spirit without any qualms. The role of non-executive directors on the board and being entrusted with corporate governance has been commented on above. Hopefully the continuing emergence of wise and prudent controls and safety measures from our best social thinkers and intellectuals will help in reducing such crises in the future (1791 words). Bibliography CIMA Global (2003). The Role of the Non Executive Director: Making Corporate Governance Work. Accessed at http://www.cimaglobal.com/Documents/ImportedDocuments/NEDSmakingcorpgovwork_techguide_2003.pdf Fox, L. (2003). Enron: The Rise and Fall. N.J.: Wiley. Gumbel, P. (2004). How it all went so sour. Time Magazine, 21 Nov 2004. Healy, P. & Krishna G. (Spring 2003). "The Fall of Enron". Journal of Economic Perspectives, Vol. 17 Issue 2. MacLean, B. & Elkind, P. (2003). Smartest Guys in the Room: The Amazing Rise and Scandalous Fall of Enron. OECD (1999). Report on Corporate Governance. Accessed at http://www.oecd.org/topic/0,3699,en_2649_37439_1_1_1_1_37439,00.html Solomon, J. (2007). Corporate Governance and Accountability. Second Edition. John Wiley & Sons. Wearing, R.T. (2005). Cases in Corporate Governance. London: Sage Publications. Read More