Need for Global Corporate Governance Standards - Coursework Example

Need for Global Corporate Governance Standards Introduction Corporate governance is a critical issue the world over. Frustrations have characterised the performance of publicly traded corporations for decades, making interventions necessary to ensure smooth operations in corporations. Since the turn of the millennium, a flurry of unpleasant events has featured the performance of corporations. Scandals have rocked many corporations around the world, such as Enron, WorldCom, Arthur Andersen, Tyco and Adelphia. The scandals involved have created an atmosphere of distrust and doubt among the investing public.1 In addition, confidence failed in the capacity of investors to make informed decisions and the markets on which stocks of public corporations were traded weakened. The outcome of poor corporate governance is the prospect of business failures, severe declines in savings invested in corporate stocks, and massive job losses.2 However, it is not always uncomplicated to identify the causes of corporate failure. Many of the times the blame is placed on the ranks of some renegades in the corporation or systemic wrongdoing. The response has been that the media, government and a number of regulatory bodies are actively involved in the call for scrutiny of the performance of corporations. The calls have gone beyond investigating organisations that have failed, touching even those that are of good economic health to ensure that they perform effectively and deliver according to the objectives set for them. There are many regulatory standards for corporations the world over. A big question however is whether these standards are able to tame malpractices in corporations. This paper thus highlights the state of affairs in global corporate governance and the need for global standards of corporate governance. The paper presents and analyses cases related to corporate governance and addresses the impact of having global standards of corporate governance. The Essence of Corporate Governance Corporate governance has gathered interest over the years. In academic studies, the focus on corporate governance had been fundamentally interdisciplinary, with much of the work being undertaken by researchers from fields of economics, finance, management, law and accounting.3 Corporate governance refers to the means through which suppliers of finance to corporations assure themselves of obtaining a return on their investment.4 This implies how suppliers of finance involve managers to return some of the profits to them; how they make sure that managers do not pilfer the capital they offer or channel the funds to bad projects; and how the suppliers of finance control managers.5 Put in another way, corporate governance implies to the ways in which companies are controlled and directed. This takes into account elaborating the respective roles of the board of a corporation, the role of the shareholders, and the role of the auditor – which have to be well coordinated to ensure productivity of the corporation. Corporate governance revolves around a number of issues, including examples such as the board’s application of corporate policy in combination with corporate governance structures to control over-investment, or an arrangement that incorporates payout policy and incentive contracts to bring into line the interests of managers and those of lenders or shareholders.6 In addition, corporate governance touches on the actions that are taken by external parties such as financial institutions or substantial shareholders to address costs that may occur when the firm’s controllers pursue their own interests while disadvantaging those with legitimate claims.7 When corporations fail to address the highlighted areas, they are likely not to deliver the expected results. In contrast however, corporate governance that adheres to high standards inarguably ensures that all players in firms reap the benefits they anticipate. The Commonwealth Business Council notes that by adopting and maintaining high standards of corporate governance that have been accepted internationally, businesses can demonstrate that open and market-based economies can perform to the mutual benefit of players.8 In addition, firms need to demonstrate that they can go beyond raising the standards of living and offering high quality goods and services in the host country. They need to show that the process can be sustained domestically and internationally by also ensuring that they honouring labour and environmental standards. Importantly, firms have to eliminate corrupt practices and ensure that ethical concerns are addressed with utmost care. Along the same perspective, it can be noted that “good” corporate laws can create enough confidence in corporate governance that players such as shareholders and lenders feel comfortable with entrusting their money to professional managers.9 Scope of Corporate Governance in the World Without a critical analysis of the performance of corporations, it can be assumed that the corporations are performing well and do not deserve any close scrutiny. However, examples of corporate collapse such as WorldCom and Enron in the United States highlight the need to tighten the assessment and control of corporations. In the 1990s before Sarbanes Oxley Act came into force in the United States, it was believed that the system of corporate governance in the United states was flawed, and that a major move from the existing corporate form to much more leveraged forms of governance was in order.10 A similar situation was experienced in the United Kingdom until 1991 when the Cadbury committee was established and tasked to identify what it regarded as the best features of corporate governance.11 Yet another example is India, and as Shankaraiah and Rao note, the accounting standards in India are inadequate.12 This means that disclosure is ineffective, which is obviously a negative aspect to a country that wishes to become a global player. Along the same line, New Zealand appears to have an effective corporate governance system but lacks an oversight body comparable to the Public Company Accounting Oversight Board (PCAOB)13 of the United States and the Professional Oversight Board for Accountancy (POBA) of the United Kingdom.14 In Asia, the Survey in Corporate Governance in Emerging Markets conducted by Credit Lyonnias Securities Asia in 2002 showed that Hong Kong and Singapore had the highest levels of corporate governance in Asia.15 Further, a survey on attitudes to corporate governance in China and Southeast Asia by the Association of Chartered Certified Accountants in 2002 showed that 60 percent of Chief Financial Officers in China, Singapore and Hong king had increased their awareness of the need for effective corporate governance. Different countries have reacted to different corporate scenarios differently. For instance, the United States adopted the Sarbanes Oxley Act of after the collapse of WorldCom and Enron due to major scandals.16 In the same perspective, the United Kingdom learnt from the experiences of high-profile scandals such as Parmalat and Ahold to strengthen the combined Code on Corporate Governance.17 The varying levels of corporate governance in different countries represent differences in global corporate governance practices. Yet there are arguments on which standard practices can be adopted around the world. Over time, Anglo-Saxon systems of corporate governance have been used in many countries, but changes in global business have necessitated significant changes, with some players calling for adoption of practices patterned after Japan and Germany.18 Nevertheless, the United States, Germany the United Kingdom and Japan are highlighted as countries with some of the finest corporate governance structures in the world.19 How the different practices can be combined to form a global standard of corporate governance is therefore amenable to discussion. One point that remains clear however is that it is possible to have systems that may not necessarily have similar characteristics in total, but which share a number of significant elements of good corporate governance. The need for global standards of corporate governance A number of organisations are involved in ensuring that there are standard practices of global corporate governance in many regions of the world. These include the Commonwealth Association for Corporate Governance (CACG), the Organisation for Economic Co-operation and Development (OECD), and collaboration efforts between OECD and the World Bank. The need for harmonising different corporate governance practices is driven by the fact that there are inherent differences between the various forms of governance that exist today. For instance, the corporate governance approach in the United Kingdom is more principles-based, which implies that companies have to comply or explain their deviations from compliance.20 This flexible approach to governance, coupled with the fact that a corporation’ shareholders in the United Kingdom are in a much stronger position as compared to those in the United States to nominate directors and forward their declarations, have put the United Kingdom capital market in a position that is more attractive to IPOs. Nonetheless, different types of corporate governance are susceptible to different types of financial scandals and misconduct. For example, the dispersed ownership system of governance in the United States is vulnerable to financial mismanagement schemes (good examples are WorldCom and Enron) while a concentrated system of ownership is more susceptible to appropriation of private benefits (as was the case of Parmalat).21 It is noteworthy that even in the wake good corporate governance standards in many countries, there is no guarantee that corporations are protected from malpractices as the standards set vary between regions. In some cases, differences between the nature of economies dictate that some governance principles used in some countries may not be easily applicable in other countries. For instance, laws styled like the Sarbanes-Oxley Act of 2002 (United States) may be too expensive for smaller economies such as New Zealand and the developing countries of Africa and Asia to adopt. To understand why some forms of corporate governance may not be appropriate and hence emphasize the need for global corporate governance standards, it worthwhile to highlight the causes of corporate failure. The main causes of corporate failure (irrespective of the geographic location of the corporation) can be summarised into six categories as (1) poor strategic decisions, (2) overexpansion and ill-judged acquisitions, (3) dominant CEOs, (4) greed, hubris and the desire for power, (5) failure of internal regulations at all levels from the top downwards, and (6) ineffectual or ineffective boards.22 It is thus evident that it is not possible to tame all the possibilities of corporate failure (given the failures that have occurred in the past). Nevertheless, there is need to put in place measures that can curb the tendencies to failure as much as possible. Because of the nature of multinational corporations, it is not possible to have a single set of regulations such as the British Combined Code, the Swiss Code of Corporate Governance or the Sarbanes-Oxley Act. It can generally be noted that the quality of firm-specific corporate governance increases as the number of corporate governance norms that are adapted increases.23 Thus, it is more appropriate for multinational corporations to adopt international corporate governance standards, which will be applicable irrespective of the area of jurisdiction. This is because the solely reference on local national regulations is not sufficient to attract international acting investment funds or other investors, as national laws and guidelines do not reference all international best-practice regulations.24 This implies that a high degree of compliance with the respective national standards of governance may serve as a clue for “good” national corporate governance, in the purview of international standards, this is not valid.25 The point is that it is important to have global standards of corporate governance because such standards are wide-ranging and applicable to wide range a wide array of firms, which may not be the case with national standards in many countries. This point can be emphasized by the remarks made by former president of the World Bank that “The governance of the corporation is now as important in the world economy as the government of countries”.26 This means that corporations have to recognize the assessment of “good’ corporate governance is determined by the focus on international standards. Further, the essence of having international corporate governance standards is the improvement of the organisation and governance standards of organisations in various ways.27 Case studies on the need for international corporate governance standards A number of cases can be used to highlight the significance of having a code of governance that can be used across many regions. These are discussed next. Germany Efforts to achieve good corporate governance in Germany were not successful until 1995. Most of the giant companies in Germany were still largely run by management boards with modest external control.28 Nevertheless, some events led to the acceleration of Germany’s corporate governance matters. These included: 1. There were well publicised failures in blue chip companies such as Holzmann and Metallgesellschaft, which led to the urgency of governance improvements, including increased political attention that led to the formation of a government commission by the German chancellor.29 2. There was an increase in the number of shareholders to the Deutsche Telekom to around 13 million, which necessitated more scrutiny of such giant corporations to protect shareholders’ interests.30 3. Competition increased in the asset management sector. In order to win clients, there was need to create opportunities for increased performance. This was sought through the pursuit of better corporate governance standards.31 Further, there is evidence that companies that demand good governance standards show comparatively higher market valuations. This is shown by the fact that a study conducted in Germany by McKinsey and the World Bank revealed that large international institutions were keen to pay a 13 percent premium for German companies with good corporate governance.32 In addition, an empirical study by Harvard and Wharton business schools for a period of ten years until 1999 showed that companies with excellent corporate governance performed on average 8.8 percent p.a. better than those companies with poor corporate governance.33 Further, a governance index that consisted of 91 companies from the German stock exchange showed that on average there was an additional 12 percent p.a. return between the best and poorest performing corporations between 1998 and 2002.34 The United Kingdom In its report titled the “The UK Approach to Corporate Governance,” the Financial Reporting Council notes that “Good corporate governance is essential to the effective operation of a free market, which enables wealth creation and freedom from poverty.”35 Further, the Council states that “The more ingrained the system of corporate governance in a business community, the less the need for detailed regulation to ensure effective compliance with good standards of business behaviour.”36 The Council also recognises the fact that the most important relationship is between the company and its shareholders rather than between the firm and the regulator.37 Hence, boards and shareholders are persuaded to be involved in dialogue on corporate governance issues. Analysis The two cases above show that focus on corporate governance is aimed at strengthening the relationship between a company and its shareholders. As it has been discussed, companies that show more compliance to corporate governance standards appear to achieve better performance and are more popular. Thus, in order to develop this trend, there is need to have standards that apply worldwide, as many companies operate in more than one country. A comparison of models of governance used in various countries shows that differences in management (such as board structure and function) are diminishing (table 1) and this shows that there is a trend of convergence toward global corporate governance standards. Table 1: Comparison of the changing attributes of the board model in various countries United States United Kingdom The Netherlands Board model One-tier One-tier Two-tier Board meetings Combined Combined Predominantly combined Board size and composition Board size - Stable Stable Non-executives ++ Stable Stable Executives -- Stable Stable Board leadership CEO/chairman split Modest support Strong support Determined by law Lead directors Strong support Modest support Not applicable The number of board committees Audit ++ ++ + Compensation ++ ++ + Nomination ++ ++ + Independent committee leadership ++ ++ No data available Source: Adapted from Maassen38 From table 1, it can be noted that one-tier boards are becoming more independently constituted and organised in the United States and the United Kingdom. It can also be noted that integrative board attributes are integrated in two-tier structures to enable the integration of decision control with decision management. Further, directors who operate with one tier boards are progressively changing their governance systems to adapt to new standards of corporate governance.39 The above analysis indicates that the diffusion of self-regulation in corporate governance has become visible not only in Europe but also the United States. Notably, the changes are driven by the desire to introduce codes of best practice and guidelines, modify the listing rules of stock exchanges, globalise and unify equity markets, harmonise corporation laws, and to emphasise the responsibility of institutional investors in company governance issues.40 Efforts to have Harmonised Corporate Governance Standards There are a number of cases to highlight the fact that global corporate governance standards are essential. Even though there are not internationally applied standards, the existing regional standards can be used as an epitome of such standards. The OECD Principles of Corporate Governance41 These Principles were agreed in 1999 and have formed the foundation for corporate governance schemes in both OECD and non-OECD countries alike. In addition, they were adopted as one of the Twelve Key Standards for Sound Financial Management Systems by the Financial Stability Forum. The Principles also form the basis of the corporate governance component of the World Bank/IMF Reports on the Observance of Standards and Codes.42 Among the key provisions of the OECD Principles of Corporate Governance include43: Principles that cover disclosure have been strengthened, especially those regarding conflicts of interest and related party transactions There is a new principle that appreciates the role of various providers of corporate information, for instance analysts and rating agencies, whose counsel should not be compromised by conflicts of interest. The roles of auditors have been strengthened to include accountability to shareholders and a duty to the company to practise due professional care in the conduct of audit. In addition, greater attention is paid to ensuring the independence of auditors, including steps to manage and reduce likely conflicts of failure. Greater consideration is given to the protection of minority shareholders It can be noted that the provisions above are can be applied in specifically to deal the loopholes that result into corporate failure – this applies to the six causes of corporate failure that were discussed earlier in this paper. OECD was joined its efforts to have corporate governance standards that can be applied across many countries by the World Bank, the Asian Development Bank, the United Nations as well as other international agencies.44 These efforts are meant to equip companies throughout the world with governance structures that might help in their own growth and success and increase their chance of attracting capital investment from increasingly well-informed markets.45 The wide range of initiatives are aimed to address specific governance problems of the different regions of the world. The pressure to have harmonised corporate governance standards is also driven by the need for firms to adapt and adjust as a result of globalisation.46 Notably, the products produced by firms have to compete directly on quality and price with those that are produced internationally. This calls for a de facto convergence of cost structures and firm organisation, which might in turn have a spill-over effect on firm behaviour and decision-making.47 The Commonwealth Association for Corporate Governance (CACG) CACG was established in 1998 following the Edinburgh Declaration of the Commonwealth Heads of Government meeting in 1997 to foster brilliance in corporate governance in the Commonwealth48. Its primary objectives are to promote good standards in corporate governance and business practices within the Commonwealth and to facilitate the development of relevant institutions that can be used to advance, teach and propagate such standards.49 Six of the 15 provisions of the CACG are highlighted by the Commonwealth Business Council50 as: Principle 1: Exercising leadership, enterprise, integrity and judgment in directing the corporation to achieve prosperity. Principle 2: Ensuring that board appointments are a mix of proficient directors, each with an ability to add value to the corporation Principle 3: Determining the corporation’s purpose and values in order to chart a successful path for the corporation. Principle 4: Monitoring and evaluating the implementation of strategies, policies, business plans and management performance criteria Principle 5: Ensuring that the corporation complies with all relevant laws, codes and regulations of best business practice. Principle 6: Ensuring that the corporation keeps in touch with shareholders and other stakeholders efficiently. From the analyses above, it can be noted that both the OECD and CACG have attempted to initiate corporate governance regulations that are sensitive to the changing market needs. Hence, it is inarguable that there is need to have corporate governance standards that will be applicable across a many countries beyond the OECD and the Commonwealth. This is driven by the fact that new opportunities are being opened in regions outside the discussed bodies. Yet the firms in the new markets also need to comply with well-known corporate governance standards. Conclusion It has been discussed that the need for global governance standards is driven by the need for firms to demonstrate that they can go beyond raising the standards of living and offering high quality services and products. Firms need to show that good governance can be sustained both domestically and internationally. This is emphasised by the revelation that firms that show more compliance to good corporate governance appear to perform better and are more popular. In addition, it can be noted that it is a high time firms realised that the assessment of “good” corporate governance is determined by paying attention to international standards. Moreover, having international corporate governance standards will raise local corporate governance standards significantly. Read More