Management Credibility and Honesty - Essay Example

Management Credibility and Honesty Introduction For any capitalist economic structure financing is fundamental to the viability of the companies and thus the preservation and availability of funds depends on the efficient allocation of resources by the economic agents from financial markets to productive investments, e.g. for the creation of new ventures or to finance the growth process of established companies. In this vein efficient allocation depends on the investors expected return, and also on the investors belief that the firm will be managed in order to maximize the returns from investment and the working capital for effective Rate of Return and thus investor confidence depends heavily on a number of factors like legal, institutional and regulatory environment that guarantees the investor protection.. The main outcomes of well managed corporate system run with honesty and credibility include enhanced shareholder value .An important performance measure for any company remains the query whether it has transparency and credibility in its dealing with stock price, financial growth or customer satisfaction. Many companies like the Enron (as mentioned below) have suffered in the past due to their abuse of customers, employees and shareholders alike. Many companies unfairly use accounting gimmicks and excessive compensation for lackluster performance which can strain their credibility with the financial community. Honesty and credibility are necessary for the ability of a company to effectively compete, innovate, and provide standard-setting customer service and support and bring about corporate governance produce impeccable business ethics and retain credibility by focusing on . - Audit and Governance; - Human Resources and Compensation; - Product Development and Acquisition; - Strategy and Organisation. A company which ignores management and credibility in its dealing with the working capital will in the long term be characterised by a negative return over the time and ultimately it will have damaged the trust of its shareholders due to its accounting manipulations.There will be a weakened balance sheet through excessive debt and poor working capital management. Based on the above problems this paper reviews through the example of the Enron Saga the importance of management credibility and honesty on working capital management for company and the effect of bad management credibility and honesty. The significance of management and the link with working capital Cooke and Williams (1998) state that without planning it is difficult to envisage the successful conclusion of any project or the effective control of time, money or resources. Planning is essential throughout all stages of the process from inception through to design, tendering, construction and commissioning stages of a project. The reasons for planning are summarised below. To aid contract control To establish realistic standards To monitor performance in terms of output, time and money To keep the plan under constant review and take action when necessary to correct the situation It is an essential function of management to prepare forecasts in order to establish a plan for the future of the business. Without a plan against which to monitor performance, management has no control and no business can be run successfully without keeping close control over the day- to -day finances. This involves providing the information necessary for keeping managers informed so that decisions can be made about how business should react to current circumstances.When managing a project, or number of projects, accurate scheduling is critical to success. Double- booked resources, inaccurate information, mishandling of materials, and more can cause significant delays in the project that result in massive profit loss. It is vital therefore that a form of cash flow monitoring is in place. Financial plans are called budgets, and the process of making, monitoring and adjusting them is called budgetary control.Hall (1974) identifies budgetary control as an important management technique used for the purpose of controlling income and expenditure. Control is achieved by preparing budgets relating to the various activities of the business, and these provide a basis for comparison with actual performance.Harper (1976) defines a budget as a ‘monetary cost plan relating to a period of time’.Pilcher (1975) indicates that a budget is a financial plan for the contract as a whole and is a financial version of the programme.There are various types of budgets; Harris and McCaffer (2000) identify these as; operating budget, annual sales budget, capital expenditure budget, cash flow budget and master budget. Cash Flow budget is described by Cooke & William, (1998) as a forecast of the movement of moneys in and out of the business in order to determine company borrowings (working capital requirements). Contracts that are in progress not only have documents in the form of programmes, materials schedules, payroll records, etc., but have behind them the realisation of risk and the probability of profit. If good records of expenditure are kept, a monthly report of cost based upon accounts paid, can be drawn up without considerable difficulty. This necessitates the use of free and fair process consultation. “Process consultation is a set of activities on the part of the consultant that help the client to perceive, understand, and act upon the process events that occur in the client’s environment” (Schein, 1987).Process consultation is one of the methods engaged that management consultants use to help organisations to undertake change. It is part of an organisational development field (French & Bell, 1999), in which the role of the consultant is to help others to help themselves.. Dawson (2000) and (Boyd and Chinyio, 2006) believe that process consultation could develop as a key industry skill, for which it would get recognised and paid, and that many directors/project managers may adopt this role, even though their contract is about task management.In particular, the process consultation technique is similar to Heron’s (1990) catalytic intervention with a client, whereby the aim is to elicit self- discovery, learning and problem- solving. (Boyd and Chinyio, 2006) Management and organisation are two vital components when dealing with cash flow. Henri Fayol in the early twentieth century devised the principles of management, and they are as applicable today as they were then. The seven principles comprise: Forecasting and planning Organisation Commanding or directing Controlling Coordination Motivation Communicating, which encompasses them all These seven main principles have been reiterated several times since, by management writers, including Brech, Denyer, Drucker, Calvert, Cole and Clutterbuck. (Cooke & Williams, 1998). Ethics and working capital Nisberg (1988:43) has defined business ethics as “a set of principles that guides business practices to reflect a concern for society as a whole while pursuing profits” Hackley (2005), defines ethics as a system of moral principles and rules of conduct that a society develops overtime. He further refers to ethics as what is right, good or consistent with virtue. Corporate Social Responsibility is the degree of moral obligation that may be put upon corporations apart from the normal laws of the state. The corporation is an individual and is amenable to treatment as an individual under the law (Nisberg, 1988, p. 74).The link between ethics and social responsibility is pivotal to a company’s long term growth .From a business point of view “ Good ethics is often good business”. Today we have a revival of the conceptions of Corporate Social Responsibility. It is reported that ethical investment funds amounting in the USA to $650 billion in 1996 (Punter and Gangneux, 1998), and over 1,400 companies belong to Business for Social Responsibility, (Punter and Gangneux, 1998).(BSR) In America the BSR has played a vital role in reinforcing marketing ethics and corporate social responsibility. Other Ethics watch dogs have been established aswell and they promote ethical behaviour(see the Nader Page located on the Web at http://www. nader.org/).There is a newfound trend in marketing and business ethics where large corporations publicize their business ethics programs on the Internet. Take the example of Shell Oil, where, after a number of environmental and public relations problems, decided to commit to recyclable and environment friendly energy and publicly promotes human rights worldwide. Again if we see the stance of the Body Shop it has found great success in having a trade charter that focuses on human rights, long term support for needy communities, environmentally sustainable resourcing, and animal protection. The ethical background of such products seems to have contributed significantly to their success.Another example is the popular coffee house chain of café’s namely Starbucks. The chain became successful for its contribution to good causes for being a top donor to the international aid agency, CARE. (See Stainer 1995). The impact of People Management on Working Capital The issue of “people management” is not clearly defined in the literature, with many conflicting definitions being used by different authors. Components of people management that will be examined include: 1. Leadership activities and strategies 2. Performance evaluation 3. Compensation management 4. Inter-group communications and management 5. Organizational management In essence, people management theory argues that if management implements a specified set of employment as well as work practices, it is going to lead to better performance (Boxall and Purcell 47-70). A lot of the practices such as teamwork, redesigned jobs, employee participation, teamwork as well as communication and information sharing - have been shown to improve performance, but not in a consistent manner (Appelbaum et al. 737-775). The strongest results have been obtained where models appear to approximate the real world of work and where measurement and sampling errors are reduced by using special-purpose surveys targeted at workplaces in specific (Appelbaum et al. 737-775) A common thread running through these studies is that people management contributes to high performance where workers are expected and encouraged to perform at a high standard. This occurs where HR and work organization practices provide workers with discretion or control over their work, where they are developed to work competently, and where they are supported and rewarded by management to work co-operatively with colleagues. Theory suggests three mechanisms - structural, motivational and cognitive - that lead to high performance. Structural alterations, for example, the creation of teams or introduction of a new reward system, may provide an initial rather than continuing improvement in performance. For continuous improvement, employees need to increase and sustain their motivation at a high level - a possibility that arises through perceptions and emotions related to greater work satisfaction and empowerment - and/or cognitive changes need to be introduced. These might include improved management communication and investment in formal training and/or on-the-job learning (Appelbaum et al. 737-775). The last 2 decades have seen a significant shift in human resource management (HRM) research from an essentially micro-analytical approach to a new macro-strategic perspective. Other from the conventional administrative role, HRM has identified new roles in terms of employee champion, change agent and strategic partner. Over the years, there has been much speculation about the role of the HR in the organization going ahead. Authors and business gurus have made various predictions regarding the role, function as well as size of the HR department. HR responsibilities have typically come under fire as a result of its perceived unresponsiveness as well as administrative and not strategic focus along with the perception that they are cost centres and not star wealth creation centres they bring in the revenue. This is particularly clear when we consider issues like cost reduction as well as life cycle model that is evident in most organizations, these are discussed later. Although there are various stakeholders in an organization, the chief strategic goal of any business is higher financial performance or maximization of wealth for the shareholders (Becker and Huselid, 53–101). Financial performance of an organization depends to a large extent on effective operational performance. The operational performance of an organization is a function of people, process and technology. People management has become a significant part of the line manager’s job and plays a crucial role in performance management. Honestly and Credibility of a Company: The Enron Saga This section examines the relevant events leading up the Financial Collapse of Enron and its impact for the future of financial reporting in line with the assessment of the impacts of honest and credible management on working capital. The essay goes on to discuss the valuable lessons from financial reporting and the preparation of published financial statements. On October 16, 2001, Enron Corporation of Houston, Texas, one of the largest corporations in the world, announced it was reducing its after-tax net income by $544 million and its shareholders' equity by $1.2 billion.1 On November 8, it announced that, because of accounting errors, it was restating its previously reported net income for the years 1997–2000. These restatements reduced previously reported net income as follows: 1997, $28 million (27% of previously reported $105 million); 1998, $133 million (19% of previously reported $703 million); 1999, $248 million (28% of previously reported $893 million); and 2000, $99 million (10% of previously reported $979 million). 1 On December 2, 2001, Enron filed for bankruptcy under Chapter 11 of the United States Bankruptcy Code. With assets of $63.4 billion, it is the largest US corporate bankruptcy.2The Enron Scandal was the most controversial time for the American Financial Markets as the tax-deferred 401(k) retirement plans of the Enron employees were reduced to nothing. The reason Enron's bankruptcy concerns the field of accounting greatly is that its prominent ,long-time auditor, Arthur Andersen, was charged with a large dereliction of duty and even fraud by the press and members of the US Congress and is still facing countless lawsuits.The current position in the Aftermath of this fiasco is that the Securities and Exchange Commission has called for the creation of a new oversight body to regulate and discipline published financial reporting.The SEC, the Financial Accounting Standards Board (FASB), and the American Institute of CPAs ( AICPA) are all under constant fire for not having clarified and properly implemented the GAAP rules relating to special-purpose entities which were the sham vehicles of Enron's shoddy accounting financial statements. 3 The following table shows some of the accounting statements/figures for Enron 4  This table shows some of the information that was used to mislead the public about the health and wealth of this promising company. Enron became a household name during its zenith, due to its promising financial records. This table shows the data from Enron Corps Annual Reports with its very promising figures concerning the records of its unconsolidated affiliates. _ This graph5 shows how as early as the end of 1999,the warning was clear in the form of an uncontrolled share price rate increase, followed by the share price exceeding the share price capacity, chaos and then collapse. Lessons from Enron: A Company which suffered from the lack of Honesty and transarency. Academics have often blamed the decline in audit quality and transparency in firm performance for the reasons such disasters occur and the rise of the limited liability firm. The reluctance and diminution in the incentives of accounting firm partners in monitoring the practice of their co workers led to the gross mishandling . 1. The removal of aid and abetment provisions for auditors made them less vigilant after the Public Securities Litigation Reform Act 1995. 2. The fact that auditors today provide consulting services erodes auditor independence as the balance of power shifts from the auditor and to the discretion of the client . “ consulting services provide a means by which audit-clients can reward auditors for succumbing to the client's wishes about what accounting treatment should be used to report novel or complex transactions and business practices”6 3. The inability of the accounting firms has been about the quality of their internal corporate governance. Another criticism of accounting practices which lead to Enron like disasters is the large amounts of payments meted out to auditors like Anderson who is reported to have been paid a whooping $25 million in audit fees and $27 million for non-audit consulting.There is growing concern that CPA’s should be prohibited from offering non-audit services on the assertion that these fees corrupt the independence of CPAs. The future of published financial statements and accounting in the light of the Enron Disaster In the light of the Enron’s disaster the future of published financial statements is all set to change and efforts are already underway to never let a such a large scale lie breed so healthily ever again. Published financial statements should be subject to laws concerning misrepresentation and fraud and the use of shoddy accounting practices like the setting up of fake SPE’s should be investigated by independent third parties. When a company as large as Enron is operating it is inevitable that it has the risks of many stakeholders involved. The drawing of large remunerations by the directors and the use of SPE’s was not dealt with strictly at that time.In the future any such practices should be discouraged and the destruction of financial statements of public importance should also be made a criminal offence.This is because the directors in this case were trying to get away by using the “paper shredder”.Never again should any company be allowed to practice such a large scale fraud and therefore in this light the use and abuse of published financial statements needs to be governed by criminal law.In England the Companies Act 2006 has taken strict notice of such accounting frauds and imposes heavy penalties upon companies who use fake or misleading published accounting records.The UK has recently gone through a current auditor liability reform process in order to reform the ways in which government considers the replacement of joint and several liability by proportional liability. The audit industry is used to be the only professionals that can't limit its liability. It claims to be an unfair victim of litigation and has deployed its considerable energy in a campaign to obtain liability concessions. They had longed for a proportionate liability regime where the recent resolutions in Company Act 2006 ultimately provided desired outcome. The Joint and severe liability regime dominated audit profession in most countries before 1975. The focus of legislative framework at that time was to protect the interest of aggrieved party. To study the motivation for liability reform, accountants tended to study relatively pioneering and often geographically isolated US regulations. During the period 1975 to 1999, the audit liability environment in US changed substantially.Concerns about auditor liability became intense starting from early 1980s (Arthur Andersen et al. 1992), where greater litigation pressure was reported from increasing frequency and large settlement against auditors . Around 1990 these concerns led the audit profession to press for changes in legal standards of auditor liability, and the next few years were characterized by a series of significant change in US auditor incorporation and liability reform. During the effort in support of the enactment of Private Securities Litigation Reform Act 1995, the American Institute of Certified Public Accountants (AICPA) admitted that public policy of excessive auditor liability is an adverse impetus in providing quality audit service (Cook et al., 1992). The threat of litigation liability acts as deterrent power for audit firms to engage risky clients .Recently the UK has passed the companies Act which promises enlightened shareholder Value and greater transparency in the dealing of the working capital of an organization.All this is one giant step towards enhanced corporate governance the pith and substance of which is shareholder protection and protection from abuse for the working capital of a company. References 1. Nisberg, J.N. (1988), The Random House Handbook of Business Terms, Random House, New York, NY., 2. Punter, L., Gangneux, D. (1998), "Social accountability: the most recent element to ensure total quality management", Total Quality 3. “Is it ethical to compete on ethics?”Stainer A, Stainer LBusiness Ethics: A European Review (UK), 1995 Vol 4 Issue 4 4. C. 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