Corporate Governance and Accountability - Case Study Example

Contents Corporate Governance 2 Corporate Governance Failures at Enron and Xerox 5 Conclusion 8 References Corporate Governance Davis (2006) cites the definition of corporate governance provided by the Cadbury Committee Report of December 1992 stating that corporate governance is the ‘system by which companies are directed and controlled. Boards of directors are responsible for the governance of their companies. The shareholders’ role in governance is to appoint the directors and the auditors and to satisfy themselves that the appropriate governance structure is in place.’ Another definition is cited from the Higgs Report stating that ‘Corporate governance provides and architecture of accountability- the structures and processes to ensure companies are managed in the interests of their owners.’ Corporate governance refers to the structure which ensures that the right questions are asked and checks and balances are in place to make sure that the answers to these questions reflect what is in the best interest of the organization for long-term sustainability of value (Minow & Monks, 2008). According to Davis (2006) corporate governance can be viewed as a system for optimizing the contributions of a number of stakeholders to a purpose they are persuaded to share. These stakeholders involve shareholders; the board of directors, customers, employees, suppliers, community and the government. Effective corporate governance has a profound effect on how well a business performs. Organizations which have found effective means of governing their businesses are prosperous and remain prosperous. The board’s inability to establish a sound governance model gives rise to the probability of failure of the enterprise (Colley et. al, 2004). The purpose of corporate governance is to ensure the survival and success of the organization (Davis, 2006). Good corporate governance requires a complex system of strict checks and balances. The three key actors in corporate governance are the management, directors and the shareholders. (Minow & Monks, 2008) ‘What is Corporate Governance?’(2004) states that for corporations a typical governance model includes the following elements: Effective board of directors that carries out responsibilities with integrity and competency A competent CEO hired by the board to run the business The CEO’s selection of a good business in an industry in which the firm can compete effectively and profitably, with the board’s consent The creation of a valid business concept by the CEO and management with consent of the board. Appropriate implementation of the business concept with goals and directions set by the board, resource planning and effective execution of plans carried out by CEO and the alignment of board and management objectives with those of shareholders. A system to ensure that the obligations to stakeholders are met with integrity and under compliance with the laws and regulations. Full and timely disclosure of the business performance to the investment community In the book Best Practices in Corporate Governance (2006), the author highlights eight core dimensions of corporate governance. These include; Identity of the organization which requires the organization to be clearly defined. Purpose which clarifies what the company aims to do and gives the organization a sense of direction. Leadership as a driving force behind corporate governance maintains focus on the purpose and enables those involved in working to achieve it. Distributing power in corporate governance refers to the sharing of power, accounting for its use and avoiding its abuse. Inclusiveness and communication is significant to corporate governance because it is the basis of trust building, it is the involvement of stakeholders and openness and transparency with them. The pattern of accountability required Maximizing effectiveness for the achievement of an agreed purpose. Ensuring sustainability through focus on achieving sustainable results. The balance of power both within and outside the organization is essential for governance. The exercise of power needs to be controlled to ensure the achievements of the agreed purpose. The board undertakes a huge fiduciary responsibility when it assumes the obligation to represent interests of owners, who do not represent themselves. In the course of this representation they are required to demonstrate integrity as well as the competence to make sound decisions (Colley et. al, 2004). Although the essence of corporate governance has been spelt out, corporations and those working for them do not always succeed in implementing them in practice. There are many examples of organizations which have crumbled due to their failure to implement these practices. Two such organizations are Enron and Xerox. An analysis of their corporate governance structures reveals that they were ineffective and eventually led to the collapse of these organizations. Corporate Governance Failures at Enron and Xerox In the Enron case, according to Solomon (2006) unregulated power in the hands of the CEO is only one of the most evident corporate governance problems faced by Enron. The overall corporate governance in the organization was weak. The Enron leadership was inappropriate and consisted of a number of immoral people willing to take part in fraudulent activities. The company’s non-executive directors were compromised due to the conflicts of interest. The function of the non-executive directors in the company was weak since they were unable to detect fraudulent activities in the internal audit. The internal audit committee itself failed in policing its auditors. The people holding responsible positions in Enron, those who should have detected fraud were not independent.. A similar governance issue in Xerox was highlighted by the SEC in a press release in 2003 was that the CEOs of the company Allaire and Thoman allegedly set the tone for the malpractices in the company by equating business success with the short- term earning targets. The employees in the finance department were allowed to make accounting adjustments to falsely show the company’s meeting of financial goals. These results were then communicated to the shareholders. The internal audit committee at Enron failed to perform its functions of internal control and monitoring the external audit functions (Solomon, 2006). The outside monitors failed in executing their responsibilities by neglecting their responsibilities or being co-opted by the Enron management to lose objectivity (Gadossy & Sonnenffeld, 2004). The audit committee is responsible for the authenticating the accounts activities of an organization and to identify any wrongdoings in the organization (Ahmed & Annam, 2006). Anderson was working as the company’s external auditor as well as a consultant this relations was getting criticism for leading to compromised audits. The audit firm was also functioning as Enron’s internal auditor, the combination of both activities raised criticism since it was felt that this led to compromising and inefficiency of both internal and external auditing (Gadossy & Sonnenffeld, 2004). There was also inaccurate representation of accounts at Xerox which misled and betrayed the investors. The company’s actual financial performance was concealed by creative accounting showing operating results which were substantially better than the company’s actual performance. Xerox used many accounting actions to manage the quality of its reported earnings. In 2002 a complaint was filed by the Securities Exchange Commission against Xerox for civil fraud. this was a result of the evidence uncovered in the SEC led investigations which revealed that the profits at Xerox had been overstated by $3 billion and the profit by $1.5 billion in the four year period starting in 1997 (Newquiest& Russell, 2003). Under the traditional theory of corporate governanabe the board of directors acts as an active management monitor for shareholder benefit. The concepts of independence and equity are central to monitoring. The equity share gives the board members goals and incentives to exercise frequent objectivity. To fulfill their responsibilities the board members need to be independent of management and should have an equity stake in the enterprise. Independence offers management the distance necessary to monitor the management effectively (Gadossy & Sonnenffeld, 2004). The board of directors is responsible for implementing good corporate governance. Although the board does not participate in the day-to-day activities of the organization, it is responsible for monitoring the activities of the CEO and the top management. The board should not have any conflict of interest with the corporation, since this leads to the chance of undermine the corporation for personal gains (Ahmed & Najam, 2006). The lack of independence leads to ineffective monitoring because it makes the directors comfortable with management and raises relational concerns not allowing the directors to disengage from it to monitor the actions objectively. The Enron directors had equity but lacked independence from management. (Gadossy & Sonnenffeld, 2004) In the Enron case many of the board members were not independent, they were found to have some ties with the company, which is the reason why many questionable actives of the company went unnoticed. And the chairman and the CEO were the same (Ahmed & Najam, 2006). The similar situation of poor corporate governance is evident in the Xerox case as well. The company had received notification from the Securities Exchange Commission for poor performance. The main reason highlighted was the fact that the Xerox board consisted of the same members that were present when the company was undergoing a financial crisis. The company also had combined roles for CEO and chairman As a result of this the company was losing investor confidence, even though effective corporate governance requires independent directors on the board (Mallin, 2007). The Enron collapse can be attributed to the organizations failure to implement effective corporate governance. The company had poor internal controls and disengaged top management (Fox, 2003).The company’s failed corporate governance is evident in the boards blind faith in the top management and its continued endorsement of top management proposals without authenticating or verifying the information, and no accountability (Ahmed & Najam, 2006). The primary failure in corporate governance in the Xerox case was the auditors. The company was primarily investigated due to revenue acceleration. Although the auditors voiced their concerns over the accounting practices at Xerox, they did little to raise the issue. The auditors failed deliver their professional duties and did not do much about the top executives’ manipulation of accounts at Xerox. In this way the auditors failed to execute their responsibilities and duties and let their financial statements pass. Conclusion For any business the ongoing updating of the corporate governance systems is essential for maintaining checks and balances in order to avoid corporate wrecks. Reforming the structure of corporate governance is important in ensuring that events like those of Enron and Xerox do not occur and that the confidence of the public in financial markets is not demolished. From the two cases discussed above it is evident that ineffective implementation of corporate governance in an organization and weakness in the system causes irreparable damages in the long run. All businesses are answerable to their shareholders and therefore it is the board’s responsibility to ensure that proper corporate governance is practiced within the organization. Both Enron and Xerox had flawed leadership, bad accounting practices, conflict of interests and lack of independence in the boards. Their leadership encouraged immoral practices and lack of concern for shareholder interests. Organizations need sound leadership to be successful since it sets the tone for how the company conducts its business. Good leadership is one which promotes ethics in businesses and discourages the use of foul practices for the achievement of short-term profit. The board needs to be independent of management so that it can effectively monitor management activities yet the boards at Enron and Xerox was not independent and had CEOs who shared positions in the board. Auditing committees should be independent and carry out their responsibilities properly. In both cases it is seen that the auditors, both external and internal failed to fulfill their professional obligations and let top managements creative accounting go unnoticed. Lastly, there should be no conflict of interest within the organization and the board as was in these two cases. Conflict of interest gives rise to individuals working for personal gains and profits even if it means violating shareholder interests. Good corporate coherence is good for business. This leads to better corporate management which in turn attracts investors. Good corporate governance requires responsibility, accountability and transparency and openness and fairness in communications with the shareholders. It is the duty of corporations to protect the interests of the shareholders and in the course of making profits they are required to fulfill their social responsibilities. References Ahmed H & Najam A 2006, How corporate governance affects the strategy of organizations: Lessons from Enron Corporation. Viewed 30 May, 2009. Colley, JL, Doyle, JL, Stettinius, W & Logan, G 2004, What is corporate governance. Published by McGraw-Hill Professional Davies, A 2006, Best practice in corporate governance: building reputation and sustainable success. Published by Gower Publishing, Ltd Fox, L 2003, Enron: the rise and fall. Published by John Wiley and Sons Gandossy, RP & Sonnenfeld, JA 2004, Leadership and governance from the inside out. Published by John Wiley and Sons Mallin CA 2007, Corporate Governance. Published by Oxford University Press Minow, N & Monks, RA 2008, Corporate Governance. Published by John Wiley and Sons Newquist, S & Russell M 2003, Putting investors first: real solutions for better corporate governance. Published by Bloomberg Press Six Former Senior Executives of Xerox Settle SEC Enforcement Action Charging Them With Fraud; Executives Agree to Pay Over $22 Million in Penalties, Disgorgement and Interest. Securities Exchange Commission. Retrieved 30 May, 2009 from Solomon, J 2007, Corporate Governance and Accountability. Published by John Wiley and Sons The text body of this document contains 2,028 words. Read More