Corporate Governance - Public Frustration with Practices of Publicly Traded Corporations - Essay Example

Corporate Governance The issue of corporate governance has gained a great deal of popularity over the past few years. There seems to be an increasing frustration in the public regarding the business practices of publicly traded corporations. The world economy has been impacted time and time again as a result of flawed practices as many examples of poor governance such as Enron, Arthur Anderson, WorldCom and Tyco along with many others have surfaced. The actions of these corporate giants and the scandals which surrounded them gave rise to a great degree of mistrust for the investors and the public which invested in them. As a result the investing public began to lose confidence (Colley, 2005). Apart from the loss of valuable investments such business failures also gave rise to the loss of jobs, shattered public confidence and the decline of the savings invested in the company stock along with the fear of future corporate failures. It was after these failures that the media and the governments made a combined effort to stress on the importance of corporate governance, not just b y highlighting what had gone wrong but also brought the board of directors of the functioning corporate into the public eyes(Colley, 2005). The Industrial Revolution was followed by a wave of capitalism. In capitalism the wealth was restricted to a particular class which continued to get wealthier whereas the remaining segment was poor. This wealth was acquired by those with flourishing businesses at the expense of their workers, customers and the public shareholders. At this point the government began to take notice of the situation and took steps to introduce measures to protected those affected in a negative way by such business practices. As capitalism developed it gave more people the opportunities to set up their businesses. Those with capital begin o to their money together to set up and sun businesses. This made them the shareholders of these businesses. As these businesses grew in size, governance became a challenge (Colley, 2005). In order to understand what corporate governance truly is we must first understand what governance in general terms means. Once we know what governance is we can look into the history of cooperates and why the need for corporate governance was felt. Governance generally refers to the art or the process of governing. This is a concept which in one form or the other has existed throughout the ages across all civilizations. Governance and its processes have changed over time to meet the changing environment. History has seen incidents of both good and bad governance, which shows that governance regardless of how it is practiced is an on going and an evolutionary process (Colley, 2005) The law considers a corporation to be fictional person. There are different types of corporations depending on their nature based on liability and investors. In order to classify as a corporation there are certain conditions which need to be met. These include that the corporation must have limited liability, which means a corporation is separate from its owners and has its own identity which is not that on its owners as well as its employees. This also means that the individual owners of the company are not individually liable to the creditors for any loss incurred. The second characteristic of a corporation is that it is a legal personality. This means that a corporate is alive only as long as the partnership is alive and the company has capital and generally has a limited life. As a legal personality the corporate is treated as an individual legally for its actions (Monks & Minow, 2008). The third characteristic of a corporation is its transferability. Transferability means that the holdings can be transferred freely. As a result of transferability the corporations stocks can be bought and sold. The fourth characteristic is the generalized management. The partnership is managed based on consensus. The overall power for the corporation lies with the directors whereas the day to day running of the business is handed over to the managers (Monks & Minow, 2008). The growing fear of the corporate corruption and the concerns about foul business practices gave the policy makers a reason to work on developing polices for corporate governance to control the situation and to protect the public investors. The Cadbury Committee was set up as a reactive measure rather than a proactive one. The key presumption in the report was that it the existing corporate governance system in the UK was sound and this report would make the system better (Solomon, 2007). In the UK a committee was set up to study the financial aspects of corporate governance. As a result of the Cadbury Committee was set up which in the year 1992 published a report under the title of the Cadbury Code 1992. The committee was chaired by Sir Adrian Cadbury and the published report covered the financial aspects of corporate governance. The report became the leader on the subject of corporate governance for the UK and was based on two key objectives. The first objective was to establish the stringent accountability of the board of directions towards the owners and their own activities. The second objective was to deal with the increasing corruption in the corporate and business world (Prasad, 2006). The report split the role of the chairman from that of the CEO while at the same time making the audit committee stronger. According to the report only independent were allowed to sit in the committee. The report therefore succeeded in highlighting the supremacy of the board, its power, integrity and accountability (Prasad, 2006). The Cadbury report was not legally binding on the board of directors, but all companies which were a part of the Stock Exchange were required to comply with the code. This way the shareholders had a way of determining whether they were satisfied or dissatisfied with the company’s corporate governance systems. The Cadbury report covered three general areas which include board of directors, auditing and the shareholders (Solomon, 2007). The board of directors was the primary focus of the report as the key mechanism for monitoring, control and ongoing assessment. The auditing potion highlights the importance of transparency and clear communication with stakeholders. The final area of the report, deals with the investors which is the largest and most influential group impacted by the actions of the company and its methods of corporate governance. The Cadbury report had a significant impact on the British corporate world and the compliance with the Cadbury Code increased over a period of time making this one of the strongest efforts in the world of corporate governance (Solomon, 2007). The Cadbury Code 1992 is a report published on corporate governance. Although the publishing of this along with many other reports in the UK highlights the importance and interest in corporate governance, the report fails to serve as a complete code and has some critical flaws which do not allow it to be a complete tool for control. Recommendations of the Cadbury Code face much criticism. One of the aspects of the report which has been criticized is that it relies on non executive directors which leads to a two tier board where different directors are fulfilling different functions. The report fails to suggest that the appointment and dismissal of the directors should be removed form the shareholders control. The two tier system operates elsewhere in Europe in such a manner that it includes provision for the supervisory board to dismiss the executive board. This leaves a sort of imbalance in the accountability purpose of the corporate governance (Dine, 2000). According to the Cadbury Code there is a need for establishing a board which includes non executive directors of sufficient caliber and number in order to make significant decisions. According to Hodges (2005) the criticism of the Cadbury report comes from the four key points on which the report is based. According to critics the validity of each of these points can be questioned. The four key points of the Cadbury Code are: The belief that the existing governance structures in the UK are broadly adequate. Recognition of duty on accountability on the part of mangers of a company only to its shareholders. Its reliance on the private sector non statutory regulation. A belief in the primary importance of published information to ensure the effective operation of all necessary controls. One of the major criticisms of the Cadbury report is that of its emphasis on the conformance of corporate governance which provides very limited discussion on other aspects. These limitations need to be kept in view while applying the Cadbury Code to the public sector. It is felt that the report looks more into the financial aspects of corporate governance rather than looking at corporate governance as a whole. Another criticism is that the report itself is not designed to be implemented in the public sector. Although the report can be considered the initial stage of implementing governance practices it cannot be directly applied to public services. The report fails to cover all aspects of performance. The use of this report has therefore been rejected by some commentator of the public services. Its application to the public sector would be useless if the demands of that particular sector are not taken into careful consideration. Due to the significant differences in the public and private sectors the report cannot easily be transposed from the private to public services. Another reason for this is that public services have a great deal of non financial objectives which are not catered to in the Cadbury report (Hodges, 2005). Another challenge for the Cadbury Code is the diversity and the complexity of the management structures which calls for detailed corporate governance policies. The Cadbury Code’s requirements for controlled balance of power and adequate working procedures combined with appropriate division of responsibility faces some risk the some divisions created for the sake of balancing power may give rise to a structure of mutual support and protection for higher positions of management (Hodges, 2005). Hodges (2005) also states that the performance dimension of corporate governance is not covered in detail in the Cadbury Code and its importance is not highly recognized. This is criticized because meeting performance objectives is critical for any type of organization. Effective corporate governance cannot be carried out if the performance is not kept as one of the primary objectives. This fails to recognize that a strong corporate structes is needed to recognize the performances based objectives of an organization (Hodges, 2005). After the publication of the Cadbury Code the Confederation of British Industry (CBI) appointed a committee under the chairmanship of Sir Richard Greenbury to deal with issues concerning the controversies which surfaced at the time. The Greenbury Report of 1995 was a product of this committee. The Greenbury Report highlighted the director’s best practices on executive remuneration and was primarily based on the principles of transparency, accountability and rewards for performance. This report like the Cadbury Code of 1992 was developed in response to the public needs and concerns to stop foul practices in the corporate world (Calder, 2008). Following the Greenbury Report was the Hampel Report which was focused more on the success of the company through practices of corporate governance. The report covered the role of directors and remuneration, role of the shareholders, more or less everything already covered in the Cadbury Code and the Greenbury Report. These two along with the new Hampel Report was developed into a combined code and applied to all companies listed in the stock exchange (Calder, 2008). The Cadbury Code and the Greenbury Code presented guidelines for effective corporate governance, but all guidelines of the two documents were combined and presented in the Combined Code. The Combined Code on corporate governance is one of the most important documents for corporate governance in the UK. This document was first published in 2006 and then updated in 2008. This document lays down the standards for good practice in relations with issue pertaining to board composition, remuneration, development, accountability audit and relations with the shareholders. All companies in the UL which are listed with the London Stock Exchange are required to report on how they have applied the Combined Code (Filho & Idowu, 2009). According to the Combined Code for the UK listed companies at least half of the boards, excluding the chairman has to be non executive directors. It also states that Remuneration and Audit Committees should be made up of at least three independent non executive directors while the Nomination Committee should comprise mostly of independent non executive directors (Pickett, 2010). In 2009 Sir David Walker was commissioned to analyze the corporate governance situation in the UK in order to identify the failures which had led to the financial crisis. According to the Great Britain HM Treasury (2009) the report published by Walker in 2009 consisted of recommendations for the size of the board, its composition and qualifications, its functions and evaluations. It also comprised of the shareholder communications requirements and engagement along with governance of risk and remuneration. It also contained the Stewardship Code which highlighted principles of best practice based on shareholders and the company’s commitment to good governance. the Walker Review present suggestions for improvement in the corporate governance and the remuneration to avoid risk taking and financial instability. Similarly Sir Christopher Hogg who in 2008 was the chairman of the Financial Reporting Council also present a review in which he stated that there was a need for balance between the executive and non executives which was put together in the Combined Code for corporate governance. With the rise in corruption in the corporate world there was an urgent need for the development of corporate governance policies to be implemented to protect investor, shareholder and public interests. Although the Cadbury report laid the foundations for such policies in the corporate world, it was not able to fulfill every requirement. Its focus on the financial aspect of corporate governance ignored other aspects of the corporate which are required for its success. It was as a result of such limitations that newer and more updated polices were introduced to supplement the Cadbury Code. References Calder A (2008) Corporate Governance: A Practical Guide to the Legal Frameworks and International Codes of Practice. Kogan Page Publishers Colley JL (2005) What is corporate governance?. McGraw-Hill Professional. Dine J (2000) The governance of corporate groups. Cambridge University Press Fihlo WL & Idowu SO (2009) Professionals ́ Perspectives of Corporate Social Responsibility. Springer. Great Britain H.M Treasury (2009) Pre-budget report December 2009: securing the recovery, growth and opportunity. The Stationery Office. Hodges R (2005) Governance and the public sector. Edward Elgar Publishing Monks RA & Minow N (2008) Corporate governance. John Wiley and Sons Pickett S (2010) The Internal Auditing Handbook. John Wiley and Sons Prasad (2006) Corporate Governance. PHI Learning Pvt. Ltd Solomon J (2007) Corporate governance and accountability. John Wiley and Sons Read More