Corporate Governance in the USA - Essay Example

Corporate Governance Roll No: Teacher: 16th April 2009 This paper compares and assesses the extent to which the recommendations and principles of corporate governance have been implemented in the United Kingdom and the United States of America. It specifically assesses the effect of corporate governance implementation on controlling director activity and ensuring they make appropriate disclosures. The introduction section gives general principles and concepts about corporate governance. The main body of the paper carries out a comparison of the UK and the US corporate governance models. It is divided into smaller subtitles such as ‘corporate governance’ and ‘implementation of corporate governance principles and recommendations in the UK and the US’ in order to cover the topic exhaustively. The conclusion section summarizes the main issues discussed in the paper and makes inferences where appropriate. Introduction Corporate governance refers to a set of laws, policies, institutions and customs that affect the manner in which a corporation is controlled, administered, or directed1. Corporate governance also incorporates the corporation’s goals of governance and the relationships among its numerous stakeholders2. The major stakeholders in any corporation include the board of directors, management, and shareholders or members. Others include regulators, suppliers, creditors who include bond holders and banks, customers and employees or labour. For non-profit organizations as well as other membership organizations, their shareholders are their members. Corporate governance is a many-sided subject3. One of the most important themes of corporate governance is ensuring the accountability of particular individuals in the corporation. This is achieved through mechanisms aimed at reducing or eliminating altogether the problem of principal-agents. Corporate governance also helps in improving economic efficiency by emphasizing on the welfare of the shareholders. Corporate governance also has encompasses other subjects such as the view of stakeholders and corporate governance models4. Modern corporations have increasingly renewed their interest in corporate governance practices, particularly since 2001. This has been attributed to the high profile crumbling of numerous big corporations in the United States, including MCI Inc and Enron Corporation. For instance, the US federal government enacted the Sarbanes-Oxley Act in order to restore the confidence of the public in corporate governance5. Corporate governance Corporate governance is a very essential tool for social and economic development6. This is because it ultimately results in an improved economy, which is very important for all the stakeholders. Corporate governance involves a number of parties such as the regulatory body that comprises of the shareholders, management, board of directors, and the CEO. Other stakeholders include customers, creditors, employees, suppliers and the community in general. In corporations, shareholders delegate their decision rights to the managers to act in their best interest. This separation of control from ownership means that the shareholders lose effective control of managerial decisions. Consequently, a corporate governance controls system helps to align the shareholders’ and managers’ incentives7. The notable increase in investors’ equity holding has presented an opportunity to reverse the problems due to the separation between control and ownership because ownership is not very diffuse. The parliament of UK standardizes the companies located in UK on the basis of Companies Act 2006 in terms of legalization8. Good governance is also based on the following of the Companies Act 2006. This act provides the rules and regulations required to be followed by companies in order to perform well and to work under the defined jurisdictions by the government of UK. The key principles of good governance include commitment to the corporation, mutual respect, accountability and responsibility, performance orientation, openness, integrity and trust and honesty. Of utmost importance is how the management and the board of directors create a governance model aligning the corporate participants’ values and then evaluating the model periodically for high effectiveness. Senior executives should particularly conduct themselves ethically and honestly. They should avoid disclosing financial reports, and ensure they are not involved in apparent or actual conflict of interest. The most commonly accepted corporate governance principles include transparency and disclosure, ethical behaviour and integrity, other stakeholders’ interests, responsibilities and role of the board, and the rights of shareholders as well as their equitable treatment9. Other issues that involve the principles of corporate governance include the dividend policy, the method of nomination for board positions, and the resources availed to the directors to enable them carry out their duties. Others include reviewing the senior executives’ compensation arrangements, overseeing preparation of the corporation’s financial statements and overseeing risk management. Moreover, the issue of independence for the corporation’s auditors, as well as internal controls comes to fore quite often. Corporate governance remains a misunderstood and ambiguous phrase even though many corporations have attempted to implement it. Implementation of corporate governance principles and recommendations in the UK and the US In the recent past, the issue of corporate governance has been in the limelight in the United Kingdom. This is as a result of a number of important reports having been published, which have greatly influenced the UK’s corporate governance environment. However, the existing corporate governance in the UK is not isolated since it closely interacts with the rest of Europe as well as the US. The collapse of WorldCom and Enron has tended to indicate that corporate governance issues are highly topical. Up to now, there seems to be no generally applicable model as far as corporate governance is concerned. Many corporations work within the boundaries set out by national regulations and laws, as well as the shareholders’ expectations and economic goals. However, some convergence has been identified internationally with regard to corporate governance. This has mainly been due to the standards set by capital markets and international investors. Moreover, initiatives by OECD and World Bank have greatly helped in providing an analytical and theoretical framework with regard to corporate governance. UK corporate governance is boosted by numerous recommendations, regulations and rules. They include the Common law rules, the statutes, and institutional documents of companies, listing rules, and the corporate governance code. Others include non-legal guidelines normally issued by institutional investors’ representatives and the city code on mergers and takeovers among others. Corporate governance in the US is predominantly determined by the 2002 Sarbanes Oxley Act. There are also other details drawn up by NASDAQ, NYSE, and SEC. Unlike in the UK whose approach is commonly referred to as ‘comply or explain,’ the US one greatly varies. However, the US uses the UK approach in a number of instances. The United States tends to impose penalties such as imprisonment and fines for those who violate its regulations. Moreover, unlike the UK, the US heavily relies on regulation to enhance its corporate governance. The US has established PCAOB aimed at overseeing the audit of corporations in accordance with the US regulations and laws. The UK approach is quite different in that its oversight body, FPRRP requires corporations and their auditors, employees and other corporation officers. The US has put in place provisions aimed at enhancing the autonomy of external auditors. On the other hand, the UK requires very detailed disclosures by public corporations. The US requires that the chief executive officers and the chief financial officers verify any periodic report contents. On the other hand, the UK only requires the board to declare that no relevant information is missing in the reports. The US requires that the CFOs and the CEOs verify all the quarterly and annual reports and assure the authorities of the effectiveness of their internal controls. On the other hand, no such certification is required in the UK. Instead, only assurance statements reaffirming the usage of the best internal control practices are required. The US requires CFOs and CEOs to forfeit their compensation when their corporations make restatements as a result of failing to comply with securities laws. On its part, the UK has no such provisions in their rules and regulations. In the US, SEC has the power of prohibiting people from serving as officers and directors in the corporations. Similarly, the UK has a similar clause in its 1986 Act, which bars and disqualifies certain people from serving as directors although it does not say much about the corporations’ officers. Unlike that of the UK, the corporate governance system of the United States has earned a lot of criticism, mainly due to failure of Tyco, WorldCom and Enron. These criticisms and failures led to a change in legislation with the enactment of Serbanes Oxley Act in 2002, as well as a number of regulatory changes. New NASDAQ and NYSE governance guidelines were issued. Compared to that of the United Kingdom, the United States corporate governance system has shown a dismal performance. The change in legislation is proving to be quite useful in the improvement of the country’s corporate governance. Even though the stock market of the United States has reported negative returns in the last few years, it has done quite well compared to other stock markets world over. There has been a significant change in the United States corporate governance since the 1980s. The US corporate governance structures before the 1980s did little to serve the interests of the shareholders. The general feeling among these executives was that they were representatives of the corporation as opposed to the shareholders. Consequently, these executives did not think that shareholder wealth maximization was part of their role in the corporations. They concentrated on ensuring the stability and growth of their respective corporations. To achieve, these executives balanced the claims of key corporate stakeholders such as the local community, suppliers, employees and the shareholders10. The executives seldom used external mechanisms of governance regarding dissatisfied shareholders. Hostile takeovers and raiders were not very common. This was also the case with proxy fights, which did not have any chance of success. The corporate boards were often very cozy and management-dominated, making the board’s oversight very weak. Long-term plans, usually based on performance, were extensively used. These plans had their basis on accounting measures such as earnings per share and sales growth. Compared to the United Kingdom, the United States compensation for its chief executives is very high11. This is as a result of numerous pay increases over the last decade or so. The pay increases have sparked a lot of controversy among the various stakeholders. On the other hand, the United Kingdom seems to be devoid of such controversies. Instead, there is a general consensus among the stakeholders with regard to compensation of the executives. This can be attributed to the fact that there has been less pay increases among these executives in the last few years. The recent stock market declines and scandals in the US have sparked an argument to the effect that such increases are a representation of undeserved transfer of the wealth of shareholders to these executives. This, they argue, happens despite there being no incentive effects that could be of a beneficial nature. The US shareholder composition has significantly changed over the last few years. Many shares in the stock market are now owned by large institutional investors. Even though this is also the case in the United Kingdom, it is very common to find a particular investor, whether retail or institutional, owning a significant chunk of a corporation’s shares. For instance, between 1980 and 1996, big institutional investors almost doubled their ownership of US companies to over 50 per cent from slightly less than 30 per cent in 1980. As a result, the number of individual shareholders has gone down to less than 50 per cent. Shareholders in the US are increasingly monitoring the management of their corporations more effectively than they did in the 1980s. The big increase in institutional shareholders in essence indicates that professional investors continue to own bigger portions of the US corporations. There are numerous corporate governance models worldwide. They differ depending on the form of capitalism wherever they are entrenched. The United Kingdom model gives priority to the shareholders’ interests. To some extent, it also puts into consideration the interests of the community, customers, suppliers, managers and workers. The UK corporate governance model encourages cost competition and radical innovation, and at the same time facilitates quality competition. UK corporations are governed by boards of directors, who have the power of choosing executive officers. The CEOs are entrusted with the powers of managing these corporations on a day-to-day basis although they require the approval of the board for them to undertake major actions like expensive projects, large capital expansions, acquisitions, raising money and hiring. The board is also charged with responsibilities such as corporate control, decision making, policy setting and monitoring of the performance of management. The board is nominally selected by the shareholders and is responsible to them. However, the by-laws of numerous corporations make it very hard for shareholders, with the exception of large shareholders, to have any say in the board’s composition. Under normal circumstances, individual shareholders only rubberstamp the sitting board’s nominees; they are never given the chance of choosing these nominees. Vicious incentives pervade a number of corporate boards in the UK. Members of the board are obliged to the CEO even though they are supposed to oversee his or her actions. More often than not, board members are also chief executives of other corporations. This has led to various instances of conflicting interests among board members. Compared to the US corporate governance model, the UK one can be regarded as superior in many respects. This is because UK corporations have had very few cases of fraud, lack of accountability and transparency, unlike their US counterparts. The UK corporate governance practices have had a great influence on those of United States as well as those of the European Union. The US heavily borrowed from the UK corporate governance model in enacting the Sarbanes-Oaxley Act of 2002, which is a corporate governance regulation guideline. In turn the SOA is playing a big role in the acceleration of the development governance regulations to be used across the EU. Conclusion The paper has investigated corporate governance in the United Kingdom and in the United States. A number of similarities have been identified in the implementation of corporate governance principles and recommendations. On the other hand, this implementation seems to have some variations in the UK and the US. The differences mainly result from the statutes, regulations and laws in the two countries. There are certain aspects of corporate governance regulations that each country either stresses on or disregards. This has as a result led to the differences in corporate governance practices in the two countries. The United Kingdom corporate governance experience seems to be quite different from that of the United States. Most corporations in the UK have a greatly dispersed structure of ownership12. This makes it very conducive for management to dominate the governance. The dispersed ownership enables the market to be very influential in developing and enforcing corporate governance as opposed to large shareholders dominating governance. For such a market-determined system governance, there is need to consider shifting the corporations’ key interest to stakeholder value from the shareholder value. Corporate governance in the US is predominantly determined by the 2002 Sarbanes Oxley Act, together with other details drawn up by NASDAQ, NYSE, and SEC. on the other hand, the UK uses the ‘comply or explain,’ approach. However, the US uses the UK approach in a number of instances. The United States tends to impose penalties such as imprisonment and fines for those who violate its regulations. References A Cadbury, Corporate Governance, Institute voor Bestuurders, Brussels, 1996, pp 14 A Dignam and J Lowry, Company Law, Oxford University Press, 2006, pp 15 B Hall and J Liebman, Are CEOs Really Paid like Bureaucrats? Quarterly Journal of Economics, 1998, pp 112 B Hannigan, The Companies Act 2006: A Commentary, LexisNexis, London, 2009, pp 23-40 C Crawford, Compliance and conviction, Santa Clara, California, 2007 pp 2 D Denis and J McConnell, International Corporate Governance, Journal of Financial and Quantitative Analysis, 2003, pp 36 G Donaldson and J Lorsch, Decision Making at the Top, Basic Books, New York, 1983, pp 57 J Colley et al, What is Corporate Governance? 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