The Importance of Corporate Governance and Ethics

Question:

Outline the development of Corporate Governance from the traditional approach through to the modern approach. Discuss the characteristics and principles of each approach.

Corporate governance is the process by which corporate organisations are monitored and administered. Corporate governance is needed for the modern organizations to maintain a balance between the organizational goals and the interest of stakeholders of the organization. After globalisation, the work environment of corporations has changed. With the increase in opportunities, the accountability of the corporation has also increased. Large corporate and even small organisations have collapsed due to the lack of proper governance. The factors that are accountable are: the motive of social welfare and their responsibility, delegation, autonomy, authority, power and other disclosure agreements and their legitimacy. The collapse of the corporations like Enron, Lehman Brothers, Robert Maxwell due to fraudulent cases are the most important and noteworthy instances (Agrawal and Cooper 2017). These collapses have shaken the roots of the respected governance bodies. The Regulations and codes of ethics have been redefined after the government has learnt the lesson because of major losses in the economy and job cuts. The scandals have made people aware of the fraudulent ways of the company standards and procedures to be checked (Solomon, 2013).

Enron is a company in Houston founded established by Kenneth Lay and Jeffrey Skilling in the year 1985. It became the largest energy providing organization in USA. Later on the company expanded to Oil and natural gases division, broadband and internet connections, Electricity, water and paper trading (Agrawal and Cooper 2017). This expansion helped the company to diversify in the global international market. After the bankruptcy, the analysis revealed that the company has significant problems regarding the dealings reported on directors. Different questions were raised regarding Enron’s managerial problems and corporate ethical approaches they took when they were in active business. It showed several unethical means that was employed by the organisation over the years. In 2001, the company announced a major loss and was coaxed to admit their false account and profitability information of $600 million (Fox et al .2016). The accounting method of Enron was very unethical as they presented non-transparent financial statements. In accrual accounting method their recorded cost and revenue were also incorrect and misleading. The hidden debt, taking excessive risks, violation in formation of balance sheets, disclosure of minimal details, overstated equity and profits to engage more shareholders were the unethical approaches adopted by the organization. These helped them to hide their losses for a short period but the strategy failed.  The proliferation of the company books, checks and balances were detected to be filled with unethical practises and also a major cause of the breakdown in corporation’s governance (Shrives and Brennan 2015). The trials in court after the company’s decline highlighted major issues that were overlooked by the civil lawyers. Excessive use of power by the CEO, private undisclosed partnerships was also the cause of the Enron’s fall.

Factors That Are Accountable

The Parmalet Diary’s scandal was a result of a failure in the governance and accounting discrepancies in privately owned corporate entity (McAlister et al. 2016). The Italian Food company’s governance failed due to the founder’s unethical practises. He controlled the shareholders and channelled their resources illegally. This was also done at the expense of minority shareholders resources. The monitoring and controlling process failed leading to the Parmalat’s crisis. The Organizational structure was at fault as both the CEO and the owner held the position of chairperson as per the codes of Parmalat Finanziaria (McAlister et al. 2016). The lack of compliance of the company’s independent policy related to the controlling of shareholders interests affected the company. The monitoring structure of the company’s governance framework, made the abuse of power and fraudulent activity to rise easily in that situation.

A similar case can be discussed form the UK. The infamous case of Robert Maxwell and his media corporation is a perfect example of the failure in governance framework. In order to survive in the sector he adopted fraudulent practises. It was estimated that they stole 727 million Euros from the pension funds of the two public companies as well as the assets from the companies (McAlister et al. 2016). The undivided control in operation in the Maxwell Communication and governance ultimately caused the downfall of the company. The non-executive directors were involved in the function of performing independent function. The auditors were involved in providing non-transparent information of financial activities and practises. The pension fund trustees also failed to observe the money laundering activities of the companies by transferring the money from one unidentified account to another (Eling and Marek 2014). This scandal also helped in raising the issues related to corporate governance ethics and codes. It was also reasoned that leadership of the company was very much incapable of using the stewardship of the company and making it properly function under their guidance (McAlister et al. 2016).

During the recession years 2008-2009, Lehman Brothers collapsed because of the reasons aforementioned (Eling and Marek 2014). The unethical business practises of the top executives in the board and auditing firms were the reason of the collapse of the company. The discrepancies in the transaction and imbalance in the balance sheet drew attention of the company. The financial information was not disclosed then. Later on, the corporation got involved in a debt of $ 613 billion where unsecured creditors in different countries owed money from them (Eling and Marek 2014).

Lessons Learned from Major Collapses

The corporate governance is a considerably old concept, evolving after the private organisations were established. The firms provided value of control regarding governance and ethics. Most importantly, the problem of monitoring and directing the process is one of the most important parts of governing the organisation (Akinteye et al. 2015). The traditional approach also included the overview of the agency problem; ownership and control of the large publicly held corporation were also questionable. The legislative power of the company was directed by the economic policies set by government (Zalata and Roberts 2016). Traditional approach emphasises on the models that only takes into consideration the exchange and transactions taking place in the market among the investors, customers, suppliers, employees and other groups (Larcker and Tayan 2015.). The two tier models were responsible for the being the foundation of governance structure of companies. It also takes into account the agency costs and transactional cost related to the financial structure of the company. It also includes the legal responsibilities of the directors as well as the shareholder’s legal mechanisms used in business. The corporate laws started to reform after 2004 (Shrives and Brennan 2015). The alternative models were also adopted during this time.

There are two types of theoretical framework, one is of broader view and the other is of narrower view. Thus, considering all factors, the models were defined for providing a solution for the companies that wants to enter the industry. The theoretical framework of the governance structure is one of the most important part to be considered. The traditional approach to share ownership and Anglo-American corporate governance goes by the transactional and agency theory of system (Shrives and Brennan 2015). In the modern joint stock market of America, the 910 companies were included.

In the perspective of UK, corporate governance was functional and the role of board of directors and owners, chief executives were defined perfectly. The focus was on the activism of the shareholder’s instruments. The transparency and financial reporting were there but the Financial Reporting Council did not play its part effectively (Zalata and Roberts 2016). The companies that were involved in Financial Crisis were involved in breaking the codes of ethics and illegal activities. Implementation of the European Union Audit Regulations and Directives Section C3 reviewed the changes in information that the companies started to send regarding solvency, liquidity, viability and risk management and investment changes (Akinteye et al. 2015). The scandals related to those data provided in the company’s journals were wrong which later stimulated in their downfall. The structure of the corporate governance was also at fault the company. Many companies were characterised as family owned and then different kinds of features were seen in the process.

Traditional Approaches to Corporate Governance

The traditional approach to corporate governance is based on the agency theory, which takes into consideration the factors of financial paradigm and economic factors. The agents that are considered in this supervisions and control structure are stakeholders of the organization (Zalata and Roberts 2016). The principles that are used in this structure are the delegation of the everyday decision making system, related to the shareholders. In this theory, shareholders wealth maximisation was an important motive of building the rules of corporate governance. The managers play with egoism and are known for being “short-termism” according to this traditional approach that has affected the company (Akinteye et al. 2015). The reduction in shareholder’s welfare is known as the residual loss in this theory.

Transaction cost theory, takes into account the important element of the behavioural theory and its components. The resources of the market that are used to coordinate the transaction among the companies are related costs control theory of transaction. Internalisation of the transaction related activities is of utmost importance in this regard. The bounded rationality is an essential part of this theory (Shrives and Brennan 2015). According to this theory, the managers are individuals who are opportunistic by nature.

Stakeholder’s theory was developed considering the individual entities. Incorporation of corporate accountability is one of the most important elements in this concept. The broad research and unified approach of this theory makes it more relevant in the current time. This research takes the best out of the traditional approach of the corporate governance as well as incorporates philosophy, ethics, political theory, economical factors and stakeholders of the organisation (Dimopoulos and Wagner 2016). The commonality acknowledged in this theory is in the exchange relationship among the stakeholders. The stakeholders are shareholders, employees, suppliers, customers, creditors and all the personnel directly or indirectly related to the company. 

The modern approach of corporate governance is of the following factors. They are supervision, cooperation and information exchange, coordination, decision-making, consulting, supervision. These significant matters are considered in this report. The task in hand is more considered in this process, emphasis is given on the situation of economic, financial, organisational, and market. There is one theory that needs to be taken into consideration in defining the modern approach, the stewardship theory (Larcker and Tayan 2015). The function of this theory is to consider the supervisory board in relation with management. The main factor that is considered in the modern approach is the motivation factor. The agent motivation was purely financial. The behavioural approach was not considered in the old age. This gave an outcome in the governance structure, which was less effective in nature. The stewardship theory talks about the control mechanisms of the individual’s in situational factors. The situational factors talks about the trust, employee engagement, collectivism, power distance and collaboration needs of the company (Boreiko and Murgia 2016). This is the main contrast from the agency theory. The governance of the companies is mainly based on the guidelines of Corporate Governance given by the OECD org amended on 2004 (Larcker and Tayan 2015).

Theoretical Frameworks of Corporate Governance

This organisation dictates the basic rules of the governance structure, accountability limitations. The following is the features, which need to be considered.

• The key ownership functions, rights and regulations of the companies regarding their shareholders are to be decided first.
• Treatments should be similar for all shareholders and not based on their ownership of shares
• Roles are correctly defined by this process
• Responsibility of the company’s body (Dimopoulos and Wagner 2016)

The recently added feature of social welfare that is included in the corporate structure depicts that the governance must give emphasis in planning the welfare of the society. The modern approach has different views that are presented to the government. The new recommendations presented have considered different holes that have been identified from the previous mishaps in corporate governance. The Hample report, Cadbury report and Higgs report were presented based on the modernisation of the corporate governance spirit (Boreiko and Murgia 2016). Different factors involved in this new method of calculation of director’s remuneration are also given in the approach. Corporate social responsibility, social welfare improvement in pension fund regulations and other rules regarding corporate governance needs to be adopted. Shareholder’s reports, trustee’s role, responsibilities, and information that need to be presented in the report and other aspects of the company should be transparent according the new approach. The impact of the new approach helps in combining the codes in UK Company’s directors and institutional investor’s relationship. Pro activism of the shareholding governance is also considered in the matter.

The separation in the ownership and control was incorporated as an essential policy in the new approach. The companies, which was in major need of improvement learnt from the scandals that plagued the noted companies as discussed above. This also affected the economy of those countries immensely. The scandals also involved major theft in some cases.

Different reports on the failure issues were presented in the federal government of USA, they presented the Sarbanes-Oxley Act 2002 in USA after the report was submitted, Higgs report in January 2001, and Smiths Report was presented in UK around that time (Al-Najjar and Abed 2014). Lack of solid foundations in UK government officials lead the investors to believe that they can earn huge profits and this helped them earning profit after investing in technological stocks. This was a good incident that happened in the late 1990s (Akinteye et al. 2015). The unlimited liability of the investors implied that the policies were not effective regarding investments. The Limited Liability act 1855 helped the company to rip off all the shareholders to earn profits that was due for the shareholders(Al-Najjar and Abed 2014).

There have been significant influences of the collapse of Giant Corporation like Enron and WorldCom, which made it necessary to redefine the possible changes in the governance structures. The Hampel Report 1998 presented in the Britain is a successor of the Cadbury report. The report is based on the regulation of director’s remunerations. This also summarizes the best practises of the UK companies. The UK companies defined separate rules in their report of governance. The common rules for directors fiduciary duties, Companies act and documents 1985 and listing rules in UK are different than the US regulations, that includes the SOX act 2002 (Honoré et al. 2015). The Sarbanes-Oxley Act 2002 is detailed regulation listed for the companies in US and is very different from the rules of “comply and explain” in UK (Al-Najjar and Abed 2014). The US regulations depend on the fines, penalties and imprisonment for violating the requirements of SOX act. The securities act 2004 consists of audit, investigations and community requirements of the companies in UK (Armstrong et al. 2015). The committee has greater power in this regard. However, the establishments of the PCAOB (Public Company Accounting Oversight Board) have the ultimate power regarding all the auditors and US security law (Bushee et al. 2013) in the country. The provisions stated in the state’s regulation in SOX, that there must be mandatory rotations in the audit partners but the restrictions in non-audit services. The external auditors can provide only the non-audit services. However, in US the auditors or the audit partners of the company can provide the audit and non-audit services (Bain and Band 2016). The CEO and CFOs of the company must regularly certify the reports to help the company mitigate the penalties of false credit citations or engaging in criminal activities (Zalata and Robert 2016). However, in UK the director’s report must contain the statement of the directors regarding relevancy of the audit information or false information given in the report. It is criminal offense for the company to make a false statement. The US legislations contain the prohibition act effective on insider trading during the pension fund scandal that happened in the country. The board does not specify it but the companies must go by the pension part 5 of the criminal justice act 1993 or Market Abuse Regime (Elmagrhi et al. 2017). However, the rules of management report and internal audit attested that the management report given in US SOC and SEC and adoption of codes of ethics is essential but it does not have any equivalent rules in UK regulations. In UK, it is expected that the companies will maintain the minimum ethics as a matter of fact (Carberry et al.  2017).

Corporate Laws and Codes of Ethics

For a company it is essential to incorporate corporate governance in the operations of the business. Both of the discussed regulations, SOX in US and Smith, Higgs, Cadbury, Greenburg report in UK and other reports has very important part in the corporate governance (Tricker and Tricker, 2015). The separation in the roles of CEO, CFO, chairman and board of directors have provided the companies with an advantage of taking different perspectives and thus form different viewpoints. The codes of corporate governance and ethics in other companies are strictly maintained after the scandals of the companies discussed above. The main issue in modern approach of corporate governance is, it does not identify consistency and significance in the relationships between performance of the firm and executives remuneration (Elmagrhi et al. 2017). The monitoring and the evaluation system is also given lesser emphasis in the acts that needs to be implemented. The Cadbury Act in UK does not consider the accounting standard changes that are modified after the commencements of the report (Denis 2016). The share repurchase from the shareholders are also an issue in corporate governance approach, which should be considered. These issues have been highlighted in this framework.

Conclusion

The constant update of the corporate governance ethics and codes of practice along methodical review of corporate governance structures are necessary to avoid downfall of companies like Enron in the future. The concept of corporate governance deals with the changes in the approach of the top level management along with the effective implementation of human resource in the company. The approach to use the penalties, fines and restrictions in case of illegal activities and breach of any contract is effective. The use of rational external auditing partners and the tight control in the internal audit members in both the countries, especially the US regulations are very essential and effective. This provides the company to safeguard the information as well as provide a transparent report.

References

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Preventing Fraudulent Activities

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