IntroductionThis report gives a summary of how corporate governance is influencingthe current world of business and explores the reasons for why corporatecollapses are still ubiquitous. Also, a study based on how the principles and theoriesthat explain corporate governance in a wider aspect are implemented and how itis related to shareholders as well as stakeholders of the company.
The limitationsof the codes and regulations put forward by different committees and countries areevaluated in this report. Finally, some recommendations on how effectivelycorporate governance can be implemented and sustained in the longer run forbest practice of accountability and overall organizational performance. Corporate Governance”I cannot accept your canon that we are to judge Pope and Kingunlike other men, with a favorable presumption that they did no wrong. If thereis any presumption it is the other way against holders of power, increasing asthe power increases..
. Power tends to corrupt and absolute power corruptsabsolutely” this letter from Lord Acton (1887) (cited in Oll.libertyfund.org. 2017)to bishop Creighton defines the relevance of corporate governance in todayscorporate world. The king and the pope in the above quote could be compared tothe chairman and CEO in todays corporate world, where they are assumed to befair and just to both the shareholders and the stakeholders.
However, practicallythis does not hold true all the time and good corporate governance practicemonitors the check and balance between the aims of the corporates and both, theshareholders and stakeholders.According to the Cadbury committee (1992) “Corporate governance isthe system by which companies are directed and controlled. It encompasses theentire mechanics of the functioning of a company and attempts to put in place asystem of checks and balances between the shareholders, directors, employees,auditor and the management”. The underlying theme of corporate governance fromall sources describes the measures that ensure accountability of the top levelcorporate management as well as the senior managers in the organization and implementationof policies and measures to reduce the principal-agent problem. Corporategovernance plays a balancing role between the shareholders’ value and thestakeholders value, by prioritizing and outweighing one another based on the strategiesand values adapted by each company.Code of practice and corporate collapsesThe creation of corporate governance codes and rules from time totime is generally related to corporate collapses starting from Polly Peck, bankof credit and commerce international and Maxwell communications corporation inthe late 1980’s and early 1990’s.
The collapse of Polly Peck was a reminder tokeep check and balance in the working of the financial institution, here inthis particular case being the concentration of power on an individual who hadmade fund transfer from London account (Polly Peck) to offshore accounts inturkey and Northern Cyprus. This was due to the lack of board control andoversight of this individual. These collapses led to the formation of the committeeon the Financial Aspects of Corporate Governance, commonly known as the CadburyCommittee.
The aim of the committee was to build up “the lack of publicconfidence in financial reporting and the ability of auditors provide thesafeguards sought and expected by users of company reports would undermineLondon as a major financial center” (Cadbury 2002).Recommendations put forward by the committee were mainly focused with:· Divisionof responsibility at the head of the company· Inclusionand majority of independent non-executive directors· Formationof audit committee The committee’s focus was to increase the accountability of toplevel management, transparency of the working and accounting practices tosafeguard and build back public confidence in the financial reporting ofcorporates to all stakeholders. This was made clear by the committee in thereport stating that “focus on the control and reporting functions of boards ofdirectors and on the role of the auditors, although it recognized that it alsohas contribution to make to the promotion of good corporate governance”(Cadbury 1992).
This was not the end of code or regulations with respect tocorporate governance, rather this was the basis on which many further reviewswere made by future committees, such as the Greenbury Committee 1995 whichdealt with the accusations concerning the level of executive directorsremuneration paid and the Hampel Committee 1998 was constituted to complementand clarify the Cadbury and Greenbury report, which emphasizes on non-executivedirectors. On doing an analysis or evaluation of these committee, it can beseen that although there had been an emphasis on non-executive directors in thereports, they fail to provide a clear and comprehensive guideline anddefinition of the same. By the early 2000’s there came the next milestone for negligence incorporate governance, known as the biggest audit failure, Enron, where “Itappears that performance incentives created a climate where employees sought togenerate profit at the expense of the company’s stated standards of ethics andstrategic goals” (IFAC, 2003). The poor financial reporting and accountingloopholes helped mislead the board of directors and the audit committee fromcomprehending the billions of dollar debts incurred by the company from itsfailed deals and projects.
But, the fact of the matter being that Enron had inplace all the policies and structure for good cooperate governance includinghuman rights and a corporate social responsibility wing. But at the end, theimplementation of these policies and unfettered power in the hand of the chiefexecutive is one that characterized Enron’s management. The recommendations putforward by the Cadbury committee were willingly violated such as the auditcommittees allowing unusual accounting practices to be overlooked and remainunquestioned. Following the failure of Enron, the United States passed a federallaw called “Corporate and Auditing Accountability, Responsibility, andTransparency Act” commonly known as The Sarbanes–OxleyAct of 2002.
Sarbanes–Oxley Act of 2002 like the Cadbury committee, was due tothe corporate collapse of Enron, Tyco International Plc. and WorldCom whichdeteriorated shareholders and investor’s confidence in the financial reportsand demanded an overall checkup of the regulatory system. The recommendationsfocused mainly, like previous codes of practices on improving the accountabilityand transparency which can be seen by the usage of section 302 and section 404,respectively. Section 302 requires senior management to certify the accuracy offinancial reports thus imparting accountability to higher-level management.Section 404 puts responsibility upon the managers and auditors to establish internalcontrol and reporting techniques which provides more transparency on theworking and internal structure of the organization which IS a very costlyimplication. “a deeper question that Sarbanes-Oxley does not address is whetherwe can (or indeed should) legislate for human greed” (Henry, 2011, p.
415)Implementing internal controls has a downside of having high cost incurrences,because of which there was a loss of initial public offerings from the Americanstock market to the London stock exchange. Later, in 2006 US treasury secretaryHenry Paulson was assigned to review the Sarbanes-Oxley act, to which nochanges were made and suggested that the government would want to look into therules being enforced, such as ‘high standard of integrity and accounting’ alongwith ‘innovation, growth and competitiveness’. However, the financial crisis of2007-08 which led to the collapse of major financial institutions suggests amore robust regulation practices for the financial institutions (Henry, 2011,p. 415, 416).
The biggest sign was the Enronization of Lehman Brothers (Kirkendall,2017), this being the collapse of Lehman Brothers, where the Lehman executives weresubjected to the provisions in the Sarbanes-Oxley legislation enacted afterEnron’s bankruptcy that imposed criminal liability on executives who had falselycertified “the (i) accuracy of the financial statements and (ii) absence ofdeficiencies in internal controls regarding the preparation of the financialstatements which proved the point of the act but failed to prevent thecollapse.”(www.businessinsider.com,2010)Concepts and theories Even with the extensive list of codes of practices and rules set inplace by different countries and committees the collapse of companies stilloccurs to date, mainly due to the lack of proper division of responsibilityamong the chairman and the top-level management (directors and mangers). Theirroles and influences in the corporate collapses can be explained by sometheories and concepts like principal-agent framework, conflicting sights of theshareholders theory and stakeholder’s theory and how their interplay becomesthe cause of collapse for the corporates.The principal-agent theory comes intoeffect, because of the separation of ownership and control of the companybetween principal (shareholder) and the agent (manager), respectively.
Thereoccurs divergence of interest between the principal and the agent since thereis “no contract, however precisely drawn, can possibly take account of everyconceivable actions that an agent may engage in.” (Henry, 2011, p. 400). Thisleads to a high agency cost (cost associated from mangers abusing theirposition) and reduces the confidence amongst the principal and the agent whichin turn have a negative impact on the company. In the case of Enron, thedirectors (agent) had a legal obligation to follow through to the investors (principal) but as explained not all the activities of thedirectors could be covered under the legal obligations, the diversion ofinterest between both and lack of alignment was the final reason for thecollapse of Enron.
The principal-agent theory is a suitable analysis tool whichwhen used properly can identify when and where the interests of investors andmangers are diverging and thus could be kept in balance and control.Conflicting views between the shareholders and stakeholder’stheory contributes another major reason for the collapse of the corporatesin today’s setting. Shareholder theory was explained by Friedman (1962, p.
133)as “there is one and only one social responsibility of the business-to use itsresources and engage in activities designed to increase its profit so long asit stays within the rules of the game, which is to say, engages in open andfree competition without deception of fraud.” On the other hand, Freeman, R.E(2009) states that “Stakeholder Theory is an idea about how business reallyworks. It says that for any business to be successful it must create value forcustomers, suppliers, employees, communities and financiers, shareholders,banks and other people with the money.
It says that you can’t look at any oneof their stakes or stakeholders if you like, in isolation.”. The underlining distinction between both theories is thatstakeholder theory calls for the interest of all the stakeholders (includingshareholders) to be considered even if it reduces the profit of the company,whereas the shareholders theory disregards other stakeholders exceptshareholders to maximize profit of the company. There has beenmisinterpretation at both ends by considering that shareholders theoryspecifies only attaining profit and thus neglecting the part of legal andnondeceptive means mentioned together with it and similarly in stakeholder’stheory by assuming that the theory does not demand a company to focus onprofitability. Farepak case study could explain the impact of stakeholder andshareholders consideration. In the year 2006, more than 150,000 people had contributedfew pounds a week to the savings club of Farepak in return for a voucher at theend of the year to spend on Christmas present.
These savers were not given whatthey were promised due to the inability of the parent company European HomeRetailer (EHR) to secure further credit form their bankers. EHR wasdiversifying into many markets which made huge losses over the years, EHRaccounts had suggested that they were struggling from 2003 onwards. Banksrejected the credit since the liability over weighed the assets of the company,but several dividends were paid out and others such as EHR’s managers,directors and family shareholders came out the with the least credit. Thequestion remains whether the poor savers (customers) were supposed to know thatEHR has diversified and made a huge loss before they invested few pounds everyweek, even though the company is not legally obliged to compensate them, but inthe long run it may not have been wise to neglect these stakeholders(customers) for short term benefits. (Henry, 2011, p.
401-403) The interplay of how the shareholder & stakeholder’s theoryrelates to the investors, the management in an organizational structure havebeen summarized below in the matrix.From the above made analysis both theories on a standalone basishave their own misinterpretations and constraints, but a balanced mix of both couldand will be the solution for properly defining and segregating the role of thechairman and the director for the efficacious running of any corporate. Limitations Some of the limitations of corporate governance that have led tothe collapses of corporates around the world can be summarized as; · Ownership-Managementseparation which has been explained by the principal-agent framework is limitedfrom considering every aspect of that relationship for instance, although thereis a legal obligation by the agent to the principal, all the activities of thedirector cannot be covered under these obligations.· Flowand asymmetry of information, another byproduct of principal-agent theory whereagent (managers) have greater access to information which may not be properlycoordinated or transferred to the principal (shareholder).
· Lackof common codes and practices among corporates in different countries andwithin the same country are causing many disparities and misinterpretation,since it is widespread and tougher to collate.· Deceptivefinancial statements have been the main cause for the collapse of manycompanies in the past and continue to occur, such as establishing complexnetwork of subsidiaries and cross-shareholding, despite various corporategovernance codes being implemented.· Costof compliance for adopting the standards, rules and regulation laid by some federalcorporate governance laws have proven to be burdensome and expensive forcorporations, for example, the internal controls proposed by the Sarbanes-OxleyAct 2002.Recommendations Considering the limitations of corporate governance and the vastnumber of corporate collapses, recommendations listed below could be utilizedto improve corporate governance and the behavior of senior management withincorporations.· Chairmanand CEO; Separation of roles for the chairman and the CEO is recommended toeliminate concentration of power, which could lead to dilution of boardsinfluence over management in countries that do not already require this.
· Codificationof the codes and rules; As mentioned in the limitation due to widespread andsegregated rules and regulations from country to country, a unified andcomplete code of practice should ideally be shaped and accepted worldwide.· Morescrutiny of company strategic plans for legitimate value creation, to prevent internal(senior management) forces from compromising long term interest for short termbenefits.· Balancebetween principal and agent; Properly communicated and agreed upon incentivescould align their goals and interests. These incentives need not always befinancial in nature thus creating a balance between the principal and theagent. · Centralizedflow of information; Everyone in the same hierarchical command should have easyaccess to required information in a simple manner so it is easy to understand.
Easyaccess to information by the board members would create a more transparentaccountability system within the corporation thus improving the confidence ofthe shareholders in the company. ConclusionOverthe years the traditional mode of operation has changed drastically, followingwhich the code of practice has adopted itself to meet the demand. But thequestions that is to be answered is whether we need to wait for anothercorporate collapse to produce newer codes of practice or rather foresee theneed of the industry and create a unified universally accepted principles-basedcode of practice which can meet the need of the current era till it is requiredto be changed in the future