Research Topics: Corporate Governance

An Overview of Corporate Governance

An Overview of Corporate Governance Introduction             A number of perspectives have emerged on the concept of corporate governance that also justifies its importance. One perspective considers corporate governance as the “system of authoritative direction, or government”[1]. This means that corporate governance involves the exercise of authority by the leaders or top executives of the corporation to direct the company towards the achievement of its goals. Corporate governance as the exercise of authoritative direction involves the application of the fundamental principles of accountability, honesty, integrity, responsibility and trust in implementing a system of governance able to balance conflicting interests and priorities to improve financial and non-financial areas[2]. In practicing corporate governance, the company should be able to achieve effectively its goals because of the control and direction that company leaders provide. Concurrently, when there is weak leadership or poor direction, then the company would likely not achieve its goals and in the worst case, it can even result to the collapse of the company.             Another perspective considers corporate governance as the management of relationships. Corporate governance is the “connection of those relationships to the corporation and to one another”[3] with those relationships pertaining to the relationships between and among “directors, managers, employees, shareholders, customers, creditors and suppliers, as well as the members of the community and the government”[4] and these relationships involve constituents. Corporate governance as encompassing the management of relationships involves the development and maintenance of effective internal and external relationships within a defined cultural orientation as a means of motivating the corporate stakeholders to contribute to the achievement of firm goals.[5] Corporate governance is important in ensuring firm viability through sustained capital investments and profitability by providing that companies should develop effective practices such as accountability and reporting that foster the building of good relationship with shareholders as the source of capital for the company. Otherwise, poor practices could destroy the trust of shareholders resulting to a withdrawal of investments that could result to the collapse of the company.             The different perspectives represent the multidimensional aspects of corporate governance. On one hand, it involves the exercise of authority to direct the corporation towards its goals. On the other hand, it also revolves around the management of different levels of relationships occurring within the corporation and between the corporation and external parties such as suppliers. When taken together, corporate governance is the application of principles of leadership and authority and the management of multilevel relationships to achieve corporate goals.             Effective corporate governance makes a big difference in corporate outcomes since the business firms that have been able to develop effective corporate governance systems are also the firms that have become industry leaders in the domestic and even in the international market. A typical governance model of successful business firms includes a board of directors who fulfil their jobs competently and reliably, a competent CEO selected by the board and accorded sufficient authority to manage the business, a system in line with laws that enables the firm to fulfil its obligations to various stakeholders, and a system of accountability and disclosure of corporate affairs.[6]             Concurrently, failures in corporate governance lead to the collapse of firms for a number of reasons. One is the loss of efficiency when leaders neglect their roles and responsibilities in running the company and managing the firm’s relationship with its shareholders. When leaders violate regulations, effectiveness of the board suffers as expressed in unmet targeted goals, irresponsibly allocated resources, and eroded investor relations. Another is the inability to achieve firm sustainability because of disruption in the normal flow of business, heavy losses, and poor public reputation.[7] When these happen, the firm loses its investors and without investors, it cannot continue its operations. The result is bankruptcy as shown in the cases discussed in the succeeding sections.             Since part of corporate governance is accountability and disclosure to various stakeholders, this justified the development of corporate governance laws and regulations applicable in different jurisdictions. Provisions on corporate governance usually include responsibility of leaders or the board to provide public access to vital information to enable investors to gain freedom of choice and practice accountability through a limited tenure of the directors, quorum rules in the decision-making process, approval systems for investment policies, and rules of financial reporting. These rules not only develop efficiency but also protect stakeholder interests through corporate affairs guided by sound principles. Corporate Governance in the U.S. and U.K.             Corporate governance in the United States works through the Sarbanes-Oxley Act 2002 that introduced corporate governance initiatives infused into federal securities statutes while corporate governance in the United Kingdom operates through the combined code that focused on board composition and functions. These initiatives constituted significant changes in the law and departed from the previous system of regulation[8]. Sarbanes-Oxley constituted a response to the widespread fraud that occurred in the United States involving corporations such as Enron, Tyco and WorldCom. The provisions of the law also enhanced corporate governance in national securities and shareholdings by widening the function of the audit committee of the corporation.[9] With the new law, corporate governance in the United States placed stress on the key areas of internal control certifications, internal control assessment, and disclosures. The combined code coincided with the reviews made in the United States in the 1990s that ended with the establishment of the combined code due to the merging of the three review committees, Greenbury, Cadbury and Hampel committees. The combined codes was a response to the case of Maxwell Communications Corporation, which involved the diversion of pension funds of the firm to fund the firm’s operations after the company’s engagement in high risk investments that resulted to huge losses and placed the corporation in debt. Since then revisions have been made in 2003 coinciding with the Sarbanes-Oxley development in the United States, with subsequent changes in 2006.[10] The combined code establishes standards for good practice relative to issues on board composition and board-related development, remuneration responsibilities, and processes of audit relative to shareholders.             An important corporate governance rule in these two jurisdictions is internal audit. In Sarbanes-Oxley, corporations take responsibility not only in filing periodic reports but also in certifying that the officer signing the document has reviewed the document and the report contains true accounts of facts on the financial condition of the company.[11] The CEO and CFO takes responsibility for quarterly certifications included in the financial reports, disclosure of all known deficiencies in control in the previous reporting period, and disclosure of fraudulent acts. Internal audit is also requires corporations to include a report on internal control that states the responsibilities of management in establishing and maintaining sufficient internal controls and processes in financial reporting and provides assessments of the level of effectiveness of the internal control system based on the financial reporting in the most recent fiscal year. In addition, the public accounting firms need to provide an attestation on the assessment of the corporation.[12] This obliges corporations to regularly assess and report on internal controls together with the attestation of the independent accountant. Under this provision, corporate management and the independent auditor takes responsibility over certification of internal controls assessment with an attestation by the independent accountant, and quarterly change reviews. In the combined code, accountability and auditing involves the board taking responsibility in deriving a clear and balanced assessment and reporting of the position and prospects of the firm. Corporations take responsibility for maintaining a sound internal control system as a means of safeguarding the assets of the firm and the investments of shareholders. The corporation should also establish a three-person audit committee and develop formal business relations with the committee.[13]             Another important corporate governance rule covers the board of directors. Sarbanes-Oxley prohibits members of the board from arranging or obtaining personal loans or other internal arrangements such as cashless options or insurance arrangements. The board of directors cannot engage in insider trading and due reports should be made with the SEC. In addition, CEO and CFO of the firm have to reimburse the firm for payments or profits earned in case the firm needs to restate financial statements because of reasons such as misconduct. In the combined code, the structure and composition of the corporate leadership, particularly on the important role of the board in taking responsibility over the success of the firm was stressed. There should also be a clearly defined division of responsibilities in order to prevent the concentration of power on one person or a small group of people. Achieving this involves the inclusion of executive and non-executive officers. In the appointment of officers, this should be made by applying a formal, thorough and transparent process of selecting directors and other members of the board. Competence has to be developed by the members of the board in considering new business related and regulatory information important to the performance of their jobs and update their skills and knowledge, with the performance of the board subject to formal evaluations. The directors are subject to re-election into their position but this should be supported by sustained satisfactory performance. The remuneration of members of the board of directors is also tackled, with the amount sufficient to attract qualified people and the system of remuneration should have links with the system of performance. A formal remuneration system should also exist so that the directors themselves do not have control over the determination of their respective remuneration.[14]             Still another salient corporate governance rule is disclosure or transparency. In Sarbanes-Oxley, the corporation reports additional information to the public regarding all material changes in its financial condition as these materialises. The report should use plain English since the intended audience is the public.[15] Real time disclosure protects investors and the public who could experience effects of the changes in the corporation financial condition. Management and independent auditor takes responsibility in monitoring emerging operational risks, reporting material events, and indicating the real time implication of these events. In the combined code, it is the responsibility of the corporate leadership to maintain communications and a good business relationship with shareholders in order for shareholders to gain important data pertaining to their investments.             Corporate governance in the United States after the enactment of Sarbanes-Oxley draws corporate management to practice truthful and responsible accounting through the assumption of responsibilities over reporting, internal controls assessments, and disclosures as well as independent accountants and auditors to take responsibility in reviewing financial reports and internal control assessments through attestation requirements. The regulatory provisions for corporations covered by the combined code provide best practices on board composition and remuneration as well as shareholder relations that constitute corporate responsibilities. Key Differences in U.S. and U.K. Corporate Governance             Although the corporate governance regulations in the United States and United Kingdom have similarities, there is a major difference in the nature and application of corporate governance in these two jurisdictions. In the United States, corporate governance rules carry the nature of being legislative and prescriptive while in the United Kingdom, corporate government regulations comprise a ‘comply and explain’ system. This means that corporate governance rules in the United States apply to corporations in a mandatory manner while the regulations in the United Kingdom work through the voluntary action of corporations.[16] This is supported by the inclusion of provisions on criminal penalties for non-compliance to the corporate governance rules in the United States while the combined code in the United Kingdom does not have similar penalties clause. In addition, the tone of Sarbanes-Oxley is prescriptive and imposing when compared to the combined code that only provide general guidelines and exact voluntary compliance largely dependent on the self-regulatory actions of the corporate leaders. As such, in the United States non-compliance results to prosecution while the United Kingdom a possible violation of best practices entails an explanation by corporate leaders.             There are also specific differences between the corporate governance regime in the United States and United Kingdom. First is the condition in the United Kingdom for the roles of CEO and Chairman to be separated in order to achieve checks and balances in the board composition. This condition is not prescribed in the United States. Second is the requirement for the composition or inclusion of independent non-executives as members of the board. In the U.K., majority of the board should be made-up of independent non-executives but in the U.S., all the members of the board should be independent non-executives to ensure accountability. Third is the prescription of internal audit committee under the U.S. corporate governance regime but there is no requirement for such committee in the U.K. but firms should explain the lack of this committee.[17] The differences are due to the variances in the corporate governance failures experienced in these two jurisdictions as shown in the cases discussed below. Corporate Governance Failures Bank of Credit and Commerce International (BCCI)             BCCI was founded in 1972 by Agha Hasan Abedi. The primary goal of the bank is to provide support to the destitute segments of the population in the developing countries[18].             The problem of the bank started with BCCI’s response to the situation of Gulf Group, one of its primary clients, a shipping company that got into financial trouble in repaying its debts and BCCI went too far in settling Gulf Group’s loan with external creditors. This took its toll on the finances of BCCI so that the company had to offer high rates of interest to attract customers to make deposits. Evidence suggests that Abedi and Mr. Naqvi, his assistants who became CEO, falsified BCCI accounts in order to hide the drain in the accounts of the bank and make the reserves report reflect a healthy firm.[19]             In 1988, police and customs office in the United States arrested seven officials of BCCI officials in Tampa for the crimes of drug trafficking and money laundering, which I think was a good warning for the bank of England to look at BCCI operations.[20]             In 1987, Abedi agreed to appoint Price Waterhouse as its sole auditing company. According to the Bingham report, which the U.K. Prime Minister John Major commissioned to investigate and report on the problems within BCCI, Price Waterhouse acted as the sole auditor of BCCI as well as consultants charging BCCI for their services.             Price Waterhouse received information of fraud within BCCI from senior employees covering doubtful loans and wrongful information stated by BCCI management to its auditors. This prompted Price Waterhouse to make a report to the Bank of England. However, Bank of England did no make any action on the report. After a month, Price Waterhouse again sought a meeting with the Bank of England and provided evidence providing Naqvi’s admission of the falsifying documents and deceiving the auditing firm. Again, the Bank of England did not make any action on the matter. Finally and after receiving a report on the details of the fraud from the auditing company that Bank of England made the decision to close BCCI, which includes details of the fraud from Price Waterhouse, the bank decided to close BCCI. It took the Bank of England five days from the receipt of the first report to act on the matter.[21]             This case shows a clear example of corporate governance failure, and it shows why we need to apply corporate governance rules or codes of best practice. One of the obvious examples is the power of the Chairman and the chief executive officer Mr. Abedi and Mr. Naqvi in which they had too much power that they were acting like they were the only owner. It seems that the board of directors were so week that they were not concerned about being asked of the reasons or explanations for what they were doing. This reminds me of the reasons of having non-executives in the board to make sure that the company is in the right track and make sure that every thing goes according to the strategy and the plan.             The second main problem with BCCI is the complexity of the BCCI structure, in which the founder Mr. Abedi registered the parent company in Luxembourg and a major subsidiary of BCCI overseas was registered in Cayman Islands. This causes complexity since there is no central regulation on oversees operations and no official lender of last resort. This caused many people to question the reasons of splitting the operations between Luxembourg and Cayman Island. Is it because of the relaxed regulations? I doubt it because in that time there were various countries with relaxed regulations than these two countries in which BCCI already got branches. U.S. and U.K. corporate governance agrees on the point that an audit company can not work as an auditor and as a consultancy at the same time because that will lead to a conflict of interest, which happened in this case.             There were a lot of problems regarding corporate governance at BCCI but what really caused the bank to collapse was the miscalculation of the risk when they agreed to pay the creditor of Gulf Group and which took most of the cash that the bank had. It seems that this problem has nothing to do with corporate governance but in reality, it has, because this kind of decision should be referred to the board. But since the board committee in BCCI was weak and were depending on only one-sided opinion, this led to a wrong calculation of the risk.             In my view the reaction of the bank of England was not only late but also wrong. There were a lot of signs that the bank of England did not give attention to, one of the signs were the Tampa trail in which the bank of England should take some precautions toward it and investigate to make sure that everything is alright. Besides the first and the second meeting that the audit company had with the bank of England seems enough to me to open a door for investigation, but the bank was fearing that the job might be too big and complex, which was proven by the worsening of events before the bank of England finally took a decision. This was a fatal decision to shut down BCCI without examining the opportunity of restructuring and saving BCCI. This constituted a difficult decision but not impossible and worth looking at, at least to save the confidence of the investor in the banking sector. Enron Corp (Enron)             Enron is an energy company that established its headquarters in Houston, Texas. Prior to December 2001, Enron enjoyed the seventh position among the top corporations in the United States and recognition as a highly innovative firm.              Enron’s problem started when the board engaged in questionable practices. Enron wanted to expand its operations by diversifying the range of its products and engaging in online trading. However, instead of becoming a broker between buyers and sellers, which is the usual practice, Enron directly traded in gas and other products. This meant that buyers bought directly from Enron and Enron purchased directly from suppliers. This means that the continuity of its trading operations largely depended on its credit rating. When its credit rating dropped, buyers and sellers halted trade.[22] Enron’s board approved a very risky strategy that did not afford the company security in case of a decline in its credit rating and the slow down of trading.             Another activity that the board approved is the special purpose entities (SPEs), which is uses third parties to collect investment funds from people and firms not related to Enron. Even if third parties collected the funds, Enron became the guarantor of the payment of the borrowed funds and this was done by offering shares to investors. Massive external borrowing affected Enron’s credit rating because external borrowing was read as a sign of problems within the firm. In addition, economic downturns together with the extreme provisions included in the debt arrangements made through SPEs made it difficult for Enron to manage its debt.[23]             In December 2001, Enron declared bankruptcy resulting to the decline in share prices from 83 dollars to less than a dollar. This was due in part to a series of corporate governance problems that eventually caused the decline of the firm.                      The cause of the collapse of Enron can be traced to poor corporate governance practices.             Enron’s board of directors did not have independence or oversight of its operations because of the structure, roles and remuneration of its board. Enron had fourteen members of the board comprised primarily of external members, which made it harder for the firm to control and direct its operations towards shareholder interests. Most of the external directors owned significant Enron shares and only one external director had stock options as part of compensation. In addition to the compensation of the board of directors, they received consulting fees. Many of the directors also engaged entities with which they have personal or business links and approved donations to organisational with which they have affiliations.[24] These created areas of conflict of interests implying the compromise of the board’s independence, which in turn meant a problematic internal control system.               The firm’s compensation system created the problem of earnings manipulations because it was dependent on performance thresholds[25]. In this system, the manipulation of earnings favours the board since higher earnings meant greater compensation. This encouraged Enron’s non-inclusion of substantial SPEs in its balance sheet to increase the amount of earnings. This occurred due to lack of oversight of Enron’s board.             Enron had an external auditor but the auditor failed to apprise comprehensively the board and regulatory authorities regarding the emerging and potential irregularities in Enron’s transactions including the remuneration systems and other transactions with external entities. This was due to the comprised independence of the auditor who was entitled to receive large amounts as consulting fee from Enron as the client. This prevented the conduct of an independent external audit or review.[26] WorldCom, Inc. (WorldCom)             Bernie Ebbers, who received a degree in physical education successfully built a motel chain and acquired a reputation for careful appropriation of corporate financial and skillful management of business deals. Together with associates, they set up a telecommunications company called LDDS or long distance discount services. After some time, the company experienced financial difficulties. Ebbers was appointed CEO by the board and within a few months he was able turn around the situation and make the company a profitable venture. [27]             Since then, the company acquired a reputation for aggressive practices during mergers and takeovers that started with WilTel, which was one of the major suppliers in 1995. The merger created WorldCom, which continued in its aggressive strategy. The company bought UUNET Technologies and within weeks, it took over another company known as MFS. As if that was not enough, it was able to outbid BT for a company called MCI. WorldCom continued its expansion in 1998 by taking over two large companies, Brooks Fiber and CompuServe.[28]             WorldCom problems commenced in 2000 when it received many complaints on its customer service and the lawsuits piled up. The approximate cost of the lawsuits reached million. The basis of the lawsuits included excessive customer charges on calls, tricking customers to sign-up for long distance services, and billing customers for service charges given without the authorization or permission of customers. In 2002, WorldCom extended 1 million to Ebbers as personal loan at a 2.16 percent interest, which was lower than the cost to WorldCom in investing or loaning the money.[29]             Cynthia Cooper, the internal auditor for WorldCom gave the report that the ordinary operating expenses of the company were listed under capital investment, which means instead of writing the expenses in the profit and loss account, which will reduce the profit they were being taken off and written over a much longer period. The audit committee was not able to act on this information. Later, it was discovered that WorldCom was able to overstate its cash flow by more than .8 billion. WorldCom gave Salomon Smith Barney, a brokerage company, an exclusive right to administer the stock option plan, in which they were charging large fees for the portrayal of a positive picture and rating WorldCom’s stocks highly, even if WorldCom’s stocks were actually falling.[30]             The strategy that WorldCom was using showed that the company has weak corporate governance. It was not able to control the subsidiary companies since each telecom acquisition had different technical structures, billing structures, and sales plans. They reached the point that they were not able to get control over all these companies, beside when they were not able to maintain their profit, they started tricking and deceiving there customer, which costs them a lot of money in law suits.             The generous loan that the board of WorldCom gave to Ebbers has no explanation, especially when it was a large amount of money and the interest charged was lower than the cost to WorldCom of actually borrowing the money and was made at a time that the company was in need of cash.               The audit committee failed to act upon the information that the internal audit has found, and I think if the audit committee and the board acted at that time there is a possibility of saving WorldCom.             The overstatements of cash and the strategy that Ebbers was using shows the weakness of the board and the one sided opinion of the decision in the company, which is a failure in corporate governance. Barings plc             Barings bank was the oldest merchant banking firm in the United Kingdom that operated for nearly 200 years since it played a part in funding the Napoleonic wars and even the Erie Canal. In 1989, Nick Leeson joined Barings bank as the general manager of the Singapore operations. In his previous employment, he gained a reputation for having a through understanding of the brokerage settlement process and this was the reason that Barings gladly hired Leeson. In 1992, Leeson, acted as general manager of the bank’s engagement in the futures market. He took over the organization of the accounting and settlement department and acted as head of the trading operations in SIMEX, Singapore’s stock exchange.[31]             According to Leeson, Barings bank in the London headquarters allowed him to establish error accounts to cover any trivial items emerging in Singapore. After only a few weeks, he was asked to retain only one error account.[32]             During his tenure as general manager, Leeson applied for and received a trading license in SIMEX, which would allow him to become a stock exchange trader. Headquarters did mind his assumption of the trader role. However, although he was supposed to trade only on behalf of clients in executing their orders, he soon began to start trading on his own behalf. He used the error account to cover up his unauthorized trading activities. Leeson engaged in risky transactions because he failed to apply hedging. Consequently, from the perspective of Barings, Leeson was becoming a successful trader because they receive reports o trading successes but not his losses.[33]             Although receiving pieces of information on the situation in Singapore, Barings ignored the warning signals, which could have been highlighted by the extremely high demands for cash from the Singapore office. When asked, Leeson responded that the money is tied up at SIMEX so that there would be a delay in reporting. In addition, Leeson went to the extent of forging documents to provide support his claims.[34]             Barings case shows a clear example of weak internal control. Leeson was able to deceive not only the managers in Barings but also the internal auditor, which raises a question of the authority and the trust that Barings manager gave to Leesons. There was a time that Barings managers did not give attention to the signs and did not question the huge money that Leeson has been asking for. This raises the question about their corporate governance and their weak strategy.             When Leeson got his license to act as a trader in SIMEX, Barings managers did not show any objection. While it is an obvious example of conflict of interest since Leeson could act as trader and at the same time responsible for accounting for those trades in the back office.             It is worth saying that Leeson’s reason for fraud was not for personal gain.  However, this leads in the end to the same conclusion. Northern Rock             Northern Rock held the position as the top-five mortgage lender in the United Kingdom with a respectable share price in the stock exchange. However, in September 2007, Northern Rock experienced runs in its bank branches, as its clients feared losing their money after the publication of Northern Rock’s huge loan from the Bank of England. Although the situation leading to the problems experienced by Northern Rock was due to the credit crunch that affected the world, there were still issues of corporate governance that occurred on the part of Northern Rock as well as the Bank of England and the regulatory authorities[35].             On the part of Northern Rock, the failure of corporate governance was due to the board approving a high-risk money making system. Standard practice is to obtain funds from depositors, payable in the medium or long-term to allow the firm to loan the amount at a higher interest rate. The difference between the interest paid to depositors and the interest gained from loans constituted the profit of the firm. However, Northern Rock used a different strategy. It obtained credit from depositors and other banks payable in the short term and loaned these to be payable in the long-term. As money borrowed by the firm matured, this is paid off by obtaining other short-term loans while awaiting the maturity of its long-term mortgage loans. This means that as long as depositors and other banks extent approve the borrowings of Northern Rock, it can continue to make money. However, in mid-2007, the monetary policy committee raised interest rates to address inflation and crisis broke out in the mortgage market resulting to banks unwilling to extend any more loans. As such, Northern Rock could no longer pay its short-term borrowings. [36]  This constituted poor corporate governance practice since the board approved a risky system that violated its responsibilities under corporate governance to enforce an internal control system intended to safeguard the assets of the firm and the investments of shareholder as well as to maintain open communications for purposes of disclosure to stakeholders.             Investigations also uncovered excessive remunerations received by the top executives of Northern Rock even if the firm is facing collapse. This constituted poor corporate governance since remunerations should be enough to constitute incentives for productivity but not to the extent of allocating unreasonable assets for this. In addition, the extended tenure of a non-executive director of Northern Rock’s board also came up during the investigations as a violation of the combined code.[37] This could constitute poor corporate governance since this could affect the independence and balance of power of the board to act independently and outside of the control or influence of one or two people. Moreover, the independent accounting firm handling the auditing of Northern Rock’s finances was put to question because it gained large sums from Northern Rock, indicating a breach in the independence of the accounting or auditing firm or group.             On the part of the Financial Services Authority (FSA) and the Bank of England, there was also poor implementation of corporate governance rules. FSA knew that Northern Rock was facing trouble as early as August 2007, two months before the bank runs. However, there were no recommendations to improve corporate governance in the firm, especially with the raised interest rates. In addition, although the Bank of England paid off Northern Rock’s loans, albeit at a time when the firm was already at the brink of collapse, the government also announced its guarantee of ensuring deposits, which heightened the alarm of depositors. Furthermore, the deposit insurance system established by FSA came into question because it only had a limited guarantee. This showed that the corporate governance rules in the U.K. have limitations and flaws that not only allowed irregular firm practice but also poor handling of business failures largely due to poor corporate governance.   Conclusion             In the conclusion, it is worth saying that using case studies has proven the importance of corporate governance regulation and afforded a deeper understanding of the issue. The analysis of the cases discussed and other cases assist social scientists and economist in coming up with the theories and legislations that we already have and no matter which codes and regulation we are using it is difficult to foresee or visualize a system which is completely free from the possibility of corporate governance failure. The point is that we have to learn and keep our legislation and codes updated and learn the lessons from mistakes. But it seems that some people can not learn from their mistakes like the Bank of England, who did not learn the lesson from BCCI and repeated the same mistake in Barings and was about to repeat it again in Northern Rock. My point is that the Bank of England was late, in the three cases, in interfering and making right decisions. It was late in BCCI and did not look at the warnings or acted on it. Not only that but the Bank of England also did not take the allegations seriously when the audit company approached the Bank of England to express doubts over BCCI accounts. It also repeated the same mistake with Barings by leaving the bank to collapse, which makes people loose their confidence in the U.K. banking sector which pressured Bank of England to interfere and finally act as a last resort in Northern Rock, but people could not trust neither the bank of England nor northern rock on their deposits.             However, I agree with the way the combined code of best practice works but In my opinion it has some weaknesses in U.K. corporate governance because the regulatory bodies, like financial stock exchange and the Bank of England, do not interfere until its too late, which is in my opinion wrong.             On the other hand, U.S. regulation is very strict as a one size fits all approach. Sarbanes-Oxley does not only fail to give attention to the nature of the business but also cause problems to arise. While Sarbanes-Oxley was able to address the regulatory problems that resulted to the cases of WorldCom and Enron, its operation also gave rise to new problems. This means that while Sarbanes-Oxley was responsive to the previous problems, it created other problems. One problem is the inconsistencies experienced by foreign companies between the regulatory policies in their home country and that of the United States, with the regulatory system considered as overreaching and excessive relative to other regulatory systems. This caused a number of firms to withdraw planned entry into the United States and operate in other jurisdictions considered to have more reasonable regulatory standards. Another problem is the limited effectiveness of its strict regulations. Another problem is the failure to influence change on other key cultural areas of corporate governance to prevent future failures in corporate governance. Sarbanes-Oxley made it the responsibility of the CEO and CFO to ensure the accuracy of financial reports and even imposed criminal penalty on these officers for failing in their duty. However, the top management culture of basing incentives and pay on performance and company earnings means the incentive to increase reported earnings remains, which motivates the directors to raise earnings. This creates a situation that could be subject to abuse. Although Sarbanes-Oxley has applied measures to prevent the repeat of WorldCom and Enron, this does not guarantee that these corporate governance failures would not happen again. Directors driven by the need to raise earnings just have to look for loopholes to report higher values than the actual earnings.             The U.S. regulation is, in a way, more responsive by providing measures that address the problems that allowed WorldCom and Enron to occur. However, the emergence of new problems could put into question the effectiveness of this strict regulatory regime in preventing corporate governance failure relapse or improving the regulatory regime in the United States.    References Arcot, S.R. & Bruno, V.G., 2006. In letter but not in spirit: An analysis of corporate governance in the UK. Available at http://ssrn.com/abstract=819784 [accessed 22 April 2008] Colley, J.L., Stettinius, W., Doyle, J.L. & Logan, G., 2005. What is corporate governance?. New York: McGraw-Hill.   Financial Reporting Council., 2006. The combined code on corporate governance. 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[3] Monks, R. & Minow, N., 2003. Corporate governance. Oxford: Blackwell Publishing. p. 9 [4] Monks & Minow 2003, p. 9 [5] Tirole 2001 [6] Colley et al. 2005 [7] Mardjono, A., 2005. A tale of corporate governance: Leesons why firms fail. Managerial Auditing Journal, 20(3), p. 272-283. [8] Romano, R., 2004. The Sarbanes-Oxley Act and the Making of Quack Corporate Governance. NYU, Law and Econ Research Paper 04-032. Available at http://ssrn.com/abstract=596101 [accessed 22 April 2008] [9] Peek, L.E., Blanco, H. & Roxas, M., 2004. Sarbanes-Oxley Act of 2002: Corporate governance and public accounting firms oversight in NAFTA countries. American Accounting Association 2004 Mid-Atlantic Region Meeting Paper. Available at http://ssrn.com/abstract=489046 [accessed 22 April 2008] [10] Arcot, S.R. & Bruno, V.G., 2006. In letter but not in spirit: An analysis of corporate governance in the U.K.. Available at http://ssrn.com/abstract=819784 [accessed 22 April 2008] [11] The Sarbanes-Oxley Act 2002 [12] See Above [13] Financial Reporting Council., 2006. The combined code on corporate governance. Available at http://www.frc.org.uk/documents/pagemanager/frc/Combined%20Code%20June%202006.pdf [accessed 22 April 2008]   [14] Financial Reporting Council 2006 [15] The Sarbanes-Oxley Act 2002 [16] Arcot & Bruno 2006 [17] How U.K. and US differ on corporate governance., 2005. Finance Week. Available at http://www.financeweek.co.uk/cgi-bin/item.cgi?id=1862 [accessed 24 April 2008] [18] Wearing , R., 2005. Cases in corporate governance. Thousand Oaks, CA: Sage Publications.   [19] Wearing 2005 [20] See Above [21] See Above [22] Gillan, S.L. & Martin, J.D., 2002. Financial Engineering, Corporate Governance, and the Collapse of Enron.  U of Delaware Coll. of Bus. and Econ. Ctr. for Corp. Governance Working Paper No. 2002-001. Available at http://ssrn.com/abstract=354040 [accessed 22 April 2008 [23] Gillan & Martin 2002 [24] Gillan & Martin 2002 [25] See Above [26] See Above [27] Wearing 2005 [28] See Above [29] See Above [30] Wearing 2005 [31] Wearing 2005 [32] Wearing 2005 [33] See Above [34] See Above [35] Lynes, D., 2007. The Northern Rock story simplified – Why did it happen?. Ezine Articles. Available at http://ezinearticles.com/?The-Northern-Rock-Story-Simplified—Why-Did-It-Happen?&id=840080 [accessed 24 April 2008] [36] Lynes 2007 [37] Bettelley, C., 2005. Northern Rock defies governance code. Finance Week. Available at http://www.financeweek.co.uk/cgi-bin/item.cgi?id=370 [accessed 24 April 2008] Credit:ivythesis.typepad.com

An Overview of Corporate Governance

An Overview of Corporate Governance Introduction A number of perspectives have emerged on the concept of corporate governan...

Explain how the adoption of effective Corporate Governance systems and processes can be positively affect company conduct and performance

Introduction This is an essay explaining how the adoption of effective Corporate Governance systems and processes can positively affect company conduct and performance. The following are the presentation of the issues to be covered by this essay: definition of terms used in this essay; the reason for the growth of interest in the subject; the way corporate governance operates in an organization; cooperate governance in relation to the corporate purpose and to business ethics. A conclusion will end the essay, summarizing key points in relation to the subject topic. This essay is in relation to the understanding of the author to corporate governance after studying several references and materials. The writer evaluated and used some listed organizations of United Kingdom and Hong Kong in order to demonstrate the analysis.  The following companies were used in order to demonstrate the answer for the good effect of effective governance, The Bank of China Limited, China Zenith Chemical Group, The Hysan Development Corp., Kee Shin Holdings Limited, Enron, Moulin Global Eye Care and CLP Holdings Limited. The author acknowledges the references used by providing a bibliography part at the end of this essay.             According to Chen (2004), there is good corporate governance and poor corporate governance. Good corporate governance provides proper incentive for the Board and the management to pursue objectives that are in the interests of the company, on the other hand, poor corporate governance can damage the interest of the parties involved. Corporate Governance is an issue attracting much attention in global strategic marketing. The need to analyze on how effective corporate governance systems and processes can positively affect a company’s conduct and performance will provide deep understanding oh how to incorporate governance in the system of a company.   Basic Definitions             The following are definitions of the words used in this paper. The definitions may derived from authorities of the subject or from dictionaries.             BUSINESS ETHICS – movement within a business or the movement to build explicitly ethics into the structures of corporations in the form of ethics codes, ethics officers, ethics committees, and ethics training (De George, 2003). CORPORATE GOVERNANCE – is the framework of rules and practices by which a board of directors ensures accountability, fairness, and transparency in the firm’s relationship with all its stakeholders. DIRECTORS – in general, person who leads, manages, or supervises an organization, program, or project. Specifically, person appointed or elected member of the board of directors of a firm who, with other directors, has the responsibility for determining and implementing the firm’s policy. He or she does not have to be a stockholder or an employee of the firm and may hold the office of the director. EXECUTIVE DIRECTORS – working director of the firm who is usually its full time employee, and has a specified decision making role as director of finance, marketing, operations, etc. on an on-going basis. NON-EXECUTIVE DIRECTORS – directors not classified as working director, and has no specified decision making. ORGANIZATION – social unit of people systematically arranged and managed to meet a need or to pursue collective goals on a continuing basis. STAKE HOLDER – person, group, or organization that has direct or indirect stake in an organization because it can affect or be affected by the organization’s actions, objectives, and policies.   Reason for the Growth of Interest in the Subject             There are various reasons for the growth of interest on conducting a single framework for effective corporate governance, According to Mohamad (2004), the term corporate governance came into vogue following the Asian Economic Crisis in July 1997 and has since been bandied about quite frequently in the business press. Furthermore, Calvin (2006) in his report stated that the Deutsche Bank Study concluded that, “The assessment of corporate governance standards is a valid measure of equity risk. There is a clear link between corporate governance and assessment and share price volatility, corporate profitability, and share price performance.             The author has derived three (3) reasons on why there is a growth of interest in corporate governance. The first one is that good corporate governance means a good conduct of business and hence the economy of a country will flourish. Second reason is that corporate governance will ensure that a corporation will unlikely to experience a problem or if cases of worst circumstances, will be able to survive any occurrence of dilemma within its organization. The author has included this reason because as the company continue to conduct its business it is inevitable that a corporation may not be able to experience any problem. The last reason is that the necessity to produce more positive outcome in the conduct of the business. Thru corporate governance, a corporation will be able to create policies and set up a framework in order to produce positive results for the company.              It is an interest with the diverse stakeholder groups, because these groups are mainly concerned with their own rights and capabilities is affected on the way the corporation is being governed. The main foundation of a corporation is the stockholder, which would in return must experience good return as to the value of its stocks. In order to provide a concrete example, The Bank of China Limited, in its Annual Report 2007, has reported that it continued to improve their corporate governance structure in accord to the principles of scientific decision-making and effective supervision. The bank also conducted its first annual general meeting which had provide excellent opportunities for communicating with their shareholders.             According to the study of About.com (2008), institutional investors in companies based in emerging markets claim to be willing to pay as much as thirty (30) percent more for share in companies that are well-governed. This was attributed to the fact that investors will have a stable return of income or profits as good governance will ensure that the business is also stable. The presence of the transparency of good corporate governance must be established not only based on the reports submitted but also with the way, it actually carries out its business. Effective corporate governance is perceived by consumer means that an organization renders services and offer products of high and best quality.   How Governance operates in an Organization             Several countries implements codes for effective corporate governance. The codes provide guidelines and policies in order for the listed companies create effective governance. In addition, the guidelines set a compulsory submission of annual reports as regard to the practice of the company. In order to illustrate how the factors that would affect corporate governance, the writer will put in some details one of the successful companies who have effective governance. Rudrum (2008) stated that the Cadbury Committee defined corporate governance as the systems by which an organization is directed and controlled, at its most senior levels, in order to achieve its objectives and meet necessary standards of accountability and probity. Governance operates in a corporation by creating rules and regulations on establishing board of directors that would explicitly handle the way the corporation will be manage. A chief executive director will head the board of directors, which is task to oversee the performance of the directors in relation to their function. The non-executive directors on the other hand will serve as the evaluator of the conduct of the executive directors in order to determine whether the executive director perform their conduct to the benefit of the corporation.             Hence, the effect of the corporate governance will be determined on how the corporation’s director will handle it functions. Asian Development Bank recognizes the principles that effective corporate governance requires partnership of the board and the shareholders and management as well as the interface with an array of stakeholders such as employees, the media, creditors, and suppliers. From this it can be inferred that the governance operates on how the corporation will be able to carry out its business for the benefit of the whole corporation, not only focusing on single matters that will only contribute a small amount to the effective conduct of the business. The corporation will benefit on the effectivity of its corporate governance if the directors will be efficiently handles its functions as what is required for them.   In order to illustrate the abovementioned statement, China Zenith Chemical Group Limited is a company, which has strategically moved to manufacturing coal, related chemical products from manufacturing petroleum refined chemical products. In observance to the Code of Corporate Code of Hong Kong, it adopted the principles laid down in order to safeguard the interests of the shareholders and enhance the corporate value and accountability. The directors of China Zenith do have different task that has been the reason for their continuous growth. The success of their strategic moved is attributed to the fact that they maintain regular dialogue with its investors and stockholders, hence, matters of resolutions, and questions as raised by the people in the company. It can be inferred from the practice of the company, that the adaptation of the principles laid down by the company was not only in its because the Hong Kong has provide stricter rules but also the principles laid down were all substantial hence it will make a company progress thru the improvement of its corporate governance.             According to Chen (2004), the study of corporate governance is about how authority originates in companies and how it is allocated amongst the parties involved. In business organizations a board was set up which comprises directors which will conduct itself in behalf of the company. The board will determine the risk to be assumed by the organization, whether it would be conducive to the business or not.     Hence, effectiveness of the corporation’s director is significantly needed to the corporation. According to the Business Round Table (1997), some of the functions of the board are to select and regularly replace the executive officer; review the major strategies and financial; plans of the corporation; advise management on significant issues facing the corporation and oversee the processes for evaluating the adequacy of internal controls, risk management and other financial matters and lastly nominate directors and ensure the structure and practices of the board provide for sound corporate governance.             On the other hand, the role of non-executive directors, according to the website ECGI, should scrutinize the performance of the management in meeting agreed goals and objectives and monitor the reporting of performance. The non-executive directors do the checking and balancing of such functions. The Hysan Development Company Limited has reported several numbers of awards they have received because of their efficient corporate governance. The company also reported in its 2007 Annual report that they established an appropriate check and balances into their governance structure, which include the need to designate a Senior Independent non-Executive Director.   The Code of Hong Kong requires independent non-Executive Director on the hand.  A director will be considered an independent director in pursuant to the requirements laid down by the Code. The INED need to comply with and operate with what is provided by the Code. As mentioned non-executive directors are tasked to check and balance the conduct of the excutive directors, the INED helps reduce reduce the possibility of fraud and improves the level of disclosure in financial reporting, in the performance of the Audit committee. As to the Renumeration committee, majority of members are INEDs.                         As aforementioned, the need to construct effective corporate governance will enable the corporation to conduct its business productively. However, there are number of companies that have been practicing poorly with their corporate governance hence resulting to their downfall. The writer will provide two companies as an example.             The fall of Enron is considered the worst occurrence of bankruptcy due to poor implementation of corporate governance. The fall of Enron, according to Munzig (2003), is attributed to the fact that there was a manifestation of the agency problem, that there were significant costs associated with the high-power incentive contracts with for the management, and due to lack of board independence, which has likely resulted to the management, rent extraction.             The writer have seen that the there has been an inefficient compensation packages with the company that has resulted into poor motivation and lack of dedication by the directors. Although the system acquired by the company was efficient especially in creating effective corporate governance, the practice of Enron has been no longer helpful to the company and has resulted to its downfall. As stated, the company will benefit to an its effective governance if it has been practicing the overall open dialogue for the directors and establishing a framework that would specifically put the directors in the perspective of achieving goals for the company.             The effectiveness of the corporate means that the policies and framework are also efficient. The efficiency of the policies and programs will determine how the corporation will be able to progress its business continuously. According to Gronow and Bache (2006), the case of Hong Kong based Moulin Global Eye care, which has considered discussions on restructuring after subsequently collapsing into liquidation after the uncovering of systematic corporate governance failures. The business of Moulin was in detrimental financial position that its based Asian-based operations cannot be saved.             The problem of Moulin was based on questionable transactions and financial statements that have brought such to the filing of a case against the company. The questionable transactions and a business that appears to be efficient nevertheless was no has brought disappointment to the creditors of the company. From that situation, it is right for the writer to say that the need to have transparency on all the company’s transactions is vital to the effectiveness of corporate governance. Hence, the need to have a constant evaluation on the corporate governance is necessary in order to run efficiently the company. As stated, the company must see to it that there is balance in the way it handles its business in relation to all the people having interest with the corporation.   Relation of Corporate Governance to Corporate Purpose, and to Business Ethics             According to Rudrum (2008), corporate governance is not solely about introducing systems of control, it is linked fundamentally to directing organization in order to achieve objectives. She further stated that corporate governance is critical to the success of the organization and is a central part of the role of the board. Corporate purpose is the goal and objectives of the corporation for the establishment of its business. In a corporation, its purpose determines the way and the system that a corporation must have to tract. The conduct of the corporation will also depends on its purpose, any deviation to its purpose means it did not handle its business efficiently or its system is not consistent with what its purpose has indicated.  Poor governance in a corporation means a negative result in the achievement of its purpose. In addition, as the directors carry out the policies of the corporation in pursuant on effectively managing the business, the actual implementation must not deviate to what the objective of the business is. Kee Shin Holdings Limited on its 2007 Annual Report stated that no amount of material uncertainties was found that might cast significant doubt about the Company’s ability to continue as its concern for the year. The company’s purpose is to have a continuous progress hence thru its effective governance there is no doubt that it has been maintaining the achievement for its purpose.               The relation of business ethics to corporate governance is important on how the corporation’s dealings. Business ethics is the proper conduct of a person in business transactions. The principles of business ethics are laid down as innate in the business market. According to the presentation of Mr. Greenwood, Director and Company Secretary of CLP Holdings Limited (2005) that their company promotes ethical standards because it is a practical steps in corporate governance. CLP has a code of conduct in order to use of objective industry standards for measurement and reporting. Hence, in effective governance the code of ethics must laid matters that would dictate the conduct of the members of the company tasking into consideration the right and wrong.               Conclusion             The adoption of effective corporate governance system and process can positively affects the company’s conduct, performance will depend on the way the directors, and how the people within the corporation will be able to manage its corporation. The cooperation of all the people involve in a corporation means that the governance is so effective in creating a harmonious system within the corporation. The relevance of a good structural framework and code of ethical framework will give an assurance that effective governance will likely to succeed. Also according to the report of ADB, from the vantage point of institutional investors, good corporate governance is a key risk management tool that helps preserve and grow capital in ways compatible with their values. Good corporate governance is considered a great weapon specially in attracting investors, and consumers.             The writer therefore concluded that the adoption of effective governance would make significant positive results to the conduct of business of a corporation. The company will have a better decision making and will improve the access to financial matters. The shareholders on the other hand will be able to be protected from abuse of fraud and other matters that would prejudiced their interest to the company. The communication within the company will be open hence; matters need to be address will be taken into consideration immediately.   BIBLIOGRAPHY BOOKS   Chen, J. 2004, Corporate Governance in China, RoutledgeCourzon, New York.   De George, R. 2003, A History of Business Ethics, 2008 Markkula Center for Applied Ethics.   JOURNALS   Gronow, N. & Bache, S. (2006), Distressed Debt in Asia, Ferrier Hodgson, 27 July.     ELECTRONIC RESOURCES   A Premium for Good Governance 2008, About.com, viewed 27 May 2008, <http://retailindustry.about.com/gi/dynamic/offsite.htm?zi=1/XJ/Ya&sdn=retailindustry&cdn=money&tm=348&gps=100_174_1020_510&f=00&tt=14&bt=1&bts=1&zu=http%3A//www.mckinseyquarterly.com/article_abstract.aspx%3Far%3D1205%26L2%3D39%26L3%3D3>.   Business Dictionary 2008, Business Dictionary Online, viewed 27 May 2008, <http://www.businessdictionary.com/>.   Calvin J. 2006, Corporate Governance Development in the UK and Continental Europe, viewed 27 May 2008, < http://www.allbusiness.com/business-planning/business-structures/4083418-1.html>.   China Zenith Chemical Group Limited 2008, 2007 Annual Report, viewed 30 May 2008, < http://www.irasia.com/listco/hk/chinazenith/annual/ar20499-ew00362.pdf>.   CLP Holdings, 2005, Best Practices in achieving Good Corporate Governance – a practitioner’s Perspective, viewed 29 May 2008, <http://sc.icac.org.hk/gb/www.icac.org.hk/hkedc/leader/p4.html>.   Corporate Governance Principles, 2008, Asian Development Bank, viewed 27 May 2008, < http://www.adb.org/documents/brochures/corporate_gov/corporate_gov_principles.pdf>.     Hong Kong Market 2005, Hong Kong Institute for Monetary Research, viewed 27 May 2008, <www.hkimr.org>.   Hysan Development Company Limited, 2007, Annual Report 2007, viewed 29 May 2007, <http://203.194.162.10/listco/hk/hysan/annual/index.htm>.   Kee Shing Holdings Limited, 2007, 2007 Annual Report, viewed 29 May 2007, http://203.194.162.10/listco/hk/keeshing/annual/index.htm>.   Mohamad, S. 2004, the Importance of Effective Corporate Governance. Viewed 27 May 2008, < http://ssrn.com/abstract=617101 >.   Munzig, P. 2003, Enron and the Economics of Good Governance, viewed 29 May 2008, < http://www-econ.stanford.edu/academics/Honors_Theses/Theses_2003/Munzig.pdf>.   Principles of Corporate Governance, 2004, OECD, viewed 27 May 2008, <www.oedc.org>.   Rudrum, J. 2008, Understanding Governance, ACCA, viewed 27 May 2008, < http://www.accaglobal.com/members/publications/accounting_business/archive/2008/march/3077388>.   Surveying the First Half-yearly Financial Reports, 2008, Deloitte UK, viewed 29 May 2008, <http://www.deloitte.com/dtt/article/0,1002,cid%253D192412,00.html>.   The China Bank Limited, 2007 Annual Report, viewed 29 May 2008, <http://202.66.146.82/listco/hk/boc/annual/2007/ar2007.pdf>. Credit:ivythesis.typepad.com

Explain how the adoption of effective Corporate Governance systems and processes can be positively affect company conduct and performance

Introduction This is an essay explaining how the adoption of effective Corporate Governance systems and processes can positively affect ...