Three Pillars of Effective Corporate Governance
Internal Corporate Governance
Internal corporate governance refers to the methods that enable shareholders to implement management control. These comprise the sufficient organization of the board of directors, effective arrangements for the exercise of shareholder rights, and a properly designed internal audit function. Regarding the responsibility of the board, the competence and efficiency of management should be promoted and monitored by an autonomous body inside the board. To guarantee the effective implementation of the shareholders rights, all relevant information must be adequately accessed. Proper arrangements for shareholder communication and decision-making is also important. Internal processes and controls should be examined, a task that must be performed by the external audit. The internal audit does not posses a legally approved role and authorization so it is up to the management to define its roles and supply it with the appropriate role.
External Corporate Governance
External corporate governance is about the control function that financial markets perform. Primary markets are very important because they give direct access to corporate financing. The key investors must be adequately informed. Sufficient investor information is a crucial issue on the secondary markets. Financial and reputational intermediaries contribute to corporate governance.
Transparency and Disclosure
Transparency and disclosure link internal and external corporate governance. External audit plays an important part in transparency and disclosure. It is essential that the external auditors are competent and independent and must be able to prevent or manage disagreement if interest.
The Case of Parmalat
In 2003, Italy witnessed the collapse of one of its most famous companies, Parmalat. Amid allegations of huge corruption involving fraud and cooking the books to hide a billion black hole in the accounts, senior members of the founding family now sit in Milan jails awaiting trial. As a company that employed 36,000 employees in 126 factories in 30 countries the fall out on investors and staff has been immense (2005). The scandal at Parmalat was largely caused by questionable practices, bad management and weak internal controls ( 2005). The collapse of the Parmalat food empire exposes the disturbing aspect about Italian Capitalism – the lack of effective financial control over its family owed companies (2005). The Parmalat situation started out as a standard accounting fraud. Managers allegedly used various accounting tricks to avoid disclosing sizeable losses, possibly with the involvement of at least some auditors and lawyers. The Parmalat group, a world leader in the dairy food business, collapsed and entered bankruptcy protection in December 2003, after acknowledging massive holes in its financial statements ( 2005).
Origin of the Parmalat Scandal
One of the major corporate scandal that led to the development of Corporate Governance involved Parmalat, a multinational food and dairy company based in Italy. It has been reported that in Novemver 2003, Parmalat failed to repay a € 150 million bond despite apparently large amounts of cash and liquid assets on its balance sheet. This was followed by the statement released by the Bank of America in December 2003, stating that a document claiming to show forgery of a large account of a Parlamat subsidiary at Bank of America. As a result, a € 3. 95 billion black hole surfaced in Parlamat’s accounts. December 27, 3003 marked the declaration of Parlamat’s collapse. In January 2004 the new administration of Parlamat declared that the company’s debt was over €14 billion ().
Parmalat’s Corporate Governance Issues
Board Composition and Independence
When Parmalat was listed in 1990, the board was composed of nine executive directors and four non-executive directors. One of these was a member of the Tanzi family. The composition of the board was influenced by the fact that 51% of the shares were controlled by the Tanzi family. This guaranteed the appointment of Calisto Tanzi as both the Chairman of the Board and the Chief Executive Officer of the company. The composition of the board revealed the appointment of the management team where in majority of the members either belonged to the Tanzi family or people with close ties to the Tanzi ().
Accounts: Auditing and Disclosure
Parmalat changed auditors from Grant Thorton to Delloitte and Touche. Grant Thorton recommended that Parmalat spins off its travel concern and a small number of other businesses, and allow these to remain under its watch. Parmalat followed this suggestion and maintained a fair degree of propriety in its main division, which was monitored by Delloitte and Touche, and used the subsidiaries to create illegal payments to the parent company. The executives produced debts owed to Parmalat by the subsidiaries, and the latter crafted forged accounts to pay the debts. The auditors of Grant Thorton then presented records of these transactions to Deloitte and Touche, who rubberstamped most of them. The subsidiaries’ auditors also conspired with the executives in other frauds like the “cut and paste” forgery and falsifying of sales figures ().
Internal Control Procedures
The hindrance in internal regulation at Parmalat was caused by the fact that more than half of the Board’s members are executive directors. This also hindered effective performance and independence of Board Committees. Members of Audit and Remuneration Committee also sat on the Executive Committee with founder and boss Tanzi. The Executive Committee, which consisted of company executives, proposed actions for Board approval and then implemented them ().
The Characteristics of the Italian Corporate Governance
1. Italian firms depend heavily on bank finance
2. Banks have never played an important role in the corporate governance of firms
3. Financial markets have historically been shallow and small
4. Ownership and control are concentrated
5. The role of the state is important
6. Groups of firms are very widespread and used as a mechanism to separate ownership and control
7. There are conflicts of interest between minority and majority shareholders
8. Boards of directors play a limited role
9. The market for corporate control is not active
10. Hostile takeovers are difficult and unlikely
The possible way to separate ownership and control has not been based on a unique model but on a set of different models: the system was self-organizing given the fact that in Italy there has been a law on corporate governance issue. The model is actually based on the following devices:
1. Hierarchical Group
The most frequent corporate governance model; it accounts for 52 per cent of manufacturing activity and is more frequent among larger firms.
2. Family Control
The second most relevant model. This is the case where family links exist among controlling shareholder.
3. Coalition Control
Coalition control is a model quite similar to the previous but more complex. The trust-link between entrepreneurs and investors is based on their sharing common values.
4. Financial Supervision
Financial guarantees to non-controlling shareholders are represented by the presence of financial companies with privileged information exerting monitoring.
The ownership and control structure of Italian listed companies is characterized by a high level of concentration, and by the presence of a limited number of shareholders, linked by either family ties or agreements of a contractual nature, who are willing and able to wield power over the corporation ( 2005). Parmalat was a complex group of companies controlled by a strong blockholder (the Tanzi family) through a pyramidal device ( 2005). The monitoring body that examines Italian listed companies includes two key gatekeepers: the board of statutory auditors and the external auditing firm.
Parmalat’s Compliance with the Italian Code of Best Practice
The Role of the Board of Directors
Parmalat Finanziaria, the listed holding company of Parmalat group had complied with the recommendations made by the Preda Code (1999, 2002) since 2001 (2005). The Preda Code recommends that matters of special importance should be reserved for the exclusive competence of the board of directors. These include the examination and approval of the company’s strategic, operational and financial plans and corporate structure of the group, and the examination and approval of transactions having a significant impact on the company’s profitability, assets and liabilities or financial position, with special reference to transactions involving related parties (2005 ).
The Composition of the Board of Directors
The Preda Code (2002) recommends the board of directors to be composed of executive and non-executive directors. The non-executive directors should for their number and authority, carry a significant weight in the board’s decision-making process. Thirteen members composed Parmalat’s board of directors in 2003. Among the members of the board, five were to be considered as non-executive directors. The fact that non-executive directors are less than executive directors is rather unusual among Italian listed companies (2005).
The Separation between the Chairperson and CEO positions
At Parmalat Finanziaria, the Chairman and Chief executive director positions were not separated. Both positions were held by . This situation led to a huge concentration of powers considering that the same person was the major shareholder of the company (2005).
Appointment of Directors and Nomination Committee
The Preda Code recommends companies to set up a nomination committee to propose candidates for election in cases when the board of directors believes that it is difficult for shareholders to make proposals. This may happen in cases when the corporate ownership and control structure is dispersed. Parmalat did not comply with this recommendation and explained that shareholders never faced difficulties in proposing candidates for elections. This may be considered an adequate explanation given the concentrated control structure of the company (2005 ).
Credit:ivythesis.typepad.com
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