Corporate Governance Post-Economic Collapse

Corporate Governance Business

Imposition of strict corporate governance and disclosure requirements is an unnecessary burden on business, they reduce competitive advantage of business, and they add extra cost to the society.”

Critically evaluate this statement in light of the recent spectacular corporate collapses around the globe. Your answer should provide arguments for and against this statement, and a judgement at the end.

Introduction

Recent corporate collapses, such as Enron and WorldCom in United States and HIH Insurance in Australia, raised an alarm for accounting standard setting bodies in all over the world and have brought the issue of corporate governance to the forefront. The regulators and other standard setting bodies took this issue seriously and promptly responded to the situation with number of new and important rules, regulations, codes of conduct and suggested best practices.

The basic purpose of these initiatives was to ensure that those responsible for governance of an organization must comply as per the expectations of stakeholders and they must act in a way to provide credibility and transparency in corporate financial reporting. According to Gillan and Martin (2007) the worldwide failure of giant corporations arose within a system of corporate governance, both internal and external to the firm and they found that the basic cause of failure was corporation’s incapability of controlling its management.

Australia also adopted a number of initiatives which include corporate code of ethics, CLERP 9 Act and ASX principles and guidelines on the issue of corporate governance and other disclosure requirements as implemented by ASIC and ASX. More recently, an important report published by the professional accountants in business committee (PAIB) of International Federation of Accountants (IFAC) explores the corporate governance in wide perspective and propose that an entire accountability framework is required for keeping a good balance between corporate governance measures and initiatives for sustainable firm value.

The assignment is divided into three parts. First part describes the importance of corporate governance in the global business and investigates the need of corporate governance so that ethics of business should not be ignored because it can have long lasting impacts. The argument is given to prove that after the major scandals in the corporate world, why there is a need to establish ethical standards and regulations.

For any multi-national corporation it is very crucial to consider the impact of its business on individuals as well as on society. Second part of the assignment discusses the costly behavior of corporate governance and disclosure in which is a burden on the business and effects competitive advantage at large. Third part is the conclusion which summarizes the whole essay according to the required topic.

Now if we go into deep in this issue we see that corporations control and manage a large part of the resources and raw materials of this planet and are dominating the economic world. But simultaneously these companies have abused their positions in some way or the other

What is Corporate Governance?

The concept of corporate governance came into circulation from last thirty years and now the term is truly international. Now there is a growing realization that good corporate governance can not only help in avoiding problems but also provide many other advantages such as facilitating capital investment and minimizing risk. Corporate governance in very simple terms is the system by which business corporations are directed and controlled (Cowan, 2004).

A good corporate governance system ensures that the corporation sets appropriate objectives and then arranges systems and structure in place to ensure that these objectives are met, and also provides the means for others, both within and outside of the corporation, to control and monitor the activities of the corporation and its managers.

Enron was unable to demonstrate and practice good corporate governance practices therefore it paid its price. Enron provided misleading information to avoid consequences and failed to inform shareholders and investors o the true level of debt With the increasing globalization of business and competition for capital, it can be said that companies which can provide assurance of being appropriately managed can gain competitive edge.

Reducing perceived risks to investors can minimize the cost of capital. On the other hand poor corporate governance also risks a loss of confidence in the position of the accounting profession itself. Developing countries are paying more importance in strengthening transparent corporate governance and accounting system because investors and consumers demand fair business and return. And if they don’t follow these criteria they will not gain competitive advantage. World class organizations such as Cadbury and Vienot have issued new guidelines which highlights the need of sound corporate governance such as audit committees, internal structure and management control.(antidote to corruption)

Role of accounting in an integral part of any corporate governance structure because accounting provides the means for audience to analyses and monitor the organization and to asses how well the management has performed. A strong disclosure regime that promotes real transparency and ethical corporate governance is a key feature of successful multinational organizations (OCED 2004 ).

Good corporate governance is a global business necessity

Therefore it can be said that corporate governance involves ensuring that the decisions made by those managing the corporation are appropriate and providing a means to monitor corporate activities and the decision making itself. Drever et al says that solution is for firms or corporations to be formed to produce and provide goods and services efficiently.

The healthy corporate governance framework ensures that timely and accurate disclosure of financial situation and performance is the outcome of the company.

The challenge for corporate governance is to balance the interest of investors and the firm at the same time because corporate governance has to set priorities, delegate power and control and maintaining accountability and disclosure. The organizations which focus reports issues such as how the firm is integrating sustainability into business will develop new ways for integrating stakeholders.

According to OCED 1999, good corporate governance helps to ensure that corporations take into account the interests of a wide range of constituencies, as well as of the communities in which they operate, and that their boards are accountable to the company and to the shareholders. This is turn, helps to assure that organizations operate for the benefit of society as a whole. It helps to maintain the confidence of investors- both domestic and foreign- and to attract more patient long term capital.

The need for corporate governance: Transparency vaccine

Now the point is why companies adopt corporate governance in their regulations? Corporate world history has a long list of frauds and scandals. In the beginning the term corporate governance was used as a mechanism for reducing errors but now the potential strength of corporate governance has widen its area.

Some instances of corporate crime: Book Robert & monk

Alleco: Mr. Morton M. Lapides was convicted and jailed of a price fixing scheme which caused record- braking penalties. The judge said that Alleco is tied with maximum illegal activity and needs a proper systematic corporate governance regime.

General Electric: In 1992, was charged with false billing with federal government for military sales to Israel during 1980’s. Company’s employees did conspiracy with an Israeli air division to divert money into their pocket. Later, GE paid $ 69 million fines and lost its reputation and trust in the market.

Gitano Group: In December 1993, company was pleaded guilty to the charges that they had sought to circumvent customs duties on imported clothes. Wal-Mart then the largest customer of Gitano ceased to do business with it unless the company follows strict ethical standards and regulation.

A.H Robins: The Company marketed an intra-uterine contraceptive device called Dalkon shield, despite the fact that it had more than 500 unfavorable reports from doctors and physicians. In 1985, the device was ultimately recalled after the death of 17 women and was found guilty and paid $2.4 billion trust fund to compensate for the act.

Few most extremes examples of the negligence of corporate governance were of De Lorean Car Plant in North Ireland- which involved defrauding the government. Blue Arrow scandal UK was the outcome of manipulating and twisting the DTI (department of trade & industry) rules and regulations. The recent fraud by Cendant was the result of disclosing and misleading excessive profit and assets. Therefore, corporate governance rules, regulations, disclosures and prescriptions are needed by the corporations because of the structure of the company.

Investors who have provided the resources to the firm in some way or the other do not directly run the company business. These contributors need to rely on managers and organization. This division between capital contributor and management is the root cause of many issues and crisis relating to corporate governance. Hayek argues that companies cannot afford to ignore the needs of stakeholders.

It is always permissible, even required for management to consider the interest of all stakeholders. Gibson (2000) insists that corporations use codes and conduct to help create a competitive advantage for the corporation. This increases their already existing reputation within the global market. Lenox and Nash, (2003) says that rules and regulations are invented to provide information about the organization with the hope these promises will be rewarded by consumers in some way or the other and ultimately improve the bond between the two.

Findings of Chang et al (2000) say that the Asian Financial crisis in 1997 had global implications and raised the need of reform issues including corporate governance. The sudden collapse of South Asian tiger like Thailand, South Korea, Taiwan, and Indonesia highlighted the fact that there is no efficient corporate governance which looks after the financial sector. Companies not only compete with each other firms within their country, but with firms from around the world.

The need for corporate governance arises when financial capital moves across internationally and it becomes necessary to ensure that the organization is not only managed according to rules and regulations but also has a good corporate management. Considerable Evidence against Harris Scarf and One.Tel depicts that government rules and practices in those firms where poor and also they lacked accountability (Bosch 2002). Altogether it can be said that there is a need for corporate governance because it enriches the wealth and performance of a firm.

Keeping in mind the future success, giant firms such as Starbucks and The Body Shop have includes in-store flyers to summarize important sections of the sustainability report, HP has made effort and also included flyers in its printer cartridges to educate and inform customers. Similarly BP has also experimented with advertising on television to educate consumers as to the real energy competition.

Organizations must balance many competing equations- long and short term notions of gain, cash and accounting concepts. As a result of corporate governance failures in the global market of USA and UK which resulted mainly due to lack of leadership and mismanagement gave birth to the need of forward thinking.

The foundation of these codes and conduct is disclosure. Transparency is the one and only criterion a firm should rely upon. Disclosure and accountability are the two watch words of the corporate governance on which long term systems are built.

Therefore, the need arises as how the corporations are governed- their ownership and control, the objectives they pursue, the rights they respect, the responsibilities they recognize, and how they distribute the value they create – has become a matter of greater significance, not simply or their directors and share holders, but also for the wider communities that serve.

Moore et al gives the example of three firms, Dofasco, Novo Nordisk and Roche who have integrated their sustainability report into their annual report. By this, they are focusing financial analysts and shareholders as their main audience. This major alignment will help the firm more effectively and efficiently to create value for their investors. Disclosing transparently allows companies to be more easily scrutinized and to engage in more straight forward and robust discussion on the challenges they are facing with their critics. Disclosure brings many competitive advantages such as leadership, a positive boost to its image, a potential growth in sector collaboration and an opportunity to build faith with key shareholders.

An Unnecessary burden- whose interest should corporations serves? There is an ongoing debate that implementing corporative governance rules and regulations is necessary for an organizations success or not? Corporate governance has a varying meaning and ever changing rules. Therefore corporate governance must not have the privilege to ‘one size fits all’ approach. Rather, good governance automatically develops with in a corporation by setting down voluntary rules and standards which best fits according to their circumstances and demand.

Justice owen reported that the key to success and growth of corporate governance lies in substance not form. It depends on how the directors and managers of a firm create a structure to fit the situation of the firm and then test it periodically for its practical efficiency. Report of HIH Royal Commission argues that it is not always necessary that those who have good governance structure will perform better than other or be immune from failure. Risks are always present in business and it should be taken a stepping stone for the organization as risks are taken for new market capture or reward.

There is no single set of rules which can prevent mistakes or cover companies and their investors from the consequences of failure. There is also an argument which says that companies should not be burdened with compliance costs. This causes in losing competitive edge of an organization. It becomes a very costly process for the management of a firm to combine legal, financial and economic logic

There is an ongoing debate that there is no universal formula for good corporate governance. Companies vary in their size, complexity, ownership etc that what is ideal for one in some circumstances may be inappropriate in others. Moreover, as companies change and increase their market size, they need to adapt their changed strategies. Tried and proven corporate governance structure can help to improve their ability to attract capital and trust but at the same time it is not necessary every time when the company grows.

As accounting information is a crucial element of any corporate governance, it has two key roles: to guide and control actions along with decisions, and to inform shareholders and other stakeholders. It is very important that information should be correct, unbiased, and appropriate. Despite prescribed nature, it can only be achieved through the ethical behavior of management.

The problem is that, whether using ethical principles and standards, disclosures can still result in be incomplete and misleading due to many reasons. Cornford 2004, argues that common assumption is that if individuals are rational, they will do their best to maximize their interest, rather than principles. Ethical principles are also rational; they will expect the management not always to act in the benefit of shareholders and investors.

Hideki says that it is true that corporate governance and disclosure enhances transparency but at the same time it has its own cost which management has to pay. The burden of this cost is on the organization which is required to make disclosure and thus on the national economic sector. At the same time, it becomes very hard to take the full advantage of disclosure without making a comprehensive disclosure regime inside the firm which includes all the auditing and accounting staff to be faithful and loyal.

Findings of Porata et al say that Disclosure has its own inevitable problems. He says that disclosure is done on the quarterly basis in U.S and twice in one year in Japan. According to him, this periodic disclosure has two drawbacks. First, there is a time difference between the date when disclosure and financial statements are prepared and when they are actually disclosed. There is an unnecessary burden on the company to update the information before coming into public. Therefore the value of any disclosure should be compared with its enforcement cost.

From- (http://www.orac.gov.au/run_close_corporation/good_corp/default.aspx) Size of the organization has a huge impact on the practices of corporate governance. In small firm with less investment and few liquid assets, informal way of practices can perform well. Medium to large size organizations need to formalize their ethical standards for their survival and competitive advantage. Also, small firm should not be overburdened with unnecessary standards and red tape.

The most tedious issue in any corporate governance system is how to make corporate world accountable to the other contributors and shareholders of the firm whose investment are utmost risk and danger. Unquestionably, the biggest challenge a firm faces is not failure but a success. If we look at the giant firms of 1960’s such as Xerox, Kodak, General Motors, Sears, and meltdowns in last thirty years, it can be concluded that when company is is failing, it is ready to try anything to save its position. At this stage, it really becomes a hard job to decide what to disclose and what not to disclose.

Globalization has raised an important issue in corporate governance and disclosing that whether there is any particular universal model of ethical standard and regulation which can assure success and competitive advantage.

Conclusion – It can be concluded from the above discussion that high ethical standard and regulations of corporate governance and disclosure by any organization can bring wonders in the business world. Nevertheless, transparency and fairness are the tools to efficient corporate governance today in any country. For any company to be transparent it is necessary to pay attention to disclosure, accounting and audit. All these functional conditions are inter-dependent on each other. The essay highlights many examples of the companies which prove that it is cheaper to disclose negative information than to suppress it and face long term penalty.

References

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