Corporate Governance

EXECUTIVE SUMMARY:

Corporate Governance is essentially about what is business for and in whose interests companies should be run, i.e. the shareholders. The paper attempts to explicate findings on stricter regulations around corporate governance and different perspectives on how it has changed the corporate world. Beginning with agency problems, some results are found around regulations, the rising importance of independent audits and CEO compensation. Further, we examine the significance of shareholders as a part of the rising importance of putting serious thought into corporate governance and how increasing shareholder value will enhance the value of the firm. The last section concludes with stakeholders' view, the way solid understanding of this builds capital structure as well as some explanation of contractual theory as well as organizational cycle.

ACCOUNTABILITY AND FIDUCIARY DUTY

From a financial perspective, when shareholders (investors) of an organization are not given the right amount of return on their outlay, problems arise. In this section of the paper, an attempt is made to provide evidence how changes in corporate governance standards have affected agency costs for corporations and what corporations need to be successful in the long run. Although this is essentially common sense, in reality it is becoming difficult to fulfill as shown by many once successful companies who have basically plummeted to their downfall due to unmistakably corrupt governance. Although this is not exactly new evidence, this section talked about some of the most important changes in corporate governance as they refer to the agency problem.

First is the increasing requirement of many shareholders to feel confident enough in corporations by knowing that corporate governance is in place before they decide to invest more. "Investing in Ethics"... by Rodger Spiller states that investors are becoming even more demanding about exceptional ethical performance as more and more laws are put in place to 'control' managerial actions and more companies are being put on the spot for unethical standards such as Enron, WorldCom and parmalat. The journal continues to point out the obvious, that the once ignored aspect of a company's success of good ethics has become a priority for all flourishing corporations. "Seven years on times have changed dramatically. From investors through to regulators, business ethics has become a mainstream issue that wise businesses are taking seriously" (Investing in Ethics... Spiller, 2006).

Second are the increasingly stricter restrictions around regulations and punishment for unethical behaviour in corporations. For example, if convicted, Conrad Black and his unauthorized payments to himself and his executives can face up to ninety-five years in jail. These changes, although harsh, have helped those companies with good ethical standards since peopled can now feel more trusting towards corporations again and trust leads to more investment. As Hermanson writes, "The Sarbanes-Oxley Act has been very effective in restoring confidence in U.S. corporate governance, and the markets have rebounded nicely. Investors today know that boards and audit committees are more independent, audit committees have greater financial expertise, external auditors are not conflicted by consulting fees, and executives are held more accountable for accounting fraud." (Ten Conclusions on Corporate Governance, Accounting, and Auditing, Dana R. Hermanson, 2006) On the other hand, there have been some repercussions for corporations regarding the Sarbanes-Oxley Act, even if they had not broke any rules of principal codes. The SOA has now made it more difficult for companies to go public in the United States and this acts more a preventive measure than anything else. Only time will show if this will have a positive or negative affect on the venture of corporations.

Hermanson also indicates that sine the SOA has passed, shareholders have been more involved with the board and majorities have made extra effort to do so. In the past, meaning approximately twenty years or so up until the millennium shareholders have not been so concerned about knowing all the legalities and small details of how management did their job. With the increasing rise of wrongful behaviour by corporations, shareholders have grown fearful and less trusting. This is why more security and regulation was needed to let investors trust the system again and thus invest so that once more the economy can continue climbing. Further detail on changes in corporate law is reviewed in more detail in the last section of the paper.

With regards to managerial accountability, research has shown that it is not a good idea to broaden responsibilities of managers as this leads to too much ambiguity. (Stakeholder Theory, Corporate Governance and Public Management: What Can the History of State-Run Enterprises Teach us in the Post-Enron Era?", Joseph Heath and Wayne Norman, 2006). The journal further stresses that managers sometimes go astray from their required activity and could take on more than they know how to handle which in turn harms the corporation and causes a rift between management and shareholders. Since shareholders are a part of the financing for corporations they should be overlooking the way management pays out fees and dividends. This agency problem becomes even more serious when top executives and management receives what shareholders may view as overpayment even when the company has had an unprofitable year, quarter, etc. When management has high stakes in the company, more pressure is placed on them to do better. This can be both good and bad. Pressure can result in hard work and quality from management but it can also result in cheating and ways to skew numbers. This topic is looked at in more detail below and especially focuses on CEO compensation.

One of the most important aspects of agency costs is CEO compensation. An interesting finding was found around UK companies and CEO compensation in the journal: Do corporate governance mechanisms influence CEO compensation? An empirical investigation of UK companies. (2006) This journal discussed the study of what factors determine CEO compensation for 414 listed UK companies for the fiscal year 2003/2004. By taking CEO compensation as the sum of base salary and cash bonus which acted as the dependent variable in a regression model and other corporate governance variables they were able to find the following;

* Larger firms and 'firms with higher growth opportunities' pay higher CEO compensation

* The larger the board size, in general the higher the CEO compensation