Corporate Governance

Corporate Governance

Executive Summary

In this report I am going to discuss the issues concerning corporate governance that have caught the attention of the business world in recent years. I will be looking at what sort of corporate behaviour created scandals and how the regulators and authorities responded to this. I will examine the effectiveness of the current governance rules that are in practice and conclude if they are adequate and analyse the costs and benefits of following these rules. Considering two alternative approaches towards dealing with governance I will decide upon whether self regulation or government legislation is the most appropriate method. My report will close with a summary. In order for me to obtain a good spread of information I have used various resources to assist me such as the internet, journals and textbooks.

Introduction

How can we define corporate governance? "Corporate governance is the system by which companies are directed and controlled", Cadbury report (1992). So we can see that it can be described as a means of controlling and ruling companies to act in the best interest of the company and its shareholders. "Corporate governance refers to the way in which companies are governed, and to what purpose", ICSA (2003). A company has a purpose to achieve its objectives and in order to do that it must follow guidelines or rules. Governance helps to provide guidelines and a direction for a firm to meet its objectives. "A company should be governed in a way that moves it towards the achievement of its objectives" ICSA (2003).

It has become quite clear in recent years that from the attention that corporate governance is receiving from the media that the subject has become a major issue in the global economy. It is the economy that depends on the companies operating under it, so therefore the extent to how companies are run and how they manage their responsibilities determines the country's competitive and economic position. The companies should be able to exercise freedom on how they operate in compliance within a required set of rules. This is where corporate governance is important and throughout this report I will discuss the development of corporate governance issues in recent years.

The nature of corporate scandals

There has been great development in corporate governance over the past two decades. In the late 1980's there were major company failures and scandals which highlighted the issue of corporate governance. The reasons behind this were said to be due to the weakness of accounting standards, a strong framework and due to the lack of the legal responsibility of the board.

"The challenge of good corporate governance is to find a way in which the interest of shareholders, directors and other interest groups can be sufficiently satisfied", ICSA (2003). It can often be difficult to keep all interest groups within an organization satisfied as a company is owned by shareholders but run by directors. This is where there could be a conflict of interest between the two parties on the running of the company. Sometimes it is the case that directors act in their own interests without the consent of the shareholders. It is this sort of behavior that leads to company failure. "The board is, off course, is accountable to the shareholders. They have appointed the directors to act for shareholders' greater good" Neville Bain and David Band (1996)

Over the last decade we have seen corporate scandals such as the energy giant Enron where the heads of the company were found guilty of manipulating the accounts to make the company look favorable in order to fool investors. "Jeffrey Skilling, Enron's former chief executive, faced 28 counts of fraud, lying to auditors for allegedly trying to fool investors into believing Enron was healthy before the firm crashed." http://news.bbc.co.uk/1/hi/business/3398913.stm (03/11/06). Here the chief executive of the company has acted out of their own interest and breached their legal obligations which has led to company failure. "Executives had used elaborate structures to hide millions of dollars of losses and debts". http://news.bbc.co.uk/1/hi/business/5335214.stm (03/11/06)

Within a business there are usually internal controls to prevent this from happening including internal auditing but in the Enron case these measures weren't sufficient enough. In this case the auditors were lied to by the directors of the company. The lack of independence of professionals that work for an organization leads to fraudulent accounting. For example if the lawyers that work for a company have close relationships with its members and are not entirely independent then this can lead to conflict of interest. If the auditors are not entirely independent and have other interest in mind then the accounts won't be prepared properly. In the case of Enron the senior manager Ms Sherron Watkins forwarded her concerns to the Enron chairman who passed her complaints on to a law firm to be examined. However the law firm had very close relationships with Enron and their independence of judgment was said to be doubtful. So her concerns were ignored because the law firm was not entirely independent.

We can see that the major scandals in recent years have been caused by the nature of senior executives acting out of their own interest due to a lack of internal controls and close relationships between professionals that have led to conflict of interest that have resulted in company failure.

The response to the scandals

Major scandals in recent years such as Enron and WorldCom shook the world and the response from the media and the government was heavy handed but fair. Heavy sentences were handed out to those involved and new legislation was introduced. "The former Enron chief executive Jeffrey Skilling was sentenced to 24 years and four months in jail yesterday" http://www.guardian.co.uk/enron/story/0,,1930051,00.html, Andrew Clark (03/11/06)

In response to these scandals a legislation titled The Sarbanes Oxley Act was introduced. "Sarbanes-Oxley was a result of the Enron and WorldCom collapses." Accountancy, Lesley Bolton (Mar 2006). The main aim of the act was to ensure tighter controls within an organistaion to ensure fair trading and in order to prevent fraud. "Regulates the internal controls that firms use to reduce the risk of fraud or error in their financial statements." The Economist (Apr 22,