The Corporate Governance - The Burdens


By

S. Vikna Prakash
MBA-3rd Semester
Department of MBA
Acharya Institute of Management & Sciences
I Cross, I Stage, Peenya Industrial Area, Bangalore-58
 


Prologue

The word Corporate Governance has became a "Buzzword" these days because of two factors. The first is that after the collapse of the soviet union and the end of the cold war in 1990,it has became the conventional wisdom all over the world that market dynamics must prevail in economic matters. The concept of government controlling the commanding heights of the economy has been given up. This, in turn, has made the market the most decisive factor in settling the economic issues.

Corporate Governance

The Corporate Governance is a set of process, customs, policies, laws and institutions affecting the way a corporation is directed, administered or controlled. Corporate governance also includes the relationships among the many players involved (the stakeholders) and the goals for which the corporation is governed. The principal players are the Shareholders, management and the board of directors. Other Stakeholders include employees, suppliers, customers, banks and other regulators, the environment and the community at large.

The Corporate Governance is a multi-faceted subject. An important theme of corporate governance deals with issues of accountability and fiduciary duty, essentially advocating the implementation of guidelines and mechanisms to ensure good behavior and protect shareholders. Another key focus is the economic efficiency view; through which the corporate governance system should aim in optimize economic results, with a strong emphasis on shareholder welfare. There are yet other sides to the corporate governance subjects, such as the stakeholder view, which calls for more attention and accountability to players other than the shareholders. (Example: The employees or the Environment)

The fundamental causes for the corporate burdens are more complex.  Accounting, or, more accurately, the misuse of accounting, was not the main problem. Rather the uncontrolled pursuit of flawed strategies, coupled with greed on the part of many, were the real reasons for the downfall of household names and previous stock market favorites.

The Strategic Failures

The companies often fail to understand the relevant business drivers when they expand into new products or geographical markets, leading to poor strategic decisions. The board of directors did not understand how the derivatives market worked, and therefore did not comprehend the risks associated with it. Often a lack of adequate due diligence, whether building a new plant or making an acquisition, exacerbates problems.

Over Expansion Driven by Greed

The companies are frustrated by their inability to grow organically sufficiently quickly, turn to acquisitions. Despite many empirical academic studies showing that less than half of all acquisitions deliver the sought-after or promised returns, this tendency shows little sign of abating. High achievers, such as top executives, are particularly ambitious and eager for more power and wealth. CEO's have every incentive to grow their companies. Since the quickest way to grow a company is often by acquisition, the greed CEO's needed little encouragement to embark on a spending spree. Very often, the desired synergies are ephemeral, and the integration costs far exceed the anticipated benefits. Furthermore, cultural differences and lack of management capacity often add to the problems.

The Domination of CEOs

The CEOs are the individuals usually emerge after a period of successful management. The company becomes packed with like-minded executives who owe their position to (usually) him and are reluctant to challenge his judgement. A complacent board, lulled by past achievements, stops scrutinizing detailed performance indicators and falls into the habit of rubber-stamping the CEO's decisions. With no challenges and critics within the company, the dominant CEO may begin, perhaps unconsciously, to behave as thought it is his own creation. Shareholders and the board became irrelevant. Seduced by the prospects of yet more power and wealth and with his strong belief in his own infallibility, he goes all out for growth.

The Failure in Control of Corporate Governance

The blurred reporting lines leaves holes in control systems. Dispersed departments add to the problems: it is more difficult to pool knowledge of goings on when departments do not work closely together. Remote operations, far from head office, are often difficult to manage since head office is heavily reliant on local management and cannot always judge whether correct and sufficient information has been transmitted. This is particularly a problem with new or unfamiliar operations. A fundamental contributor to control failure is a weak, or ineffective, internal audits with the objective of uncovering potential cost savings, rather than financial audits with the objective of uncovering potential cost savings, rather than financial audits with the objectives of safeguarding company assets. A CFO without a professional accounting qualification is a significant additional risk factor. Bankers, or for the matter MBAs do not have the broad range of skills to oversee the finances of a large company and certainly not ones as complex. In many cases in appropriate financial structures have played a part. Thereafter companies suffered under heavy debt burdens and manipulated their accounts to disguise the effects of this illogical behavior.

Independent Directors

A board is supposed to provide a non-partisan judgement of the senior management's action and strategic proposals and to look after the interests of shareholders. Directors with strong financial or other links to the company may well find their judgement clouded. Even where directors were formerly classified as independent, they may not have been so independent after all. Many audit committee members have too little financial expertise, making it difficult for them to understand complex accounting matters. Instead, they have tended to go through the motions of reviewing controls rather than undertaking a much more detailed study, which would involve posing challenging questions.

Complacency

A background of raising share prices and earnings may have lulled boards into thinking that all was well, that management was doing its job and may explain, if not excuse, the "hands off" approach that many adopted in the late 1990s. But once share prices started to fall and the companies came under pressure, there was no excuse for directors to sit back. Many boards failed to question management; failed to assess their competence. The directors have not had the necessary knowledge or specific industry experience required to make an effective contribution and in most cases have allowed themselves to be dominated by CEO. This must be wrong. The CEO should be the servant of the shareholders and board.

To reduce the Burdens of the Corporate Governance

  • At practical level, the chairman should set the agenda for board meeting, in consultation with the CEO, and appropriate papers should be sent out to directors in good time so that they can properly prepare for the meeting, which would make for more constructive use of time.
  • An effective board which reviews strategy plans and questions management thoroughly should act, at the very least, as a brake on poor decision-making and at best be a positive force, using its wider vision experience, to direct the company onto the most profitable path.
  • As part of a necessary system of checks and balances, the roles of chairman and CEO should be separate in all cases. Each has a separate and distinct contribution to make furthermore, a retiring CEO should not step up to the chairman position as that risks emasculating or at least overshadowing the new incumbent.
  • A competent audit committee is essential to ensure that the appropriate internal controls are in place and working adequately; to ensure that companies financial statements give a true and fair view of the company's affairs; and to appoint, oversee and, if necessary, remove external auditors.

Re-Align Executive Compensation

The granting of share options, which are just a one-way bet, should be avoided or, at the very least, expensed immediately. A better incentive scheme would involve restrictive shares whose value can go down as well as up. Any share awards should be conditional on their being held for a minimum of a year after the beneficiary (CEO or other senior executive) has left the company (apart from any sale necessary to pay tax on the award) or, if still with the company, until a suitable period, perhaps three years, has elapsed. Company perks such as private use of aeroplanes should be disclosed in annual reports at their pre-tax value.

Epilogue

The passing of legislation will do little to prevent future failures (while in the process undeservedly enriching the very accounting firms who were, in part, culpable in the recent disasters), as it cannot address the underlying causes. What directors, managers and others need to remember is that ethics matter and must be demonstrated from the top; That it is better to manage market expectations rather than to manage earnings to meet expectation; and that it is false economy to scrimp on information and control systems. None of this will prevent companies pursuing flawed strategies or making poor acquisitions. Nor will it rein in the overly ambitious and greedy CEO unless there is a strong, knowledgeable and challenging board.

" STRIKE WHILE THE IRON IS HOT "

Reference:

Ashwathappa.k,"ORGANIZATIONAL BEHAVIOUR",2005,revised,Himalaya Publication.

John Oliver,Caroline, "CORPORATE COLLAPSE:FINANCE,GOVERNANCE AND BUSINESS CYCLE", 2002, Cambridge University Press.

www.iimahd.ernet.in/~jrvarma/papers/iimbr9-4.pdf

http://www.blonnet.com/2003/12/17/stories/2003121703110100.htm

http://www.encycogov.com/WhatIsGorpGov.asp

http://www.encycogov.com/

http://en.wikipedia.org/wiki/Corporate_governance

http://www.corpgov.net/

http://knowledge.wharton.upenn.edu/india/article.cfm?articleid=4157

 


S. Vikna Prakash
MBA-3rd Semester
Department of MBA
Acharya Institute of Management & Sciences
I Cross, I Stage, Peenya Industrial Area, Bangalore-58
 

Source: E-mail October 7, 2007

 

       

 

Occasional Papers Main Page

Important Note :
Site Best Viewed in Internet
Explorer in 1024x768 pixels
Browser text size: Medium