CORPORATE GOVERNANCE 1

CORPORATE GOVERNANCE

Name

Course

Professor

Institution

City and State location

The Date
 CORPORATE GOVERNANCE 1

TABLE OF CONTENT

1. Introduction…………………………………………………..4

1.1Background Information………………………………....4

1.2 Definition of Corporate Governance……………………4

1.3Importance of Corporate Governance…………………..4

1.4Corporate Governance Theories………………………....5

1.5Corporate Governance Codes……………………………5

2. Corporate Governance Mechanism………………………….6

2.1Corporate boards………………………………………….7

2.1.1 Corporate board Structure…………………………...7

2.1.2 Role of corporate board……………………………..8

2.2Institutional Investors……………………………………9

2.2.1 Role of Institutional Investors ……………………..9

2.3 Other Corporate Governance Mechanisms…………...10

3. Case Studies………………………………………………...10

3.1Enron…………………………………………………….10

3.1.1 Background………………………………………..10

3.1.2 Enron’s Failure of Corporate Governance………..11

 CORPORATE GOVERNANCE 1

3.2 Reckitt Benckiser………………………………………12

3.2.1 Background………………………………………..12

3.2.2 Failure of Corporate Governance…………………12

3.3 Satyam………………………………………………….13

3.3.1 Background………………………………………..13

3.3.2 Failure of Corporate Governance ………………..13

3.4 WorldCom……………………………………………..14

3.4.1 Background……………………………………….14

3.4.2 Failure of Corporate Governance………………...14

4 Recommendations…………………………………………15

5 Conclusion…………………………………………………17

6 References…………………………………………………18
 CORPORATE GOVERNANCE 1

Introduction

1.1 Background

Many scholars, economists, and other professions consider 2007- 2009 global financial

crisis as the worst financial crisis ever since the great depression of 1930. The period

characterized by the collapse of many financial institutions, massive bailouts, the economic

downturn and finally the great recession was primarily attributed to the failure of corporate

governance. As much as this was a low point in corporate governance, it also showed its

importance not only to individual firms but to the world economy as a whole (Tricker & Tricker

2015). Never before has the notion that corporate boards and institutional investors are the most

important corporate governance mechanisms in the firms with important implications for the

sustainable long-term success of the firm been so vividly seen. From time immemorial as

humans, we have always learned from our mistakes and the 2007-2009 was an eye opener

especially to corporate governance. Before I can explain further on the notion, it is important to

learn the basic aspects of corporate governance.

1.2 Definition of Corporate Governance

Corporate governance in simple terms refers to the set of rules, processes, and practice

through which a company is controlled and directed with (Solomon 2007). It involves balancing

the interests of the organization with the interests of other parties such as the government,

investors, lenders, suppliers, the community etc.

1.3 Importance of Corporate Governance

When executed properly, corporate governance can help a company avoid certain risks

such as lawsuits, fraud, and misappropriation of funds. In addition to that, good corporate
 CORPORATE GOVERNANCE 1

governance helps in boosting the organization’s brand and reputation to the media, investors,

suppliers, customers and the society as the whole. Furthermore, cooperate governance protects

the financial interests of the individuals involved with the company such as the shareholders and

the employees as explained by (Vitez, 2017).

1.4 Theories of Corporate Governance

Corporate governance can be defined in many ways but when it comes to analyzing it, we

do it through a framework of different theories. One of those theories is the agency theory which

looks at the shareholders as the principals and the executives that have been hired to run the

business as their agents. Another theory is the stewardship theory which looks at the executive as

the stewards of the shareholders with both parties sharing the same goals. In addition to that, we

have the resource dependent theory which considers the board as to be in existence so as to

provide resources to the management with the aim of achieving the overall objectives of the

business. Stakeholder theory comes from the assumptions that it is not just the shareholders who

have an interest in the company but other parties too such as suppliers, the government, creditors

among others (Farrar 2008). This means that this parties too can be affected by the success or

failure of the business. Other theories of cooperate governance include transaction cost theory,

political theory, and ethical related theories.

1.5 Corporate Governance Codes Introduction

The code of governance over the years have originated for various reasons or in response

to various circumstances. The first major release was in 1992 by Sir Adrian Cadbury popularly

referred to ‘Cadbury Code’ titled “the Financial Aspects of Corporate Governance”. Following
 CORPORATE GOVERNANCE 1

serious revisions over the years, the code is nowadays administered by the Financial Reporting

Council. The Organization for Economic Co-operation and Development (OECD) developed the

first internationally influential codes back in 1999 following a business advisory committee that

was led by Irra Milstein.

Boards that govern companies are influenced by several documents which include but not

limited to articles of incorporation, by-laws, corporate governance guidelines, committee

charters, and codes of conduct. When it comes to the United States, various federals laws such as

the Sarbanes-Oxley Act of 2002, the Dodd-Frank Wall Street Reform and Consumer Act, federal

laws as well as federal security laws in addition to regulations, rules, and guidance from SEC are

used. These documents are meant to be used for the purpose of best practices and flexible

working standards to safeguard the various parties that have an interest in the organization. In

short, they basically outline the interaction between the board and management outlining the

structure and the behavior of the board. The codes are normally contributed to by various

individuals including investors, accounting firms, regulators, banks, corporate governance

interest organizations, academics, and stock exchanges, among others.

Corporate Governance Mechanism

Policies, control, and guidelines are vital for an adequate corporate governance

mechanisms. An effective corporate governance mechanism will consist of a number of various

mechanisms. The first level consists of internal mechanisms which monitor the business from

within and take corrective measures when the business stray away from its set objectives. They

include reporting lines that are clearly defined, systems that measure performance and systems
 CORPORATE GOVERNANCE 1

for the smooth operation of the business. The next level is the external mechanisms which are

controlled by those outside the business and serve the objectives of outsiders such as the

regulators, government, financial institutions, and trade unions among others. The objectives of

the external mechanism include proper debt management and legal compliance by the company

in question. The last level consists of an audit of the entity’s financial statements by an

independent auditor who generally works to serve both the internal and external parties that are

involved with an organization to ensure that their interests are guided and that the management is

doing everything properly. They also act as a second opinion to back up what the management is

saying.

2.1 Corporate Boards

The board generally consist of groups of individuals elected or nominated by

shareholders in the annual general meeting. The board of directors normally act as a bridge

between the company and the shareholders -it decides as a fiduciary with the aim of protecting

the latter’s interests. This is the norm with a Public company even though nowadays most non-

profit making organizations and private companies also have a board. Their main mandate is to

make policies for corporate management and also to make decisions on major issues that affect

the company.

2.1.1 Corporate Board Structure

The structure of the board of directors is mainly guided by the company’s bylaws which

sets out the structure, number of members, how often they meet etc. The most important element

is that it should be able to balance both the interests of the management and
 CORPORATE GOVERNANCE 1

Shareholders. The duties are regulated by the statutory laws, federal statutory laws, listing

standards, common law and shareholder activism and litigation.

The membership of the board normally constitutes independent directors, senior company

executives, non-independent directors such as former senior executives of the company among

others. Nasdaq rules require the majority of the board members to be independent and in they

constitute up to 75% or more of the boards in 93 of the top 100 US companies. Most boards

consist of 8 to 15 members. There are no age and nationality restrictions although in recent years

gender balance has been emphasized.

2.1.2 Roles of the Corporate Boards

The board's primary role as discussed earlier is the fiduciary duty to safeguard the

finances and the legal requirements of the entity. They do this by ensuring that the entity in

questions does all that is required of it by the law, and the funds are properly used. Another role

of the board of directors is setting up the mission and vision of the organization. In addition to

that, they ensure that the management adheres and work towards achieving them. Over sighting

the activities of members of the organization such as executives is another role of the corporate

board. The board ensures that the management adheres to rules and regulations and do their work

as prescribed. Other roles of the board of directors come up in the annual meetings where-by,

they announce the annual dividends, oversee the appointment of key executives and amend the

by-laws where it is necessary (Dimopoulos & Wagner, 2016).

Other roles of the corporate board include setting up the strategy for the company for

long-term survival, short-term gains and future exploration of opportunities that are likely to

arise. This might also include setting up the structure of the company to ensure efficiency. The
 CORPORATE GOVERNANCE 1

board, however, does not take part in the day to day running of the organization and thus serve

another role of delegating the duties to the management. The board should also monitor, control

functions and set up compensation plans for the executives. Last but definitely not least, the

board helps in acquiring resources for the organization while ensuring continuity.

With great power comes great responsibilities. The board must always use their powers

for the right reason and do what is required of them by the shareholders of the company. The

board must always carry out whatever they do in the full interest of the company, and in case

there is a conflict of interest then the interests of the company should always come first. They

must also carry out their task with due care minding the interests of both the shareholders and

that of the employees. Other responsibilities of the board include acting as the court of appeal in

case there are disputes, accessing the performance of the firm and enhancing the organization’s

overall public image and brand name.

2.2 Institutional Investors

An institutional investor is a person, persons or organization that pools money or

provides funds to purchase securities, other investment assets, property or originate loans. They

include financial institutions such as banks, Insurance companies, pension and hedge firms,

investment advisors, commercial trusts and mutual funds. For a firm to grow, it requires

resources inform of money which is provided by these institutional investors who get profits and

interests as compensation for their troubles in taking the risk. The returns should exceed the fees

and expenses of the investments and is compared against treasury bills which are considered to

be risk-free.

2.2.1 Roles and Responsibilities of Institutional investors

 CORPORATE GOVERNANCE 1

The best thing about institutional investors is the fact that they have expertise and

knowledge to monitor the health and progress of the business. With this knowledge, they can

provide the best advice the organization and also control the tendency of the management to put

their interests first as opposed to the interests of the company. This active monitoring helps

reduce misappropriation of funds and other forms of fraud (Gillan & Starks 2002, pp. 275-305)

The institutional investors can act as a source of stability in hard times as was the case in

the coal crisis in India recently. By offering additional funds, the institutional investors increase

their stake and say in the company thus can push for better corporate governance. Another aspect

related to this is the fact the institutional investors have a louder voice compared to minority

investors. Most of the time when minority shareholders raise their concerns on corporate

governance, they will rarely get addressed or at times get thwarted by the minorities which are

not the case with institutional investors.

2.3 Other Corporate Governance Mechanism

Other parties that are involved in corporate governance include the shareholders

themselves who have the biggest interests as the main contributors of capital, the employees who

get their incomes and job security from the good governance of the company, the government

which gets taxes from the organization and the society as a whole which benefits from job

creation, income distribution, corporate social responsibility activities of the firm among other

benefits.

Case Studies

3.1 Enron

3.1.1 Background
 CORPORATE GOVERNANCE 1

The story of Enron was not only the largest bankruptcy case at the time but also the

biggest audit failure. This was cited by many as the biggest corporate governance failure

especially on the part of corporate boards and institutional investors.

Enron was founded in 1985 by Kenneth Lay who also triples up as the chairman and

chief executive officer. This was after merging Houston Natural gas and Intermonth. Other key

people involved with Enron included: Jeffrey Skiing who was the C.O.O, Andrew Fastow who

was the CFO and Rebecca Mark-Jusbasche who was the once a vice chairman.

From 1995 to 2000 Enron was in fact named America most innovative company by

Fortune. In the mid-2000s at its peak, the shares of Enron were trading at $90.75 per share. By

the end of November 2001, they were trading at less than $1 per share. This was when the

shareholders filed a $40 billion lawsuit. Enron filed for bankruptcy on December second, 2001

with assets worth $63.4 billion making it the biggest bankruptcy scandal ever in American

history at the time. At this stage, the shares were going at $0.26 per share.

3.1.2 Failure of Corporate Governance in Enron

Lack of due care and skill from the board was one of the reasons why Enron failed. As

submitted by S.Watkins, Kenneth Lay who was Enron’s chair, could not get what was being said

to him in regards to the company having questionable accounting practices. This also showed

lack of proper communication between the board and the executives. This was further elaborated

by Jeffrey McMahon, the new Enron’s president who said it was virtually impossible to

challenge the authorities at Enron. A culture of intimidation had also developed at the company

with the likes of Ms. Watkins fearing to lose their jobs. The board literally failed in its role of

directing. This showed some sort of conflict of interests where they were more than happy to
 CORPORATE GOVERNANCE 1

receive high compensations without asking serious questions which would have led to a decrease

in their personal bonuses. The management who carried out the day to running of the Enron

misrepresented information by allocating Enron’s debts to its dubious partners. This also showed

the lack of proper internal controls at Enron (Carberry & Zajac 2017, p.15134).

The corporate investors also failed to properly supervise the company and advice

accordingly. For example, according to an economist at Enron, it was important it was all mind

games as it was important for the employees, investors, and analysts to believe that the stock will

bounce back. Other corporate investors such as the two trustees of Enron’s 401(k) plan failed in

their duties as they did not warn the plan participants despite a memo detailing the accounting

malpractices. The institutional investors also had all the knowledge and expertise but failed to

utilize them- they just sat back and believed whatever they were told.

3.2 Reckitt Benckiser

3.2.1 Background

Reckitt Benckiser is a British multinational that produces consumer goods to do with

hygien, health, and home products. The name comes from the merging of a United Kingdom

company Reckitt & Coleman and Benckiser NV that was based in the Netherlands back in 1999.

The most well-known products worldwide include Dettol and Strepsil.

Reckitt Benckiser acquired Korean Oxy brand in 2001 which had been using

polyhexamethathylene guanidine (PHMG) in a product since 1996. In 2011, PHMG was banned

by the Korea Centers for Disease Control and prevention after a published report showed a link

to lung damage and report. Several reports also came out supporting the Korean report, and at the
 CORPORATE GOVERNANCE 1

height of this in 2016 a coalition of consumer groups came out for the total boycott of Reckitt

Benckiser products after it had been linked to more than 500 deaths from a BBC report.

3.2.1 Failure of Corporate Governance Mechanism in Reckitt Benckiser

In the case of corporate governance, the management and directors fail as a whole in

doing their duty of due care and skill when acquiring the Korean Oxy brand. They had a duty to

investigate and know what is in the product. They put the company’s financial interests before

the safety of the consumers. In addition to that, several attempts were made by the board and

management to suppress investigations instead of taking corrective measures.

Even though this was mostly a failure by the management and board, institutional

investors also had the power to ask questions. Despite the various reports, they were silent till

there was outrage in the mass media.

3.3 Satyam

3.3.1 Background

Satyam was India’s fourth largest computer service company in India which has a

population of over 1 billion. It was even listed on New York Stock exchange in 2001 with

revenues exceeding $1 billion. The founder, M. Raju Ramalinga who was also the chair was a

highly regarded person in the business often gracing all the major corporate events. In 2008

Satyam won the coveted prize of the Golden Peacock Award for compliance issues and Risk

Management in corporate governance. In 2009, M. Raju confessed that the company’s accounts

had been falsified by a massive $1.47 billion (Bhasin 2005). In the same year, Satyam stock was

banned from trading on the New York Stock Exchange, and the Golden Peacock Award stripped

off. Mr. Raju was later convicted together with other senior members.
 CORPORATE GOVERNANCE 1

3.3.2 Failure of Corporate Governance Mechanisms

The board at Satyam failed in their primary duty of due care and monitoring the activity

of the business as they did not notice the discrepancy. This was so evident that the first order was

to appoint a temporary board. The board also put their interests first at the expense of the

company for financial gains as confessed by their chairman.

Despite the amount that falsified being that large, the auditors who were Price Water

House Coopers failed in their auditing duties as they did not report anything amiss despite

having all the expertise and experience. They were even fined $6 million by the US stock

exchange for not following the code of conduct and auditing standards in when offering their

services to Satyam. Institutional investors also failed to raise questions or properly examine the

financial statements. Furthermore, with their expertise, they should have pushed for compliance

with the corporate code of governance.

3.4 Worldcom

3.4.1 Background

Before filing for bankruptcy protection in 2002, WorldCom was the second largest long

distance phone company in the United States. With assets totaling over $104 billion, $30 billion

in revenues and over 60,000 employees WorldCom filed for bankruptcy protection on July 1,

2002. The company later wrote down more than 75% of the total assets with over 17,000 of the

workers losing their jobs. Over the period between 1999-2002, WorldCom had deliberately

overstated their income before tax by over $7 billion which was the main reason behind the

falling from grace to grass. It is currently known as Verizon business or Verizon enterprise
 CORPORATE GOVERNANCE 1

solution after being acquired by Verizon Communications and is slowly rebuilding and being

integrated into the parent company.

3.4.2 Failure of corporate Mechanism in WorldCom

The biggest failure of WorldCom was the fact that the board had failed in its structuring

role. Over the years, it had acquired a lot of companies with even one accountant confessing that

they would get calls from people they did not even know existed. The departments were also not

even properly structured for efficient working and were very decentralized. For example, the

finance department was in Mississippi; the network operations were in Texas, the human

resource in Florida and the legal department in Washington DC. This provided a challenge of

communication as each department developed their ways of doing things. Apart from that, the

difference in management style and the culture that was developed of not questioning seniors

was a discouragement for employees who wanted to correct any issues that arose. In fact, there

was a deliberate attempt by the management to hide vital financial issues as explained by Buddy

Yates, the director of general accounting who was told he would be thrown outside the window

in case he had shown the numbers to the auditors by Gene Morse, a senior manager. The

employees also put their self-interests above the interest of the company as loyal employees were

often compensated above the company’s approved salaries and bonus packages by Ebbers and

Sullivan. The biggest failure was the board however as they failed terribly in all their roles and

responsibilities including due care, supervision, bridging the gap between management and

shareholder among others.

In the case of institutional investors, they also failed terribly. No one raised a question on

the structure of the firm or why the firm was highly decentralized. The increase in the salaries

and compensation for the ‘loyal’ employees in the finance and accounting department should
 CORPORATE GOVERNANCE 1

also have raised questions. Institutional investors should have also used their expertise to confirm

the information that was being provided to them.

Recommendations on Improving the Quality Of Corporate Governance

Corporates Boards Should Meet Regularly: The corporates boards do not take part in the

day to day running of the business, but they have a supervisory role. To carry out the tasks

effectively, they need to meet more often (Christensen et al 2015, pp.133-164)

Division of Responsibilities: The duties and responsibilities of a firm should be properly

defined and allocated within an organization. This will help in reducing conflicts and also

knowing who is liable and for what. This will also help enhance effective communication within

an organization.

Stronger Internal Controls: Controls in an organization should start from within for

effective corporate governance. The controls include the supervision of seniors, physical

controls, controls among others.

Transparency: Corporate governance is all about transparency. Transparency does not

mean revealing the companies but being honest in its activities. In case there is a loss it should be

stated and corrective measures to correct it taken,

Proper succession planning: One of the best attributes is that its life is not limited to that

of the owners or directors. A proper succession plan should, therefore, be set in place to ensure

that the values of the company that encourages proper corporate governance are passed from one

generation to the other within the company

 CORPORATE GOVERNANCE 1

Proper training of directors: The directors of the company are the eyes of the society and

shareholders in the business. They need to be properly trained to carry out their tasks effectively

as is required of them. Another option is to select a board of directors that is highly qualified in

the different fields that the business is engaged in.

Independent members increase: Any organization that is interested in improving its

corporate governance should try as much as possible to increase the list of independent parties in

its running. The independent parties with no direct relation can view the business from a better

neutral point (Klapper & Love 2002, pp.703-728)

Conclusion

It is crystal clear from the discussions above that the corporate governance mechanisms

such as corporate boards and institutional boards are the backbone for the survival of any

company. From the cases discussed above, we can see the consequences of bad corporate

governance and the fact that it does not matter how big the company is. In addition to that, there

is a failure the many bodies that are meant to supervise corporate governance. Corporate

governance board needs to do more than just take the words of corporations. It is an

understatement to say that corporate governance should be a priority, it should actually be a

prerequisite (Lebedeva et al 2016).

 CORPORATE GOVERNANCE 1

References

Bhasin, M.L., 2015. Corporate accounting fraud: A case study of Satyam Computers Limited.

Carberry, E. and Zajac, E., 2017, January. How US Corporations Changed Executive

Compensation after Enron: Substance and Symbol. In Academy of Management

Proceedings (Vol. 2017, No. 1, p. 15134). Academy of Management

Christensen, J., Kent, P., Routledge, J. and Stewart, J., 2015. Do corporate governance

recommendations improve the performance and accountability of small listed

companies?. Accounting & Finance, 55(1), pp.133-164.

Dimopoulos, T. and Wagner, H.F., 2016. Corporate Governance and CEO Turnover Decisions.

Farrar, J., 2008. Corporate governance: theories, principles and practice. Oxford University

Press

Gillan, S.L. and Starks, L.T., 2000. Corporate governance proposals and shareholder activism:

The role of institutional investors. Journal of financial Economics, 57(2), pp.275-305.

Ilya, P., 2015. inc. [Online]

Available at: www.inc.com/ilya-pozin/14-highly-effective-ways-to-motivate-employees.html
[Accessed 27 January 2018].

Klapper, L.F. and Love, I., 2004. Corporate governance, investor protection, and performance in

emerging markets. Journal of corporate Finance, 10(5), pp.703-728.

 CORPORATE GOVERNANCE 1

Lebedeva, T.E., Akhmetshin, E.M., Dzagoyeva, M.R., Kobersy, I.S. and Ikoev, S.K., 2016.

Corporate governance issues and control in conditions of unstable capital risk. International

Journal of Economics and Financial Issues, 6(1S).

Solomon, J., 2007. Corporate governance and accountability. John Wiley & Sons.

Tricker, R.B. and Tricker, R.I., 2015. Corporate governance: Principles, policies, and practices.

Oxford University Press, USA.

Vitez, O., 2017. Bizfluent. [Online]

Available at: https://bizfluent.com/facts-6884459-importance-corporate governance.html
[Accessed 21 February 2018].