Corporate Governance
Introduction
Corporate Governance Definition
US, OECD, Cadbury Report
• Corporate governance refers to the formally established guidelines that
determine how a company is run. The company’s board of directors
approves and periodically reviews the guidelines, which must align with the
company’s direction, performance and regulatory practices.
• Corporate governance guidelines serve a company in a similar way to the
constitution of the United States serving the USA.
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Corporate governance specifies the rights and responsibilities of company
stakeholders, with particular emphasis on three groups:
• shareholders who own the company
• the board of directors who oversee the managers
• and management which runs the daily operations
A key function of corporate governance is to determine how power is
distributed between these groups to ensure that the company runs fairly and
optimally for all. It may also specify the rights of other stakeholders, such as
employees, customers, creditors and suppliers.
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• Organisation for Economic Co-operation and Development (OECD) was
officially born on 30 September 1961, when the Convention entered into force.
• Other countries joined in, starting with Japan in 1964. Today, 34 OECD member
countries worldwide regularly turn to one another to identify problems,
discuss and analyse them, and promote policies to solve them. The track
record is striking. The US has seen its national wealth almost triple in the five
decades since the OECD was created, calculated in terms of gross domestic
product per head of population. Other OECD countries have seen similar, and in
some cases even more spectacular, progress.
• The OECD brings around its table 39 countries that account for 80% of world
trade and investment, giving it a pivotal role in addressing the challenges facing the
world economy.
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DEFINITION
Procedures and processes according to which an organisation is directed and
controlled. The corporate governance structure specifies the distribution of
rights and responsibilities among the different participants in the organisation –
such as the board, managers, shareholders and other stakeholders – and lays
down the rules and procedures for decision-making.
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Cadbury Report
1992 The Committee on the Financial Aspects of Corporate Governance and Gee and
Co. Ltd.
Corporate governance is the system by which companies are directed and controlled.
Boards of directors are responsible for the governance of their companies. The
shareholders’ role in governance is to appoint the directors and the auditors and to
satisfy themselves that an appropriate governance structure is in place. The
responsibilities of the board include setting the company’s strategic aims, providing the
leadership to put them into effect, supervising the management of the business and
reporting to shareholders on their stewardship.
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Corporate governance became a very important issue in 2002, with the passing of the
Sarbanes Oxley Act. It sought to restore public confidence in corporate
governance following the collapse of several major companies, due to accounting fraud,
such as Enron and WorldCom.
Corporate governance continues to be a hot topic today with the rising interest in
corporate ethics. For example, one such issue is whether corporations’ should take
responsibility beyond their direct shareholder interests, to include the communities they
serve and environmental issues.
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A brief history of corporate
governance(U.K, U.S and E.U)
• In 2003 the European Union Internal Market Commissioner Frits Bolkestein
said, “Company law and corporate governance are right at the heart of
the political agenda, on both sides of the Atlantic. That’s because
economies only work if companies are run efficiently and
transparently. We have seen vividly what happens if they are not:
investment and jobs will be lost; and in the worst cases, of which there are
too many, shareholders, employees, creditors and the public are ripped off.
Prompt action is needed to ensure sustainable public confidence in
financial markets.”
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The E.U was just the most recent organization to implement new corporate and
company governance at the turn of the century, both the United States and the
United Kingdom had already implemented new laws to try and prevent repeat
events of the 20th century.
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Sarbanes-Oxley Act Of 2002 – SOX
• The Sarbanes-Oxley Act of 2002 is a legislative response to a number of corporate scandals that sent
shockwaves through the world financial markets. Some of the biggest issues involved Enron, Tyco and
WorldCom. The Sarbanes-Oxley Act, commonly referred to as SOX, attempts to strengthen corporate
oversight and improve internal corporate control.
• The main purpose of SOX is to protect shareholders from fraudulent representations in corporate financial
statements. Investors need to know that the financial information they rely on is truthful, and that an
independent third party has verified its accuracy.
• SOX is a long and complicated law, but it has a few key provisions.
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Section 302 requires that corporate management certify that they have reviewed the
financial statements and that they are accurate and truthful.
Section 401 requires that financial information include disclosures about any relevant
off-balance sheet obligations that may exist.
Section 404 requires management to state whether or not the company’s internal
control procedures are adequate and effective. Section 404 had costly implications for
publicly traded companies as it is expensive to establish and maintain the required
internal controls.
Section 409 requires management to update the public of significant financial matters
when they happen, rather than wait until the quarterly or annual report.
Section 802 imposes penalties for violations of the SOX rules, which can include fines
or even jail time.
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The Sarbanes Oxley act had the following 8
effects on business in the U.S:
1.
It reformed and re-empowered the corporate board of directors. The most
prominent change SOX engendered was a shift from a perspective that the board serves
management to a perspective that management is working for the board.
2.
It encouraged the adoption of corporate codes of ethics. SOX required companies to
disclose whether their senior executives and financial officers followed a code of ethics. If
they didn’t have one, they had to explain why. Around the same time, both the New York
Stock Exchange and NASDAQ adopted rules requiring that listed companies adopt and
disclose a code of conduct. While the SOX rule didn’t require adoption of a code, it made
clear that the SEC expected one.
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3. It created the PCAOB.SOX created the independent Public Company Accounting Oversight Board
(PCAOB) in 2002 to oversee the independent auditors of public companies, replacing a self-regulatory scheme
and mandating true independence. The Board’s inspection powers mean the audits of companies’ internal
controls are subject to scrutiny.
4. It both clarified and complicated the role of in-house counsel. SOX created an SEC rule that requires
in-house and outside lawyers practicing before the SEC to report evidence of a material violation to the
company’s CLO or CEO. The CLO then must investigate the evidence and take reasonable steps to respond to
the report. If the reporting attorney isn’t satisfied with that response, the lawyer must then report the potential
misconduct to the audit or another committee.
5. It laid the cultural roots of shareholder activism. Shareholder activism is increasing, with Dodd-Frank
pushing forward shareholder proxy access and “say on pay” compensation advisory rules. Such trends have
their roots in SOX and the Enron-era corporate scandals, which shoved issues like executive compensation and
board independence into the spotlight.
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6. It made public companies more expensive to run. The survey also found that most companies in their first
year of SOX compliance say the costs outweigh benefits. However, after the first year, they consistently take the
opposite view, identifying benefits such as a better understanding of control design and increased effectiveness
and efficiency of operations.
7. It empowered the SEC. Among other measures, SOX extended the statute of limitations for the SEC to
pursue actions and increased the penalties at their disposal. According to Currier, SOX changed the balance of
power between companies and prosecutors, putting prosecutors in the driver’s seat.
8. It changed things for private companies, too. Private companies that aren’t subject to SOX reforms have
nonetheless adopted some of its provisions as best practices, such as ensuring the independence of directors and
adopting audit and audit committee procedures.2
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Situation in UK
The United Kingdom implemented the Financial Services and Markets Act
2000 a similar regulation two year prior to the American Sarbanes Oxley
agreement. It to sought to improve transparency in companies, maintain
the confidence of the financial system, increase public understanding
of how the financial system works, establish protection for investors
and to reduce fraud and other bad business practices by creating regulations
that businesses must follow and too great a singular entity to monitor that the
businesses were following the guidelines.
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Situation in EU
In 2003 the European Union published a paper entitled the Action Plan
on Modernizing Company Law and Enhancing Corporate Governance
in the EU. It discussed why the governance of companies and their corporate
structure needed new regulations because of all the recent scandals that were
occurring at the time, the fact that many European countries were in deep
international trade relationships with each other, the invention of new
information and communication technologies and the rapid expansion of the
European Union.
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Corporate Governance System in CEE
• CEE economies went during last twenty years through complex economic transformation.
Such process was not an easy one and was different in different countries.
• It was process of basic ownership transformation. Together with economic liberalization,
privatization, and development of market infrastructure.
• Transformation process was characterized by different speed, various ways and under
different political circumstances in CEE countries.
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• Individual countries started to concentrate after the privatization on effectiveness, efficiency and
performance of transformed companies. New decision making activities are taking place and
system of corporate governance is developing. It is new situation that companies have to meet.
• Corporate Governance system was developing in “western countries” for centuries, new
economies had only few dozens years. CG system in developed countries represents complex of
acts, guidelines, codes, politics and institutions and authorities that are all making institutional
environment.
• There were no elements (in newly born economies) such as legal and justice systems, capital
market, bank sector and relevant human resources.
• All shortcomings of central directive planning were discovered during the transformation period
and were transferred into new macroeconomics. These are poor effectiveness, low performance,
high unemployment rate, deficits of state budgets, high external debts, obsolete economic
structure etc.
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• Managers from old state enterprises consolidated their positions and in many cases employees as well.
• It was necessary to prepare new legislation thanks to new ownership, bankruptcy of companies, and
requirements on financial reports.
• General phenomenon in CEE countries is permanent change of acts and guidelines.
• There is no doubt that further institutional development is needed. In most of CEE countries were
recorded enormous progress. But the final situation vary from country to country. Majority of
countries developed their codes of best practices regarding CG. There is still long way to achieve the
best practice in most developed countries.
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NEXT LECTURE:
From an Anglo-American Model to a Continental-European one
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