Analysis of Governance Issues Creating Unrest in the Corporate Sector - Research Paper Example

Analysis of Governance Issues Creating Unrest in the Corporate Sector With the expansion of trade and the increasing complexity of businesses and especially the failure of certain companies in the last two to three decades, society felt the need for the establishment of a set of rules that companies would follow in order to ensure the welfare of the society. Government’s job is to ensure the welfare of the society as a whole, therefore these set of rules were imposed by state laws in various countries. These particular set of rules have been termed as code of corporate governance. Corporate governance has gained a lot of importance in the last decade as it has been deemed necessary to establish a universal code of business conduct. Corporate governance does not have a specific definition, However it basically addresses to the same elements that are internal controls of a company, greater accountability and transparency of company’s performance, the responsibilities and structure of board of directors and the rights and equitable treatment of stakeholders. All of this is based on moral and ethical values. The initial enforcement of corporate governance has been a difficult task. The first problem is the lack of understanding of corporate governance, since traditionally there has been no culture of corporate governance. Lack of independent directors and non effective structure of the board of directors are some other factors that contribute to this problem. These problems need to be tackled because if corporate governance is not enforced, it can lead to graver situations. This need for corporate governance arose due to a number of factors such as the collapse of major businesses for example Polly Peck and BCCI, the shift of financing to local investors, the concentration of share ownership in the hands of institutions, the need of companies for gaining confidence in the stock market of its company, privatization and the technological advances. Governance issues can create a number of problems as observed from the past. It can cause issues of integrity, financial crisis, failure of regulatory framework and untrained directors. Let us discuss the above mentioned issues one by one. There are several examples in which governance issues have created problems of integrity. Today the key factor in corporate governance is “integrity” which means the integrity of the company that general public perceives and holds in their eye. Today’s financial crisis due to financial institutions begs the question of the cause of irresponsible lending involving excessive risk. The credit crunch that the world is facing today could have been avoided by the establishing a system of check and control that could have foreseen the consequences of this excessive risk. The OECD’s conclusion on this topic is “the financial crisis can be to an important extent attributed to failures and weaknesses in corporate governance arrangements which did not serve their purpose to safeguard against excessive risk taking in a number of financial services companies" (Kirkpatrick, 2009). Furthermore, the introduction of more regulations has clearly failed that is why we need a better quality code of conduct for business to ensure that the management clearly recognizes its aims and goals. The conservative view of running a business as a director does not require any formal qualification. However, after the fall of Enron and Worldcom, the world has finally recognized the importance of specific qualification and training of company directors. In Australia corporate governance has managed to introduce some such courses on the MBA level to ensure the best quality training of potential business runner. Governance issues can create unrest in the corporate world since corporate governance is related to the economy of any particular country. OECD published its report back in 2009, linking the global financial crisis with the absence and malpractice of corporate governance. Corporate governance is closely related to the status of economy. The intermediary between the two is the corporate sector which basically acts as the catalyst and bearer eventually. Stijn Claessens, a Professor of International Finance at the University of Amsterdam published his finding in “Corporate Governance and Development”. He explains how governance is linked with the well being of an entity and the economy as a whole. In the absence of good corporate governance, the firm loses its integrity which ultimately cuts the financing of the firm therefore the shortage of cost of control, poor performance due to inappropriate allocation of resources and hence bad reputation and relationships with the stakeholders. If however, good governance is followed, it can guarantee integrity and promise access to even external financing. Larger investment and financing will lead to high growth rate and employment opportunities. Second most notable effect of following good corporate governance would be the lowering of cost of capital and higher value to investors. All this by itself will help the entity perform better by efficiently allocating resources through better management. The company will be able to create good relationships with the stakeholders and ultimately the financial crisis of the whole economy can be avoided. OECD’s report published in 2009 under the title “Corporate governance lessons from the financial crisis” highlights the unrest caused by governance issues in the corporate sector of United States. According to the report “Crisis in the subprime market in the US, and the associated liquidity squeeze, was having a major impact on financial institutions and banks in many countries” (Kirkpatrick, 2009). The default rates on subprime mortgages began to rise and a number of warnings were issues by several institutions. As a result financial institutions faced a challenging situation since the credit crunch kept on widening. This financial crisis pointed to severe shortcomings of the risk management practices. The key elements that needed to be considered here were the drawbacks of the governance. Malpractice of governance can also lead to such dire results. What happened was that more attention was focused on internal controls than the whole context of risk management and so firms’ understanding of its inherent risk was misinterpreted. Moreover, the control over growth of balance sheet and liquidity needs was limited. The other issue concerned the transmission of risk that did not happen through effective channels as required by the corporate governance model. Furthermore, remunerations had to be aligned with the long term benefit of the firm and its shareholder which was overlooked and as quoted in the report “remuneration and incentive systems have played a key role in influencing financial institutions sensitivity to shocks and causing the development of unsustainable balance sheet positions” (Kirkpatrick, 2009). Together deficiencies in risk management and incentive and remuneration system point to the shortcomings of the board of directors. This factor accounts for the re-emphasis of the roles and responsibilities of CEO’s and Directors. The report also concludes that a survey of European banks shows that most banks have not incorporated risk management in their organization which is a clear violation of good corporate governance. The result is crystal clear here. The organizations should have restructured their board of directors. The article goes further into highlighting the reasons for this financial crunch which include deficiencies in supervisory staff, misuse of off-balance sheet assets and lower transparency. Good corporate governance needs to be implemented upon as the unrest it is causing in the corporate sector requires immediate attention. It can be handled by taking certain necessary steps to apply the corporate governance model and ensure regular practice of the code. The moist initial step is the need for training of current and potential businessmen, judges, directors and even general public. Secondly the corporate sector’s activities must be transparent and open to all shareholders and general public. Last but not least there is a dire need for the revision of existing laws of certain states that do not legally force the implementation of code of corporate governance. Law should also protect the rights of minority shareholders. The main problem lies in the lack of institutional framework. This problem can be tackled by introducing private institutions to support corporate governance and improving the audit procedure of public companies. These two will help in the independent rating of any firm. It is therefore clear how important the role of good corporate governance is in today’s businesses. Corporate governance covers the rights and responsibilities of board members and stakeholders of the firm, transparency and accountability of the organization’s activities and system of controls which incorporates itself into risk management. As the value of governance increases so does its relationships with the investors. This in turn increases the organizations rating which helps it grow. Corporate governance is related to the economy as a whole. Every business must be conducted on some set of rules based on morals and ethics. The absence or malpractice of corporate governance can cause severe problems that the society has to face together as explained in the case of USA’s financial crisis caused by the subprime mortgage. By following the code the situation of the firm can considerably become better as studies have shown. Initial enforcement of corporate governance may be a difficult problem to tackle; however, the problems that arise from not implementing the code of corporate governance are far worse. Works Cited Claessens, S. (n.d.). Corporate governance and development. Retrieved from http://www.ifc.org/ifcext/cgf.nsf/AttachmentsByTitle/Focus_1_CG_and_Development/$FILE/Focus_1_Corp_Governance_and_Development.pdf Dambachultem, B. (2006, February). Corporate governance in mongolia. 6th meeting of the eurasia corporate governance roundtable. Retrieved from http://www.oecd.org/dataoecd/7/22/37090482.pdf Kirkpatrick, G. (2009). The corporate governance lessons from the financial crisis. Retrieved from http://www.oecd.org/dataoecd/32/1/42229620.pdf The importance of corporate governance. (2009). Retrieved from http://www.applied-corporate- governance.com/importance-of-corporate-governance.html UN. (2003). Selected issues in corporate governance: Regional and country experiences (UNCTAD/ITE/TEB/2003/3). Retrieved from United Nations website: http://www.unctad.org/en/docs/iteteb20033_en.pdf Vishny, R. (1996, April). A survey of corporate governance. Retrieved from http://www.nber.org/papers/w5554.pdf Read More