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August 22, 2012

Essay Paper on Corporate Governance: Failure, Scandals and Improvements


Corporate Governance: Failure, Scandals and Improvements
Introduction
The feature of current corporate malfeasance prevailing currently has subjugated the business news and fascinated attention of an increasing number of governments, professional organizations, regulatory bodies, and legislators in the world since collapses, bankruptcies and scandals transpired at some globally popular multinational firms like Enron, Adelphia, ,and Parmalat in Italy. Professional bodies and legislators have made contributions to achieve this goal. For instance, in the United States, the president George W. Bush signed Sarbanes-Oxley Act of 2002 which is prominent to respond governance failures at foregoing firms of USA. At the meantime, a series of corporate governance proposals designed to ensure the independence of directors, enhance corporate accountability and financial transparency have been approved by US organizations such as NASDAQ, The New York Stock Exchange (NYSE), and The Institute of Internal Auditors (IIA). In Italy, in response to the pressure from recent Parmalat scandal, from the ongoing integration of European capital markets and from international, primarily U.S, the new legislation has been launched aiming to strengthen the country's capital markets and competition with other centres in Europe (Alessandra, A1).
Corporate governance reforms regardless of in U.S, EU, Australia and New Zealand, do help to provide companies with guidelines of achieving better corporate governance so as to avoid repeat of collapses or financial scandals. On the other hand, it has been suggested that professional bodies and legislators have focused on the pathology of failure in governance rather than the board's real strategic contribution. Effective governance, as a dynamic, preventive process throughout sorts of levels from shareholders even to employees, must be achieved by effective board of directors as an effective board of directors is central to good corporate governance; and good corporate governance, in turn, is central to good corporate performance. Therefore, the pursuit of reasons of governance failure is though important, the board's strategic role could be ignored on the grounds that strategic contribution is an essential function of the board which is same as its other ones like monitoring, auditing, and shareholder value creating. Ignorance of board's real strategic role would be matters of attending to trifles but neglecting essentials. (Magda, 120)

Current Corporate Governance Reforms
Arising from evidence of variation in the corporate governance framework by ownership structure, industry sector and development stage of the business is the perception that the role of the board will vary accordingly. Nevertheless, the most important task of the board in an organization whatever role changed is to maximize shareholder interests. A fundamental fiduciary responsibility of managers and boards is to create economic value for their shareholders. (Alessandra, A1) The board should "shifting attention to sustainable value creation, has not thus far addressed what those architectures should be". (Peter, 156) As a result, the board should always act on behalf of the shareholder's interests rather than those of themselves. Unfortunately, board of directors in reality cannot always perform governance function according to this kind of premise. Enron scandal could be a very typical example. As once the seventh biggest public company in U.S, Enron's board failed to provide shareholders with safeguard as the phenotype of allowing management to engage in high-risk accounting, inappropriate conflict of interest transactions, excessive executive compensation and other self serving actions (Peter, 156).
International academic literatures and researchers have summarized the reasons why Enron suffered. Enron's board was unable to provide effective and enough oversight when senior managers conflicted with each other due to respective interests (Peter, 156). Enron's bankruptcy was partly from its board failure where Enron's board failed was in misunderstanding the risks which were inherent in the company's business strategic plan and failing to implement an effective system of internal control. (Peter, 156)
Corporate governance fraud is not just an American problem; a massive financial scandal took place in Parmalat, Italy's largest food company as of 2004 resulting from the disappearance of more than $10 billion in declared assets (Claudio, 13). Parmalat is accused of having used dozens of offshore financing vehicles to manipulate its balance sheet and defraud investors. The board of this dairy giant of course was responsible for the scandal owing to the lack of monitoring transparency in bond market and out of controlling use of offshore financing vehicles. Corporate governance is also falling into dire straits in other countries. Economic value added (EVA) can be seen as a measure of shareholder value creation that takes into account the cost of equity capital when measuring profitability.
Corporate governance is a dynamic and sustainable system that consists of series of laws, codes, and regulations that serve to the company's running. This system helps guide and constrain company behaviour, set the objectives of the company, define liability and rights of different participants- shareholders, directors, management and employees, and clarify the relationship between these participants (Claudio, 13). Board of directors is under the right system to fulfil its role. Once the system is broken, the board will be dysfunctional and the company might in risk. Professional bodies and legislators across the world have to focus on the pathology of governance failure through collapses and scandals in recent years. It is found that poor governance- including financial opaqueness, conflicts with interest, the lack of monitor and audit, and excessive executive compensation, is the central reason to lead to corporate failure.                                                                             
In order to maintain the system running, retrieve financial markets and investor confidence, and avoid the repeat of the business disaster, authorities of countries have renewed and amended a wide range of Act, codes and regulations. Among, the Sarbanes-Oxley Act of 2002 is especially important because it is not only pertaining to the recent malfeasances of Enron and WorldCom in U.S, but also it is influential to corporate reforms of other countries including the UK, Australia, Italy and New Zealand etc.
Given the Act is in response to collapses of Enron and WorldCom in the United States, The Act increases "the accountability of directors and executive officers, enhances disclosure obligations, includes steps to ensure auditor independence, provides that audit committees must be independent and increases the responsibilities of the audit committee"(web source, http://www.aar.com.au/corpgov/over/index.htm). The Act also expands corporate reporting requirements and creates a new accounting industry oversight body - Public Company Accounting Oversight Board that is made up of 5 members. This five-member board will be responsible for related activities of public accounting firms, including work-paper retention, second partner review, approval of audit reports, and the testing and reporting of internal control systems etc. (Robert, 875).
Correspondingly, the Securities and Exchange Commission (SEC), the New York Stock Exchange (NYSE), the NASDAQ Stock Market, and the Institute of Internal Auditors (IIA) also approved proposals or measures respectively, designed to ensure the independence of directors, increase accountability and transparency for the benefit of investors, and strengthen internal and external audition, as supplementary regulations of the Act, responding to recent well-publicized accounting scandals (Robert, 878).
As the result of Parmalat, the Commission of Italy's main securities and markets regulator have proposed extensive changes to Italy's securities laws and financial markets oversight. These changes emerged in Italy's new Company Law, country's tax regime and controversial Italian Single Banking Act, with the functions of strengthening the country's capital markets and making the country more competitive ( Marco, 43). Amendments have been introduced to the law of corporate governance, including the rights of shareholders to a voice and exit, and of corporate finance, where considerable freedom of contract has been introduced in an area of law traditionally pervaded by mandatory rules (Robert, 880).
These amendments involved in a much-needed new Company Law that radically reforms the models of corporate governance available to Italian joint-stock companies have given the potential impact on the current governance system. They signal recognition by the Italian legislators of the fact that corporate governance needs to be updated to bring them into line with the requirements of today's economic and business environment. Besides, one of the most positive aspects of these reforms looks at the harmonization of governance system for the purpose of creating a true common market which has already been underway in most other EU countries. Unsurprisingly, it is hoped that this will lead to an increase in the number of foreign investors prepared to base their businesses (and therefore increase their investments) in Italy by offering these investors governance models that are well established in their own jurisdictions (Magda, 120).
Other than American and Italian, other countries' regulators like in UK, Australia, even New Zealand, focused on the pathology of failures in governance. In the UK, the government-sponsored Higgs Review of the role and effectiveness of non-executive directors published in January 2003, accompanied by the Smith Report have introduced recommendations as changes to the Combined Code, aiming to increase board accountability in UK listed companies (Alessandra, A1).
Over all, as a broad result, the collapses and scandals occurred in U.S, Italy or other countries stimulate professional bodies and legislators to have to focus on the pathology of governance failure. However, preparing a code of good practice of corporate governance for companies is the easy part of the job rather than implementation of both the letter and the spirit of the code that are ultimately more important and more difficult. Corporate governance effectiveness is the important standard of assessment of the code implementation, while board of directors plays definitely important role for achieving governance effectiveness. Among, the strategic role of the board is in essence. Therefore, the importance of board's strategic role should not be ignored forever by the legislators and professional bodies among these countries.

Board Strategic Contribution
Researchers have argued that the strategic governance is a comprehensive and ongoing management planning process aimed at formulating and implementing strategies that enable a firm to compete effectively internationally (Melis, 239). In this process, the board plays the role that decides and develops higher-level policy objectives and keeps the organization on track within the agreed strategy (Melis, 239). Put it another way, board of directors could be regarded as the policy definer, strategy formulator and implementation monitor as it not only helps formulate company strategy, but also provides executives with supervision to the quality of strategic thinking.
The strategies will affect organizational performance thereafter link with the success or failure of the company. According to Charles (2003), “corporate governance can be highly influential to organisational performance in so far as it is related to the strategic management of the corporation.” (Charles, 330) Unfortunately, recent collapses and scandals are offering negative examples that may server as a lesson. Despite of many reasons led to failure of Enron, like lack of enough oversight, serious interest conflicts between board and management, and its fall should be seen in a wider context. Also, we can see board that is unable to implement its strategic role from the case of Parmalat's bankruptcy.
The story occurred in 1997, when Parmalat formulated strategy of becoming a global player and started a campaign of international acquisitions, financed through debt. Parmalat's founder and now former CEO Calisto Tanzi engaged the firm in several exotic enterprises, such as a tourism agency called Parmatour, and the purchase of the local soccer club Parma. It was such acquisitions that brought Parmalat in red figures instead of bringing in profits. It has been reported that Parmatour, now closed, has a loss of at least EU 2 billion, and getting insolvent of the Parma soccer club are as yet fully known (Melis, 239). The importance of strategic management for organization performance has been proved; it is thus necessary for both legislators and professional bodies in strategic role of the board, to have a clear focus.
In a word, strategic contribution is an essential premise for board of directors to achieve its effectiveness. Nevertheless, especially after scandals of Enron’s etc. more attention of legislators and professional bodies have been shifted on board's monitoring role through diagnosing illness of governance failure. The responsibility of the "monitoring board" is to monitor the corporation's managers in running the business because managers might have a conflict of interest with shareholders where managers might act in their own self-interest. No doubt it would be important to do that way, but ignorance of board's strategic role would be putting the incidental before the fundamental. As Reinhard (2004) hold the fact that a director's role is not simply to be a monitoring mechanism over management, but also to offer expertise and advice and to offer linkages with external resource. (Reinhard, 32)

Monitoring Strategies
The final destination of board of directors is maximizing shareholder interests. Regardless of role of monitoring, strategic, or transformer of policy etc played by board, ignorance of any one will led to poor corporate governance that is the main cause for business failure. Each board of directors has at least the following three functions to fulfil its effectiveness: First of all, the board of directors is responsible for lending an air of legitimacy to the corporation. The second one is focused on auditing and legal requirements. Thirdly, the corporate board of directors is expected to determine, modify, and approve a business strategy (Clair, 74). It is necessary for legislators and professional bodies across the globe to reform current governance practice for bringing back investor and shareholder confidence and better company performance no matter what approaches they take, because there is no one-size-fits-all model will be adopted globally (Charles, 330). This is the point that also has been summarized by other researchers, as there is no one model that adequately reflects the governance requirements of all forms of organization (Charles, 330).
In fact, board's role of strategic maker and guider is a traditional one. With global economy is undergoing new changes and facing rigorous challenges on behalf of collapses and scandals of many traditional multinational companies like Enron and Parmalat, new demand for consideration of broader issues of integrity, accountability and transparency in the way people manage companies, have been much more focused. Nevertheless, ignorance of traditional strategic function will make company in risk because any strategic flaw would be the root of the failure that can be seen by examples of Enron, Parmalat and AOL Time Warner. Furthermore, regulatory disciplines just provide theoretical platform for establish good corporate governance. What more important is that corporations must strictly follow these regulatory disciplines to maximise shareholder's wealth because "all of the governance reforms in the world would not bring about real improvements in corporate governance" (Clair, 75).

Conclusion

Corporations must act within the law. Governments are responsible for designing the legal framework to monitor and control the activities of corporations in order to protect employees, stakeholders etc. The legal and regulatory requirement that affect corporate governance should be enforceable and transparent. The penalties for serious violation of the law can be extremely severe, even life threatening for corporations. Compliance is not only appropriate but also essential. Reasonable steps should be undertaken to develop, implement and maintain effective legal compliance, with periodic review to gain assurance.
Notwithstanding the contributions of corporations to communities in terms of employment, education, development of infrastructure, contributions to social and cultural events and being a corporate citizen generally, there are also negative side effects. Some corporations have contributed to the destruction of environments and cultural traditions. Global institutions have entered communities, shaped peoples' futures and ecosystems, and then depart when natural resources have been exhausted, leaving skeletal monstrosities. Corporations should strive to be ethical in nature and be the protectors of the environment and people.
The factor of competitors must also be viewed in relation to corporate governance. One of the main objectives of any corporation is to secure value for shareholders investments. An ill effect of transparency in corporate governance is that competitors may be able to view market policies, past trends and other information of an organization. They may then be able to formulate plans to penetrate opponents markets thereby diminishing the returns of the first organization, an effect to be felt by all stakeholders.
Performing corporate governance correctly is important to economic success. However there is little evidence to verify that this practice will prevent further corporate failure or improve organizational effectiveness. The quality of corporate governance practices has become as important as financial performance. The benefits of good governance should not be seen as the successful completion of an audit or a milestone achieved. It should be a model of best practice by all stakeholders. The board, employees and staff of all levels should extend a structure that best suits its legislation, operating environment and objectives.
In conclusion, through foregoing discussion, it may be asserted that in order to improve corporate governance and company performance, legislators, regulators and professional bodies should, focus on the pathology of governance failure, but no ignorance of developing board's real strategic contribution for companies. For both authorities and board of directors, only one way to effective corporate governance is cohesion between compliance with the governance code and construction of board itself.

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