Era of Corporate Governance: Necessity for Survival

Business Practices

Era of Corporate Governance: Necessity for Survival

Corporate Governance (CG) has succeeded in attracting the public interest because of its perceptible significance for the country's growth, economic health of corporations, and of society at large. However, the concept of CG is poorly defined because of its wider coverage of large number of stakeholders in distinct economic phenomenon. In the changing global scenario, implementing potential CG framework gives organizations a cutting-edge competitiveness in the world market. It is the basic mantra in the current scenario for future survival.

As long as the owners articulate the value system very clearly, as long as they show by example, the company can hold on its own in any environment, even faced with intense competition and avoid the pitfalls of the likes of Enron, WorldCom, Qwest, Tyco and others.

It's better to lose a million dollars than lose a good night's sleep.

-- Narayan Murthy,
Chairman of the Board and
Chief Mentor of Infosys Technologies Limited.

Backdating `represents the ultimate in greed'. It is stealing, in effect. It is ripping off shareholders in an unconscionable way.

-- Arthur Levitt,
Former Chairman of the Securities
and Exchange Commission.

Daily headlines emphasize how crucial the issue of trust in the governance of corporations has become since Enron's breach of trust. However, at present the case of Ramalinga Raju's disclosures regarding forging accounts of Satyam have come as a serious shock and disappointment for the Indian corporate world, which impacts the development as well as has a major impact on investors, clients and employees, going forward. Industry players also claim that there is a need to examine the loopholes immediately in regulation, accounting, auditing and governance and address them with urgency as this has traumatized the confidence of investors in both domestic and global perspectives, the repercussions of which could be felt all over.

Corporate Governance – A Saga

In a wider sense, author Gabrielle O'Donovan defines corporate governance as "an internal system encompassing policies, processes and people, which serves the needs of shareholders and other stakeholders by directing and controlling management activities with good business savvy, objectivity, accountability and integrity. Sound corporate governance is reliant on external marketplace commitment and legislation, plus a healthy board culture which safeguards policies and process."

Corporate Governance (CG) in general refers to the practices by which organizations are directed, controlled and held to account to various stakeholders. CG includes the relationships among the many dramatis personae (stakeholders) involved in the environment of the objectives of the organization. The principal or primary players are the management, board of directors and the shareholders. The various other secondary stakeholders include employees, customers, suppliers, banks, regulators, lenders, environment and the society at large. The structure of CG in various organizations helps in predicting the rules and procedures for making decisions on ultimate corporate affairs. It provides the way for perfect planning and structuring, through which the company objectives are determined, as well as the CG structure is a means of attaining and monitoring the performance of those objectives. It is about ethical business conduct, trust, commitment values and transparency. However, in essence, CG translates into conducting the affairs of a company in a manner that ensures fairness to fund providers, shareholders, customers, employees, suppliers, various regulators and the society at large. The absence of transparent governance structures and lack of adherence to the governance principles increases the danger of public corruption and exploitation of entrusted power by the management in the business world and society as a whole. Refer to corporate governance framework depicted in Figure 1 to understand the involvement of various parties in the framework.

Numbers Game – Organization with Successful and Failed Governance

Numbers in the context of CG are company profits, assets, share price and other prominent working capital ratios, which play a vital role for an organization to be successful. The liberated market ideology was that corporations were held responsible to shareholders, customers, workers and the society. Almost in every scenario, the customer and investor behavior correlated with the change in company share price. Millions of individual `electorates' in the marketplace ensured that they behaved. `Bad' corporations were punished by selling complete shares in the market. `Good' corporations were rewarded by buying the shares at premium market prices. Market pressures and forces will sort it all out-this famous ideology underpinned the idea of CG and accountability.

There are many factors and situations which lead to non-transparent auditing in organizations like:

• Conflict of attention remains in all audits, even where the consulting associates are abolished.

• One of the major concerns is that some auditors are looking for better paying jobs in the companies they audit.

• Many audit companies and auditors are under tremendous pressure to get next year's audit business.

• An old accounting standard helps auditors to use the flaws and utilize them for manipulating the accounts, which in return, do not always give the fullest picture.

• Globalization and e-technology are used for easy manipulation of accounts and also makes reliable audits extremely difficult.

Business author Gabrielle O'Donovan goes on to say that the projected quality of a company's CG will influence its share prices as well as the cost of raising capital. The word `quality' is determined by the legislation, financial markets and other external market forces plus how policies and procedures are implemented and how people are led. To a large extent, external forces are outside the circle of control of any board. The internal environment in any organization is quite a different matter, and offers organizations the opportunity to differentiate from competitors through their CG framework and board culture. To date, too much of CG argument has centered on legislative policies to deter fraudulent activities and transparency policy which misleads executives to treat the symptoms and not the cause.

According to the Sebi Committee (India) Report on CG, it is the acceptance by the entire company management of the inalienable rights of shareholders as the true owners of the corporation and their own role as trustees on behalf of the company shareholders. It is about trust, commitment to values, ethical business conduct and about making a distinction between corporate and personal funds in the management of a company.Refer to Chart 1, Tables 1 and 2 for county CG rank, international companies and national companies CG rating.

Financial reporting is a decisive factor obligatory for the system of CG to function effectively and efficiently. Accountants and auditors are the primary providers of information to participants and regulators. The directors of an organization should be entitled to anticipate that managements prepare the financial statements in compliance with regulatory, statutory and ethical duress, and rely on auditors' expertise.

The current accounting policies and practices allow a degree of freedom or choice of method in determining the method of measurement, criteria for credit, and even the definition of the accounting entity principle. The exercise of this choice to improve apparent performance imposes extra information costs on the information users. In the extreme, it can involve non-disclosure of other sensitive and crucial information.

One of the major areas of concern in many cases is the accounting firm which acts as both the independent auditor and management consultant to the company it is auditing. This may result in a divergence of interest which places the integrity of financial statements in doubt due to client pressure to satisfy management. The authority of the corporate client to initiate and terminate management consulting services and, more fundamentally, to select and reject accounting firms contradicts the concept of an independent auditor. Changes enacted in the US by incorporation of the Sarbanes-Oxley Act prohibits accounting firms from providing both management consulting and auditing services. A similar kind of provisions and policies are in place under Clause 49 of Sebi Act in India.

The infamous Enron collapse is one of the legendary examples of misleading financial reporting. Enron obscured huge losses by creating a delusion that a third party was contractually obliged to pay the amount of losses. However, the third party was an entity in which Enron had a sizeable economic stake. In discussions of accounting practices with Arthur Andersen, the partner in charge of auditing, discussions inevitably led to the client's view prevailing.

However, good financial reporting alone is not a sufficient prerequisite for the effectiveness of CG, if the corporate does not process CG, or if the informed corporates are unable to exercise a monitoring role due to high costs. Refer Figure 2 for good CG structure.

Monitoring Role: The board of directors, CEO and CFO of an organization with their legal authority to hire, fire and compensate top management safeguards total invested capital. Conservative board meetings allow potential problems to be identified, discussed and avoided. Even as non-executive directors are considered to be more independent, they may not always result in more efficient and effective CG and may not enhance performance. Diversified board structures are optimal for different firms. Moreover, the aptitude of the board to monitor the company executives is a function of its access to information. Executive directors, CEO and CFO have the power of superior knowledge of the decision-making process and therefore evaluate and examine the top management on the basis of excellence of its decisions that lead to financial performance outcomes. It could be argued that executive directors look beyond the financial criteria.

Balance of Power: The balancing of power is very general; the authority and power executed by a president will be different from that of a treasurer. This application of separation of power is further developed in companies where separate divisions check and balance each other's actions. The power and authority plays a vital role in building better CG structures and framework.

Remuneration: Performance-based remuneration is premeditated to relate some proportion of salary to individual performance. It may be in the form of cash or non-cash payments such as shares and stock options, superannuation or various other benefits. Such incentive methods, however, are imprudent in the sense that they provide no mechanism for preventing mistakes or opportunistic behavior and can elicit narrow-minded thinking.

Managing CG Failure in Corporations

Malfunction in CG is a real threat to the future of every organization. CG like business ethics issue is thousand times more powerful than the Internet or globalization and can destroy any kind of business in a day. To make matters worse, principles of CG are changing quickly in response to haphazard events which capture public imagination. The business ethics is changing rapidly, like what was good, is becoming bad in the present era, and what was considered bad, is becoming good. Standards of CG that have worked for previous decades are looking immoral or old fashioned while other practices that elicited questions are becoming totally acceptable.

The word `success' itself is being redefined as the fundamental rethink about the purpose of corporations. Corporate responsibility will be far more extensively interpreted. Real success will be everything that was previously taken for granted in high performance-oriented companies plus the highest ethical standards in all the areas.

Successful Toyota's CG

In October 2007, Toyota set up a committee called CSR Committee consisting of directors of executive vice-president rank and above, together with auditors. The committee's role is to synchronize and implement significant activities in order to fulfill our social responsibilities (Refer Figure 3). It discusses plans for CSR policy and proposals to ensure the harmonious and sustainable development of society and the global environment, as well as debates priority issues relating to legal compliances, corporate ethics, risk management, social contribution, and environmental management, and also looks into the responses to these issues.

The committee brings coordination between the corporate ethics committee, which was established as the core body for compliance, and the corporate philanthropy committee. It deals with activities in the field of social contribution, and works to maintain and progress activities in each of the relevant areas.

Overcoming the Word Greediness: A Winning Strategy

With the collapse of Satyam Computers, the company seems suddenly to be a gigantic fabrication. Satyam has grabbed world headlines for the wrong reasons. The word `greed' and `materialistic comforts' are the big evils motivating us to commit frauds. Apparently, the whole Satyam fraud case is just the tip of the iceberg. In a corrupt system the more one dwells into corporate mis-governance, the more of Satyam-kind of cases will pop-up everywhere. Before one can forget Enron, Worldcom, Daewoo, today Satyam has done something, which has scared almost everyone. Imagine what will happen if every company is investigated.

The system of CG must win the trust of the global community.

• Steps to rebuilding trust in the corporation

Transparent: Absolutely open, going ahead of current requirements or prospects.

Responsible: Clearly acting in the wider or broader and long-term comfort of all.

Uncompromising: Total obligation to highest ethical positions.

Successful: Great results combining brilliance in all areas with strong principles.

Temperate: Taking care to avoid major uncertainties, wild decisions and excessiveness.

The fundamental issues that everybody perceives of many recent scandals:

• "I did what I was directed by others."

• So whom do we serve?, Our boss?, The boss of the boss?, CEO?, Board?, Stakeholders?, Customers?, Society?, Courts of law?, Your own conscience?

• Extreme force on employees to toe the official line.

• Harassment and threats by people demonstrating huge power.

Sure, greed is one of the significant reasons for every scandal, there is some uncertainty in saying this truth and it is atypical of many people. Doubtfulness is understandable as without greed everything in this humankind will come to a standstill! Different forms of greed are the driving force for all human behavior and activities without exemption. It is the driving force in social service, politics, business, spirituality, preaching, charitable activities, etc. Thus, it is not possible to name any activity where the fundamental greed is absent. When this all enveloping greed is moderated, it is respectfully called as enticement and it is healthy and also the trademark of our civilized living.

Conclusion

With the changing technologies and business structures, the corporations will be anticipated in future to build a better future - by marinating basic values and legal compliances, business need to take from society and need to return back to the society, only then can a business survive successfully. Every corporation needs to maintain transparency for its shareholders but also for its customers, employees, business partners, community, nation and the wider world. Those companies with excellent CG and ethics should be build based on this core value which will have an added competitive advantage: Attracting and preserving talent and generating optimistic reactions in the world marketplace.

-- Challa Madhavi
Faculty Member,
INC (HQ),
Hyderabad.
The author can be reached at
madhaviprasadchalla@gmail.com