With the mode of governance acquiring an increasingly significant meaning with each passing financial quarter, Corporate Governance is drawing a lot attention in top echelons and especially among the market watchers.
In general parlance, Corporate governance can be interpreted as the system of rules, practices and processes through which a company is directed and controlled.
It essentially involves balancing interests of a company’s various stakeholders who can be anyone like customers, suppliers, financiers, shareholders, management, government or the community.
Providing a framework of how to attain a company’s objectives, the corporate governance encompasses almost every sphere of management, from corporate disclosure, action plans and internal controls to performance measurement.
So who influences the corporate governance the most — the board of directors which is the primary direct stakeholder.
Elected by shareholders or appointed by other board members, the directors represent company’s shareholders. The board is expected to undertake important decisions, such as corporate officer appointments, executive compensation and dividend policy.
There are yet examples when board obligations stretch beyond financial optimisation, when shareholder resolutions call for certain social or environmental concerns to be prioritised.
Detrimental Effect of Good and Bad Corporate Governance
It is important to understand and remember that “Good Corporate Governance” leads to transparent set of rules and controls in which shareholders, directors and officers have aligned incentives.
Majority of the companies aim to ensure a high-level of corporate governance. Just being a profitable company doesn’t sound enough for many shareholders. They want the company to demonstrate good corporate citizenship in terms of environmental public awareness, ethical behaviour and sound corporate governance practices.
On the other side, “Bad Corporate Governance” can create susceptibility about a company’s reliability, integrity or obligation to shareholders. Also, tolerance or support of illegal activities can create scandals.
Critical Factors Leading to Bad Corporate Governance
In the recent past, the various critical factors leading to many corporate failures have included poorly designed rewards package, including excessive use of share options (that distorted executive behaviour towards the short term), the use of stock options, or rewards linked to short-term share price performance (led to Aggressive earnings management to achieve target share prices), trading did not deliver the earnings targets, aggressive or even fraudulent accounting tended to occur.
Enron – An Example of Bad Corporate Governance
Enron turned a major example where the top-rung officials appeared to have permitted a culture to flourish in which secrecy, rule-breaking and fraudulent behaviour were acceptable. Performance incentives seemed to have created a climate where employees sought to generate profit at the expense of the company’s stated standards of ethics and strategic goals (IFAC, 2003).
The US company had all the structures and mechanisms for good corporate governance. It had a corporate social responsibility task force and a code of conduct on security, human rights, social investment and public engagement. But none complied with the code.
The board of directors allowed the management to violate the code, particularly when it permitted the CFO to serve in the special purpose entities (SPEs); the audit committee allowed suspect accounting practices and made no attempt to examine the SPE transactions; the auditors failed to prevent questionable accounting.