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CG relates to the way a company is governed. It helps institutions to achieve their corporate objectives, in determining ways to take effective strategic decisions, to assess and monitor risks. It is actually carried out by the board of Directors and the committees concerned to serve stakeholders' interests. "Corporate Governance is a system by which corporations are directed and controlled." (Sir Adrian Cadbury, 1999)
Simply put, CG ensures transparency which entails a balanced economic development. It allows establishments to thrive as institutions for advancing long-term shareholder's value and safeguarding shareholders' interests. Oman (2001) defined CG as a term refers to the public and private corporations that include regulations, laws and business practices which manages the relationships between business managers and stakeholders.
2.2 Historical perspective of Corporate Governance
Modern CG originated in the U.S.A in the 1980's where strong and superior executive of major corporations were acting in ways that were inconsistent with the interests of the owners (investors). In response, these investors employed their powers as owners and devised special CG guidelines about how organisations should be run. In 1992, the breakthrough for CG of Europe accompanied the publication of the Cadbury report in the United Kingdom. It also came with the corporate scandals in UK in the late 1980's. Later many countries founded their own reports on CG; the King Report (1995) in South Africa, the Report on CG in Hong Kong (1996), the Netherlands Report (1997), amongst others.
2.3 Corporate Governance in US and corporate scandals
The US CG has been largely criticized as a consequence of giant corporate collapses such as Enron, WorldCom, Tyco and some other major corporations. Those collapses and denigrations entailed a legislative alteration (Sarbanes-Oxley Act 2002-SOX) and regulatory change (new governance guidelines). It is important to illustrate why corporations have failed despite seeming healthy by reviewing an example from recent years.
Arthur Andersen and Enron were two major industries who took advantage of not only investors, but also the public and the Government so that they could increase their personal wealth illegally. Anderson had a very active role in Enron's company through both consulting and auditing. However, Anderson's role in Enron fiasco should have been predicted. Anderson had two major audit failures just a few years apart and just a short time before Enron filed for bankruptcy. Evidences suggest that Andersen did not fulfill its professional responsibilities regarding audits of Enron's financial statements, or its obligation to bring into light the intention of Enron's Board issues about Enron's internal contracts over the related party transactions. On June 15, 2002, Andersen was found guilty for shredding documents related to its audit of Enron, resulting in Enron collapse.
Enron's published accounts for the year ended 31 December 2000 showed a profit of $979 million and there was nothing that could warn shareholders about the imminent disaster that was going to occur over the next year making Enron the biggest bankruptcy in US history. Enron's shareholders lost more than $60 billion while its stock price dropped from $90 to $1. Eventually in December 2001, Enron filed for bankruptcy.
2.4 Effects of these scandals to Mauritius
In all these scandals, the interests of various shareholders have been negatively affected due to unethical and illegal behavior of management. This required USA authorities to devise new laws to better control the direction of corporations. These corporate failures created worldwide concern on CG issues. Needlessly to point out that Mauritius is linked to the world and it is government policies to strengthen those links by attracting Foreign Direct Investment (FDI) and providing services (Offshore, BPO). So, the issue of CG is of great importance. In September 2001, Minister Sushil Khushiram set up a National Committee on Corporate Governance (NCCG) where the committee was given wide terms of reference, which was fundamentally to raise the CG standard of Mauritius to the world level.
After preliminary work and discussion, it became apparent that there was a lack of awareness in corporations of what really implied good CG. The objective of the committee was to prepare a report and the associated code to fill this knowledge gap.
2.5 Importance of Corporate Governance
Good CG is important as it ensures a fair and transparent corporate environment and that companies are held responsible for their actions. On the contrary, weak CG entails mismanagement, bankruptcy, corruption and waste. The importance of CG arises in modern corporations due to the separation of ownership control and management in organisations. The main agent problem is reflected in the direction and management related problems due to the conflicting interests of corporations' stakeholders.
The OECD (2004) recognizes that: "Good corporate governance should provide proper incentives for the board and management to pursue objectives that are in the interests of the company and its shareholders and should facilitate effective monitoring." Fine CG establishes standards for prominent investment environment which is required by competitive firms to gain strong and efficient market position and also eases the success of the organisation.
Furthermore as noted by Gregory and Simms (1999), the quality of CG is important since it has a direct impact on:
a. The efficiency with which a corporation employs assets.
b. Its ability to attract low-cost capital.
c. Its ability to meet the expectations of society.
d. Its overall performance.
2.6 CG in Mauritius and Financial Scandals.
Mauritius has seen a rise in the level of fraud and corruption in the recent years. It also has its lots of financial scandals from banks to companies quoted on the Stock Exchange of Mauritius (SEM). Commercial banks namely the Bank of Credit and Commerce, the Habib bank, the Mauritius Cooperative Central Bank, the Union Bank and the Delphis Bank have been forced to closure while the Banque Nationale de Paris and the Citibank have disappeared due to mergers with the Barclays Bank and the Mauritius Commercial Bank (MCB) respectively.
Local corporate cases, the Air Mauritius, the Delphis Bank affairs and recently the MCB/ NPF case have been exposed and fingers pointed out at the weak internal control and CG in these institutions.
In February 2003, a major fraud in hundreds of millions of rupees came into light at the Mauritius Commercial Bank (MCB Ltd). The fraud was committed at the expense of one of MCB's clients, namely the National Pension Fund (NPF). Later in March, the Governor of the Bank of Mauritius met with the Chief Executive Officers and the Board of Directors of certain banks to critically appraise their management practices and their compliance with the ethics of CG. Since then, steps have been taken by companies to mitigate CG risks and failures; MCB has undertaken some actions for effective risk management including the creation of risk management function and recruitment of a Chief Risk Officer.
DCDM Marketing Research Report (2009) indicates that compliance with the code is still not the norm in Mauritius, in that only 30% of the companies mention that they currently comply with the Code, 29% do not comply, as indicated by the level of non-response of the survey (41%). An analysis from Annual Reports of some 86 companies that could be collected shows that there is an improvement in the proportion of corporations presenting a CG report in their Annual Report over the last 3 years (from 74% in 2006 to 85% in 2008). However, information on Directors' emoluments, well-defined and detailed risk management and internal control seemed less likely disclosed in the ARs. In addition, an increase in the level of companies setting up Board Committees to address CG issues was noted. Also, companies had less than 2 Executive Directors as defined in the Code and lacked diversity in terms of age, gender, qualifications or ethnic origin.
The World Bank Report on the Observance of Standards and Codes (ROSC) for Mauritius recognised the improvement of CG in the country through the enactment of the Companies Act 2001, the Listing Rules, and the financial regulation of the Financial Services Commission (FSC) but advocates further enhancement.
Soobaroyen and Mahadeo (2009) argued that whilst claiming to comply with the 'philosophy' of the CG code, companies may be selectively implementing some requirements of the Mauritian code more for legitimacy reasons rather than for purely maximising ones. Although this has been initially suggested by Burton (2000, p.195), Aguilera and Cuervo-Cazurra (2004, p.44), empirical findings remains inconclusive.
2.7 The Report of CG for Mauritius
The Report revised in 2004 is divided in two main parts:
The code of CG
The Report on CG
In 2001, a list of measures was introduced, designed to align where possible the practices of corporate Mauritius with best practice worldwide. These measures were:
Introduction of a new Companies Act
Introduction of International Accounting Standards (IAS)
Introduction of new listing rules for companies listed on the Stock Exchange of Mauritius
Setting up of a National Committee on CG
The World Bank was asked to complete a Report on Standards and Codes (R.O.S.C) on CG in Mauritius that was published in August 2002.
In 2002 and 2003 the World Bank undertook and published Reports on Standards and Codes in respect of Auditing and Accounting, Insolvency, and the Rights of Creditors.
2.8 Components of the Mauritius Code of CG
2.8.1 Board and Directors
Effective and good governance rests with the board of directors. The board sets the direction, core values of an organisation, overseas performance and safeguards shareholders' interests. Responsibilities of the board are formally defined in by-laws. Furthermore, the board should ensure that the organisation abides by the appropriate laws, regulations and business practice codes. The board should also communicate with its shareholders and stakeholders overtly and promptly.
22.214.171.124 Independent Directors/ Outside Directors
An independent director is one who does not participate in work management. Board independence is an indispensable condition for effective governance. Board's effectiveness in monitoring management is a function of both insiders and outsiders who serve on the Board (Fama and Jensen, 1983).
Concordant with this monitoring argument, Weisbach (1988) testified a higher correlation between CEO turnover and corporate performance for companies which are dominated by outside BOD rather than companies in which insiders predominated. After Satyam fiasco, January 2009, in India the issue of independent director was raised.
Satyam was not the only case where the independent director showed a lack of commitment. For instance, Enron, WorldCom and Tyco and other companies were cases where the independent directors failed to perform effectively. The appointment of an independent director brings value to the firm as well as providing board support.
126.96.36.199 Responsibilities of the Board
By law, Board members have fiduciary responsibilities - the duty of care, the duty of loyalty, and various other duties - that they are expected to discharge. The responsibilities of the board under the inclusive approach are to define the purpose of the corporation, to determine strategies and values by which the daily activities of the company will be performed.
The board's duty is then to monitor the strategies implemented. It is the board's responsibility to provide effective CG. The board is also responsible for managing risks and should ensure that the corporation maintains a robust system of risk management. In regard to the obligation of the Code, the board needs to ensure that there is effective communication of its strategic plans, internal and external ethical code and adequate internal controls.
2.8.2 Board Committees
Board committees are increasingly important in management and governance of organisations. They serve as a means of assisting the board and its directors in discharging their duties and responsibilities. There should have full disclosure and transparency from the Board Committees, which should comprise of board members only as far as possible. All companies should have, at a minimum, an audit committee and a CG committee comprising of a Nomination Committee and a Remuneration Committee. Furthermore the number of times the committees meet in a year must be disclosed in the AR.
2.8.3 Company secretary (CS)
According to the Companies Act 2001, the company secretary needs to be appointed by the Board as a whole and should ensure that the appointee has the necessary attributes, experience and qualification to properly discharge his/her duties.
It is the responsibility of the CS to ensure that the company is abiding to relevant statutory and regulatory requirements as far as the interests of the company are concerned.
2.8.4 Risk management, Internal Control and Internal Audit
Risk management is defined by the King report (2002) as "the identification and evaluation of actual and potential areas of risk as they pertain to a company, followed by a procedure of termination, transfer, acceptance (tolerance) or mitigation of each risk. Risk management is therefore a process that utilises internal controls as a measure to mitigate and control risk."
Risk management is effected by the BOD, management and all its employees with respect to their defined roles within the company. Internal controls contribute in the management and mitigation of risk. The Board must ensure that the mechanism of internal controls is operating effectively and manages risk in a way approved by the Board. Internal Audit function provides assurance to the board to the effectiveness of risk management and internal control.
2.8.5 Accounting and Auditing
Directors are responsible for adequate accounting records, maintaining effective internal control systems and selecting appropriate accounting policies. Audit committee's key responsibilities are to oversee the process of producing accurate and timely financial statements while ensuring their corporations have effective internal control mechanisms. Market regulators, commissions and accountancy bodies have recommended the establishment of audit committees as an important step in improving CG.
According to the spirit of the Financial Reporting Act 2004 (FRA), all public interest entities including some 40 statutory bodies listed in the Schedule of the Act, should prepare their Financial Statements in accordance with International Financial Reporting Standards (IFRS) and should include in their Annual Report a Corporate Governance Statement.
Audit Committees are expected to monitor the reliability of a company's accounting processes and compliance with IFRS and ensure that financial statements are prepared in accordance with these standards. Broc Romanek and Dave Lynn (2008) even argued that the Enron scandal might not have occurred if the US Financial reporting system had adopted the IFRS standards.
2.8.6 Integrated sustainability reporting
PricewaterhouseCoopers' corporate reporting suggests that the economic crisis is a reminder that financial measurement alone does not provide enough insight into organisational performance. Stakeholders require clear and explicit information on external factors affecting their business, their approach to governance and controlling risk and how the business model really functions.
Integrated sustainability reporting focuses on the social context, physical environment and society within which the business operates. It provides an indication of past accomplishments of a non-financial nature along with the aims of the company in the long-run and its ways to get there. Effective sustainability reporting is important for communicating with stakeholders about how the company is performing against its objectives. Businesses that embrace this have an advantage over their rivals and enhance shareholders' value.
According to the Code, every organisation should regularly (at least annually) report to its stakeholders on its policies and practices as regards:
health and safety
188.8.131.52 Business practices and ethics
Business practices are procedures or rules and operational tactics employed by organisations in the pursuit of purpose, objectives and strategies. The overriding goal is to ensure consistency, predictability, and accountability in conduct, decision making, and performance. Ethics are moral principles that an organisation considers important in achieving its objectives. Ethics and a well-defined code of conduct contribute to good CG and also ensure that the organization treats its stakeholders fairly and equitably within legal framework and social expectations. The collapse of Enron has been mostly due to the lack of ethics from the part of the board rather than deficiency in regulations (Downes and Russ, 2005).
Due to SOX Act whistle-blower provisions, corporations need systems to field complaints and investigate potentially illegal and unethical conduct. Reporting malpractices is critical to the success of a corporate ethics, compliance initiatives and corporate overall wellbeing.
According to the International Business Ethics Review, companies are increasingly using organisational help lines for reporting misconduct, as well as providing employees a safe means of reporting wrongdoing. The 2011 National Business Ethics Survey, who examines organisational ethics from the employee perspective revealed historically low levels of current misconduct in the American workplace and record high levels of employee reporting. Nevertheless, there are warning signs of potentially significant ethics decline ahead.
2.8.7 Communication and Disclosure
Communication between the Board, shareholders and other stakeholders is an important element of the corporation's CG process. Timely and candid communication is necessary to allow these groups to understand what is expected and needed from them to enable each party to execute their responsibilities effectively and efficiently.
The lines of communication should be transparent and open. Communication is essential in valuing its role in society. The Board must judge the reliability of information suitable for disclosure. It must also act in line with any relevant laws or legislation avoiding such disclosure. It would be appropriate for the Board to explain clearly reasons for non-disclosure in such case.
Disclosure and transparency are the cornerstones of good governance principles. They reveal the quality and reliability of information- financial and non-financial- provided to lenders, shareholders and the public by management. Access to information lays down the basis for accountability, assessing performance and attaining strategic objectives.
The board should ensure full and transparent reporting ( not just disclosure), as well as ensuring that the company is satisfying its disclosure obligations and that information disseminated is valid and accurate. Companies are required to disclose on an annual basis its approach to CG. A "Statement of CG practices" should be included in the AR and should be in accordance with the guideline.
Investors choose to invest their funds in a particular business and they will do so by investing in a business that is financially stable and will continue to be profitable in the foreseeable future. Investors therefore use published ARs of companies in order to have an assertion that the business is well managed. However, although ARs may give a true picture of the business' current position, there are many facets that are not reflected in the annual report.
The extent and level of disclosure is of paramount importance to market participants in making accurate assessment of a corporate financial position, business activities and risk management practices.