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Business Ethics & Corporate Governance
Corporate governanceis set ofprocesses, policies, laws, customs, and institutions affecting the way acorporationis directed, controlled or administered. Corporate governancealso includes the inter-relationships between the stakeholders and company goals, which form the foundation of an organization. The main stakeholders in a company are theshareholders, board of directors and the management. Other stakeholders are employees, creditors, customers,regulators, suppliers, and the community as a whole.
An important aspect of corporate governance is to ensure theaccountabilityof certain individuals in an organization through mechanisms which try to reduce or eliminate theprincipal-agent problem. A related but different segment of discussions focuses on the impact of a corporate governance system ineconomic efficiency, with a heavy weightage on shareholders' welfare. There are other aspects also to the corporate governance subject, such as thestakeholders' viewand the corporate governance models around the world.
It is a system of controlling, constructing, and operating a company with mission to achieve long term goals to please shareholders, creditors, employees, customers and suppliers, in accordance with the legal and regulatory requirements, over and above matching environmental and local community needs.
SEBIcommittee report defines corporate governance as the acceptance as management of the rights of shareholders as the original owners of the company and of their own part as trustees on behalf of the shareholders. It is about adhering to ethical business conduct, values, and making a subtle distinction between corporate and personal funds in the management of a company.
The Financial Aspects of Corporate Governance:
“Corporate governance is a system by which companies are directed and controlled. The responsibility for governance of the companies is on the Board of directors. The shareholders' role in governance is to appoint the directors and the auditors and to satisfy themselves that an appropriate governance structure is in place.
The responsibilities of the directors include setting the company's strategic aims, to provide the leadership to put them into effect, to supervise the management of the business and to report to shareholders. The Board's actions are subject to regulations, laws, and the shareholders in general meeting.”
The principal elements of good corporate governance include trust, honesty and integrity, performance orientation, openness, accountability and commitment to the organization responsibility and mutual respect.
Important thing is how the management and directors construct a method of governance that aligns the values of the corporate stakeholders and then analyze the method periodically for its effectiveness. Particularly, the prime executives should carry their duties ethically and honestly, especially concerning the actual or predicteddisputes, and disclosure in financial reports.
The principles that are commonly accepted for corporate governance are:
§ Roles and responsibilities of the board:
A variety of skills and understanding is required by the Board of directors to be able to manage various business problems and should have the capability to test and review the management performance. It should have an subsequent level of commitment to fulfill its duties and responsibilities.
§ Rights and equality in treatment of shareholders:
Firms should honor the rights of shareholders and assist them to exercise their rights. Organizations can help them by effectively communicating information that is accessible, understandable and which encourages shareholders to take part in meetings conducted.
§ Ethical behavior and integrity:
Responsible and ethical decision making is not only important for public relations but also necessary element in risk management. Organizations should construct a code of conduct for their employees and directors which promote ethical and responsible decision making. It is important to understand that dependance by a company on the ethics and integrity of individuals will lead to eventual failure. Because of which, many organizations establishCompliance and Ethics Programsto minimize the risk that the firm.
§ Interests of other stakeholders:
Firms should recognize that they have law related obligations and other obligations to all the stakeholders.
§ Transparency and disclosure:
Organizations should clarify the code of duties of board and management to provide shareholders with a particular level of dependence and trustablity. Organizations should also implement procedures to protect and verify the crediblity of the company's financial reporting and analysis. The material matters concerning the organization should be revealed, balanced and routine to ensure that all investors have access to accurate information.
Issues in Corporate Governance
There are several issues in corporate governance principles, like:
§ the freedom of the entity's external auditors and the standards of their audits
§ internal auditors and controls
§ overview of the preparation of the entity's financial accounts.
§ management and prediction of risk
§ the resources made available to directors in carrying out their duties
§ review of the compensation policies for the chief executive officer and other top executives
§ dividendpolicy of the organization
§ the method in which individuals are appointed for positions on the board
Corporate governance, despite some small efforts from various quarters, remains doubtful and often misunderstood phrase. For a while, it was confined only to corporate management. It is something much wider, for it must include a just, benevolent and transparent administration and attempt to meet certain well defined,written objectives. Corporate governance must go far beyond the law. The Quantifiable Elements of managerial and financial disclosure, the degree to which the board of Director exercise theirresponsibilities and the assurance to run a transparent organization- these should be constantly evolving. The Board is responsible for the efficient handling of the corporation. That responsibility cannot be relegated to management.
In India, the new corporate culture to follow code of good practices and adhering strictly to them, is emerging and is likely to prevail for long.
Mechanisms and Controls
Corporate governance mechanisms and working are designed to minimize the failures that arise frommoral hazardandadverse selection. For example, to monitor managers' behavior, an independent third party attests the accuracy of data provided by management to investors. A model control system should regulate both motivation and ability.
Internal corporate governance controls:
Internal corporate governance controls monitor activities and then take corrective action to accomplish organizational goals. Examples include:
§ Power Balance:
The balance of power is very common; require that the President be a different person from the Treasurer. This usage of separation of power is further developed in companies where separate divisions check and control each other's actions. One group may propose company-wide administrative changes, another group review and can veto the changes, and a third group check that the interests of people (customers, shareholders, employees) outside the three groups are being met.
§ Monitoring by the board of directors:
The board of directors, with its legal authority to hire, fire and compensate top management, safeguards invested capital. Regular board meetings allow potential problems to be identified, discussed and avoided. Moreover, the ability of the board to monitor the firm's executives is a function of its access to information. Executive directors possess knowledge of the decision-making process and therefore testify senior management on the basis of the quality of its decisions that lead to financial performance outcomes,ex-ante.
Performance-based remuneration is made to relate some proportion of salary to individual performance. It may be in the form of cash or kind payments such as sharesandshare options, or other benefits. Such incentive schemes, however, are reactive in the sense that they provide no mechanism for preventing mistakes or opportunistic behavior, and can elicit myopic behavior.
§ Internal control procedures and internal auditors:
Internal control procedures are policies administered by board of directors, audit committee, management, and other personnel to provide reasonable trust of the entity achieving its objectives related to reliable financial reporting, operating efficiency, and compliance with laws and regulations. Internal auditors are people within an organization who test the design and implementation of the entity's internal control procedures and the reliability of its financial reporting.
External corporate governance controls:
External corporate governance controls encompass the controls external stakeholders exercise over the organization. They include:
§ debt covenants
§ demand for and assessment of performance information (especiallyfinancial statements)
§ government regulations
§ managerial labor market
§ media pressure
Benefits of Corporate Governance:
* Good corporate governance has a positive effect on:
o Share valuation
o Risk assessment
o Reduction of market volatility
* Good Corporate governance can:
o Reduce the cost of capital
o Increase the pool of investors
o Improve management accountability and performance
* Other benefits of Corporate Governance:
o Investment (direct and portfolio)
o Growing export markets (good and services)
o Transfer of technology & “know-how”
o Economic policies that foster entrepreneurialism
o A government that can keep corruption under control—or is at least trying its best
o An increasingly credible set of laws and regulations governing economic interaction
o Ongoing capacity building within government and legal institutions (including the judiciary)
A corporation enjoys the status of a separate legal entity; however, the formation of a public listed company is such that its success is dependent upon the performance of a contribution of factors encompassing a number of stakeholders. A ‘stakeholder' is a person (including an entity or group) that has an interest or concern in a business or enterprise though not necessarily as an owner. The ownership of listed companies is comprised of a large number of shareholders drawn from institutional investors to members of public and thus it is impossible for it to be managed and controlled by such a large number of diversified minds.
Hence, management and control is delegated by the shareholders to agents called the Board of directors. In order to achieve maximum success, the Board of directors is further assisted by managers, employees, contractors, creditors, etc. Therefore it is imperative to recognize the importance of stakeholders and their rights.
Communication with stakeholders is considered to be an important feature of corporate governance as cooperation between stakeholders and corporations allows for the creation of wealth, jobs and sustain ability of financially sound enterprises. It is the Board's duty to present a balanced assessment of the company's position when reporting to stakeholders. Both positive and negative aspects of the activities of the company should be presented to give an open and transparent account thereof.
A shareholder is not responsible for managing corporate activities as responsibility for corporate strategy and operations is entrusted with the Board and the management team. Shareholder rights must, therefore, focus on issues such as the election of the Board, amendments to the company's organic documents, approval of extraordinary transactions in addition to basic issues specified in the Companies Ordinance and internal company documents. In order to exercise these rights shareholder participation is essential in general meetings.
Shareholders, including institutional investors, should carefully consider the costs and benefits of exercising their votes. A shareholder must be familiar with the rules that govern shareholder meetings so that he/she may effectively vote. Dates, locations and agendas of general meetings annexed with the issues proposed to be discussed must be provided for purposes of allowing the shareholders a familiarity of the subject so that they may raise questions and may also be able to place items on the agenda.
All shareholders should receive equitable treatment, including minority and foreign shareholders and all shareholders should be able to obtain effective redress for violation of their rights.
The primary responsibility for the administration and performance of a company lies with the directors. The directors administer the company on behalf of shareholders and their powers and duties are covered in the statute.
All employees have some responsibility for implementation of effective internal control procedures as part of their accountability for achieving objectives. They collectively should have the necessary knowledge, skills, information and authority to operate the company. This will require an understanding of the company, its objectives, the industries and markets in which it operates, and the risks it faces. Their endeavors towards these requirements will contribute positively to the performance of the company and success will ensure job stability and satisfaction. A secure work environment and one that protects and safeguards the rights of employees is a means by which to attain optimum levels of performance. The Code requires that a statement of ethics and business practices must be prepared and circulated annually by the Board of directors of every listed company to establish a standard of conduct for directors and employees.
Contractual stakeholders like customers, contractors and sub-contractors are fundamental for any corporation. A relationship based on trust develops between the corporation and such stakeholders and it is normal, especially where transactions are frequent, for credit to be extended. Past experience with the company establishes the basis for the development of such trust; however a framework that protects the interest of the creditor is essential in instances where the trust has yet to develop or in the event of disputes, which may arise. When extending credit, the creditor must be satisfied and convinced that an efficient and speedy system for recoveries has been outlined in order to provide redress if the need arises.
Corporations the world over have been publicly criticized for improving their firm's bottom line at any moral or social cost. Ethics essentially “refers to the issues of right, wrong, fairness and justice.” Clearly, examples such as Enron, WorldCom, and even Conrad Black tested society's views on sound ethical business and the link to what society sees as “good” governance practices. Although the controversies involve issues matched in variety only by the types of companies, they all virtually involve some form of abuse of stakeholders trust.
Example of “Good” Corporate Governance: TOYOTA
Toyota is a global leader in automotive sales, technology and production while also retaining one of the world's most recognizable and highly valued brands. At the heart of their success is the innovative and groundbreaking production methods made possible by the company's recognition of the value of employee empowerment. Employee involvement is defined as “consisting of a variety of systematic methods that empower employees to participate in the decisions that affect them and their relationship with the organization.” At Toyota, the company has employed these proven techniques of co-determination to encourage employee, and supplier involvement in their decision making process, since these practices “help improve both the ability and attitude” of stakeholders. In fact, one of the guiding principles of Toyota requires the company to “foster a corporate culture that enhances individual creativity and teamwork value, while honoring mutual trust and integrity.
Example of “Bad” Corporate Governance: ENRON
Many companies are involved positive and negative risk that it takes. Enron was a company caused by poor corporate governance. It has also triggered a flood of legislative and regulatory changes and codes of conduct across the developed and emerging worlds to improve systems for ensuring that public companies are run properly in shareholders' interest. The situation Enron faced as a company was alleged corporate fraud. It responded by ensuring that the company rules and policies were updated with the standard set by Sarbanes-Oxley requirements. As a result, Enron is compelled to go back to its basic fundamentals where it laid its foundations.
Enron was a financial scandal that was reveled in the late 2001. After a series of revelations involving irregular accounting procedures bordering on fraud, perpetrated throughout the 1990s, involving Enron and its accounting firm Arthur Andersen. Enron filed for bankruptcy on December 2, 2001. Enron's Devastation occurred after it was revealed that much of its profits and revenue were the result of deals with special purpose entities. Enron as a company had many unsolved problems dealing with financial disputes. Not having the right people in management caused Enron to fall right on its face.
The company had a corporate culture that encouraged its staff to influence public policy-makers on the deregulation or privatization of the U.S. (and world) energy sector. Second, the company both instructed and led its accounting firm into `dubious' financial transactions, which ultimately caused the collapse of Enron and may have ended Andersen as an independent firm, especially in its core business of accounting.
Conclusion & Recommendation
CORPORATE governanceand theenterprise culture have become important for the survival of companies and indeed of national economies in the increasingly globaleconomy. Corporate governance is an effective policy instrument in many areas of the operation of the national economy.While it should certainly not be perceived as some sort of panacea, the widespread practice of good corporate governance can help to achieve multiple objectives in both developed and developing countries.To cite a few examples, good corporate governance contributes:
To increase probity, efficiency and effectiveness of the financial markets - and weall saw from the South East Asia financial crisis of 1997-98 what happens whenthere is a systemic failure of corporate governance. Good corporate governance also contributes to the attackon the supply side of corruption - and we all know that corruption is not only bad but that it has an enormously damaging effect on national economies and to the self-regulation of companies, especially newly privatized utilities and public service companies.
The principles, structure and systems of corporate governance can and shouldbe applied in a wide range of organizations - not just publicly listed joint stockcompanies, but also throughout the banking sector, in state enterprises, in co-operatives, in the ever-growing and increasingly important NGO sector, and in public services such as health and education boards.In this way, the impact of improved corporate governance can be felt in all sectors of ournational economy.
Corporate governance should be embraced by the leading institutions in all the sectors of the national economy.The stock exchange and capital markets authority can influence the listed companies, especially through listing requirements and annual reports.The Central Bank can enforce corporate governance on licensed commercial banks who in turn would similarly do so on their corporate customers (including private and family owned companies).And state enterprise and privatization agencies can set standards for government and newly privatized companies.