Corporate Governance and Risk: A Systems Approach (Wiley Finance)
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Macquarie University. Monash University. RMIT University. State Library Victoria. The University of Melbourne. The University of Queensland. University of New England. University of the Sunshine Coast. University of Wollongong. Victoria University. Western Sydney University. Non-executive directors are expected to outnumber executive directors and hold key posts, including audit and compensation committees. In the United Kingdom, the CEO generally does not also serve as Chairman of the Board, whereas in the US having the dual role has been the norm, despite major misgivings regarding the effect on corporate governance.
In the United States, corporations are directly governed by state laws, while the exchange offering and trading of securities in corporations including shares is governed by federal legislation. Many US states have adopted the Model Business Corporation Act , but the dominant state law for publicly traded corporations is Delaware General Corporation Law , which continues to be the place of incorporation for the majority of publicly traded corporations. It is sometimes colloquially stated that in the US and the UK 'the shareholders own the company'.
Recent scholarship from the University of Oxford outlines a new theory of corporate governance, founder centrism, which is premised upon a narrowing in the separation between ownership and control. Corporations are created as legal persons by the laws and regulations of a particular jurisdiction.
These may vary in many respects between countries, but a corporation's legal person status is fundamental to all jurisdictions and is conferred by statute. This allows the entity to hold property in its own right without reference to any particular real person. It also results in the perpetual existence that characterizes the modern corporation. The statutory granting of corporate existence may arise from general purpose legislation which is the general case or from a statute to create a specific corporation, which was the only method prior to the 19th century.
In addition to the statutory laws of the relevant jurisdiction, corporations are subject to common law in some countries, and various laws and regulations affecting business practices. In most jurisdictions, corporations also have a constitution that provides individual rules that govern the corporation and authorize or constrain its decision-makers.
This constitution is identified by a variety of terms; in English-speaking jurisdictions, it is usually known as the Corporate Charter or the Memorandum and Articles of Association. The capacity of shareholders to modify the constitution of their corporation can vary substantially. The U. This law made it illegal to bribe government officials and required corporations to maintain adequate accounting controls. It is enforced by the U. Substantial civil and criminal penalties have been levied on corporations and executives convicted of bribery.
The UK passed the Bribery Act in This law made it illegal to bribe either government or private citizens or make facilitating payments i. It also required corporations to establish controls to prevent bribery. The Sarbanes—Oxley Act of was enacted in the wake of a series of high-profile corporate scandals.
It established a series of requirements that affect corporate governance in the U. The law required, along with many other elements, that:. Corporate governance principles and codes have been developed in different countries and issued from stock exchanges, corporations, institutional investors, or associations institutes of directors and managers with the support of governments and international organizations. As a rule, compliance with these governance recommendations is not mandated by law, although the codes linked to stock exchange listing requirements may have a coercive effect.
The investor-led organisation International Corporate Governance Network ICGN was set up by individuals centered around the ten largest pension funds in the world The aim is to promote global corporate governance standards. The network is led by investors that manage 18 trillion dollars, and members are located in fifty different countries.
ICGN has developed a suite of global guidelines ranging from shareholder rights to business ethics. The World Business Council for Sustainable Development WBCSD has done work on corporate governance, particularly on Accounting and Reporting , and in released Issue Management Tool: Strategic challenges for business in the use of corporate responsibility codes, standards, and frameworks. In , the International Finance Corporation and the UN Global Compact released a report, Corporate Governance - the Foundation for Corporate Citizenship and Sustainable Business , linking the environmental, social and governance responsibilities of a company to its financial performance and long-term sustainability.
Most codes are largely voluntary. An issue raised in the U. For example, the guidelines issued by associations of directors, corporate managers and individual companies tend to be wholly voluntary, but such documents may have a wider effect by prompting other companies to adopt similar practices. The modern practice of corporate governance has its roots in the 17th-century Dutch Republic.
Robert E. Wright argues in Corporation Nation that the governance of early U. Means pondered on the changing role of the modern corporation in society. Chandler, Jr. According to Lorsch and MacIver "many large corporations have dominant control over business affairs without sufficient accountability or monitoring by their board of directors". In the s, Eugene Fama and Michael Jensen  established the principal—agent problem as a way of understanding corporate governance: the firm is seen as a series of contracts. In the period from to , corporate directors' duties in the U.
In the first half of the s, the issue of corporate governance in the U. The California Public Employees' Retirement System CalPERS led a wave of institutional shareholder activism something only very rarely seen before , as a way of ensuring that corporate value would not be destroyed by the now traditionally cozy relationships between the CEO and the board of directors for example, by the unrestrained issuance of stock options, not infrequently back-dated.
In the early s, the massive bankruptcies and criminal malfeasance of Enron and Worldcom , as well as lesser corporate scandals such as those involving Adelphia Communications , AOL , Arthur Andersen , Global Crossing , and Tyco led to increased political interest in corporate governance. This was reflected in the passage of the Sarbanes-Oxley Act of In the East Asian Financial Crisis severely affected the economies of Thailand , Indonesia , South Korea , Malaysia , and the Philippines through the exit of foreign capital after property assets collapsed.
The lack of corporate governance mechanisms in these countries highlighted the weaknesses of the institutions in their economies. Al-Hussain , A. However, using stock return as a performance measure revealed a weak positive relationship between the efficiency of corporate governance structure and bank performance. This is a list of countries by average overall rating in corporate governance: .
Key parties involved in corporate governance include stakeholders such as the board of directors, management and shareholders. External stakeholders such as creditors, auditors, customers, suppliers, government agencies, and the community at large also exert influence. The agency view of the corporation posits that the shareholder forgoes decision rights control and entrusts the manager to act in the shareholders' best joint interests. Partly as a result of this separation between the two investors and managers, corporate governance mechanisms include a system of controls intended to help align managers' incentives with those of shareholders.
Agency concerns risk are necessarily lower for a controlling shareholder. In private for-profit corporations, shareholders elect the board of directors to represent their interests. In the case of nonprofits, stakeholders may have some role in recommending or selecting board members, but typically the board itself decides who will serve on the board as a 'self-perpetuating' board.
Smale wrote in "The board is responsible for the successful perpetuation of the corporation. That responsibility cannot be relegated to management. The board has responsibility for: CEO selection and succession; providing feedback to management on the organization's strategy; compensating senior executives; monitoring financial health, performance and risk; and ensuring accountability of the organization to its investors and authorities. Boards typically have several committees e. All parties to corporate governance have an interest, whether direct or indirect, in the financial performance of the corporation.
Directors, workers and management receive salaries, benefits and reputation, while investors expect to receive financial returns. For lenders, it is specified interest payments, while returns to equity investors arise from dividend distributions or capital gains on their stock.
Customers are concerned with the certainty of the provision of goods and services of an appropriate quality; suppliers are concerned with compensation for their goods or services, and possible continued trading relationships. These parties provide value to the corporation in the form of financial, physical, human and other forms of capital. Many parties may also be concerned with corporate social performance. A key factor in a party's decision to participate in or engage with a corporation is their confidence that the corporation will deliver the party's expected outcomes.
When categories of parties stakeholders do not have sufficient confidence that a corporation is being controlled and directed in a manner consistent with their desired outcomes, they are less likely to engage with the corporation.
When this becomes an endemic system feature, the loss of confidence and participation in markets may affect many other stakeholders, and increases the likelihood of political action. There is substantial interest in how external systems and institutions, including markets, influence corporate governance. Many of the UK's largest pension funds are thus already active stewards of their assets, engaging with corporate boards and speaking up when they think it is necessary.
Control and ownership structure refers to the types and composition of shareholders in a corporation. In some countries such as most of Continental Europe, ownership is not necessarily equivalent to control due to the existence of e. Some features or types of control and ownership structure involving corporate groups include pyramids, cross-shareholdings , rings, and webs.
German "concerns" Konzern are legally recognized corporate groups with complex structures. Cross-shareholding is an essential feature of keiretsu and chaebol groups . Corporate engagement with shareholders and other stakeholders can differ substantially across different control and ownership structures. Family interests dominate ownership and control structures of some corporations, and it has been suggested that the oversight of family-controlled corporations are superior to corporations "controlled" by institutional investors or with such diverse share ownership that they are controlled by management.
One of the biggest strategic advantages a company can have is blood ties," according to a Business Week study. The significance of institutional investors varies substantially across countries.
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While the majority of the shares in the Japanese market are held by financial companies and industrial corporations, these are not institutional investors if their holdings are largely with-on group. The largest pools of invested money such as the mutual fund ' Vanguard ', or the largest investment management firm for corporations, State Street Corp. The idea is this strategy will largely eliminate individual firm financial or other risk. A consequence of this approach is that these investors have relatively little interest in the governance of a particular corporation.
It is often assumed that, if institutional investors pressing for changes decide they will likely be costly because of " golden handshakes " or the effort required, they will simply sell out their investment. Particularly in the United States, proxy access allows shareholders to nominate candidates which appear on the proxy statement , as opposed to restricting that power to the nominating committee. Corporate governance mechanisms and controls are designed to reduce the inefficiencies that arise from moral hazard and adverse selection.
There are both internal monitoring systems and external monitoring systems. Furthermore, the various board mechanisms provide for internal monitoring. External monitoring of managers' behavior occurs when an independent third party e. Stock analysts and debt holders may also conduct such external monitoring. An ideal monitoring and control system should regulate both motivation and ability, while providing incentive alignment toward corporate goals and objectives. Care should be taken that incentives are not so strong that some individuals are tempted to cross lines of ethical behavior, for example by manipulating revenue and profit figures to drive the share price of the company up.
Internal corporate governance controls monitor activities and then take corrective actions to accomplish organisational goals.
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Examples include:. In publicly traded U. While this practice is common in the U. External corporate governance controls the external stakeholders' exercise over the organization. The board of directors has primary responsibility for the corporation's internal and external financial reporting functions. The chief executive officer and chief financial officer are crucial participants, and boards usually have a high degree of reliance on them for the integrity and supply of accounting information. They oversee the internal accounting systems, and are dependent on the corporation's accountants and internal auditors.
Current accounting rules under International Accounting Standards and U. GAAP allow managers some choice in determining the methods of measurement and criteria for recognition of various financial reporting elements. The potential exercise of this choice to improve apparent performance increases the information risk for users. Financial reporting fraud, including non-disclosure and deliberate falsification of values also contributes to users' information risk.
To reduce this risk and to enhance the perceived integrity of financial reports, corporation financial reports must be audited by an independent external auditor who issues a report that accompanies the financial statements. One area of concern is whether the auditing firm acts as both the independent auditor and management consultant to the firm they are auditing. This may result in a conflict of interest which places the integrity of financial reports in doubt due to client pressure to appease management.
The power of the corporate client to initiate and terminate management consulting services and, more fundamentally, to select and dismiss accounting firms contradicts the concept of an independent auditor. Changes enacted in the United States in the form of the Sarbanes-Oxley Act following numerous corporate scandals, culminating with the Enron scandal prohibit accounting firms from providing both auditing and management consulting services.
Similar provisions are in place under clause 49 of Standard Listing Agreement in India. Increasing attention and regulation as under the Swiss referendum "against corporate rip-offs" of has been brought to executive pay levels since the financial crisis of — Research on the relationship between firm performance and executive compensation does not identify consistent and significant relationships between executives' remuneration and firm performance.
Not all firms experience the same levels of agency conflict, and external and internal monitoring devices may be more effective for some than for others. Some argue that firm performance is positively associated with share option plans and that these plans direct managers' energies and extend their decision horizons toward the long-term, rather than the short-term, performance of the company. However, that point of view came under substantial criticism circa in the wake of various security scandals including mutual fund timing episodes and, in particular, the backdating of option grants as documented by University of Iowa academic Erik Lie  and reported by James Blander and Charles Forelle of the Wall Street Journal.
Even before the negative influence on public opinion caused by the backdating scandal, use of options faced various criticisms. A particularly forceful and long running argument concerned the interaction of executive options with corporate stock repurchase programs. Numerous authorities including U.
Federal Reserve Board economist Weisbenner determined options may be employed in concert with stock buybacks in a manner contrary to shareholder interests. These authors argued that, in part, corporate stock buybacks for U. Gumport issued in A combination of accounting changes and governance issues led options to become a less popular means of remuneration as progressed, and various alternative implementations of buybacks surfaced to challenge the dominance of "open market" cash buybacks as the preferred means of implementing a share repurchase plan.
The primary responsibility of the board relates to the selection and retention of the CEO. However, in many U. This creates an inherent conflict of interest between management and the board. Critics of combined roles argue the two roles that should be separated to avoid the conflict of interest and more easily enable a poorly performing CEO to be replaced. The deed usually gets done, but almost always very late. Advocates argue that empirical studies do not indicate that separation of the roles improves stock market performance and that it should be up to shareholders to determine what corporate governance model is appropriate for the firm.
In , Many U. Empirical evidence does not indicate one model is superior to the other in terms of performance. From Wikipedia, the free encyclopedia. Local Global. Governance, risk management and compliance. Environmental, social and corporate governance. Management accounting Financial accounting Financial audit. Business entities. Corporate group Conglomerate company Holding company Cooperative Corporation Joint-stock company Limited liability company Partnership Privately held company Sole proprietorship State-owned enterprise.
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