Welcome to the first edition of our Corporate Governance Weekly Blog! In this series, we will explore the multifaceted world of corporate governance, its significance, and how it impacts the functioning of businesses across the globe. Let’s kick things off with an essential foundation: understanding the basics of corporate governance.
Definition of Corporate Governance
Corporate governance refers to the system of rules, practices, and processes by which a company is directed and controlled. It involves balancing the interests of various stakeholders, such as shareholders, management, customers, suppliers, financiers, government, and the community. The goal of corporate governance is to achieve long-term sustainable success while ensuring transparency, accountability, and ethical conduct.
Key Principles of Corporate Governance
Several key principles underpin effective corporate governance:
- Responsibility: The Board of Directors is responsible for overseeing the company’s management, strategy, and overall performance. They must act in the best interests of the company and its shareholders.
- Accountability: Corporate leaders must be accountable for their actions and decisions. Transparent reporting and disclosure of financial and non-financial information are crucial.
- Fairness: Companies must treat all stakeholders fairly, ensuring that conflicts of interest are appropriately managed and resolved.
- Transparency: Openness and clear communication are vital. Companies should disclose relevant information to stakeholders to build trust and confidence.
- Independence: The Board of Directors should have sufficient independent members who can objectively assess management decisions.
Role of the Board of Directors and Shareholders
The Board of Directors plays a central role in corporate governance. Its primary responsibilities include:
- Strategic Oversight: Setting the company’s vision, mission, and long-term strategy.
- Risk Management: Identifying and managing risks that could affect the company’s success.
- Monitoring Performance: Evaluating the company’s performance against established goals and objectives.
- Appointment and Compensation: Appointing and compensating key executives, including the CEO.
Shareholders, as owners of the company, play a critical role in corporate governance as well. They exercise their influence through voting on significant matters and electing directors who represent their interests.
Examples of Failed Corporate Governance Practices
Over the years, various companies have exemplified both good and poor corporate governance practices, with significant impacts on their success or failure. Companies with effective governance tend to experience better long-term financial performance and stakeholder satisfaction. On the other hand, businesses that neglect governance principles may suffer reputational damage, financial losses, and even legal consequences. Some examples include;
- Eron: Claiming forecasted profits that had not generated any revenues. Enron’s share price plummeted from $90.7 (mid 2000) to $0.26 (Nov 2001) and shareholders filed a $40 billion lawsuit. Enron filed for bankruptcy on December 1, 2001, the single largest corporate bankruptcy in U.S. history at the time. The scandal led to the Sarbanes Oxley Act, passed in 2002, to protect investors from fraudulent financial reporting.
- Lehman Brothers: The company amassed a portfolio of mortgage-backed securities valued at $85 billion, four times the value of its shareholders’ equity. To disguise some of this leverage, Lehman entered into agreements with banks in the Cayman Islands that effectively transferred some of the firm’s liabilities, agreeing to repurchase them later. Lehman manipulated accounting standards to record these agreements as sales, the company obtained cash in the short run without recording any liabilities. Lehman filed for bankruptcy on September 15, 2008, as the global financial crisis related to the sub-prime mortgage era was unfolding and begged the question of it any firm is “too big too fail”.
- Volkswagen: The U.S. Environmental Protection Agency (EPA) announced that Volkswagen had installed software in diesel cars to defeat emissions testing. The software, called a “defeat device”, recognized when a car was undergoing an emissions test. This defeat device was installed on 11 million cars worldwide between 2009 and 2015. Volkswagen paid a heavy price for its governance failures, including a massive $18 billion fine imposed by the EPA. Volkswagen’s shares plunged 30% in the aftermath of the scandal, a loss of over $26 billion in value.
In the next issues of this blog, we will delve deeper into specific aspects of corporate governance, exploring topics such as board composition, executive compensation, ethics, risk management, and more. We hope this series will provide valuable insights and best practices for individuals involved in corporate decision-making and governance.
Thank you for joining us on this corporate governance journey. Stay tuned for our next issue, where we will explore the composition and responsibilities of the Board of Directors!
Note: Stay informed and connected with us for more in-depth discussions on corporate governance topics. Please feel free to share your thoughts and suggestions in the comments below. We value your input!
Reference Poor Governance – The common thread of the corporate blunders: https://owlesg.com/2022/11/01/poor-governance-the-common-thread-of-corporate-blunders/