Accounting Theory and Analysis - - Essay Example

CORPORATE GOVERNANCE & CORPORATE FAILURE Introduction & Corporate Failure Corporate Governance is a system through which a company is directed and controlled (Tricker and Tricker 2002). It provides guidelines through which an entity can achieve its objective and avoid corporate failure. Normally, all corporate governance codes provide guidelines in many areas such as internal controls, constitution of board, and performance management etc (Fernando 2009). There is no universal definition available for corporate failure, but generally it refers to a situation where an entity ceases to carry its business due to a heavy loss or bankruptcy and etc.

filing for bankruptcy, delisting from stock exchange, ceasing to trade for any reason or entering into receivership can be termed as corporate failure (Patrick 2011). Corporate governance guidelines are designed by the experts keeping in mind the causes of corporate failure incidents happened in past so these guidelines would surely be helpful to companies in avoiding future collapses. Guards against Corporate Failure Enhancement of Independence of External Auditors and Partner’s Rotation Corporate Governance requires board of director to take all necessary steps to enhance the independence of the external auditors for the fair and unbiased audit of the financial statements.

If the independence is threatened due to any reason than the auditor may fail to provide true and fair view of the financial position of the company (Plessis‏ 2011). Enron was one of the biggest companies listed in US stock exchange, collapsed in October 2001, due to the fact that the auditor was forced not to report the financial losses in their reports. Arthur Andersen was the auditor of Enron whose independence was threatened due to the fact that a large portion of their revenue was being generated from Enron.

In addition to this, Corporate Governance codes require the rotation of the audit partner after certain period of time. In case of Enron the audit partner was not rotated and the result of departure from these guidelines was $20 billion loss to its shareholders due to the fall in Enron share prices from $90 per share to $1 per share, further Arthur Andersen was also collapsed due to this famous scandal (Theodore 2002). Constitution of the Board Corporate Governance code requires the companies to include both executive and non executive directors (NEDs) (Jill 2004).

According Australian code of corporate governance the board should be constituted with both executive and non-executive directors. NEDs does not take part in the affair of the company, but they critically analyze the decision made by the executive directors and bring their expertise for the success of the business. In case of non presence of NEDs in the board executive director may take poor strategic decisions. According to Hamilton poor decision making is one of the reason for the corporate failure of the companies in past which can be countered with the inclusion of the Non executive directors in the board.

Separation of CEO and Chairman of the Company One of the main reasons for the corporate failure is the use of excessive powers by the executives. In many companies, one person holds both the designation of CEO and Chairman having supreme decision making authority. Due to the seriousness of this fact, corporate governance codes requires chairman and CEO to be different person so that they can be hold responsible for their decisions (Güler 1996). For example, if the CEO takes highly risky decision chairman of the board can resist him to risk company’s resources.

Acting upon the guideline will surely bring the chances of corporate failure to a low level. Evaluation of Board’s Performance Corporate Governance code requires the company to evaluate the performance of the board after a reasonable time period. Normally, NEDs are responsible to judge the performance of the executive directors (Clarke 2007). It is a good provision of the corporate governance codes and because of it executive director will take careful decision in the best interest of the company.

In the absence of this provision it the board of director may take risky decision in order to obtain short term benefits which main ultimately result in loss to shareholders. Agency Theory and Communication with Shareholders Agency theory in corporate governance stresses on the need of two sided control that is; the manger and the owners. This theory assumes that there will be some sort of mistrust between these two groups. In addition to this managers of the business are under the fiduciary duty to act in the best interest of the company and they must report all significant matters to the shareholders to obtain their willingness in taking risky decisions.

Corporate governance code also requires the board to communicate with the shareholders on sufficient regularity to bring into their knowledge all the affairs of the company. HIH insurance is another example of the biggest corporate failures in Australia due to the risky practices and miscommunication from the management and eventually it was collapsed in 2001. The company had total assets of $7.8 billion dollars and there were huge debts and insurance claims which reduced the net assets of HIH to only $133 million and ultimately the company was insolvent.

The management did not communicate the presence of heavy debts and claims over the assets of the company. Liquidator estimated that HIH demise took place with around $5.3 billion which is the considered to be the worst ever collapse in the Australian history. Effective Internal Control and Financial Reporting System All the corporate governance codes stresses on the need of effective internal control system to avoid fraudulent activities. In some countries like United States the director including CEO are required to report on the appropriateness of the internal control system.

Similarly financial reporting system is also one of the most important tools recommended by the corporate governance to control unauthorized transactions (Nate‏ 2008). In the absence of effective internal control, it is very easy for staff to hide the fraudulent transaction and obtained unfair benefit. The CFO of Enron with the help of the other executives successfully misled audit committee and board with the use of accounting tricks and hide multi billion dollars debts which the company was liable to pay due to project failure.

WorldCom is also one of the main victims of the corporate failure due to the financial reporting issues. Due to the downfall in the economy in early 2000, the share price of the WorldCom was declining sharply and the company was under huge pressure from their bank to cover the markup on the loans. This situation continued till 2002 when CEO, Controller and the Director of general accounts used accounting trick to show the better results than actual. Due to this fraud company’s declining financial position was shown as growing and the stock went upwards.

The accounting department understated the cost of revenue by around $3.6 billion to increase the revenue; on the other hand revenue was inflated. Conclusion Different aspects of the corporate governance have been discussed above with their benefits. Above mentioned facts show that the corporate governance practices help corporate entities to avoid corporate failures. Different courtiers have different codes for corporate governance, but the essence of all code is to bring transparency in the business and avoid heavy losses to shareholders as in case of Enron and WorldCom.

However, it is important to mention that there is a huge cost involve in complying with the requirements of the codes, so the corporate entities must make cost benefit analysis to put this system in place and avoid corporate failure. Bibliography Clarke, Thomas. International Corporate Governance: A Comparative Perspective. New York: Routledge, 2007. Fernando, A. C. Corporate Governance: Principles, Policies and Practices. Delhi, India: Dorling Kidersley Private Limited, 2009. Güler, A. Global Perspectives on Corporate Governance and CSR.

Burlington: Gower Publishing, 1996. Jill, Solomom. Corporate Governance and Accountability. Chichester: John Wiley & Sons, 2004. Nate‏, Stephens M. Corporate Governance Quality and Internal Control Reporting Under SOX. Arizina: Proquest, 2008. Patrick, Gaughan A. Mergers, Acquisitions, and Corporate Restructurings. New Jersey: John Wiley & Sons, 2011. Plessis‏, Jean Jacques du. Principles of Contemporary Corporate Governance. New York: Cambridge University Press, 2011. Theodore, Sterling‏ F.

The Enron Scandal. New York: Nova Science Publishers Inc, 2002. Tricker, Bob, and Ian Robert Tricker. Corporate Governance: Principles, Policies and Practices. Oxford: Oxford University Press, 2002.