Business and Corporate Governance - Assignment Example

Business and Corporate Governance Introduction Business ethics refers to moral principles with which business is to be conducted. Corporates that run businesses need to be governed keeping these business ethics in view in all their activities. The only maxim known to corporates in the early days was maximisation of profit for the sake of shareholders on whose behalf the corporates were supposed to be managed by the elected board. Historically, religious beliefs have been the motivating factors for observing ethics in business, such as not to harm ‘thy neighbour’ and not to profiteer. Democracy is its one of the dimensions with communism having failed. As such democracy and capitalism have come under more scrutiny and there have been opinions that democratic systems vary from country to country. It has been said that there should be industrial democracy i.e democracy at the industrial level so that democracy at the national level can blossom. It applies to multinational companies also as they develop as ‘nation-states’ and greater democracy is needed within organisations for employee motivation (Davies 1997). There are similar interested groups like suppliers, bankers, government agencies, and NGOs who have stakes in the company expecting that their interests should also be safeguarded. Corporate governance is the manner in which all the stake holders’ interests are safeguarded. Cadbury (1990) has said that what hold the company together as glue are its beliefs and values and not its structures and systems. Though business ethics at first will appear as anti-business, it helps maximisation of firm value for the owner in the long run. As a corporate governance tool It is like management accounting as a management tool as it helps management take informed decisions. Though small business can do without it and even corporates to some extent blindly operate without it in favourable circumstances, absence of management accounting is a serious handicap to business. It may be more adventurous to dispense with such aids but end result will not be as effective as it can be when the location of target and identity are known. Business ethics affords greater perception of what is important for business and improves business performance as the business ethics can identify the right business mission and vision and the ways and means of achieving them. (Sternberg 2000) Relevancy of business ethics Shareholders verify the ethics of the companies they have invested in. Investment decisions are driven by not only financial strengths but also of the attitude and behaviours of the companies. In the U.S and UK, institutional investors resent the bad business practice of the companies. As said earlier, business ethics is all pervasive in organisations having several dimensions with the involvement of more than one group of stake holders. ((Sternberg 2000) The most vulnerable aspect It is very simple and easy to observe business ethics in the stake holder areas such as suppliers, employees, shareholders, government agencies and others, at least not as complicated as it can be in accounting of the company. And these accounting aspects affect all the above said areas. If business ethics is ensured in this area, half the job is done. The management can be sure of having established a fool-proof system as an insulation against anti-business and anti-ethical activities. And this is what corporate governance is all about. In fact business ethics acquired its present importance among the public and the media, only after the surfacing of accounting scandals that shook the entire corporate world. Accounting is therefore a vulnerable area where business ethics could be compromised and ever since the infamous scandals such as Enron, Worldcom,HIH and others shook the confidence of the investors and other stakeholder, legislations like Sarbanes Oxley and Cadbury report have been made to make the accounting area fool-proof against ant- ethical activities. In order to know how these can damage, Enron episode is discussed hereunder. Enron Tens of billions of dollars were lost by investors on the collapse of Enron in 2001. Pension fund and retirement fund investors also were among them. This was due to the company’s hiding of billions of debts and losses from the financial statements. Accounting failures and corporate governance failures were the apparent reaons for such huge collapse. This had repercussions not only in the U.S but also in the U.K. since the issue gave rise to doubts among the stake holders as to how the directors managed their companies. It was not as a result of single irregularity but due to series of irregularities that culminated and brought the Enron down within a span four years. It was started in 1985 in Texas by a former economist Kenneth Lay later joined by Jeffery Skilling. The company’s project of small oil and gas pipeline promised to supply gas and oil at a fixed price and at fixed future date. The company expanded into electrical power markets following their deregulation as a key strategy and started lobbying politicians spending lot of time and money for getting access into utility markets which hitherto had been the domain of the pubic sector. As a result Enron became the largest buyer and seller of natural gas through establishment of power plants and pipeline projects all over the world. Soon it started facing competition from players in energy markets and the its business arrangements became more and more complicated. The competitive environment and the freedom enjoyed by the employees of the company paved way for creation of innovative products that never existed before with the result its customers were able to buy at a fixed price at a future date regardless of changes in interest rates, commodity prices and even weather. Thus its business in non-traditional items far exceeded that of its traditional products. Encouraged by this success, it started trading in any item that it could lay its hands on. Its growing revenues made it a dream company and its stock prices started souring. Fortune magazine admired the company as the most innovative one. Behind the scenes, things were different of late. The company’s involvement in broadband communications and international projects in India, South America and Europe turned out to be failures. Its dubious transactions in California Electricity market added to its owes. It felt that it could not keep up the promise to the investors. The company had to hide its losses in financial statements as its collapse would become imminent. Hence it started making special purpose financing entities and used them to transfer its debts and losses to those accounts and made them disappear from the company’s balance sheets. The special purpose financing entities alone appeared in the balance as current assets which in fact were false. This could not have been done without the collusion and complicity of the company’s accountants and auditors. At the same time, the company was forced to keep its stock prices high in the stock market for which it used the shares of its own stock. Although company was started for innovation, it fell victim to the competitive forces and was in its bid to do make-believe, it started indulging in unhealthy practices one after another. Company analysts got suspicious of its over priced stocks only after the management of the company lacked transparency and started being arrogant. The just promoted CEO Jeffrey Skilling’s sudden resignation for personal reasons in August 2001 shocked both its employees and the stock market. Soon the stock market for Enron collapsed and the it had to announce in November 2001 that its undisclosed loss or overstated earnings amounted to $ 600 millions which had accumulated from 1997 to 2000. The Enron executives were accused of selling stocks for more than $ 1.1 billion knowing fully well that company was on the verge of collapse. (Fusaro and Miller 2002) Company’s policies The company’s policy on hiring and firing of employees in quick succession enraged them and it created the enmity between groups of employees who were on the verge of being dismissed for non-performance and those who were retained for good performance. At any given point of time, half of the strength of employees had the risk of losing jobs at any time so one can imagine the tension that prevailed in the company. Actually the management’s tough attitude towards employee performance had been the reflection of rigour it faced outside in the market place. Accounting failure was by far the single most reason for Enron episode. Otherwise, its down fall would have been faster and many losses to its stake holders could have been avoided. If the ethical practices had been in place, Enron would have treaded its path carefully and would not have plunged into controversial and highly risky projects without proper insulation. The accounting practice was not resisted by the company auditors. Why did Arthur Anderson failure failed to raise alarm remained a mystery until a study of two accounting professors Steve Sutton and Charles Cullinan revealed that the method of accounting adopted by the auditing firms could never find a client’s cooking of the books at the highest level of executives. Auditors now a days rely on computer generated data unlike in the olden days when they had to dig deeply to find out how the clients maintained their books. Since the computerised data ensured arithmetical accuracy and tallying of books and the auditor’s lesser involvement in the day to day accounting made it convenient for the top brass to indulge in their malpractices.(Fusaro and Miler 2002) The computerisation only prevents low-level employees’ steeling of cash and not high level executive’s manipulation of books. Sutton and Sullivan have said “No matter how many locks you put on the door, some one has the keys, and that person is likely to be the chief executive or chief financial officer” (Fusaro and Miller 2002) Discussion The foregoing narration of business ethics principles and accounting failure which is the most vulnerable area for compromise of the ethics would illuminate the need of corporate governance, though it has been seen business ethics it self is a corporate governance tool. Only the tool should be used and not kept idle or compromised. In UK revised combined code on Corporate Governance was issued in 2003. Beginning from 1st November 2003, all listed companies were required comply with it. The code has 17 main principles and 48 provisions summarised in the appendix 1. (Accounting web). These provisions would somewhat cover the entire range of corporate governance which if in place, business failures due to unethical practices will be avoided. Avoidance of employee harassment and avoidance of violation of environmental obligations can also be ensured Buisness ethics has been a source of strength for the corporations since it would infuse confidence amongst the stakeholders. Further through business ethics company gets a holistic view of stake-holder relations that helps in promotion of business practice. In early 1970, the issue was whther it was ethical to deal with and invest in the companies that were run on the principles of apartheid. Only such issues have now multiplied with the need for a code of practice. As for weaknesses, many CEO are content with running the company with integrity and honesty without ensuring its percolation to the bottom levels of employees and also at the horizontal levels of stake holders. Only then can it be said to be all pervasive in an organisation. Business ethics should not only be present but also must been seem to be present. Hence the CEOs must be vocal as much as possible about the need and practice of business ethics. (Webley 2001) Conclusion What has been discussed above is the need for business ethics in companies and how it operates as a tool of corporate governance so as to satisfy the expectations of all the stake holders. Business ethics itself is not panacea for all the corporate owes. The beginning must be good in the first place. A wrong venture with compliance of business ethics is not good either. References AccountingWeb, Combined code on corporate governance –overview accessed 12 May 2008 Cadbury, Sir Adrian, The Company Chairman, Director Books, Fitzwilliam Publishing Ltd., 1990 Davies F W Peter 1997 Current Issues in Business Ethics Routledge p 16-19   Fusaro C Peter and Willey Miller M Ross 2002 What went wrong at Enron, accessed 11 May 2008 Sternberg Elaine 2000 Just Business: Business Ethics in action Oxford University p 23-25 Webley Simon, 4/30/2001, The Status of Business Ethics: A U.K. Perspective IBER, Volume 4, Issue 1 Accessed 13 May 2008 Appendix 1 (AccountingWeb, Combined code on corporate governance –overview accessed 12 May 2008 http://www.accountingweb.co.uk/) “A - Directors  every company should be headed by an effective board  there should be a clear division between the running of the board and that of the business  the chairman and chief executive should be different people  No individual or group should dominate a board  At least half the board, excluding the chairman, should be independent non-executives (previously one third). B - Remuneration  Remuneration should be linked to performance  Non-executives should not receive share options  Executive contracts should have a maximum notice of 12 months  Remuneration committees encouraged to reduce/eliminate payments on termination, especially relating to poor performance  Three independent non-executives should sit on the remuneration committee (two for smaller, sub-FTSE350 companies). C - Accountability and audit  Annual report to discuss internal controls and risk management  Audit committee to include three independent non-executive directors (two for smaller companies), including one with relevant financial experience D - Relations with shareholders  Dialogue with shareholders responsibility of the whole board, though most contact will be with chief executive and FD  Chairman and other directors should understand shareholder concerns and issues.  Annual report to contain commentary on the above. E - Institutional shareholders  Institutional investors should review corporate governance disclosures  they should also attend AGMs and make use of their votes” (Accounting web) Read More