Corporate Governance before the Global Financial Crisis - Coursework Example

Name: xxxxxxxxxx Course: xxxxxxxxxx Institution: xxxxxxxxxxxxx Title: Corporate Governance Date: xxxxxxxxxxxxx Corporate Governance Introduction Corporate governance refers to the laid down framework of rules and regulations which guides the board of directors of a particular organization in delivering accountability and transparency between the organization and its stakeholders (Stolt 2009, p.2). A lot of focus in the study of corporate governance has been to address the key issues of aligning the interests of the owners of a firm to those of the management. There is a general disbelief by shareholders that the interests of the management team do not necessarily reflect the desires of the owners therefore the need to align the two is crucial. In the process dominant theories have emerged such as the agency and stewardship theories which give a different approach to solving the problems associated with corporate governance. However, there was a shift of focus by researchers on the key issues affecting corporate after the failures witnessed during the global financial crisis to addressing the concerns that led to this crisis chief among them being incentive scheme design (Stolt 2009). Corporate governance before the Global Financial Crisis Much of the research on corporate governance has followed the path of identifying solutions to areas where failures have occurred. For example, in 1990s much of the researched was aimed at finding a solution to the conflicting arising from interests of analysts and brokers as a result of the burst of the high tech bubble. This prompted the revision of the OECD corporate governance principles with an introduction of a principle labeled ‘V.F’ (Kirkpatrick 2009, P.3). This principle asserts that the access to timely, accurate and relevant information by the board of directors is crucial if they are to perform their duties and responsibilities in an effective and efficient manner and guarantee the realization of the organization’s goals and objectives. Another corporate failure this time by Enron/WorldCom brought to surface another set of issues with regard to the independence of the auditor and the auditing committee as well as the inadequacies in the accounting standards. To address these concerns and seal the loop holes, the OECD once again revised is corporate governance principles, this time introducing principles V.B, V.C and V.D (Kirkpatrick 2009, p.3, OECD 2004). The most elaborate of them all being principle V.D which underscored a number of key functions of the board of directors. These include providing guidance and regular review of the corporate strategy, risk policy, business plan, the annual budget and major action plans; establishing the performance goals to be achieved; maintaining vigilance on the implementation and performance of the firm; monitoring and controlling huge financial expenditures, divestitures and acquisitions; overseeing the actions and initiatives of the key executives with mandate to compensate and replace underperforming individuals; reviewing the remuneration packages for the board and other key executives as well as the board nomination process is characterized by an atmosphere of transparency; monitoring keenly the accounting and financial reporting systems of the firm in order to ensure integrity at all levels and an independent audit process; examining and reviewing the effectiveness of all governance practices and initiating changes where necessary; finally monitoring the process in which disclosure of crucial and sensitive information is made (ROSC 2003, p.13; Institute of Directors in Southern Africa 2009, pp-27-30, OECD 2004). On the other hand principle V.C underscored the need for the board to ensure that all the interests and concerns of the shareholders were taken into account. Moreover, the board should ensure that the firm complies will all applicable laws. Principle V.B aims to create a balance by asserting that all shareholders should receive fair treatment in cases where the decisions by the board seems to affect different groups of shareholders differently (ROSC 2003,p.12). As visible from the two examples above it is clear the stimulation behind the majority of research on corporate governance issues before the global financial crisis has been the dilemma surrounding the control and ownership of firms and the resulting problems brought about by this separation. The main objective of the research being to zero in on the assurance that the internal management will pursue the goals and objectives laid down by the owners (shareholders) of the firm in the most effective manner (Filho, p.2). It is also worth noting that corporate governance had been viewed as a preserve for high flying banking and financial institutions trading in the respective stock exchange markets. Much of the debate centered on such issues as the remuneration of the CEO and other directors, increase of compliance, pressure to perform and the need to involve more stakeholders in the governance of firms. In a bid to address some of these issues two schools of thought emerged namely the agency theory and stewardship theory. The proponents of the agency theory assert that the board of directors should comprise more of outside and independent directors. In addition, the positions of the CEO and the chairman of the board should not be held by the same person at any one time. The premise for this argument is the notion that the interests of the management team are in contrast with those of the owners of the company (O'Connor & Masson 2007, p.326). Therefore there is need to align the interests of both parties and the only way to do this is to create a board that is all inclusive but with a greater focus on the interests of the shareholders since they are the major stakeholders in the firm (Nicholson & Kiel 2003, p.3; Pillai 2003, p.1; Mäntysaari 2010, p.170). This kind of board composition will ensure a high degree of vigilance by non executive directors into the activities and initiatives of inside directors in order to ensure that the outlined goals are achieved efficiently and effectively (Knott 2002, p.8). A research conducted by Nicholson and Kiel (2003) discovered that majority of the 348 companies enlisted in the Australian Stock Exchange had adopted the agency theory since their findings show that only six companies had a board comprising of full internal directors. Thirty six companies had a board fully comprising of outside directors while the rest had a blend of the two groups but with outside directors taking the lion share at a mean of 69% (Nicholson & Kiel 2003, p.3). On the other hand, stewardship theorists are in favour of the executive managers. Their premise is that managers are trustworthy and therefore can be trusted with the stewardship of the company resources. Their argument is that in order for the firm to achieve a better performance the board should constitute more of inside directors since their key aim is to maximize the profit margins for the benefit of the shareholders. Furthermore the internal directors understand the firm more than the non executive directors and therefore are better placed to make better informed decisions than the latter. In addition, the internal directors would also be extremely careful to avoid making decisions that will put them on a collision course with the shareholders since in so doing they end up damaging their own reputation. By being good stewards they are also positively impacting their careers both for the good of the firm and themselves. A good example for this model of corporate governance is visible in Japan where workers act as stewards and diligently execute their duties to fulfill the mandate outlined to them. The stewardship school also advances the notion that CEO duality is good for the firm since it creates clarity in the leadership of the firm and also cuts down on the costs for monitoring the initiatives of the internal directors by the non executive directors (Abdullah & Valentine 2009, p.90). Corporate Governance the Global Financial Crisis However, since the onset of the global financial crisis in 2007 which was blamed much on the failures of corporate governance, a lot of focus has been shifted into addressing the key issues arising from this crisis. Key among the factors that contributed to this crisis include laxity by the board to oversee the actions of the executive management, failure to check exorbitant compensation schemes which had limited relation to strategic plans or long term company goals but only served to encourage greater risk taking by the management. Although the crisis was triggered by the failure to offload subprime mortgage securities risks, the root cause for all this can be traced back to the laxity of the shareholder to maintain a keen eye on the unrealistic managerial incentives. Furthermore, the pressure by non executive directors on the managerial team to deliver short term results also triggered the urge for greater risk taking in order for the management to achieve the goals set therefore pulling the trigger on an already loaded gun (Erkens, Hung & Matos 2009, p.2). It is worth noting that majority of the failed firms employed most of the principles advocated by the agency theory such as discouraging duality of the CEO among others. A good example is Lehman Brothers who had adopted all corporate governance principles including following guidelines for compensation and adhering to the code of ethics but still fell prey to the crisis (Berrone 2008, p.2). In the aftermath of the crisis focus on research has now shifted in the direction of analyzing and determining the best way to offer compensation packages to key executives while at the same time laying a greater emphasis on the risk taking and management process. The issue of incentives has become more complex than ever. Although many incentive schemes look impressive on paper, they have failed in practice to deliver the results. The design and implementation of incentive schemes has now be dogged with a trial and error approach since the most dominant theories namely, agency and stewardship have failed to provide tangible results. The key question that remains unanswered is how to put in alignment the interests of the owners of the firm (shareholders), key management team and the society. Therefore in the wake of the global financial crisis the dilemma to find an appropriate all inclusive incentive schemes is what is drawing the focus of corporate governance researchers (Berrone 2008, p.4). Conclusion After carefully examining a sizeable amount of research in corporate governance practice in the years before the global financial crisis it is evident that much of the research focused mainly of issues relating to board composition, risk management policy, accounting standards, oversight of management by non executive directors, compensation schemes and flow of information. However after the onset of the global financial crisis much of the focus has now shifted on the thorny issue of designing an all inclusive incentive scheme that will meet the interests of both the shareholders and the management team. 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