Recent Financial Scandals Exposed Questions of Corporate Governance

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Introduction

The recent financial scandals of Adelphia, Enron, WorldCom, and some other companies exposed a lot of questions of the corporate governance, which made corporate governance received much attention and became a hot topic again both in the academic and financial world. Corporate governance is defined by the OECD (2004) as a set of relationship between a company’s directors, its shareholders and other stakeholders. It also provides the structure through which the objectives of the company are set, and the means of achieving those objectives and monitoring performance, are determined. Accountability is one of the most important parts of corporate governance, the Cadbury Committee (1992)s terms about the corporate governance were to review those aspects of corporate governance specifically related to financial reporting and accountability; Charkham (1998) also mentioned that good corporate governance means a proper balance between enterprise and accountability. Therefore, with the purpose of getting a good understanding of the corporate governance, this paper sets out to discuss the relationship between accountability and enterprise. In order to meet the purpose, the paper fist discuss of various governance mechanisms and their effects which is followed by an analysis of two alternative models, insider and outsider models. The third part is going to discuss whether good corporate governance can improve corporate performance or not. It will make some recommendations in the fourth section about how to improve the corporate governance mechanisms. The last two parts are concerned with the future of corporate governance and draw a conclusion about the topic. The effectiveness of various mechanisms John and Senbet (1998) proposed a more comprehensive definition of corporate governance that it deals with mechanisms by which stakeholders of a corporation exercise control over corporate insiders and management such that their interests are protected. In different countries, corporate governance mechanisms are different. However, Filatotchev and Nakajima (2010) suggested that corporate governance has both internal and external aspects. Internal aspects include ownership structure, the board of directors and committees, internal control, risk management, transparency and financial reporting; External aspects can either be market-oriented, or can take the form of credit ranking, and/or social requirements. Accounting and finance researchers have focused on a variety of corporate governance mechanisms, especially the internal mechanisms relating to boards and board performance. Non-executive directors and audit committee are the most representative two key mechanisms in the corporate governance, which can enhanced board effectiveness and to add value to shareholders. Kirkbride and Letza (2005) studied of non-executive directors and their role in monitoring company management, on behalf of shareholders. Research has generally showed there is a positive relationship between the number of non-executive directors and corporate performance (Ferris et al., 2003). The heart of the governance is the board of directors, the governance operation rely on the board of directors. Higgs report (2003) provides a functional outline of the role of non-executive directors: Firstly, non-executive directors should add to and dispute the trend of strategy. Secondly, non-executive directors should inspect the performance of executive managers and check the treatment of performance. Thirdly, non-executive directors should make financial information truthful and make sure the financial controls and risk management are effectiveness. Finally, non-executive directors should fix on the remuneration for executives and employ and eliminate the senior managers. In a word, the effective non-executive directors can supply the useful advices to guide the corporate operation. They can also formulate a high standard long-term strategy plan and monitor the manager’s behavior. Audit committees are board mechanisms to enhance accountability around the financial reporting and accounting functions, and have been extensively researched (Turley and Zaman, 2007). Also, Gramling et al. (2005) provided an overview of the role of internal audit in a corporate governance context. Audit committee is a key mechanism in the area of accountability. The Smith report (2005) pointed out that the role of audit committee should include five parts: Firstly, the audit committee should review a company’s internal financial control and risk management. This enables the risk management more effective and limits risks. Secondly, the audit committee should monitor and review the internal audit. Thirdly, the audit committee should give some recommendations to the board on the shareholders general meeting. It also should manage the external audit on the remuneration and engagement part. Fourthly, the audit committee should judge the financial reporting which made by internal accountants. Finally, the audit committee should monitor and review the external audit. After recognize the role of the audit committee, it can be drew out that, if the audit committee operates effectively, it has a lot of benefits. When it reviews the financial reporting, it can improve its quality and the executives can make the proper decisions. When it monitors the internal control and risk management, it can reduce the risks and seize the opportunities. It also helps the non-executive directors make an independent judgment and play a positive role. In the external audit part, it can strengthen the position of the external auditor and make them more independence. Researchers have also investigated the relationship between executive remuneration and financial performance (Core et al., 1999). A good executive remuneration can make staffs love their work and improve working efficiency. To sum up, the good governance mechanisms can affect the company’s strategy and therefore improve the company performance. But Rediker and Seth (1995) also mentioned that, a single governance mechanism can’t play an effective role over the company performance. The use of multifaceted bundles of governance mechanisms as well as both accountability and enterprise can influence the company performance. Alternative models: Insider model and outsider model Franks and Mayer (1996) distinguished two models from the corporate governance system, which are insider model and outsider model. In outsider systems, such as the UK and US, shareholders r are essentially investors, however, in insider systems, such as Germany and Japan, shareholders are those people closely connected to the company. Insider model: In this model, the commercial banks are usually the company’s major shareholders and it has tight shareholder control mechanisms to control and supervise the operation of the company. This pattern is conducive to the company’s long-term development. This is a proactive and positive model. If shareholders are not satisfied with the company’s operators, they can directly through the “hands vote” to express their views. The disadvantage of this model is that the securities market is relatively backward. Financing is mainly through banks, corporate debt ratio is relatively high and controlling over the market is underdeveloped. Furthermore, the information disclosure and insider trading control are far weaker than outsider model. Outsider model: This model indicates that the aim of corporate governance is to safeguard the shareholders benefit; the shareholders are in the dominant position in corporate governance. In fact the implementation of its corporate governance structure is the single-board structure. Companies only set up the board of directors and no board of supervisors. It has well-developed and efficient capital markets, improved the financial audit system, strict information disclosure system, well-developed market and business managers are closely linked to performance reward mechanism. Under this model, developed and efficient capital markets promote the rational allocation of social resources, so that the competitiveness of enterprises can be improved. But it also has some disadvantages: 1. Operators ignoring long-term interests in order to meet investors in the short-term returns and cost-effective demand; 2. the company often ignores the interests of other stakeholders. Franks and Mayer (1995) argue that both insider model and outsider model may be suitable in different contexts. Insider model may be best appropriate to corporate activities with long-term pay-offs, but may be slow in undertaking necessary remedial action. Outsider model may be better suited to riskier investments requiring large amounts of new capital investment, where it involves well-diversified public owners, but corrective action may be taken impulsively. In a word, a company should choose the suitable model to enhance the corporate performance. Good corporate governance OECD (2004) mentioned that good corporate governance is a significant step in establishing market confidence and encouraging more stable, long-term investment flows. Many countries regard good corporate governance practices as a better way to improve economic performance. Corporate Governance Code published by Financial Reporting Council (2008) mentions that good corporate governance should contribute to better company performance by helping the board to perform their duties well and it also can bring value to shareholders. Good corporate governance can reduce the risk of a company and enhance the shareholders and stakeholders wealth. The good corporate, therefore, can improve the performance of the firm. Recommendations for improving corporate governance Good corporate governance enhances market confidence, integrity and efficiency, thus promoting economic growth and financial stability. A system of corporate governance needs a responsible board of directors, at the same time allowing the board to make profit for the shareholders (Short et al, 1998). While identifying those two objectives of good corporate governance, the Cadbury Report’s recommendations were directed towards issues of accountability and control; therefore, a company can improve their corporate governance through the following three ways: Firstly, strengthen the board of structure. In the corporate governance structure, the board can effectively carry out the decision-making and monitor the management. As a result, the strengthen board of structure can protect and maximize stakeholders wealth. Secondly, improve the transparency. If the company can improve the transparency of the operation, it can improve the staff’s motivation, increase the reputation in the social and improve the performance. Finally, pay attention to risk management. The company should emphasis on risk management, because of it can help managers choose the best risk response, minimize surprise and losses, identify and manage risks across the organization and seize opportunities. The future of corporate governance There are two tendencies in the corporate governance in the future: Firstly, the company may be more emphasis on social responsibility. Nowadays, the operation of a company is not only related to the stakeholder’s interests but also influence the social interests. On the other hand, the aim of corporate governance will not only to maximize stakeholder wealth but also emphasis on social responsibility. Secondly, make people-oriented enterprise culture. This kind of enterprise culture requires transform traditional control, monitoring, instructions, management mode to a new one, and fully respects the staff in the company. The company need to create a good interpersonal environment for employees and, mean while, improve the transparency of corporate governance to arousing the enthusiasm of enterprise staff of the company, thus achieve the company’s goals. Conclusion Given the length of this paper it seems inappropriate to give a detailed discussion regarding the relationship between enterprise and accountability. However, some brief conclusions can be made. In particular, if a company wants to improve the performance, it should consider the relationship between enterprise and accountability. In the part of mechanisms, a company should also take advantage of various mechanisms to make the corporate governance more effective. Furthermore, a company should also choose a suitable model to enhance its performance.

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