Corporate governance deals with procedures, policies, and institutions that affect the way a corporation is controlled. Corporate governance is the term used when describing a failure to prevent the collapse of corporations, such as Enron. After the collapse of Enron it occurred to many experts that organizations had to be held accountable and this includes the high-level executives. Corporate governance has made strides since the trouble with Enron because people saw it was necessary to institute a better system. Corporate governance is important for companies and corporations to function properly and when discussing it important questions must be answered:
- What are the roles of The Board of Directors, Creditors, Rating Agencies, Security Analysts, Activist Shareholders?
- How do their roles set the framework for good corporate governance?
- What are the ethical issues that are raised by these roles and how are they addressed?
What are the roles of The Board of Directors, Creditors, Rating Agencies, Security Analysts, Activist Shareholders?
The Board of Directors can either be elected or appointed to oversee the activities that occur in an organization. One of the most important roles that the Board of Directors has is to appoint the CEO of the organization. The CEO is responsible for the day to day activities, and is the person held accountable for every action that occurs in the organization. This person has to be responsible and will act in the best interests of the company. The Board of Directors also governs the organization and creates policies for the CEO and employees to follow. The Board is also responsible for acquiring the resources for the organization to do business, this generally means that they are acquiring the financial means to do business. The Board is held accountable to the shareholders, so they must assess their own success or failure.
Creditors have a significant impact on corporate governance. Finance can have a huge impact on an organization. As previously, mentioned it is the job of the Board to acquire resources for the organization to do business. Many times these resources are financial ones and can involve the organization going into debt. Creditors are generally an institution, such as a bank, which would lend money out to corporations. Most medium and large size organizations have debt because they had to borrow from creditors.
Rating agencies are very well known, especially in the current economy. They rate an organization based on many factors. This rating is looked at by investors and creditors. An organization needs investors for expansion and other financial needs. “The regulatory use of ratings, such as the use of credit ratings to determine bank capital requirements”. Rating agencies look at many factors when judging a business, however, it is their role to give an impartial judgment about the business so that creditors and investors can have all the facts so they can make their respective decisions.
Security analysts help the average person in understanding different aspects of the organization, which may seem confusing at first glance. “Security analysts guide investor behavior by interpreting and disseminating information about corporate finances, strategic decisions, and industry trends, and by rendering summary judgments about the firms that they follow”. Their guidance helps an investor decide whether to keep certain stocks, if a company is worth investing in, ect.
Activist shareholders use their stake in a publicly traded company to put pressure on the management to influence their behavior. This activity can be very risky and is not necessarily against the Board of Directors. This behavior can be against other stakeholders, which can include other corporations, organizations, and individuals.
“These days, good corporate governance is not just about balancing the incentives of the shareholders and managers (top management team), it is also about balancing the incentives and interests shareholders (owners), board (top management team), employees in general, customers and consumers, suppliers and other partners (banks, financial partners, ect.), society and government, locality and environment, and any other stakeholder who can cause a difference to the business”.
The role of being an activist shareholder is extremely important and sets up a system of checks and balances for the organization. All the major players in corporate governance are accountable to other people so that no particular group has complete control over every aspect. This system is a delicate balancing act, as previously mentioned and each role has its responsibilities and incentives.
How do their roles set the framework for good corporate governance?
The Board of Directors is vital to good corporate governance. They need to have certain strategies put into place so that there will be accurate information going in and out of the board. There are certain characteristics that must be present for the board to be successful, “clear strategy aligned to capabilities, vigorous implementation of strategy, key performance drivers monitored, effective risk management, sharp focus on views of City and other key stakeholders, and regular evaluation of board performance” . Part of the role of the board is to evaluate their own performance and when some of the directors are tired or do not have fresh ideas, it is time to replace them. Having these characteristics in place will allow the board to have good corporate governance.
Creditors have a large impact on corporate governance. Many experts now claim that enough emphasis has not been put onto debt repayment and efficiency. “Debt appears to be slowly emerging as a device for exerting control over medium and large enterprises”. It is now stated by experts that certain provisions need to be put into place for corporations to continue to thrive. There are “three crucial underpinnings to creditor monitoring and control in market economies: adequate information, market-oriented creditor incentives, and an appropriate legal framework for debt collection”. Having a legal frame work in place is the type of procedure and policy that make corporate governance successful. The creditors do not lend money out to everyone. There already is a system in place for an organization to borrow money. The creditors look several factors to see if they would be good candidates to borrow money. This is similar to when an individual tries to take out a mortgage.
By instilling good corporate governance a firm should maintain profitability. Security analysts help with this because they can influence the decisions and the policies that are made. They are seen as impartial and therefore the consumer and/or investor listens to what they are saying very carefully before making a decision. “Analyst reports have a significant influence on the behavior of investors and other members of the financial community toward a focal firm, including bankers, debt holders, and ratings agencies”. The security analysts report to the general public about their finding about an organization, and therefore are making the board and the management accountable to the shareholders.
Activist shareholders are a controversial issue, however they do help with corporate governance. Without having outside people to keep other in line an organization could get away with anything. These stakeholders make sure that no one group is too powerful. Stakeholders can make the board get rid of members, or even the CEO. This is useful in times of crisis or when the high level executives are abusing their power.
What are the ethical issues that are raised by these roles and how are they addressed?
An important aspect of every organization is the Board of Directors, these men and women need to be knowledgeable and be of sound moral character. There are some instances, such as with Enron, that it became apparent that this was not true. “The board of directors was composed of a number of people who have been shown to be of poor moral character and willing to conduct fraudulent activities” . When the board is willing to conduct fraudulent acts, then it can easily be assumed that the rest of the organization is equally as perverse and unethical. The Board of Directors can be replaced, or only certain members who are doing unethical actions. Another ethical issue is “many provisions in investor protection laws may not be binding since firms have the flexibility in their corporate charters and bylaws to either choose to 'optout' and decline a specific provision or adopt additional provisions not listed in the legal code” . This situation is when it is beneficial to have activist stakeholders. The board can be held accountable to the shareholders, so it's important that they are active and interested in the processes that our occurring in the companies that they invest in.
There are many ethical issues that get raised in regard to the creditors. In many instances legal protection, so that creditors will have rights. They have been given rights because of the people that would take advantage of the creditors. “Management was able to transfer cash and other assets out of a
company with outside investors. These assets may have been used to pay the management’s
personal debts, or they may have been used to shore up another company with different shareholders, or they may have become straight capital flight into a foreign bank account” . This example shows how creditors can be involved in fraudulent activity. Another problem is when rating agencies do not give correct ratings, this directly affects if they receive loans or not. The rating is very important to a business, similar to when a credit rating to an individual.
One of the ethical issues that has come across in the media because of the current economy is the ethical behavior of rating agencies. Many politicians have made it important for their constituents to know that it is possible for the rating agencies to act unethically. “Inaccuracy of credit ratings in the years leading up to the 2008/2009 financial crisis has led politicians, regulators, and academics to conclude that rating agencies' business-model is plagued by 'huge conflicts of interest'” . Many experts think that the system needs to be re-worked so that there will not be any “conflicts of interest”, therefore eliminating any possibly unethical behavior. Part of the problem with ratings agencies is that they get paid for their ratings and there does not seem to be a penalty to them for getting a rating wrong. The consequences to getting a rating wrong are disastrous for the organization and the investor. If a rating is too low the organization can lose investors and may not be able to borrow necessary money from banks. If the rating is too high then investors could potentially lose a lot of money. Security analysts in turn tell the truth about the money and the financial situation of a company, which is available to investors and the general public so that they can decide for themselves if the ratings are correct.
As previously, mentioned security analysts are the ones who report to the public about the details of the organization's financial records and other key information that would be of use to the investor and consumer. Part of their role is to report on anything that is unethical. If they do find out that there is fraudulent activity then they should be reporting that to the shareholders because the board and the managers are held accountable to the shareholders. When they analyze financial statements to explain to the public key financial information it is part of their job to notice if money is being transferred around from the corporate accounts into personal ones. By giving the public (investors, consumers, ect.) this information it makes the activist shareholder ready to address the board with correct information and the ability to make demands that will benefit the company.
Activist shareholders are considered by many people to be unethical. They use their stake in the company to influence people into doing what they want. Although this may not necessarily be the Board of Directors in some cases it has been the Board. Part of the unethical behavior is “that public pension funds sometimes seek to alter firm investment policies to pursue politically motivated or social objectives..thus, shareholder activism may yield benefits to the fund managers without improving the target firm's performance” (Karpoff 7). In the case of public pension funds the activist stakeholders are not acting alone, but they are not acting to benefit the organization that they have invested in.
In conclusion, corporate governance helps to keep an organization in check so that unethical behavior is not allowed. One of the biggest themes in corporate governance is the need to hold all people accountable for their behaviors. The different roles and ethical duties of each person is what creates an effective system for corporate governance.