| Corporate Governance and Financial Regulation Essay
The term corporate governance arose in the 1970s in the United States after the discovery that major American corporations had engaged in secret political contributions and corrupt payments abroad. Corporate governance can be defined broadly as a set of processes, |s, policies, laws, and institutions (Volpin 2002, 61-65; France 2002, 37-47). These affect the way in which a corporation is controlled, directed and administered. It has to do with the relations and specifies the distribution of rights and responsibilities among management, shareholders, board of directors, and other principal stakeholders. Good corporate governance contributes to a sustainable economic development by enhancing the performance of companies and increasing their access to outside capital (Anderson 2004, 68; Volpin 2002, 61-91). The main principles of corporate governance include determining the key practical issues concerning shareholders, transparency and disclosure, legal and regulatory environment, and appropriate risk management measures. From an ethical dimension, the key issues of corporate governance entail questions about associations and building trust mutually within and outside the company (Arjoon 2003, 99-115; Valentina 2006, 28-35).
The United States automotive industry has had significant failings in corporate governance and control arrangements. This has resulted in the industry being poorly organized across its business as a whole. The period between 2007 and 2010 was marked by recession and crisis in global markets (Baker 2010, 23; Anderson 2004, 68). It was the tumultuous period in the history of the U.S automotive industry. It saw the bankruptcy of General Motors Corporation, Chrysler LLC, and hundreds of parts suppliers. The combination of the collapse of world credit markets and growing economic recession created the worst market for the production and sale of motor vehicles in decades (Treck 2009, 465; Federal Reserve Bank of New York 2010, 21-23). GM and Chrysler owed their troubles to such shortcomings as mismanagement and labor costs that were beyond their control. However, GM experienced problems long before the present financial crisis further aggravated its situation. From 2000 to 2005, GM had already lost 74 percent of its market share and was saddled with more than $1600 per vehicle in legacy costs (Federal Reserve Bank of New York 2010, 21-23; France 2002, 37-47).
Corporate Governance Mechanisms.
Many companies in the U.S have adopted legal compliance mechanisms, which address and conduct issues in formal documents. Increased media attention has raised awareness among those directly affected, as well as the trade society as whole. Globalization, technology, and rising competition are the other aspects that have brought ethical issues into the spotlight. Valentina (2006) notes that the new realities of corporate governance show that no entity is immune from fraudulent practices. They have redefined the baseline for what is considered prudent conduct for businesses and executives (Brown 2006, 409-434; Collins 2001, 20-23).
Legal compliance mechanisms are difficult to manage. For instance, a company can file misleading accounting statements that are in complete compliance with generally accepted accounting principles. Laws regulating companies are ambiguous and regulators and common shareholders have a hard time grasping abstract and sophisticated financial concepts. As such, the legal compliance mechanisms, which include corporate ethics programs, codes of conduct and mission statements, provided little help in such environments (Collins 2001, 20-23; France 2002, 37-47). The general perception is that legal compliance programs exist only to protect top management from blame. Legal compliance mechanisms emphasize a set of laws and uses amplified monitoring and punishments to enforce the rules. The mechanism is geared towards preventing unlawful conduct (Arjoon 2003, 99-117). Legal compliance mechanisms are predisposed to encourage the liberty of indifference, which corresponds to the letter of law. This may not necessarily instill or inspire excellence. Legal compliance mechanisms are insufficient and may not address the real and fundamental issues that inspire ethical behavior (Cohen 2005, 9-13; Doidge 2006, 100-123).
Ethical compliance mechanisms include such aspects as ethical leadership, fair treatment of employees and open discussion of ethical issues. A sound ethical compliance program does not encourage self-interest and unquestioning obedience to authority. Trust, integrity and fairness matter a lot and are crucial to the bottom line. Ethical mechanisms encourage the elevation of employee interests, as well as those of |ers and communities they operate in. Expectations of investors are reset so that they are more realistic (Shleifer 2001, 737-783; Ferrell 2005, 12-15). Ethical mechanism serve as a guide to those directly responsible for corporate governance and check whether corporate actions are consistent with legal obligations. They also provide the grounds for a moral critique of existing laws and practices related to corporate governance. These mechanisms urge managers of corporations to serve equally the interests of shareholders and the interest of other stakeholders, such as employees, creditor, suppliers, |ers, and community. Ethical compliance mechanisms promote a freedom of excellence, which corresponds, to the spirit of law (Shleifer 2001, 737-783; France 2002, 37-47).
Corporate Governance and Financial Crisis.
Government bailed out an unprecedented large number of financial institutions since the onset of the global financial crisis in 2007. Many attribute these events to failures in corporate governance, such as lax board oversight and flawed executive compensation practices. Most of the failed corporations did not have proper corporate governance practices before the financial crisis. Many banks and financial institutions were the makers of innovative, yet highly risky financial products (Klein 2009, 185; Jacobs 2004, 17). All these encouraged aggressive risk taking among corporations in the United States. Top executives wanted to exploit these risky opportunities but did not want to risk their own compensation and bonuses. When they were put to a test, corporate governance routines failed to serve their purpose to safeguard against excessive risk taking (Federal Reserve Bank of New York 2010, 21-23; Franklin 2010, 9831018).
The 2007 macroeconomic environment demanded most out of corporate governance arrangements. During this time there were many cases related to mismatching between business structures. The incentive management, internal control systems, and risk management policies were greatly mismatched. Financial institutions and investors adopted risk models, which failed because of several technical assumptions (Dandino 2004, 41; Treck 2009, 465). The dimension of corporate governance is how such information was used in the organization, including transmission to the board. Risk management systems were continuously adjusted to fit corporate strategy and risk appetite (Dandino 2004, 41). Board members did not get all the necessary information required to make decisions. On a number of occasions information on exposures failed to reach the board. The boards had to be clear about the strategy and risk-craving of the firm to be able to react in an appropriate way. They also required ensuring that risk management and remuneration systems compatible with their objectives and risking appetite (Doidge 2006, 110-123; Harshbarger 2004, 22-28).
Pay and performance of top executives and board of directors was among the leading causes of financial crisis. The outrage over the executive pay in many companies was a sign of poor corporate governance within firms. Additionally, there was a weak link between pay and performance. Studies conducted after the financial crisis show that compensation practices played a role in promoting the amassing of risks that eventually led to the global financial crisis (Srinivasan 2005, 291-330; Ryan 2008, 5-16). Executive pay structure was designed to enhance risk taking and create value for shareholders, but not to protect debt holders. This was particularly strong in the banking industry, because banks are highly leveraged and their advantage is subsidized. Equally sensitive, employees were being given short-term incentives that were not in line with the long-term sustainability of their companies. This also contributed to the buildup of unmanageable risks that eventually brought the companies down (Harshbarger 2004, 22-28). What corporations have learnt is that corporate governance is the core of any business operation. Company officials, shareholders, policy formulators, and regulators need to have more interest in corporate governance issues (Harshbarger 2004, 22-28; Goodhart 2008, 30).
Industry players with significant financial markets and banking operations were seriously damaged by the dramatic deterioration of global conditions. They suffered severe losses requiring public support and even bailout measures. The vast majority of those affected include financial institutions, investors, banks, common citizens, employees, different players in the manufacturing and service industry, insurers and reinsurers (Ferrell 2005, 12-15; Rohan 2006, 67-74).
Proposed Reforms of Financial Markets.
The reforms put in place include a large stimulus package of about $850 billion, of which two-third will be used to increase spending and one-third will be spent on tax cuts. This package is meant to make the recession less painful than it would otherwise have been. It is expected to foster economic recovery in the remainder of 2009. Another reform passed by the Congress is the anti-foreclosure measure, which allows for the refinancing of mortgages, which are in default. However, lenders must initiate this refinancing (Franklin 2010, 1018; Gompers 2003, 107-155; Brummer 2008, 30-35).
Corporate Governance Changes Would Help to Avoid Financial Meltdowns.
The financial crisis has established that the most venerable and reputable institutions can find themselves on the brink of demise. However, there are changes that can be adopted to avoid similar scenarios. Companies should introduce independent directors and separate board chairpersons and CEOs. This way no entity influences the actions of the entity. Another aspect is the establishment of corporate audit and risk committees. These committees are given the responsibility of identifying risks and mitigating them before they get out of control (France 2002, 37-47; Brummer 2008, 30-35). Additionally, institutional shareholders and hedge funds should become more active in monitoring and disciplining corporations. This will keep the managers and other regulators on toes.
Another key aspect that must be observed is transparency in corporations. The transparency programs must be meaningful and understandable in terms of features and communication. Most stakeholders have lost their faith in complex and esoteric structures and wordings. Consistent communication with shareholders is also a fundamental aspect (Goodhart 2008, 30). Consistent and timely communication helps companies make best use of their reputation with stakeholders. In hard times, consistency is a prerequisite to maintaining stakeholders trust (Brummer 2008, 30-35; Shleifer 2000, 737-783).
Investors and shareholders must take keen interests in management of their investments. This role should not be entirely left to managers and regulators. By being keen they may identify loopholes and eliminate them before they pose risks to their investments. Boards of directors must be chosen to safeguard not only their interests but also the interest of shareholders. Moreover, banks board must understand and probe their firms risk management processes. Senior management should question the nature and sustainability of higher returns being achieved (Gompers 2003, 107-115; Brummer 2008, 30-35).
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