The Importance of Corporate Governance in Organizations Essay
With the recent financial crisis, companies’ defaults and crushes, the importance of corporate governance has risen significantly. Corporate scandals that have impacted companies all over the world have led to the re-examination of the role of corporate governance in their day to day operations. The Organization of Economic Cooperation and Development (OECD, April 1999) defines corporate governance as follows: “Corporate governance is the system by which business corporations are directed and controlled.
The corporate governance structure specifies the distribution of rights and responsibilities among different participants in the corporation, such as, the board, managers, shareholders and other stakeholders, and spells out the rules and procedures for making decisions on corporate affairs. ” (Hebbie A. , Ramaswamy V. , 2005) Some corporate governance problems, as for example CEO’s almightiness, Board of Director competencies, shareholders interests, etc, become important only when some organization gets into trouble. In periods of glory and prosperity, rarely anyone think about these issues.
To be sure, a CEO can maintain control over corporate governance only as long as companies are not demonstrably in difficulty” (Greenspan 2002). When companies run into trouble, existing shareholders and stakeholders will usually search for the ways to displace the board of directors and the CEO. This process raises many questions and can create hostility among participants. World’s economy has grown and changed a lot. Business units have become larger, ownership more dispersed, opportunities wider. Few shareholders have sufficient stakes to be able to influence the choice of CEO or board of directors.
They neither have sufficient knowledge nor will to do so. “The vast majority of corporate share ownership is for investment, not to achieve operating control of a company. ” (Greenspan 2002) Thus, CEO remains the only person who has power and knowledge to guide the business in the way he or she perceives to be in the best interests of shareholders. He or she is also the person, who proposes majority of the boards of directors to be appointed by shareholders. The CEO sets the business strategy, influences accounting practices and financial statements to measure his or her own success. Shareholders usually perfunctorily affirm his/her choices.
Apart from large instituional investors, whose number is generally small, few shareholders can read financial statements and analyze corporate reports. Also, a big number of the Board members have insufficient knowldege in accounting and finance to fairly estimate CEO’s performance. In order to help organizations and shareholdres in the corporate governance debates, many countries have issued laws or rules, such as the Sarbanes-Oxley Act in the United States, European Commission’s Action Plan in the European Union countries and Corporate Governance Framework by Organization for Economic Co-operation and Development (OECD).
There are three fundamental areas in which the Sarbanes-Oxley Act, the European Union Commission and the OECD framework have in common. Those three areas are: the controlling and/or monitoring of board members’ actions, the identification of the responsibility of the board members individually and collectively, and the duties board members have to stakeholders. (Stanwick 2008) These papers are supposed to protect shareholders and, at the same time, make it easier for corporations to make important decisions.
For example, according to the Sarbanes-Oxley Act, each publicly traded firm must be accountable to a government appointed Public Company Oversight Board which is comprised of 5 members who are “financially literate”. Of the 5 members of the oversight board, two members must be Certified Public Accountants (CPAs). The oversight board creates and approves the guidelines used by external auditors in their review of financial information pertaining to the firm. The Act also requires that the external (independent) auditors who review the financial statements of the firms are restricted to performing audit based functions.
Contrary to what was acceptable in the past, external auditors are not allowed to perform bookkeeping functions, nor are they allowed to do non-audit based consulting. The firm’s audit committee must pre-approve all the services provided by the external auditors. In addition, the lead audit partner and the partner responsible for the audit must change at least once every 5 years for the same client. One of the most critical components of the Sarbanes-Oxley Act was the requirement that both the firm’s CEO and CFO must certify all annual and quarterly reports sent to the Securities and Exchange Commission (SEC).
This was a significant change in the past policy of the SEC. Based on the certification process by the CEO and CFO, the CEO no longer can plead ignorance as a defense for inaccurate financial statements. (Stanwick 2008) As with the Sarbanes-Oxley Act, the European Commission’s Action Plan requires that the Board of Directors be collectively responsible for the firm’s financial statements. In addition, each publicly traded firm must disclosure the firm’s compensation policy and each director’s level and the composition of their total compensation must be easily attainable and transparent.
These are just a few examples of what corporate governance is and how it is applied in organizations. Even though I agree that current market economy requires a structure of formal rules, bankruptcy statutes, a code of shareholder rights, I think that rules cannot substitute for character. “In virtually all transactions, whether with customers or with colleagues, we rely on the word of those with whom we do business. If we could not do so, goods and services could not be exchanged efficiently. (Greenspan 2002) In my opinion, the current CEO dominance, with all its faults, will probably continue to be viewed as the most viable form of corporate governance for today’s world. The only credible alternative to it is for shareholders to exert far more control than they have been willing to exercise, which is too hard to implement. Therefore, I would like to emphasize that organizations should be very careful with choosing a CEO. Companies run by people with high ethical standards do not need detailed rules and procedures to act in the interests of shareholders.
However, people are more likely to perceive their own interests, seeking ways to cut corners and make things look better than they actually are. Corporate governance is therefore of utmost importance in any organization to limit CEO almightiness and protect shareholders interests. Such acts as SOX should be applied by absolutely every organization in order to be fair to everyone, however, not all companies are the same and this Act might not work equally good for every of them. Officials, who write this kind of rules and procedures, bear a huge responsibility in front of all shareholders and organizations.
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