People work collectively in corporations to make value and produce income. In recent era, corporations have become a progressively more foremost part of economic life. People rely on corporation for employment, goods, services and the value of the pensions, for economic growth and social development. Managing earnings [1] , a system of assembling things look enhanced than they in reality are to keep stockholders happy, entice new investors, meet budgets, and most importantly, earn executive bonuses. Executive bonuses are tied to specific levels of earnings, making it extremely tempting to do just about anything to meet -- or appear to meet -- the goal. But not all book cooking is motivated by greed. By making revenues appear larger than they actually are, a struggling company could stay afloat with investors' money until it can turn a true profit.
Investors are attracted by rising stock prices of public companies, which make the company's financial statements extremely important documents. Wall Street analysts depend on the documents and input from the companies themselves for their recommendations. The public company depends on the infusion of cash from investors to fund company growth. Stockholders expect the price per share to go up once they buy stock. When the price goes down, they lose money. [2] To satisfy the investors, shareholders, and ultimately, to run the company, the strategy of "cooking the books or cooking up of accounts" is used as a bailout plan.
"Corruption ought to also encompass some acts that may be legal in a strict narrow sense, but where the rules of the game and the state laws, policies, regulations and institutions may have been shaped in part by undue influence of certain vested interests for their own private benefit," said Daniel Kaufmann, a governance expert at the Brookings institute. It is mandatory for a corporation to be registered to be considered as a legal, fictitious or a moral person. Board of directors govern a corporation and other titled office bearers manage the corporation's activities.
CASE STUDIES- FAILURE OF CORPORATE ENTITIES
Enron:
Enron was honoured to be the most important energy sector company among the world. They were said to be the seventh largest company and the largest energy sector in the United States of America. They counted on to be the biggest human union employed from more than 40 countries and they experienced an extraordinary growth in 15 years from the launch of the company. A tremendous shock was given by the Enron Corporation when they filed their Bankruptcy without any aforementioned symptoms or claims.
Enron's downfall and Provisions:
A company should have proper guidance and their operations should be monitored strongly within their financial activities and management sector of the company. The directors should understand the process of business and their accountability to the performance of company. The welfare of the shareholders shall not ultimately depend upon the information supplied by the management and the auditors as they also support evidences of clear understanding of the company by the directors and their autonomous decision.
The PSI - Permanent Subcommittee on Investigations submitted some findings on the committee of governmental affairs from the senate of United States as;
"The Enron Board of Directors failed to safeguard Enron shareholders and contributed to the collapse of the seventh largest public company in the United States, by allowing Enron to engage in high-risk accounting, inappropriate conflict of interest transactions, extensive undisclosed off-the-books activities, and excessive executive compensation. The Board witnessed numerous indications of questionable practices by Enron management over several years, but chose to ignore them to the detriment of Enron shareholders, employees and business associates." Also, the Board failed to guarantee the independence of the company's auditor [3] .
Directors should be part of the solutions examined by their individual performances and their decision made through the lines of attainment with the company regulation. There should be no compromise under the pressure in the company with the decision made by the director. They should strictly adhere within the company lines for the achievement of company goal through the strategies and policies divided within the company mended with the diversification and extension of business activities.
Action: Lawsuit:
A class of consolidated action combined in lawsuit was presented against Enron Corporation in the U.S district court of Houston by Lerach Coughlin Stoia Geller Rudman & Robbins, LLP Attorneys led by William Lerach on April 8, 2002. The attorneys on behalf of their clients seek certain relief in the period of October 19, 1998 - November 27, 2001 against the purchasers of public traded debt securities and equity.
The trading proceeds were said to freeze within an amount of $ 1.2 billion by the Lerach Coughlin attorneys. The same attorneys involved numerous investigation and interviews against organizations like Enron and related entities and partnerships and sought expedited development from Enron's auditor Anderson and Enron Corporation. A considerable enquiry and investigation with the auditor revealed the fraud packing untold documents and the attorneys went to the court for preservation of evidence. Lerach Coughlin Attorneys also exposed the destruction of Enron's document at the Houston's headquarters during their factual investigation.
The U.S District court denied most of its motions for the dismissal of the litigation as the parties were engaged in motion practice and discovery for the depositions made during the summer2004. Lerach Attorneys are in provision with prison for fraud and defaulting for his clients. Now their status in bar and his license is about for cancellation and concerned to barred or suspended to practice and is considered to be almost debarred from the Bar association [4] .
WORLDCOM:
Ebber was appointed as the chief Executive officer who formerly incorporated the LDDS (Long distance discount services) along with a crew of eight members in the year 1985. Scott Sullivan joined the services of LDDS in the year 1992 and was designated as the Chief Financial officer in the year 1994. LDDS was renamed as the WorldCom in the year 1995 and it amalgamated later in the year 1998 with MCI. In the year 2001overpayments on sales were observed by the internal auditors. The resignation of Ebber as CEO was made in the year 2002 after the findings regarding the loans availed by him. He had availed of almost $341 million's besides the bankruptcy filed by the WorldCom following the overstating cash flows enriched in them. The process of bankruptcy filing has also claimed additional irregularities in the tune of $3.3 billion. Sullivan admitted his facts of fraud and plans for implementation for the fraud in conspiracy with Ebber's in the year 2004.
Causes for Collapse - WorldCom:
The downfall of WorldCom was initiated by the roar of Internet and the failure or fall of Tele-communication in the mid of 2000. The revenue of the company was lesser in accelerating expenses during this period. Scott Sullivan and Ebber's evolved a close relationship and they had a vast control over the board for the execution of fraudulent activities concealed from the shareholders. The Accounting process in the management had a great hit and manipulations resulting in the decrease of revenues without proper justification or evidences were declared in the year 2000 including capital investments shown as operating expenses. The personal expenses were accounted on the company's funds and the personal loans exceeded the limits with the pledging of the company's holding as a collateral functionality for the stock prices by the CEO, Ebber.
BCCI - Bank of Credit and Commerce International:
Agha Hasan Abedi was the founder of the Bank of Credit and Commerce International. The BCCI was founded in 1972 and was said to be the largest international bank expanded with almost 70 countries around the world [5] . The BCCI was also considered to be the seventh largest private bank [6] with interwoven specific entities organising a complex structure in the corporate world with concealed activities of capital and goods movement that resulted in the financial collapse [7] .
The investigations and evidences in the final stage lead to a conclusion that the BCCI organisation was formed or incorporated for the wilful commitment of fraudulent activities by their extensive bank jurisdiction with secrecy. The activities were assorted, different, diverse and enormous and were found hard to be tracked by the regulators in the initial period. The officers were intricate and were in the commitment to deceive and commit fraud in intensive manner hence they did not bring any of the activities that might slightly show or penetrate light for the tracking of their fraud [8] . The best explained quote for the BCCI case is "Power corrupts man, Absolute Power corrupts absolutely".
MAXWELL
Robert Maxwell was a successful publisher of scientific journals and books from his Pergamon Press. In 1968 and 1969, Maxwell failed in his bid efforts for the 'News of the World' and 'The Sun' which went in favour of Rupert Murdoch. [9]
In 1969, Maxwell (Pergamon Press) consented to a merger plan with Saul Steinberg (Leasco).The Price Waterhouse audit proceeded to conclude if the merger bid will be carried out and finally highlighted that Maxwell's Pergamon's profits had been exaggerated. Maxwell gained total control of Pergamon in 1974; took control over British Printing Corporation (BPC that was later renamed as BPCC) in 1981; bought Mirror Group Newspaper in 1984; renamed BPCC as MCC (Maxwell Communications Corporation) in 1987; acquired MacMillan for $2.6 bn; purchased 'New York Daily News' newspaper and floated shares of Mirror Group Newspapers (MGN) in 1991. The disappearance of Maxwell in sea threw light on the collapse of the Maxwell's empire. [10]
Causes for Maxwell's scandal
Assets were pledged to leverage additional loan amounts although they were sold for cash instead of giving them to the lender. Shares were pledged the same way as how assets stood for additional security to tap loan amount to Maxwell's private companies. Also, the amount realised from the pledging of shares was used to falsely increase the share prices of MCC and MGN. This was done to maintain the financial credibility of the company. Besides, Maxwell the funds of MGN were invested in Maxwell's private companies. Maxwell's empire was built on complex organisation structure that was interlinked and interwoven in funding activities. Maxwell also took undue advantage of the employer taking a holiday in making employer's contributions to pension fund and also pledged shares of the pension fund as collateral security against bank loans. [11]
Lessons learnt from Maxwell scandal
The highlight of the Maxwell's case was that many lost their pension that influenced the wave of public sentiment and accelerated the wrath of people on Maxwell. This resulted in the review by Cadbury Committee giving direct recommendations in line with the Maxwell's case which are discussed. [12]
There should be a demarcation between the responsibilities of a chairman and a chief executive so as to avoid the decision making in single hands and also it is recommended that board should be vested with an individual who is authoritative, and a senior acknowledged by the board to be steering the organisation towards achieving its goals (Code of Best Practice, item 1.2). The board should comprise of non-executive directors to continue in providing weightage with vital decisions in the interest of the shareholders (Code of Best Practice, item 2.1). The board's non-executive directors should be free of any interference in the company's activities so they can exercise independent judgement. (Code of Best Practice, item 2.2) [13]
ACTS RELATING TO CORPORATE GOVERNANCE IN US AND UK
SARBANES-OXLEY ACT, US
Sarbanes-Oxley [14] Act stands as a master piece of corporate legislation that impacts companies since Securities Exchange Act of 1934. This Act was mainly formed due to the corporate disaster by Enron, Arthur Anderson, WorldCom, Tyco and Global Crossing. [15]
The effectual Board Structure cannot guarantee the appropriate execution of the directors. Both fine board configuration and competence of the directors should co-exist for good governance. One of the factors essential for effective functioning of the board is the autonomy of the board in taking decisions, which is highlighted by the Act. [16]
"Section 906 of the Act makes it mandatory for CEOs and CFOs to certify that all financial reports are in compliance with Securities Exchange Act". This section also imposes heavy penalty up to $1 million and/or up to ten years imprisonment for executives who wilfully misstate financial statements knowing that the statements do not adhere to requirements. Also, the act mandates the CEOs and CFOs to provide additional disclosures relating to compensation and profits of CEO and CFO thereby standing accountable for the information provided by them to the shareholders.
Section 1102 levies penalty and/or imprisonment up to twenty years for knowing and wilful destruction of record to hinder the official proceedings. Criminal and civil penalties for violations of the official procedures try curbing the negligence of the directors in the view of the penalty and punishments. Section 806 assures protection to employees and whistleblowers that bring into light the fraudulent activities of a company. Section 501 lists the rules that need to be adhered to during conflict of interests when investment banking activities are carried on by the company. [17]
This Act also recommends for certification of internal audit reports by external auditors besides auditor independence and pre-certification by the company's Audit Committee of all other non-audit work. It is necessary that annual audit reports should furnish information on the existence and condition of internal controls. The Act also prohibits audit firms providing extra "value-added" services to their clients. [18] Section 404 of the US - Sarbanes Oxley Act 2002 references the Turnbull report for its guidance on the internal controls. [19]
COMPARATIVE ANALSIS OF CORPORATE GOVERNANCE IN US AND UK
Regulatory Bodies
SOX shaped a body, Public Company Accounts Oversight Board (PCAOB) which keeps vigil on the audit and accounts of the American companies. In so far as the SEC is concerned, its regulatory mechanism was improved by the Act. Further, it guarantees the autonomy of the external auditors and changes the selection pattern of audit partners. The periodic financial statements have to be endorsed and signed by the CEOs and CFOs. The provisions of the SOX Act prescribe the financial data and the proforma data that are to be released.
In as much as UK's corporate governance is concerned, Companies (Audit Investigation and Community Enterprise) Act 2004 gives power to the financial review panel and Secretary of State to supervise the audit administration in the companies. The compulsory change in the auditors though is not in existence is under consideration. Para 12.30 of UK Listing Rules prescribes the procedure for disclosure of off-balance sheet and proforma information. Comparatively, this Act is not very effective as SOX operates in US Corporate administration. [20]
prominent aspects of Corporate Governance in the UK are:
We have Cadbury, geernbury, Turnbull Report, and Hampell Report, smith, Tyson report all the reports aims the following points
There should be diversification between Chief Executive and Chairman
There should be equilibrium between executive directors and non-executive directors
Independent functioning of audit and remuneration committees
Performance evaluation of the board at regular annual intervals
Ensuring clearness of recruitments and compensation for the services
Upholding the shareholders' interest
SHAREHOLDERS & DIRECTORS
Shareholders
The role of a shareholder in United Kingdom is superior when compared to United States corporate system. To explain this general body meeting can be called by total ten percent of the shareholders and can remove a director with a simple majority were as, in US the existing board has an upper hand in appointing director and the shareholders scope in electing new directors is limited , given the expensive exercise involved in it. [21]
Directors
The directors is termed as the guardians of the company who is also termed as trustee and there by answerable to the members of the trust (share holders). The board is the inner voice of the company.
Personal traits of Directors
A director should be knowledgeable person governing a company in every aspect, he should have energetic mind in winning bold decision even at the time of crisis. Communication skill is a fundamental aspect accredited to a victorious director. Every progress of the company should be a far sighted one. The director being a member of the board should be aware of the structure of the company, its nature of actions and goals. He supposes to be responsive of the law in relation to the company and internal rules of the company. The director must aware the company's activities, its advantage and disadvantage, the area which need steady attention for development.
Development related functions
The Cadbury report gave importance to the recommendations of the non executive directors. The existing directors should add weight age to the views of non-executive director as they possess lot information. They assume the role of a gate way for the board to receive external data's. In the same way they became the face of the company as they advertise the aspects and prospects of the company to the outside world. The non-executive director utilise their external contacts for the development of the company, for example: celebrities and former political leaders are offered directorships so that they could use their contacts for the development of the company. [22]
Conformance oriented function
Due to the exposure the external directors has in various fields, they tend the board to take innovative decision rather than stereotype one. The directors blend the old and new to give a renewed face for the company. They also scan and monitor the activities of the company and assist the board in taking an ideal decision. Independence of the director is crucial and fundamental but the same comes under suspicion when it is a "nominated director". [23]
Legal obligations of a director
The legal functions of directors are twin fold - the role of trustee and the role to protect. In US the directors have a function similar to that of a trustee in governing a company. In common law particular in UK directors have to take the" best interest "and if the decision of the board is not in the best interest recourse can be taken to courts. In the history of corporate governance the courts have taken a narrow stand that the decision of a director will be testified from the position of a "reasonable person "to that of a "director" .there is a prohibition on "party transaction" and no director should have any dealing or any personal interest in the activities of the company. In US "internal trading" of the director may lead to penal punishment, in UK any malfeasance by a director will amount to "corporate man slaughter". [24]
The regulations of Securities Exchange Commission and SOX Act entrust responsibilities not on the domestic directors which means the board should comprise of independent members. There are various committees Viz Audit Committee, Administration (Corporate) Managing Committee, Payment (compensation) committee. The significant feature of all these committees is that each director is independent. Though both Delaware and Texas permits delegation of the responsibilities to the smaller committees, however delegation of important tasks is prohibited. The NYSE Rule 303A.02 mandates that company should authenticate the independence of the directors by filing either yearly pseudo statements or Form 10-K to the Securities Exchange Commission. [25]
Appointment and Functioning of Directors
SOX Act list out the eventualities under which a person cannot adorn the role of a director. Some of the stringent conditions disentitling an individual to become the director of the company are:
If he/she is an employee of the company or anyone in the family holding executive position in the company.
If he /she or anyone in the family received compensation of $ 1,20,000 in the last one year from the company.
If he/she is a partner or anyone in the family was a partner in the company in the last three years.
If the aspirant or anyone in his family worked as an Executive Officer of a company where the present company's executives employed as members of the compensation committee.
If he/she or any of the close relatives is an employee of the company which has funded to the present company. [26]
The qualifications for the appointment of directors in UK are governed by Directors Disqualification Act 1986. Besides, Cadbury Report insists on the selection of non-executive directors who serve the company without the interference of the board and who can exercise decision making without any influence. [27]
Code of Conduct
The code of conduct for the officers and the attestation by the auditors are special features in the SOX Act which are absent in UK laws. Supervision of company's performance once in three years by the SEC is a salient feature in US corporate governance whereas in UK's Companies Act 2004 empowers the Secretary of State to form body to review the functioning of companies. [28]
CONCLUSION
"Milton Friedman criticised the social responsibility concept in commercial activities". There is nothing like altruism or concept of moral in business. The only loyalty for corporate management is to increase the profits for the shareholders. [29] The above concept was emphasised by Dodge Vs Ford where the court endorsed that the most important alarm and responsibility for the directors is to protect the interest of the shareholders and enhance the profits and interests. It is also termed "Best interest of the corporation". [30] The relation between business enterprise and ruling establishment had a sea change when inclusion of amendment legalised corporate spending for elections. Such a relationship had an adverse impact on the government formulating regulation for business sector. [31] Thus, it is pertinent to point out that history has seen so many institutions getting ruined during the passage of time and despite all the bickering, the corporation has survived. [32]
From this it is clear Vital to the success of any company is an effective board of directors that not only provides entrepreneurial leadership, but also ensures that effective controls are in place to manage risks
