Corporate Governance ( Enron\'s case )

The subject of corporate governance leapt to global business limelight from relative obscurity after a string of collapses of high profile companies. The collapse of Enron leaves a huge scar in modern business due to their unethical and illegal operations. The result of Enron's scandal leads to thousand people losing their jobs and pensions, and all of their shareholders lost the money they had invested in the corporation. This provokes questions of fundamental aspects of corporate governance in America and functions assigned to the management of companies, particularly the role of committees on board, interests of shareholders and reduce the principal-agent problem.
Corporate governance is where legal and non-legal principles and practices held in the business corporation, exercising controls and providing direction to management considering the benefit of company's stakeholders carried by the board of directors and committees. In other words, it is "how investors get the managers to give them back their money" .It also concern holding balance between economic and social goals. The aim is to align the interests of individuals, corporations and society as near as possible. It is also designed to reduce or eliminate the principal-agent problem which occurs when an individual (agent) being able to make decision by his own best interest on behalf of another individual (principal).
In the 1990s, institutional investors' share of market increase suggested firms will be more effective monitors of management because it concerns more of firm's performance to reach profit maximization. The boards remove director suggesting decisions from CEO's control through nominating committees. The number of external directors increased during the period as did directors' equity compensation as a percentage of their total director compensation. However, these improvements are immediately shadowed when Enron's scandal surfaced suggesting that corporate governance was not immune from failure and highlight flaws of it.
The failure of Enron has shed light to few governance issues. : (i) Kopper whom has a dual role violating Enron's own Code of Ethics and Business Affairs. (ii) Misallocation of firm funds due to principal-agent problem and management abandoned their responsibility to serves as governance mechanism. (iii) Massive incentives for management self-dealings and illegally manipulate financial statements to boost stock price .(iv) The Compensation Committee lacking of oversight review to disproportionate compensation for their management. (v) The lack of transparency of financial reports to shareholders. (v) The lack of independence on Enron's Board and Andersen's auditing services.
Corporate governance functions to protect shareholders' rights. However it failed to function in Enron's case. The result of residual control rights, discretion of managers may engage to own benefits instead of shareholder's interest. The expropriation of funds through transfer pricing process shows managers in favor of self-interests manipulating financial statements abandoning their responsibility to shareholders. Using stock options grants to boost price will also allocate more costly risk taking , resulting Enron to "became hedge fund taking leveraged bets which produce huge, disproportionate bonanza for its executives...downside seemed a problem only for the shareholders." It is undeniable that executive stock options would align management and shareholder interest but management which are restrained by amount of funds in firm, is unwilling to draw attention of shareholder regarding the issue with the fear of being replaced.
The technologies used in comprehending entities in balance sheets made transactions complicated and difficult to be understood by investors, not allowing them to look into firm's financial conditions. The inaccurate financial statues of firm sabotage the rights of shareholders to make decision whether to continue to invest or server their shares allocated in the firm. Besides, the outside investors will have difficulty to recognize nature of partnerships.
Lastly, the unethical behavior was institutionalized in Enron causing the company's code of ethic insignificant. Enron is proved not following the spirt of their own procedures of codes of ethic, conduct and governance.
WorldCom presents a different situation, where it categorized operating expenses as capital expenditures, reclassified the value of assets as goodwill including future expenses and manipulated bad debt reserves calculation. The failure of WorldCom is due to fiasco corporate culture. The different background of directors at WorldCom forms hierarchical nature of organization leading departments distant from each other lacking awareness on WorldCom's issues.
The Compensation Committee is to supervise compensation of officers but in WorldCom's proxy statements, they had the power to determine 'salaries, bonuses, and benefits' of the officers. The lack of independence of board members failed to take any action allowing Ebber's loans to carry on –ignoring shareholder interests. Directors dependent on 'large issuances of equity' created conflicting interest where the goals are more focused on growth of stock instead of best interest of company. Besides that, directors close relationship with Ebbers impotent them to be independent from doing their task. The governance is obviously infringed where shareholders and company's interest serves as minimalist in consideration.
Satyam's scandal has been the greatest scandal in history of corporate world in India, where it is publicly announced and Raju confessed of having a falsified the account leading to collapsed in price of company stock. Prevention of an attempt by minority shareholding promoters to use firm's funds to buy two companies own by them. This shows CEOs unbridled greed and role of Satyam's independent directors termed as 'unpardonable', acting against interest of large shareholders. The rating agencies displayed lack of attentiveness towards assessment of Satyam and refer to fraudulently prepared and audited financial statements of the firm, thus failing to warn investors about Satyam's deteriorating conditions. After Satyam, governance issues are more emphasized in India and were made as reference to prevent the same scenario. This is crucial since India is still a developing country.
In Tyco's case, Kozlowski (CEO) took unapproved transactions and abused loan programs of Tyco. Kozlowski committed the worst violations to ethical codes by creating delusion for investors to frame them to keep investing while he sold his stock and also, claims to make donations to charity when is used as 'tax shield' for his fraudulent operations. The whole company has immensely suffered especially the shareholders which depend on information given causing them to lose money when the stock price falls sharply. 'Questionable accounting practices' used and the autocratic leadership organization culture of Tyco shown that it had established unethical ways used to gear profits margins to portrait the goodwill of the firm to increase shareholder's confidence, which is not true.
From the examples above, it is undeniable that corporate governance has not been adopted. The firms did not emphasize enough on governance and make it a compliance culture. The term 'Corporate Governance' has almost become rhetoric, where it is the most spoken and least doings. Instead of making it just a lips service, the firm should offer proper training from the top to bottom based on hierarchy chart.

High performing companies emphasize on character of a person rather than their specific qualifications because it is impossible to pay people to be committed unless they are willing to give of themselves to develop a company as equally as they needed the company for income and benefits. Enron's collapsed is perhaps because of engagement of nefarious attempts due to the environment which encourage unethical behavior.
The scandals is not just morally affected but also, economically affected. The scandals may lead to 'wealth-effect' significantly affecting consumer spending, and lead to reduction in GDP. One of the reasons of declining in financial markets is due to corporate scandals. This affects the overall revenue of the local government which will gives impact on state and local budgets for upcoming activities, the retirement funds and pensions contributing to the people.
Due to the fall of Enron and other companies in the US, the Sarbanes-Oxley (SOX) Act became law and requires all companies to provide year end reports about internal controls of companies and effectiveness of it. The Act established new financial reporting standards where the information presented in financial statements of company is under the responsibility of company's CEO and CFO. The Act also consists of criminal penalties for failure of CEO/CFO financial statement certification, influencing agency investigation and administration and retaliation against whistleblowers.
The passing of SOX benefits the firm and investors. Researches shows that SOX enhanced corporate transparency in cross-listed firms, improved internal controlof companies leading to increase in share price, and most importantly, more reliable financial statements. However, there are criticisms saying that SOX a costly government interference into corporation managements causing them at competitive disadvantage with foreign firms. The smaller international companies are more likely to list in stock exchanges in the UK rather than US stock exchange.
The Sarbanes-Oxley Act is probably the best piece of legislation to protect investors in modern times, and providing corporate governance and accountability. SOX also prevent fraud cases like Enron and other corporations to take place again. It encourages ethical culture by forcing top management to be transparent and employees to be responsible whilst protecting whistleblowers.
Compare to the US, the UK used to focus on moral philosophy rather than economics, focusing on participation and responsibility towards stakeholders. However, things changed after conceptual framework provided to bring economic theory into mainstream UK company law analysis. Law Commission increasingly utilized economic theory in their company law work and Court of Appeal use economic analysis deciding in Item Software Ltd v Fassihi - showing support. Despite so, moral philosophy still has a strand in debate.
In response to scandals, various laws have been passed in many countries on issues of corporate governance. In recent years, there has been a strong trend towards the adaptation of 'soft regulation' in form of codes of corporate governance. The codes can be defined as 'a non-binding set of principles, standards or best practices, issued by a collective body and relating to the internal governance of corporations'.
These codes first arise from The Cadbury Report which addresses issues such as relationship between the chairman and chief executive, the role of nonexecutive directors and reporting on internal control on company's position. The recommendations in the report containing set of rules addressed to directors of all listed companies in the UK, and many are still in force today. The trademark in the report is 'comply or explain' approach, where the companies need to report whether they had followed the recommendations, and requires explaining why they had not done so.
Despite going through numerous changes subsequently updating the Code to reach the qualified corporate governance practice, the 'comply or explain' approach is still retained. Today, the UK Corporate Governance Code is regarded as international benchmark for good corporate governance practice. This approach shows flexibility, allowing companies to make choices whether to comply with its principles contrasting to US concept of corporate governance. The merit is due to the idea of encouraging companies to adopt spirit of the Code rather than compliance statutory exercising. It needs to be implemented regarding to the culture of individual company which may vary enormously from different companies depending on their individual factors.
Although it is not compulsory for companies to implement the Codes, companies need to make explanations which measures up to the expectations of shareholders. The stronger explanation provided will be less likely to be rejected by shareholders adopting a box-ticking approach. Shareholders may apply pressure to persuade the board to change its mind, indirectly deciding level of compliance as shown in Morrisons' case. Codes are not compulsory but exist for guidance and represent best practice.
This flexible mechanism enables companies to adopt a different approach which is more appropriate to their circumstances, without imposing requirements that are excessively burdensome and costly, especially for small companies. Also, it encourages introduction of new provisions promoting innovation which belief that it will lead to better governance in substance. Therefore, it allows companies to think of the purpose of provision rather than just 'tick the box' helping companies internalize it as their own norms.
Whether the company's governance practices are effective, the assessment of sustainable success of company is made by intended beneficiaries – shareholders. Therefore, shareholders need to have sufficient information to make judgments on governance practices of companies and rights to influence the board when they disagree. For system to work efficiently, appropriate regulatory framework is needed.
The 'Comply or Explain' approach basic premise has been adopted by several other countries such as Austria and Germany. However, the German Corporate Governance Code uses two-tier system where supervisory board plays an active role to advice and control management board with company's best interest. This system concerns the independency of supervisory board and its members to ensure effective governance. The boards play a massive role in German due to their acknowledgement of companies' circumstance; whereas in the UK, shareholders still have sayings despite having insufficient knowledge of companies' operations.
In the US where Sarbanes-Oxley Act codified as law shows a stricter approach towards corporation governance due collapsed of Enron. This contrasts with the UK whom adopts uncodified constitution. There is no room for flexibility in US since they are one of the developed countries which play a massive role in worldwide economy. If the US companies did not fulfill the requirements stated in the act, it will be held as crime. While in the UK, the Boards are required to give explanation which meets expectation of shareholder interest. Coherently, US are more economical based where UK lean more to moral philosophy.
In Malaysia, the practices of governance mechanism can be analyzed from directions in master plans so as orders from regulatory bodies. The Malaysian Code on Corporate Governance 2000 is perhaps almost aligned with UK Corporate Governance Code, however Malaysia's state of corporate governance is highly intertwined with pervasiveness of race based affirming in all aspects of companies. Besides Malaysia aims to improve quality earnings among firms thus, discretionary accrual was used for earnings management and was regressed on two governance mechanism: board of directors and audit committee.
Malaysian Code is constantly under review to improvise the regulations adopting by country's circumstances. The public interpreted that unethical corporate behavior in country is due to poor regulations affecting the judiciary system. Therefore, the judge has to meet criteria laid down by government resulting prosecutors is under pressure to meet the government goals instead of public interests, shown in Pancaran Ikrab Berhad case. Government intervention using political decisions is the main reason of failure to reach the primary objective of corporate governance acting as stakeholders safeguard mechanism.
It is suggested that perhaps Islamic ethics could be a possible solution to prevent unethical governance acts since Malaysia highly intertwined with race based in different aspects of corporate sector. By applying religious theories, it educates a person to uphold moral values in their lives. It should be adopted since young encouraging one to observe matters spiritually rather than the letter of law. However, this suggestion concluded with criticism as there is substantial lack in theories since some people do not believe in religion and even so, they do not believe it should be apply in one's daily life.
Compare to the UK, Malaysia Governance Code is less rigid and comprehensive as Malaysia is still taking baby steps to implements Codes suitable for the multi-racial based country which requires all aspects of considerations to prevent injustice and racism issues.
Tesco's scandal which is due to profit exaggeration to make their performance more appealing and PwC (external auditor) allows Tesco to get away with overestimation in profit. Despite already warn Tesco of 'risk of manipulation' in commercial income account, PwC effort in protecting shareholder's interest is still insufficient.
In Malaysian Scenarios, the Transmile Group and Megan Media scandals are regarded as mini-Enron shocking the local securities market. Both scandals has identical unethical issue involving external auditor not highlighting the problems in companies' accounts in board meeting and even engaged in engaged in the activities. This shows that unethical behavior of one not considering shareholder interests. The auditors breached the scope of their job to highlight the problems in accounts, showing failure of governance behavior.

Perhaps it is true that Corporate Governance is already in practice, but the importance of corporate governance is not emphasized enough in the current globally expanding and competitive market. Improving governance and continuously have them updated is crucial in this blooming economy to prevent another Enron's case. This improvement could be done through legislation or regulation.
The legislation regarding to this issue should have law validity as reminder for companies that it is illegal to do such unethical act. Therefore, Sarbanes-Oxley Act is regarded as the best piece of legislation. However, the Governance Codes which is adopted in several countries shows flexibility. Perhaps the 'explain' approach to shareholders considered as sufficient for the board to make decisions, however it is only efficient when shareholders has knowledge and accurate information presented to them.
The agency and stakeholder theory should reconciled and develop "responsive codes of practice" that incorporate relevant parties in the preparation, monitoring and amendment of codes.
Multinational companies have a critical role to uphold and advance corporate governance to social and environmental standards, especially in less developed countries. They could offer proxy voting to give shareholders to discharge board members. Most corporate fraud are due to greed, thus the executive's pay should be fully disclosed. Companies should outline strong whistle-blowing framework to employees to emphasize on ethics.

The independence of directors is necessary component to be maintained and they are supposed to be a free individual not relating to managements, being able to exercise independent judgment based on significant business experience. Truly independent board members are crucial because there are several examples of the scandals involving the unprofessionalism of the board allowing the unethical behaviors to prevail. Not only shareholder interest and company revenue should be focus on, stakeholders' interest should also be considered as whole to achieve true governance behavior.
Corporate governance should not be just merely a term, and should be practiced in all companies to deliver ethical behavior resulting long-term success of companies.






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