Finance Business

Corporate Governance Failures from the Global and Indian Perspective

Laws must be passed to address frauds that have an impact on the corporate and securities markets. Given the frequency of corporate governance failures within an organization, governance strategies are necessary. Failures in corporate governance will have a significant impact on stakeholders and investors in addition to the economy.

Every organization would have sufficient mechanisms in place to ensure compliance with corporate governance. However, when it comes to compliance, organizations must adhere to efficient processes. It is crucial to comprehend what governance means to comprehend the structure supporting efficient corporate governance.

Corporate Governance

The interaction between an organization’s numerous stakeholders is referred to as governance. Shareholders, directors, workers, and the general public can all be considered stakeholders. Therefore, corporate governance can be defined as the connection between an organization’s shareholders, stakeholders, and employees. The corporate governance framework makes sure that there is enough transparency among the organization’s stakeholders.

Corporate governance failures can take many different forms when there is ineffective transparency within an organization. A business can focus on its corporate aims and commercial goals by creating a sustainable corporate governance system. The business must take into account cultural values, market forces, governmental policies, and other legal considerations when putting in place a corporate governance structure because these elements frequently have a direct impact on the firm.

The growth of the economy and profit maximization by a corporation are causally related to corporate governance. It aids in creating a framework for compliance for an organization. There must be regular checks in place for this framework to be regularly monitored. Companies would abide by the law in this fashion, and society would experience fewer instances of corporate governance failures.

Evolution of Corporate Governance

Corporate governance has existed for a very long time. The Securities Act of 1933 and the Securities Exchange Act of 1934 were created in response to the USA’s Great Depression in 1929. The Securities Exchange Commission (SEC) was founded to oversee the securities and financial markets in the USA after legislation was put in place. Due to the evolution of corporate governance over time, theorists have proposed several models and theories. Because of corporate governance failures, these ideas have been created in the USA and the UK. Thus, it is clear that corporate governance theories have existed for a very long time since ancient periods.

Corporate Governance Failures from the Global Perspective- USA Scenario

The Securities Exchange Commission was founded in the USA after the Great Depression to oversee the corporate market and the governance of securities. Take the case study of the Enron Corporation from the year 2002. The market and investors were horrified by one of the biggest corporate governance breaches. One of the most innovative and creative companies in the USA was Enron Corporation. The organization’s corporate officials thought about embracing the perseverance motive.

Additionally, the organization developed particular proactive practices that allowed it to grow to new heights. The business’s stakeholders filed a securities lawsuit in 2002, accusing the corporation of deceiving the public. The management oversaw the corporate governance failure that Enron caused. A proper compliance requirement must exist in an organization with a proper corporate governance framework. Lack of communication between the management, auditors, directors, and lenders was a major factor in Enron’s case.

Situations which led to the corporate governance failure of Enron

The hierarchy of governance would descend from the management. The organization’s management and auditors were accused of fabricating financial records. The following were some of the reasons why Enron’s corporate governance plan failed:

Market Diversification – Free commerce was established, and markets were opened up for diversification. Enron’s management took advantage of this chance to promote its products, and its extensive network of government contacts enabled them to grow quickly.

Lack of SEC Monitoring of the Securities Market: Even after the agency’s inception, there was a lack of SEC oversight and poor management, which contributed to the mess.

Transparency – Enron’s directors and stockholders lacked transparency. Additionally, the management of Enron placed a greater emphasis on corporate objectives than on stakeholder ones.

Auditors’ manipulation of the accounts – Auditors were a key factor in the collapse of the energy giant Enron. To raise the share prices on the open stock markets, they massively manipulated Enron’s financial records. The auditors were not regularly rotated aside from this. This prompted the decision to have the same auditors provide both auditing and non-auditing services.

Mistreatment of Specific Purpose Entities (SPE) – A variety of assets are stored in Specific Purpose Entities. All of the debt transactions were transferred to these organizations, but Enron mistreated them.

The main causes of Enron’s collapse were the five things mentioned above. This is one of American history’s biggest corporate governance failures. However, this resulted in a number of different corporate governance problems at diverse organizations. Due to the prevalence of corporate governance failures, it was necessary to develop proper corporate governance reporting and compliance mechanisms.

Federal Regulation to Tackle Corporate Governance Failures- Sarbanes Oxley Act (SOX Act)

To look into the number of market failures, several pieces of legislation were introduced at the federal, state, and institutional levels. The Public Company Accounting Reform and Investor Protection Act, more commonly referred to as the Sarbanes Oxley Act 2002, was one of the crucial pieces of legislation that was introduced in this field to control governance. The goal of this legislation was to regain the trust of investors in the US government.

Essential Features of this Act

• Applies to domestic and foreign businesses that are listed on stock markets like the NASDAQ and NYSE.
• Every public accounting company in the USA is under this act’s scrutiny.
• Compliance is required, and non-compliance must be reported.
• All American public firms must comply with this law.
• Private companies are exempt from this requirement.

Has the Sarbanes Oxley Act Reduced the Number of Corporate Governance Failures?

The Sarbanes Oxley Act applies to all public companies and businesses that are listed on public stock exchanges due to the aforementioned factors. Private businesses are exempt from the mandatory application of this law. Private enterprises are as susceptible to corporate governance failures. The federal government and institutions would implement emergency measures, as was seen during the 2008 global economic crisis. As a result, the Sarbanes Oxley Act has served as a safeguard against poor corporate governance. However, the law must be updated and improved regularly. Without it, there will be numerous instances of corporate governance failure.

Corporate Governance Failures- Perspective from the Indian Scenario- Introduction of the Companies Act 2013

In 1990, marketplaces in India were opened up. The Corporations Act 1956 (previous company law) was passed to investigate how businesses founded in India were being run. A securities regulator, similar to the SEC, was established in India to ensure that the country’s securities laws were being followed. The Securities Exchange Board of India (SEBI) is the official name of this organization. After instances of poor corporate governance, such as the Harshad Metha fraud, this was established in 1992. The SEBI serves as a market watchdog for listings, much like the SEC. All businesses that are regarded as public firms are required to abide by SEBI-related legislation.

The software industry suffered negative effects during the 2008 financial crisis, which had a significant influence on that industry. Think about Satyam Computers as an example. One of India’s biggest examples of poor corporate governance. Given that Satyam was one of the biggest information technology companies in the Indian economy, the Satyam crisis has been proclaimed “India’s Enron.” It is possible to draw comparisons between the Enron and Satyam scandals, both of which had management leaders who misled shareholders and investors.

There were many similarities and distinctions between the two scandals mentioned above. The SOX Act’s guidelines would apply to Satyam because it had securities listed on the NYSE (New York Stock Exchange). Some of the factors that contributed to Satyam’s downfall:

• The company’s accounts are being falsely reported, which raises stock prices.
• Hiding debts and assets.
• Governance and transparency concerns were the main contributing factors to the Satyam Fraud and lack of communication between the auditors and management.
• In India, family businesses lead to a lack of professionalism.
• SEBI’s capacity for monitoring.

Following the Satyam scandal, there were numerous conversations about how to modify the way the prior firms operated. In response to the numerous instances of fraud and poor corporate governance, the Indian government introduced the new companies act in 2013.

Legislation Action for Corporate Governance Failures (Companies Act 2013)

The Companies Act of 2013¹ was enacted in 2013 as a first step towards regulating India’s corporate culture. This led to a number of adjustments in the company’s requirements for compliance. Some of the laws that were passed include the following:

• Having independent directors is necessary.
• Having a woman director on the board is mandatory.
• It has corporate social responsibility compliance standards.
• Placed importance on the function and accountability of directors.
• Access to transparency among stakeholders has been improved.
• Guidelines for a corporate governance system were given.

Effect of the Companies Act 2013- Has It Reduced the Number of Corporate Governance Failures?

Even though the Companies Act of 2013 has significantly altered the corporate landscape, the number of governance failures in the nation has not decreased. Less compliance and the meagre fines levied against the offending company are some of the causes of this. Additionally, the enforcement procedures used by different Indian institutions are cumbersome. This situation necessitates the adoption of tighter regulations by Indian businesses. Innovation is crucial, in addition to the ongoing requirement for the law governing compliance and reporting in India; by effectively implementing the aforementioned procedures, corporate governance problems can be prevented.

Conclusion

The relationship between the organization’s management, shareholders, and stakeholders is known as corporate governance. To guarantee successful compliance, there must be enough transparency between the aforementioned parties. After the Enron scandal, the Sarbanes Oxley Act was introduced. The reporting standards of businesses have undergone many adjustments as a result of this statute. As a result, the Sarbanes Oxley Act has fewer instances of bad corporate governance. The need for innovation in governance laws is continual, nevertheless. Despite the adoption of the Companies Act 2013, there have been corporate governance failures from the standpoint of the Indian situation. However, this law has given businesses a way to comply with it. To decrease the incidence of poor corporate governance, the Companies Act 2013 has to be amended.

FAQs

1. https://www.mca.gov.in/content/mca/global/en/acts-rules/companies-act/companies-act-2013.html