9870310368 9810688945

Learning

Learning » Finance Business » Corporate Governance Failures from the Global and Indian Perspective

SP Services

Corporate Governance Failures from the Global and Indian Perspective

Varun Hariharan

| Updated: Apr 09, 2020 | Category: Finance Business

Corporate Governance Failures

In light of frauds that affect the corporate and securities market, laws must be brought out to handle such debacles. There is a requirement of governance strategies given the number of Corporate Governance failures that happen within an organization. Corporate governance failures will affect not only the economy, but it will also have a critical impact on stakeholders and investors.

Every organization would have adequate systems in place for corporate governance compliance. However, organizations must follow effective protocols when it comes to compliance. To understand the framework behind proper corporate governance, it is essential to understand the meaning of governance.

Governance is considered the relationship between various stakeholders of an organization. Stakeholders can be understood as the shareholders, directors, employees, and also the general public. Hence corporate governance can be understood as the relationship that exists between the shareholders, stakeholders, and the employees of an organization. The corporate governance framework ensures that there is adequate transparency between the stakeholders of the organization. Without having effective transparency in an organization, there can be multiple corporate governance failures.  By developing a sustainable corporate governance framework, a company can concentrate on the business goals and priorities of the organisation. While implementing a corporate governance framework, the company must consider cultural values, market forces, government, and other legal factors that tend to affect the corporation directly.

Corporate governance forms a causal link between the maximization of the company’s profit and the development of the economy. It also helps in developing a compliance framework for an organization. To continuously monitor this framework, there must be constant checks in place. In this way, companies would comply with the legislation, and there would be fewer amounts of corporate governance failures in society.

Corporate governance has been present since ancient times. The Great depression in 1929 in the USA brought out the law related to the Securities Act of 1933 and the Securities Exchange Act of 1934. With legislation in place, the Securities Exchange Commission (SEC) was established to regulate the securities and financial markets in the USA. Because of the development of corporate governance in time, there have been various models and theories propounded by theorists.  These theories have been developed in the USA and UK because of Corporate Governance Failures. Hence it can be understood that corporate governance theories are present since ancient times.

Corporate Governance Failures from the Global perspective- USA Scenario

After the Great Depression in the USA, the SEC was established to monitor the governance mechanism of securities and the corporate market.  Consider the case study of Enron Corporation (2002). This was one of the largest corporate governance failures which shocked the market and the investors.  Enron Corporation was considered as one of the most modern and innovative organizations in the USA. The corporate executives of this organization considered adopting the motive of perseverance.  The organization also devised specific proactive policies that made the organization reach new heights. In the year 2002, a securities action was brought by the stakeholders of the company for misleading the public. The corporate governance failure, which was brought about by Enron, was led by the management. If there is a proper corporate governance mechanism in an organization, there has to be the requirement of proper compliance. The failure of Enron was the lack of transparency between the management, auditors, directors, and bankers.

Situations which led to the corporate governance failure of Enron

Governance from the management would go down the ladder of hierarchy. The management and auditors of the organization were blamed for falsifying accounting statements.  Some of the factors that led to the failure of the corporate governance strategy of Enron were the following:

  • Market diversification and initiating free trade– The markets opened up to diversify. The management of Enron used this opportunity to develop its products, and a vast amount of government contacts helped them to expand rapidly.
  • Lack of Monitoring of the Securities Market by the SEC- Even after establishment, there was a lack of monitoring by the SEC and maladministration, which lead to the debacle.
  • Transparency- Lack of transparency between the directors and the shareholders of Enron. Moreover, the management of Enron focussed more on the company’s interests rather than the interests of the stakeholders.
  • Manipulation of Accounts by Auditors- Enron’s Auditors had a pivotal role to play in the downfall of the Energy Giant. They extensively falsified accounts of Enron, to increase the share rates in the public stock exchanges. Apart from this, the auditors were not rotated regularly. This led to the intention that Auditing and Non-auditing services were carried out by the same auditors.
  • Mistreatment of Specific Purpose Entities (SPE) – Specific Purpose Entities are used to store the number of assets. However, these entities were mistreated by Enron, and all the debt transactions were moved to these entities.

The above five factors were the main reasons for the fall of Enron. This was one of the largest corporate governance failures in the USA. However, this brought about a spate of various corporate governance failures of different companies.  There was a requirement to bring out proper corporate governance reporting and compliance mechanism due to the number of corporate governance failures.

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

At a federal, state, and institutional level, various laws were brought out to investigate the number of failures that affected the markets. One of the essential legislation which was brought out in this area to regulate governance was the Public Company Accounting Reform and Investor Protection Act, known more as the Sarbanes Oxley Act 2002. This act was brought about to restore shareholder confidence in the government of the USA.

Essential Features of this Act

  • Applies to domestic companies and international companies who are registered in stock exchanges such as NASDAQ and NYSE.
  • This act monitors all public accounting firms in the USA.
  • There is a requirement of complying and report for non-compliance.
  • This act applies to all public companies in the USA.
  • Private Companies don’t have to follow this mandatorily.

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

In light of the above considerations, the Sarbanes Oxley Act applies to all public companies and companies that are listed in public stock exchanges. This law does not apply mandatorily apply to private companies. Corporate Governance Failures can also happen in private companies. Federal institutions and government would bring out emergency measures that were witnessed in the 2008 global economic crisis. Given this, the Sarbanes Oxley Act has acted as a measure to curb corporate governance failures. However, there is a requirement of constant amendment and innovation of the law. Without this, there will be a large number of Corporate Governance Failures.

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

Indian markets were liberalized in 1990. The companies Act 1956 (Previous Company Law) was enacted to check into the operation of companies that were established in India. Like the SEC, a securities regulator was set up in India to check the compliance of securities law in India. This institution is known as the Securities Exchange Board of India (SEBI). This was set up in the year 1992 after corporate governance failures like the Harshad Metha scam. Like the SEC, the SEBI acts as a market monitor for listing. All companies that considered public companies must be compliant with the laws related to SEBI.

During the 2008 crisis that had a critical impact on the financial sector, the software sector was also impacted adversely. Consider the case of Satyam Computers. This was one of the largest corporate governance failures in India. The Satyam scandal can be proclaimed as India’s Enron since it was one of the largest information technology giants in the Indian economy. A comparison can be made between the Enron and Satyam scandal, where management executives were involved in deceiving the investors and shareholders.

There were a lot of similarities and differences between the above two scandals. Satyam had its securities listed in the NYSE (New York Stock Exchange), so the provisions of the SOX Act would apply to Satyam. Some of the causes which lead to the downfall of Satyam:

  • Falsifying Accounts of the company leading to an increase in stock prices.
  • Concealing Assets and Debts.
  • Lack of transparency between the auditors and the management- Governance and transparency issues were the primary cause related to the Satyam Fraud.
  • Family Businesses in India causes a lack of professionalism.
  • Monitoring capabilities of the SEBI.

After the Satyam fraud, there were several discussions to bring about a change to the previous companies’ act. The government of India brought out the new companies’ act in the face of the number of corporate governance failures and frauds that occurred.

Legislation Action for Corporate Governance Failures (Companies Act 2013)

The enactment of the Companies Act 2013 was a stepping stone in the laws which regulated the corporate culture of India.  This brought out various changes regarding the amount of compliance that is required by the company. Some of the provisions which were enacted are as follows:

  • The requirement for having independent directors.
  • Mandatorily condition of having a women director on the board.
  • The compliance requirements for Corporate Social Responsibility.
  • Placed Importance on the Role and Responsibility of Directors.
  • Improved the access towards transparency between the stakeholders.
  • Provided Guidelines for a corporate governance mechanism.

Effect of the Companies Act 2013- Has it reduced the number of Corporate Governance Failures?

While the companies act 2013 has brought out sweeping changes in the corporate world, but it has not reduced the number of governance failures in the country. Some of the reasons for this are less compliance and petty penalties which are imposed on the contravening company. To add to this, the enforcement mechanism followed by various institutions in India is slow. In light of this scenario, there is a requirement for stricter rules to be followed by companies in India.  Apart from the need for constant development of the law related to compliance and reporting in India, innovation is essential. Through effective implementation of the above mechanisms, corporate governance failures can be avoided.

Conclusion

Corporate governance is the relationship between the shareholders, stakeholders, and the management of the organization. There has to be an adequate amount of transparency between the above to ensure that there is effective compliance. The Sarbanes Oxley Act was introduced after the Enron Scandal. This act brought out a lot of changes regarding the reporting norms of companies. Given this, the Sarbanes Oxley Act has reduced the number of corporate governance failures. However, there is a constant need for innovation in governance laws. When it comes to the perspective of the Indian scenario, despite the introduction of the Companies Act 2013, there have been corporate governance failures. However, this act has provided a compliance mechanism for companies to follow. There is a requirement for amending the law related to Companies Act 2013 to reduce the number of corporate governance failures.

  •  
  •  
  •  
  •  
  •  
  •  
  •  
  •  
  •  
Varun Hariharan

Varun Hariharan has completed the Legal Practice Course from BPP Law School, Manchester. He has a Masters in Commercial and Corporate Law from the Queen Mary University of London and LLB Honours from Bangor University, UK. He specialises in law related to corporate, artificial intelligence and technology law.

Business Plan Consultant


Request A Call Back

Are you human?: 3 + 4 =

Categories

Startup CFO

Trending Articles

Hey I'm Suman. Let's Talk!