Essay on Corporate Governance

Question 1. Corporate Governance

Corporate governance is a compliance of rules that govern an organization basing on the stakeholders interests, the local government laws, customers as well as financial institutions, and other valuable partners (Aguilera et al., 2012). In order to gain an efficient corporate governance, an organozation has to take into account the election process of a board of directors ruled by the assigned chief executive officer. The organization also has to assign an independent chairman. The nowaday business world, separates corporate governance as the most vital aspect that controls the company’s status. In the end there has appeared some myths about the notion of corporate governance that apparently has no concrete evidence supporting them. Unfortunately, most companies have inculcated these practices at the roots of their companies’ management and there have been adverse effects that have threatened the existence of these companies.

The myths include; the quality of the board is determined by the structure of the board, that CEOs are overpaid, regulation improves corporate governance, companies are prepared for a CEO succession and that the best practices are the solution to effective corporate governance. All the above-listed myths have not been proven that they can work (Larcker and Tayan, 2013). However, Charlie Munger who is the Vice-Chairman and partner to CEO Warren Buffet at Berkshire Hathaway dismisses the myths as not being the best practices to guide the operation of a company. He instead comes up with his insights that are a contrast to the commonly known best practices.

Charlie Munger insists on a trust-based kind of governance which he says is far much better than the ground rules on compliance and regular uncalled for audits. He argues that trust is a piece of fabric which if practiced within the confines of a company makes it efficient. Another issue that he talks about is on having a powerful CEO. The Chief Executive Officer should be someone who can guide the company towards the right direction. Most importantly he should be guided by integrity in making elaborate long-term decisions for the company. He or she should be able to create a good relationship between the organization and the outsiders.

The CEOs and directors of companies should be modestly compensated according to Charlie Munger. He adds that one should not run a business in which he has made it easy to steal because it will eventually turn the good employees into bad people. Methods which make it hard to steal should be devised in organizations to counter theft (Larcker and Tayan, 2014). Another aspect is that the company has to be built on a particular culture; a culture that distinguishes the company from all the other companies in the field. The culture will go a long way to dictate how the company operates for generations. It should be in such a way that an outsider cannot tell that there has been a change in the management structure long after the ones currently in charge are gone. It is a trend which more often than not leads to business success.

CEOs and director compensation is also very important at least according to Charlie Munger. He says that it should be carried out modestly. A large number of firms in the U.S compensate CEOs with an amount far much below the company’s net worth. That is how it should be because the CEO has the responsibility of making the company better than he found it. He gives examples of CEOs in the past who have turned down compensation in the best interests of a company. Some of the take home no salaries, they barely survive on dividends (Tayan and Larcker, 2014). Compensation from a company to directors and CEOs should just but be a token of appreciation rather than a given percentage of a company’s revenue.

Conservative accounting is quite recommendable if good financial reports are to be realized (Tricker, 2015). In as much as a business has thrived well, it should not be assumed that that will always be the case. The future is always so unpredictable in every aspect of the business, especially in accounting. The way accounting is done therefore should neither be too optimistic nor pessimistic. Optimistic accounting more especially is the cause of most problems that the world faces today. It might result in revenue overstatement and a consequent underestimation of the loss that is likely to be incurred (Keyser, 2015). In my own opinion, I agree with Charlie Munger and indeed accept that the incorporation of his system in companies is likely to lead to unprecedented levels of success.

Q2. Role of SEC, PCAOB

The Securities and Exchange Commission (SEC) plays a major role in regulating the accounting standards. It was established in 1934 by the Congress and is responsible for coming up guidelines that must be followed by all companies registered by the stock exchange. Under the SEC we have the Generally Accepted Accounting Principles (GAAP) which applies to all publicly traded companies (Securities and Exchange Commission, 2015). While other countries have been unable to regulate securities exchange, the SEC finds it easier to deal with 12 000 companies to which the federal securities legislation applies which is a significantly small number as compared to about 3.7 million corporations in the U.S. SEC expects strict compliance from all the organizations involved. This is ensured by the elaborate governance system which has zero tolerance to non-compliance in all the stages of management

SEC is so powerful that it can subject any company that is not compliant with its standards. There are a lot of accountants and lawyers working in various offices with the Securities and Exchange Commission. That is a clear indication that the commission has enough resources to adequately investigate a company before taking action as prescribed by the law. If SEC receives information that a given company is following its standards other than the ones required, they first make an inquiry through a cover letter (Securities and Exchange Commission, 2015). SEC then proceeds to file a case against the company if the allegations turn out to have some truth in them.

The Public Company Accounting Oversight Board (PCAOB) which was created in 2002 has the duty of monitoring the audits of public companies. This is in a bid to ensure that the audits are compliant with the set standards and to protect the interests of investors. It is focused towards seeing to it that accurate audit reports are released to the general public. All the activities of registration, inspection, standard setting, and enforcement carried out by this board must be approved of by the Securities and Exchange Commission (Keyser, 2015).

Q3. Board of Directors - Structure and Consequences

The structure of the board of directors in a company is quite essential as far as best practices are concerned. The company should have an independent Chairman as well as a Chief Executive Officer. The duty of the chairman is to chair the board, and that of the CEO is to lead the company. That is a clear indication that the duties of the two are quite different. In the boardroom diversity is equally important. It is prudent to have directors from different ethnical backgrounds, sex, tribes, and even with a wide variety of skills to enhance the spirit of togetherness.

The board ought to have a well-laid succession plan for its directors which should be disclosed for usage in the future. The board of directors should be individuals who have been a lot in dealing with different scenarios in the business community with vast knowledge of what the needs of the company are. The board of directors should be accountable to the shareholders by attending the board meetings, vying in the annual board elections and dedicating much of their time to safeguarding the interests of the shareholders. (Larcker and Tayan, 2015).

Gender parity is an emerging issue in the 21st century and should be addressed with utmost urgency. This poses the need to include a certain percentage of women in positions previously prominently known to belong to men. At the top of the list is the board of directors of companies which over the centuries has been dominated by men. Most countries have passed the increase in the number of women representation on the board as a legal requirement. Norway was the first country to comply by setting their percentage at forty in all publicly traded companies. Later in Britain and France followed suit (Aguilera and Kabbach-Castro, 2012)

Research shows that the incorporation of women in the board comes with a lot of benefits as opposed to having their male counterparts alone. Women think differently on matters customer service, market structures especially when the target market are women, investment opportunities that the company can venture into and innovation of the existing systems of operations. Ladies are also known to be critical thinkers characterized by firm decisions making. A survey the first women ever to be elected to a board revealed that a majority of them had impressive professional and personal backgrounds which is what propelled them to the board (Larcker, Tayan, 2015). Over the years, women have also made an effort to improve their academic qualifications to fit the requirements of lucrative positions. It is evident most companies have experienced significant growth during the tenure of women on their board of directors unlike any other time,

Q4. Earnings Management and Earnings Quality

Earnings management and quality should be taken into significant consideration in any company that aspires to grow. If earnings are not managed properly, then there are adverse consequences that result. The Adelphia Communications Corporation Scandal is an excellent illustration of what can befall a company in the event of poor earnings management. The key players in the fraud incident were John Rigas and his three sons Timothy, Michael and James Rigas as well as two senior executives James R. Brown and Michael C. Mulcahey. The above named were named in the worst fraud that has ever occurred in a public company, and as a result, SEC filed a case against them (Lessambo, 2014).

The charges that SEC brought against Adelphia were an abuse of control, breach of contract, breach of RICO act, fraudulent conveyance among others. Adelphia was unable to stabilize after their liabilities had overtaken their assets with a significant margin hence forcing them to file for bankruptcy on June 25, 2002. One of the major factors that contributed to the fall of Adelphia was the fact that the board of directors comprised of a large percentage of family members. This is not advisable since subjecting a family member to prosecution in the event of fraud is not an easy thing to do. Secondly, the Rigas were unable to differentiate between their expenses rather than those of the company. They kept spending company assets for their gain till it was too late to reverse the situation they had placed the company in (Tricker, 2015).

References

Larcker, D. F., & Tayan, B. (2013). Seven myths of corporate governance.

Aguilera, R. V., Kabbach-Castro, L. R., Lee, J. H., & You, J. (2012). Corporate governance in emerging markets.

Larcker, D., & Tayan, B. (2015). Corporate governance matters: A closer look at organizational choices and their consequences. Pearson Education.

Larcker, D. F., & Tayan, B. (2014). Corporate governance according to Charles T. Munger.

Keyser, J. D. (2015). The PCAOB’s role in audit conduct and conscience. Research in Accounting Regulation, 27(2), 111-118.

Securities and Exchange Commission. (2015). How the SEC protects investors, maintains market integrity, and facilitates capital formation.

Johnston, R., & Petacchi, R. (2017). Regulatory oversight of financial reporting: Securities and Exchange Commission comment letters. Contemporary Accounting Research, 34(2), 1128-1155.

Larcker, D., & Tayan, B. (2015). Corporate governance matters: A closer look at organizational choices and their consequences. Pearson Education.

Tricker, R. B., & Tricker, R. I. (2015). Corporate governance: Principles, policies, and practices. Oxford University Press, USA.

Lessambo, F. I. (2014). Corporate Governance, Accounting and Auditing Scandals. In The International Corporate Governance System (pp. 244-263). Palgrave Macmillan UK.