Corporate Governance in the Aftermath of the Global Financial Crisis, Volume IV

Zabihollah Rezaee

• Publisher: Business Expert Press
• Year: 2018
• Print ISBN: 9781947843745
• eBook ISBN: 9781947843752
• Topic: Business
• Subtopic: Business General
• Index: Business

Corporate governance has evolved as a central issue for public companies in the aftermath of the 2007–2009 global financial crisis. Corporate governance is a process (journey) of managing corporate affairs to create shareholder value and protect interests of other stakeholders. This book presents a road map for various functions and measures of corporate governance. The participants in the corporate governance process are the board of directors, executives, stakeholders, internal and external auditors, financial analysts, legal counsel, and regulators. This book is organized into four separate volumes; each volume can be utilized separately or in an integrated form. The first volume consists of five chapters that address the relevance and importance of corporate governance as well as the framework and structure of corporate governance. The second volume consists of four chapters that present the three prevailing corporate governance functions of oversight, management, and monitoring. The third volume consists of four chapters that address corporate governance functions performed by corporate gatekeepers, including policy makers, regulators, standard-setters, internal auditors, external auditors, legal counsel, and financial advisors. The fourth volume consists of five chapters that address the emerging issues in corporate governance, including governance for private companies and nonprofit organizations and convergence in global corporate governance.

CHAPTER 1

Corporate Governance, Performance, Evaluation, Accountability, and Reporting

Introduction

Corporate governance has evolved in the best decade as primarily a compliance process to its integration into the corporate culture and business environment. In the aftermath of the 2007–2009 global financial crisis, countries worldwide have taken initiatives to improve their corporate governance by establishing more robust corporate governance measures to enhance performance, promote economic stability, public trust, and investor confidence in their financial reporting. Good corporate governance also implies the need for a network of monitoring and incentives set up by a company to ensure accountability of the board and management to shareholders and other stakeholders. The strongest form of defense against governance failure comes from an organization’s culture and behaviors. An effective corporate governance demands proper communication among shareholders, the board of directors, management, and other gatekeepers. This communication is very important in ensuring democracy in the boardroom and transparency of managerial decisions and actions in achieving sustainable performance to create shareholder value. The role of corporate governance is to align management incentives with investor interests. Accountability and performance of all corporate governance participants should be properly measured and reported. This chapter presents corporate governance reporting (CGR), ratings, and index in reflecting the effectiveness of corporate governance measures and in establishing a benchmark in evaluating performance.

Corporate Governance Performance Evaluation

Corporate governance has evolved as a central issue within regulators and public companies in the wake of the 2007–2009 global financial crisis. Corporate governance is defined from a legal perspective as measures that enable and ensure compliance with all applicable laws, rules, regulations, and standards. From the agency theory perspective, corporate governance is defined as a process of aligning management interests with those of shareholders in creating shareholder value.¹Thus, corporate governance performance should reflect how effectively companies achieve their corporate governance objective of creating shared value for all stakeholders, while ensuring compliance with all applicable laws, rules, regulations, standards, and best practices. All corporate governance participants—from the board of directors to executives, regulators, internal and external auditors, legal counsel and financial advisers, and investors—play vital roles in the effectiveness of corporate governance. Good corporate governance is committed to transparency, which should lead to an increase in capital inflows from domestic and foreign investors.

Corporate governance has evolved from compliance with laws and regulations to a business imperative in creating shared value for all stakeholders. The effectiveness of corporate governance in promoting sustainable performance and in enabling all corporate governance participants—from directors to executives, employees, and auditors—to add value to the success of their organizations should be communicated through CGR. Organizations can communicate the roles and responsibilities of all corporate governance participants and send a signal to shareholders about their success through CGR. The effectiveness of corporate governance depends on a vigilant board of directors, responsible and competent executives, and talented high-performance employees. The business culture of integrity, competency, and accountability can be measured in terms of corporate key performance indicators (KPIs), disclosed through CGR, verified by corporate governance assurance, and assessed by corporate governance ratings discussed in this chapter.

Companies have recently undergone a series of corporate governance reforms aimed at improving the effectiveness of their governance, internal controls, and financial reports. Effective corporate governance promotes accountability, improves the reliability and quality of financial information, and prevents financial crisis and scandals. Poor corporate governance adversely affects the company’s potential, performance, financial reports, and accountability and can pave the way for business failure and financial crisis. While effective corporate governance may not ensure complete corporate success and may not prevent all corporate failures and financial crisis, ineffective corporate governance is a recipe for corporate failures and financial crisis. Corporate governance measures of the oversight function assumed by the board of directors, managerial function delegated to management, internal audit function conducted by internal auditors, external audit function performed by external auditors, and compliance function enforced by policy makers, regulators, and standard-setters are vital to the effectiveness of corporate governance, improvements in corporate governance performance, and the quality of financial information.

To improve corporate governance performance, corporate governance participants—from the board of directors to executives, auditors, and legal counsel—must structure the process to ensure creating shared value for all stakeholders. The corporate governance structure is shaped by internal and external governance mechanisms, as well as policy interventions through regulations. Corporate governance mechanisms are viewed as a nexus of contracts that is designed to align the interests of management with those of the shareholders. The effectiveness of both internal and external corporate governance mechanisms depends on the cost–benefit trade-offs among these mechanisms and is related to their availability, the extent to which they are being used, whether their marginal benefits exceed their marginal costs, and the company’s corporate governance structure. Corporate governance performance can be significantly improved when there is an appropriate “balance of authority” exercised by boards, management, and shareholders in the corporate decision-making process and governance. Directors and executives are now accountable to a wide range of stakeholders, including shareholders, creditors, employees, customers, suppliers, government, and communities in which the corporation operates.

In 2016, the Rock Center for Corporate Governance at Stanford University along with The Miles Group conducted a nationwide survey of 187 board directors of public and private companies.²The study reveals that while boards generally rate themselves positively in terms of skills and expertise, significantly high negatives are a cause for concern for a large number of firms. The vast majority (89 percent) of respondents say that their board has the skills and experience necessary to oversee the company, whereas boards are less effective in taking proactive steps to ensure retaining a proper mix of skills. Over half (57 percent) of the directors agree that their board is effective in bringing new talent, and only one-third of directors (34 percent) rate their board very positively on planning for director turnover. Results of the survey suggest that boards can improve in the following areas³:

1. Trust levels are adequate as about two-thirds (68 percent) of directors report that they have a very high level of trust in their fellow board members.
2. Directors do not often provide each other with honest feedback as only a quarter (23 percent) of surveyed directors rate their boards very effective at offering feedback to fellow board members.
3. Boardroom dynamics are suboptimal for the majority of surveyed boards in the following areas: the active participation of all directors in decision making, the possibility of personal or past experience to dominate directors’ perspective, hesitation in expressing honest opinions in the presence of management, building consensus too quickly, not being focused on board issues, and a lack of proper understanding of the boundary between oversight function and managerial activities.

Corporate top executives including CEOs and CFOs should be periodically evaluated by the board of directors for their performance. Executive compensation should be determined based on their performance. The 2016 public survey on executive compensation reveals that CEOs are generally overpaid with no relation to their performance; therefore, their compensation should be significantly reduced.⁴The survey suggests the following: (1) CEOs are compensated more than they deserve as about 74 percent of Americans believe that CEOs are not paid the correct amount relative to their performance and in comparison with the average worker pay; (2) the majority of Americans (62 percent) believe that there is a maximum amount that CEOs should be paid relative to the average worker (e.g., 20 times compared with over currently paid 210 times), regardless of the company and its performance; (3) the majority believe that CEO pay should be capped in some manner; (4) the majority of respondents say that CEOs should receive only 0.5 percent of the annual revenues/value creation reported by the company as compensation; and (5) about half of respondents (49 percent) report that the government should do something to change current CEO pay practices based on the increased value creation.⁵

The 2016 survey of CEOs and directors on pay indicates the following: (1) public company directors give CEOs considerable credit for corporate success, believing that 40 percent of a company’s overall results, on average, are directly attributed to the CEO’s efforts; (2) about 76 percent of CEOs and directors believe that CEOs are paid correctly, based on the expected value of compensation awards at the time they are granted; (3) the high majority (95 percent) believe that CEO pay is aligned with performance; (4) more than 77 percent report that compensation arrangements contain the correct mix of short- and long-term incentives; and (5) about 75 percent report that a CEO’s compensation package should be performance based (rather than fixed or guaranteed).⁶

Corporate Governance Reporting

Several corporate governance reforms in the United States have been established in the past two decades, including the SOX and the DOF to restore investor’s confidence in corporate America and financial markets. CGR is intended to present reliable, useful, timely, relevant, and transparent information regarding the way the organization is managed and run—from the independence and effectiveness of the board of directors to executive compensation and risk management and investor democratic election. Effective CGR should disclose all corporate governance KPIs in a systematic and standardized format. The content and format of such reporting should be tailored to the company’s organization culture, applicable regulatory measures, the corporate governance structure consisting of principles, mechanisms, and functions, and the roles and responsibilities of all corporate gatekeepers. The new corporate governance paradigm, drawn from scholarly research, suggests that shareholders and other non-shareholding stakeholders collaborate in achieving sustainability performance and disclosing both financial economic sustainability and non-financial environmental, social, and governance sustainability performance information (that create long-term shared value and resist short-termism.⁷)

CGR entails assessing the quality and effectiveness of the organization’s corporate governance and reporting findings to interested stakeholders, including the board of directors, executives, auditors, regulatory agencies, and shareholders. CGR should disclose all relevant information about the effectiveness of the company’s corporate governance, focus on the company’s economic, governance, social, ethical, and environmental sustainability performance, provide transparent information about the company’s performance and its impacts on all stakeholders, and assess the company’s responsiveness to the needs of its stakeholders.⁸

Drivers of CGR are the following: (1) increasing attention on corporate governance in the aftermath of financial scandals at the turn of the twenty-first century and the 2007–2009 global financial crisis; (2) growing demand by investors and regulators on how public companies are run and managed; (3) market-driven interests in companies’ business models and KPIs; (4) changes in the balance of power between investors, the board of directors, and management resulting from new governance measures imposed by recent regulatory reforms; (5) more interest shown by stakeholders in understanding the roles and responsibilities of all corporate gatekeepers, including the board of directors, legal counsel, internal auditors, and external auditors; (6) the market demand for better alignment between management compensation and firm risk-taking and sustainable performance; (7) ever-increasing corporate governance regulatory reforms and best practices; and (8) the ongoing debate on how to improve the effectiveness of corporate governance either through principles-based and market-driven best practices or through rules-based and regulatory-driven reforms or perhaps through a combination of both.⁹

It is expected that regulatory reforms continue to advance, and best practices in corporate governance will evolve. The expected progress in corporate governance necessitates a better uniform and standardized CGR. Nonetheless, the establishment of globally accepted governance reporting presents many challenges regarding the format, content, structure, and frequency of reporting. Prevailing challenges are¹⁰the following:

1. CGR is a sensitive issue addressing the roles, responsibilities, activities, and accountability of directors, which may have some business and legal repercussions.
2. There are a wide range of audiences for corporate governance with no clear reporting purposes. This growing diversity of audiences and of their information needs makes standardizing CGR difficult.
3. Corporate governance disclosures are often isolated from the story in the sense that major initiatives and developments along with major challenges are typically not ment...

Table of contents

• Cover
• Half Title Page
• Title Page
• Copyright Page
• Contents
• Preface
• Acknowledgments
• Chapter 1 Corporate Governance, Performance, Evaluation, Accountability, and Reporting
• Chapter 2 Transformation of Corporate Governance and Global Perspectives
• Chapter 3 Corporate Governance of Private Companies and Not-For-Profit Organizations
• Chapter 4 Contemporary Issues of Corporate Governance
• Chapter 5 Future of Corporate Governance
• Index