Comply or Die Series – Blog #2 – Corporate Governance – “We didn’t think it would ever actually happen though”
It is hard to ignore the impact of corporate governance since the millennium, likewise it is hard to ignore the words ‘Enron’, ‘WorldCom’, ‘Arthur Anderson’ or ‘Sarbanes-Oxley’ when discussing any element of corporate governance. Essentially corporate governance refers to the way in which a company is controlled and administered. Its scope is not just internal in nature but also encompasses to the external stakeholders including suppliers, shareholders and the general business community. Its focus is ensuring that companies are accountable for their actions, transparent with much of their dealings and administered in the best interests of the business. The issue of corporate governance rose to the front pages of the broadsheets in the early part of this decade when a number of blue chip companies were found to have undertaken fraudulent accounting practices in an attempt to conceal financial liabilities and mislead shareholders. The scandal and others similar in nature led to:
• the collapse of the Enron Corporation from assets over $60 billion in Q1 2001 to bankruptcy in Q4 2001;
• the collapse of WorldCom from assets over $100 billion in Q2 2001 to bankruptcy in Q2 2002; and
• the demise of Arthur Andersen LLP from one of the big five accounting practices in Q2 2001 to withdrawal from the market in 2005.
What is interesting about the latter is that since 2005, Arthur Andersen has had its fraud convictions in Enron over-ruled in the US, yet the partnership has not re-entered the market under its former prestigious name as the negative impact to its public image has been terminal and irreversible.
It is not just accounting scandals that corporate governance seeks to limit; more recent examples include the subprime mortgage model that is considered the lynchpin of the recent global economic downturn. Although many analysts and actuaries will tell you that the lending model in the subprime mortgages was genius in its inception (but) it is a corporate governance point that the senior management in the financial institutions never considered the ‘what if’ scenarios and looked at whether the business model could actually be supported in the real world. The BP oil spill in the Mexican gulf highlighted another corporate governance point that asks ‘should BP have had better reporting processes in place and information disclosure available for an internal situation that was clear to any reasonable man would affect all company stakeholders and the external environment further down the line’.
The cost of poor corporate governance is all too clear and all too serious for any business. So what can businesses do to stay on top of corporate governance?
Corporate governance is something that should be ingrained into the company like its life blood. It should be promoted from board level and pushed through every level of the organisation including the supply chain. A company needs to ensure they recruit the best people to define the strategic and steer the company, people who aren’t known to cut corners, people who the stakeholders can place their trust in and most importantly, people who are not afraid to take responsibility for the actions of the company.
Those people who reside at mid to senior management positions and are involved in the steering of the company should also have clearly defined roles. A team of directors should be exactly that, a team. No one director should be directly in charge of operational and financial planning. No one director should be responsible for human resourcing and information systems… and so on. Ensuring there is a clear role identification and division of responsibility helps remove the ‘primary agent’ problem where you have much executive control limited to a just a few.
Moving into the operational area, companies need to make clear their strategy and communicate the type of company they are and what they are trying to achieve. They need to ensure they adopt tried and tested processes for business activity underpinned by a suitable ‘checks and bounds’ system, so that mistakes are easily identified and dealt with effectively in the first stage before a snowballing effect can ensue. From my experience, many companies and individuals within companies do (and will at some point) make mistakes, but it is not the mistakes that define a corporation, it is how those mistakes are dealt with and resolved both internally and externally.
Of course we have discussed the problems with financial accounting above and on the back of the Enron saga, legislation such as the Sarbanes-Oxley Act in the US, the Companies (Audit, Investigations and Community Enterprise) Act 2004 and the Companies Act 2006 in the UK (along with a host of others), all laydown rules and regulation for companies operating within their jurisdictions. All companies within the relevant jurisdiction must abide by such legislation which is clear and obvious and should ensure they perform the necessary due diligence on engagement with professional advisors that are providing legal and financial advice to the company. All professional service markets around the world are competitive and if the company feels unsure about the actions of one of their advisors, they should explicitly ask the pertinent questions or ask competitors for advice. In the case above, it seems obvious that a top five accountancy firm or magic circle law firm could not be wrong, but would it have been so hard for Enron’s senior management or any other company for that matter to take a view that shredding important financial documents is probably not an acceptable practice allowed for in legislation, or as the case may be not lead to a anything at all that is commercially positive?
The same level of due diligence should be employed in the engagement of other third parties to the company. Simple vetting of customers for money laundering or criminal activity will prevent the company from being involved with monies that have come from the proceeds of crime (an offence that can attach to the receiving party in the UK if proper checks were not undertaken). Vetting of suppliers of their company values and working practices is also a definite best practice. You will see over the next few blogs in this series how supplier’s working conditions can seriously undermine a company that has no direct connection with the supplier other than that, a contract for the provision of goods or services.
Finally as well as making clear to the outside world the company’s corporate governance strategy and company mission, transparency with the media and regulatory services is always going to be the primary channel for promoting the company’s corporate governance initiative and generating a positive public image. Dealing with the media is a skill in itself hence why many FTSE 250/Blue-chip firms have large dedicated marketing teams. However many companies take the view of massively exposing the good and covering up the bad. In this current day of digital information disclosure, very little stays covered up and it is very easily for news items to escalate over a very short time. The simple solution, turn every negative into a positive, if a company has done wrong in the eyes of market, then take the exposure to show how it has been resolved, what the company has learnt from the wrong and what initiatives are being introduced to ensure a similar incident does not occur again. It goes without saying that actually going through these steps internally before such communications are a necessity.
All in all, from all of the drivers, corporate governance is the most encompassing but it is the one that is easiest to deal with and implement as ultimately underneath all the bravado, it is simple commercial common sense. It is holding your hands up when you get it wrong, it is flying the flag high when you get it right, it is acting on that uncomfortable twinge that sometimes occurs when dealing with a third party and it is making sure that the company is always acting in the best interests of its number one stakeholder… itself.
Rob Smith is the head of enterprise projects within the Product Development Partnership Group of companies. He is also a fully qualified commercial solicitor.
Contact Rob firstname.lastname@example.org