Sox Act and Importance of Corporate Governance - Essay Example

Corporate finance Table of Content 3 Case background 3 Answer 4 Answer 2 5 Combined and importance of corporate governance 6 SOX Act and importance of corporate governance 8 References 10 Bibliography 11 Abstract This paper represents a strategic financial report of academic area of corporate finance. This report focuses on two major areas of corporate finance of a newly formed country. These are corporate reporting and corporate governance. The objective of the report is to develop a report for the finance minister about development of standard corporate reporting regulations in the country and importance of standard corporate governance regulations as an important part of corporate reports published by the public companies. Therefore, this report will deal with these two areas of corporate finance through in-depth analysis on these areas with respect to the situation. Case background Breakavia is a newly formed country. The country has been formed recently by splitting from earlier communist states. The newly formed government of this country has recognised that there are many advantages in developing a democratic country and forming capital principles to regulate the country. Government also identified that the country has enough natural resources like oil and mineral reserves and therefore, it can functions as an independent state depending upon these huge natural resources sufficient for sustainable development of the country. As a newly developed country, the government thinks to invite the European multinational companies to enter to this market and use the natural resources which lead to overall development of the country in terms of many areas like economic development and employment and many more. For this purpose, the finance department of the country has decided to develop a standard tax regime and banking systems which will provide low cost finance for commercial and domestic housing development opportunity for developing tourism industry in the country. The government is also aiming to setting up Stock Exchange in Heeritis, the capital of this newly formed country. Therefore, to develop corporate sectors consists of domestic as well as foreign companies; the government is seeking corporate financial advice regarding development of a standardised corporate reporting for regulating businesses sector in the country. For this purpose, the finance minister of this country needs advice regarding two important areas of corporate finance. First, advice for standardised corporate reporting development by adopting any existing international standardised financial reporting. Second is importance of corporate governance in business and as an important part of annual corporate report the companies. Answer 1 International Accounting Standard Board is the one and only organization that can support and implement the development of standardised corporate reporting standard in the country. The board has recently developed latest standardised financial reporting standard i.e. International Financial Reporting Standard which has been implemented in many countries and most of the multinational organizations in the world. It is the best and mostly used financial reporting standard which the country can adopt as their standard corporate reporting the domestic businesses. International Accounting Standard Board is an independent non-profit organization or body that continuously involve in developing and improving policies of international accounting standard. On April 2001, this board was founded which was previously named as International Accounting Standard Council. This board has recently developed International Financial Reporting Standard which is major revised form of former International Accounting Standard. The main objective of formation of IFRS is to reduce the limitations of policies of former IAS complained by many multinational organizations (IFRS, 2012, p.1). Therefore, IFRS is a most advance and efficient accounting standard that any country can adopt and implement as standard corporate reporting for the companies listed in stock exchange in the country. After formation of IFRS, it has become the parent entity of IASB and it has incorporated as independent entity based in London with the main objective to continuous development of international standardised financial reporting principles. This board consist of two main bodies. One is trustee and another is accounting standard board. Accounting standard board also consists of two department i.e. interpretation committee and advisory council. IASC trustees have the right to appoint the members for IASB. They involve in raising funds for running the board and also exercise oversight. Answer 2 Corporate governance is the standard set of principles developed by the companies to show its extent of confidence in terms of capability of the company to maintain sustainable interest of all the stakeholders. Main objective of corporate governance principles to conduct a business with integrity and fairness and the business should be transparent in all financial transactions. It should provide all necessary disclosure and discussions following all laws of the land and it should have responsibility and accountability towards its commitment to the stakeholders so that it can run a business with an ethical manner. Good corporate governance refers to standard level of confidence from a company through its positive commitment through corporate governance policies. The independent present in board leads to high confidence of the company in the market (Van Horne & Wachowicz, 2008, p.15). It one of the important criteria on which the long term investors value a target company or an institutional investment decision is made by leading investment firms. Therefore, companies should have very clean, transparent and objective oriented corporate governance which would help to raise fund from both creditors and from market. There are many researches, studies, reports and acts developed by individual researchers and governmental agencies on importance of corporate governance in busi8nesses and as a part of corporate reports. Two most important principles of corporate governance are Combined Code and Sarbanes Oxley Act. These two corporate governance principles focus on the importance of corporate governance in businesses and in corporate reporting. Therefore, the second objective of this study i.e. importance of corporate governance will be conduct based on discussing these two principles. Combined Code and importance of corporate governance Combined code is one of the important corporate governance codes of conduct. It was derived from three different report of corporate governance. These are Hampel Committee’s Final Report, Greenbury report and Cadbury Report. The combined code was developed in 1988 and it is appended mandatory to the corporate governance policies of the companies listed in London Stock Exchange. Therefore, compliance of the combined code was mandatory to all the listed companies. The main constituents of combined code i.e. Cadbury report and Greenbury report were developed by Hample Committee and Greenbury Committee respectively in 1995. The main objective of combined code is to ensure that companies need to follow a standard set of corporate governance policies. The board of directors need to develop and maintain confidential corporate governance policies to safeguard the interest of the stakeholders’ interests (Block & Hirt, 2008, p.35). For this purpose the board need to have full control over the business activities so that shareholders’ investment and companies’ assets can generate adequate return for profitability of the companies as well as the shareholders. The directors should conduct review of effectiveness of policies implemented at least once a year or if possible in each quarter. They need to review the extent of control the company has over company’s assets and total capital invested. Internal control of the company includes financial, operating, legal compliances, risk management and financial and non financial disclosure to the shareholders. The code was divided into two major sections. First are the corporate governance principles of best business practice regarding provisions for companies and second is bets business practice for maintaining the monetary inte3rst of the shareholders of the shareholders who have invested huge amount in the company. Though compliance of code is not mandatory but this code was appended to the existing rules of London Stock Exchange which requires that the companies need to provide sufficient detailed financial and non financial information to the shareholders (Grinyer, 1986, p.77). The objective of this policy is that shareholders can access the extent of compliance of the companies where they have invested or willing to invest. Non-compliance instances need to be justified to the shareholders by the companies. First section of combined code is very much comprehensive that covers the operation and composition of the board, directors, remuneration, and corporate relationship with the shareholders, disclosure of information to the shareholders, accounting audit and financial accountability. The main fact of section 1 of the code is that corporate governance principles and provisions will combined together to develop a code that would be more powerful to be effected and also would be flexible enough for the companies to implement. Section 2 of combined code is very much specific compared to Section 1 and covers some corporate activities like shareholders voting rights and evaluation of corporate governance disclosure. Institutional investors invest on the companies on behalf of their shareholders they have responsibility to hold the companies account in which they already invested. The code recommends that the companies need to maintain good relationship with individual as well as institutional investors. The publication of three reports that consolidated into combined code of corporate governance in 1998 resulted major change in corporate governance policies by the companies. This leads to also change in their day to day business activity that further resulted sustainable growth and flawless ethical business activity by the UK companies. SOX Act and importance of corporate governance Sarbanes Oxley Act 2002 is an important principle of corporate governance which was established to set enhanced standard for the corporate governance of public companies of United States. It is also known as Public Company Investor protection and Accounting Protection Act. This Act was developed in response to the high profile WorldCom and Enron scandals to protect the interest of the shareholders and other stakeholders’ interests. Strictly mandated of this Act resulted reforms in financial disclosure by the companies for all stakeholders of the companies. It reduced fraudulent accounting activities which was the main objective of this Act. Two main provisions of Sarbanes Oxley Act are Section 302 and Section 404. Section 302 is a mandate that recommend senior management to clarify of financial reporting. Section 404 recommends that auditors and top management need to have internal control on financial reputing techniques and methods. But, this Act is very costly to implement in public companies and it also maintain necessary control on financial reporting in higher extent that ensure any kind of non fraudulent financial reporting (Brounen, Jong, Koedijk, 2004, p.44). The impact that Sarbanes-Oxley Act (SOX) and particularly its Section 404 on the corporate governance environment in the last one decade, results major change in corporate governance policies of US based companies. The author states in the beginning of the article that the SOX Act has been triumphant in averting some of the problems it was formulated to deal with. The positive impact of SOX in fortifying the business oversight has been widely accepted by professionals in the audit industry. The Act is believed to have unquestionably enhanced the audit quality, though its Section 404, which stressed on internal control besides the financials, has been widely considered to be premature. However, implementation of the Act had ensured that businesses made better decisions and in many cases even discovered superior competence resulting in cost savings. In the initial stage companies had to incur higher expenses to perform extensive audits of their internal control systems and consequently in the initial years of its implementation, there were reports of many companies going private as they could not afford the audits (Brealey, Myers & Marcus, 2009, p.65). In spite of cost involved and the complicated audit requirement, SOX has been able to fortify the function of autonomous audit committees in terms of superior corporate governance. SOX Act was developed on the need of evaluation and declaration of corporate organizations’ internal control efficiency. It emphasises that though SOX obligates a thorough evaluation of all financial reporting associated internal controls and hence requires a huge amount of resources, its positive impact on the quality of audit and corporate governance makes it highly beneficial and a necessity in the modern business environment. However, besides evaluation of internal controls, emphasis should be made on controlling security of the information very efficiently. References Block, S.B., & Hirt, G.A. (2008). Foundations of financial management, 12th ed., New York, New York: McGraw-Hill/Irwin Brealey, R.A., Myers, S.C. & Marcus, A.J. (2009) Fundamentals of corporate finance. 6th ed., New York, New York: McGraw-Hill/Irwin. Brounen, D., de Jong, A., Koedijk, K. (2004). Corporate finance in Europe: confronting theory with practice, Financial Management, 33(4), 71-101 Grinyer, J.R. (1986). An alternative to maximization of shareholders’ wealth in capital budgeting decisions, Accounting & Business Research, 16(64), 319-326 IFRS. 2012. The move towards global standards. [Online]. Available at: http://www.ifrs.org/Use-around-the-world/Pages/Use-around-the-world.aspx. [Accessed on December 31, 2012]. Ross, S.A., Westerfield, R.W. & Jordan, B.D. (2008). Essentials of corporate finance, 6th ed., New York, New York: McGraw-Hill/Irwin Van Horne, J.C. & Wachowicz, Jr., J.M. (2008). Fundamentals of financial management, 13th ed., Harlow, Essex: Financial Times Prentice-Hall Bibliography Arnold, G. (2007). Essentials of corporate financial management, Harlow, Essex: Pearson Education Limited Atrill, P. (2009). Financial management for decision-makers. 5th ed., Harlow, Essex: Pearson Education Limited. Ballas, A.A., & Hevas, D.L. (2005). Differences in the valuation of earnings and book value: regulation effects or industry effects? The International Journal of Accounting, 40(4), 363-389. Childs, P.D., Mauer, D.C., & Ott, S.H. (2005) Interactions of corporate financing and investment decisions, Journal of Financial Economics, 76(3), 667-690. Read More