The Adoption of Effective Corporate Governance Systems - Coursework Example

Swarna1 Word count: 3884 P.Swarnalatha ID # 5448 Order # 171195 d 23rd May 2007 Explain how the adoption of effective Corporate Governance systems and processes can positively affect company conduct and performance. Basic definition of corporate governance: Corporate governance can be described as the set of norms and procedures that sid in directing, administering and controlling the direction of any firm or organizaton. Corporate governance is a multi-dimensional management tool that helps in strategic management. It concentrates on issues of accountability and fiduciary duty, essentially advocating the implementation of guidelines and mechanisms to ensure good behaviour and protect shareholders. It also balances the economic efficiency and share holder welfare. It is generally exercised by maintaining good relationships among the many players involved (the stakeholders). The main players are the shareholders, management and the board of directors. Other stakeholders like employees, suppliers, customers, and banks and other lenders, will also be involved under perspective of corporate governance. For example, Dow (The Dow Chemical Company) is a multinational firm which manufactures products for a wide range of markets that are vital to human progress, including food, transportation, health and medicine, personal and home care, and building and construction, among others. Dow is a diversified chemical company that harnesses the power of innovation, science and technology to constantly improve what is essential to human progress. The Company offers a broad range of products and services to customers in more than 175 countries, helping them to provide everything from fresh water, food and pharmaceuticals to paints, packaging and personal care products. Effective corporate governance has made Dow to commit to its principles of sustainability. At present, Dow has annual sales of $49 billion and employs 43,000 people worldwide. Ninety percent of the products Dow sells in Europe are made in Europe. It also ensures higher transparency by increasingly using the services of external providers to conduct anti-corruption auditing, and due diligence and training. Hence the corporate governance aids in enhancing the overall performance of the companies which is outlined in this paper. It concentrates on systems and processes deal with matters such as delegation of authority. It also helps in motivating individuals to align their actual behaviors with the overall participants with a final objective of comapany welfare. It paves the ways for successful fulfilling of the defined objectives. It also verifies the extent of progres made with the implementation of the governance plan and future strategies would be formulated accordingly. Its importance was felt in several important occasions. To name a few, the South East asian countires like Thailand and Malaysia would have regained faster from the crisis of 1997 had they institutionalized the corporate governance during that time. Similarly, the multinational companies like Arthur Anderson and Enron got damaged due to the negtive effect of corporate governance. Role of executive and non-executive directors Board of directors have the main responsibility for overall performance of any company and they are answerable to the Company’s shareholders. The Board of directors would be given enormous powers to regulate the business direction of the company. The Board sets the Company’s strategic aims and ensures that necessary resources are in place in order for the Company to meet its objectives. All members of the Board take collective responsibility for the performance of the Company and all decisions are taken objectively and in the interest of the Company. The Board is responsible for satisfying itself as to the integrity of financial information and the effectiveness of the Company’s system of internal control and risk management processes and is responsible for ensuring that the Company’s obligations to its shareholders are met. In Dow Board of Directors and management are committed to strong corporate governance and sound business practices. An ethical tone at the top serves the interests of our stockholders. Dow has elected eleven Board of Directors in May 2007 for one year term (Dow, 2007). It consists of both executive directors and non-executive directors. The Board will delegate the normal operational management of the Company to the Executive Directors and other senior management which form the guidelines requiring specific matters to be subject to decision by the full Board of Directors, including material acquisitions and disposals, investments and capital projects. However, the Non-executive Directors have a particular responsibility to challenge constructively the strategy proposed by the Chief Executive and Executive Directors, and to scrutinize and challenge performance. They also work independently to work on the integrity of financial information and they ensure appropriate remuneration for Executive Directors and other senior members of the management team. There will be regular meetings of the Board during any calendar year to discuss on the prime company maters. It will be ensured that at least annually, the non-executives meet without the executive directors present. The executive directors look after the following main agenda : Leadership of the Board, ensuring its effectiveness and setting its agenda Ensuring, through the Company Secretary that the members of the Board receive clear, accurate and timely information Arranging the regular evaluation of the performance of the Board, its Committees and individual Directors Facilitating the effective contribution of non-executive directors and ensuring constructive relations between executive and non-executive directors Developing strategic operating plans. In case of Dow, it has tried to increase the economic and energy efficiency of the firm by collaboration with firms in other countries. Recently, Dow has collaborated with China’s energy research institute for enhancing the energy efficiency in China. This is made possible due to effective corporate governance. Preparing annual budgets and medium term projections for the Company and closely monitoring performance against plans and budgets Ensuring effective communication with shareholders. In recent annual meeting of Dow held in may 2007, 1050 stockholders of the company attended the meeting reflecting its stronger integration. Overseeing the day to day management of the Company Role of non executive directors in maintaining the balance of company structure: The board of directors, with its legal authority to hire, fire and compensate top management, safeguards invested capital. Regular board meetings allow potential problems to be identified, discussed and avoided. Whilst non-executive directors are thought to be more independent, they may not always result in more effective corporate governance and may not increase performance. Different board structures are optimal for different firms. Moreover, the ability of the board to monitor the firms executives is a function of its access to information. Executive directors possess superior knowledge of the decision-making process and therefore evaluate top management on the basis of the quality of its decisions that lead to financial performance outcomes, ex ante. The Board Should Include The Balance of Executive & Non - Executive Directors. The Board is considered to be of sufficient size such that the balance of skills and experience is appropriate to the size of the business. The Board should be balanced by a strong non-executive element and at least half of the Board, excluding the chairman, and it will ensure independence in character and judgment. The Companies would follow a formal, rigorous and transparent procedure for the appointment of new non executive directors. The Nominations Committee leads the process for board appointments and for succession planning and makes recommendations to the Board. None of the full time executive directors will have more than one Non-executive directorship in company to maintain the neutrality. In Dow, the non executive directors are called as non employee directors who will not have any direct linkage with the company except for the term period of contract in delivering their services in corporate governance. They regularly attend the executive sessions of the company. The positive role of non executive directors in promoting the best practices and economic efficiency of companies was reported by some researchers (Christopher Pass, 2004). The non executive directors would help in other functionaries to understand their roles and responsibilities for higher effectiveness, in overcoming the pitfalls and help in the company’s legal position . Relation of Corporate governance to Corporate Purpose, and to Business Ethics One of the main principles of corporate governance is to maintain the business ethics. Failures of corporate governance have been at the root of recent well known cases of management defrauding the shareholders in some of the most advanced economies. This behavior was both an example of bad governance and unethical. It will disappoint stakeholders, detract them from the performance of the companies involved, and will weaken the economic system in genera. Where corporate governance works well, it re-enforces ethical standards; where it fails, it permits unethical practices. Good governance leads to corporate social responsibility, because a well governed corporation is expected to adhere to the values and norms of the community. If one analyzes the situation of Dow, the corporate governance has enhanced the ethical standards enormously. Dow adopts a Code of Business Conduct to provide guidelines for ethical conduct by Directors, officers and employees. In the area of corporate governance, the Code of Business Conduct contains guidance regarding conflicts of interest, corporate opportunities, confidentiality and protection of company assets. Dow also adopts a Code of Financial Ethics for the Chief Executive Officer, senior financial officers and appropriate financial managers. But these very values of the community are not with a great deal of precision as they affect corporate behavior, whether in the private or public sector. This is where the drafting of codes of good governance for public and private enterprises can contribute greatly. Ethics, of course, refers to the shared values of the members of a community. Finding ways to give expression to these values in a financial context is a challenge. There are three components of governance arrangements that apply in both private and public contexts which will be aiding in maintaining the ethical values: It is important to understand the objective of an organization, and to align incentives for managers with the preferences of stakeholders, particularly shareholders. In Dow, all the employees are provided with performance based incentives which resulted in higher net profit of the company. It is important to benefit from transparency: stakeholders must be able to observe the actions of managers, and must have access to the information that is necessary to form an opinion on them. By making all the stockholders attending the annual meetings and through regular release of company related information, the transparency is the main key of Dow. Accountability is important: managers need to demonstrate that they have done their utmost to achieve the objective of the organization. Codes and standards of corporate governance provide a metric to guide and gauge behavior. They are a means of giving expression to the broad ethical principles of the community in each enterprise. The mission statement of the institution; the codes of conduct for members of the board of directors, the management, and the whole staff; the ethics code, the personal account trading rules, procurement codes and compliance policies must be clearly defined. If governance codes are to be accepted, they must be devised in an inclusive manner. If they incorporate the ethical standards of the community, they will be more acceptable than if they are ethically neutral. Governance codes need to be backed up by effective means to ensure compliance. The incentives must be in place to make sure that they are observed. These incentives can be economic, legal and moral. As mentioned earlier, the incentives provided by the Dow to its employees is one of the best in the industry. However, they should also be clear and simple and transparently directed towards the fundamental goals of the enterprise. Governance issues in the international arena Governance codes are being developed on a national, regional and international level. On the international level, three of the most significant initiatives are: OECD Corporate Governance Standards, Basel Committee Core Principles Basel Committee work on corporate governance. Dow has integrated all these standards in its code of ethics which are strictly followed while functioning at international level. As a result, Dow Won 2006 ACC Responsible Care Energy Efficiency Award. Andrea Melis (2006) observed the key corporate governance developments in Italy, including the 1998 Draghi law, the Preda Code of conduct and some of most recent developments concerning corporate governance after the Parmalat scandal. Regulation and actual corporate practice have been changing fast in the recent years, although they have not solved completely the key corporate governance issue concerning the relationship between controlling shareholders and minority shareholders. The study revealed that the overall awareness of the importance of corporate governance issues has increased among senior managers and directors of Italian listed companies (Andrea Melis, 2006). Reasons for the growth of interest in the subject As the success stories have been evolved out due to strict implementaton of corporate governance, all major companies have been paying higher attention to this area of strategic management. At the same time, corporate governance related issues are receiving greater attention in both developed and developing countries as a result of the increasing recognition that a firm’s corporate governance affects both its economic performance and its ability to access long-term, low-cost investment capital. Dow has been functioning with strong fundamentals of corporate governance since its initial establishment. As a result of strong corporate governance, Dow has established strong linkage with its stockholders, expanded its size of operations and achieved best economic and energy efficiency. Today, Dow offers a broad range of products and services to customers in more than 175 countries, helping them to provide everything from fresh water, food and pharmaceuticals to paints, packaging and personal care products. Because of effective corporate governance, it maintained its principles of sustainability, achieved the annual sales of $49 billion with an employee size of 43,000 people worldwide. Numerous high-profile cases of corporate governance failure have focused the minds of governments, companies and the general public on the threat posed to the integrity of financial markets, although it is not clear that any system will or should prevent business failures, or that it is possible to provide a guarantee against fraud. One more important reason for higher attention to corporate governance is due to faster spread of messge through some renowned books. For the United States, an analysis of these concerns has been published by the New York Society of Securities Analysts in their 2003 Corporate Governance Handbook. What constitutes good and bad corporate governance is an on-going debate in politics, civil society, and academia. The investors or general public have shown interest to pay premium for thos companies with good corporate governance as revealed by Global Investor Opinion Survey of over 200 institutional investors first undertaken in 2000 and updated in 2002. The researchers found that 80% of the respondents would pay a premium for well-governed companies. This implies the importance of corporate governance in shaping the future of the company. The independence nature of directors and market value of share have been identified as the major parameters for judging the company’s performance. This holds true for Dow as it has sound share value and efficient non executive directors. Even the independenc eof directors is strictly monitored at Dow. How Governance operates in an organization For effective corporate governance, there is a strong necessity to study and analyze the market forces. The second step is to train professionals and educate the general public. In many countries, governments and regulators have great difficulty in competing with the private sector for scarce professionals. It is also difficult to find qualified board members. There are some basic principles of corporate governance which would help in effective and smooth running of any company. Main elements of good corporate governance principles include honesty, trust and integrity, openness, performance orientation, responsibility and accountability, mutual respect, and commitment to the organisation. The oversight of the preparation of the entitys financial statements is a crucial factor in corporate governance which also aids in enhancing the company’s performance. Dow has been highly transparent and regular in disclosing itas financial statements for each quarter. The internal controls and the independence of the entitys auditors has to be ensured for effective corporate governance. Dow shall provide each Director with complete access to the management of the Company, subject to reasonable efforts to avoid disruption to the Companys management, business and operations. The Board of Directors and Board committees shall have the right to consult and retain independent legal and other advisors at the expense of the Company. Similarly, continuous review of the compensation arrangements for the chief executive officer and other senior executives is to be ensured. Organisations should recognise that they have legal and other obligations to all legitimate stakeholders. As the share holders are the owners of the company, their rights should be protected. The way in which individuals are nominated for positions on the board must be neutral and transparent. All the shareholders of Dow are invited to annual meetings in which the board of directors are elected. There should be balanced and optium resources made available to directors in carrying out their duties. The dividend policy must take the interests of the shareholders in to prime consideration. As discussed earlier, the ethics of business must be perfect for effective corporate governanace. Organisations should clarify and make publicly known the roles and responsibilities of board and management to provide shareholders with a level of accountability. Performance-based remuneration is to be encouraged. The compensation provided by Dow to its employees is performance based and considered to be the best in the industry. Why it is of interest to diverse stakeholder groups As the different stake holders are involved in the overall progress of the company, it is equally important for the board of the directors to ensure the interests of diversified groups are fulfilled accordingly. The main stakeholder involved in corporate governance is in the form of the regulatory body which includes the Chief Executive Officer, the board of directors, management and shareholders. Broadly speaking, other stakeholders who take part include suppliers, employees, creditors, customers and the community at large. In general, the shareholder delegates decision rights to the manager to act in the companys best interests. In other words, shareholders lose effective control over managerial decisions. Hence they should not get feeling that their rights are being misused by the board of the company. It is their responsibility to endorse the organisations strategy, develop directional policy, appoint, supervise and remunerate senior executives and to ensure accountability of the organisation to its owners and authorities. Hence the corporate governance plays a crucial role here by maintaining balance between the shareholders’ views and management decision. Dow implements the principles of corporate governance strictly for effective balance between share holders and management. In this way, the interests of the shareholders would be protected by the corporate governance. At the same time, the rights and interests of other stake hoders have to be protected which would help the company to prosper in the long run. Examples of good practice The implementation of ideal principles of corporate governance at Dow is the example of good practice in corporate world. The role of corporate governance in enhancing and sustaining the operating profit and business volume of Dow is highly significant. In addition, Dow also contributed significantly to social responsibility by contributing to innovations in science and technology to meet the basic needs of the society. Effective corporate governance has made it to contribute $18 million towards charitable activities of the society which is noteworthy. Self monitoring and the internal evaluation and appointment of independent directors are the other examples of good practices (Maciej zierznowski and Puiotr Tamowicz, 2002). It was envisaged that the performance of Portuguese companies was positively influenced by the level of compliance of the code of best practice issued by the Portuguese Securities Market Commission and the returns of the concerned companies (Carlos F. Alves and Victor mendes, 2004). The positive impact of corporate governance structures and mechanisms at Telecom Italia S.P.A. resulted in its higher economic performance. Since privatisation in 1997, Telecom Italia has offered some examples of how minority shareholders may face difficulties to have their interest safeguarded. However Telecom Italia has tried to improve its corporate governance, which may currently be considered an Italian best practice, thanks to the companys efforts to strengthen minority shareholders protection in order to be more competitive in capital markets (Andrea Melis, 2006). It was found that the corporate governance had positive impact on 5 thousand government or public firms. The results revealed that one-point-increase in our overall corporate governance index would result in around a half-percent increase in performance; and worst to best change in our overall corporate governance index predicted about 40% increase in companys performance (Vitaliy Zheka, 2006). It was also confirmed that company performance was positively influenced by elements of corporate governance such as shareholder rights, transparency and board independence on performance. Examples of bad practice The non implementation of good practices or principles of corporate governance would result in collapse of companies. In some occasions, the planning of corporate governance might be good, but implementation is lacking leading to poor performance. This was proved right in case of both Enron and HIH Insurance company, Australia. Both these firms acknowledged good corporate governance as a prevailing framework, yet failed to implement it. Each of the principles had been violated and had served as an attribute to the firms’ failure (Amerta Mardjono, 2005) Conclusion The constitution of all the main companies reveals the fact that share holders are the major driving force for their success. Hence it is highly ethical to protect their rights and interests. They should feel that they are real part and parcel of company as far as the major decisions are concerned. Corporate governance plays significant role in meeting this main objective. Dow has a strong corporate governance policy which ensured high level of code of ethics, higher economic and environmental efficiency and sound relation with its stockholders. In addition, corporate governance will ensure the independence of decision making through recruitment of non executive directors. It will also identify the possible threats for the company prospects and future management strategies would be formulated to sustain the company performance. Hence the effective corporate governance holds the key in deciding the overall performance of multi national companies like Dow. Bibliography Amerta Mardjono. 2005. A tale of corporate governance: lessons why firms fail. Managerial Auditing Journal. 20 (3) 272-283. Andrea Melis. 2006. Corporate governance developments in Italy. In Handbook on international corporate governance: country, analyses, C. Mallin, ed., P: 45-68. Andrea Melis. 2006. Strong Blockholders and Corporate Governance Structures that Improve Minority Shareholders Protection: The Case of Telecom Italia. In International corporate governance: a case study, c. mallin, ed., edward elgar publishing. Carlos Alves and Victor mendes, 2004. Corporate governance policy and company performance : The Portuguese case. Corporate Governance: An International Review, 12 (3) : 290-301. Christopher Pass. 2004. Corporate governance and the role of non-executive directors in large UK companies: an empirical study. Corporate governance. 4 (2):52-63. Dow. 2007. News Centre. Dow directors and officers are elected. Midland, Dated 10th May, 2007. zierznowski and Puiotr Tamowicz, 2002. The corporate governance code for Polish listed companies. Gdansk Institute for Market Economics Papers. Available at SSRN: http://ssrn.com/abstract=363420. Read More