Corporate Governance: An Ethical Perspective - Literature review Example

Corporate Governance Essay Name Professor Institution Course Date Corporate Governance Essay Introduction In past two decades, the corporate governance has drawn a strong public attention due to its obvious significance for economic health of companies and general society (Arjoon 2005, p.3). The headline in the recent years has depicted sad news of business ethics and even lack of it. Arjoon (2005, p.3) claims that some of the companies that have been in the limelight because of ethics or just lack of it include Enron, WorldCom, Merrill Lynch, Anderson, Enron, Qwest Communication and Computer Associates among others. Agrawal & Chadha (2005, p.378) contend that corporate failure, unconvincing accounting practices, falling stock markets, corporate failure abuses is what some of the managerial decisions have led to, hence weakening the confidence of the investors. According to Arjoon (2005, p.3), many experts believe that such malpractices are attributed to conflicts of interest facing many managers. Also, it has led to questioning of the role of accounting and auditing in the organization. These issues have resulted into renewed interest in corporate government. Based on the information, this essay will critically discuss the conflict of interest between principals and agents. Also, it will evaluate the role of the CEO, Chairperson and the board of directors. Conflict of interest between principals and agents Conflict of interest is widely defined as an array of situations which make a risk which professional actions or judgment concerning a primary interest will be overly impacted by secondary factors or interest (Institute of Medicine 2009). In simple terms, it is normally described as a situation whereby an organization or individual is involved in several interests such as emotional or financial which could corrupt his motivation. McDonald (2011) argues that the existence of a conflict of interest is often independent of incidence of impropriety. In the definition, primary interest means the principal objective of the activity or profession like the client’s protection, the patients’ health, the duty of public officers and integrity of research among others. On the other hand, secondary interest compose of not just the financial gains, but also intentions as the yearning for professional progress and desires to do favors to family and close friends (McDonald 2011). Conflict of interest has intensified over the years between principals and agents. According to McDonald (2011) Conflicts of interest are issues which emerge when a principal (owner) employs an agent (manager) to carry out particular duties on behalf of the principal which either be costly or taints the image of the agent. A conflict of interest could arise when the principal creates a platform where the agent holds an incentive to match his interest with those of principal. When the principal has les knowledge concerning the business, the agent get an opportunity to act as the principal and do what the principal is supposed to do (Michael & Stark 2001). Some principal hires agents to manage their assets since they are convinced that they do not the knowledge to deal with market forces hence transferring that responsibility to the agent (manager) (Kaskarelis 2010, pp.259). In that process, the agent gets an opportunity to be able to defraud the principal. Since the agent and the principal in most cases pursue diverse goals, conflict often arises in their relationship, and the agent create an opportunistic behavior of concealing information to the principal making it difficult to expose unethical behaviors and agent costs within the organization. The principal exercise control and also expects the agent to increase his returns. Since the manger understands that owner could fire him when the business post low returns he may choose to reward himself (Kaskarelis 2010, pp.261). Rewarding himself is self interest which could make the owner to sue him. As mentioned earlier, companies such as Enron, WorldCom, Computer associates, One.Tel, Thornbug Mortage have collapsed as a result of conflict of interest. In Modern Corporation which is legally constituted, arrangement is made where the owners appoint others to act or run the company on their behalf (Donaldson & Davis 1992, p.50). In such arrangements, the owner is considered the principal while the manager is regarded as the agent. In this perspective, financial managers including accountant, chief financial officer and human resource managers are the agents of the company. According to Donaldson & Davis (1992, p.50), managers are expected to maximize shareholders’ profit on behalf of the owner. The managers are monitored by the CEO and his board of directors which is independent. Agency theory holds that both the principal and agent have self interests. While principals want an agent whom he or she can control to maximize his wealth, agent also has the interest of maximizing his personal interest including his salary, employing his family and friends (Donaldson & Davis 1992, p.51). However, conflict of interest frequently arises when the CEO holds two positions, that of the Executive officer and the chair. This is because he is likely to protect the interest of the management while sacrificing the interest of the principals (owners) (Donaldson & Davis 1992, p.51). In that case, agency theory argues that there will be agency loss and managerial opportunism. Conflict of interest also emerges in a complicated organization structure. For instance, in a board of directors which is not properly constituted hence less independent directors, there is a possibility of rewarding themselves more salaries or profits (Clarke & Dean 2007). Similarly, there a possibility that they can manipulate the accountants or the finance officers to reward them with hefty packages which they are not entitled to (Bhagat & Bolton 2008, p.259). Even though performance and compensation management system was developed to reward and retain its valuable staff, but the system led to a dysfunctional corporate culture which turned out to be obsessed with short-term increase of bonuses and earnings particularly for the executives. According to Bryce (2008), employees continuously attempted to initiate deals, frequently ignoring the quality of profits or cash-flow so as to get a good rating concerning the performance evaluation. Furthermore, accounting and financial outcomes were documented quickly to continue the stock price of the company (Salter 2008). This action encouraged conflict of executives and deal-makers got large bonuses. Cai, Garner & Walkling (2010, p.18) argue that conflict of interest also arises between principal and agent when there are no clear internal controls. Controls ensure that company interest is differentiated from an individual interest. It provides that the directors and managers provide financial reporting to enable shareholders, including the principal to know the financial status of the company (Brown & Caylor 2009, p.136). The intents of some directors, CEO and financial officers were questionable. Lack of internal controls made these executive to reward themselves with bonuses on the basis of opportune creation and new systems and programs. Hopt & Leyens (2004) contend that such actions normally take place when no testing and documentation is emphasized on by the management hence compromising the integrity of the board of directors. As a result, the company may collapse leading to loggerheads with principals (shareholders).after engaging in conflict of interest some agents destroy important documents to conceal the information to prevent auditing of crucial company accounts. It is these actions which contributed greatly to collapse of the company. Even though, some conflict of interest is as a result of personal greed, some are resulted by low payment offered by the companies to their workers (van der Steen 2011, p.523). There are situations where a public officer handle large sum of money may be as an accountant yet the money being offered to them as remuneration is not enough to meet their needs. Therefore, conflict of interest will come in and the officer will find himself using dubious accounting practices so as to defraud the company. Even the most moral of individuals could give in to temptations when the prospective benefits are large (Psaros 2009). It might be unattainable to get rid of every conflict of interest but preventing them will positively improve the chance with which individuals will conduct their work morally. Organizations which are strictly concerned with ethics must first make sure that there exist few cases of conflicts of interest. The role of the CEO, Chairperson and the board of directors In most countries across the globe, public companies are needed to appoint Board of Directors, which is assigned with the responsibility to oversight the corporate actions and safeguard the shareholders’ interest (Cai, Garner & Walkling 2010, p.17). The chairman in most cases normally heads the board of directors who influences the direction of decisions. Donaldson & Davis (1992, p.51) argue that in some cases, chief executive officer often holds topmost position in management and sometimes serves as the chair of the board of directors. This is witnessed with firms which have expanded and still retain their founder in such positions. Cai, Garner & Walkling (2010, p.21) argue that as the director, manager, decision-maker and the leader, the CEO has complete power to create structure which can help improve performance. The power a clear-cut and cannot be challenged. It is such powers that some CEO use to influence the financial officers and accountants to manipulate that company accounts for his own benefit (Anderson & Orsagh 2004, p.69). As an agent of the principal, he has the responsibility to pursue the interest of the owner which is to increase the shareholders value. The principal expect the CEO to do everything within his means to make sure the company makes profit. When the CEO also holds the position of a chairperson, the challenge is that it decreases the effectiveness and efficiency of the board since the person holding the position may be tide from taking a stand at shareholders meeting (Donaldson & Davis 1992, p.51). Also, such person may not support the maximizing the profits of other shareholders. The situation enables the CEO who is also the chairman to reward themselves while ignoring the other principal who happens to be people who invest into the company through buying of shares (Hopt & Leyens 2004). The chairperson is not supposed to vote in the executive remuneration. However, according to Scapens (2006, p.21) when the chairperson also holds the position of CEO, he has the right to vote; a situation which creates conflict of interest. In circumstance where the position of the chairperson is separated from that of the CEO (executive chairperson), the chairman has the responsibility of representing the company in government meetings (Psaros 2009). Also, the chairman organizes and coordinates and activities of the board like setting the annual agenda and evaluating the CEO’s performance and that of other directors. On the other hand, the board of directors’ role is to monitor mandates and operation of the company and make sure that it run based on the set goals (Picou & Rubach 2006). The board of director appoints the CEO and keeps watch on his actions. Within the board, the CEO role is to advise the directors on strategies which the company needs to take so as to remain competitive. Donaldson & Davis (1992, p.51) asserts that the board holds a monitoring role over management and act on the best interest of the shareholders. However, when the board has CEO as a close friend of the directors or is partnership in a side business, independence is not reflected. The circumstance where directors’ decision is influenced by the CEO or the chairman has manifested in companies such as Enron, One.Tel and Thornbug Mortage which has since collapsed. These cases have put the role of directors into much scrutiny. Chhaochharia & Grinstein (2007) claim that with the arrival of The Sarbanes–Oxley Act in 2002, most of executives who are involved in accounting and auditing crimes have found themselves in court hence reducing cases of corporate collapse. Conclusion In conclusion, it is evident that the collapsed companies cannot be credited to one person but many parties. However, the biggest factors to blame for the crumble include Informal structure, inadequate corporate governance and professional ethics. The corporate collapses in numerous organizations have a very strong message to contemporary companies. The powerful point is that the directors and managers have to play an effective and active role in the operation of the firm, individual staff has to be held responsible for their decisions and actions, appropriate reporting of finance and expenditure. References Books Bala, G.D. & Bufkins, W.R., 2004. Enron: Corporate Fiascos and Their Implication. Los Angeles: Foundation Press. Bryce, R., 2008. Pipe Dreams: Greed, Ego, and the Death of Enron. New York: PublicAffairs. Clarke, F. and Dean, G., 2007. Indecent Disclosure: Gilding the Corporate Lily. Cambridge: Cambridge University Press. Michael, D & Stark, A., 2001. Conflict of interest in the professions. Oxford: Oxford University Press. Psaros., 2009. Australian corporate governance, A review and analysis of key issues. Frenchs Forest, NSW: Pearson Education Australia Chapter 3 page 43-53. Salter, M.S., 2008. Innovation Corrupted: The Origins and Legacy of Enron's Collapse. Harvard: Harvard University Press. Journals Anderson, G. & Orsagh, M., 2004. The Corporate Governance Risk. Electric Perspectives, 29(1), 68-70. Agrawal, A. & Chadha, S., 2005. Corporate Governance and Accounting Scandals. The Journal of Law & Economics, 48(2), 371-406. Bhagat, S. & Bolton, B., 2008. Corporate Governance and Firm Performance. Journal of Corporate Finance, 14(3), 257-73. Brown, L. & Caylor, M., 2009. Corporate Governance and Firm Operating Performance. Review of Quantitative Finance and Accounting, 32(2), 129-44. Cai, J., Garner, J. & Walkling, R., 2010. Shareholder Access to the Boardroom: A Survey of Recent Evidence. Journal of Applied Finance, 2(2), 15–26. Chhaochharia, V. & Grinstein, Y., 2007. Corporate governance and firm value: The impact of the 2002 governance rules. The Journal of Finance, 62(4), 1789-1825. Donaldson, L. & Davis, J., 1992. Stewardship Theory or Agency Theory: CEO Governance and Shareholder Returns, Australian Journal of Management, 16(1), 49-65. Kaskarelis, I.A 2010, The principal-agent problem in economics and in politics, Humanomics, 26(4), 259 - 263 Picou, A & Rubach, M.J., 2006. Does good corporate governance matter to institutional investors? Evidence from the enactment of corporate governance guidelines. Journal of Business Ethics, 65, 55-67. Scapens, R.W. 2006. Understanding management accounting practices: a personal journey, British Accounting Review, 38(1), 1-30. Van der Steen, M. 2011. The emergence and change of management accounting routines, Accounting. Auditing & Accountability Journal, 24(4), 502 – 547. Report Hopt, K. & Leyens, P., 2004. Board Models in Europe – Recent Developments of Internal Corporate Governance Structures in Germany, the United Kingdom, France, and Italy', EGCI Working Paper. Webpage Arjoon, S., 2005. Corporate Governance: An Ethical Perspective [Online]. https://sta.uwi.edu/conferences/financeconference/Conference%20Papers/Session%205/Corporate%20Governance%20-%20An%20Ethical%20Perspective.pdf [Accessed 3 Dec. 2015]. Institute of Medicine, 2009. Conflict of Interest in Research, Education and Practice [Online], Washington, National Academies Press, Available from http://www.ncbi.nlm.nih.gov/books/NBK22942/ [Accessed 3 Dec. 2015]. McDonald, M 2011. Ethics and Conflict of Interest, W. Maurice Young Centre for Applied Ethics. http://ethics.ubc.ca/peoplemcdonaldconflict-htm/ [Accessed 3 Dec. 2015]. Read More