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James Wolfensohn, the former president of the World Bank made a striking remark about corporate governance in the wordings “The governance of the Corporation is now as important to the world economy as the government of countries”.
Corporate governance as we all know is a company’s modus operandi or the process by which a company is overseen and managed. In the decades that followed the governance concern has become a focal point of discussion among governments and corporates.
Innumerable frauds continuously uncovered in the newspapers have raised eyebrows among the general public. In relation to these frauds, quite frequently we come across the terminology ‘corporate governance failure’. These failures are a result of unethical behavior by the trusted board members of a company. The malafide intentions of the executives of such conglomerates can take various shapes & forms. They can either diverge the funds of the company in an illegal manner or indulge in insider trading or overstate the value of their assets in public or manipulate their stock price or think of many such unethical means to gain illicitly. Investors are at the receiving end of corporate debacles whose trust is deeply shaken and taken advantage of. The basic fiduciary responsibility owed by the company towards its stakeholders is infringed. Let us take a look at three such corporate governance failures that have taught the need for good governance to the world at large.
1. Enron – It is undoubtedly one of the most infamous scandals spoken about in the corporate world. Enron was formed when two gas pipeline companies were merged in 1985 and was considered one of the biggest companies in the USA. The downfall of the company began in 2001 when the accounts of the company as disclosed in its balance sheet started to look suspicious to trade analysts and the SEC. Upon investigations, it was revealed that Enron, which appeared extremely profitable on paper to the investors and creditors was in fact oozing loads of losses. It tried to cover its liabilities through the creation of Special Purpose Entities (SPEs) with the aid of its auditor Arthur Anderson and its CFO. They showcased that multiple transfers of stocks were made to these SPEs and their returns were used to manipulate the financial statements. When these wrongdoings were uncovered, Enron's stock price saw the biggest dip from $90.56 to less than $1 hitting the investors really hard.
The Enron scandal had severe impacts on corporations, the governmen,t and society. Thousands of employees were left with no jobs. The company had to file for bankruptcy and the US government had to enact the Sarbanes Oxley Act, 2002 to tighten corporate governance and regain the faith of investors. It taught the world how important is the credibility of auditors to a company.
2. Parmalat – The famous company was an Italian family-run milk business that later diversified into bakery and beverage. The company to save itself from drowning financially resorted to a number of unethical methods. To make its balance sheet look profitable to the shareholders, the company engaged in creating imaginary and fake assets and transactions through a double-billing scheme and showcasing fake sales proceeds. These dummy assets on the balance sheet also helped them to fool banks and get loans from them. The company was hugely debt-ridden and all these malpractices were intended to cover huge loads of its debt.
The scandal had a similar effect to Enron leaving a huge dent in the trust of people. The scandal highlights the risk that the minority shareholders are exposed to in a family-run business where the family is the major shareholder and how such a set-up lacks transparency because the board members were all family members. It also emphasizes the need to have Independent Directors on the board.
3. Kobe Steel – A Japanese steelmaker, which enjoyed a legacy for over 100 years was put under the radar in 2018 for bad governance practices for many years. It provided steel to automobile giants like Honda, Toyota, and Mitsubishi. The company painted a false picture of the quality of its products hampering the safety of its users. When allegations were investigated, the low standards of its steel and aluminum products were discovered revealing how its quality inspection group and board dishonestly and intentionally delivered products to the customers for years that were not up to the mark and fell short of customer specifications. The fraud not only led to the resignation of its CEO Hiroya Kawasaki but also saw a major drop in its share price.
The company in its apology letter dated March 06, 2018, stated the reason for this fraud in the words “a management style that overemphasized profitability, and had inadequate corporate governance”. The scandal speaks of a lot of corporate flaws such as the greed of directors who knew about the practice but allowed its continuation to merely not let profits go away, lack of transparency within the organization and the need to strengthen the accountability of the board.
There are many such cases that shed light on bad governance and its consequences. Playing with the sentiments of investors is prima facie corrupt and immoral. It shakes and dents the confidence and trust of the investors who wish to invest in the stocks of the company and puts the company to disrepute for a lifetime. It is thus extremely crucial for companies to preserve the pillars of governance by maintaining independence, transparency, accountability,, and responsibility.
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