LPC Solicitors

Poor Corporate Governance And Corporate Failure

1. Introduction
2. Brief history
3. Benefits of good corporate governance practice
4. Implications of poor corporate governance practice

Overview

Corporate Governance has been defined as the system by which companies are directed and controlled – Cadbury Report 1992.

Corporate Governance encompasses practices and procedures to ensure that a company is managed in such a way that it achieves its objectives. In profit oriented enterprises, these objectives would be to maximize the returns to its shareholders. However, differing interest of other stakeholders is recognized. In addition, the organization has to function within its evironmental guidelines and constraints which include behaving in an ethical manner and in compliance with laws and regulations. Boards of directors have responsibility for the governance of their companies. The shareholders’ role in governance is to appoint the directors and the auditors and to satisfy themselves that an appropriate governance structure is in place.

The purpose of corporate governance is to facilitate effective, entrepreneurial and prudent management that can lead to the long-term success of the company. – UK Corporate Goverance Code 2012.

The importance of sound corporate governance is especially relevant for large Public Companies. A company is a legal person controlled by a board of directors in the interest of shareholders. Sometimes, the interest of both groups could be divergent; the challenge of good corporate governance is to find a way in which the interest of the shareholders, directors and other stakeholders can be sufficiently satisfied.

Development/History of Corporate Governance

A main impetus for better practices in corporate governance can be traced to the UK when in the 1980s and 1990s, a number of companies unexpectedly collapsed (Bank of Credit, Commerce & Industry, the Mirror Group, Polly Peck Int’l and Barings Bank). In each case, there appeared to be serious accounting and financial reporting irregularities and inadequate internal controls and risk management.

As questions were asked about how such well established companies could collapse suddenly without warning, common grounds were found: –

• Investors were not kept informed about what was going on in the company.
• Published financial statements were misleading
• External auditors were accused of failing to detect the warning signs.
• The activities of powerful company chiefs who lacked business ethics
• Board failures to restrain self seeking company chiefs from acting improperly
• Financial controls had been inadequate or ineffective.

At the instigation of the London Stock Exchange, a committee headed by Cadbury was set up to look into the financial aspects of corporate governance amid concerns that the financial reporting by companies was often misleading and suffered from ‘window dressing’. The stated aim of this committee was to help raise standards of corporate governance and confidence in financial reporting and auditing, by setting out what it
saw as the respective responsibilities of those involved and what it believed was expected of them.

The Cadbury report published in 1992 included a code of best practice and UK listed companies came under pressure to comply with the requirements of the code. Subsequently, there was the Meyners Report of 1995 which made recommendations on the relationship between institutional investors and company management and how it should be conducted. The significance of this report was that it urged institutional
investors to reassess their role as shareholders and their responsibilities for ensuring good corporate governance and the success of the companies they invested in. Following the Meyners report, representatives of the institutional investors organisation responded by issuing guidelines to members on corporate governance issues and principles of corporate governance.

Successive Committees that produced their reports on related matters include the Greenbury (1995) which focused mainly on directors’ remuneration, the Hampel (1995) which reviewed the Cadbury Code, Higgs (2003) with a focus on the role of nonexecutive directors and Smith (2003) on audit committees.

Following the banking crisis of 2007-2009, recognition of governance problems in UK Banks led to a review by Sir David Walker in the Walker Report of 2009.

The most recent report in the UK is the 2012 UK Corporate Governance Code.

Corporate Governance in the US

Following the Enron scandal, Arthur Andersen collapsed in 2002 and recommendations for change were proposed by the New York Stock Exchange . This resulted in statutory provisions on Corporate Governance in the Sarbanes Oxley Act of 2002.

Corporate Governance in Nigeria

In Nigeria the mechanism of corporate governance are the Companies and Allied Matters Act 2004, Investment & Securities Act 2007, Securities & Exchange Commission 2011 Corporate Governance Code and various industry specific governance codes.

The Atedo Peterside led Committee on Corporate Governance was commissioned by the Securities and Exchange Commission (SEC) to consider corporate governance issues in Nigeria. This resulted in the publication of the 2003 SEC corporate governance code and presently a revised SEC Code 2011.

Industry specific codes have been published by the regulators for companies under their purview. They include the CBN Code 2006 (For Banks & Other Financial Institutions), PENCOM Code 2008 ( For Pension Fund Administrators) and NAICOM Code 2009 (For Insurance Companies).

Benefits of good corporate governance practice

A central theme common in all the regulations across different jurisdictions is recognition of the need to embrace a value system with potential for a holistic achievement of societal goals. Myriad laws and regulations may never suffice without a corresponding willingness to act ethically. Ethics go beyond compliance with laws and regulations, it encompasses a tendency to just ‘act right’. It implies a recognition and
acceptance aligned with a desire to abide by the spirit of laws/regulations. Several concepts apply to sound corporate governance, but best practice can be achieved where there is:

• Openness, Honesty and Transparency: indicative of a willingness to make available to individuals, groups and all interested parties, information that makes clear the position and performance of the company in a timely fashion.
• Independence: the extent to which procedures and structures are in place so as to minimize or avoid completely potential conflicts of interest that arise, of particular relevance to non-executive directors and professional advisers.
• Accountability: Directors responsibility to account to shareholders for the decisions they make over a given period.
• Fairness: a principle that all shareholders should receive equal consideration.
• Ethical conduct with regard to behaviour that is in accordance with a written or unwritten code of ethics and a set of moral values. It is pertinent to observe that personal and business ethics underlie all the regulations and codifications in corporate governance. It should be emphasized that laws and regulations alone can never suffice to guarantee fair practices. Individuals in positions of influence and authority have to want to apply fair practice and abide by the rules.

Robust though these laws and guidelines are, they are not without limitations and this was aptly captured in the preface of the 2012 UK Goverance Code, wherein it stated that “Nearly two decades of constructive usage have enhanced the prestige of the Code. Indeed, it seems that there is almost a belief that complying with the Code in itself constitutes good governance. The Code, however, is of necessity limited to being a guide only in general terms to principles, structure and processes. It cannot guarantee effective board behaviour because the range of situations in which it is applicable is much too great for it to attempt to mandate behaviour more specifically than it does. Boards therefore have a lot of room within the framework of the Code to decide for themselves how they should act”.

 

It continued further “To follow the spirit of the Code to good effect, boards must think deeply, thoroughly and on a continuing basis about their overall tasks and the implications of these for the roles of their individual members”.

In today’s economies, interest in corporate governance goes beyond that of shareholders in the performance of individual companies. As companies play a pivotal role in our economies and we rely increasingly on private sector institutions to manage personal savings and secure retirement incomes, good corporate governance is important to broad and growing segments of the population. The benefits of sound corporate governance include the following:

• Elimination of the risk of misleading or false financial reporting
• Prevention of domination of companies by self seeking chief executives.
• Strong reputation and therefore lesser likelihood of exposure to reputational risk
• Higher probability of achievement of commercial success. Good governance and good leadership in management often go together.

Furthermore, good governance encourages investors to hold shares in the companies for the longer term as companies often benefit from having shareholders who have an interest in the longer-term prospects.
The presence of an effective corporate governance system, within an individual company and across an economy as a whole, helps to provide a degree of confidence that is necessary for the proper functioning of a market economy. There is growing consensus that corporate governance has a positive link to national growth and development.

The importance of corporate governance is more pronounced for large public quoted companies (PLCs) where the separation of ownership from management is wider than for small private companies. PLCs depend on the stock market to raise capital; Investors are very conscious of the safety of their investments, uncertainties about the integrity or intentions of those in charge of a company can quickly affect the value of such a company’s shares and its ability to raise new capital. G. O. Demaki (FCIS) writing in Business and Management Review Vol. 1(6) pp. 01 – 07, August, 2011 cited Okene et al (2010) review of Mckensey (2010) study among investors that three-quarters of them thought good corporate governance is as important as financial performance when evaluating an investment.

The degree to which corporations observe basic principles of good corporate governance is an increasingly important factor for investment decisions. Of particular relevance is the relation between corporate governance practices and the increasingly international character of investment. International flows of capital enable companies access financing from a much larger pool of investors.

If countries are to reap the full benefits of the global capital market, and if they are to attract long-term “patient” capital, corporate governance arrangements must be credible, well understood across borders and adhere to internationally accepted principles. Even if corporations do not rely primarily on foreign sources of capital, adherence to good corporate governance practices will help improve the confidence of domestic investors, reduce the cost of capital, underpin the good functioning of financial markets, and ultimately induce more stable sources of financing. (The OECD Principles of Corporate Governance 2004)

Implications of Poor Corporate Governance Practice

Whilst it is not implied that poor corporate governance accounts for all corporate failures, the general implication of poor corporate governance of a company is an inability to achieve the intended purpose of the Company, and its reason for being is defeated. On a macro level, this is amplified.

A study¹on Corporate Governance and Bank Failure in Nigeria was carried out to investigate issues, challenges and opportunities associated with corporate governance and Bank failure in Nigeria, and to ascertain if a significant relationship exists between corporate governance and Banks failure. The result of the study not only revealed that the new code of corporate governance for Banks is adequate to curtail Bank distress but that improper risk management, corruption of Bank officials and over expansion of Banks are the key reasons Banks fail.

According to the former Governor, Central Bank of Nigeria (CBN), Lamido Sanusi,² the inability of key personnel in some banks to live up to expectations negativel y impacted on the institutions and reiterated that the failure of corporate governance in most financial institutions led to the recent crisis in the banking sector.

Eight chief executives and executive directors of some Nigerian banks were summarily dismissed between August and October, 2009 due to issues related to poor corporate governance practices. This was sequel to the conclusion of audit investigations embarked upon by CBN to determine the soundness of Nigerian banks. The release of these reports led CBN to conclude that the affected banks acted in manners detrimental
to the interest of depositors and creditors. This was at variance with the clean bill of good health earlier given to these banks by regulatory authorities (CBN inclusive) and their so called appointed reputable external auditors ³. The Regulatory Authorities and Economic and Financial Crimes Commission had reported that their investigations had culminated in the decisions for the summary dismissals and prosecution of the affected
chief executives and that the situation had been handled in the way it was arising from the consciousness of the sensitiveness of such information on the market perception given the fickleness of price.

The Company Secretary and Corporate Governance

The Company Secretary occupies a unique position and could play a major role in ensuring the satisfaction of the need for ethical, open, honest and transparent behaviour by a company in line with established best practices and procedures. The SEC Code⁴ states that ‘the Company Secretary has the primary duty of assisting the board and management in implementing this code and developing good corporate
governance practices and culture’

The role and responsibilities of the company secretary makes clear the pivotal position he occupies, and how uniquely he is placed to observe the corporate governance in practice as he is usually the compliance officer of the Company. The primary company law in Nigeria, Companies and Allied Matters Act 2004 which provides for the office of the Company Secretary defines his basic duties. An appreciation of the essence of a proper discharge of these duties is pertinent. He has a responsibility not only to be conversant with existing applicable laws and published codes of governance but be keenly aware of the inherent reason for these provisions. Thus he must be ethical in the discharge of his duties.

Conclusion  – Ethics and corporate governance

Personal and business ethics underlie all the regulations and codification in corporate governance. Law and regulations alone can never guarantee fair practice. Individuals in positions of influence and authority have to want to apply fair practice and adhere to the rules. Some individuals, however, will be far more concerned with themselves than with the collective aims of their organisation. In extreme cases, an individual will have
only personal interests in mind, to the exclusion of any other interests, and regardless of his or her position within the organisation. To some, laws, stock market regulations and corporate governance codes are viewed as obstacles to be overcome rather than guidelines for conduct.

Laws, regulations, accounting standards and codes are framed on the assumption that they will be followed. For would-be transgressors, there is some threat of punishment in the law. When there is evidence of misdeeds in corporate governance, new l aws may be introduced carrying stiffer penalties, in the expectation that potential wrongdoers will hesitate before doing anything selfish and wrong. Even so, the threat of criminal and civil punishments is never enough on its own. Good practice in corporate governance practice calls for ethical conduct and a firm sense of what is right and wrong.

Statutory and regulatory compliances are merely starting points for an effective governance system. Good corporate governance is not equated with religiously ticking off the company’s compliance with applicable laws/codes and the compliance officer reports to the Board that the Company had been compliant. That in itself evidences a lack of application of mind by the Board as to whether it is governing in an accep table manner. The marketplace is the ultimate compliance officer, this is in line with the reasoning in several jurisdictions for companies to choose to “comply or explain” rather than “comply or else” with regard to directors’governance of a company. In a regime of comply or explain the directors are duty bound to apply their minds as to the guidelines which are most suited for the business of the company. If they believe that noncompliance with a guideline is in the interest of the company and they explain it the true test will be whether the market accepts that explanation or whether stakeholders flee the company. If investors and other stakeholders continue to support the company then the question answers itself. In the end, it is the evaluation of the quality of the governance by the company’s ultimate compliance officer, the marketplace that is important.

By Emmanuel Osajie

 

 

 

 

¹ Ifeanyi Desmond Nworji(Babcock University, Ilishan Remo, Ogun State) Olagunju Adebayo and Adeyanju Olanrewaju David (Redeemer’s University, Mowe, Ogun State)
² At an event on financial systems stability organised by Olaniwun Ajayi LP March 16, 2012.

³ Ben Emukufia Oghojafor et al. on Poor Corporate Governance and its Consequenceson the Nigerian Banking Sector
⁴ Code of Corporate Governance for Public Companies 2011