The change in ownership from 100% privately held toward an increased share of publicly traded shares brings along with it the probability that a firm may be managed by hired professionals and not the owners.
This raises the possibility that ownership and management may not be perfectly aligned in their business and financial objectives, the so called agency problem .
Although the governance structure of any company – domestic, international, or multinational – is fundamental to its very existence, this subject has become a lightning rod for political and business debate in the past few years.
Spectacular failures in corporate governance have raised issues about the very ethics and culture of the conduct of business.
The single overriding objective of corporate governance is the optimization over time of the returns to shareholders.
In order to achieve this goal, good governance practices should focus the attention of the board of directors of the corporation by developing and implementing a strategy that ensures corporate growth and improvement in the value of the corporation’s equity.
Equity markets should reflect the market’s constant evaluation of the promise and performance of the company.
Debt markets should reflect the company’s ability to repay its debt in a timely and efficient manner.
Auditors and legal advisors are responsible for providing an external professional opinion as to the fairness, legality and accuracy of corporate financial statements.
Regulators work to ensure, among other things, that a regular and orderly disclosure process of corporate performance is conducted so that investors may evaluate a company’s investment value with accuracy
Failures in corporate governance have become increasingly visible in recent years.
In each case, prestigious auditing firms missed the violations or minimized them, presumably because of lucrative consulting relationships or other conflicts of interest.
In addition, security analysts urged investors to buy the shares of firms they knew to be highly risky (or even close to bankruptcy).
Top executives themselves were responsible for mismanagement and still received overly generous compensation while destroying their firms.
Corporate Governance Reform Within the United States and the United Kingdom, the main corporate governance problem is the one treated by agency theory: with widespread share ownership, how can a firm align management’s interest with that of the shareholders? Because individual shareholders do not have the resources or the power to monitor management, the U.S. and U.K. markets rely on regulators to assist in the agency theory monitoring task. Outside the U.S. and U.K., large, controlling shareholders are in the majority – these entities are able to monitor management in some ways better than the regulators can.
Mini-Case Questions: Governance Failure at Enron
Which parts of the corporate governance system, internal and external, do you believe failed Enron the most?
How do you think each of the individual stakeholders and components of the corporate governance system should have either prevented the problems at Enron or acted to resolve the problems before they reached crisis proportions?
If all publicly traded firms in the United States are operating within the same basic corporate governance system as Enron, why would some people believe this was an isolated incident, and not an example of many failures to come?