Horizons of Corporate Governance
The field of corporate governance is constantly evolving. At the same time, the rate of advancement in the discipline has been impressive. As financial markets become more sophisticated, much larger in size, and more global in reach, the goal of protecting investor interests would gain even more traction. While a great deal has been done, there is much more to come.
Whereas the laws and regulations have taken the lead in defining threshold requirements of company governance, this alone is not enough. Indeed, if it were, there would be no more misbehaviors on the part of management, board, auditors, and other coregulators. The fact that financial frauds happen, restatements of financial statements occur, conflict of interest persists, and insider trading is prevalent suggests that there is room for improvement.
Broadly, root causes of many of the remaining problems appear to be human, that is, in the form of leadership and leader behavior, manage rial motivation, group dynamics, and morality. This area is foreign to the laws and will have to be explored through rigorous empirical research rather than outright specification of rules. For now, the best that can be done is to find ways to notice anomalies in behavior and respond to the situation accordingly and perhaps without much support from the law.
CORPORATE GOVERNANCE ECOSYSTEM
Because the shareholder is at the core of governance goals, it is important to recognize questions related to company ownership. A director conscientiously working on behalf of the shareholders has to visualize whose interests the director is representing sitting in the boardroom. Increasingly, individual investors are outpaced by institu tional investors; thus, the focus shifts to knowing institutional inves tors with stakes in the company. The problem of focusing on the shareholder, even among the institutional investors, could become more aggravated as the choices of investment vehicles – Mutual Funds and ETFs – shrink to a few very large, dominant, and powerful channels of investment. In the future, only a handful of investment vehicles may be involved in making up the entire body of outstanding shares.
Perhaps this diffusion of identification of the persona of share holder could be a boon to the current momentum toward account ability toward not just shareholders, but the entire stakeholder group. Private equity firms have no problem in identifying their investors; they are less likely to be asked about other stakeholders, except in the context of compliance with legal and regulatory requirements. For public companies, the future lies in balancing the interests of other stakeholders versus those of the shareholder. Without nurturing other stakeholders, the interests of shareholders may not be delivered as well.
The emphasis on maximization of shareholder returns in the long run is unlikely to be displaced; however, it will be increasingly shaped by concerns for other stakeholders, including the community at large, the nation, and the world. Issues of sustainability, both of an entity and the environment in which it thrives, are now at the front and center of the governance challenge. Climate change, alternative energy sources, green living, etc. will become germane to almost every organization. You can’t do good to your investors unless you take care of the universe around the corporation. This challenge of optimizing across all stakeholders will tax both management and the board in the future. Experiments of the idea of a triple-bottom line which includes corporate social responsibility (CSR), have been in play for some time and will continue to gain ground as a potentially viable metric.
The search for board members who are capable, available, interested, and independent will continue to become even more intense. As a group, diversity of the board will be under the microscope of investors. One very influential fund announced recently that it will be looking for at least two women on the board of companies targeted for investment. This illustrates a larger point, namely that the voice of large investors and institutional investors will continue to gain strength and will not easily be disregarded.
Multiple directorships of board members will also come under scrutiny, for it represents a double-edged sword. Well-connected board members could help the company benefit from their relationship; however, representation on multiple boards splits time and attention at a time when governance becomes a critical matter for the company, its shareholders, and the regulators.
REGULATION AND COMPLIANCE
The SOX and Dodd-Frank Act introduced significant sophistication in the field of governance, mostly in the spirit of problems caused by bad behavior on the part of corporations or industries. Independence of regulators is further emphasized and a clear link is established between the independent auditors and the audit committee of the board. Additionally, management’s responsibility for truthfulness of the financial information is clarified. Such measures help in improv ing governance.
BALANCE BETWEEN THE MARKET AND STATUTORY REGULATION
Regulation is a tightrope exercise in balancing political, economic, and business interests. The role of regulation is to require entities to perform particular actions while prohibiting others. The overarching idea is to bring the behavior of governed and those in charge of governance to an acceptable level. Overall, the intentions are reasonable from the viewpoint that if the government does not protect, who else could do so? Enforce ment of regulation is a punitive measure that attempts to bring some balance in the economic behavior of organizations and their managers.
Unfortunately, as new regulations grow without limits, there is no real justification needed to bring on yet another regulation. But regulators are rarely incentivized to propose removal of any rules in place. The situation is comparable to what happens with curriculum at universities. The faculty and administrators expand their curricular programs by adding courses, diplomas, and degrees. However, there rarely is a proposal to cut any of the courses, no matter how dated, from the catalog. Universities may put forth an argument that “dead” curricula do not impose any harm to anyone, so why worry? In contrast, once in place, regulations have the force of law and continue to remain a burden on the economy. In some cases, this may be true even when the goal behind such regulation is gone or worthless. Unless there is a trigger that would require action to cut regulation, not much happens in bureaucracies and clans. Some states in the USA have adopted a zero-base budget: all rules come to a halt unless they are explicitly triggered back in time.
FUTURE ISSUES AND CHALLENGES
Corporate governance has been around for centuries, although the degree of sophistication infused in it is relatively recent. One might wonder why so many surprises emerge almost regularly; after all, the field of corporate governance is not new. The core of corporate govern ance rests in human behavior, and it is not easy to modify or regulate management, board, or auditor behavior. Here are some examples:
- Conflict of interest can appear quickly, without conscious awareness of, or control over, it. People are weak in identifying such conflicts, and when identified, dealing with them properly. The Baltimore, Maryland, mayor had to quit her prestigious post of mayor because her book was purchased in volumes by those interested in pleasing her.
- It is easy to blame pressure in doing wrong things. However, pressure is often internal and the individual experiencing such pressure must endure it. To blame pressure is inappropriate; it is not an escape valve for any compromises.
- Maturity, or motivation, to deal with the issue may be lacking. Newer board members, for example, are more vulnerable because they are not experienced in looking at situations in larger context.
- Rewards and relationships might be too attractive to strike a challenge to something that is “fishy.” In one experiment reported by Dan Ariely, judges of artwork who were compensated regardless of how they rated artwork were biased in favor of the institution that paid their fees. The fees were not tied to the decision, but the judges still rewarded those who paid their fees.
- Courage is a very personal thing.
- The law is always way behind the times. Regulatory measures could be ineffective, especially when they fail to guide behavior. In the Boeing 737 MAX disasters under investigation, it became apparent that the regulators at the FAA relied too much on the company engineers in approving the jet as safe for flying. Private ordering of one’s regulatory duty makes ineffective the very step that is sup posed to guarantee risk mitigation. The situation is much like company audits by independent auditors, where the reliance placed on the evidence submitted by the auditee could result in poor audit quality and perhaps faulty financial information.
- Power corrupts. Influential managers could use their influence in many ways to pull off a wrongdoing.
As the above list illustrates, it is the human that stands at the core of not doing the right thing. While changes on many fronts help improve the governance outlook, not being able to address the human side fully and properly is a major void. For the foreseeable time, this is not likely to change, even though research is underway to examine the core issue of human behavior as it relates to corporate governance. Meanwhile, directors, auditors, and other coregulators will have to be vigilant in scanning the environment for potential irregularities emanating from the human psyche. And that is a laudable task!
- Cyber-Risk Oversight Executive Summary, Handbook Series 2014 Edition. National Association of Corporate Directors (NACD) in collaboration with AIG and Internet Security Alliance (ISA), Washington, DC.
- 2021. Google Image.
- Rai, S. 2014. Cybersecurity: What the Board of Directors Need to Ask. Altamonte Springs, FL: Institute of Internal Auditors Research Foundation.
- Raval, V. 2020. Corporate Governance. A Pragmatic Guide for Auditors, Directors, Investors, and Accountants. CRC Press.