In recent years, we have seen many scandals at a number of corporations involving issues such as bribery, personal misconduct, and several glaringly egregious business practices.[i] The result of these scandals has led to reduced corporate profits as well as the decline in shareholder wealth; all of this has harmed customers. These scandals have also decreased the faith that customers and individuals have in institutions in general.[ii] What has contributed to nearly all of these scandals has been a failure of corporate governance.
Corporate governance can be defined as “the mechanisms and procedures that determine how corporations are run.” [iii] Furthermore, “Corporate governance seeks to ensure that an organization’s management and board of directors operate with the best interests of the owners in mind.” [iii] Noting that, “the emphasis of corporate governance is on developing and supporting mechanisms that enhance shareholder value.”[iii] It should be noted that “risk management is one of the most important concerns of corporate governance. Corporate governance practices should strive to ensure that the organization is addressing the full range of risks and opportunities it faces, as well as complying…with all legal and regulatory requirements.” Simply put, corporate governance is about a firm’s board of directors and managers serving the interests of their owners and clients by creating value, effectively managing risk, and complying with the law.
The problem is that in a number of cases, the opposite has happened. At the start of the last decade, we had corporate scandals at a number of large firms. An especially bad example was the energy firm, Enron who misstated earnings and took on a dangerous amount of risk in the energy business. This was very much the result of unethical and excessively risky leadership fostered by Enron’s board and leadership team.[iv] Results of this behavior included lost shareholder wealth, fraud, and embezzlement on a massive scale. The mortgage crisis of 2008 involved a number of mortgage and financial companies improperly underwriting mortgages and collateralizing these risky mortgages into securities purchased by investors that did not understand the risk they were assuming. When the housing bubble burst in 2008, millions of homeowners and shareholders were harmed.
All of these outcomes are attributable, to a large extent, to poor corporate governance. In the last year, we have seen more corporate scandals at a variety of firms whose common denominator continues to be a failure of adequate corporate governance. [i] Following the Enron scandal in 2002, Congress passed legislation known as “Sarbanes Oxley” (named after the sponsors of the bill) that required publically traded companies to improve their corporate governance practices. Even so, corporate governance problems persist. Given the importance of firms having strong leadership at the board level, what can be done to promote good corporate governance?
First, organizations should have a board-level risk committee whose duties include “considering risk in relation to the creation of new strategies; assisting the board in establishing the organization’s risk appetite and risk tolerance level; monitoring the organization’s compliance with established risk limits and how noncompliance is addressed; advising the board on risk strategy.”[v] A recent article in Harvard Business Review also recommends that firms have an ethics committee for the board. “The board of directors should designate a committee of nonexecutive directors with responsibility for the firm’s culture of integrity and for creating a robust program of controls and processes to promote ethical conduct and compliance.”[vi] If possible, firms should also appoint a chief risk officer to “establish risk management policies and promote risk management competence in the organization.”[vii]
While all of these concepts and structures can foster positive corporate governance, it comes back to people! Simply put, it’s about choosing people with enough integrity, wisdom, and ability to run our organizations in a professional, constructive, and ethical fashion.
Corporate governance is critical to organizational success. The choices that corporate boards make, and hence corporate governance in general, can very much determine the success or failure of organizations. As previously noted, bad corporate governance choices have (and continue to have) very negative effects on customers, employees, shareholders, and society at large. To improve corporate governance, firms should consider creating risk committees, having chief risk officers, and having ethics committees. There are many other structural and legal concepts that can be employed to improve corporate governance but at the end of the day, these structures are only as good as the people who are appointed and serve on corporate boards and their committees. In short, successful corporate governance and leadership are ultimately about choosing the right people.
[ii] An article that addresses loss of faith in institutions. Dunkelman, Marc. J “The Key to Reviving American Institutions May Lie Next Door.” The Atlantic September 9, 2015
[iii] Elliott, Michael W. “Enterprise Risk Management” The Institutes 1st Edition page 4.3 2015
[iv] See the book “The Smartest Guys in the Room: The Amazing Rise and Scandalous Fall of Enron” November 26, 2013 by Bethany McLean and Peter Elkind
[v] Elliott, Michael W. “Enterprise Risk Management” The Institutes 1st Edition page 4.21 2015
[vii] Elliott, Michael W. “Enterprise Risk Management” The Institutes 1st Edition page 4.15 2015
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