Corporate Failure and Governance Essay

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Introduction

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Enron, WorldCom, Adelphia and Global Crossing are a few names which had resulted in corporate failure a few years back. When one looks at these cases, one search as to who is to blame? No doubt the CFO of these companies dint perform their duties with the utmost due diligence or that SEC were not monitoring the regulations carefully but since the problem between these corporate failure is general and persistent, it can be determined that only a systematic problem have been the root of such failures i.

e. the current accounting system. There are a lot of books which are applicable on the companies rather than a single set for example, GAAP, SEC filings; acquisition accounting and tax accounting are just a few. This results in confusion as different treatments are available for one problem which leads to inconsistency and management is able to dress the financial statements in their favor. Therefore it is necessary to have an accounting system that provides a disciplined approach yet flexible in order to guide the companies through the principles without showing instability.

(Source: Recent Corporate Failure)

However with further breakdowns of companies since these major upsets it is also learnt that gaps in accounting system is not to be blamed entirely as weakness in corporate culture has also caused failures. With greed for power and wealth, failure to maintain effective internal controls, overpowering CFOs, uncontrolled expansion, and hurried acquisitions are just a few reasons of failures which a prospective investor should be alert of. (Source: Editorial Review)

Body

The above mentioned factors were merely a gist of why corporations failed. Another factor that overshadows success is ‘a lot of success’. As facts have revealed that most of the corporate failures were once highly successful; later lead to inconsistencies due to this success. Attitude changes once success is found among companies that constitute the reason why companies out grow. Pride dwells in companies which also bring the entities down like Microsoft were fortunate to have an antitrust suit stopped against them in time. But the most natural aspect of all this is that companies loses their security upon having a taste of a lot of profit. This had been the case WorldCom where window dressing took place simply because the normal business was unable to produce great numbers to be reflected in the balance sheet. (Source: Causes of Corporate Failure)

            Australia has followed a similar path as well. In the early 1980s, exchange rate, foreign bank entry, interest rate and exchange control deregulation caused fundamental increase in investment in Australia as the world financial market was open to get in Australia. But going from the most stringent regulations to an unregulated market, caused a downfall on the economy as many entities failed, one after the other. (Source: Regulation and the Regulatory Burden)

            Even though an environment of uncertainty was created by such events, which has soured interest rates, the finance market is inspecting the corporate entities performance in terms of borrowing more than ever before. Lenders are afraid to invest in companies as they are constantly in search for any indication of failures. This is why accurate means of forecasting failure is important resulting in a move towards systematic way. Models have been introduced to ease this concern of many investors and have been in place since the great depression and a rise in the number of defaults. Yet as many models are available for the use but financial analysts preferably utilize the ‘Z-Score’ model for predicting purpose. (Source: Predicting Corporate Failure)

            The government of Australia introduced another methodology to further strengthen its market and economy by improving the framework of corporate governance. Effective regulations of corporate governance prevent the chances of fraud or misrepresenting their true figure so that before the corporation collapses, strong indications would alert the investors and hence prevent such magnitude of failures. The ASX’s Corporate Governance has made two key principles after such incidents to redeem the confidence of shareholders. By respecting the privileges of shareholders and making timely and unbiased disclosure to the financial statements will result in more transparency. This can be seen in an example where the CEO of Aristocrat, operator of poker, failed to meet these two criteria and showed incompetency which cause major financial issues for Aristocrat; also damaged its goodwill in the eyes of the current and prospective shareholders. Therefore it is of utmost importance for the companies to realize that this framework is not merely the rule of law but serves more than just guidelines as failure to comply with the requirements will result in penalties. (Source: Strengthening Corporate Governance Regulations)

Recent turmoil in corporate failures had prompted a legislation response in USA thereby introducing what is known as Corporate Social Responsibility. Due to the lack of governing and accounting practices the politicians were required to step in to pass Sarbanes-Oxley Act through the Congress in order to protect the reliability in the American business. Even though this act was introduced in July 2002 but final results, over a certain period of time and constant statement process with the general public, an optimistic stride for corporate governance was established thus making it more than just a political step to saving from the crises. (Source: Recent Experience with Corporate Governance in the USA)

Sarbanes-Oxley appreciates the value of stockholder as they are the reasons why companies exist. It is their investment that has established many organizations; without their confidence the growth of America’s technology and economy wouldn’t have been possible. In this way the act strengthens the agency relationship of the directors towards the stockholders as stewards. (Source: Recent Experience with Corporate Governance in the USA)

Failure to understand the significance of the corporate culture has led to many failures in America. CFO’s misdeeds in relation to ethical point of view have been a highlight for many failures. Similarly the role of the directors is to safeguard the assets of the company and to look at the affairs of the company therefore they can never be full time employees. That is why it is quite often that management sees the directors with a conflicting eye. However with the introduction of Sarbanes-Oxley, same queries which used to pose problems are now being accepted as another function of the directors. This oversight function of the directors to check management for committing crimes is certainly the right way of securing corporations from failing. Similarly giving as much of information necessary for investor’s decision making is considered in Sarbanes-Oxley, therefore giving the investors the power to be regulators by disclosing all the relevant yet important details to determine whether to invest in a particular company or not. (Source: Recent Experience with Corporate Governance in the USA) In America, with the recent major crises to the extent that financial market could go to ground zero, central banks jumped in to rescue the world and its market from these crises. Around $110 billion were pumped in by the U.S. Federal Reserve through short term loans to ease the liquidity position in the global market. AIG was extended an emergency loan of $85 billion to save the major insurance company from going bankrupt. Already Fed had given nearly $900 billion to save corporate firms from the crises of credit crunch and insurance companies from claims against natural disasters, it had to further provide Treasury securities worth $479 billion to further provide assistance which would be redeemed back at a future date once the financial market gets its roots restored again and regulation strengthen. It’s possible that the investment could reach up to $1 trillion in an attempt to bank the market as regulators announced that measures will be taken to normalize the situation in the current market to preserve and protect the public’s investment. Even though most of the investment is worthless at this point but the government hopes to make some, if not all, from this spending over a few years. (Source: Central Banks move to Restore Confidence, Treasury secretary says the rescue plan, news of which rallied markets, is needed to restore the financial sector)

Conclusion

Epitomizing, we can see that the increased government regulation has improved by a major fold on the American and Australian economy. Stocks were down by major percentage as investors were no longer feeling safe in investing in financial sector, more recently since the collapse of Lehman Brothers Co. Such events have changed the social economic relations between the government and the public at large as institutions were politically driven. But with the financial assistance of both the governments to not just the local but also global crises, the investors’ confidence has risen and the stock market shot back to the top again. However the objective of this assistance was not to bail out companies from the crises but to tighten the rules on the instruments in such a way that government is able to secure its funds and prospects of such downturn do not arise anymore. This can be seen in the Australian economy, reformed during the Howard Government by empowering the independent agencies to scrutinize the need for growing the regulations, in effect reducing the prospects of such downturn from occurring again. (Source: Regulation and the Regulatory Burden, Central Banks move to restore confidenc

Reference

Humphrey Nash, Recent Corporate Failure. Retrieved September 20, 2008, from the Internet Explorer Website: http://home.sprintmail.com/~humphreynash/recent_corporate_failures.htm
Editorial Review. Retrieved September 20, 2008, from the Internet Explorer Website: http://www.amazon.com/Greed-Corporate-Failure-Lessons-Disasters/dp/1403986363
Causes of Corporate Failure. Retrieved September 20, 2008, from the Internet Explorer
Website: http://www.lonnypaul.com/lonny.paul/2006/07/27/causes-of-corporate-failure/

Predicting Corporate Failure. Retrieved September 20, 2008, from the Internet Explorer Website: http://www.kordamentha.com/downloads/ResearchUnit/Publication%20706%20-%20Predicting%20Corporate%20Failure%20-%20March%202007.pdf
Regulation and the Regulatory Burden. Retrieved September 20, 2008, from the Internet Explorer Website: http://www.ipa.org.au/news/1630/regulation-and-the-regulatory-burden
Alex Proimos. Strengthening Corporate Governance Regulations. Retrieved September 20, 2008, from the Internet Explorer Website: http://www.emeraldinsight.com/10.1108/15285810510681900
Central Banks move to restore confidence. Retrieved September 20, 2008, from the Internet Explorer Website: http://www.traderoots.org/newsArticle.jsf?documentId=2c9e4f691c740c29011c75e1ae0a028b
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Treasury secretary says the rescue plan, news of which rallied markets, is needed to restore the financial sector. Retrieved September 20, 2008, from the Internet Explorer Website:
http://www.startribune.com/nation/28678864.html?elr=KArksD:aDyaEP:kD:aUq9_b9b_jEkP:QUiD3aPc:_Yyc:aUU

Commissioner Paul S. Atkins. Recent Experience with Corporate Governance in the USA. Retrieved September 23, 2008, from the Internet Explorer Website: http://www.sec.gov/news/speech/spch062603psa.htm

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