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Corporate Governance

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Autor:   •  December 18, 2010  •  2,586 Words (11 Pages)  •  426 Views

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Corporate Governance - Effective or Inefficient?

In the wake of the corporate sandals involving Enron and WorldCom at the start of the 21st century, public awareness incited a new era of corporate governance with the passage of the Sarbanes-Oxley Act. This legislation, in addition to further amendments to the stock exchange's regulations, was meant to prevent further misconduct by aligning the incentives of shareholders with those of management. In order to redirect the manager's interests, SOX alters corporate structures through changes in board composition, executive compensation, audit requirements and reporting standards. However, these regulations had an unanticipated affect on firms in the initial announcement period, creating a positive abnormal return in firms initially perceived as less compliant with the laws. Moreover, there is also 'variation in response across firm size. Large firms that are less compliant earn positive abnormal returns but small firms that are less compliant earn negative abnormal returns, suggesting that some provisions are detrimental to small firms.' (c.g. and firm value 1) In addition to the affect on stockholders, the bond market is also significantly affected by the announcement. In the long run however, a series of recent studies have managed to 'document negative relations between various indices of antitakeover provisions (ATPs) and both firm value and long-run stock return performance (c.g. and acquirer returns) It is of great economic importance that legislators and investors understand how these major corporate governance mechanisms operate as well as their affect on share-holder wealth, yet the results of many studies are ambiguous as to whether following these provisions actually leads to more effective monitoring and improved firm value.

Corporate governance is the set of guidelines, procedures and organizational and reporting structures that supervise the way a corporation is run. The principal entities and relationships considered when administering corporate regulations are the shareholders, managers and board of directors. "These rules include different provisions whose purpose is to ensure alignment of incentives of corporate insiders with those of investors, and to reduce the likelihood of corporate misconduct and fraud." (Journal of Finance, Vol. LXII, No.4. Aug 2007) For example, SOX requires more timely disclosure of equity transactions by company executives, as well as imposing more stringent punishments of those found guilty of unethical behavior. Moreover, Sarbanes - Oxley dictates that audit committees and the board of directors must be largely independent of corporate influence in order to improve monitors systems and lead to higher corporate value. The perception of strong corporate governance can not only impact the company's share price in the market, but also the cost of raising capital, both important factors in continued firm performance. As such, the secondary focus of corporate governance legislation is to ensure that economic efficiency is improved or maintained by the provisions, so as not to overly encumber businesses in their pursuit of profit. On the whole, most research shows that "portfolios of firms that are less compliant with the rules earn positive abnormal returns compared to portfolios of firms that are more compliant." (C.G. and Firm Value, 1791)

Topic has been studied in a variety of ways and has come to ambiguous conclusions on whether the SOX provisions have a significant impact, as well as if all firms benefits from them. The most advantageous governance structure depends on a corporation's monitoring requirements in addition to the inherent cost and benefits of the monitoring processes utilized. Firms of differing size or industry may benefit most from varying control mechanisms, while others may be inefficient or ineffective once implemented. As such, "imposing one structure on all firms might be suboptimal at least to some firms." (Journal of Finance, Vol. LXII, No.4. Aug 2007) Holmstrom and Kaplan posited that small firms incur higher costs relative to their size by complying with the internal control provisions of SOX because it is more difficult and costly for smaller firms to obtain talented independent directors for their board committees. (Journal of Finance, Vol. LXII, No.4. Aug 2007) When studied, results showed that when the internal control and director independence provisions were examined, abnormal positive returns after the announcement of SOX were found only in larger firms. Moreover, Gomes, Gorton and Madureira (2007) studied the effect of Fair Disclosure regulation on firms' cost of capital, and found that the legislation reduced cost of capital in larger firms, but increased the burden on smaller firms.

A number of corporate control mechanisms exist that help mitigate the manager-shareholder conflict of interest, such as the market for corporate control

Corporate issues involving fraudulent accounting, malfeasance and data quality issues frequently dominate news headlines; CEOs and Boards of Directors (BoD) are under public scrutiny and, as a result, regulatory requirements have emerged to address these issues using commonly accepted principals of corporate governance

Numerous reports on corporate governance have emphasised the desirability of increasing the number of outside directors on boards. An equally important and related issue is a growing insistence that the role of chairman and chief executive should be separate, though on this issue there is less unanimity in the U.S. than in other countries. Choosing the right Chief Executive officer is the key task for the board of directors. Pressure on chief executives to perform in ever decreasing time frames makes it essential that the CEO and the Board work closely together. An effective chief Executive will drive company strategy, lead the top team and fulfill shareholder ambitions . A good CEO will transform Board dynamics by keeping an open line of communication, placing a high value on Board input, and promoting the belief that management and the Board is working toward common goals. The average Board size is between eight and nine members. It used to be that Boards were constructed of executives with one or two non-executives; but trends are swiftly driving executives out of the boardroom as even the CEO's familiar role as chairman has been called into question. There has been a notable shift from executive director to non-executive director in the boardroom. The supposed advantages to these changes are to provide greater board independence from management, greater objectivity, and a representation of multiple perspectives. Bosch believes that the fundamental principle underlying this composition is accountability; if you have strong

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