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Government’s Regulation of the Corporate Directors Essay (Critical Writing)


Introduction

In the recent past, numerous scandals involving corporate board members have been witnessed, most of which have led to huge losses to investors. Some scholars have found a close connection between the scandals and self-regulation, which is evident in many contemporary organisations. Generally, the directors of a company are supposed to maintain a fiduciary relationship with shareholders (Hasan & Omar 2015).

They are not supposed to make any secret profits. However, in the recent past, directors have been colluding with auditors to defraud the shareholders and investors at large. It is believed that issues such as the independence granted to the directors and the lack of diversity within the boards are to blame for the escalation of the problem. In the light of the highlighted views, this paper investigates the causes of irregularities within the companies’ boards to determine if the intervention of the government may help to avert such abnormalities. To achieve the objective, the paper adopts a literature review approach in which articles supporting the intervention of the government and those opposed to such interventions are reviewed.

Literature Review

Arguments Supporting Government Regulations

Hassan and Farouk (2014) argue that self-regulation of the corporate boards can contribute to business malpractices, which predispose shareholders to risks of loss of their money. In the past, Chief Executive Officers (CEOs) headed most corporations. Such bosses were not answerable to the government. In other words, the CEOs acted independently, a situation that led to numerous business malpractices. Nepotism, which refers to the practice of exercising favouritism in the process of hiring of the workforce, was a common phenomenon in the traditional corporations due to the lack of government regulations (Jaskiewicz et al. 2013).

Corporation heads have been accused of hiring members of their family, as opposed to hiring people from diverse communities (Jan 2016). Sceptics such as Jan (2016) argue that many company officials come from the CEO’s families. Nepotism can be beneficial for a company if familial or friendly relationships of board members improve knowledge management and leadership, but the approach can be problematic and even detrimental to business (in case family members are promoted without merit) and society (Jaskiewicz et al. 2013). The latter aspect refers to diversity issues.

Indeed, labour laws in some developed countries (for example, the United Kingdom) require organisations, whether public or private, to embrace diversity in the workforce (Dembo & Rasaratnam 2014, Ozeren 2013). Under the traditional systems, CEOs had the power to influence the recruitment process. When given such power, CEOs may choose to appoint their confidantes to gain more control over a firm’s affairs (Jan 2016; Jaskiewicz et al. 2013). In such cases, diversity is not reflected, hence confirming the challenges that the self-regulation of company boards can pose.

Isaac (2014) observes that organisations with the board of directors that are comprised of at least one independent director tend to make better decisions compared to those that do not have an autonomous administrator. This claim indicates that the independence of the board is essential to the operations of a firm. Additionally, other scholars such as Dembo and Rasaratnam (2014) assert that diversity in company boards is essential to the protection of the shareholders’ interests. Diversity in the administrative centre entails to the practice of hiring employees who are obtained from varied cultural and ethnic settings. Casalino, Ciarlo, and Lombardo (2014) assert that workforce multiplicity is crucial to a firm’s performance since it ensures that the concerned business benefits from the different ideas from the workforce.

Some diversity examples include various ethnic backgrounds, age, and tenure. In their study of 1,489 American companies, Harjoto, Laksmana, and Lee (2015) demonstrate that inclusive boards which incorporate people who are diverse with respect to the mentioned features tend to be more compliant with corporate social responsibility guidelines. Moreover, Torchia, Calabrò and Morner (2015) demonstrate in a study of almost 400 Norwegian companies that diverse backgrounds and even personalities in board members, while having the potential for causing conflict, increase their creativity to a statistically significant extent, which is a positive outcome. To sum up, there is extensive evidence to diverse boards being beneficial for companies and the society, which implies that this diversity should be promoted by multiple means, possibly, including governmental actions.

Conversely, although workforce diversity leads to amplified performance, it needs to be properly managed to avert the various effects that it may have on a company (Qian, Cao & Takeuchi 2013). If not well tackled, diversity may attract conflicts in the workplace and develop various forms of bias in employees, which may lead to diminished performance (Kulik 2014). Based on the stated setbacks, businesses need to manage diversity to mitigate any associated challenges.

One of the strategies used by managers to alleviate diversity issues is functional flexibility, which presupposes training various employees multiple skills to make them suitable to work in different departments within a company (Machado 2016). The presence of flexible employees in a business makes departmental reshuffles possible, a situation that reveals how people from different organisational units interact to mitigate any threatening challenge.

To support the argument that the government should regulate the composition of corporate boards, Casal and Caspar (2014) explore the case of Bacardi- Martini, a UK-based company. The performance of the company has received acclaim to the point of getting extensive coverage in the news; also, it increased shareholders’ value throughout the past decades. The company employs about 550 workers in all its subsidiaries. However, according to Casal and Caspar (2014), an interview with the company’s HRM reveals that the company experiences various challenges regarding human resources. The challenges include diversity issues, conflict of interest between managers and the employees, and diminished morale among the workforce.

To overcome the challenges, the firm embraced diversity in its corporate board in which people from both genders were incorporated (Devillard, Sancier-Sultan & Werner 2014). This approach is known to be beneficial from multiple perspectives, including those related to performance, reputation, morale, and legal requirements (Kamalnath 2015). The strategy ensured that the business remained competitive against the backdrop of the heightening competition in the industry.

Both the employer and the employees benefitted from the arrangement, which made the company attractive to the stakeholders. For the employer, the practices led to increased profits while workers benefitted from augmented salaries (Devillard, Sancier-Sultan & Werner 2014). The example can be viewed as an illustration of a successful improvement of the board through the designation of its contributors.

Some examples of the government issuing helpful board-improving legislation can also be offered. Bhagat, Hirt, and Martin (2013) use the Sarbanes-Oxley Act to illustrate the need for governments to regulate the operations of the corporate boards. The mentioned Act was enacted to regulate the operations of companies following numerous scandals such as Enron and Layman Brothers. The companies’ fall prompted the US accounting body to make changes to its reporting standards. The changes were facilitated by the enactment of the Sarbanes-Oxley Act that defines the reporting standards.

The SOX Act is meant to improve the precision of commercial admissions to shield depositors. Under the Act, companies’ CEOs are held responsible for losses incurred by an investor who relies on their financial statements to invest in the corporation in question. The Act also establishes new reporting standards, penalties for failure to comply, the independence of auditors, and the limits of engagement between auditors and corporate managers. Under the Act, all companies in the US should provide an annual report on the effectiveness of their internal controls (Bhagat, Hirt & Kehoe 2013).

The Act also establishes an oversight board in every company to act as a watchdog for large companies. The oversight board is responsible for setting auditing standards, thus leading to uniformity in accounting systems that are used in different companies. The Act also prohibits auditors from offering additional services to their clients. Thus, their independence is maintained. Since its enactment, scandals were drastically reduced, as CEOs would fear to engage in such undignified practices to avoid liability. This outcome illustrates the effectiveness of government interventions in mitigating business malpractices perpetrated by the directors.

In a similar discussion, Agnihotri and Bhattacharya (2015) explore the issue of corporate governance in reference to India. India has lagged behind in the efforts to establish standard corporate governance principles for a long period of time, but the situation changed in 2011. That year, the country made an attempt at determining the rules that it would use to frame its corporate culture by passing the so-called ‘companies bill’ that contains the key governance principles which are approved by the Indian parliament.

The bill borrows much of its content from the UK corporate governance principles. As a result, it faced criticism because of the differences between the two countries: for example, the UK has an open market while India has a closed market. Before the ratification of this bill into an operational regulation, the Securities and Exchange Board of India (SEBI) played an oversight role in India’s business configuration (Pathak & Purkayastha 2016). The team established various suggestions that were executed in 2000.

The selected board has suggested the need to review the information about the principals that comprised the board of directors and insisted that the number of the supervisory and non-executive ones should have been roughly equal. The team also proposed the audit group to operate under the umbrella of a self-governing administrator. The stocktaking team was supposed to include no less than three administrators, with the financial regulator being regarded as an associate in the group. The fiduciary affiliation was eventually meant for the administrators. Their earnings were to be entirely revealed and permitted by the shareholders. Before the corporate governance laws were enacted, Indian companies could lose a lot of money to irresponsible directors. However, after the laws were enacted, cases of corporate scandals reduced drastically. This finding highlights the need for governments to intervene in the operations of company’s directors.

Apart from the examples of successful and reasonable regulations, several failures that can be attributed to the lack of regulation can be mentioned. For instance, Westphal and Bednar (2005) support the need for governments to regulate the composition of the corporate boards by claiming that such a move would increase the directors’ independence. The authors cite the fall of Enron to substantiate the view that the lack of government control contributes to the misuse of power by the board members. One of the reasons that led to the fall of Enron was fraudulent acts by the executives, which caused huge losses to the company. The corporation did not reveal the losses that were later witnessed from its contracts. The authors also focus on the unethical conduct of the company’s management.

Similarly, Bernstein (2015) supports the idea of government involvement in the recruitment of directors by analysing the case of Satyam. The company started to experience issues in 2009 after the decision to purchase a stake from the Matyas firms which was not approved by the shareholders; in fact, the stakeholders’ opinion was not solicited despite the legal requirement to do so. However, the decision received opposition from the shareholders, especially when they learnt that Matyas was owned by the family members of one of the managers (Marilen & Ana-Cristina 2013).

Ramalinga Raju, who was the executive director of the company at the time, also confessed to carrying out ghost transactions and ballooning profits. Such examples of shareholders being excluded from decision-making and harmed by a poor control over the managers of the company can be viewed as arguments for government interventions.

Arguments against Government Interventions

Other scholars in the field have argued against government’s interventions in the management of company boards. For instance, Daily et al. (1998) argue that a special body should be created to regulate the operations of directors, as opposed to engaging the government. The body should help to avoid the above-mentioned issues by clearly determining the specific obligations of the stakeholders, especially the owners and directors. The CEOs of companies should not be allowed to own many shares in a business since this move might give them the power to make influential decisions without involving other directors (Yu & Zheng 2014).

The directors’ recruitment should be carried out by a group of independent directors within the companies’ boards; the decision must be made through the analysis of the experience and skills of the potential directors to ensure a merit-based choice (Ahmed 2015). On the other hand, a limit must be chosen for the directors’ terms; a one-year period for every director should be appropriate. The end of the term does not mean that the director cannot service the company anymore, but the election process must be repeated. Each company should be required to establish a strong code of conduct that would be based on honesty, transparency, and integrity. Ongoing, regular assessments should be carried out to control the process and ensure that the provisions are carried out to the letter. This way, there will be no need to involve the government.

Another option that can keep the government out of the situation presupposes dealing with the above-mentioned issues with business tools. Although the numerous frauds that are committed by company directors are likely to have multiple causes and reasons, at least one of them, which is particularly prone to leading to deceptions, may be the fact that businesses tend to lack properly defined guidelines and rules that would control business conduct (Ricard 2015). Similarly, Ricard (2015) points out that the lack of a proper implementation of the rules may be another issue that causes frauds. Although cases involving deception cannot be fully controlled, they can be reduced by employing preventative measures, especially since it is possible to detect some of the reasons.

For example, according to Dedman (2003), instances of fraud can be reduced by applying the following two approaches: preventative and palliative ones. A palliative control measure involves the alteration of the existing methods and the introduction of new ones. When it is properly carried out, this control option should be able to detect fraudulent activities. The alternative (preventative) measure refers to preventing such fraudulent activities before they cause significant harm, which seems to make it superior both from the short- and long-term perspectives. The mentioned measures already exist in current corporate laws, but it is difficult to check if they are well-implemented. If corporations could embrace the rules, there would be no need for the government to regulate the company directors.

The diversity issue can also be handled by organisational means. Adams and Ferreira (2009) observe that although diversity can create problems amongst the board members, it can lead to better performance if the multiplicity issues are well managed. Diversity management typically requires a code of conduct, which should contain all the guidelines on diversity-related behaviour for all the employees and employers. Non-compliance should involve penalties. This strategy ensures that employees remain committed to acting ethically to avoid the penalties, which they were part of their formulation (Ahern & Dittmar 2012).

In other companies, diversity problems are managed through the establishment of a healthy organisational behaviour. Organisational behaviour can be described as a particular field of management that refers to people’s conduct (Wood, Zeffane & Fromholtz 2015). A successful business has to manage its human resources in a most effective manner, which is crucial for gaining a competitive advantage (Armstrong & Taylor 2014). One of the objectives of organisational behaviour management is to remedy the diversity issues that may arise. In particular, organisational paradigms (for example, values and norms) and policies can be modified to improve the organisational behaviour with respect to minorities (Kulik 2014).

Some examples that are described by Ozeren (2013) deal with the organisations that implement policies which promote a safe environment for LGBT employees and employers; the results include an increased number of coming-outs and overall improvement of the performance shown by LGBT stakeholders.

The author uses these examples to criticise the policy of “don’t ask, don’t tell,” which he shows to be guided by the idea that the presence of LGBT employees and employers is likely to lower the morale of other employees. Instead, Ozeren (2013) reviews the evidence which shows that LGBT-friendly environments foster more open communication, increased job satisfaction, and better performance in non-LGBT people as well (p. 1206). This illustration can be used to explain the need for effective diversity management, demonstrate its potential positive outcomes, and indicate that organisations are capable of managing this issue without governmental incentives or interference.

The human resource is apparently one of the firm’s key assets that directly affect its output. Thus, human resource management is a priority for managers, which highlights the significance of effective work with the behaviour in an organisation. Therefore, this field of management can also be viewed as a tool that business can use to improve the conduct of their boards without governmental interference, although it can be implied that some governments might exert additional influence through the diversity-promoting laws that were mentioned above (Ozeren 2013).

Conclusion

In the recent past, various scholars have come out to support the intervention of the government in setting up corporate boards. The supporters of this school of thought argue that the government’s interventions can lead to diversity in the boards. Diversity is a crucial element of the board that is attributed to the good performance of a company. Conversely, in a situation where the board members have a commonality of interest, it is easy for them to manipulate each other to defraud a company.

However, other scholars in the field dispute the view on the grounds that government interventions may lead to bureaucracies in the recruitment process, a situation that may be harmful to companies. Additionally, the opponents of government interventions claim that diversity cannot guarantee good performance. This paper has reviewed the literature concerning the topic. It has found that the government’s intervention may be important in streamlining the operations of company boards while alternative solutions are also present.

Reference List

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IvyPanda. "Government’s Regulation of the Corporate Directors." August 6, 2020. https://ivypanda.com/essays/governments-regulation-of-the-corporate-directors/.

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IvyPanda. 2020. "Government’s Regulation of the Corporate Directors." August 6, 2020. https://ivypanda.com/essays/governments-regulation-of-the-corporate-directors/.

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