The Myths Behind Good Corporate Governance

According to Richard Lochridge (Board Member, PetSmart, Lowes), “the board is a slow vehicle for figuring out when there is a problem and taking appropriate action. Management is hesitant to tell the whole truth; the board doesn’t know nearly what management knows; and, board members don’t always pay attention to all that’s going on.”

The recent financial crisis has raised serious questions about the effectiveness of boards of directors in exercising their fiduciary duties. Corporate governance requires that the board be a check and balance on the CEO and the executive team. The obvious question is whether directors of public companies properly oversee management and ensure management’s actions are in the best interests of shareholders?

The Council of Institutional Investors has long held that good corporate governance—defined to include general issues affecting market transparency, integrity and accountability and specific relationships between boards, management and shareowners—is in the best long-term interests of shareowners.

In his paper ‘Unblocking Corporate Governance Reform’ Dr. Lucian Bebchuk suggested “Because insiders gain the full benefits that arise through lobbying for lax corporate governance rules, while their firms bear most of the costs of such lobbying, insiders have an advantage in the competition for influence over politicians. Their lobbying, which is carried out at the expense of their companies, is subsidized by their shareholders” (Bebchuck, 2009).

In a written response to a lawsuit filed by shareholders in a New York federal court, AIG conceded that its executives were, at times, too optimistic, but denied any intent to deceive investors, “Being wrong or even unwise, in hindsight, is not the same as violating the securities laws.”

In defending itself against the shareholders’ lawsuit, AIG contends, “Statements of optimism about the future…that turn out to be wrong are simply not actionable. Even in times of market turmoil, the company need not presume the worst about its market prospects.”

To federal prosecutors, corporate directors, investment professionals and shareholders, how do you know where delusion ends and dishonesty begins; how do you distinguish the difference between incompetence and ill intent?

Today, transparency into publicly traded companies is amorphous.  Information is often incomplete, irrelevant or outright incomprehensible. This online forum aims to demonstrate that transparency can work.  When information is relevant, standardized and public, it fosters intelligent decision-making.

 “The point of regulation is to increase transparency.” (Michael Oxley, Sarbanes-Oxley Act of 2002, Fortune, March 24, 2010). “If you read any of the books that have come out, from Hank Paulson’s book [On the Brink] to Too Big to Fail, the common thread is an incredible lack of transparency and no accountability.”

Is it possible to ever close the loopholes in transparency? Unequivocally, Yes!

One viable means to find out what’s really going on inside a company is to improve internal transparency with reporting via an independent third party.

Improved internal transparency from an independent third party provides investors with comprehensive information about the quality of the business and strength of the management team.  The information would serve as a check and balance against the information currently disclosed by management as well as auditors and outside consultants.

Recent studies indicate that employees find more corporate fraud than regulators (Adair Morse, assistant professor of finance at the University of Chicago’s Booth School of Business).

Employees with knowledge of questionable business practices now have access to a reliable, structured process to disclose information without fear of reprisal or reprimand; to prevent executives from coercing employees into going along with risky corporate strategies; and, prevent misrepresentations by executives in public filings.

A new online information service provider offers an innovative solution to disclose illegal, unethical, or questionable practices of individual managers, while providing the Company an opportunity to take corrective actions to remedy non-conformances, and implement preventative measures to avoid recurrence.

Employees can initiate an Ethics Action Report (EAR) to document misconduct at work, which include but is not limited to: managerial mischief, fraud, unethical behavior, illegal activity, questionable business practices of individual managers, lying, falsification of records, sexual harassment, and drug and alcohol abuse.

Applying the Failure Modes and Effects Analysis (FMEA) based preventive action system to ethics and corporate governance provides the Company an opportunity to analyze misconduct, processes, and other activities for the detection and elimination of the causes of non-conformances.

The corrective action system provides the Company a structured process to search for the causes of non-conforming behavior and identify corrective actions. Preventive actions and controls can be initiated, after which a management review confirms the efficacy of the implementation. These are implemented with the goal of preventing recurrence.

It’s time for pension fund managers to draw the line with Corporate America. It’s not just enough to overhaul the regulatory architecture. Pension funds need market-based discipline. To succeed, investors will need tools that hold corporate directors’ feet to the fire. That includes improved internal transparency from an independent third party to safeguard investments against corruption, fraud, and poor management.

A sample report from the online service provider is available at http://www.zethics.com/investors.php.

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About zethics
CEO and founder of zEthics, Inc. Thirty years of experience with finance and accounting background in public private sectors.

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