Corporate Governance and SOX Act Overview

Study Notes

Corporate governance is the process of directing and controlling companies to ensure they act in the long-term best interests of stakeholders.
It became prominent after the Enron and WorldCom scandals.
The Sarbanes-Oxley Act (SOX Act) was enacted to strengthen corporate governance by focusing on board independence and improving financial reporting.
It includes the appointment of independent directors detached from operational duties and without business dealings with the company.

The SOX Act is primarily a corporate governance regulation.
It requires the evaluation of internal controls for reliable and transparent financial reporting.
SOX enhances board independence, requiring more independent directors.
It also includes oversight of audits of corporate financial statements, whistleblower policies, and transparent disclosures of financial and non-financial information.

The Organisation for Economic Co-operation and Development (OECD) defines corporate governance as a system of stewardship and control guiding organizations in fulfilling long-term economic, moral, legal, and social obligations towards stakeholders.

Management is responsible for day-to-day operations.
Corporate governance involves oversight and monitoring of corporate performance and operating results, ensuring the business is run properly.
This role is fulfilled by the board of directors.

Corporate governance aims to fulfill long-term economic, moral, legal, and social obligations towards stakeholders, including investors, creditors, suppliers, employees, government regulators, and society.
- Economic obligations include providing sufficient returns to shareholders through dividends.
- Moral obligations include paying appropriate compensation to employees.
- Legal obligations include complying with legal requirements and contractual obligations.
- Corporate social responsibility is also a key objective.

Stockholder theory states that corporations exist for the benefit of shareholders.
Stakeholder theory states that corporations exist for the benefit of all stakeholders, including employees, creditors, suppliers, government, and society.

The goal of corporate governance is to reconcile long-term customer satisfaction with shareholder value, benefiting all stakeholders and society.
It aims to hold the board and senior management accountable for ethical behavior through regulations, performance standards, and ethical guidelines.

The agency problem arises when managers (agents) use their authority for personal benefit, not the benefit of the owners (principal).
This is common in companies with many shareholders, as direct management by all owners is impractical.
Short-termism occurs when managers prioritize short-term profits over long-term growth.
An example is self-dealing transactions where a manager benefits at the expense of the company, like an inflated purchase from their own business.