Corporate Governance: Sarbanes-Oxley Act PDF

## The Need for Corporate Governance: Sarbanes-Oxley Act **Stakeholder Theory** - Theory stating that the corporation exists for the benefit of the stockholders or stockholders. - The opposite is the **short-termism** theory, which advocates for increasing short-term profits only. - **White knight...

## The Need for Corporate Governance: Sarbanes-Oxley Act **Stakeholder Theory** - Theory stating that the corporation exists for the benefit of the stockholders or stockholders. - The opposite is the **short-termism** theory, which advocates for increasing short-term profits only. - **White knight** refers to a friendly investor that purchases a target company at a fair price and with the support of existing management and directors. **The Need for Corporate Governance: Sarbanes-Oxley Act** - **Corporate governance** is the effective way of directing and controlling companies. - Corporate officers such as CEOs, CFOs, directors, and others, must act for the long-term best interests of shareholders. - The term "corporate governance" became a household name following the Enron and WorldCom fiascos. - The **Sarbanes-Oxley Act (SOX Act)** was passed in response to these financial scandals. - It is primarily a corporate governance regulation. - It seeks to strengthen the functioning of the board of directors, enhancing board independence. - This includes appointing more independent directors. - Independent directors should be detached from operational duties and should not have business dealings with the company. - SOX also requires evaluation of internal controls to ensure reliable and transparent financial reporting. - Other improvements include: - oversight of audits of corporate financial statements. - whistle-blower policies. - transparent disclosures of financial and nonfinancial information. **Definition Of Corporate Governance** - The OECD defines **Corporate governance** as the system of stewardship and control to guide organizations in fulfilling their long-term economic, moral, legal, and social obligations towards their stakeholders. **Concept of "Stewardship" and "Control"** - **Management** runs the business and is involved in day-to-day operations. - **Corporate governance** is the oversight or monitoring of corporate performance and operating results, ensuring that the business is being run properly. - This role is performed by the board of directors. **Fulfillment of Long-Term Obligations** - Corporate governance is not simply a deterrence to fraud but a means to fulfill long-term economic, moral, legal, and social obligations to stakeholders, including investors, creditors, suppliers, employees, government regulators, and the society as a whole. - **Fulfillment of economic obligations** include providing sufficient returns to shareholders in the form of dividends. - The board of directors must periodically conduct an oversight of the financial performance of the company to ensure that the company is performing sufficiently to provide dividends. - **Fulfillment of moral obligations** include paying appropriate compensation to employees. - **Fulfillment of legal obligations** includes complying with legal requirements and contractual obligations. - **Fulfillment of corporate social responsibility** is also within the objectives of corporate governance. **Stockholder Theory and Stakeholder Theory** - **Stockholder theory** states that the corporation exists for the benefit of the shareholders. - **Stakeholder theory** states that the corporation exists for the benefit of all other stakeholders, including employees, creditors, suppliers, government and the society. **Long-Term Sustainability Goal of Governance** - According to the OECD, corporate governance is a system of direction, feedback, and control using regulations, performance standards, and ethical guidelines to hold the board and senior management accountable for ensuring ethical behavior. - The ultimate goal is to reconcile long-term customer satisfaction with shareholder value to the benefit of all stakeholders and society. **The Agency Problem** - The **agency problem** arises when the "agents" (corporate managers) use their authority for their own benefit and not for the benefit of the "principal" (the owners). - This often occurs when a company has a thousand or more shareholders, as it's impractical for all owners to directly manage the business. - **Short-termism** occurs when managers focus on short-term profits at the expense of long-term growth. - One example of the agency problem is self-dealing transactions that benefit the manager but not the company, such as a purchasing manager setting up a trading business and buying materials from their own business at an inflated price. **To ensure that corporate managers act in the best interests of the owners, the following are being implemented:** 1. External and internal audits 2. Oversight of managerial performance by the board of directors 3. Management compensation is linked to corporate performance and/or stock price 4. Code of ethical conduct 5. Internal controls 6. Government regulation (e.g., Sarbanes-Oxley, SEC regulations) ## Difference Between Governance and Management - **Management** takes charge of the day-to-day operations of the business, dealing with "running the business." - **Governance** ensures that the business is being run properly, performed by the board of directors and oversight committees such as the audit committee and risk oversight committee. ## Board Independence - The board of directors is responsible for setting the future direction of the company, approving strategic plans and long-term capital investment proposals. - The board oversees the implementation of these plans by management and conducts an oversight of actual performance. - The board of directors must be objective and competent to ensure truthful and accurate assessment of managerial performance. - In small and family-owned businesses, managers are also the members of the board, which is acceptable since the company has no public accountability. - For larger organizations, such as banks and publicly-listed companies, a minimum number of independent directors are required to protect the interests of depositors and shareholders. ## Board Setups 1. **All-executive board**: The board is comprised solely of executive or corporate managers. This is common in small or family-owned corporations. 2. **Board with nonexecutive directors**: This is common for publicly-listed companies and other regulated entities such as banks and insurance companies. ## Governance Structures - **All Executive Board**: All board members are executive managers. - **Majority - Executive Board**: Most board members are executive managers, but there are also a few non-executive directors.