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Chapter 4 (Answers)

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26 views6 pages

Chapter 4 (Answers)

please read

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utshow.d.r
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Chapter :4

1. Evolution of Corporate Governance, Problems Developed, and


Current Trends

Corporate governance has evolved from a shareholder-centric


model to one that now considers a broader array of stakeholders,
influenced by economic changes, corporate scandals, and global
shifts in business ethics. Initially, corporate governance in the U.S.
and other major economies focused primarily on maximizing
shareholder value, with boards serving as intermediaries to monitor
executive performance on behalf of shareholders. However, as
corporations grew, so did the complexity of stakeholder needs,
including the interests of employees, communities, and the
environment.

Major shifts occurred following scandals like Enron and WorldCom


in the early 2000s, which exposed serious governance weaknesses,
including conflicts of interest, poor internal controls, and a lack of
board independence. These scandals prompted significant
regulatory responses, particularly the Sarbanes-Oxley Act in the U.S.,
which emphasized financial transparency, accountability, and
increased penalties for fraud. In response to the 2008 financial crisis,
governance standards were further revised to enhance risk
management and promote more comprehensive oversight. These
regulations aimed to address issues of transparency, accountability,
and ethical leadership within corporations.

Key problems that developed over time include conflicts of interest


between executives and shareholders, boards’ lack of
independence, weak risk management, and poor internal controls.
Additionally, some boards were criticized for being too passive or
acting in their self-interest, such as granting excessive executive
compensation packages without alignment to long-term
performance. These issues have undermined trust in corporate
governance and have led to increasing demands for reform.

Current trends emphasize increased transparency, stakeholder


engagement, and Environmental, Social, and Governance (ESG)
integration. More companies are including ESG metrics as part of
their governance frameworks to address the growing expectations
of society and investors. Board diversity is also becoming a priority,
as diverse boards are believed to bring more balanced perspectives,
reducing the risk of “groupthink” and promoting ethical decision-
making. These trends reflect a broader shift toward sustainable,
socially responsible governance that seeks to balance profitability
with ethical considerations.

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2. Major Criticisms of Boards of Directors and the Most Important


One

Boards of directors play a crucial role in corporate governance, yet


they face major criticisms concerning their effectiveness and
accountability. A primary criticism is that some boards lack
independence from the management team, leading to potential
conflicts of interest. This is often seen when boards are filled with
individuals who have close ties to executives or are former
executives themselves. Such connections can impair a board’s ability
to act objectively and hold management accountable.

Another criticism is that many boards are too passive, relying


excessively on information provided by the executive team without
actively probing or challenging management’s strategies. This can
result in oversight failures, particularly in areas of risk management
and ethical standards. Additionally, boards are frequently criticized
for inadequate diversity, leading to homogeneity in thinking and
missed opportunities for innovation. A lack of gender, ethnic, and
professional diversity can restrict a board’s ability to respond to
complex issues in a nuanced way.

Compensation practices are also a significant concern. Some boards


have approved excessive executive compensation packages that are
not aligned with long-term company performance, rewarding short-
term gains over sustainable growth. This misalignment can erode
shareholder trust and encourages a risk-focused approach rather
than stability and ethical practices.

The most important criticism is a lack of accountability and


oversight. When boards fail to act as effective checks on
management, it can lead to poor decision-making, ethical breaches,
and, in severe cases, corporate scandals. Without accountability,
boards are less likely to address risks or challenge management
when necessary, which can lead to significant financial and
reputational damage. Effective oversight is crucial to maintaining
shareholder trust and ensuring that executives are working in the
best interests of the company and its stakeholders. Strengthening
this role would enhance governance and help prevent many of the
issues that have plagued companies in the past.

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3. How Governance Failures Like Enron Could Happen and


Avoidance Measures

Governance failures, like those seen at Enron, occur due to a


combination of weak internal controls, conflicts of interest, and a
corporate culture that prioritizes profits over ethical practices.
Enron’s board of directors permitted risky accounting practices,
allowing the company to hide debt and overstate profits, which
ultimately inflated its stock value. This manipulation was enabled by
a compromised internal structure where auditors and other
monitors failed to act independently or to challenge the executive
team’s practices.

One major factor that allowed Enron’s governance failure was the
lack of an effective board structure to challenge or limit
management’s power. The company’s board was closely aligned
with management, reducing its capacity to act as an independent
check. Additionally, Enron’s external auditors had conflicts of
interest, as they earned significant fees for consulting work, creating
incentives to overlook accounting irregularities.

Avoiding such governance failures requires a focus on strengthening


regulatory frameworks, enhancing board independence, and
fostering a corporate culture of accountability. First, enforcing
stringent auditing standards and reducing conflicts of interest within
auditing firms can promote greater objectivity in financial reporting.
Regulatory measures, like those introduced in the Sarbanes-Oxley
Act, provide guidelines for transparency, internal control, and
executive accountability that can mitigate risks.
Implementing a whistleblower policy is another key step, as it
empowers employees to report unethical practices without fear of
retaliation. Educating executives and board members on ethics and
corporate responsibility can also help create a culture where
decisions prioritize long-term value over short-term gains. Overall, a
combination of stronger governance structures, transparency, and
ethical leadership can prevent future governance failures similar to
Enron.

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4. Suggestions for Improving Corporate Governance and Most


Important Ones

Various suggestions have been made to improve corporate


governance, focusing on transparency, accountability, and board
effectiveness. Key suggestions include increasing board
independence, implementing more robust risk management
frameworks, and mandating clear, transparent reporting standards.
Enhancing board diversity is another recommendation, as it can
bring a range of perspectives that better represent the interests of
diverse stakeholders and reduce the risk of “groupthink.”

One of the most critical suggestions is to increase board


independence. An independent board, without close ties to
management, is more likely to exercise impartial oversight and make
decisions in the best interests of shareholders and other
stakeholders. A truly independent board can effectively mitigate
conflicts of interest, avoid undue influence from executives, and
hold management accountable. Independent directors are more
likely to scrutinize decisions objectively, reducing the risk of ethical
breaches and financial misreporting.

Another important suggestion is the integration of Environmental,


Social, and Governance (ESG) factors into governance frameworks.
Including ESG metrics helps companies assess their impact on
broader societal issues and can improve trust and loyalty among
stakeholders. This shift reflects the growing recognition that
companies have responsibilities beyond financial performance,
including environmental stewardship and social impact.

In my opinion, the most essential suggestion remains increasing


board independence. Independence strengthens the board’s role as
an objective oversight body, ensuring that it acts in the best
interests of all stakeholders. This foundation of independence,
coupled with transparent practices, creates a governance structure
that promotes accountability, ethical standards, and sustainable
growth.

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5. Corporate Responsiveness to Owners/Stakeholders and Areas for


Improvement

To become more responsive to owners and stakeholders, companies


are increasingly adopting practices that enhance transparency,
accountability, and environmental and social responsibility. Many
corporations now report their ESG efforts, openly discussing their
environmental impact, community engagement, and social
responsibility initiatives. By disclosing their ESG metrics, companies
not only address investor concerns but also strengthen relationships
with stakeholders by demonstrating a commitment to broader social
values.

Companies are also taking steps to engage shareholders more


directly, such as through regular communication channels, annual
meetings, and opportunities for shareholders to voice their
concerns. Shareholder activism, particularly among institutional
investors, has also driven companies to adopt more responsive
governance practices, as companies recognize the value of aligning
their goals with stakeholder interests.

However, further improvement is needed in areas like executive


compensation and environmental responsibility. Aligning executive
pay with long-term performance, rather than short-term gains, is
critical to encouraging sustainable growth. Additionally, companies
can improve by setting clear goals for reducing environmental
impact, such as carbon footprint reduction, waste management, and
responsible sourcing practices. These improvements would
demonstrate a stronger commitment to both shareholder and
stakeholder expectations.

To enhance corporate responsiveness, companies must integrate


stakeholder engagement into their core business strategies. This
approach can build trust, attract investor confidence, and
strengthen corporate reputation. By doing so, businesses can
demonstrate that they prioritize long-term value creation,
benefiting both shareholders and society at large.

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