Impact of Bad Corporate Governance

While there is no exact definition for what constitutes bad corporate governance, there are plenty of examples. In fact, it is easier to point to examples of “bad” governance than “good” governance, with the collapse of the US company Enron being the most prominent example. The company had poor corporate governance, deficient accounting systems, and unsound policies. The executives lied about the company’s financial results for a long time in order to increase the value of their personal share options. Still, their actions went unnoticed by the board of Enron. Numerous others also failed to realize what was going on, including Enron’s auditors, regulators, and ratings agencies, and when the company eventually collapsed, many were surprised. A proper and efficient governance system would have enabled Enron’s board and auditors to realize what was going on long before the company’s eventual demise. Indeed, this case clearly shows that disregarding the fundamental standards or policies already considered is a strong indicator of bad governance. Absence of corporate governance principles such as openness, honesty, transparency, trustworthiness, and accountability undermines the financial viability of companies and can lead to their eventual downfall, as revealed by numerous examples from the recent financial crisis. It can also increase corruption, resulting in a lack of accountability for public funds. Frequently this is due to the professional behavior of the board and/or management falling short of what is required.

A number of key indicators signal poor corporate governance practices. Weak management is one strong sign. Weak bank governance is a lack of effective governance and can happen when the board fails in its responsibility to ensure that its institution has “proper procedures to monitor and control risk and to provide the necessary check on the executive” (Independent Commission on the Future of the Cyprus Banking Sector 2013, 25). In this situation, the board of directors lacks the knowledge to make informed decisions; even where the accounting systems produce accurate reporting, the board does not have the financial literacy to understand the nature of what is being reported. The board is primarily controlled by one individual who may frequently disregard expert advice or who may inappropriately delegate his or her responsibilities without providing proper supervision. Additionally, board accountability may become distorted, there may be insufficient examination of company decisions, and reviews of company decisions may be casual or even completely absent. Further, companies may tend to follow unsound policies. To illustrate, ifexecutives are overly optimistic about sales targets and therefore hold high levels of stock, they may restrict the company’s working capital while reducing its cash flow. This can prove detrimental in the event of a liquidity crisis. Moreover, companies that have poor corporate governance standards tend to borrow more than they are able to service, which puts them at risk of being unable to make the repayments when they are required. This can cast doubt on the ability of companies to achieve future sustainability; actually, one major impact of poor corporate governance is the failure of businesses to develop in a sustainable way. This is also evident if companies have deficient or inadequate accounting systems in place. Companies with poor financial reporting systems fail to evaluate performance accurately and have difficulties with future forecasting and cash flow planning. Finally, companies with bad corporate governance procedures often concentrate excessively on a single project and ignore other lower risk projects. Investing too much time, effort, and resources in that single project can be damaging to a company’s future survival. Let us next examine how the financial services/banks sector as well as accountants/auditors and politicians are regulated.