Volume 18, Number 3 Article by Shailaja V Pai September, 2006
Cases in Corporate Governance : By Robert Wearing, Sage Publications, 2005, pp 162, Price: £ 21.99.:
Cases in Corporate Governance comes at a time when the corporate world has had its fill of financial scandals. However, this slim volume captures some of the most perfidious corporate dramas in recent times in an eminently readable form which will appeal to its target audience – students and practitioners. The UK has had its BCCI and Barings Bank, the US its WorldCom and Enron and Italy its Parmalat. These companies have brought misery to employees, lenders and investors in no mean measure. This volume discusses these cases and many more – nine, to be precise – in the context of corporate governance.
The author starts out with a discussion on the two alternative perspectives from which corporate governance is often discussed – the agency theory and the stakeholder theory. Essentially, the former talks about governance in the context of shareholder wealth maximisation alone, whereas the latter talks about it in the context of all stakeholders including employees, creditors, suppliers and government. A healthy approach, says the author, lies somewhere in between.
A chapter on governance laws in the UK and the US gives the readers a quick rundown on the impact of these cases on legislation in these countries. The recommendations of the Cadbury Committee (1992), the Greenbury Committee (1995), the Higgs Review and the Smith Report (2003) as well as the main features of the Sarbanes-Oxley Act (2002) are discussed in this chapter.
The main body of the book consists of nine cases. Each case begins with the history of the organisation in question, its growth, the issues of failed governance and the status of the company as on the date of writing. The author does not attempt to provide simplistic solutions to complex issues. Instead he tries to highlight the underlying problems which have brought down many a corporate giant – individual greed and compensation plans, organisational weaknesses, lacunae in regulatory processes – and invites the reader to form her opinion on how organisations can possibly avoid such dangerous scenarios in the future.
The ill effects of concentration of power in the hands of chairmen and chief executives, especially when both the posts are held by the same person, are well brought out in the two cases ‘Maxwell’ and ‘Polly Peck’. Maxwell was headed by the charismatic Robert Maxwell who failed to take the counsel of his non-executive directors. By using various methods like siphoning funds from group companies and selling assets pledged as collateral against loans, he defrauded shareholders. He was also guilty of using employees’ pension funds to prop up falling share prices. In Polly Peck, the chairman and chief executive Asil Nadir, feels that the market is undervaluing his firm. His efforts to prop up the price-to-earnings ratio boomerang and the share price falls further. This leads to liquidity problems which in turn lead to the collapse of the company. The Cadbury Committee (1992) expressed concern over such developments and the UK code of governance recommends a separation between the post of chairman and chief executive.
The use of complex financial structures and accounting devices among managements to obfuscate shareholders and analysts is discussed in the cases on Enron, WorldCom, BCCI and Parmalat. Enron gave Special Purpose Entities a bad name. WorldCom wrongly capitalised current expenses in order to improve current profits. BCCI and Parmalat used a number of companies in different countries under different accounting jurisdictions to disguise the flow of funds. Parmalat also descended to downright fraud by showing an account with funds when there were none. In each of these the role of the audit function has been explicitly discussed and criticised. The Sarbanes-Oxley Act, 2002, specifically states that the audit and non-audit services have to be separated. The overstatement of oil reserves by Shell shows that old and reputed companies are not beyond accounting frauds.
The Board of Directors of a company has a very important role in its governance and a strong board can prevent corporate frauds. In the case of Enron, WorldCom, Maxwell and Poly Peck, the role of the board has been strongly criticised. None of the boards were able to take appropriate action in spite of seeing several red flags during the course of their tenures. These cases highlight the fact that it is not only governance structures which matter but the determination and action of individuals and groups which have the final say in governance.
Incomplete contracts often cause problems in agency relationships. Often, drawing up a water-tight contract may be impossible or too costly a proposition to pursue vis-à-vis the incremental benefits expected. The Eurotunnel case illustrates the souring of the relationship between the shareholders and the board when important information about capital outlays is left out of the IPO prospectus. The prospectus is a contract between prospective shareholders and the management. Though the Euro tunnel has been an engineering success, its financial management has left much to be desired. Falling share prices finally led to the board being summarily booted out in 2004.
The Barings case shows how lack of internal controls can be a major loophole which an employee can exploit for quite some time without being detected. It proved to be fatal for the bank which collapsed when derivative trader Nick Leeson’s fraud was finally discovered.
All these cases are highly recommended for classroom discussion. In each one, the descent of the firm into problems is well picturised and the governance issues adequately highlighted. Each case is followed by a brief discussion and a set of questions. A table with a chronological list of key events is also provided. In addition to a descriptive narration, the cases bring alive the story by providing details and descriptions of the questionable financials of the company. For example, the Enron case describes the way in which certain off-Balance sheet entities were used by the firm in hiding debt. Some of the cases, like Shell and Parmalat, are illustrated with charts showing the share price movements around the scam period. Students of corporate governance as well as finance stand to gain by this approach. All in all, the author manages to strike a good balance between the theoretical aspects of corporate governance and the practical aspects as portrayed by the failures in governance. Thus, the book may prove to be useful to academics as well as to practitioners.
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