Best Practices of Corporate Governance Stem from an Unethical Past

Nicholas J Price
6 min read
In past decades, before new corporate governance regulations, it was a long-standing practice to trust the board of directors and the management of large corporations to accurately report the company's financials to its shareholders, by simply taking them at their word.

That all changed when, in the late 1990s and early 2000s, dozens of companies were caught with their hands in the cookie jar. Their books and accounting practices revealed messy public financial scandals and generated a flurry of global mistrust.

Poor corporate governance led to a culture of greed among the top executives and managers, many of whom routinely rewarded themselves with large bonuses. The companies were caught and held accountable by various means, including SEC investigations, whistleblowers, new management takeovers, and bankruptcies. We can learn a lot from the mistakes they made.

Here's a fast look at where the companies went wrong and who was to blame.

The Top 10 Worst Corporate Accounting Scandals

This infographic depicts the 10 worst corporate accounting scandals, including who the main players were, how they did it, how they got caught and the penalties they paid. The list of major scandals includes:

  1. Waste Management '1998
  2. Enron '2001
  3. WorldCom '2002
  4. Tyco'2002
  5. HealthSouth '2003
  6. Freddie Mac '2003
  7. American Insurance Group '2005
  8. Lehman Brothers'2008
  9. Bernie Madoff'2008
  10. Satyam'2009

The Problem with Individual Corporate-Led Governance Principles

Without having any basic best practices for corporate governance to follow and with very few laws to hold them accountable, companies had the latitude to run their companies according to their own principles ' ethical or not.

The lack of accountability caused some managers and executive directors to lose their sense of ethics. Corporations looked at earnings as the truest measure of their success, even when profits were short-lived. Many managers avoided talking about low profits or losses, which made it appear to the shareholders and others that the company was profitable.

When the true earnings were questioned by any source, managers scrambled to cover their tracks by resorting to creative accounting practices and directly falsifying numbers to show perceived higher earnings. Managers who got past auditors and investigators continued to reward themselves with large bonuses and stock options at the expense of the shareholders.

Some boards of directors also ignored their responsibility and approved fraudulent financial statements, or failed to request financial statements that were clear and understandable. Like their managers, they placed too much focus on short-term gains rather than long-term objectives.

Another strategy that managers used to cover up accounting discrepancies was to collude with auditors and get them to approve the books without modifications or corrections.

The Mass Movement to Restore the Public's Trust

To help restore the public's trust in stocks, financial committees were formed to issue reports with recommendations for corporate best practices. The good news is that these scandals brought forth new regulatory practices that protect stockholders. These developments also place more pressure on boards of directors and managers to ensure accurate accounting practices, stronger oversight, and enhanced auditing practices.

Here's a look at some of the reports with recommendations for best practices for corporate governance in the United States and across the globe:

The legislation that's had the largest impact on corporations in the United States is the Sarbanes-Oxley Act of 2002. The official name of this act is the Public Company Accounting Reform and Investor Protection Act of 2002. It was the first act related to federal securities in the U.S. since the Great Depression.

What Are the Accepted Best Practices for Corporate Governance?

A diverse group of 13 of the top corporate CEOs met and issued an open letter to the public in 2016 called the Commonsense Corporate Governance Principles. The goal in developing this report was to find some common ground that came from the highest level of corporate governance to be used as a basic guide for every corporation.

The unique nature of each corporation doesn't make it possible for there to be a single, comprehensive set of best practices. The Commonsense Corporate Governance Principles are intended to be a basis for constructive discussion at every level of the corporate structure so that each corporation can fine-tune their own unique set of principles and practices that promote trust in their corporations.

New corporations should read the full report before deciding on their corporation's best practices.

Pillars of Common-sense Principles of Corporate Governance

The consortium recommends that corporations begin with these eight basic, common-sense principles of corporate governance:

  1. Composition of the board and internal governance. Directors should be independently loyal to the shareholders without undue managerial influence.
  2. Board of director responsibilities. Communicate with shareholders, place priority on their concerns, meet regularly in executive session, focus on long-term strategies.
  3. Shareholder rights. Avoid dual-class voting and treat shareholders equally.
  4. Public reporting. Report with transparency, avoid reporting estimations, disclose long-term goals, and explain mergers and acquisitions.
  5. Board leadership. Make careful decision about combining CEO role with board chair and, if done, hire an independent director with clearly defined authority and responsibilities.
  6. Management succession planning. Board and shareholders should have access to senior management so they can evaluate management. Companies should have identified succession plans and be able to communicate those plans on both a regular and an emergency basis.
  7. Management compensation. Compensation should be competitive to attract the best talent, should evolve over time but have continuity over the long term. Boards should communicate benchmarks and compensation plans with shareholders and consider the benefits of making compensation in the form of stock or equity-like instruments.
  8. Asset managers' role in corporate governance. Asset managers have a strategic role in holding the board accountable. They should evaluate the issues that matter most to shareholders, giving special merit to long-term investment success. Asset managers evaluate the board directors and oversee proxy voting. They should have access to the board, management and others within the company as needed. Asset managers who raise critical issues in the early stages go a long way toward earning the trust of the shareholders.

Some Final Thoughts About Best Practices of Corporate Governance

While the regulatory acts in recent years are helping companies to regain the public trust they lost through the corporate greed of the past, small companies were the most affected by stronger regulations. Many smaller companies could not afford to meet the new regulations. They lack the funds to hire attorneys, management and purchasing software. Some companies needed to delist their shares from public exchanges as a result.

The overall feeling is that increased oversight is a small price to pay for the security of knowing that companies are conducting business with accountability and transparency. Shareholders want assurance that they are truly protected. To make sure that your board is sticking to the best practices for corporate governance, you should consider using a board portal. Using a board portal will allow you to comply with all corporate governance practices in a secure and streamlined environment. See how you can improve your corporate governance in a simpler environment.