Corporate Governance Systems May Be Failing
Has COVID Caused a Decline in Corporate Governance
The case for business ethics has been well demonstrated through the costs and impacts of the repeated high-profile cases of corporate greed and misconduct. Often those integrity failures are a result of individuals crossing ethical boundaries as well as ignoring or circumventing the rules set out in law.
In today’s environment, stakeholders have high expectations that companies should be run in accordance with good corporate governance practices – it is the directors who bear ultimate responsibility for the business. It follows that if corporate governance lies at the very heart of the way businesses are run, it is imperative that ethical values should be part of what makes those hearts beat.
Questions of ethics, or the “right way to run a business”, are inherent in all aspects of corporate governance and in every board decision and action. These include the discretionary decisions a board takes to deliver on its duties as set down in law and demanded by shareholders and other stakeholders. And the choices a board makes within the core business strategies that they pursue and the way they direct the business as a whole.
In his book Corporate Governance and Ethics, Zabihollah Rezaee points out that corporate governance is shaped by internal and external mechanisms, as well as policy interventions through regulations. Internal mechanisms help manage, direct, and monitor corporate governance activities to create sustainable stakeholder value. Examples include the board of directors, particularly independent directors; the audit committee; management; internal controls; and the internal audit function.
External mechanisms are intended to monitor the company’s activities, affairs, and performance to ensure that the interests of insiders (management, directors, and officers) are aligned with the interests of outsiders (shareholders and other stakeholders). Examples of external mechanisms include the financial markets, state and federal statutes, SEC regulations, court decisions, and shareholder proposals. Three noteworthy points are: (1) independent directors enhance governance accountability; (2) separation of the duties of the CEO and board chair minimizes conflicts of interest; and (3) separate meetings between the audit committee and external auditors strengthen control mechanisms.
A recent report from the Institute of Internal Auditors said that, despite gains in 2020, the quality of corporate governance degraded in 2021. Last year the organization's American Corporate Governance Index gave businesses an overall B-, over the previous year's C+. This year's grade remains a B- though a weaker one than before, with the majority of companies scoring between a C and a B.
The index is scored along eight principles: clear communication across the company; meeting shareholder/stakeholder expectations; board performance; sustainable strategies with long term focus; corporate culture; information given to the board; external disclosures; and evaluating corporate governance. The only area that gained over last year was "evaluating corporate governance," while "information given to the board" remained the same. Every other metric was worse than the previous year, sometimes by a little (corporate culture) and sometimes by a lot (meeting shareholder/stakeholder expectations).
More granular metrics show worsening scores in other specific areas. For instance, when it comes to employee support, companies did worse in 2021 on ensuring adequate training, crafting compensation policies to support strategic goals, and their ability to respond to crises or disruptions as they arise.
The report theorized that COVID-19 fatigue is responsible for this backslide.
"Data from this year’s American Corporate Governance Index (ACGI) survey point to signs of fatigue as governance improvements seen in 2020 slowed or stagnated across a number of areas examined," said the report. "This slowdown is understandable, if not anticipated. Indeed, governance gains made amid the chaos of COVID-19’s initial onslaught highlighted commendable resilience among publicly traded companies and provided one of the few bright spots in an otherwise distressing year. However, those initial successes have given way to potential slips and setbacks. Grappling with the fatigue factor as wave after wave of pandemic-related ills wash over the economy will be one of the challenges for executive management and boards in the coming year."
Effective corporate governance is the key to establishing an ethical corporate culture. It sets the tone at the top and provides guidance for employees. In addition to those areas addressed above, strong corporate governance systems are essential to ensure whistle-blower claims are taken seriously and dealt with effectively.
The many failures we witnessed at the turn of the century in companies such as Enron and WorldCom stand as examples of how poor governance systems can get a company in trouble. In both cases, the companies were run by top executives who turned a blind eye toward internal controls and ethical practices. In both cases, the CFOs carried out the directions of the CEOs to “cook the books.” the companies failed, in both cases, and shareholders and employees were left holding the bag. In both cases, the board of directors was ineffective.
Companies should not let their corporate governance systems fall by the wayside because of the challenges of COVID. It’s more important now than ever before to establish strong and effective corporate governance systems to ensure that organizations are run ethically with appropriate systems to back up the ethical practices that should be the foundation of those systems.
Blog posted by Dr. Steven Mintz, The Ethics Sage, on January 19, 2022. You can sign up for his newsletter and learn more about his activities at: https://www.stevenmintzethics.com/. Follow him on Facebook at: https://www.facebook.com/StevenMintzEthics and on Twitter at: https://twitter.com/ethicssage.