2. PAGE 1
Table of content
1. What is Corporate Governance?
1.1 Main role
1.2 Financial scandals through decades
2. How does it apply?
2.1 Principles based approach in UK
2.2 Rules based approach in US
3. Why is it needed?
3.1 Scenario without Corporate Governance
3.2 Benefits of Governance
(Redeslibre, 2015)
3. PAGE 2
What is Corporate Governance?
MAIN ROLE
“Corporate governance is the system by which companies are directed and
controlled”
(Cadbury, 1992)
orporate Governance makes
sure that the business is ran
properly and monitors
whether or not the board of directors
of listed companies are acting in the
best interest of the internal and
external stakeholders. (Council, 2014)
Corporate Code is not a fixed set of
rules; it keeps being updated in order
to provide a better quality of
information to the investors. (FRC,
2014)
In order to be more precise Corporate
Governance covers the control on
the inside such as boards of
directors, sub board management,
employees and their representatives
and external control such as
auditors, government and both
institutional and small investors.
(Council, 2014)
(Author, 2016)
C
4. A good relationship with the investors
means a higher value and longevity for
your firm!
(Martynoflynn, 2014)
Since the directors are the agents who have to act transparently towards the
shareholders, known as principals, conflicts of interest might be arisen therefore
Corporate Governance helps their relation to work properly, minimizing the risk of
financial scandals. (Wong, 2014)
5. PAGE 1
WHAT ARE THE PRINCIPLES OF CORPORATE
GOVERNANCE?
(Council, 2014)
• To give the company a long term
successLeadership
• The board and the committees must
have the right skills and experience to
accomplish their duties
Effectiveness
• The financial report of the company
needs to be understandableAccountability
• It must me fair in relation of the
director`s performanceRemuneration
• General meeting must take place in
order to have a clear dialogue between
the directors and shareholders
Relation with
shareholders
6. PAGE 1
Is Corporate Code adopted only in the UK?
Not at all!
The report aims to underline the
global spread of Corporate Code: it is
not just a local requirement, but it is
followed in US and it became largely
used all over Europe too (ECGI, 2016).
In the following section the report
takes into consideration UK and
Germany in terms of structure of
Corporate Code and the main
features.
UK and German Corporate Code
present some similarities such as:
Principle based approach
Aim to firm’s longevity
The main differences are:
Two-tiered board structure for
Germany
Majority of stakeholder
orientated companies
Unitary board structure in UK
Shareholder orientation
(Kodex, 2015)
7. PAGE 1
What does it mean exactly?
The chart below made by the author on purpose for this report show the two-
tiered board structure peculiar in German firms
(Abdul Rasheed, 2012)
As it was previously mentioned the
main difference between UK and
German Code is the company
orientation.
The report includes a key point
comparison between the shareholder
and the stakeholder orientation,
made by the author on purpose for
this report.
Two-Tierd Board
Management
Decision
Development and
Implementation
Report to firm's
Supervisory
Board
Supervisory
Employee Co-
Determination
8. (Wall, 2011)
Considering the comparison above
the report will discuss about the issue
that stakeholder orientation might
face. As it was mentioned above the
Employee Co-Determination, a
German characteristic feature, in a
stakeholder orientated company,
creates more dialogue between
employees and directors (Abdul
Rasheed, 2012) since they are involved
in the decision making process, but
does it lower the shareholder
value? Gorton and Schmid empirical
data research shows that labor
participation does not comply with
the shareholder’s interest and this has
an impact on the profit and on the
company value. (Schmid, 2004) On
the other hand Freeman and Lazear
state that this collaboration between
employees and directors helps the
internal control to work better and
therefore it reduces agency costs.
(Richard B. Freeman, 1995)
The chart shows a comparison
between the DAX Deutsche Boerse
AG, German Stock Index and the
London Stock Exchange and FTSE UK
showing the company’s performance
over the past 5 years.
The chart shows that the
performance of DAX is considerably
better than the British one from 2011
until 2016. (Finance, 2016)
Shareholder
Aims to
maximize
shareholder's
return
Stakeholder
Acts in interest
of: employees,
customers and
shareholders
9. (Finance, 2016)
The report will not be focused on this section since its purpose is to focus on
financial scandals and analyse them in order to have a better understanding of
Corporate Governance.
10. PAGE 1
FINANCIAL SCANDALS
In order to understand more
accurately the importance role of
Corporate Governance this report
analyses three main financial
scandals during the past decades
starting with Enron in the 90`s,
followed by Lehman`s Brother in
2008 and Volkswagen in 2015. The
report does not take into
consideration UK financial scandals
because it aims to analyse the
greatest and the most famous ones,
including correlation with UK too in
the next chapter.
ENRON
LEHMAN
BROTHERS VOLKSWAGEN
Year
1985 - 2001 2008 2015
Sector Energy Financial
services
Automotive
What
happened?
o Overstated
revenue
o Hidden
o $619 billion
debt
o Subprime
o Fuel
emission
falsified
11. PAGE 1
debts
o Drops in
stock prices
o Bankruptcy
declared in
2001
(Osborne,
2016)
mortgage
lending
(Telegraph
T. , 2008)
o Bankruptcy
declared in
2002
(CNBC,
2008)
since 2009
they were 40
times higher
than legal
limit
(Telegraph,
2016)
Why did it
happen?
o Internal:
planned
falsification
o External:
“hard to
read”
financial
reports
(Library,
2016)
o Default of
payments by
borrowers
o Mortgaged
backed
security
under-
written
(Telegraph
T. , 2008)
o Bosh made a
software just
for testing
o The
software did
not show
real data
(Times,
2016)
What
happened
next?
o Massive
shareholder
losses
o Unreliability
o Job losses
(GILPIN,
2001)
o 26,000
employees
fired (CNBC,
2008)
o Shareholder
losses
(Telegraph
T. , 2008)
o Drops in
sales (-2%)
(VOLKSWA
GEN, 2015)
o Less
reliability
towards the
company
12. As the table above shows, those
financial scandals all belong to
different sectors, different periods of
time and it all happened under
different circumstances.
Let`s take into consideration the first
case of Enron, the American energy
company. Back to the 90`s the
Corporate Governance in US
experienced a noticeable failure and,
as previously mentioned, since it is
not a fixed list of rules, there was
more flexibility and less control
regarding the financial statements
(Donald H. Chew, 2013). One of the
reasons why Enron Inc. had been
hiding its debts for years was the
difficulties, the auditors and external
shareholders had, to read their
financial reports. Why did the
external controllers validate their
statements then? Did anybody asked
why their shares kept raising in price
relentlessly? (CNN, 2002)Is it possible
to win every time? How did they
manage to hide losses in India, to
cause electricity crisis California in
2000 by shutting down pipelines
illegally? (Gibney, 2005) Enron
scandal was a global shock, but later
on legal proceeding had been taken
and Corporate Governance has been
improved (Donald H. Chew, 2013).
But was it enough in order to control
the power of the Board of Directors
and their actions towards the
stakeholders? 2008 huge financial
crisis can answer to this question.
The report takes into consideration
the bankruptcy of Lehman`s
Brother, one of the pillars of US
economy (Economist, 2013). And still
it has been lending subprime
mortgage without any credit control
towards the borrowers, enlarging the
debt which brought it to bankruptcy.
Was there a control on their
investment risks? On their
security assets? It was highly
dangerous to borrow large sums of
money without a proper credit
assessment.
New decade, new scandals, now in
Europe, more precisely Germany. The
automotive firm Volkswagen falsified
its fuel emission, even though they
13. PAGE 1
advertised “natural diesel cars”
(Report, 2015) which increased their
profit (VOLKSWAGEN, 2015). It has
to be taken into consideration that
this case is probably the least serious
in terms of external impacts. This is
probably why Corporate Governance
has been playing a stronger role
during these decades (Council, 2014).
The report took those relevant
financial scandals in order to
highlight the global impact they had
and how it affected ordinary people
who lost their jobs and investors who
lost their shares. Additionally, the
decrease of reliability towards the
firms have a considerable influence
on potential investors. Corporate
Governance helps it to prevent it.
How does it apply?
PRINCIPLES AND RULES BASED APPROACH
Another question might be arisen.
How do apply Corporate Code? The
report analyses two ways of applying
it: The Principle Based Approach in
UK and the Rules Based Approach
common in US taking into
consideration the financial scandals
previously mentioned.
(Energy, 2012)
14. PRINCIPLES BASED
APPROACH (Investor, 2016)
RULES BASED
APPROACH (Clipartkid,
2016)
Features o Flexibility towards the
legal provisions
o Required to comply
with codes
o “Comply or explain”
principle: companies
can be non-compliant
only under valid
justification (Global,
2015)
o Mandatory
legislation under
Sarbanes–Oxley
Act, 2002
o “One-size-fits all”
approach: same rules
for any company type
and size (Global,
2015)
Limitations
o Ethical
misunderstanding
might happen (ICAEW,
2016)
o Lack of flexibility
o Alternative methods
are not provided
(ICAEW, 2016)
Enron was a Corporate Governance
failure (Dbe, 2003) as a response for it
USA issued the Sarbanes Oxley Act in
July 2002 (Global, 2015). Rules based
approach had been taken in order to
regulate the firms and avoid
accounting scandals. It also aims to
protect whistleblowers under section
806, since Sherron Watkins tried to
speak out about Enron’s suspicious
accounts but he was silenced.
(Fitzmaurice, 2012) But why UK chose
15. PAGE 1
to adopt another approach for
Corporate Governance after Enron
scandal? The British Government
stated that it would be better to gain
and keep investor’s trust by
“concentrating the legislative power
on specific targets” and to not set
fixed rules, with a system which
perfectly fits in an emergent
economic environment. (Eaglesham,
2002) UK goes for the flexibility of the
company, and if they can’t comply
then they have to explain, while US
prefers a strict list of regulations
which must be followed. Lehman
Brothers did not seem to follow the
rules though. The UK Supreme Court
stated that they did not comply with
the legislation regarding client’s
money protection. (David J.
Billington, 2012) One of the greatest
scandal peculiar to the 2008 financial
crisis is attributable to poor
governance, in fact the company
showed positive stock evaluation and
negative financial ratings and
investors were aware of that. (Bolton,
2012) Is principles more effective
than rules based approach then?
As previously written Germany, as
UK, follows principle based approach
for Corporate Governance and
Volkswagen scandal came out in 2015,
thanks to an American investigation
on the German firm’s cars. (Guardian,
2015) In the 2015 annual report of
Volkswagen it was stated $18.4 billion
for legal costs, including $8.0 billion
dollars for “legal risks” and a further
$1.2 billion for provisional liabilities.
(VOLKSWAGEN, 2015) Poor internal
control? Negligence of
PricewaterHouseCoopers, firm’s
external auditor? In the auditor
report PWC stated that Volkswagen
was totally compliant to EU
regulation. (Report A. , 2015) The
report shows a negligent behavior in
both approaches, but since Enron the
scandals greatness and their impact
have been considerably reduced and
that happened because of the
development and effectiveness of
Corporate Governance.
16. PAGE 1
Why is it needed?
SCENARIO WITHOUT CORPORATE GOVERNANCE
After the analysis taken in the report,
the reader might ask why Corporate
Governance is needed considering
the scandals happened through these
years.
Does Corporate Governance actually
benefit the firm or is it just a waste of
time? What would the scenario be
without Corporate Governance?
Not only shorter financial reports for sure.
Corruption Scandal Bankruptcy
17. PAGE 1
Which parties are affected when a company goes bankruptcy?
The fault of few can be a disaster for many
Taking into consideration the
financial scandals previously
analyzed, without a proper control
the firm was actually increasing the
profit more easily: Enron overstated
its profit, Lehman`s Brothers made
recklessly risky investments, and
Volkswagen made up an entire
marketing campaign with false
information on the product
advertised.
Is it more convenient to plan a potential loss in profit in case of penalty
than actually be compliant and face extra costs?
• Creditors, Directors, Suppliers will lose their money
Stakeholders
• Investors will be less incentivated to be capital lenders
Shareholders
• Job losses
Employees
• Job seeking allowance taken over by unemployed
people
• Lower disposable income
Economy
18. Without Corporate Governance…
× Director activities are not well monitored: Enron had a corrupted internal
control which is responsible for the scandal (Newswire, 2002)
× Business survival is not ensured: Enron and Lehman Brothers both went
bankruptcy (Osborne, 2016) (Telegraph T. , 2008)
× Reputational losses can occur: Volkswagen deeply suffered for it (News,
2015)
The trust of your investors has no price!
SCENARIO WITH CORPORATE GOVERNANCE
Which benefits does Corporate Governance give to the firm?
At the beginning of the report a list of principles of Governance was showed, but
how do they bring value to the company in real life?
Directors and
Shareholders in
good relations
Investor's trust
Increase in
demand
Esier access to
borrowings
Firm's
Longevity
19. PAGE 1
The evidence regarding the benefit of Corporate Governance will be taken from
Volkswagen case, and not the others previously analyzed in the report, due to the
impossibility of evidence support for good governance in companies which went
bankruptcy and closed down.
Let’s have a look at some numbers…
Please notice the numbers taken into
consideration concern the third
quarter of fiscal years 2015 and 2016
for a fair comparison, since the fiscal
year 2016 did not end yet.
All of the numbers are taken from the
consolidated financial statement of
Volkswagen annual report group.
2015’s third quarter was a tragic
financial time for Volkswagen:
The shareholder capital was
EUR -2,541 million
The stock prices dropped
dramatically from EUR 167,95
on the 11th
of September 2015
to EUR 92,36 on the 2nd
of
October in the same year
Negative EBITDA of EUR -390
million
(Volkswagen, 2016)
Volkswagen, after the scandal, stated
in their annual report explanation
and apologies regarding the emission
falsification. Additionally they said
that they will make improvements in
order to avoid any further error.
(Volkswagen, 2016)
In 2016 Volkswagen considerably
improved its performance:
Shareholder capital is EUR
+1,966 million
Last stock price registered on
the 28th
of October 2016 is
EUR 125,95
EBITDA jumped to EUR
+6,035 million
(Volkswagen, 2016)
20. PAGE 1
The data shows that the company is
recovering from its hard reputational
loss, their interim report shows also
an increasing number of external
investors which can assure us to the
longevity of Volkswagen.
Concluding why should you adopt Corporate Governance?
In an emergent market with a principle based approach code the
company has higher chances to be successful in the long term.
Being successful in the long term will not only benefit the company,
but the employees, the shareholders and the economy in general.
Corporate Governance builds the basis for a better transparent
economy which benefits both firms and the external world around
them.
21. PAGE 1
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