You don’t have to look far to find Corporate Governance failures. They appear in news headlines all too frequently. Feature films are made about them, best-selling books are written on the back of them. They have it all: high financial stakes, risk-it-all tales of morality and fraud. Think back to the Enron scandal in 2001, and the subsequent book and film which followed hot on its heels, aptly titled, ‘The Smartest Guys in the Room’ and the more recent Theranos case, currently in the news because of the Silicon Valley lawsuit against the former CEO, Elizabeth Holmes. These true crime sagas never fail to captivate our imagination and demonstrate a clear failure of Corporate Governance.
Good corporate governance on the other hand, should lead to improving the transparency of information. It should create more accountability of boards with respect to the functioning of the company, and more protection and influence of shareholders. But, corporate governance can be defined in various ways, and there is not a generally agreed purpose.
In most cases, there isn’t a neatly captured Hollywood version of events where good triumphs over evil. Real corporate governance problems are complex and demand a multi-disciplinary approach. This is why Corporate Governance is, alongside Financial Management and Management Accounting, one of the three main topics of MaastrichtMBA’s module on Corporate Finance and Accounting. The module improves the participants’ theoretical knowledge and practical skills in the field of corporate governance.
The purpose of corporate governance
In essence corporate governance is about exercising power over corporations. Dr. Rogier Deumes, Assistant Professor in corporate governance, control and auditing at the School of Business and Economics, explains the definition and purpose of corporate governance. “In a broad sense, corporate governance is about the exercise of power over corporations with the aim of increasing the value provided to the organisation’s various stakeholders. The latter include providers of finance, but also other stakeholders like employees, suppliers, and customers.” Deumes continues: “In the broadest sense, society at large is a stakeholder of a corporation. Viewed in this way, corporate governance is important for everybody. Yet not everybody has a direct say when it comes to major decisions taken by corporations.”
What if we look at corporate governance in a more narrow sense? According to Deumes, “corporate governance relates to the ways in which the suppliers of finance assure themselves of getting a return on their investment. This is important for a well-functioning capital market. To complicate matters, different groups of stakeholders, including finance providers, often value different things, or they value things over a different time horizon. This does not mean that the interests of stakeholders always differ, or that they differ in all respects, but to some extent interests differ.”
Hence, corporations cannot always please everyone. Also, within groups of stakeholders different interests can exist, and not everyone has the same information. “Once the problem is clear from various perspectives, you need to assess what different solutions mean for different stakeholders. More importantly, you need to decide what matters most. What do you value? This is of course subjective, so opinions will differ. Real corporate governance issues are debatable”, explains Deumes.
Self-dealing CEOs
A classic issue in corporate governance is what economists call moral hazard problems. A perfect storm for media-hungry attention-grabbing headlines. One example is self-dealing by CEOs. This can involve the CEO enjoying so-called perks. A classic example is the personal use of the company plane by the CEO. To shareholders this often reveals that there are larger underlying problems. Another form of self-dealing is appointing friends or family to important positions. In an extreme case of self-dealing, executives are stealing assets from the company. Further common issues are a lack of transparency, for example regarding executive expenses, excessive executive compensation, a weak link between executive pay and performance, and of course accounting manipulations. Unfortunately, these issues are quite persistent and frequently appear in the media.
Moral hazards
Benefits of corporate governance include mitigating moral hazard problems. In doing so, corporate governance prevents value destruction. Boards themselves are a key mechanism in mitigating moral hazard problems. “The fact that you can frequently read about corporate governance failures in the newspapers, indicates that corporate governance solutions are far from perfect”, says Deumes. Some so-called solutions create new problems. The question is how many corporate governance failures are currently in the making and go undetected. Deumes doesn’t know the answer, but he is sure that without corporate governance mechanisms there would be more corporate governance failures. In a broad sense, the benefit of corporate governance provides more value to the various stakeholders, or at least a better balance of value.
A defect moral compass
One important aspect of good corporate governance is selecting the best executives and making them accountable. This is more difficult than it may sound. Deumes zones in on the ethical component of corporate governance, “I like to paraphrase Warren Buffet, who said that in looking for people to hire, he looks for three qualities: integrity, intelligence, and energy. If a person does not have the first, the other two will kill you. Unfortunately, many corporate governance failures illustrate this.” In this vein, Deumes recommends watching the documentary film about the Enron scandal, ‘The smartest guys in the room’. “It is a classic case about very smart and energetic people with a defect moral compass. They created a ‘fantastic’ company, before ruining it.” Deumes also refers to the recent Theranos case and its CEO, Elizabeth Holmes. “Allegedly she lied about the effectiveness of the company’s main product. She probably took the expression ‘fake it till you make it’ a bit too far to stay out of jail”.
What Deumes makes clear is that corporate governance demands a multi-disciplinary approach. When a board doesn’t possess all the necessary qualities it will never work out properly. That is why corporate governance, financial management and management accounting form a trinity. One does not work out well without the other. And the fallout when this doesn’t work out? You can read that story in the news.
MaastrichtMBA – Executive On-Campus
This article was written in the context of the ‘Corporate Governance’ course that is part of the Executive On-Campus track of the MaastrichtMBA programme at UMIO. This track entails a unique journey that enhances knowledge and enriches capabilities through action-oriented learning, encompassing business practice and interactive co-creation with professors and fellow students.
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