Corporate Governance And Firm Cash Holdings In US

Responsibilities of Board of Directors

Discuss about the Corporate Governance and Firm Cash Holdings in US.

Corporate governance is referred to a system of procedures, rules and practices which direct and control a company’s actions. The purpose of corporate governance is to balance the interest of stakeholders in a corporation such as customers, shareholders, suppliers, government, management, and society (Harford, Mansi and Maxwell, 2012). It is a common misconception that shareholders are the most important stakeholder for a company and the board of directors have to take actions by prioritising their interest. The principles of corporate governance provide that each stakeholder is equal and directors cannot prioritise the interest of shareholders over others. A company is an artificial person, therefore, its decisions are taken by the board of directors, and they have a fiduciary duty to ensure that they focus on the interest of the company rather than their personal interest. They are also responsible for ensuring that they take business decisions which are in the interest of each stakeholder rather than focusing on just the benefit of shareholders (Knudsen, Geisler and Ege, 2013). This report will evaluate why whether directors should not prioritise the interest of shareholders over other stakeholders based on the principles of corporate governance. Various evidence and examples will be given in the report to understand the importance of compliance with corporate governance. Furthermore, recommendations will be given for directors to guide them towards making business decisions by considering the interest of each stakeholder.

The objective of a corporation is to survive and thrive in the market, and its decisions are taken by its board of directors. Directors have substantial powers in order to manage the operations of a company, and they are bound by different duties to ensure that they did not take business decisions to fulfil their personal interest. The Corporations Act 2001 (Cth) provides various duties which are necessary to comply by directors while discharging their duties. According to AICD (2018), directors are required to comply with following duties while taking business decisions in the company.

• Care and diligence

Firstly, directors have a fiduciary duty towards the company due to which they are required to act with a certain degree of care and diligence which a reasonable person would in the particular situation.

• Good Faith

Directors have to act in good faith of the company and its stakeholders, and they cannot misuse their powers to gain an unfair advantage in the company.

• Not to improperly use position

Myth of Shareholder Supremacy

Directors should not misuse their powers to gain an unfair advantage; they should perform within limits and avoid taking any decisions which could adversely affect the corporation or its stakeholders.

• Not to improperly use information

While discharging their duties, directors collect confidential information about the company and its future operations. It is their duty that they should not use this information for personal gain or to cause harm to the stakeholders.

These duties show that directors have to use their position carefully, and they are responsible towards all stakeholders rather than just shareholders. It is not their duty to take actions which benefits shareholders only by increasing their overall value (Jo and Harjoto, 2012). Based on these duties, directors have to prioritise the interest of the company above all. In case directors failed to comply with these duties, then it leads to negative consequences in which the court can punish directors for breaching their duties. For example, directors were punished in case of AWA Ltd v Daniels (1992) 13 ACLC 614 because they took business decision in personal interest rather than focusing on the benefit of shareholders (Yeo, 2016). There are a number of corporations which have gained success and increased their shareholders’ value by implementing effective corporate governance policies.

Along with director duties towards corporations, the role of Corporate Social Responsibility (CSR) has increased. Organisations cannot just focus on increasing their profits without taking appropriate measures to comply with their corporate responsibilities. Many countries have made it mandatory for corporations to implement CSR policies and directors are required to provide an annual report regarding their CSR actions. For example, in the jurisdiction of Brazil, the fiduciary duties of directors include the corporation’s obligations to its non-financial stakeholders (Eccles and Youmans, 2015). Effective CSR structure focuses on the interest of different stakeholders such as environment, customers, government and others. It shows that directors are responsible towards all stakeholders, and they should focus on achieving their interest rather than just focusing on the benefit of shareholders.

The AICD is concerned that most directors believe that they are responsible for putting the interest of shareholders above all other stakeholder interests since they take the highest risk in the enterprise. It is a common misconception among people. Traditionally, the purpose of the incorporation of a company was to generate as must profit as it can for its shareholders and directors achieve this target by any means necessary. However, this concept changed with time, and the concept of corporate responsibility prevailed. It provides that a corporation is an artificial person and it has corporate responsibilities just as a human being (Queen, 2015). A company cannot generate profit by adversely affecting others such as people or the environment. Although, this concept has become popular with the CSR model, however, still many directors believe that they are required to focus on shareholder interest above all due to lack of strict policies.

Examples of Companies

Furthermore, many directors argue that the generation of wealth for shareholders is beneficial for the entire corporation and its stakeholders since more wealth leads to more opportunities for everyone. However, this concept is not correct. As per Kakabadse and Kakabadse (2013), directors take decisions which are in the interest of shareholders, but, they negative affect other stakeholders. For example, increasing the working hours of employees or not providing them health benefits to reduce costs. They also misuse environmental resources which negatively affect society as a whole. Thus, directors have responsibility to business decisions which are in the benefit of all stakeholders rather than just shareholders.

Following are various examples of companies which have achieved success due to effective corporate governance structure and which have failed because directors focused on the interest of shareholders rather than all stakeholders.

Apple is currently the world’s most valuable company with a valuation of $923 billion (Divine, 2018). The company also has a positive brand image in the market because it complies with its corporate responsibilities effectively. For example, the corporation manufactures 100 percent of its products by using green and renewable energy sources. It avoids using harmful materials and chemicals in its products to reduce costs. The company focus on reducing its carbon footprint, rather than saving money to increase its shareholders’ value. Due to its positive brand image and eco-friendly manufacturing process, customers prefer to purchase its products even at high costs which provides them good quality products and increase its shareholders’ value (Lehman and Haslam, 2013).

It is a German automaker giant which offers a wide range of cars to its customers from high-end luxury vehicles to affordable and efficient cars. Volkswagen group consist of large brands such as Lamborghini, Skoda, Bentley, Audi, and many others. Recently, the company was involved in a scandal in which it was found out that it has cheated on emission tests to sell highly polluting cars in the market. Directors took this decision to increase shareholders’ value rather than fulfilling corporate responsibilities. The company had to pay a fine and executives involved in the scandal were charged by the court (Hotten, 2015). However, most importantly, the company lost its reputation in the market which adversely affected its profitability. It shows that directors are responsible for considering the interest of all stakeholders while taking corporate decisions (Crete, 2016).

Google is a multinational technology company which is the world’s third most valuable company with a valuation of $754 billion (Divine, 2018). The corporation has achieved significant success due to its innovative products such as YouTube, Android, search engine and others. The company also has the best CSR reputation in the market due to its effective corporate governance structure which focuses on the interest of different stakeholders. The corporation uses renewable and green energy sources while performing its operations to reduce its carbon footprint. Furthermore, the company has awarded as “the best place to work” many times because its directors implement effective policies for its employees. For example, it offers free lunch, free education facility, unlimited sick leave, long maternity leaves, free vacations, time to work on personal projects and others (Miceli, 2015).

Recommendations

The bankruptcy of Enron was largest in the history of America because its director failed to comply with its corporate responsibilities. Directors turned blind eyes, and they violated various codes to hide the debt of the company to keep shareholders happy. Later, shareholders filed a lawsuit of $40 billion against the company due to which its stock price fell (CNN, 2018). It shows that directors should ensure that they focus on the interest of diverse stakeholder audiences to ensure the success of the enterprise.

As discussed above, directors are equally responsible towards all stakeholders, and they are required to implement policies while considering their interest rather than just focusing on the benefit of shareholders. Following recommendations should be followed by directors to ensure that they take business decisions by considering the interest of all stakeholders.

• Statement of Significant Audiences and Materiality

As per the study of Eccles and Youmans (2015), every company should issue a ‘Statement of Significant Audiences and Materiality’ which is made by its directors, and it includes information about all stakeholders of the company. This report can be just one page long, and it should include information about stakeholders of the corporation and how they are affected by the decisions of the company. Directors will be able to identify stakeholders of the corporation based on this statement, and they would be able to consider their interest while making business decisions.

• Evaluation of the impact of the decision

While making a business decision, directors should evaluate various parties who will be affected by such decision which would guide them in making decisions which are in the interest of all stakeholders. Although, it is true that directors cannot make each stakeholder happy, however, they can evaluate their decision to benefit a diverse range of stakeholders than just shareholders. For example, directors of Microsoft evaluate the impact of their decision on different stakeholders to ensure that they benefit a wide range of stakeholders (Jizi et al., 2014).

• Strict CSR Policies

The governments across the world should make it mandatory for corporation to implement a CSR structure in which they are required to made regulation disclosures regarding the actions taken by directors regarding fulfilling company’s corporate responsibilities. Organisations which did not comply with these policies should be punished which would ensure that directors take business decisions towards the interest of all stakeholders (Jo and Harjoto, 2012). Directors should also strictly comply with CSR model to ensure that they fulfil the interest of diverse stakeholder audience.

• Increasing Awareness

Organisations such as AICD should increase awareness among directors regarding their duties towards stakeholders by organising seminars, meetings or others. Most directors believe that they did not do any wrong if they take business decisions by prioritising shareholders’ interest. This belief should be changed by increasing awareness among directors regarding their duties towards all stakeholders (Klettner, Clarke and Boersma, 2014).

Conclusion

In conclusion, directors have huge powers because they take business decisions for a corporation and it is their responsibility to ensure that they take business decision which is in the benefit of all stakeholder rather than just shareholder. Examples of various companies are discussed in the report to understand the importance of a stakeholder’s approach. For example, Apple and Google have succeeded in the market due to effective corporate governance approach whereas companies such as Volkswagen and Enron have failed. Various recommendations for directors are given to ensure the interest of stakeholders while taking business decisions such as preparation of Statement of Significant Audiences and Materiality, increasing awareness, strict compliance with CSR structure and evaluation of the impact of decision. Based on these recommendations, directors can fulfil their duties and become more responsive to diverse stakeholder audiences.

References

AICD. (2018) General duties of directors. [PDF] AICD. Available at: https://aicd.companydirectors.com.au/~/media/cd2/resources/director-resources/director-tools/pdf/05446-6-2-duties-directors_general-duties-directors_a4-web.ashx [Accessed on 28^th July 2018].

CNN. (2018) Enron Fast Facts. [Online] CNN. Available at: https://edition.cnn.com/2013/07/02/us/enron-fast-facts/index.html [Accessed on 28^th July 2018].

Crete, R. (2016) The Volkswagen scandal from the viewpoint of corporate governance. European Journal of Risk Regulation, 7(1), pp.25-31.

Divine, J. (2018) The 10 Most Valuable Tech Companies in the World. [Online] US NEWS. Available at: https://money.usnews.com/investing/stock-market-news/slideshows/the-10-most-valuable-tech-companies-in-the-world?slide=11 [Accessed on 28^th July 2018].

Eccles, R.G. and Youmans, T. (2015) Why Boards Must Look Beyond Shareholders. [Online] MIT Sloan Management Review. Available at: https://sloanreview.mit.edu/article/why-boards-must-look-beyond-shareholders/ [Accessed on 28^th July 2018].

Harford, J., Mansi, S.A. and Maxwell, W.F. (2012) Corporate governance and firm cash holdings in the US. Corporate governance, pp. 107-138.

Hotten, R. (2015) Volkswagen: The scandal explained. [Online] BBC. Available at: https://www.bbc.com/news/business-34324772 [Accessed on 28^th July 2018].

Jizi, M.I., Salama, A., Dixon, R. and Stratling, R. (2014) Corporate governance and corporate social responsibility disclosure: Evidence from the US banking sector. Journal of Business Ethics, 125(4), pp.601-615.

Jo, H. and Harjoto, M.A. (2012) The causal effect of corporate governance on corporate social responsibility. Journal of business ethics, 106(1), pp.53-72.

Kakabadse, N.K. and Kakabadse, A. (2013) Privatizing Vulnerability: The Downside to Shareholder-Value Maximization. State Crimes Against Democracy, pp. 204-223.

Klettner, A., Clarke, T. and Boersma, M. (2014) The governance of corporate sustainability: Empirical insights into the development, leadership and implementation of responsible business strategy. Journal of Business Ethics, 122(1), pp.145-165.

Knudsen, J.S., Geisler, K. and Ege, M. (2013) Corporate social responsibility in the board room–when do directors pay attention?. Human Resource Development International, 16(2), pp.238-246.

Lehman, G. and Haslam, C. (2013) Accounting for the Apple Inc business model: Corporate value capture and dysfunctional economic and social consequences. Accounting forum, 37(4), pp. 245-248.

Miceli, M. (2015) Google Tops Reputation Rankings for Corporate Responsibility. [Online] US NEWS. Available at: https://www.usnews.com/news/articles/2015/09/17/google-tops-reputation-rankings-for-corporate-responsibility [Accessed on 28^th July 2018].

Queen, P.E. (2015) Enlightened shareholder maximization: is this strategy achievable?. Journal of Business Ethics, 127(3), pp.683-694.

Yeo, V.C.S. (2016) Directors’ Duty of Care and Liability for Lapses in Corporate Disclosure Obligations-Observations and Comments on Select Issues. SAcLJ, 28, p.598.