At the turn of the 21st century, Australia has seen some of the largest corporate failures in history. These failures have raised concerns about the faulty corporate governance practices and the underlying role that they played in leading to these corporate failures. These instances of bankruptcies had their immediate cause as burgeoning liabilities but a critical analysis of these is required so as to highlight the actual contributing factors. The fact that various measures have been taken by regulators and professional organisations to improve the corporate governance framework implies that the lack of this might have been a culprit for these disasters. The objective of this report is to critically analysis there cases of corporate failures in order to identify the role played by liabilities. Also, a brief overview of the corporate governance principles by ASX along with code of ethics for accountants in the form of APES 110 has been provided.
For improving the corporate governance framework and reducing the incidence of corporate frauds, a key measure has been taken in the form of insertion of corporate governance principles in the listing agreement which makes it mandatory for listed companies to abide by the same. These principles are briefly explained as follows (ASX, nd).
With regards to accountants also, APES 110 serves as a useful code of ethics which spells out the values that these professionals need to highlight at their profession (APESB, 2010).
Integrity – Professionals must avoid any dishonest conduct and fraud practices even at the request of their clients.
Objectivity – Professionals must not be biased in their assessment and hence avoid situations having an inherent conflict of interest.
Professional competence and due care – Professionals need to continuously update their professional knowledge and should take requisite precautions so that there is no negligence on their part.
Confidentiality – The personal and other privileged information about the clients need to be safeguarded or kept confidential unless exceptional circumstances arise.
Professional Behaviour – Professional need to conduct themselves in a professional manner when offering their services and interacting with clients.
A background of the various prominent cases of corporate failures is presented as follows.
ABC Learning
The company after listing as ASX embarked an ambitious expansion plan where it aimed to open a number of franchise so as to cover a large amount of territory. This plan was cheered and applauded by shareholders as the stock outperformed significantly. The strategy that the company adopted was too aggressive since while ensuring the geographical expansion, the company cannot assure that the quality standards were met and as a result the brand of the company suffered a setback. However, no change in this strategy was brought leading to eventual bankruptcy (CPA, 2012).
HIH Insurance
After 1990’s, the company executed a host of acquisitions for aggressive growth both in terms of geography as well as product portfolio. However, the company had insufficient risk management practices for the business that the company was present in. The acquisitions coupled with new product entry further worsened the risk management framework of the company and hence the company suffered significant losses. However, instead of reporting these losses and changing the risk management framework, the management continued with these faulty policies leading to further increase in the losses which eventually brought about bankruptcy (Mak, Deo & Cooper, 2005).
One Tel
The failure of this established player in the telecom industry can be attributes to the faulty management practices which continued for long thereby leading to the bankruptcy of the company. For enhancing the subscriber base and gaining new connections in USA, the company created an aggressive promotion plan which was not financially feasible. Through creative accounting, these losses were then kept off the books of the company. This ensured non-intervention from the shareholders and the continuation of company policies and hence the losses kept on mounting. This eventually paved way for the failure of the company. (Monem, 2009).
Reason for Liquidation
ABC Learning
As discussed earlier, the management of the company pursued an expansion plan which was focused on opening higher number of franchises with the objective of maximising revenue from franchise partners as franchise fee. The company did not make any attempts to ensure that the franchise owners could have a sustainable business. The result was that the quality of service at the franchises could not meet the minimum quality standards leading to surge in customer complaints (Arens et. al., 2013). Despite the strategy failing to generate long term wealth for shareholders, the management continues with the policy as there entire focus was on maximising the compensation which they could draw. Further, the company also entered into new markets by making acquisition. This also added to the woes of the poor management policies and led to continuous deterioration in the company’s financial performance which led to eventual bankruptcy of the firm (Kaplan, 2011).
HIH Insurance
The company primarily focused on inorganic growth which was fuelled with acquisitions not only domestically but also internationally. However, there was little merit in most of these acquisitions and they were only done in order to jack up the share price and also maximise compensation of executives. A case in point is of FAI where the conduct of the board was quite negligent and the decision to purchase the company was made without performing the necessary due diligence. Also, the price paid for the acquisition of the company was exceptionally high (Mirshekary, Yaftian & Cross, 2005).
The company also ventured into a competitive international market in the form of USA. Owing to the high competitiveness, the company offered insurance premiums which lead to losses. Also, the losses of the company were compounded owing to the reinsurance based model where the company can potentially suffer the losses if there is default on the part of reinsurer (Gay & Simnett, 2012). Despite this not being the norm in the insurance industry in Australia, the company continued with the same policy while adding companies, geographies and product portfolios. As a result, the associated losses also kept mounting which the management concealed though quid pro quo relation with the external auditors (Mak, Deo & Cooper, 2005).
One Tel
This is another example of the ambitious expansion strategy which was not well implemented and the resulted losses were hidden for years thus confirming the downfall of the company. In this case, the company aimed at enhancing the subscriber base of the company without considering the underlying profitability implications. Further, the company also made elaborate measures in order to ensure that the internal controls were absent and also the external auditor was not independent (Caanz, 2016). As a result, the company was able to report false numbers of financial performance for an extended period of time. However, during this period, the losses kept on mounting which eventually led to the failure of the company (Gilbert, Joseph & Terry, 2005).
It is apparent that for all the three companies, the bankruptcy was filed since the underlying assets were not sufficient to meet the mounting business liabilities. However, the key question one should ask is what led to this situation which is where the true answer lies. At the heart of the failure of the three companies was a desire to exhibit ambitious growth. Each of the companies had their own mechanism of pursuing the same (Brown and Caylor, 2009) For instance, ABC aimed for growth through franchising, HIH through acquisitions and One Tel through low plan costs to consumers. However, one common aspect was that for all the three companies, the underlying strategy was flawed since it created growth in the top line at the expense of lower bottom line. As a result, these strategies were not conducive for the shareholders’ wealth (Arens et. al., 2013).
However, in all the cases, the management continues with their respective flawed strategy and resorted to faulty corporate governance practices in order to enable the same. It is apparent that if the corporate governance practices in these organisations were in line with the ASX corporate governance principles for listed companies, the flawed management strategy would have been rectified long ago and the companies could have been saved from liquidation Bhagat, and Bolton, 2008). Also, the external auditors also played a critical role in enabling these managements to continue with the value destruction. Had the auditors not aided the management and would not have compliant with APES 110 ethical principles, the corporate failure in these cases could have been averted (Deegan, 2014).
From the above discussion, it may be concluded that liabilities did not play a major role in the failure of the three companies. Instead the primary reasons of failure include unethical and irresponsible executives, unsound corporate governance practices and unethical conduct by external auditors.
Based on the above analysis of the corporate failures, it is apparent that for avoiding the corporate failures, it is imperative to pay significant attention on the corporate governance practices of the firm. This is because sound corporate governance practices ensures that the abuses of power are kept within control and requisite disclosures take place in a timely manner thereby ensuring action by shareholders and regulators. The introduction of ASX corporate governance principles as part of the listing agreement is therefore a step in the right direction since it provides a sound framework for the firms to base their corporate governance practices. Also, there has been an increase in the directors’ personal liability for the breach of duties towards the company and the shareholders (Arens et. al., 2013). These measures are a step in the right direction but more steps need to be taken. This is particularly with regards to the role of non-executive directors which need to be enforced with zero tolerance as they go a long way to protect the interest of the minority shareholders who tend to be the worst sufferers in corporate failures. Besides, measures relating to independence of audit committee and external auditors need to be strictly enforced considering the importance of the same. Further, the liability of auditors in case of fraudulent conduct also needs to increase (Clout Chappelle & Gandhi, 2009).
References
APESB (2010) APES 110 Code of Ethics for Professional Accountants, [online] Available at https://www.apesb.org.au/uploads/standards/apesb_standards/standard1.pdf [Accessed September 10, 2018]
Arens, A., Best, P., Shailer, G. and Fiedler,I. (2013). Auditing, Assurance Services and Ethics in Australia, 2nd eds., Sydney: Pearson Australia
ASX (n.d.) Corporate Governance Principles and Recommendations, [online] Available at https://www.asx.com.au/documents/asx-compliance/final-revised-principles-complete.pdf [Accessed September 10, 2018]
Bhagat, S. and Bolton, B. (2008), ‘Corporate Governance and Firm Performance’, Journal of Corporate Finance, Vol.14, No.3, pp. 257-273.
Brown, L and Caylor, M. (2009), ‘Corporate Governance and Firm Operating Performance’, Review of Quantitative Finance and Accounting, Vol. 32, No. 2, pp. 129-144.
Caanz, S. (2016), Auditing and Assurance Handbook 2016 Australia, 3rd ed., Sydney: John Wiley & Sons
Clout, V, Chappelle, E and Gandhi, N (2013), ‘The impact of auditor independence regulations on established and emerging firms’, Accounting Research Journal Vol. 26, No. 2, pp. 88-108
CPA (2012) ABC learning collapse case study., CPA Website, [online ] Available at https://www.cpaaustralia.com.au/professional-resources/education/abc-learning-collapse-case-study [Accessed September 10, 2018]
Deegan, C. (2014). Financial Accounting Theory, 4th ed. Sydney: McGraw-Hill
Gay, G. and Simnett, R. (2012), Auditing and Assurance Services in Australia, 5th eds., Sydney: McGraw-Hill Education
Gilbert, W., Joseph J. and Terry J.E (2005), ‘The Use of Control Self-Assessment by Independent Auditors’. The CPA Journal, Vol. 3, pp. 66-92
Kaplan, R.S. (2011). ‘Accounting scholarship that advances professional knowledge and practice’. The Accounting Review, Vol. 86, No.2, pp. 367–383.
Mak, T., Deo, H. and Cooper, K. (2005), ‘Australia’s Major Corporate Collapse: Health International Holdings (HIH) Insurance ‘May the Force Be with You’, Journal of American Academy of Business, Vol. 6, No.2, pp. 104-112.
Mirshekary, S., Yaftian, A. and Cross, D. (2005), ‘Australian Corporate Collapse: The Case of HIH Insurance’, Journal of Financial Services Marketing, Vol. 9, No.3, pp. 249-58.
Monem, R. (2009), The Life and Death of OneTel, Griffith University, [online] Available at https://www98.griffith.edu.au/dspace/bitstream/handle/10072/42673/74746_1.pdf [Accessed September 10, 2018]
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