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The Economic Efficiency Principle Underlies Management Effectiveness Essay Sample

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The Economic Efficiency Principle Underlies Management Effectiveness Essay Sample

Before any discussion on strategies the Board undertakes to properly direct and control an entity it will be prudent to have an understanding of the role and responsibilities of the Board. It is also important to note here that the role of the Board of Directors has changed significantly since the Enron Scandal of 2001. Far more responsibilities have been placed on the Board after the Enron Scandal in USA than before.

The Sarbanes/Oxley Act of 2002, which was America’s response to the Enron Scandal, introduced what is perhaps one of the most significant pieces of legislation associated with the oversight of corporate ethics – which sets guidelines and requirements for Accounting, financial disclosure, and the ethical behavior of corporations.

Other scandals that have contributed “positively” to corporate governance in entities include the Worldcom Scandal and the Parmalat Scandal. Both of these scandals, along with the Enron Scandal, led to significance changes on the composition, structure, ethical behavior, roles and responsibilities of Boards of Directors over the past decade. Details of these scandals and what contribution they made to corporate governance will be discussed in this paper.

Through Board decisions and decisions of Sub-Committees of the Board, control is exercised in an organisation. However, as shall be discussed later in this presentation, the integrity of the individual Directors and Managers and their commitment to good corporate governance is essential for the success of these controls.

The failure and bankruptcy of key global enterprises including Enron, Parmalat and WorldCom between 2001 and 2003 point to a total lack of ethical behaviour by Board and Management despite the existence of Sub-Committees of the Board.

Traditional Role of Boards

“At the core of corporate governance, of course, is the role of the board in overseeing how management serves the long-term interests of share owners and other stakeholders. An active, informed, independent and involved board is essential for ensuring the company’s integrity, transparency and long-term strength…” General Electric, 2002 Annual Report.

Boards have always been expected to play significant roles in the management of an entity. How effectively Boards play these roles is dependent on a variety of factors including its composition ,whether its members are non-executive or executive, and whether or not the CEO plays the role of chair as well.

As I indicated earlier, these roles are quickly changing and evolving.

• The Oversight Role of the Board

The role of the Board has traditionally been understood to be one of oversight. The Board is expected to supervise top Management of an entity on behalf of shareholders (some could be part of the board as non executive directors). Shareholders appoint the Board and delegate certain authority, including oversight authority, to the Directors to “direct” and “control” the entity on behalf of the shareholders. Their role therefore, is not just limited to taking care of shareholders’ wealth and ensuring a good return on investment but also supervising the top Management to ensure prosperity and survival of the entity.

In this role the Board is held accountable to the shareholders.

• Focal Point for Corporate Governance

Conflict of interest between sitting Directors and the company on whose Board they sit is discouraged. The Board is meant to ensure that there exist no business interests and conflict between their private companies or those of Management and the company. Proper division of the roles and responsibilities of the Board and Management is also enforced. In order to enhance good corporate governance the Board formulates policies and oversees their implementation by Management.

This is important as it ensures independence of the Board. Involvement in business association with the company often erodes the independence of the Board in decision-making.

• Ensuring Financial Reporting and Ethical Performance

Falsification of an entity’s accounts so as to reflect a better financial position to the share-holders goes to the core of sound corporate governance of an enterprise. Very often, this is done to hide the directors’ or the Management’s own mismanagement.

It is therefore the Board’s role to ensure proper accounting is done and the audited accounts are presented to the share-holders by the Board.

• Ensure the entity’s Future Survival

Adoption of policies and formulation of strategies that ensure strategic objectives are achieved is a key function of the Board. Achievement of strategic objectives is important in ensuring survival of an enterprise.

• Hiring and Setting the Remuneration of the CEO

“Hiring and firing” the Chief Executive Officer of a company is also the role of the Board. The Board is also responsible for the hire of Senior Management staff of an enterprise. However, as shall be discussed later in this presentation, complications arise when the sitting CEO is also the Chairman of the Board. Although the Board may delegate of its functions to the CEO, such delegation does not mean abdication of responsibility.

• Risk Anticipation and Management

Survival of the enterprise is one of the key roles of the Board, as stated earlier. In order to do this, the Board needs to be able to asses and manage risks that face the enterprise.

This role is relatively new and does not strictly fall within the traditional roles of the Board. Increasingly, boards and management teams are embracing the concept of enterprise risk management (ERM) to better connect their risk oversight with the creation and protection of stakeholder value.

ERM is a process that provides a robust view of key risks facing an organization.

In today’s environment, the adoption of ERM may be the most effective and attractive way to meet ever increasing demands for effective board risk oversight. If positioned correctly within the organization to support the achievement of organizational objectives, including strategic objectives, effective ERM can be a value-added process that improves long-term organizational performance.

ERM can, therefore, assist management and the Board in making better, more risk-informed, strategic decisions.

SUB-COMMITTEES AS CONTROL MECHANISMS

From the discussion so far, we notice that the Board has various duties and responsibilities to satisfy share-holder expectations, ensure the survival of the enterprise, mitigate risks and control, hire and fire the CEO and top management. Let us now discuss how the Board exercises direction and control of an entity.

Various mechanisms and strategies are at the disposal of the Board in this regard. We shall discuss each one of these strategies in turn. However, it must be noted that personal integrity of the Board Members and Management is critical in the success of these mechanisms and strategies.

i) Decisions of the Board as a Mechanism / Strategy

The Board is the supreme policy making organ in an entity. It meets quarterly, usually, or as the need may arise to review the performance of the organisation. Through Board decisions Management is left with little or no leeway but to implement Board decisions. In this way, the Board exercises control of what may or may not be done by management. The Board is responsible for internal control in company and for reviewing its effectiveness. Procedures are often designed for safeguarding assets against unauthorised use or disposal; for maintaining proper accounting records; and for the reliability and usefulness of financial information used within the business or for publication. Such procedures are designed to manage and mitigate the risk of failure. At Board meetings, Management presents its own proposals for approval or rejection. Rejection or approval is the Board’s prerogative and an option the Board exercises in order to control what happens in an entity. Control is exercised through:

o Approval, rejection or varying of the entity’s budgets.

o Approval, rejection or varying of departmental budgets.

o Approval or rejection of contracts.

o Hiring or / and firing of the CEO and top management.

o Adoption of Audited Accounts of the company.

o Formulation of policies and strategies for their implementation.

i) Board Sub-committees as a Mechanism / Strategy

For specialized scrutiny, control and direction, Boards organize themselves into Sub-Committees of the Board. These sub-committees may be permanent or ad hoc.

What is essential is that they are chaired by a Board member with unique qualifications, experience and understanding of the nature of the task. The sub –committees also have within its membership Board members with the requisite experience, training and professionalism.

Examples of Sub – Committees of the Board may include:

o The Audit / Risk Monitoring Sub Committee

o The Staff Sub-Committee/ Remuneration Sub-Committee

o The Nomination Sub – Committee

o The Corporate Sustainability Sub-Committee

In order to fully understand how Boards exercise control through sub-committees, we need to examine the roles of these sub-committees.

a) The Audit/ Risk Monitoring Sub Committee

The establishment and maintenance of appropriate systems of internal control is primarily the responsibility of the Audit Committee. The Internal Audit function, which is centrally controlled, monitors the effectiveness of internal control structures across the whole organisation and reports to the Audit Sub-Committee.

Even though the Internal Auditor is a key member of staff, the occupant of this office does not report to the CEO but rather, to the Audit Sub – Committee. In this way, Board exercises control.

The Audit and Risk Monitoring Sub Committee is also responsible for advising the Board on high-level risk-related matters and risk governance and for non-executive oversight of risk management and internal controls (other than over financial reporting).

Timely reporting is essential for the company to take corrective action.

b) Staff Sub-Committee/ Remuneration Sub-Committee

The Staff/ Remuneration Committee is responsible for approving remuneration policy. As part of its role, it considers the terms of bonus plans, share plans, other long-term incentive plans and the individual remuneration packages of executive Directors and other senior company employees, including all in positions of significant influence.

However, for the sole purpose of enhancing integrity, no directors are involved in deciding their own remuneration.

This Sub Committee is also charges with the responsibility of selection, short listing, recruiting and fixing remuneration of the CEO and Senior Staff. It also handles issues pertaining to promotion, renewal of contracts, and discipline of the Staff. The Chairman of this Sub-Committee is usually a Board Member conversant with matters of Human Resource Management and Labour Relations.

It is important to note that recruitment of the CEO and Senior Management is subject to their signing of a “Performance Contract”

Findings and recommendations of this Sub-Committee (as all other committees) are then presented to the Board for approval.

In this way, the Board, through this strategy ensures all recruitment

(c) Nomination Committee
The Nomination Committee leads the process for Board appointments, and identifies and nominates candidates, for approval by the Board, with the support of external consultants as appropriate, and satisfies itself that appropriate plans are in place for orderly succession to the Board reflecting an appropriate balance of skills and experience on the Board. Before recommending an appointment to the Board, the Committee evaluates the balance of skills, knowledge and experience of the Board and, in light of this, and taking into account the needs of the company’s businesses, identifies the role and capabilities required for a particular appointment. Candidates are considered on merit against these criteria. Care is taken to ensure that appointees have enough time to devote to the company.

Corporate Sustainability Sub- Committee

The Corporate Sustainability Sub-Committee is responsible for overseeing the company’s Corporate Sustainability policies (principally environmental, social and ethical matters) and for advising the Board, committees of the Board and executive management on such matters. Ideally, a company should have a Corporate Sustainability/ Responsibility department within the Head Office. In certain companies, this department is a unit in the Human Resource Department. As I mentioned earlier in this presentation, the function of this sub-committee is relatively new and was not a traditional role of the Board. Besides the Sub Committees that I have discussed above, the Board usually has discretion to form other sub-committees as and when it deems fit.

OTHER CONTROL MECHANISMS
i) Performance Contracts
These are usually targets set by the Board for achievement. The CEO and Senior Staff are given targets that are measureable and achievable that they must meet. Failure to meet these targets would invite sanctions against the Manager concerned. Directors, in some instances, are also subjected to performance contracts by which achievement of set goals and objectives are gauged. ii) Continuity through Retirement by Rotation

This is a mechanism where one-third of Board members retire from the Board leaving two-thirds of Board members to continue in their roles. New Board members are then invited to replace the retiring Board Members. This mechanism ensures continuity and control of the entity as there will be more “old” Board Members to provide direction. Control of the entity is not lost, therefore. iii) Reporting Structures as a Control Mechanism

This is a structure in an organization that indicates responsibilities of every role player and the reporting lines. It is known as an “organo-gram” or the “Organization Chart”. The Board of Directors at the top with Sub-Committees below it. It requires that the Sub-Committees report to the Board. The CEO on the organo-gram is placed below the Sub-Committees, and below him , all the other staff in order of Seniority and Responsibility. Strict adherence to the reporting structures ensures control. It also allows the Board to give direction on what should be done.

The Enron Scandal – lessons learnt
The best example of what Boards should not do was provided by the Enron Scandal of 2001. The Enron scandal is the most significant corporate collapse in the United States. This scandal demonstrates the need for significant reforms in accounting and corporate governance in organizations, as well as for a close look at the ethical quality of the culture of business generally. I shall attempt to examine reasons for failure of Enron, one of the most powerful corporate giants in United States history. i) Conflict of Interest

One of the most significant tenets of good corporate governance is the elimination of conflict of interest. There should not be any conflict between personal interest an entity’s corporate interests. At Enron, Arthur Andersen was the external auditor but was also a consultant to Enron. He did business with Enron. Enron faced a situation where any payments made to Arthur Anderson in his capacity as a Consultant were later audited by himself as an External Auditor. This clearly led to an unacceptable conflict of interest.

ii) Falsification of Books of Accounts
The lack of attention shown by members of the Enron board of directors to the off-books financial entities with which Enron did business; and the lack of truthfulness by management about the health of the company and its business operation led to a poor financial state and near – collapse of the entity. Arthur Anderson, in his role as Auditor, admitted before a Congress Sub-Committee to having falsified the accounts and to having shredded or concealed official accounts that related to Enron. iii) The Board’s Failure to Monitor

One of the principle roles of the Board of Directors is to monitor and evaluate the performance of an enterprise to ensure that shareholders get a fair return on their investment and that the enterprise itself survives. At Enron, the Board was paid excessive amounts as remuneration. This gave them little motivation and incentive to closely monitor what management was doing. They failed to protect share-holder wealth. The blatant lack of ethics at Enron was in spite of the existence of a Code of Ethics, Sub – Committees of the Board, Performance Contracts, Audit and Risk Monitoring Committees and all the control measures. The lack of ethics and what came to be known as “reckless greed” on the part the Board and Management continued and was abetted by the Board. The Oxley Act, 2002

Following the Enron corporate and accounting scandal in the USA, Congress passed the Sarbanes-Oxley Act of 2002 (Sarbanes-Oxley). Sarbanes-Oxley established new and enhanced standards for corporate accountability in the USA. Even where an entity’s corporate governance structure was believed to be robust and in line with best practice, changes were necessary to ensure compliance with Sarbanes-Oxley. Senator Paul Sarbanes and Representative Michael Oxley, who drafted the Sarbanes-Oxley Act of 2002, sought to place further accountability, improve corporate governance and ethical behavior in companies. The Oxley Act, 2002 had the following new measures:

1. Created a Public Company Accounting Oversight Board to enforce professional standards, ethics, and competence for the accounting profession; 2. Strengthened the independence of firms that audit public companies; 3. Increased corporate responsibility and usefulness or corporate financial disclosure; 4. Increased penalties for corporate wrongdoing;

5. Protected the objectivity and independence of securities analysts; and 6. Increased Securities and Exchange Commission resources 7.
Prohibited the granting personal loans to members of the Board and Management Staff. Enron collapsed as a result of corporate misbehavior. If anything came out of the Enron Scandal it is that the scandal itself heightened awareness of the importance of integrity in Accounting and Business in general. Ethically, the Enron Scandal led to the enactment of the most significant pieces of legislation associated with oversight of corporate ethics, The Sarbanes-Oxley Act, 2002.

REFERENCES

Board of Directors http//Wikipedia.org (accessed on 24th July, 2012)

Committee of Sponsoring Organizations of the Treadway Commission (COSO), Enterprise Risk Management – Integrated Framework, September 2004, New York, NY HSBC Group: Internal Control: Revised Guidance for Directors on the Combined Code: HSBC Group 1992 The Sarbanes-Oxley Act, 2002

U.S. Securities and Exchange Commission, Speech by SEC Chairman: Address to the Council of Institutional Investors, 2009 Zameeruddin, R; The Sarbanes-Oxley Act of 2002: An Overview, Analysis, and Caveats. Northwestern Illinois University, Illinois, USA

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