Seven myths on corporate governance cleared

May 11, 2020 5:15 AM

Corporate governance is a tricky topic that board members and senior management must constantly revisit, improvise.

The myth that corporate governance ‘doesn’t apply’ comes from a view that it’s only theoretical and doesn’t impact the bottom line or performance.

By Vidya Hattangadi

Largely, people believe that only public limited companies or conglomerates and established companies need to be concerned about corporate governance. They feel these companies can benefit from implementing corporate governance practices; whereas the reality is that all companies—big and small, private and public, start-ups etc—compete in an environment where good governance is imperative. One size doesn’t fit all, but right-sized governance practices will positively impact the performance and long-term viability of every company. Corporate governance is a tricky topic that board members and senior management must constantly revisit and improvise. The business environment sometimes experiences a recession and, at times, a boom.

The following are some common myths about corporate governance that need illumination:
Myth 1: Corporate governance is just a theoretical term.
Reality: The myth that corporate governance ‘doesn’t apply’ comes from a view that it’s only theoretical and doesn’t impact the bottom line or performance. Some feel that it cannot be tailored to a company’s size and stage of development. In reality, all companies (with or without corporate governance) compete in an environment where good governance is a business imperative in relation to things like raising capital, obtaining loans, attracting and maintaining talented and qualified people, meeting the demands and expectations of shareholders, and expansion of firms.

Myth 2: Corporate governance does not have a single accepted definition; therefore, it is a vague idea.
Reality: Broadly, the term describes the processes, practices and structures through which a company manages its business and affairs, and works to meet its financial, operational and strategic objectives and achieve long-term sustainability. It is generally a matter of law based on corporate legislation, securities laws and policies, and decisions of courts and securities regulators. Directors owe a duty of loyalty to the companies they serve, and have a fiduciary duty to act honestly, in good faith and in the company’s best interests. Corporate governance is also shaped by other sources such as stock exchanges, the media, shareholders, NGOs and interest groups. Corporate governance practices help directors meet their duties and the expectations from them.

Myth 3: One cannot expect a return on investment in corporate governance.
Reality: Some companies view investment in corporate governance as a mandatory expenditure, whereas few realise that it gives significant returns—directly and indirectly. In Asia and Latin America, for example, institutional investors pay, on average, 22% premium for firms showing improvements in governance because they get better returns from improved stock performance. Companies with good governance also receive better credit ratings, which, in turn, help them get better interest rates, better supplier terms and improved working capital. Better-governed firms do better than peers. Companies must not view investment in governance as an opportunity to mitigate risk, improve the brand and generate returns.

Myth 4: Training staff in ethical conduct costs the business a big sum.
Reality: Most firms will prove ineffective in establishing a culture of ethics. The amount spent on training employees in ethical behaviour and their understanding differs. The percentage of employees completing training doesn’t measure whether employees are behaving more ethically. Moreover, high-sounding principles in standardised governance training hold little meaning for employees and are rarely applied. Individuals have their core moral standards, which is difficult to be altered. Practically, the training modules must be tailored for each employee based on a standard operating procedure (SOP).

Myth 5: Legislation compliance ensures good governance.
Reality: Legislation can never account for a large proportion of corporate frauds; firms that want to get into frauds can find loopholes in the system. Firms cannot rely on compliance to create ethical behaviour. A lot of large-scale corporate frauds are committed by employees at firms that comply with all regulations. For example, Satyam Computer Services Ltd, which saw its employees commit India’s largest corporate fraud, was compliant with Indian law and International Financial Reporting Standards (IFRS) financial disclosures.

Myth 6: Audit committees are powerful to reinforce corporate governance.
Reality: While audit committees take the blame for lapses in governance, the reality is boards often do not give the audit committee the right scope or support it with the right processes. Audit committees’ ineptness has little to do with their powers or the quality of the directors. Their focus is often diluted as committee charters and responsibilities are rarely defined, and the group becomes an owner of risks which the board of the firm does not want. This impedes oversight on governance and increases risks of frauds. Firms that formalise the audit committee charter and conduct meetings and agendas at the beginning and make those reports available to public build market confidence.

Myth 7: A strong fraud management system is the most important way to record misconduct.
Reality: When a firm establishes fraud detection and controls systems, but doesn’t take actions that are most important, it loses sense. Fraud management is not enough to reduce misconduct. To build an effective governance framework, progressive companies create a culture of ‘speaking-up’, under which employees report misconduct without the fear of retaliation. It has been observed that when employees speak up (called whistle-blowers) they are fired or harassed by top officials. According to a 2010 Association of Certified Fraud Examiners report, employee information was found crucial in clearing up 47% of fraud cases, which is more than all the other tools fraud management relies on. Organisations must reinforce the commitment to integrity with a strong ‘tone from the top’ and demonstration of organisational justice. A lot depends on conduct of top management people’s behaviour.

The author is a management thinker and blogger.

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