Importance of Corporate Governance- Finance Perspective

Posted in Finance Articles, Total Reads: 1338 , Published on 19 March 2016

Importance of Corporate Governance is studied from a finance perspective through this article. In the light of the growing number of scams, accounting scandals, massaging of books, misuse and misappropriation of public money, the importance of Corporate Governance can’t be overstressed. Formation and proper functioning of Corporate Governance body abiding by international rules and regulations has become of quintessential importance today as survival and success in global market can be ensured only via foreign investment, foreign customers: simply in a word by going global.

Corporate Governance is the way a corporation polices itself. It intends to increase the accountability, transparency and efficiency of the management and advocates adoption of consumer and environment friendly business practices. It encompasses the board of directors and various stakeholders namely Employees, Investors, Customers, Suppliers, Creditors and its goals broadly include (1) Keeping the interest of stakeholders in mind, (2) Treating Shareholders equally (3) Ensuring Transparency & Ethical Behaviours (4) Lowering Risk & (5) Safeguarding the public image of the company. We begin by discussing a few infamous events that eventually led to Corporate Governance taking the centre stage and thereby forever altering the dynamics in which businesses work.

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The Enron Corporate Issue

Enron Corporation was an Energy, Commodity and Service Company based in Houston, Texas, USA. In the year 2000, Enron employed 61,000, operated in over 40 countries, and reported revenues of $101 billion, and was ranked seventh among Fortune 500 that year. Enron grew from revenues of $20 billion in 1997 to $100 billion in 2000 with a tenfold increase in profit of $979 million in 2000. Enron, however, was involved in a series of fake transactions with dubious limited partnerships, called Special Purpose Entities (SPEs), and created by accounting loopholes and poor financial reporting that led to its filing for bankruptcy in June 2001. In October 2001 Enron was suspected of a massive financial statement fraud; Chairman Kenneth Lay, former President Jeffrey Skilling, and former Chief Financial Officer Andrew Fastow, were accused of shielding debt from public view, and overstating revenues and earnings, thus giving the impression of rapid profit growth.

Enron’s corporate ethics failure represents the biggest business bankruptcy ever. In the end, those misplaced morals killed the company while it injured all of those who had gone along for the ride. A lot of people suffered, not the least were the shareholders and pensioners who lost it all.

The Case of Satyam Computer Services Ltd.

Satyam Computer Services, Ltd. was a rising star in the Indian outsourced information technology services industry. The company was formed on June 24, 1987 in Hyderabad, India by B. Ramalinga Raju. The firm began with twenty employees and grew rapidly as a global business. Satyam proposed on December 16, 2008 that it would spread risk by diversifying into the infrastructure and real estate business by acquiring two family-run firms: a) a listed Maytas Infra Ltd where the Raju’s brothers had a stake of 35%, and b) an unlisted Maytas Properties Ltd where the family ownership was about 36%. The spontaneous and immediate uproar of Satyam investors against the proposal led the board to call it off in 2009. Very shortly, Satyam shares plunged 55% in trading on the NYSE. Subsequently, B. Ramalinga Raju, Satyam Chairman, revealed that, especially in the wake of the bubble bust and subsequent loss of IT business from several Fortune 500 companies, the company had been reporting inflated profits, understating debts, and doctoring other financial parameters to fight its market share erosion vis a vis domestic competitors. The case of Satyam is an example of negligence of fiduciary duties, total collapse of ethical standards and lack of social responsibilities. This led to the closure of the company and job-loss to thousands of employees and money-loss to several groups of internal and external stakeholders. It has demonstrated that even highly credible, qualified, and educated persons are no insurance for corporate governance, that they are no watchdogs of the minority shareholders whose interests they are supposed to serve.

Inappropriate Accounting Case of Toshiba

A latest addition to high profile Corporate Governance scandals in Japan after Olympus case in 2011 came to limelight on July 20, 2015 where a third party investigative report talked about a systematic overstatement of operating profits of $1.2 Billion over the past six years. The industry response to this scandal in the multinational conglomerate goes like this: “The biggest problem in Japanese corporate governance is companies’ rigid respect for hierarchy and that one should never go over his boss’s head or he will suffer retaliation,” “This keeps bad news from rising.”

Aggressive profit targets were set and fraudulent accounting methods were extensively misused to keep the books balanced. The audit committee failed to function with sufficient independence and at the outbreak of the news of this inappropriate accounting scandal all the honchos resigned. It seems Toshiba’s move to adopt American Style corporate governance culture based on modified “Hybrid” board Committee system and build an effective independent Corporate Governance body via leveraging the “Best of both worlds” failed miserably.

Corporate governance is a key target of Prime Minister Shinzo Abe’s effort to boost Japan’s long-flagging economy and Industry Stalwarts are voting for more diversity in Corporate Governance in Japan and are advocating for more focus on board functioning than its structure.

Nevertheless there is a brighter side as put forward by Karou Kamisaka, an independent financial information consultant of Japan Economic Pulse- “Non-Japanese investors are taking a rational view of the Toshiba scandal, indicating that they see the resignation of top figures at the company possibly opening the way to firmer corporate governance,”.


At the outbreak of the massive accounting scandal at Toshiba Shinya Tsujimoto, Chief Operating Officer of Nippon Life Global Investors, the asset management unit of the insurance giant said “I don’t think the Corporate Governance Code and the Stewardship code can remove Toshiba-type problems perfectly”, “But the government might continue to focus on corporate governance and the momentum might be accelerated”. The legal framework to ensure the independence of the audit committee needs to be tightened globally.

Proper Corporate Governance Code, proper functioning of the same & sensible business steps of top management overall can hinder such fall outs from happening in the future.

This article has been authored by Anurag Das and Saransh Mahajan from XLRI Jamshedpur




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