Introduction
ONE
Â
The focus of this book is on case studies of companies that have experienced problems with their corporate governance procedures. Nine case studies are presented here and it is hoped that the reader will find the material both interesting and instructive. Some common themes tend to run through these cases, such as charismatic and powerful business leaders, companies experiencing rapid and unsustainable rates of growth, unreasonably optimistic market expectations of future growth and unnecessarily complicated organization. Not all the companies discussed in this book have collapsed. Shell, for example (see Chapter 12), operates profitably but its corporate governance procedures have been the subject of debate in the media because of its overstatement of oil and gas reserves, announced in January 2004.
Many believe that robust systems of corporate governance are important for both large and small organizations. The purpose of this book is to provide some insight into why corporate governance can break down and, by discussing case studies, to look at what might be done to remedy such situations. In addition, two chapters provide an introduction to corporate governance theory and corporate governance regulation.1
This book can be thought of as a supplementary source of material, which encourages topical discussion in seminars and classes. Each case study in the book is designed to introduce the reader to a factual âreal lifeâ episode which has corporate governance implications. Each case is designed to reinforce the readerâs knowledge and understanding of corporate governance theory and help to explain why corporate governance codes and regulations are widely thought to be essential in modern business life. It is intended that each case will motivate students to discuss, in a seminar or class setting, the reasons why corporate governance failed, or was seen to be inadequate.
This book does not pretend to offer easy solutions to the problems identified in the case studies. However, certain elements and themes can be identified, such as the problems that can occur when the chairman or chief executive becomes too powerful (or indeed is the same person) or when the non-executive directors are seen to be lacking in independence and authority. The reader is encouraged to adopt an independent and analytical approach to the case material and use the discussion section to reinforce their understanding of corporate governance issues.
Corporate governance cases and their ramifications tend to be in the public eye over a long period of time. When court action is involved, cases can take many years to resolve. Cases such as BCCI and Polly Peck came to the publicâs attention in the early 1990s, but legal disputes are still ongoing.
Case studies have a valuable role to play in affording a deeper understanding of corporate governance issues. Case-study analysis can also assist social scientists in the development of theories and hypotheses, which can then be subject to more rigorous scientific investigation. At the same time, it is important to be aware of the difficulties involved in trying to derive general conclusions from a case study.2
The book is structured as follows: the two chapters on the theory and regulation of corporate governance are followed by nine case studies, with a final chapter which offers a synthesis of conclusions.
Chapter 2 on corporate governance theory reviews the development of the modern corporation and discusses principalâagent theory and stake-holder theory as suitable frameworks for analysing corporate governance problems.
Chapter 3 on corporate governance regulation discusses the development of The Combined Code on Corporate Governance in the UK and SarbanesâOxley legislation in the USA. It is debatable whether these codes and regulations can ever be sufficient on their own to tackle âweakâ corporate governance, and there have been suggestions that a change in business culture is required. Also, when framing corporate governance codes and regulations, a suitable balance needs to be struck between the demands of managers and the needs of stakeholders. Finally, the chapter closes by suggesting that some answers to the question âWhat is good corporate governance?â may be found by analysing and dissecting cases where many observers would agree that a definite failure in corporate governance procedures has occurred.
Chapter 4 discusses the case of the Robert Maxwellâs business empire. In November 1991 Robert Maxwell, an apparently successful business leader with important newspaper and publishing interests, disappeared at sea from his yacht Lady Ghislaine and it soon became apparent that his business empire was in serious financial difficulties. Employees who lost substantial pension entitlements were particularly disadvantaged. Chapter 5 discusses issues arising from the collapse of Polly Peck, a large UK quoted company, in October 1990. In 2004 this case had not yet been fully resolved, mainly because the former chairman and chief executive is effectively in exile in northern Cyprus.
Chapter 6 discusses the case of the Bank of Credit and Commerce International (BCCI), which was forced by regulators to suspend its operations in July 1991. The Bank of Englandâs regulatory practices were subsequently criticized in an official report the following year.
Chapter 7 addresses the financial scandal surrounding Enron, one of the worldâs largest energy groups, operating in the USA. The company filed for bankruptcy in 2001 and it was discovered that reported profits had been substantially overstated. Chapter 8 discusses another corporate failure, WorldCom, which became bankrupt in July 2002. A main concern was that capital expenditures were found to have been misclassified. It is widely believed that Enron and WorldCom were crucial factors in getting the SarbanesâOxley legislation onto the statute books.
Chapter 9 discusses the events surrounding the financial collapse of Parmalat, an Italian multinational company. In 2004 senior executives of the company were facing charges of false accounting in connection with the collapse.
Chapter 10 examines the relationship between the company and shareholders of Eurotunnel. Eurotunnel came to the market in 1987, but its actual capital expenditures proved to be much higher than those projected in the original prospectus. In addition, projected revenues proved to be substantially overstated. This case specifically addresses the issue of how shareholders (as principals) can effectively monitor the actions of managers (as agents). Chapter 11 discusses the case of Barings Bank which collapsed in 1995 following unauthorized trading by one of its derivatives traders, Nick Leeson.
Chapter 12 examines events at Shell. In January 2004 Shell announced that it had overstated its oil and gas reserves, and this case study examines the subsequent impact on the share price and how the company has attempted to reform its organization structures and corporate governance practices.
Chapter 13 attempts to draw together the arguments and issues raised in the previous chapters and offers suggestions and recommendations for improving corporate governance. This chapter aims to show that the study of real-world examples of corporate governance is necessarily âbackward lookingâ, but it is through this type of analysis that lessons can be learned for the future and relevant theories and hypotheses can be developed.
Finally, it should be noted that the discussion questions, which appear at the end of each case study, have not been formulated with the intention of leading to a ârightâ answer since there is unlikely to be complete consensus on what is âgoodâ corporate governance. Managers of companies are more likely to be aware of the costs of corporate governance, in terms of resources devoted to compliance with codes and regulations. On the other hand, stakeholders are more likely to be aware of the benefits, which could prevent or avoid loss of shareholdersâ capital, loss of employment, loss of pension entitlements and loss of amounts owing from failed companies.
REFERENCES
Mallin, C.A. (2004) Corporate Governance. Oxford: Oxford University Press.
Monks, R.A.G. and Minow, N. (2004) Corporate Governance, 3rd edn. Oxford: Blackwell.
Ryan, B., Scapens, R.W. and Theobald, M. (1992) Research Method and Methodology in Finance and Accounting. London: Academic Press.
Solomon, J. and Solomon, A. (2004) Corporate Governance and Accountability. Chichester: Wiley.
NOTES
Â
Corporate Governance Theory
TWO
Since the nineteenth century, when incorporation was first introduced into the UK, there have been significant changes to the way firms are organized and financed. In order to appreciate how theorists have tried to make sense of corporate governance issues, we can refer to two widely discussed âtheoriesâ or approaches commonly used to attempt to understand how corporations are governed and how the system of corporate governance can be improved. The first approach is often called principalâagent theory (or agency theory). The second approach is referred to as stakeholder theory.
In the literature on the theory of the firm, we soon encounter the term âseparation of ownership and controlâ. What does this mean? If we go back to the nineteenth century, many of the largest companies were both owned and controlled by their founding proprietors. Over time the original founders were able to accumulate substantial wealth as profits were rein-vested in their enterprises. But, despite this, the proprietors began to realize that their own resources were not sufficient to finance sustained growth. Often they were in a position to raise additional loan capital, which would not dilute their own shareholding and therefore not affect control of the company.
But there is a limit to how much debt finance a company can sensibly carry. And, in order to maintain their competitive advantage and benefit from economies of scale, there was an inexorable need to grow in size. Therefore they needed to raise additional share capital via the stock markets. This meant that their personal shareholding became smaller relative to the company as a whole. In addition, as they retired or died, their shares were parcelled out amongst their descendants. In the early part of the twentieth century it became evident that the largest shareholdings were becoming fragmented and dispersed. In other words there was a reduction in ownership concentration.
OWNERSHIP
What do we mean by ownership? It is a truism to say that the shareholders own the company. Unfortunately this statement offers us little insight into complex corporate governance relationships; indeed, as well pointed out by Blair (1995), it often obscures the important issues instead of illuminating them. One explanation of the distinctive features of share ownership compares it with ownership of a physical object, such as a house:
When I tell you that I own my house, you will infer that I decide who may enter it or live in it, and who not; that I determine how it will be furnished and decorated; and that I have the right to dispose of all or part of it and keep the proceeds for my own benefit. When I buy a share in BT [British Telecom] I enjoy none of these rights in relation to BT, except a limited version of the last. (Kay and Silberston, 1995: 87)
This is really the essence of the problem. Particularly in the case of small shareholders, the ownerâs rights are very limited and in practice amount to receiving dividends and disposing of the shares, usually because the company has performed poorly in the past and is unlikely to do better in the future, or because the company has performed well in the past but is unlikely to do as well in the future. So this is a relatively passive form of ownership. It is true that a shareholder has a right to vote in the annual general meeting (AGM) on critical matters such as the election of directors. But in reality, and given that a large company can have hundreds of millions of ordinary shares, the chances of a small shareholder swaying the balance in an AGM are about as likely as a single voter determining the choice of government in a general election.
In fact the issue of ownership is even more complex than the above analogy suggests. In reality, even though I own a house or motor car, I cannot do whatever I like with it, since I am subject to other constraints â such as building regulations in the case of housing and safety legislation in the case of motor cars. And in the case of share ownership, there are subtle distinctions in the difference between influence and control depending, not only on the absolute proportion of shares held in a company, but also the absolute proportion relative to blocks of shareholdings owned by others. For example, if I hold 10 per cent of the shares in a company and the remainder are highly fragmented, it is quite possible that I could exert some influence on the board of directors. But if the remaining shares include two blocks of 30 per cent each (and the owners are in collusion), then my 10 per cent might give me very little influence indeed.
In the nineteenth century it could be reasonably argued in many cases that the owners were in control, that in fact the owners were also the managers. As we move into the twentieth century, the managers, a distinct and separate professional elite, are said to be in control. Berle and Means (1932) proposed the separation of ownership and control as an important explanation for corporate behaviour and the problems confronting owners (fragmented...