A Comprehensive Structure of Corporate Governance in Post-Enron Corporate America

By Manuel A. Tipgos and Thomas J. Keefe

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Corporate governance structures have traditionally been a private matter between shareholders and managers with some state law restrictions, but the Sarbanes-Oxley Act (SOA) has made structures governing the conduct of the corporation a matter of federal law. Even the adoption of a code of ethics, previously within the domain of management prerogatives, is now a requirement under SOA.

The principal weakness of corporate governance today is the excessive concentration of power in the hands of top management. Rebalancing or equalizing this power is a prerequisite for controlling management fraud and promoting accurate financial reporting. To regain the confidence of the financial markets, a revolutionary approach to corporate governance is needed. Formally recognizing employees as a group and as key participants in the corporate process, rather than as a factor of production and a commodity traded in the labor market, is an important element in a transition to a more balanced governance structure.

A comprehensive structure of corporate governance is needed in reflecting this revolutionary view of employees. The authors describe such a structure in the following sections in the hopes of stimulating thought and discussion about alternatives to the current “tone at the top” approach. Built using a bottom-up process to support the view that the corporate enterprise exists under a public trust charter granted by the stakeholders or society in general, this approach depends more on checks and balances among the board of directors, top management, and the employees.

A Symptom of a Problem

The systemic problems at companies such as Enron, WorldCom, and Tyco International arose because of an imbalance of power in favor of top management in corporate organizations. The shift in power from shareholders to management started with the appearance of large corporations as a result of the Industrial Revolution, when small capitalists pooled their resources to finance bigger ventures that were operated by professional managers referred to subsequently as “managers for hire.”

Evidently, the unlimited power of managers for hire over the affairs of a corporation has grown consistent with the growth and importance of the corporate enterprise in our society. The first glimpse of management’s power was reflected in the corporate social responsibility debate of the 1960s and 1970s. Classical economists, led by Nobel Prize laureate Milton Friedman, argued that the purpose of business is to earn maximum profit for the shareholders. Others rejected the notion of maximum profits as the sole, overriding purpose of business. Maintaining that business has a social responsibility to its stakeholders and to society at large, they advocated that top management should use the vast economic power of business to promote social goals such as cleaning the environment, urban renewal, and equal opportunity. Since then, top management’s power has grown, and boards of directors have become rubber stamps.

Balancing Corporate Power

Of interest is whether SOA would provide a mechanism for rebalancing the power between the board of directors and top management. More fundamentally, can implementing the SOA provisions prevent management fraud?

SOA does not diminish the existing discretions and prerogatives of management in conducting and pursuing the business of the corporation, nor does its requirement for an independent board of directors and an independent audit committee really change the power of management. The force of law or regulation can be a deterrent, but it cannot stop management fraud. Management fraud can be stopped only by management itself.

The authors’ proposed corporate structure attempts to rebalance power in the corporation by recognizing employee groups as members of the corporate team. In this context, the three key participants in the corporate process—the board of directors, management, and the employees—can communicate directly with each other within and outside the confines of the board to share critical information about the business of the corporation.

The Corporate Process and the Employees

The conduct of the corporation is a three-way process involving the board of directors, top management, and the employees. Unfortunately, the potential role of the employees in this process has never been adequately recognized. The employees have traditionally been considered under the control of management, while the conduct of the corporation’s affairs is worked out between the board of directors and top management.

In the last 10 to 15 years, two significant and dramatic changes have transpired in the social and economic status of employees. First, reengineered organizations and the concept of employee empowerment have led employees to become a force in making significant decisions affecting the success of a corporation. Second, the employees are increasingly owners of a corporation as participants of 401(k) and other savings and retirement programs. As “new owners,” they are connected with the corporation in three significant ways:

  • by direct interest in the corporate enterprise through gainful employment;
  • as a source of security in retirement years through 401(k) and other retirement programs; and
  • as a source of “collateral benefit” from being a stakeholder (as members of society) in the corporate enterprise.

Pursued to its fullest, a three-way relationship among the board, management, and the employees will balance power within the corporation, promote accurate financial reporting, prevent management fraud, and regain the integrity of the financial markets with minimum interference from the government.

Empowered Relationships: Shared Visions

At the core of restructuring corporate governance is empowerment at all levels—shareholders, the board, top management, and the employees—consistent with the concept of empowered or reengineered organizations. The goals and objectives of the corporation will be a shared vision. SOA has changed the playing field for controls, creating an environment where such change can occur. Under the law, top management has to certify the accuracy of the financial reports and make certain disclosures about the controls and procedures in place to avoid fraudulent financial reporting. Even a code of ethics for senior corporate financial officers is now a requirement of the law.

To keep all these constituencies focused and vigilant about their shared responsibility of complying with SOA as well as their responsibility to the stakeholders of the corporation, each of them will assume a primary responsibility of upholding key shared goals. Matching and assigning the goals to each group is crucial to the success of the new structure, considering each group’s past problems.

Internal control. Historically, internal control has focused on conforming employees’ actions to the desires of management. One of the problems underscored in the recent scandals, however, has been management’s inappropriate overrides of accounting systems that were functioning properly under the control of employees. Assigning internal control to the employees will enhance the integrity of the financial records by preventing management from overriding the controls and manipulating the transactions.

Corporate governance. The board’s job will be to create and maintain a structure that will ensure harmony and cooperation between management and the employees in pursuing the goals and objectives of the organization rather than simply rubber-stamping the actions of management.

The code of ethics. Management will be assigned responsibility for the code of ethics to promote the importance of corporate morality and ethical standards. This will also put management in a leadership role rather than in the cop’s role it currently plays in internal control systems.

Continuous vigilance by each group will rebalance corporate power, guarantee accurate financial reporting, stop management fraud, and encourage good corporate behavior. Under the concept of empowered or reengineered organizations as the cornerstone of this comprehensive governance structure, all three goals are shared visions and shared responsibilities.

Recognizing the Role of Employees

The recognition of the role of employees as key participants in the corporate process signifies a move toward an enlightened view of employees in general, which will promote a cooperative relationship among shareholders, top management, and employees in the corporate environment.

The psychological impact on labor, individually and collectively, will be of historic magnitude, and perhaps may be understood only sometime in the future. In the near term, however, the new self-esteem of employees will probably lead to dramatic gains in productivity. A new era in resource management may open, including a reconsideration of compensation issues.

Management fraud will be prevented at its source because it would be difficult for management to cook the books by overriding internal controls or manipulating transactions under the watchful eyes of employees. This will also lead to management’s accountability in other areas.

Even though retaliation or retribution from management is now a crime under SOA, SOA does not guarantee that employees will step up as whistle-blowers. As recent whistle-blowers have found out, coworkers and other sectors of society view them as traitors. Direct and equal access to the board, management, and the independent audit committee will empower employees to confront any group for misbehavior.

Completing the structure. There is a distinction between the interests of stakeholders and of stockholders in an enterprise. Stakeholders, broadly defined as society as a whole, are interested in the collateral benefits derived from the success of the enterprise, such as the abundance of a product or a service, a clean environment, or a general rise in the standard of living. Stockholders have a dual interest in the success of the enterprise: direct interest as a reward for their investment, and collateral benefit as stakeholders. Similar benefits are enjoyed by management and employees based on their close association with the enterprise. Therefore, for stockholders, management, and employees with empowered relationships, the success of the enterprise becomes a shared goal.

The Public Trust

Stakeholders provide the corporate enterprise with a “charter” to operate and enjoy approval under the public trust. Business corporations, as well as other social institutions, must uphold the public trust to maintain their legitimacy. The public trust has been shaken by revelations of misconduct by corporate America, and the current volatility of the financial markets continues to reflect the concerns of the investing public

Stakeholders use a corporation’s annual reports and financial statements to gauge the success of its operations and to judge whether it is upholding the public trust. Stakeholders require truth, honesty, and integrity in these financial reports. This expectation makes the quality of financial reports one of the most important components of corporate America. The current SOA requirement that both the CEO and the CFO attest to the accuracy of their financial reports may accomplish this end to a considerable degree, but not completely. The best guarantee will come from a reengineered corporate structure predicated on the checks and balances outlined above, whose constituent parts adopt the qualities of truth, honesty, and integrity of financial reports as part of their shared vision.

Two groups act primarily of “guardians of the public trust” in the proposed comprehensive reengineering of corporate governance structure. They are an enlightened public accounting profession and the independent audit committee.

An enlightened public accounting profession. A public accounting profession, practicing with extraordinary dedication and integrity, is an important element of satisfying the public trust for stakeholders as well as shareholders. Accountants with the knowledge, training, experience, and mindset needed to guard and uphold the public trust should be sought by every corporation desiring to ensure its stakeholders that its financial statements and disclosures meet the stakeholders’ expectations.

The independent audit committee. Under the empowered, reengineered relationships among management, employees, and the board, the audit committee will have two fundamental responsibilities. Internally, it will oversee the annual audit to ensure the accuracy and integrity of the financial statements as required by legislation or statute. It will also ensure that there are no breakdowns in corporate governance rules and procedures, including the rules of ethical conduct and internal control. The audit committee also would be the practical monitor collecting information regarding corporate misconduct and encouraging those with such information to come forward.

Externally, the role and responsibility of the independent audit committee would be to uphold the public trust with respect to the operation of the corporate organization, serving as the link between the stakeholders and the corporate organization. An illustration of the relationships discussed is shown in the Exhibit.

Internal audit function and management accountants. The internal audit function should generally report to the independent audit committee, and its work should be focused to uphold the public trust. While continuing to perform its basic responsibilities, such as compliance audits, operational audits, assistance to external auditors, special projects for the audit committee, and other tasks requested by the operating departments, the internal auditor will no longer act as a watchdog for the board to ensure that management creates an environment of controls to protect corporate assets from misuse or fraud committed by the employees. Rather, the internal auditor will promote a positive, cooperative relationship among the key participants of the corporate process.

Management accountants would face a big challenge. They would be charged with responsibilities for:

  • employees’ active and knowledgeable participation in their new role as a member of the corporate team;
  • the business’ profitability;
  • internal control functioning as planned;
  • continuous vigilance against any type of “cooking the books” and creative accounting;
  • implementing the infrastructures to facilitate top management’s certification and disclosure responsibilities under the Sarbanes-Oxley Act; and
  • a code of ethics that will transform the corporate enterprise into a moral and ethical entity in the post-Enron era.

Manuel A. Tipgos, PhD, CPA, is a professor of accounting at the School of Business at Indiana University Southeast.
Thomas J. Keefe, PhD, is an associate professor of business administration at the School of Business at Indiana University Southeast.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



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