Regulation and Corporate Governance in Business

Introduction

There is a great deal of talk about regulation and corporate governance in every corporation that exists. Every business should have a set standard of guidelines known as regulations that drive the company's mission forward, and is usually supervised by regulatory bodies.

Corporate governance arises from emerging financial scandals and has grown rapidly , particularly since the collapse of Enron in 2001. Why did the collapse occur and how to prevent it from happening again? Can the investor’s confidence be restored again? All the answers are within topic that we will be discussing.

Most importantly, are regulation and corporate governance two sides of the same governance coin? Are they interdependent?

Body

Corporate Governance can be simply defined as: ‘the way in which companies are directed and controlled (Cadbury Report, 1992).’

The basic purpose of corporate governance is to monitor parties within a company which control the resources owned by investors. It is concerned with the relationship between company management and the shareholders by ensuring that the company is managed in the best interest of stakeholders. “Corporate governance is concerned with both the shareholder and internal aspects of the company, such as internal control, and external aspects, such as organisation’s relationship with its shareholders and other stakeholders,” (Mallin, 2019). Although corporate governance is considered fundamental to the investors, many have overlooked the fact that good corporate governance is also essential to attract new investment.

The primary objective of sound corporate governance is to contribute to improved corporate performance and accountability in creating long-term shareholder value. The growing of corporate governance has caused massive changes in every organisation in the corporate world. Many countries have set corporate governance codes which all companies are expected to abide. These codes normally emphasise transparency, accountability, honesty, integrity and other ethical corporate management in order to manage organisation efficiently and assure compliance.

Regulation

Buckley (2011, pp.101) defines regulation as “the control of human or societal behaviour by rules and/or restrictions. It can take many forms. It embraces legal restrictions set by a government or similar authorities. It may involve self-regulation by an industry, for example via a trade association. It could involve social regulation via norms of behaviour which may vary from group to group. And it may involve market regulation. Regulation imposes sanctions against deviation.”

Purpose of Regulation

Market failure happens when resources are allocated inefficiently. Most markets, are unsuccessful and need intervention from regulatory bodies or government. The regulatory instruments that are normally used by government are subsidies, tariff, trade restrictions, price ceiling to correct market failure.

Regulation has significant contribution towards societal well-being and economic development. The intention of regulation is the public concern where the public heavily depends on the financial system. For instance, savers would want to ensure that banks have their money whenever they needed it. Businesses rely on banks for borrowing to maintain the business. The public concerns about the safety of financial institutions and their products as poorly regulated financial institutions have the potential to undermine the stability of the system. Moreover, customers are prone to harmful upshot and damage business profile. Regulation is important so that rules can be set up to protect consumers, mitigate risk and safeguard the financial institution from horrendous collapse from self-interested groups.

However, some argue that the government is incapable of effective regulation but the legislative success over Great Depression suggested otherwise. During severe economic downturns, failure of financial firm led to a massive disruption of the system and this is avoidable through effective regulation.

OECD Regulations

Emergence of regulation has been very important to governance of Organisation for Economic Co-operation and Development (OECD) since the past thirty years. An important area of focus between regulation and economic growth has been discovered and where the effective regulatory policy has opened pathway to innovations, benefits both consumer and entrepreneurship (OECD iLibrary, 2019). Beyond improving economic performance, regulation is also supporting broader goals for society such as quality of life, social cohesion and rule of law. It has encouraged more open societies where the users view are heard,by amplifying the approaches to public consultation.

To make sure firms abide by the rules of regulation, they have to be supervised. Examples of regulatory bodies are Bank of England (BoE), Prudential Regulation Authority (PRA), Financial Conduct Authority (FCA), Financial Services and Markets Authority (FSMA) and more growing bodies. It is important to monitor firms especially financial service providers to make sure they are following the rules.

Impact of Ethics on Corporate Governance and Regulation

Ethics is defined as “the values an individual uses to interpret whether any particular action or behavior is considered acceptable and appropriate (Stanwick, 2009)”. An example of ethics is the code of ethics set by a business.

Code of ethics guides rather than rules corporations. It is used to motivate corporations and its people to act ethically. The main difference between corporate governance and ethics is that the ethics are the philosophical and morally decent standards that a corporation attempts to stand by, while governance processes are the means by which a corporation attempts to remain as ethical as possible while still making a profit (Bizfluent, 2019).

Ethics is fundamental in the business world. In fact, ethics should be made a priority in governance. It is a moral obligation that guides corporate behavior. Ethics is described as the conduct of “doing the right thing,” . The obligation of “doing the right thing” while striving for profit should be carried out in an accountable, transparent and responsible manner in order to support the long-term sustainability of corporations.

Conflicts Between Corporate Governance and Ethics

The main source of conflict between corporate governance and ethical obligations is the fact that a corporation exists to make a profit, and ethics exist to benefit the social good. Without enough ethical training, this will make the staff vulnerable to ethical hazard when making decisions.

Proposed Solution to the Conflicts

Companies may provide guidance to staff regarding code of ethics and code of conduct more comprehensively through training. This will help to nurture the standard in themselves to ensure the quality. As a result, the example of risks below can be prevented;

A manager unintentionally exposed confidential information of employee to a phisher which violates the General Data Protection Regulation (GDPR)

An inspection step was skipped, and low-quality raw materials caused a safety issue

Failure to follow appropriate procedures when a machinery needs repair which results in an environmental disaster and severe fines.

Ethical staff who adheres to the codes of conduct will be able to help guards company reputation. Moreover, training will reduce operational risk as staff adhere to the code of conduct. As an outcome, the excellent business practice will reduce errors by personnel, procedures, systems or external events. It is important to mitigate operational risk especially to secure long-term shareholder value. Corporations need to satisfy their shareholders to avoid the selling of shares . If shareholders are unhappy this could possibly lead to downward pressure on stock prices. Hence, businesses need to periodically assess threat from all anticipated risks through comprehensive staff training. Lack of training causes unproductive and unethical staff.

Code of Ethics

A code of ethics is a guide designed to help firms conduct business with respectful integrity. It may outline the mission and values of the corporations, methods to approach problems professionally and the ethical principles based on the corporation’s core values.

Most firms have adopted a code of ethics. For instance, Chartered Financial Analyst Institute (CFAI) which is the most respected and globally recognised financial professionals. According to CFAI, members of CFA Institute must adhere to their code of ethics outline. One of the few is to act with integrity, competence, diligence, respect and in an ethical manner with the public, clients, prospective clients, employers, employees, and colleagues in the global capital markets (CFAInstitute.org, 2019) .

Code of Conduct

Code of conduct is different from code of ethics in a way that it contains information pertinent to individual and their behavior towards the job. Most companies will require the employee to sign the code of conduct documents in prior to their employment, in which becomes a legal agreement between both parties.

The purpose of a code of conduct is to maintain an acceptable standard of conduct for the company, customers and employees. Although they are different between industries, the conduct code includes behavior guidelines that are consistent with company policies. It also serves to remind the employee of what is expected of them, and that their actions, appearance, conduct and demeanor will affect their career as well as the company.

Similarities and Differences of Ethics and Conduct

Code of ethics and code of conduct has been widely confused and interchangeably used by many. The key difference is that code of conduct is less morally driven than code of ethics. For instance, the code of conduct might require all employees to wear corporate lanyard when in the office. This is an example of conduct issue designed to create cohesiveness among employee and not an ethical issue nevertheless.

In other words, the code of conduct may not always be ethically driven, but every code of ethics scenario should have a corresponding set of rules in the conduct code. Both have goals of setting a standard of behaviors from employees. Every business should have a clear vision, when it comes to ethics and conduct. What that happens, then employees work better as a team, job satisfaction increases and performance improves when companies set the tone with meaningful ethical and conduct standards. The result is a positive corporate culture, in which people want to go to work and that consumers enjoy working with these employees.

The Influence of Board of Directors in Overseeing Corporate Governance

The internal and external parties involved in corporate governance within an organisation are known as stakeholders. (Kaplan, 2019) defined stakeholders as “any person or group that can affect or be affected by policies or activities of an organisation”. Directors have the most duties and responsibilities as a stakeholder. In every decision they make, they must put into consideration of how it will affect the employees, customers, suppliers, communities and shareholders. Directors will control the company in the best interest of the stakeholders while ensuring compliance with company legislation.

Directors are appointed by the shareholders of the company who set overall policy for the company. The corporate board of directors assists in corporate governance by supervising executive management and makes strategic decisions for the company. The board generally govern the corporation on behalf of the shareholders, effectively acting as trustees for stockholder interests.

A functional board needs to have a diverse range of expertise, perspective and knowledge, as well as various range of age, gender, race, religion, skill and experience. The diversity will be able to make huge development towards the corporate governance as it will challenge the differences in board’s perspective. Board of directors are tasked to plan and strategize short term and long term goals and objectives. This relies on how the board of directors address uncertainties and seize opportunities in the future. The way they manage potential risks will inspire trust from investors. Hence, they should be able to articulate their plans to gain shareholders’ and investors’ trust. In order to ensure good governance, listed companies are required to set up audit committees of minimum three directors, on which, two-thirds should be Independent Directors. The audit committee chaired by an Independent Director shall inspect the company’s financial statements and can also recommend replacement of the statutory auditor. (Jan and Sangmi, 2016),

Corporate governance revolutionised as a response to the rapid change in financial sector. To this regard, board of directors must be able to adapt and respond quickly to opportunities and threats. Board of directors should ensure that good corporate governance is applied in firms to deter fraud and deceptive practices that could ruin the corporation image. Hence, policies for code of business conduct, code of ethics, conflicts of interest and whistleblowing should be developed.

Communication

Board of directors must be able to perform effective communication in a timely manner to develop mutual confidence and trust with stakeholders. For instance, having regular conversation with manager regarding risk mitigation and prevention. It is important for managers to understand risks so that they can plan ahead the processes required to protect the company. Global Logistic Properties (GLP) non-executive chairman Seek Ngee Huat encourages management to seek help from the board, and the board has to be interactive to allow the business guidance (Businesstimes, 2019) .

The Influence of Ethics Through Corporate Social Responsibility on the Behaviour of Corporates

Enrico Cavalieri, in his journal believes that companies or organisations influence market and economic growth of the society it belongs to and operate for. For that reason, it is believed that organisations and companies have some sort of responsibility towards the society they belong to and operate for (Cavalieri, 2007).

CSR comprises a number of corporate activities that focus on the welfare of stakeholder groups, including society and the natural environment (Sprinkle & Maines, 2010). The growth of interest on corporate social responsibility (CSR) in the corporate world has increased. A lot of organisations incorporate CSR as part of their integral part of their business, due to the growing expectations from various stakeholder groups. These can be in terms of pressures on social and environmental issues, with reason being that companies of all sizes and types have to take into account ethical issues and that they are responsible for being socially and environmentally friendly. It is believed that companies can benefit strategically through good cause such as CSR in terms of good corporate reputation and this is of tremendous value. Hence, each company is ought to find ways to make full use of their resources and capacity to organise CSR activities.

A key aspect of corporate reputation is stakeholder groups’ perceptions of organization’s CSR, or more precisely, their perceptions of how well the organization’s CSR initiatives and outcomes meet stakeholders’ social and environmental values and expectations. Indeed, research of Husted & Allen (2007) demonstrates that good corporate reputation has a significant potential for value creation and is difficult to replicate. Corporate reputation is a key competitive advantage in markets where product differentiation is difficult. According to Melo & Galan (2011), this competitive advantage is strengthened through the use of CSR.

Conclusion

In conclusion, regulation and corporate governance are two sides of the same governance coin. Corporate governance has vast interaction with regulation. The interaction not only impact the company, but the legal system and the country as a whole. Corporate governance is a matter of not controlling too much, but setting a framework for managers to work within. Regulation on the other hand is enforced usually by a regulatory agency mandated to carry out the provisions of a legislation. However, there can be a downside where intensive regulation can be inefficient. Regulations need to be well-designed to avoid over-regulation. Breach of both regulation and corporate governance code will result in severe implications and actions will be taken by the authorities on the matter.

Corporate governance exerts positive effects on performance as the practices play a crucial role in company functioning and shareholder protection. Importantly, interaction effects the strength of regulations and the companies’ corporate governance practices. Corporate governance cannot substitute regulation and vice versa. Every organisation needs both to ensure sustainability. It is believed that flexibility provided by adopting the codes is the strength of corporate governance and regulations help to enhance it. Finally, both works together to protect shareholders, creditors and consumers.