Risk & Compliance

The Global Effect on Governance

Why CFOs need to pay attention to boardroom pressures occurring abroad.
Theodore Roosevelt MallochAugust 25, 2011

In recent years, a plethora of laws, rules, and cases has made companies and their senior executives, especially CFOs, more accountable for the manner in which they manage their organizations. The spread of higher standards for corporate governance can be seen worldwide, from the passage of Dodd-Frank legislation in the United States to promulgation of the Cadbury Report and similar guidance in the United Kingdom.

Illegality concerns at Rupert Murdoch’s News Corp., the Red Cross’s potential mishandling of the 9/11 funds, the government’s mismanagement of the relief efforts after Hurricanes Katrina and Rita, and the United Nations’s missteps of the Oil for Food Program in Iraq all highlight the ubiquity of concerns for governance and transparency in recent years.

Higher standards for governance across sectors and new reform-minded legislation bring increasing responsibility and liability, something CFOs must be cognizant of and ahead of the curve on as both officers and directors. Their companies’ corporate governance could be even more influenced by pressures and changes that are occurring outside the United States.

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As a result of the process of globalization, recent trends have spread. These include an increased emphasis on shareholder value and corporate responsibility, a growing perception of the need for independent directors and committees, and the need for better disclosure of relevant financial information.

Some recent developments that have added impetus to the corporate-governance movement include globalization itself. Action at a distance requires a high level of reliability and transparency, increasing competition for investment funding for all sectors. This increases requirements for performance and assessment, and for improved standards of productivity and service in lead organizations.

Increasingly, boards, CEOs, and CFOs are also adapting to the new cry for corporate (social) responsibility. Those who take a lead in setting high standards for themselves are gaining respect and value for their enterprises and organizations. But first they need to examine what corporate governance is supposed to achieve. The corporation is a separate legal entity with a pool of assets that do not belong to any particular constituents. These assets are not the property of those making the decisions. Corporate decisions regarding the use of such assets must be placed in a larger context. In the United States and in Europe, boards tend to focus on the principal-agent problem and to assume that directors should serve shareholder interests while producing outcomes for those served.

In some other countries, broader social interests are often recognized. And given globalization, these other issues may begin to have an impact in the United States as well. U.S. CFOs may assume that widely spread ownership means weak monitoring. However, the mobility of capital in companies protects minority shareholders by enabling them to divest easily. This is not the case to the same extent everywhere in Europe or Asia. In other countries, organizations have traditionally had large shareholders actively involved in monitoring so that shareholder protection seems less urgent than it does here.

Many recent studies show that convergence over governance principles similar to that in the United States and the United Kingdom will occur elsewhere. There are significant differences in legal systems, ownership patterns, and social/political systems. But there appears to be some convergence of functions — e.g., in transparency, oversight, and an objective audit process. Increasingly, the focus is on substance, not form — specifically protection of investors, donors, or taxpayers within the context of local traditions. U.S. institutions will continue to play a dominant role in shaping these emerging global-governance standards.

Accountability and risk management are part of the reason governance has become such a concern around the world. Several factors raise the requirements for accountability and management of risk. First, foreign direct investment is now much more volatile, and directors must become more aware of ways to minimize the associated risks. Second, corporations throughout the world rely increasingly on global equity financing, rather than on bank loans and retained earnings. Third, corporations are increasingly subject to pressures from institutional investors.

Moreover, there are significant differences between the U.S. and the European liability systems. The continental model appears to be moving at least to some extent in the direction of the Anglo-Saxon model. One question is whether the legal liability system will also evolve in a similar direction. It would be logical to argue that there will be some such evolution, on the basis that, if continental shareholders are demanding new rights, they will also demand new remedies. Will they go the way of the United States, where aggrieved shareholders may file class and derivative actions against directors alleging fraud and mismanagement?

CFOs need to be vigilant about the constant shifting and new demands brought by corporate governance in the United States and abroad. This is a trend going in only one direction. Ignore it at your own peril.

Theodore Roosevelt Malloch is a research professor at Yale University. The author of Doing Virtuous Business (Nelson 2011), he is CEO of The Roosevelt Group, a leading strategy firm on business ethics, corporate governance, and fiduciary responsibility.

 

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