Thursday, December 29, 2011

Enterprise Governance – A Good and Bad Corporate Governance

 

Despite a proliferation of material, there is still much confusion surrounding this subject. Put in its simplest form, corporate governance is the systems and processes put in place to direct and control an organisation in order to increase performance and achieve sustainable shareholder value. As such, it concerns the effectiveness of management structures, including the role of directors, the sufficiency and reliability of corporate reporting, and the effectiveness of risk management systems.1 Where the confusion arises, however, is that corporate governance appears to embrace everything from budgeting to internal auditing, the role of non-executive directors to business ethics. It is very difficult therefore for finance professionals to define their changing responsibilities and ensure they are doing what is now expected of them.

In a joint in-depth survey of more than 300 CFOs and senior finance executives by CFO Research and Ernst & Young, nearly three-quarters ofrespondents said that better decision support was the main reason for improving their finance systems. Only half cited the need for better regulatory compliance.

In order to achieve good corporate governance a company must adopt a clear stance on each of the following:

• strategy

• stewardship

• corporate culture

• corporate reporting

• IT systems

• board operation.

There is plenty of evidence to show that if those pieces of the corporate governance jigsaw are not put together properly, the effectiveness of risk management systems across an organisation will prove inadequate.

The Good, the Bad and the Ugly - Examples of Corporate Governance

The Good: Unilever2

Unilever is one of the world's largest packaged consumer goods companies with more than 700 brands in its portfolio. Owned by Netherlands-based Unilever and

UK-based Unilever Plc, it operates as a single company, linked by equalisation agreements, which regulate the mutual rights of respective shareholders.

The company has grown to become a dominant force in the food, home and personal care markets, and is not only one of the largest ice-cream manufacturers, and the biggest producer of packet tea, but a world leader in deodorants, anti-perspirants and skin cleansers. It also operates a prestige fragrance business boasting designer brands to include Obsession, Eternity, CK One and CK Be.

It has made an impressive series of sales and acquisitions over the past ten years, to rationalise its operations and focus on core brands. Sales of these brands grew by more than 5 per cent in 2002. The company also took a number of its traditional brands into new markets.

As an organisation divided into two companies operating under two different sets of financial reporting regulations, there are obvious anomalies in corporate governance requirements. For example, the supervisory board as recognised in Holland is not known in the UK, neither are non-executive directors recognised in the Netherlands.

However, Unilever has created a governance structure often held up as an example of best practice. Advisory directors, as required under Dutch reporting regulations, act as non-executive directors, chosen for their broad experi­ence for an initial period of three to four years. All appointments and re-appointments are based on the recommendations of a Nomination Committee.

Board committees are divided into an executive, audit, corporate risk, external affairs, corporate relations, nomina­tion, remuneration and routine business committees.

Directors' service contracts, under Unilever's Articles of Association require all directors to retire from office at every AGM. Directors are expected to retire by their 62nd birthday.

 

The Good: General Electric3

In 2002, GE was ranked the world's second most admired company in the Fortune 500. Not only highly regarded for its financial services, GE is also involved in engineering, broadcast media, power generation and medical imaging.

Its good standard of governance has no doubt helped keep its stocks at such consistently high levels and contributed to its continued brand strength. When in 2002, the company faced intense investor scrutiny over earnings from its financial services operation, GE Capital, it resolved the situation by dividing GE Capital into commercial finance, consumer finance, equipment manage­ment and insurance. In the same year, GE also announced plans to further strengthen its governance standards to serve the long-term interests of its stakeholders.

The Bad: HIH

The problematic aspects of the corporate culture of HIH can be summarised succinctly. There was blind faith in a leadership that was ill equipped for the task. There was insufficient ability and independence of mind in and associated with the organisation to see what had to be done, and what had to be stopped or avoided. Risks were not properly identified and managed. Unpleasant informa­tion was hidden, filtered or sanitised. And there was a lack of sceptical questioning and analysis when and where it mattered.

(Royal Commission on the collapse of the Australian insurance company HIH)4


The Ugly: Boeing5

In December 2003, Boeing, one ofthe world's most famous aerospace companies, found itselfcaught up in a scandal that was to see its CFO sacked and its CEO resign - albeit not as a 'direct consequence' of the scandal.

The scandal followed investigations by a number of military and civilian departments into allegations that Boeing acted improperly in the $18bn sale of 100 Boeing 767 tankers to the United States Air Force (USAF).

The firm had already been rocked by a similar 'unethical practices' scandal involving the possession of documents belonging to rival Lockheed Martin during bidding for a military rocket-launch contract in 1998. As a result of the allegation the Pentagon subsequently suspended Boeing from bidding on future rocket contracts pending a review of its practices. Lockheed Martin sued Boeing for alleged theft.

Alleged accounting irregularities surrounding the acqui­sition of McDonnell Douglas cost the company $92.5m after shareholders accused the then CEO Phil Condit of using accounting tricks to massage the company's financial health. In 2003, Boeing paid out more than $1bn in deal-related write-offs.

Alleged Unethical Practice

In February 2001, Boeing, already feeling the corporate pinch, bid to supply the USAF with re-engineered 767s for a price tag of $124.5m each. Although the proposition was initially well received, research later showed that the air force did not need any new tankers until 2010.

The terrorist attacks of September 11 brought about more financial misery for Boeing as airlines worldwide reduced the number of flights. Shortly after the world-stopping events, Boeing laid off around 30 per cent of its commercial aviation workforce. By 2002, it had also scrapped plans for a new faster, smaller long-range aircraft - the Sonic Cruiser.

A short-lived turnaround followed, with the announce­ment of a $9bn deal to supply Ryanair with 100 new aircraft, and a $9.7bn deal with the USAF for transport aircraft. However, the run of good luck was brought to a halt when strike action threatened to halt production.

But in 2003, the Washington Post broke an article alleging that Boeing executives had met with USAF official Darleen Druyun, who, it was alleged, had provided bid details to Boeing. It was also alleged that she suggested ways of finding the money to fund the deal through a leasing agreement.

Druyun then entered discussion to join Boeing in October 2002, but continued to work on the deal for the USAF until November. She then officially joined Boeing in early 2003. Following the story, Boeing publicly defended itself, publishing a number of articles in leading US newspaper titles. But the scandal still persisted.

According to a Wall Street Journal report, Boeing had committed $20m to Trieme Partners, a firm set up by Richard Perle, a key political ally of the Pentagon's right-wing leadership, who had long supported the Boeing/ USAF deal. It was alleged that articles written by him supporting the deal were ghost written, as were a number of other articles by leading military figures, who later became Boeing consultants.

As the scandal deepened, CEO Condit fired his CFO Michael Sears. Druyun was the next to go. Condit's resignation was alleged not to be 'related to the scandal', but opinion to the contrary persists.

Former vice-chairman of the Boeing board, Harry Stonecipher, came out of retirement to replace Condit in

December 2003. He maintained that in spite of the controversy the tanker deal would remain on the table.

Market Position

In 2002, commercial aircraft accounted for 52 per cent of Boeing's sales. By 2003, its 70 per cent market share had dropped to 50 per cent with fewer than 300 planes delivered. Boeing spent more than 10 to 20 per cent more on building costs than its main rival Airbus.

Shortly before Thanksgiving 2003, aircraft manufacturer Boeing fired CFO Michael Sears and vice-president Darleen A. Druyun after an internal investigation alleged that Sears personally lobbied to hire Druyun in late 2002 while she worked for the Air Force - with whom Boeing was negotiating a $21 billion contract. A week later, Boeing CEO Phil Condit resigned as well, just as book reviewers received their copies of Soaring Through Turbulence: A New Model for Managers Who Want to Succeed in a Changing Business World - a primer on ethical business management by former Boeing CFO Michael Sears.6

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