Corporate Governance and Responsibility Foundations of Market Integrity

CORPORATE GOVERNANCE Spotlight OECD principles Corporate governance and responsibility Foundations of market integrity Bill Witherell, Head, OECD Directorate for Financial, Fiscal and Enterprise Affairs © Getty Images Good governance goes he recent spate of US corporate investment assessments followed by a sharp beyond common sense. It is failures and breakdowns in truthful market correction that spelt the end for a key part of the contract Taccounting has undermined people’s thousands of high-tech wannabes. Still, it is faith in financial reporting, corporate difficult to disentangle the negative effects that underpins economic leadership, and the integrity of markets the these two parallel developments have had on growth in a market economy world over. The fact that the wave of the confidence of investors. scandals has come hot on the heels of a and public faith in that collapse in the high-tech bubble has a sharp With the bursting of the high-tech bubble, system. The OECD ironic flavour. Both events have their roots in share values were written down and venture Principles of Corporate the heady days of stock market exuberance, capitalists took a bruising, as did many when anything was possible, from creating shareholders. That is the downside of Governance and Guidelines multibillion dollar companies with little committing resources to investments with a for Multinational more than an idea, an investment angel and high risk/high reward profile. But in the cases Enterprises are two a lot of faith, to believing that markets would of corporate misbehaviour, the public, buy any yarn a group of fast-talking employees and pensioners were deliberately essential instruments for executives could spin, even if to cover up misled. They have now lost many billions of ensuring that this contract serious losses and illegal practices. The dollars, and in some cases their life savings, corporate scandals and the bursting bubble while some insiders benefited. The truly is honoured. have different causes though: on the one unfortunate part is that both events might in hand, illicit management decisions and their own way have been avoided (or at least cover-ups, and on the other, over-bloated anticipated) if effective corporate governance Observer No. 234 October 2002 7 CORPORATE GOVERNANCE OECD principles Spotlight and high levels of corporate responsibility constantly under scrutiny and must remain achieving effective implementation in the had been respected. so. Some private pension funds, for dynamic markets of the 21st century. instance, have recently been informing their The role of good governance and corporate pensioners of the prospect of reduced Corporate structures change fast, while responsibility in helping to assure the payments, due to falling stocks. If market financial innovation and globalisation all well-functioning markets needed for risk and cycles were the only cause behind present new challenges to maintaining economic growth and development cannot these announcements, that would be fine. good corporate governance. The recent be taken for granted. This idea has been The stakeholder public would probably live high-profile cases of governance failure and repeated by government and business leaders with that, and anyway, the market provides corporate misconduct have shown that the world over, and most recently reaffirmed other instruments for customers to invest in, corporate governance mechanisms sometimes at summits from Doha to Johannesburg. But like property or long-term bonds. But to the have not kept up with these developments. we are falling short: the systems may be there extent that the market’s fall can be traced to – the US had, on paper, one of the best – but scandals and breaches of trust, public The OECD principles already highlight that evidently they have not worked. Fixing them support wanes and the market becomes an annual audit of accounts be conducted by will require both private initiatives and unworkable. The state’s reputation is also “an independent auditor in order to provide strong government action. at stake. an external and objective assurance on the way in which financial statements have been Good corporate governance – the rules and This underscores a widespread public – and prepared and presented”. The principle is practices that govern the relationship between hence political – interest in reinforcing there, but as we have seen recently, it was not the managers and shareholders of corporate governance practices. Such always heeded. Governments, security corporations, as well as stakeholders like concerns become even more important in market regulators and the private sector itself employees, pensioners and local communities are all taking steps to strengthen the – ensures transparency, fairness and implementation of this principle. accountability. It is a prerequisite for the We need to develop governance integrity and credibility of market institutions. tools and incentive structures Nor have company boards lived up to their By building confidence and trust, good that are more robust in the face responsibilities. For instance, the OECD governance allows the corporation to have of rapid financial innovation, principles recommend that the board access to external finance and to make reliable and procedures that leave no “monitors and manages potential conflicts of commitments to creditors, employees and doubt as to the stakes involved. interest of management, board members and shareholders. It is this contract that underpins shareholders, including misuse of corporate economic growth in a market economy. Accounting standards need to assets and abuse in related party become principle-based, rather transactions”. There is obviously a gap When this trust is undermined, lenders and than being based on rules that between risk management practices by investors lose their appetite for risk, and invite evasion. corporations and investors and the existing shareholders offload their equity, resulting in tools for disclosing, accounting for and lost value and reduced availability of capital. controlling risk. And monitoring is not easy, This goes for every stage of the investment since the conflicts of interest that have been process, affecting issues from property an international context where the full identified extend beyond the corporations protection and ownership registration, to benefits of free capital flows will only be themselves to financial analysts, rating disclosure and the distribution of authority realised if there is a mutual understanding agencies and financial institutions. In other and responsibility among company organs. on the basic elements of good corporate words, who can we trust? We need to governance. These are the core concerns develop governance tools and incentive Clearly, the importance of good corporate that triggered and nurtured the discussions structures that are more robust in the face of governance goes far beyond the interests of on corporate governance in OECD rapid financial innovation, and procedures shareholders in an individual company. countries, leading to the development of that leave no doubt as to the stakes involved. Indeed, the central corporate governance the OECD Principles of Corporate Accounting standards need to become principles of transparency and accountability Governance. These principles, that have principle-based, rather than being based on are crucial to the integrity and legal received OECD ministerial backing, form rules that invite evasion. credibility of our market system. We already the basis of a true global standard in trust corporations to create jobs, generate tax corporate governance. But while details and principles may be revenues and provide markets with goods strengthened on paper, they will serve little and services. Increasingly we make use of In the light of recent developments, OECD purpose without the political commitment to private sector institutions to manage our ministers have called for an assessment of abide by them. The aim is to reinforce the savings and secure our retirement income. these principles. The basic ideas enshrined in contracts of trust that drive our market the principles are not being questioned, but democracies; governments as custodians Private participation in delivering these there evidently is a need to provide further must take a lead in ensuring these contracts services has been proven to work, but it is guidance, particularly with respect to are not only understood, but honoured too. 8 Observer No. 234 October 2002 CORPORATE GOVERNANCE Spotlight OECD principles Responsibility End of an affair? Corporate managers’ responsibilities, of An opinion poll in BusinessWeek magazine shows half of the US believing that what is good for business is not necessarily good for their country. Hardly surprising, you might think – course, are not limited to producing truthful except that the poll was carried out over two years ago, before the high-tech bubble burst financial reporting, carrying out the core and well before the recent corporate scandals. And the fact that the opinion poll was in one functions of conducting business and of the US’s main pro-business magazines meant that the results simply had to be taken obeying the various applicable laws. seriously. Businesses also have to respond to the expectations of the democratic societies in They were also quite unexpected. The BusinessWeek poll was wide-ranging, with which they operate – expectations that often respondents asked to agree or disagree

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