Transparency and its importance in corporate governance, case study of Enron
Organization leaders are charged with duties and responsibilities of emphasizing on transparency, integrity and honesty in the course of executing operations of management. The adoption of policies of this nature leads to prosperity while minimizing scandals which may ruin the confidence of stakeholders. The objectives of corporate governance in the organization are the increase in the level of transparency and this is important for organizations such as ENRON. However, the issue of transparency has been controversial. Most people are for the opinion that an extremely high level of transparency may become unambiguously good the the health of the organization. From the perspective of corporate governance, the high increase in transparency is associated with costs and also benefits at the same time. This brings about an optimal level above which an extra increase in transparency would culminate to low profits. Transparency plays a very crucial role in risk assessment for organizations such as ENRON. Through positive disclosure together with transparency, good governance in organizations is achieved. They lead to the demonstration of information quality in addition to reliability of financial and non- financial that the management should provide to the lenders, the shareholders and the general public (Bryce, 2008)
According to empirical evidence, high transparency rates significantly impacts on costs of capital. The supply of information in a reliable and timely manner results to a great level of confidence of important decision makers in the organization. This results to the formulation of good decisions for the interest of the business with a direct effect on the level of profitability and the general growth. The proper supply of needed information also influences decision makers from external of the entity. This means that the investors, the lenders and the shareholders are able to decide the risks that are associated with their ventures. In an organisation such as ENRON, the information that is provided is a good indicator to decision makers together with the outside interests of the extent that the organization has been able to comply with the legal requirements. Disclosure is very important to the understanding of the public about the activities of the company, their policies as well as performance in consideration of the environmental as well as the ethical standards in addition to the relationships that they have been able to develop with the communities around where the organization operates (Cruver, 2003).
Corporate governance practices in Enron case and the guidance in combine code of corporate governance
Corporate governance practices in Enron were associated with financial statements that were not transparent and therefore failed to account for the operations as well as the finances in as far as the shareholders and the analysts were concerned. The practices of corporate governance were also marked complex models of business in addition to unethical practices that led to the adoption accounting limitations in an attempt of misrepresenting the earnings together with modification of the balance sheet aimed at portraying performance depictions in a favourable way.
The scandals facing Enron were attributed to the steady accumulation of the values, habits as well as actions that arose way back and then proliferated beyond controllable levels. The primary motivations in the accounting along with the financial transactions at Enron were geared towards keeping of the reported income together with the reported cash flow at high levels, inflating the asset values together with off-booking the liabilities. All these issues combined contributed to the bankrupsy of Enron. Most of the problems were perpetuated by the executives of the company.
The compensation structure that was set in Enron together with the system of performance management was designed in a manner that could attract and retain the employees who were quite resourceful to the company. However the system setup also played a significant role in the dysfunctioning of the corporate culture in the organization. The setup had been infatuated with a short term focus of earnings for the purpose of maximizing on bonuses. The employees perceived at deals of high start volume while they disregarded the cash flow and profits quality for the purpose of coming at higher rating in the course of performance overview. Further to this there was an immediate recording of accounting results so that to be at par with the stock prices of the company. The intention of this practice was to cover the deal makers together with the executives who were given significantly huge cash bonuses in addition to stock options (Bryce, 2008).
The principle focus of the company was the stock prices with an extensive compensation of the management through the use of the stock prices. This led to the creation of expectations by the management which indicated rapid growth with the intentions of showing the appearance that the earnings reports would meet the expectations of Wall Street.
Before the fall of the company the tools of financial risk management that were applicable were seen to be appropriate. The issue of risk management in the company was seen to be very important based on the nature of regulatory environment that it operated under coupled with the business plan of the company. Commitments of long term nature had been established at Enron that required significant hedging for appropriate preparation for fluctuation which was inevitable in future due to the energy prices. The downfall of the company was attributed to the recklessness with regard to the application of derivatives together with the special purpose entities.
Through the hedging of the risks with the inherent special purpose entities, the company was in a position of retaining the risks that were allied to its transactions.
It was difficult to hide the aggressive practices of accounting at the company from board of directors. Although some of the improper practices of accounting were never known to the board, all the practices relied on the decisions that were deliberated by the board. In spite of the fact of extensive reliance on the use of derivatives in the company to transact its businesses, the Finance Committee of the company together with the board lacked a comprehensive background of the derivatives to understand what was actually communicated to them. If the board had gained a clear insight of the actual organization of the derivatives, then it could have been possible to prevent their use (Collins, 2006).
In the context of economics, principal-agent problem has the implication of the difficulties that surrounds existing conditions associated with information that is incomplete in addition to being asymmetric at the time that an agent has been hired by the principle. There arises a need for the application of a variety of mechanisms in the course of aligning the interests of the two parties. The mechanisms have a link to attempts of motivating the agent towards the directions of meeting the needs of the principal. Such mechanisms may include offers of commissions or rates, sharing of profits, provision of efficient wages, posting of a bond by the agent, fear of being fired among others. The principal agent problem prevails in the situation of a relationship of an employee to the employer. A good example is the situation that stakeholders in corporations hire their top executives (Cruver, 2003).
Agency Theory Basic idea (P: Principal, A: Agent)
The issues of the principal-agent problem revolve around motivation of one of the parties to work for the interest of the other party. The compensation made by the principal to the agent for the purpose of encouraging the agent towards performing specific acts that will be beneficial to the principal while they are of cost to the agent is the core element of the principal agent theory. Some performance elements whose observation is costly are the duty of the agent but the beneficiary is the principal. This case applies to majority of the contracts that are agreed upon in the context of uncertainty, risk and information asymmetry (Cruver, 2003).
Importance of governance disclosure and what a company should disclose.
The senior executives in an organization have a duty of conducting themselves in honest and ethical manner particularly with regard to conflicting interests coupled with disclosure of financial reports. It is the duty of organizations to make clarifications of the roles together with the responsibilities of the board as well as the management so that the shareholders are provided with a significant level of responsibility and accountability. They are also supposed to implement some procedures while verifying independently along with safeguarding the integrity of financial reporting in the company. Disclosing the material matters relevant to the company should be done in a timely and balanced approach such that all interested investors conveniently accesses the factual information relating to the company (Collins, 2006).
Therefore the securities reports should disclose the following:
The shares that are held by the company for strategic purposes and the issues amounts on latest balance.
The amount of shares that are held by the company to achieve the realization capital gains
The role of corporate social responsibility and ethics in organisations
Corporate social responsibility applies to corporations across the board but corporations such as Enron whose businesses forge a naturally close interaction with the community are at an even greater need to form a relationship that builds upon their business. In modern way of doing business, the manner in which the affairs of businesses are run needs to take into consideration the thoughts, perceptions and aspirations of the societies in which they operate. The mage the public gets about a company or how the public perceives a corporation plays a major role in the success of a business because the consumers of the businesses’ products are the people. The politics between people and corporations determine success or failure and for this reason, the corporations need to build an image that makes them appear to be friendly neighbours of the community so to speak. Corporate social responsibility can therefore be defined as the policies or steps that a corporation takes to give back or to improve the communities in which they do business (Dharan & William, 2004).
The need for internal controls and risk management.
Internal controls and risk management in any organization are important features in any organization and they contribute significantly to the corporate governance of the institution. They also enhance the structure of internal control, the analysis of risk management and the process of financial reporting. The contributions of the editors in most organizations are to provide the services of consultancy together with assurance to the managers such that their companies are able to comply with the existing regulations. The resources of internal audit have in the past undergone expansion for the purpose of giving satisfaction to the high level of demand for the services in an attempt of assisting in the process of executive certifications with regard to internal controls together with financial reports (Collins, 2006).
Importance of cash flow information for both internal and external decisions.
The cash flow information, also called the cash flow statement, statement of cash flows or funds flow statement, is used in financial accounting is used as an indicator of the effects in cash and cash equivalents in the balance sheet accounts as well as income. It also breaks the analysis of operations, investments and the financing activities. It is ideally takes account of the cash flow in and out of the organization. The statement also serves in the capturing of the current results of operation together with the changes that are accompanied with the operations in as far as the balance sheet is concerned. Cash flow information is an important analytical tool for the purpose of the determination of the company’s viability on the short term and more so the ability of the company with regard to the payment of bills.
Importance of cash flow information for internal and external decision is to supply the needed information concerning the company’s financial position, the current performance together with the changes of the enterprise financial position. This information is essential for economic decision making for a wide array of users. For this reason, it is important to come up with cash flow information that can be easily understood and also relevant, comparable as well as reliable. It should reflect all the reported assets, equity, liabilities, expenses as well as incomes all having a close link to the financial position of the company (Collins, 2006).
The information should be understood by all readers who are equipped with reasonable business knowledge together with the economic activities and accounting with a positive will of analyzing the information in a diligent manner.
External and internal user needs which are satisfied by cash flow reporting
Cash flow reporting is needed by the owners and the managers of the organization for the purpose of making important decisions relating to their business. These decisions pose some significant effects on the continuation of the operations of the business. He cash flow reporting is then used during financial analysis to give the management a deep understanding of the figures reflected in the reports. The statements are also needed during the preparation of the annual reports by the management to be presented to the stockholders (Collins, 2006).
The employees of the company also require the use of these reports at the time that they make their agreements of collective bargaining with the company’s management. The labour unions and individual employees apply the reports to negotiate their promotion and compensation.
The reports are also used by prospective investors during their assessment of the viability of their intended investments in the company. The decisions for their investments are made after careful consideration of the reports that have been presented to them by professionals.
The reports are also resourceful to the financial institutions such as banks and the lending institutions. The decision of granting a company some working capital or extend the securities of debt and the expansion of finance solely depends on the reliability of the reports. The vendors who give some credit to the company also rely on the statements for the purpose of assessing the company’s creditworthiness. The media along with the general public have some interests in the reports for varied reasons (Collins, 2006).
The tax authorities in government also make use of these reports. They form the basis of determining the propriety together with the level of accuracy of taxes together with other related duties that have been declared payable from the company.
Is current cash flow information adequate for the above needs?
The current cash flow information adequate for the above needs is exposed with some loopholes. This is indicated by the fact that there is all possibilities that the reductions in equity account will lack a direct effect on the cash flow of Enron. However, there is also a possibility that the financial flexibility of the company may be impaired as a result of the decline in the equity value at Enron. The company is therefore left with the option of depending on debt to meet its future needs of finances. the financial flexibility of the company has continued to be on the decline leading to potential tracing of the confidence of the investor.
Bryce, R., 2008, Pipe Dreams: Greed, Ego, and the Death of Enron. PublicAffairs.
Collins, D., 2006, Behaving Badly: Ethical Lessons from Enron. Dog Ear Publishing, LLC.
Cruver, B., 2003, Anatomy of Greed: Telling the Unshredded Truth from Inside Enron. Basic Books.
Dharan, B. & William R. B., 2004, Enron: Corporate Fiascos and Their Implications. Foundation Press.