Financial engineering Essay Example

business strategy, although the board of directors is responsible for making strategic decisions.

Shareholder

A shareholder, also referred to as a stockholder, is an individual who possesses shares in a company. These shares can be owned directly by the shareholder or held on their behalf by a nominee. In the United States, these shares are commonly known as "stock". Corporate governance plays a vital role in large public firms where there exists a clear distinction between ownership and management, particularly when compared to small private companies. Institutional investors typically hold diversified portfolios that encompass various investments, including shares. The safety of their investment is paramount to investors, meaning that any concerns regarding the integrity or intentions of a company's leader can impact the value of its shares and impede its ability to raise new capital.

Insufficient corporate governance in certain countries poses difficulties in attracting foreign investment. The significance of effective corporate governance in bolstering capital markets is widely acknowledged. However, the push for implementing better practices and enforcing stricter regulations has primarily stemmed from scandals and setbacks resulting from inadequate corporate governance. Consequently, these occurrences have led to decreased share prices of companies and overall underperformance of stock markets.

Stakeholders In A Company

A stakeholder in a company refers to someone who has an interest or 'stake' in the company and is impacted by its actions. Each stakeholder or stakeholder group has specific expectations regarding the behavior and actions of the company. They can also anticipate having some influence over the decisions and actions taken by the company. The distribution of power among various stakeholder groups and how it is exercised are

crucial elements in corporate governance. In the case of a public company, there are multiple stakeholder groups, including its members or equity shareholders who are the owners.

In small companies, the owners often serve as directors. In contrast, directors in large public companies may own some shares but are not usually the largest shareholders. Shareholders in such cases prioritize share value and dividends, but they have limited authority and rely on the board of directors to act in their best interest. However, this dynamic shifts when there is a majority shareholder or significant stakeholder.

A dominant shareholder possesses the ability to exert influence over company decisions by controlling the board of directors. In situations where a majority shareholder exists, the concerns and interests of minority shareholders might be disregarded. The board of directors bears the responsibility of providing guidance for the company and entrusts most executive powers to the Managing Director. Nevertheless, specific decision-making authorities, such as securing funding, distributing dividends, and making substantial investments, remain under the jurisdiction of the board.

The performance of executive management is accountable to the board, which comprises both executives and non-executives. Executive directors simultaneously hold positions in the company's executive management and serve as directors. Non-executive members solely fulfill director duties without any executive responsibilities. Unlike non-executives, executive directors are fully paid employees who often receive performance bonuses, leading to potential differences in interests.

The board consists of members with distinct interests and objectives. Certain individuals, like the chairperson and CEO, hold more power and authority in making decisions for the board. Whether they are non-executive or executive, the chairperson is responsible for overseeing the board's operations.

The

CEO, also known as the Managing Director, is the top executive who reports to the company's board of executive management. While it was originally used in the US, both 'CEO' and 'managing director' are now commonly used terms in the UK. Executive directors typically prioritize power, authority, a high salary, and a luxurious lifestyle. In future organizational structures, "independent" non-executive directors who have no ties to management or significant shareholders will offer unbiased viewpoints during board discussions.

Management is accountable to the board of directors (and specifically the CEO) for the operation of the business. Like executive directors, individual managers may desire power, status, and high compensation. As employees, they view their stake in a company in terms of career development and income. Employees have a stake in their company because it offers them employment and income. They also have expectations regarding what their company should provide for them, such as job security, fair compensation, and suitable working conditions.

Employment law safeguards specific rights of employees, although their authority is generally restricted. Lenders and other creditors possess an indirect concern in a company as they anticipate receiving the payments owed to them. If these lenders have a longstanding business association with the company, they will anticipate the company's compliance with their contractual obligations. In case of insolvency, unpaid creditors may assume a more significant role in governing the company, contingent upon the country's insolvency laws. This might entail pursuing legal measures to obtain control over the business or its assets.

Investment institutions, like insures and pension funds, exert influence over publicly traded companies in the stock market. Their objective is to coordinate their members' actions,

including voting for particular resolutions during annual general meetings of the companies they have shares in. These organizations represent the collective opinions of the investment community.

Large companies have stakeholders beyond just their own employees and investors. The general public is one such stakeholder group as they rely on the goods or services provided by companies to support their daily lives. For instance, households depend on utility companies for an uninterrupted supply of water, electricity, or gas to their homes. Additionally, they expect reliable and convenient transport services at a fair price for commuting to and from work. Pressure groups like environmental protection organizations also attempt to influence the decision-making process of companies.

Key Objectives In Cooperate Government

Corporate governance involves addressing the challenge of balancing the interests and demands of different stakeholders. Some stakeholder groups possess decision-making authority or can influence company decisions, while others depend on the managers, particularly directors, to act in their favor. Furthermore, conflicts of interest may emerge among various stakeholders.

Corporate governance involves a conflict of interests between the board of directors and other stakeholders. Employees may want higher salaries, but this could harm shareholders' dividends. This poses the question of whether directors should prioritize their personal interests over those of other stakeholders and how to prevent this.

The executive directors have a deeper understanding of the company's information system and ongoing activities. They also have the ability to control or modify information given to hardliners or employees, which could result in illegal actions like insider trading or market manipulation. These offenses are considered criminal under the Security Services Act. Shareholders rely on the board of directors

to effectively govern their company and prioritize their interests.

Investors commonly evaluate a company's performance by examining its annual report and financial statements. The data provided by the directors on behalf of the company greatly influences their investment decisions. The reliability of this data is contingent upon both the honesty of the directors and confirmation from auditors that the published financial statements correctly depict the company's profitability and financial status.

Why Corporate Governance Is Necessary

The principal-agent problem occurs when the interests of those in control of a company and those who provide external funding diverge. This issue arises from the separation of ownership and control, as well as the distinction between individuals within and outside the corporate realm. When governance is lacking, information imbalances and monitoring challenges leave capital providers, who lack control over the corporation, vulnerable to risks and high expenses when protecting against managers and controlling shareholders engaging in opportunistic behavior.

Corporate governance problems often arise from the connection between shareholders and the board of directors. Codes of conduct and best practice guidelines aim to resolve these issues by reducing conflicts, placing limitations on executive directors (particularly the CEO), and achieving a harmonious balance between the interests of both stakeholder groups.

Key Issues In Corporate Governance

The main focus of the debate on corporate governance is the conflicts or potential conflicts of interest between shareholders and the board of directors. These conflicts arise when directors prioritize risky decision-making to achieve short-term performance, while shareholders are primarily concerned with the company's long-term viability and their investment value. In case a company encounters financial difficulties, managers can easily switch to another company

while shareholders bear most of the financial losses.

Various aspects of corporate governance can give rise to conflicts of interest, such as financial reporting and auditing, director's remuneration, company-stakeholder relations, risk-taking, and effective communication between directors and shareholders. When directors engage in misleading financial statements and dishonest comments to conceal their company's true financial performance, it creates a conflict of interest. This behavior obstructs investors from making informed assessments about the company's financial condition.

During the late 1900s and early 2000s, the UK and US were concerned about inaccurate financial statements being published. This led to an increased demand for improved corporate governance. Many companies were found to have committed accounting irregularities, leading to stricter accounting standards. However, it is expected that some level of window dressing will persist. In the US, worries about financial reporting grew after the Enron scandal in 2001, where Enron intentionally manipulated its financial statements before going bankrupt.

Several US companies, including telecommunication group World, Global Crossing, and Rank Xerox, experienced similar problems such as accounting fraud. Additionally, Italian group Parallax faced issues at the end of 2003. A crucial corporate governance concern is determining the extent of directors' awareness regarding the potential collapse of their respective companies. If directors were indeed aware of these problems, shareholders should have been informed promptly.

When a company's annual financial statements are found to be misleading, concerns arise regarding the effectiveness of external auditors. Two key issues pertain to the external audit of a company. Firstly, should auditors be responsible for uncovering financial fraud and significant errors? Secondly, there is the issue of the relationship between a client company and its auditors, and the

degree to which auditors are independent and not influenced by the management of the client company.

The relationship between auditors and their client company can impact their objectivity, potentially resulting in the endorsement of a disputable accounting method that portrays the company's performance or financial status more favorably. The downfall of Arthur Anderson in 2002 serves as an illustration of compromised independence due to influential clients such as Enron. In South Africa, several cases of corporate misconduct have sparked worries over auditors neglecting their professional obligations.

South African listed companies must adhere to international Financial Reporting Standards (FIRS), including audits that follow international auditing standards. Directors have the ability to grant themselves substantial salaries and additional incentives, including bonuses, a lucrative pension plan, share options, and other perks. Institutional shareholders generally do not oppose generous compensation for directors, but they believe that the rewards should primarily be based on the company's performance and the advantages gained for shareholders.

When the company performs well, directors are rewarded, which is considered fair. However, when the company does poorly, directors may still receive high pay. The debate on directors' compensation has varied across countries in the past. In the KICK, these concerns resulted in the Greenberg Committee being formed in the 1 CSS, and the subsequent publication of the Greenberg report. Since then, director's remuneration has remained a contentious issue.

The Directors Remuneration Report Regulations were implemented in 2002, resulting in changes to UK company law. These regulations require listed companies to create an annual report on directors' remuneration. The purpose of this report is to allow shareholders to vote on both the report and the company's general

meeting. Within a company, the board of directors holds significant decision-making authority. There has been ongoing discussion in the field of corporate governance regarding how professional managers, who are part of the board, utilize their power for the benefit of shareholders and other stakeholders. This debate also considers whether limitations should be placed on directors' powers.

This section of corporate governance focuses on the structure of the board of directors and the role played by independent non-executive board members. It also examines the powers granted to shareholders under company law and debates whether these powers should be expanded through corporate law reform, such as giving shareholders authority over approving remuneration policies or board members' remuneration packages (see chapter 8 for more details). Additionally, it explores whether shareholders should fully utilize their existing powers, such as voting against re-electing directors. Risk management is another important aspect covered in corporate governance. Typically, investors expect higher returns when taking on greater business risks. If a company makes decisions that increase its level of risk, it is expected that profits and dividends will also increase. However, there is concern that company directors may prioritize profit growth without adequately considering associated risks. In certain cases, companies may continue operating without addressing the evolving risk profile of their current businesses.

When investors purchase shares in a company, they possess knowledge about the company's nature, business type, potential returns for shareholders, and its financial risks. Shareholders value both high returns and investment risks. Conversely, directors are rewarded based on the company's achieved returns, tied to profit or dividend growth. Their remuneration is not directly linked to the risk factors of their business.