Ernst & Young Corruption Survey Results

Ernst and Young surveyed over 3,000 employees from 36 countries in Europe, the Middle East, Africa and India and found that a large percentage are aware of fraud in their organizations. The percentage admitting they knew of fraud seems to increase as you move up the management ladder of the organization. For example, 42% of board members and senior managers admitted to knowing about financial reporting irregularities. Apparently they admitted that either sales or costs had been manipulated...

Before you're tempted to dismiss this as due to corruption in the under developed nations, it turns out that while the rates are much higher in the third world, even highly developed countries in Europe report significant amounts of fraud (including financial reporting fraud) is going on in their companies. My guess is that the US is probably not as good as the best European nations

So much for fairly stated financial statements, not to mention, bribery and other forms of corruption...

Great follow-up on yesterday's post...

The Board of Directors Club

I have been thinking about corporate governance and the role of the board of directors a great deal lately. My thoughts keep coming back to this post at the Harvard Law School Corporate Governance Blog. The post discusses a recent study on the appointment of CEOs as outside directors. Among other things, the study finds that, "The appointment of a CEO outside director helps certify the appointing company and its management, but it does not lead to measurable improvements in operating performance or corporate policies." Still, even though CEO directors add little (or nothing) to the corporate governance environment of the boards that they sit on, they are still highly sought after by firms.

We have recently posted on the need to get rid of moonlighters, and the shortage of truly independent directors. A host of other issues, such as executive compensation, would be reduced or perhaps solved by stronger governance from directors. So what needs to change in order to strengthen the governance of the board?

Perhaps one way we could improve upon our current situation is to increase the consequences of negligence. Ideally, stricter penalties for a failure in oversight would weed out directors who are not adding value to the corporation on behalf of the shareholders. Although firms may need to look outside of the 'club' for independent directors, the resulting increase in independence and oversight would go a long way toward reducing the occurrence of fraud.

The buck stops here: The Board of Directors

Corporate governance has long been a concern when massive corporate frauds come to light. Today, Boards of Directors are being criticized for their role in the subprime crisis. Ultimately, the Board is the highest level of control that can prevent or detect corporate malfeasance--whether it be fraud or other illegal business practices. An article in The New Yorker discusses the current state of corporate governance and suggests that Boards need to be much more than moonlighting opportunities for the CEO's friends. The article concludes by saying:

Right now, boards are made up of moonlighters. And, if the last few years have shown anything, it’s that protecting shareholder interests is a full-time job.

Directors and Corporate Governance

I wonder how many frauds could have been prevented if board members had been more active in protecting the interests of shareholders. While most, if not all, recognize the need for a strong, independent board, I don't know that our current system encourages board members to actively pursue shareholder interests.

My personal (anecdotal) experience with directors is that most boards seems to be comprised in a manner similar to the following example:

• Chairman of the Board (usually either the current or former CEO of A Corp.)
• Several other C-level executives and a few VPs from A Corp.
  
• "Independent" directors who are executives at B, C, and D Corps., where the CEO of A Corp. is also an "independent" director
• Enough additional independent directors to meet independence and expertise requirements
  

Most of these individuals seem to be inclined toward favoring management over the shareholders. In such a situation, I doubt that the remaining independent directors have enough influence over the board to adequately represent the shareholders. We can continue to stress the importance of corporate governance, but until we see more independence among board members, said governance will be flawed and will continue to be a weak deterrent to fraud.