The corporate scandals of the past two years have had a profound effect on the way companies do business – and on the attitudes of regulators and shareholders. Many important changes have already been made. But, says Jim Turley, it is essential that global standards on corporate governance converge in the interests of rebuilding investor confidence and ensuring better corporate behaviour
To look back on the regulatory and corporate governance debate of the past two years is to see a landscape transformed. Corporate calamities have prompted legislative change of unprecedented depth and breadth.
Today, more than at any time in our history, boardroom discussion is focused on issues of governance, accountability and disclosure; the voice of shareholder activism has never been louder and the focus of regulators and legislators perhaps never as intense. And, of course, media scrutiny remains sharp.
The questionable events of recent years have been a huge wake-up call for key players in the financial sector – including corporations, investment bankers, investors, governments, regulators, and the accounting and auditing profession. Speaking for Ernst & Young, these changes have had a profound effect on the way we do business.
We have clearly acknowledged the need for our profession to respond to these corporate collapses decisively and forcefully, as a means of contributing to the restoration of investor confidence.
We have elevated the role of quality and risk management to the global board. We have substantially increased technical and fraud training for our people, and added significant technical resources to work with our client-facing teams.
We have also tightened client acceptance and continuance criteria. We are actively managing the rotation of our audit partners and teams. And, in some instances, in response to the marketplace, we are limiting the scope of services we provide beyond levels required by the regulators.
While our firm has made considerable progress, our work is not done, and these issues will remain a focus in the future. There is work to be done in other areas as well. The case for the closer integration of capital markets in the global business environment of the 21st century is well documented.
However, the effective integration of capital markets remains hampered by legal, political and regulatory barriers, as well as the absence of a common financial reporting language.
Progress is being made in the convergence of accounting standards – and their auditing standards counterparts – and further convergence continues to be a priority of the standard setters. But, securities regulators and other lawmakers still need to make a concerted effort to harmonize regulatory frameworks before we see the effective integration of capital markets.
Regulators have been commendably swift and thorough in their response to the challenges of the recent past and are now making accommodations in the interests of global commonality. The US Securities and Exchange Commission has recognized the needs of corporations operating across borders in allowing some non-US businesses to abide by the spirit of the Sarbanes-Oxley Act without disrupting existing practices.
The US regulators have further stated their intent to partner with their counterparts outside the US to develop an effective, efficient and cooperative regulatory process.
In the UK, the Financial Reporting Council has refreshed its Combined Code, and, while its “comply or explain” regime is in contrast with the “comply or else… ” nature of the US provisions, there is common ground with Sarbanes-Oxley in the critical areas of internal controls and directors’ responsibilities to report publicly on their effectiveness.
These are positive developments, and we would encourage further cooperation among more regulatory agencies.
However it is also important to focus on the role corporate governance can play in restoring investor confidence. My colleagues and I have discussions and interactions with thousands of business leaders around the globe on a regular basis, where we are seeing a clear desire for the development of a more uniform global corporate governance model as a necessary means of restoring investor confidence.
It is tempting to argue that the need for global convergence around corporate governance is a direct result of the global nature of the various corporate failures we have witnessed in recent years.
While it is certainly true that the US corporate sector accounted for too many of the most notorious collapses, it is equally true that this was not just a US problem, and that, in fact, the spate of corporate collapses was an international phenomenon.
But this is only part of the story, because the argument for globally consistent governance platforms is based not so much on what has happened in the past, as important as that is, but on what is happening in the present.
This is in the context of the increasingly global nature of business and capital in the 21st century. In a world where scores of individual corporations boast revenue figures that exceed the GDP of whole nations, there is a clear need for global businesses to be able to operate across borders with consistency of practice. Equally, investors in these global businesses require certainty that their interests will be safeguarded regardless of where the activity occurs.
While legislation and regulation are one way of securing a commonality of practice, another – potentially more powerful – means of achieving change is through the day-to-day actions of the individuals involved.
And here the recent behaviour of board members provides an interesting pointer to how strong governance can be spread somewhat independently of government and authority: this is the demonstration of the “tone at the top” which commentators, shareholders and regulators are seeking.
Corporate governance experts report that many European companies are taking action themselves to strengthen governance practices. Management is improving internal controls and reporting. Directors are taking responsibility for the integrity of financial data. The need for the separate existence of board audit committees is being recognized. There is growing emphasis on the role of non-executive directors in monitoring executives. New disclosure committees are reviewing information released to financial markets, while management is taking formal written responsibility. And boards are becoming more aggressive in curbing executive pay packages that are considered excessive or potentially counter to good governance.
In our own experience in working with the boards and senior management of many significant global businesses, the board of directors is becoming a much more potent force in the corporate organization – taking steps from requiring increased accountability from management to reviewing company filings and media releases before distribution and certifying internal control processes. Boards are also meeting more frequently and in longer sessions, and they are renewing their responsibility to uphold investor interests. They are also becoming an independent arbiter between management and auditor.
So where might we start in a bid to deliver some convergence of corporate governance provisions? In conjunction with the independent group Tapestry, we recently established an Audit Committee Leadership Network to provide a forum for discussion of these matters.
The Network is made up of audit committee chairpersons representing leading global businesses. It has identified several key issues that are of particular concern to audit committees and which would therefore be of value if addressed consistently across global markets:
- What is the role of the audit committee in setting the tone at the top?
- When is the audit committee justified in crossing the so-called bright line into operational matters?
- What is the appropriate balance between the cost of internal controls reporting and its value to stakeholders?
- How can the board’s relationship with external auditors be strengthened?
- What changes are needed in the roles and capabilities of internal audit?
It will come as no surprise that as head of a professional services firm I single out the important issue of audit committees. Strong, independent, highly qualified audit committees are a lynchpin of a robust governance approach.
In highly complex global organizations they play an even more critical role in providing the necessary oversight and scrutiny required to ensure investor confidence.
The globalization of corporate governance is a challenge that will be best met with the combined will of directors, executives, governments, regulatory bodies, investors and professional advisers taking a positive and careful multi-jurisdictional view.
What we do not need is legislation for the sake of it; nor do we need a “winner takes all” approach where one system supersedes all others. Equally unsatisfactory would be a multiplicity of governance regimes in which global businesses are stifled by conflicting requirements wherever they operate. Rather what we need is a common sense consensus that brings together the “best of the best” in the interests of investor confidence and appropriate corporate behaviour.
Such reform is the next logical step in the continuing evolution of business practice. The time for unilateral action at the country level is behind us. Ahead is the challenge of developing a mode of corporate governance that allows executives and management to do their job – under the guidance and scrutiny of strong, independent and accountable boards – while giving investors the certainty and confidence they need.
James Turley is chairman and chief executive officer of Ernst & Young.