Principles and Mechanisms of Corporate Governance: Literature Review with Tesco Case Study

To Identify The Principles Of Corporate Governance.

To Explain The Mechanisms Of Corporate Governance.

To Understand The Definition And Structure Of The Board Of Directors.

To Find Out The Role Of The Board Of Directors.

An important place has been acquired by the corporate governance in the conduct of corporate sector at the global level and the concept of corporate governance is increasingly considered by the organization not just in creating wealth but also in addressing various societal issues. In one of the studies conducted, that compared the firms founded in 1960 and 1900, it has been found that in both the set of firms, the growth of ownership diffused at the same rate. It was argued based on this that the modern United Kingdom withdrawal of the corporate governance by the founding families also operated.  In addition to this, in the later part of 20^th century, the rights of the shareholders in the country was extremely weak and the diffusion of the ownership was attributable to the legal protection of shareholders (Knapp 2018). It was in the middle of the century the pyramid of corporate governance gained importance. Development of such pyramid was against the hostile takeovers who was less risky to raiders after the implementation of corporate disclosure in 1948 (Ferraro 2019). However, the private benefits extraction was precluded due to the governance of the corporate insiders by ethical conduct of higher standards. This pyramid was dismantled and the control blocks was sold and this has resulted into the prevalence of diffuse ownership of British corporations.

The initial surge of interest in the corporate governance began in the United States, for nearly decades, this concept was barely mentioned in Britain. It was in the beginning of 1990, corporate governance began its earnest before the establishment of Cadbury committee. The growth intensity of the theme of corporate governance began in 1990s and the increasing concern of the investors about the corporate governance initiated in UK.  The first version of the corporate governance code of UK was published by the Cadbury committee in 1992. The code of corporate governance was revised over the years and its expansion accounted for the increased demand on the framework of corporate governance of UK. One of the crucial factors encouraging long term investment and delivering higher standards on governance is stewardship activities of investors and collective responsibility principle within a unitary board (Shrives and Brennan 2017). Nonetheless, the results of financial crisis and cases of inadequate misconduct and governance intensified the debate about the extent and nature of the framework. There has been rapid development in the environment in which the companies, wider stakeholders and shareholders operate. Existence of any company cannot happen in isolation and the society and economy is underpinned by the sustainable and successful business by creating prosperity and providing employment. The long term success of the company is dependent upon the relationship of the companies and directors with several stakeholders and such relationship is enduring and successful based on trust, respect and mutual benefit. In accordance with this, openness and integrity is promoted by the culture of company imbibing a good practice of corporate governance (Holland et al. 2016).

Literature Review

The paper is developed to conduct a review of the literature of the concept of corporate governance by demonstrating a detailed discussion on the functions and mechanisms of corporate governance. Such concept is evaluated by using a case study on the importance and role of governance in the chosen organization. This also involves discussion on the role of mitigating risk and risk controlling in case organization. The chosen case organization is Tesco Plc and the reason this organization is chosen for analysis is because of their accounting scandal in year 2014 where the company was accused of manipulating the financial figures that resulted in overstating its profit (Rudkin et al. 2019). The paper is initiated with the detailed review on the literature of corporate governance which incorporates discussion on the functions and mechanisms of corporate governance.  This would help in evaluating the corporate governance practices in Tesco Plc and its effectiveness. The objectives of conducting this assessment is listed below:

Corporate governance has many definition as policies, process, structure and mechanisms and in spite of the difference in the focus, the concept mainly addresses the rights and protection of the stakeholders and sustainable economic growth. It can be defined as the practice and system that helps in controlling and directing the company and comprise of a set of relationships between the management of company, its shareholders, its board and other group of stakeholders. A structure that helps in setting the objectives are provided by the corporate governance that helps in attaining the objectives and determining the monitoring of performance. In other words, corporate governance can also be defined as the set of incentives mechanisms that assure of the good management practice on behalf of the management, stakeholders and shareholders of the organization. System of corporate governance is viewed as the bundles of intertwined and interrelated internal and external forces that helps in identifying the relationship between stakeholders and management of the firms by providing processes and structures (Holland et al. 2017).  

The stakeholder rights should be recognized by the framework of corporate governance with the help of mutual agreements and established laws and thereby encouraging active cooperation between stakeholder and corporations in creating jobs, wealth and sustainability of enterprise. The corporate governance reporting of the company should coherently relate to various other parts of the annual report such as complementary information and other strategic report that assist the shareholders in assessing the governance arrangements of the company and activities and contribution of the boards effectively. Every company is responsible for adopting the good corporate governance practice and a comprehensive framework of the corporate governance is provided by the law that assist the introduction of best practices and high standard of governance in the governance system of the company (Smith and Collin 2017).

Explaining The Corporate Governance

One of the most significant issues suggested and noticed by researchers and investors following the great financial ignominy like WorldCom, Enron, Cisco and Adelphi is corporate governance that addresses the requirement of management control of company, improving board performance of accounting systems, mangers and auditors and maintaining the rights of stakeholders and investors.  The importance of corporate governance has been measured in the multiple criteria for measuring the status of corporate governance and these include relationships of financial stakeholders, ownership structure, disclosure and clearance of the information and board of managers. The 21^st century has marked corporate governance as one of the most important terms in commerce. The function and roles of corporate governance is different and is determined by the application of different theories such as stakeholder and agency theories (Nordberg 2018).   

Corporate governance is described as the system as per agency theory and such system helps in controlling the management behavioural interests. It is required from the perspective of this theory that role revision should be independent of managers. Some of the agency theory example is the managers of different department in an organization and relationship between stockholder and managers (Kusumaningtias et al.2016).

A framework for the accountability system of the institution is provided by the corporate governance and the governance relates to the control, business direction, supervision and control of managers.  

Organization with the help of corporate governance are able to create a culture of accountability, transparency and enhanced disclosure of the information. Improved process and structure of corporate governance would contribute in enhancing the long term success and prosperity of the company, encouraging effective planning and ensuring quality decision making in an organization. The business transactions are transparent if there is a sound financial system of the company disclosing the complete auditing and accounting procedures (Okaily et al.2019).

Organizations are entrusted with efficient and effective risk mitigation system in place with the help of effective system of corporate governance. The board of directors become well acquainted with the majority of the risks associated with different strategies with the help of accountable and transparent system.

The mechanism of corporate governance are of three types that helps in aligning the objectives and interest of mangers with the shareholders. All the mechanism for designing control and reducing the conflicts is incorporated in the corporate governance system. The mechanism is divided into two parts that is internal and external (Madhani 2017).

Functions of Corporate Governance

Under the direct mechanism, there is direct alignment of the interest of managers with that of shareholders and thereby managers are induced to conduct the management in an efficient manner. Some of the examples include stock options, compensation plan of executives and direct monitoring by the board.

 In another method, corporate controls are dealt indirectly such as managerial labor markets, capital markets and insider dealing prohibitions.

Another mechanism involves offering greater incentive and the ability to monitor the management to the shareholders and thereby strengthening their rights. The legal protection from managers expropriation used in this approach helps in enhancing the investor’s right. Some examples include making prohibitions against involving in insider trading and shareholders right enforcement and protection. The shareholder rights to control the company is supported by the legal framework and in many scenarios, management and the board are accountable to the shareholders explicitly (Bhaskar and Flower 2019).

Financial market is one of the eternal mechanism of the corporate governance that assist in the stock market development. There exist a direct relationship between market value, manager competence and efficiency. Management would always intend to sell the shares if they are likely to hamper the shareholder interest and thereby decreasing the company’s value (Knapp 2018). Therefore, the shares value is impacted by this mismanagement and there exist the risk of being replaced after the new investors have been taken over.

In developing the framework of the corporate governance, the most crucial role is placed by the board of directors. It is the responsibility of the board to balance the competing demands along with preventing conflicts and achieving adequate returns for their shareholders and monitoring the managerial performance. Moreover, it is required by the board to have some degree of independency from the management so as to assist them in fulfilment of their monitoring role and they are the part of management in practical scenario. The distinctive differences in the roles between the managers and board of directors forms the basis of good corporate governance practice. The board of directors are not required to indulge in micromanaging the company and rather they should focus on the planning and oversight. However, some of the duties are delegated by the board to board committees. Furthermore, board has the authority to replace the management of the corporation with the management that is more effective and contributes in maximization of the profits. In addition to this, the board is also entrusted with the responsibility of remuneration of the board itself and key executives (Smith and Collin 2017).

The practical issue faced by the board of directors is that of the board becoming entrenched. Such situation probably arises due to reviewing of the remuneration of the board and executive and compensation due to their activities (Kusumaningtias et al. 2016).

Therefore, board of directors is one of the control mechanisms that has been much debate over the last decade. This mechanism appeared as the most preferred because the functions of controlling managers contributes to minimize the costs due to the separation of control and ownership in any organization.

This section of the report demonstrates the critical evaluation of the framework of the corporate governance of Tesco Plc. Tesco Plc is a leading retailer of Britain that has it’s headquarter in Hertfordshire, United Kingdom and serves millions of customers. The importance of corporate governance is recognized for supporting the sustainability and long term success of the business. An effective and robust framework of governance is maintained that helps in execution and application of strategy. The critical factor contributing to the building of a successful business that is capable of sustaining in the long term is corporate governance. The commitment of the board of directors is to maintain highest standard of corporate governance in its accountability to the stakeholders and shareholders and managing the various affairs at Tesco (tescoplc.com 2020).  However, the corporate governance is not about complying with the codes and checklist and thereby its existence is not in isolation. The long term vision and the custody of the value of company rests with the board of directors that provides guidance and strategic direction to the company. It has been ensured by Tesco Plc over the past few years that the good governance is incorporated in the conduct of doing the business and is a part of working and thinking (Oh et al. 2018).

The board of Tesco Plc is leaded by the chairman and he is entitled to promote the highest standard of corporate governance and accounts of the various stakeholder groups along with ensuring the effectiveness of the board. In the recent years, much of the focus has been on the corporate governance that has resulted in the continuous evolving and changes to the standard. The remit of nomination committee is enhanced for devoting adequate time on the discussion and understanding of the maters of governance. Any changes in the governance framework of Tesco Plc is done by the committee after reviewing the proposal of financial reporting council (Kukreja and Gupta 2016).

There are five working committees supporting the workings of the board and the effective operations of the board is dependent upon the work of committee. These committees comprised of audit committee, nominations and governance committee, corporate responsibility committee, remuneration committee and disclosure committee. On behalf of the board, consideration of the work is done in greater detail and depth by the committee and issuing relevant to their reference term. In addition to this, at every board meeting, they present a report to the board of directors (accaglobal.com 2020).

It has been found from the annual report of Tesco Plc that complies with the relevant provisions that is set out in the code of UK corporate governance along with the application of main principles. It is the responsibility of the board of Tesco to account for concerns and needs of the stakeholders and intends to build a sustainable business by maintaining strong relationships with stakeholders. Another fact presented is in relation to the remuneration policy that has been developed according to the principles of UK corporate governance code.

Assessment, identification and monitoring of the principal risks faced by the business is done by the established process of risk management. The impact on monitoring and development of the appropriate internal controls and assessment of the likelihood of risks forms the basis of process of risk management. The risks that is expected to have significant impact on the performance of organization is systematically reviewed and such risks include those that would threaten the business model of the group, its liquidity and solvency position and future performance as well (Wang et al. 2019).  

The board of director is responsible for managing and mitigating the risks and having a direct involvement when it comes to mitigation, assessment and risk appetite. It is their responsibility to manage the risk profile of the group and implementing the interval control by maintaining the effective framework. Management of the group maintains and establish an appropriate system of internal control and risk identification so that any fraud and irregularities can be detected and prevented. One of the essential part of the role of board is protecting the group against operational and reputational risks. The organization has been able to gain a better understanding of the risks faced by their business with the additional support from the audit committee. The committee test and develop the risk tolerance and ensuring the reflection of the opportunities and strategic objectives of the group through the risk map. Management of the risks are done at the business and group level where the board committee or the board reviews the principal risks on an annual basis (Knapp 2018).

The accounting scandal of Tesco Plc in the financial year 2014 resulted in the suspension of the senior directors of the company. The profits generated by the company was overstated by amount of £ 250 million making it £ 1.1 billion and such overstating of the profits was done with the intension of attracting funds and investment (Kukreja and Gupta 2016). The overall reputation of Tesco Plc declined due to the influential event of the accounting scandal with a major impact on the investment value of the shareholders and market price of shares. The corporate governance framework of Tesco Plc was well known for its commitment to serve the communities in ethical manner. Such overstating of the profits by considerable amount has questioned about the adoption of the improper accounting policies and composition of the board of directors of the company (Jack et al. 2018).

The board of Tesco did not have any non-executive directors with retail experience before the appointment of two non-executive directors on 7^th, October, 2014.  Due to domain knowledge weakness, it was suggested that the board lacked the expertise and necessary knowledge to challenge and question the executives of company. The manipulation risk in recognizing the commercial income was discussed by the external auditors, but the anticipated cost savings and prematurely recognition of income was prevented by them. In this regard, the board subsequently signed off the profits figures with the accounting treatment assumed and accepted by the audit committee (Ft.com 2020). However, the accounting treatment was questioned by one of the employees of company that resulted in the emergence of issue. In one of the article issued by financial times, it was suggested that the current system of corporate governance was a failure due to recognition of income and issues in the composition of board. The abuses of the corporate governance was failed to curb resulting from the failure to establish adequate regulatory mechanism. This is reflected by making an estimation of commercial income inaccurately. Therefore, this accounting scandal incorporating the involvement of the board of director suggests that there was massive failure of the corporate governance at Tesco Plc. Tesco made a deal to bring about changes in their corporate culture in the fallout of the accounting scandal (tescoplc.com 2020).  

Conclusion

The paper demonstrates the importance of corporate governance structure in the organization and how the improper mechanism causes the company to bear considerable consequences. Confidence of investors has been shaken by various accounting scandals at some of the prominent organization. The weak internal control system of the organization is largely blamed for the failure of the financial reporting and the internal control system is driven by the management of the governance structure. Failure of the corporate governance at Tesco Plc due to weak internal control system and its impact on earnings in the form of misstatement generated serious accounting issue. It can be inferred from the case of accounting scandal of Tesco Plc that the corporate governance framework was at fault and the mechanism of the governance is directly associated with the misstatement or manipulation of the earnings earned by the company. In the aftermath of the accounting scandal, Tesco Plc, initiated bringing structural changes that focuses on making the employees adopt the key policies that emphasizes on compliance and ethics. They reset the incentive stricture of the commercial team and commercial relationships with the suppliers (Farrell 2014).

The analysis of the case of accounting scandal of Tesco Plc implies that the improper governance structure resulted into the weak internal control systems of the company resulted into the negligence of auditors and board of directors. Therefore, the issues associated with the governing bodies who allowed for such manipulation in the earnings generated and presented false figures to the investors and shareholders. One fact that is deduced from the evaluation of the case that while effective auditing forms an important part of the governance, the better preventive measures can be regarded as the adequate and effective internal control system that would help in ascertaining the existence of any issue or misstatement and whistleblowing them. The ultimate price of the scandals are paid by the shareholders and they place great importance on the governance structure and bodies. It is the duty of the governing bodies and its member to prevent the bypassing of the control system.  

It is required by the entity to strengthen their corporate governance structure by the adoption of appropriate framework. The aftermath of the accounting scandal at Tesco requires the overhauling of their corporate practices. There should be the adoption of extensive program of change to bring improvement in the corporate structure. Moreover, a strong channel of communication should be developed for the investors to make them well acquainted with the business models and updating their beliefs in regard to the business model sustainability.

References List

Bhaskar, K. and Flower, J., 2019. Financial Failures and Scandals: From Enron to Carillion. Routledge.

Farrell, S., 2014. Tesco to be investigated by FCA over accounting scandal. [online] the Guardian. Available at: https://www.theguardian.com/business/2014/oct/01/tesco-investigated-fca-accounting-scandal [Accessed 8 Jan. 2020].

Ferraro, F., 2019. Going political? Towards deliberative corporate governance. Journal of Management and Governance, 23(1), pp.3-20.

Ft.com., 2020. Cost of Tesco accounting scandal goes beyond fines | Financial Times. [online] Available at: https://www.ft.com/content/f50ca092-13ab-11e7-80f4-13e067d5072c [Accessed 8 Jan. 2020].

Holland, K., Lindop, S. and Zainudin, F., 2016. Tax avoidance: A threat to corporate legitimacy? An examination of companies’ financial and CSR reports. Refereed paper. British Tax Review, (3).

https://www.accaglobal.com, A., 2020. Tesco scandal | Student Accountant | Students | ACCA Global. [online] Accaglobal.com. Available at: https://www.accaglobal.com/gb/en/student/sa/features/tesco-scandal.html [Accessed 8 Jan. 2020].

IN., 2020. Former Tesco directors cleared of fraud over 2014 accounting scandal. [online] Available at: https://in.reuters.com/article/britain-tesco/former-tesco-directors-cleared-of-fraud-over-2014-accounting-scandal-idINKBN1O519Q [Accessed 8 Jan. 2020].

Jack, L., Florez-Lopez, R. and Ramon-Jeronimo, J.M., 2018. Accounting, performance measurement and fairness in UK fresh produce supply networks. Accounting, Organizations and Society, 64, pp.17-30.

Knapp, M., 2018. What We Can Learn from Corporate Governance. In Enterprise Portfolio Governance (pp. 111-140). Springer, Singapore.

Kukreja, G. and Gupta, S., 2016. Tesco Accounting Misstatements: Myopic Ideologies Overshadowing Larger Organisational Interests. SDMIMD Journal of Management, 7(1), pp.9-18.

Kusumaningtias, R., Ludigdo, U., Irianto, G. and Mulawarman, A.D., 2016. Rethinking of corporate governance. Procedia-Social and Behavioral Sciences, 219, pp.455-464.

Madhani, P.M., 2017. Diverse roles of corporate board: Review of various corporate governance theories. The IUP Journal of Corporate Governance, 16(2), pp.7-28.

Nordberg, D., 2018. Edging toward ‘reasonably’good corporate governance. Philosophy of Management, 17(3), pp.353-371.

Oh, W.Y., Chang, Y.K. and Kim, T.Y., 2018. Complementary or substitutive effects? Corporate governance mechanisms and corporate social responsibility. Journal of Management, 44(7), pp.2716-2739.

Okaily, J.A., Dixon, R. and Salama, A., 2019. Corporate governance quality and premature revenue recognition: evidence from the UK. International Journal of Managerial Finance, 15(1), pp.79-99.

Rudkin, B., Kimani, D., Ullah, S., Ahmed, R. and Farooq, S.U., 2019. Hide-and-seek in corporate disclosure: evidence from negative corporate incidents. Corporate Governance: The International Journal of Business in Society, 19(1), pp.158-175.

Shrives, P.J. and Brennan, N.M., 2017. Explanations for corporate governance non-compliance: A rhetorical analysis. Critical Perspectives on Accounting, 49, pp.31-56.

Smith, E. and Collin, S.O., 2017. Corporate governance and corporate entrepreneurship in different organizational forms. In Handbook of Research on Corporate Governance and Entrepreneurship. Edward Elgar Publishing.

Tesco PLC., 2020. Our corporate governance framework. [online] Available at: https://www.tescoplc.com/investors/corporate-governance/our-corporate-governance-framework/ [Accessed 8 Jan. 2020].

Tescoplc.com., 2020. [online] Available at: https://www.tescoplc.com/media/392344/tesco_ar17_principal-risks-and-uncertainties.pdf [Accessed 8 Jan. 2020].

Wang, R., Zhou, S. and Wang, T., 2019. Corporate Governance, Integrated Reporting and the Use of Credibility-enhancing Mechanisms on Integrated Reports. European Accounting Review, pp.1-33.