Post on 04-Mar-2015
This paper will discuss the relationship between corporate governance and prevention
of Fraud. One can safely argue that corporate governance is a medicine to cure
corporate fraud in an organisation. The systems, procedures and policies set by the
organisation to curb anomalies such as fraud and corruption largely entail corporate
governance. To make this task easier, this paper shall define in detail the meaning of
corporate fraud and later proceed by way of analysing how it can curbed by corporate
governance.Wikipedia defines fraud as follows: It is a deception made for personal
gain at the expense of an entity. According to GAW Kachali, it involves deception,
confidence and trickery.
There is local, national, regional and global resurgence of interest on how to prevent
all forms of unethical practices such as corruption and fraud in both private and public
sector including public bodies. Generally institutions with resources to prevent or
combat corruption and fraud in all sectors seem to thrive. This is mainly successful
through the setting up of strong pillars which promote transparency, fairness,
professionalism, integrity and democracy in running the organisation; this is made
possible by corporate governance. Corporate governance provides a positive direction
which an entity must take.
The most common definition is fraud is a generic term, and embraces all the
multifarious means which human ingenuity can devise, which are resorted by an
individual, to get an advantage over another by false representations.(G.A.W
Kachali,2005) It is done with the purposes or intention of gaining advantage over
another through false pretence for example someone can enter wrong information in a
report deliberately to justify trickery he or she should have done for his or her own
benefit at the detriment of a company.
To prove that it can be done by anyone in the organisations, types of frauds have been
put in place, which explains why there is need of a code of conduct of employees in as
much as there are also regulatory mechanisms for the employers such as external
audits and boards. Fraud is classified into following categories: A way some people
classify fraud is to divide
frauds into: Those committed against organizations, and those committed on behalf of
organizations.
In employee fraud, for example, fraud committed against an organization, the victim
of the fraud is the employee’s organization. Usually this is done by diverting goods or
services meant for the organization for personal use. A good example is a situation
whereby goods meant for a promotion are sold for the benefit of the employee
carrying out that project.
Usually such culprits take advantage of lack of efficient and effective monitoring
mechanisms or abuse the trust which is bestowed upon them by their companies. In
some instances they divert clients made for the organization they work for to other
companies to get kickback or they even create bogus companies.Procecedures of
awarding a tender a seriously flouted for the selfish benefit of fraudsters in control of
granting those tenders.
On the other hand, with financial statement fraud, for example, executives usually
commit fraud” on behalf of an organization, usually to make its reported financial
results look better than they actually were or are In this case, the executives of a
company usually benefit because a company’s stock price increases or remains
artificially high and the victims are investors in the company’s stock.
Sometimes, executives misstate earnings in order to ensure a larger year end bonus.
Financial statement fraud often occurs in companies that are experiencing net losses
or have profits much less than expectations. Some of these even connive with external
auditors in order for them to portray a false picture to their advantage and detriment of
the company.
As stated by G.Mugaga, usually such anomalies are created by the companies
themselves by creating weak systems in the company and also powerful individuals in
the name of top management such as directors and chief executive officers. This is
also resulted by poor follow up mechanisms by the companies. For example when the
board meets they spent most of the time quarrelling on what should be done so that
they obtain more power at the expense of more important issues to do with corporate
governance. They do not have much time to discuss about how to implement
recommendations made either by external auditors or external evaluators.
There is social concern that massive frauds in the private sector can jeopardise
economic and political institutions (Recent cases of Enron and the Crunch).This can
also be done to dummy whoever concerned into releasing whatever resources for the
institution. A prominent constitutional expert Lovemore Madhuku was convicted after
duping the law firm he worked for $20 000 by making clients pay to him through the
backdoor whilst using the name of the lawfirm.This was only discovered after whistle
blowers had tipped Manase and partners, a law firm which he was working for,
investigations followed.
Usually such unethical acts are facilitated by weak systems and policies, systems
which create powerful individuals in an organisation. The organisation becomes more
of their briefcases and it becomes difficult to challenge them. Corporate governance
seeks to wash away such anomalies which are detrimental to the growth of
organisations rather than individuals
.On the other hand perpetrators take advantage of trust bestowed upon them by the
corporate they work for. As stated by G.Makunike, Fraud perpetrators are the least
suspected and most trusted of all the people with whom victims associate.
Examiners Association of Certified Fraud defines fraud as the use of one’s
occupation for personal enrichment through the deliberate misuse or misappropriation
of employing organisation’s resources or assets. Occupational fraud results from the
misconduct of employees, managers or executives. The report to the nation on
occupational fraud and abuse by the association of Certified Fraud Examiners states
that, the key to occupational fraud is that the activity is clandestine, violates the
employees’ fiduciary duties to the organisation, committed to the purpose of direct or
indirect benefit of the employee.
The ACFE includes three major categories of occupational fraud; Asset
misappropriations which involve theft or misuse of an organisation’s assets,
corruption, in which fraudsters wrongfully use their influence in a business
transaction in order to procure some benefit for themselves or another
person ,contrary to their duty to their employees or the rights of another and
fraudulent statements which generally involve falsification of organisation’s
statements.
The types of fraud include employee embezzlement, vendor fraud, management fraud
whereby financial statements are frauded, customer fraud, investment scams and
miscellaneous fraud. All these types are fraud are carried out easily in the event of
poor systems and policies and failure to implement the recommendations made to
ensure that corporate governance prevails in a company.
Blurred reporting lines leave gaps in control systems, nowhere more obvious than in
the case of Barings, where no one believed that they had overriding responsibility for
the activities of rogue trader Lesson. Reporting must be periodical, hence deadlines
for reports must be set and ensure that such time timelines are adhered to. The
authenticity of such reporting must be taken seriously, whilst recommendations are
seriously considered at every level. Feedback by the superiors is also a pre-requisite
for efficient systems in an organisation.
Dispersed departments can add to the problems: it is more difficult to pool knowledge
of goings on when departments do not work closely together. In WorldCom, where
the finance and legal functions were scattered over several states, communications
were poor and employees lacked support to question the CFO’s (Scott Sullivan’s)
actions.
Departments must be coordinated to ensure joint implementation of the policies and
systems.Fraudlent activities are easily done whenever there is discord in an entity as
this results in different interpretations of the organisational policies. Important issues
like audits are easily done when the corporate is well coordinated as there will
generally be uniformity in the operations
This also led to biased decision-making, where Ebbers relied on a small clique of
insiders (not all the most senior personnel) to discuss strategy.
knowledge of goings on when departments do not work closely together.
In WorldCom, where the finance and legal functions were scattered over
several states, communications were poor and employees lacked support
to question the CFO’s (Scott Sullivan’s) actions.
Unity of purpose in a company promotes transparency, professionalism and integrity
as opposed to biased decision making which creates a lot of divisions, hated and
tensions which result in insubordination and undermining each other, this also grooms
fraudulent activities as a way of tying to fix those on top.
Changing the organisational structure can often leave gaps in information
flow and responsibilities until the new one matures. Vital data can be
overlooked. At Marconi, the delegation of responsibility to division heads
and the abandonment of Weinstock’s famous ratios and trend lines meant
that the deterioration in the working capital position was not addressed
early enough. It becomes very difficult to trace where challenges associated with
misappropriation of funds or fluting of procedures would have occurred if there is no
continuity in the operations of companies organisational structures.
Remote operations, far from head office, are often difficult to manage
since head office is heavily reliant on local management and cannot
always judge whether correct and sufficient information has been transmitted. This
normally results in the cooking of reports and financial statements. The company will
have to rely on an individual who heads such remote corporates.This gives room for
clandestine actives and in general it distorts the uniformity of the company hence an
easy task to resort to corrupt and fraudulent activities.
This is particularly a problem with new, or unfamiliar, operations such as in the cases
of Barings and Ahold.Under-resourced risk management departments (if indeed they
exist) together with inadequate information systems can be a fatal weakness in a
trading operation, as witnessed in both Barings and Enron who lost 5 million dollars
due to e-fraud, whereby technology will be in full use to perpetrate fraud and/or
corruption.
Another fundamental contributor to failure is a weak, or ineffective, internal audit
function. Often this is regarded as an expensive and unnecessary
overhead. As a result, in many companies, such as Barings and
WorldCom, the function is understaffed, and has chosen, or been forced, to
perform mostly operational audits with the objective of uncovering potential
cost savings rather than financial audits with the objective of safeguarding
company assets.
Corporate governance is the most significant development in business strategy for the
first century based on management strategies, but on a culture of performance with
conformance to stakeholders, business and community stakeholders in a unique
partnership. Corporate governance entails the establishment of relevant systems to
promote the smooth running of an institution. It creates checks and balances in an
organisation to promote the growth of the organisation through efficient and effective
management; it allows positive delivery of the goods and services as offered by the
organisation from the top management to the least ranked employee. Businesses that
succeed have good systems and controls.
Corporate governance does not start with the corporation but with people such as
directors, managers and employees. In individual governance process important
attributes include: consistency uprightness, wholeness, truthfulness and honest.
Equally important are visions for success that embraces other people, these include
self control, self discipline and intellectual integrity. John Hendricks and Leigh
Hendrikse have coined formular triangles for business success: It is illustrated by way
of a corporate governance success triangle: Attitude which is made up of
honesty ,integrity and intention and aptitude made up of tripple bottom,line success
and expertise. Commitments starts ethics ought to provide the basis for accountability
The concept and practice of accountability is expected to make public officials
including trustees responsible for their actions or inactions. It is supposed to increase
the transparency of governments/state corporations It is supposed to emphasize and
enhance government or state corporation responsiveness and its legitimacy
.
With the right attitude and the right approach to work in the best interest of
shareholders, company and stakeholders. Corporate governance does not just
happen ,there has to be a commitment to develop and educate the directors and
managers as to the expertise and skills of governance.
Corporates have policies and systems in place to give a direction to be taken in the
direction. These include constitutions, codes of conduct, policies and in some cases
rules and regulations, nonetheless before the organization resorts to those issues,
individuals must be able to be committed to doing their best to deliver for the
organisation.Attitudes that drive talents and skills include self control, self discipline,
personal character building, intellectual integrity and a willingness to do things right.
Attributes such as open communication in company does away with unethical
practices such as fraud. A culture of regular meetings ensures that all the possible
anomalies can be done away with, equally important are full disclosure, participative
leadership, managerial resourcefulness, strategic partnership, technical and
innovation., Another critical factor are values. Values can be defined as relatively
stable convictions about what is good or desirable. These are categorized into
strategic values whereby the shared conviction of the organization about the desired
objectives.
For any organization to function optimally, good relations and interactions between
stakeholders are required .Typical ethical values are
respect,transparency,fairness,justice.Adherence to ethical values ensures that
stakeholders inside and outside the organization get along well with one another.
Apart from upbringing, the social setting of organizations that individuals work in;
can also have either a good or corrupting influence on their moral character
The company also has to consider the following: rewards for employees, personal
success, a respected leader, a respected executive and increasing wealth making a
difference.
The checks and balances must also be in place to ensure that single individuals or
units are powerful at the expense of a corporate as a whole. The total family of
shareholders and stakeholders has to be part of the governance mission to make a
company a better place for all. A win-win situation for recognition and rewards for
stakeholders must also be made in place. Procedures must also be followed in very
strict manner because once one step is jumped it creates confusion and disarray in the
organization.
In corporate governance the other most important programmes are monitoring,
evaluation and audit. They provide a mirror in which the organization sees whether
there is progress or not, it also shows shortfalls in all sectors of the corporate’s
operations. Audit is the most important of all for it brings out clearly the systems are
being followed in line with resources and procedures within the corporate.
The audit committee is the principal governance watchdog in most
companies/parastatals and was the first governance committeee to gain broad
acceptance in the business community. According to M .Davidson, an annual audit is
an essential part of the checks and balances required, and it is one of the cornerstones
of corporate governance.
Its purpose is to provide additional focus on financial issues that are vital to
corporation but which often cannot be fully examined by the main board because of
shortage of time made available to it. The composition of audit committee should be
diligent and knowledgable.The recent Enron collapse provides ample evidence of the
need for the audit committees to examine corporation’s company’s accounting
policies thoroughly to ensure that they are appropriate to its business and satisfy the
needs of its stakeholders. Special attention should be given to any unusual policies or
policies which rely on fine distinctions of interpretation for their legitimacy.
The relationship between management and auditors is also critical in coming up with
an objective audit, for example disagreements between management and auditors.
This is echoed by G.A.W Kachali who states that, professionalism and skill on the
part of auditor and management are critical in ensuring a credible audit. Any
disagreement in this context is serious and needs careful consideration by an audit
committee in the first place and even by the board as a whole
.A decision to dismiss auditors should have the support of the audit committee and
should be made by the full board. This avoids unilateral decisions which might be to
the advantage of an individual. The initial selection of external auditors is
usually the responsibility of the audit committee. Normally when a vacancy occurs,
proposals from suitably qualified firms are invited then each firm submits proposals to
the audit committee.
Auditors ought to be faithful and prudent, knowing their businesses and all the points
and articles of the account in rents, outlays, returns of stock(W.Henly:1400). A
fundamental contributor to failure is a weak, or ineffective, internal
audit function. Often this is regarded as an expensive and unnecessary
overhead.
As a result, in many companies, such as Barings and
WorldCom, the function is understaffed, and has chosen, or been forced, to
perform mostly operational audits with the objective of uncovering potential
cost savings rather than financial audits with the objective of safeguarding
company assets.
Traditionally, external auditors partially filled the gap with their financial,
transaction-based audits. Today, ‘risk-based’ audits are more
common, where the focus is on areas identified as being the most exposed.
This has left gaps where internal controls are rarely, if ever, audited. The
door is left wide open to fraud.
Internal audit’s independence is further undermined when it reports solely to the
CEO or CFO or when the audit programme, findings and employee remuneration are
dependent on the CEO or CFO, such as in the examples of WorldCom, Barings,
Enron and Tyco.
A recurring feature is poor cash control: at Marconi the spiralling level
of working capital was not detected and dealt with early enough; at
WorldCom, revenue was more important than collecting debts; at Enron,
profit over the life of a contract was more important than the fact that it
made losses and consumed cash in its early years.
The objective an audit is to enable the auditor to express an opinion as to whether or
not the financial statements fairly represent in all material aspects, the financial
position of the entity at a specific date, and the results of its operations and cash flow
information for the period ended on that date, a accordance with an identified
financial reporting framework and/or statutory requirements.
External auditors are ultimately responsible for reporting to shareholders on the
financial statements.Inorder to do so they must place reliance on risk management and
internal controls in corporation/company Before doing so the external auditor will
evaluate the quality of the work done by internal auditor to ensure it is smooth
flowing .The annual report should disclose the remuneration and expenses of the
auditors giving details of the fees and the purpose of which they were incurred to
avoid manipulation of the process by management or administration.
Evaluation and monitoring is also very important to check on the sustainability of the
activities which are being done by the company, the level of involvement of relevant
stakeholders in the organization and possible changes which can be done to ensure
that threats are countered whilst opportunities are pursued for the benefit of the
organisation.This allows the rooting out of bad practices such as fraud, it also
identifies possible issues which can result to this bad practice. Again it works better if
it is carried by a credible consultancy firm assisted by the internal monitoring and
evaluation department.
The most critical thing in issues of audit and monitoring is the independence of the
service providers, hence appointment of such should be done in a very transparent
manner with enough consultations, lest the process is used the advantage of
individuals in a company. Evaluation results should be reviewed by the nomination
committee or such similar committees of the board.
There is also need to ensure that heads of institutions are kept with serious monitoring
and evaluation to avoid hijacking corporate to their advantage. Individual director
evaluation, directors contributing and reporting to the board should measure against
their duties
.The nomination of a director at the A.G.M should not be an automatic process and
should only occur after the proper evaluation of the performance and attendance of
the director in question. Should a deficiency in directors performance be identified, a
plan should be developed and implemented for the director to acquire the necessary
skills or develop appropriate behavioral pattern.
It is important that the directors’ evaluation be approached in an open, constructive
and non-confrontational manner. The chairperson should also be evaluated. The
chairman should not be present when his performance is being discussed by the board.
The chairman, or a committee appointed by the board, should evaluate the
performance of the C.E.O at least once a year.
People tend to be naturally greedy, rarely content with what they have
achieved. High achievers, such as top executives, are particularly ambitious
and eager for more power and wealth.
Since there is a clear, positive correlation between size of corporation (measured by
revenue or by capital employed) and executive pay and status, CEOs have every
incentive to grow their companies. Since, it has already been argued, the quickest way
to grow a company is often by acquisition, the greedy CEOs of WorldCom,
Tyco, A hold, Parmalat and others, needed little encouragement to embark
on a spending spree (S.Hamilton and A. Micklethwait, 1989)
These individuals usually emerge after a period of successful (or apparently
successful) management. The company becomes packed with likeminded
executives who owe their position to (usually) him and are
reluctant to challenge his judgement.
A complacent board, lulled by past achievements, stops scrutinising detailed
performance indicators and falls into the habit of rubber-stamping the CEO’s
decisions. His drive, commitment,(often) charisma and streak of ruthlessness have
contributed to the previous success. To ensure that the company is saved from such
greedy and corrupt people the organisation must ensure that they have credible boards
in their organisations.
Improved board performance and effectiveness can be achieved though regular and
timely appraisals of the board.Perfomance of the board, its commitment and
individual directors should be evaluated annually. Board should be made of experts,
management and shareholders to have the right direction. Even the principles adopted
in the evaluation of the board should be applied to the board should be applied to the
board committees, chairmen and members.
The most important stage in corporate governance is implementation-putting it all into
practice, personal action plan initiated by the head of the institution, chairperson, with
all executives delegated with responsibility of implementation. It is implentation at
grassroots level, in the boardroom, in the broiler room, creating a win-win opportunity
for recognition and rewards for shareholders and stakeholders. Corporate governance
is not good intentions; it is good actions flowing out of good intentions. Most
organisations fail to put into practice what is written on paper. They try to portray an
expected picture through reports and financial statements. This causes
underdeliverence on the part of the corporate.
The failure to implement is caused by either lack of will to do so or lack of capacity
on the part of personnel which is supposed to play that role. Technical expertise can
be a major setback, for instance in introducing system to do with technology, people
with skills must take a front role. Without such a kind of arrangement such an action
plan will fail dismally. The corporates apart from the systems, policies and procedures
used for corporate governace, there must be capacity building initiatives, staff
development, motivation of employees, strategic planning meetings and other related
processes. They help in ensuring the reality of implementing measures which promote
corporate governance.
There can also deliberate neglection of the genuine company policies and systems for
the sole reason of deceiving the stakeholders in that company. There can also be
issues such as dissatisfaction on the part of employees, having been demotivated by
the behaviour of their bosses or poor renumeration.So inorder to undermine them they
can flout the procedures, they can even do it in the name of trying to make a living
having realised that the company does not even care about them.
The politics can also be at the top whereby, in the struggle for power juniors in the
company can be used to disrespect their immediate supervisors hence the need to
ensure that outside the parameters of the policies, procedures and systems, there is
need of other critical pillars to support these initiatives.
The issue of individual characters also comes back into picture as discussed earlier. It
only takes people who have the company at heart, people who do their work
obediently, people who are not crooks, people with a reputation to protect. People
who have principles and ethics, this makes the implementation process easy to
achieve.
In conclusion the issue of corporate governance can just be a lip service if there are no
strategies put forward to ensure that it is taken from paper to the ground. It takes the
whole corporate from the largest shareholder to the toilet cleaner to ensure that
corporate fraud does not occur in the organisation. If there is no commitment in the
company to implement then it will remain a dream. The importance of corporate
governance to cure the cancerous disease of fraud and corruption can only be realised
when the entity is already in taters.The saying prevention is better than cure really
makes sense in this vain, given that corporate fraud is only avoided by having tight
controls to human manipulation through strong systems which strengthen the
institution at the expense of greedy individuals who are bent on amassing their power
and wealth at the expense of the generality of stakeholders in the company. Such a
stance coupled with innovation at all levels to ensure excellence ensures that
corporate fraud is avoided.
Corporate governance therefore should be a glowing light in the direction of the
organisation starting from recruitment and placement, management of an employee,
disciplinary measures of the latter, dismissal and retrenchment and even high profile
appointments in a corporate. As long as there is such a direction they won’t be any
problems in the context of corporate fraud.