Is Corporate Finance Shaken After Eron?
The collapse of energy conglomerate Enron in the US and IT services giant Satyam in India are synonymous with corporate governance breakdown on a huge scale. Corruption, fraud, deception, conspiracy and greed were all words bandied around to describe the downfall of these corporate giants.
Both companies were discovered with massive accounting regularities that overstated assets, incomes and hiding huge losses through complex international transactions. All the while executives continued getting fat with bonuses and selling shares when they knew the ship was sinking.
In the case of Enron the chief architects of the conspiracy including chief executive Jeffery Skilling, chief financial officer Andrew Fastow and Richard Causey (chief accounting officer) were all sent to jail for their part in the scandal. Founder Kenneth Lay died before he was put on trial. In the case of Indian IT company Satyam, the fallout has begun with the pending charges against many executives. Accounting and auditing firms associated with Enron have already paid a heavy price for the scandal.
This might seem all too late for the thousands of investors and employees caught up in the scandal. Has corporate finance in general been shaken up and made to clean up its act? Has finance firms (accountancy and auditing) associated with the corporate sector improved its own governance standards?
The answer seems to be an emphatic NO if the recent case of Satyam in India is to be used as an example. Fraud and conspiracy associated with corporate finance is still frequently reported all around the world. A recent financial securities scandal involving renowned investment banker Bernard Madoff is estimated to affect USD $50billion worth of investments. Madoff has admitted to running a giant ponzi scheme. The corporate finance department and finance firms associated with Madoff must have been involved to carry out fraud of that magnitude.
After Enron, regulations were changed to close auditing, financial reporting and reign in executive powers. However, bent corporate finance people, if motivated enough, will continue to find a way to defraud and deceive companies and shareholders.
What is corporate finance?
Corporate finance is the department within a company which handles capital and investment matters. Everything from debt/capital funding required for growth, to acquiring new businesses, planning investments, managing cash and the financial policies of a company. Corporate finance personnel include chief financial officer, financial controllers, financial analysts, investor relations officer, credit and cash managers and the like. Corporate finance is often dealing intimately with finance firms, accounting partners, banking institutions and investors.
Corporate finance can span all different industries – so the rules and regulations that were enacted after Enron can not specifically cover all industries. Five factors are crucial to controlling corporate finance and limiting fraud opportunities.
1. Company incentive for corporate finance executives
If executives continued to be rewarded handsomely for short term indicators like share price, the temptation to fudge figures will remain.
2. Relationship between corporate finance and finance companies
Accounting and banking firms are intimately associated with corporate finance as deals are done and finances need to be audited. If this relationship is not governed and monitored, opportunities for fraud will continue to exist.
3. Organisational culture
If risk taking cultural is encouraged in a company but not monitored through stringent governance policies, another Enron is likely to occur again.
4. Recruitment and leadership
Recruitment policies by companies for their corporate finance personnel need to extend beyond qualifications and experience. People who engage in fraud and deception exhibit certain personality traits so that should be taken into account. Leadership is vital – the chief financial officer or treasurer sets the standards. One with integrity and moral standards can go a long way to ensuring the corporate finance department tows the line when it comes to obeying the law.
5. External factors: laws and disincentives
Laws on corporate governance need to be continuously improved and update to match the dynamic nature of the finance industry. Punishments for breaking the law need to be stronger – Enron executives received between 5-10 year prison sentences. Considering the harm they did to the wealth of others, the punishment seems to be very light.
In any field of endeavor there are cheats that try to get ahead by breaking the rules. Enron could happen again and still happens in smaller scale everywhere around the world. The only weapons against another Enron is vigilance in the five factors listed above.