Corporate Governance in the Banking Industry

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Introduction

Corporate governance refers to the processes, methodologies, and relations through which companies are run, directed and regulated. In every organization, structures have been established to illustrate how responsibilities and rights are distributed among shareholders. The structures also identify how rules and procedures are to be followed whenever crucial decisions are to be made in the corporation by the board of directors, stakeholders, managers, regulators, creditors, and organizational shareholders. Corporate governance endeavors to align the stakeholders interests with any companys overall agenda, especially after the collapse of various major corporations in the United States such as MCI Inc. and Enron immediately after the enactment of the Sarbanes-Oxley Act of 2002. The major interest of corporate governance is to enhance a corporations accountability. Most of the companies that collapsed in the early 2000s faced accounts of fraud. With this insight, this paper utilizes various theories such as the stakeholder theory and the stewardship presumption to demonstrate how corporate governance may contribute to higher standards of accountability and business performance in the banking industry.

Corporate Governance and Accountability

The systems and processes of developing corporate goals and objectives are defined through corporate governance. Such procedures are crucial in pursuing social, market, and regulatory forthrightness. Corporate governance also enables the companies management and agents to monitor the actions they undertake together with the policies that they enact. According to Jizi et al. (2014), corporate governance can boost accountability and business performance in the banking sectors concerning the various principles that clarify how banks should carry out their operations. The principles that guide corporate governance are derived from legal documents such as the Cadbury Report, Sarbanes-Oxley Act, and the principles of corporate governance by the Organisation for Economic Cooperation and Development (OECD). The stakeholder theory asserts that companies should be managed in the best interest of all their stakeholders. The conjecture regards employees as important stakeholders in an organization and that their interests and those of the suppliers and local communities should be factored when organizations make decisions. This theory is affirmed in various principles of corporate governance.

The first principle that guides corporate governance is the right of shareholders and their equitable treatment (Madison et al. 2015). According to this principle, a corporation such as a bank must ensure that its shareholders are respected and that their rights are guided and guarded. Rehman and Mangla (2012) reveal how a bank has a responsibility to communicate effectively and efficiently to all stakeholders concerning their rights. It is also the responsibility of financial institutions to encourage all stakeholders to be active participants in all corporate general meetings. When stakeholders are informed of their responsibilities and rights, they can challenge and contribute to policy issues of the company. The stakeholder theory is also manifested through the second principle that guides corporate governance in terms of safeguarding the interest of other stakeholders who are not shareholders (Jizi et al. 2014). All financial institutions have social, market-driven, legal, and contractual-based obligations to ensure that all non-shareholders and their interests in the organization are safeguarded. These non-shareholders may include all employees, the community, company suppliers, the customers, and creditors. This category forms a major facet of the institution. Non-shareholders satisfaction with the activities of the organization is important for its success.

Corporate Governance and the Stewardship Theory

The stewardship theory of corporate governance holds that bank directors are not led by self-interest, but by their loyalty to the objectives of the financial institution. According to the theory, the success of a financial firm is highly dependent on the relationship between the firms chair of the board and the CEO. Appendix 2 gives fine details of this relationship. The stewardship theory is guided by the third principle that guides corporate governance in safeguarding the role and responsibilities of the board. As a principle, the board needs to be well informed and skilled to be in a position to challenge the bank managers decisions. The presumption considers accountability a key aspect that determines the success or failure of any banking institution. The principle also dictates that the board needs to be independent and separated from all other functions to ensure commitment to critical evaluation. Khalid (2011) presents the need for banking companies to demonstrate integrity and ethical behavior in the appointments and conduct of all their stakeholders. Through such vetting, the interest of the board members and their loyalty to the banks goals and objectives can be realized. Integrity tests should begin from the initial contact stage to guarantee the uprightness of all stakeholders right from the point at which they join the banking corporation. The issue of integrity pushes the financial sector to come up with codes of conduct that guide the appointment and nomination of banking managers.

Integrity tests should also guide decision-making and the conduct of officials, employees, and directors (Jizi et al. 2014). The tests uphold the need to monitor corporate organizations at all levels. Increased accountability safeguards the success of the financial organization. The roles and responsibilities of a banks board of directors and managers should be made known to all stakeholders to enhance monitoring and accountability. Issues such as open communication and clarification of the job description of senior bank officers guide their relationships while at the same time minimizing conflicts. Hence, they warrant the success of the banking institution. Corporate governance also ensures that the process of financial reporting is well monitored to ensure the integrity and trust of the institutions (Rehman & Mangla 2012). The principle also dictates that disclosure of information on matters that concern any bank stakeholders should be balanced and justified. All stakeholders in the banking sector are guaranteed access to information that concerns them in an open, just, and straightforward way. The principles of corporate governance guide the honor of all stakeholders and the image of any bank in the corporate world.

Commercial Laws at Federal and State Levels

Various legal principles form the basis of corporate governance in the banking sector. As a legal function, a bank originates and exists as an officially permitted body (Rehman & Mangla 2012). The law permits the body (bank) to own property and carry out transactions just like a person can do. This provision is a powerful boost in the realization of the corporate governance agenda. A bank can exist anywhere through the general laws of the state. Besides, it can be established through the enactment of specific legal statutes. In addition, banking institutions are guided by the common laws. The financial sector is also guided by internal regulations where in-house constitutions are followed in all decision-making processes. As such, corporate charters and the Articles of Association (AoA) act as legal structures in corporate governance. Since the AoA is internal, shareholders retain the right to alter it at will without or with minimum government interference. Various governments of the world have also enacted laws such as the Foreign Corrupt Practices (FCPA) that was enacted by the government of the US and the Bribery Act that was enacted by the government of the United Kingdom (UK). The laws strengthen corporate governance in the banking sector (Rehman & Mangla 2012). These laws have outlawed acts of corruption and bribery of government representatives by corporate officials in exchange for favors at the expense of shareholders. Development of methods that curtail corruption in the banking sector and the corporate world at large has saved the shareholders of their money while at the same time ensuring the success of their deposits. Appendix 1 shows the situation in Australian banks that have recorded excellent performance, thanks to the role of corporate governance in Australia. Trust and reliability are key elements in the banking industry that relies on customers and shareholder deposits for sustainability. These legal guidelines enhance stakeholder confidence.

The Sarbanes-Oxley Act is another definite corporate governance legal guiding structure that ensures heightened standards of accountability and success in the financial sector (Williamson 2002). This Act was put in place by the US government in 2002 to safeguard the interest of shareholders after the collapse of various major companies on the grounds of poor corporate governance. The Sarbanes-Oxley Act directs that all companies, including banks, to establish the Public Company Accounting Oversight Board (PCAOB). This board is tasked with the role of regulating auditing frameworks. Through the guidance of this Act, financial institutions are supposed to uphold professionalism in auditing, even without legal regulations. Professional or registered auditors should review the financial statements of a bank and provide their official stance concerning the banks financial position. The Act also recommends the committees that audit financial statements to be independent and that there be a member who is professional in finance. Whenever the audit committee is deficient of a professional accountant, there should be a formal explanation if proper rules of corporate governance are to apply. The Sarbanes-Oxley Act also postulates certain financial auditing services that cannot be provided through external audit consultancies (Rehman & Mangla 2012). Also, the provision that the lead auditor in external auditing must be altered after five years minimizes the chances of bribery, corruption, and loyalty in the financial sector. The Act also directs that an external auditing firm cannot be permitted to carry out auditing in a particular bank in which its officials are shareholders in that auditing firm. This provision eliminates the chances of conflicts of interest. The move has saved banking institutions from underground corrupt deals that many companies were engaging in previously.

According to Erturk et al. (2004), various codes have been enacted to boost corporate governance standards and business performance in various parts of the world. Stock exchange markets, associations, and companies that are supported by both international institutions and internal governments reinforce these codes. One of these guidelines is the OECD. According to Holton (2006), the OECD is considered the most influential corporate governance technique. In fact, the OECD led to the establishment of the United Nations Intergovernmental Working Group of Experts on International Standards of Accounting and Reporting (ISAR). This organization guides the process of financial reporting in the banking sector. In an effort to ensure accountability, transparency, and success of financial matters in banks, the ISAR corporate financial reporting guidelines direct the disclosure of various issues (Lee & Shailer 2008). These issues include revelation of auditing processes and reports, the board of management and the organizational structure, disclosure of corporate responsibility activities and companys compliance with regulations, disclosure of financial information, and the disclosure of structures of ownership and/or how rights of control are exercised in the banking sector. Such structures minimize the loopholes of corruption.

Hovey and Naughton (2007) present the second code, namely the stock exchange listing standard, which makes it compulsory for companies that are already listed on the stock exchange in the US or other parts of the world to meet a particular threshold regarding governance standards. The code does not spare the banking sector. For instance, stock exchange listing guidelines require bank directors to be independent. Hence, the managing directors of a stock-listed bank have to be detached from any loyalties that can bar them from making independent decisions concerning their banks. The premise is that independent directors can carry out their oversight roles and responsibilities effectively. The absence of conflicts of interest in the board of directors also paves a way for more scrutiny and oversight of the management and the performance of the respective bank (Erturk et al. 2004). For accountability purposes, the bank director should not have any financial or material connection with the bank, apart from what is provided for by his or her position as the director. This provision ensures transparency in governance mechanisms. The stock exchange listing standards also require the board to hold meetings without the banks management officials (Williamson 2002). The board should hold regular meetings to deliberate issues of the company without involving the management.

Through such meetings where the management is absent, oversight issues can be discussed openly and explicitly. Such a meeting strategy warrants oversight, accountability, and financial success of the respective bank (Hovey & Naughton 2007). The presence of the management can bar justice and fairness of the raised issues that are meant to boost the operations of the bank. The nonattendance of powerful officers such as the banks chief executive officers and other managers paves a way for the directors to evaluate their performance against the objectives of their respective financial institutions (Lee & Shailer 2008). Since auditing is a sensitive issue in the stock exchange, all financial institutions that are listed in the market must prove the accountability and disclosure of their financial information to ensure healthy competition in the market. The guidelines that are thoroughly checked in the process of listing banks in the stock exchange bazaar ensure that financial institutions are run in a transparent and accountable manner and that the investors are not short-changed by the management. The whole plan forms the basis of financial success in financial institutions.

Mechanisms for Corporate Control

Mechanisms for corporate control are crucial in regulating any immoral conduct and adverse actions that go against the financial institutions governance principles. Monitoring systems are both internal and external. In internal monitoring, a banks board of directors not only recommends but also takes charge of the oversight of the activities of the management. Major shareholders of the organization can also play the role of monitoring and oversight in the organization where they have invested (Erturk et al. 2004). Such shareholders also make recommendations and official suggestions from their observations and investigations. On the other hand, a third party carries out external control processes. These parties may include an external registered auditor who is hired by the bank. The party must be completely independent of the organization and/or the persons whose office is being audited. The external auditor is hired to certify that the information that is provided to shareholders is accurate or otherwise (Williamson 2002). Such internal and external control mechanisms play the role of motivating the management and/or assist in aligning the managerial decisions and actions to the overall organizational goals. Therefore, ethical guidelines for corporate governance need to be followed to avoid compromising its existence and applicability in the banking sector (Khalid 2011).

For internal corporate governance, various control mechanisms are exercised. To begin with, the board of directors carries out corporate monitoring (Madison et al. 2015). The corporate board of directors is charged with the responsibility and power to hire or fire various officers. Secondly, procedures and internal auditors of the company regulate such internal mechanisms. Other internal regulatory procedures have also been established to guide the process of auditing (Madison et al. 2015). These procedures are enacted by the board of directors or the management for internal benefit to the firm. It is a requirement of corporate governance that banks have internal dictatorial procedures that address their objectives (Lee & Shailer 2008). For instance, banks should have in-house policies that define their operational efficiency, financial reporting, compliance with legal requirements, and efficiency of production (Valentin & Vitaliy 2006). The in-house auditors also ensure that the interior control mechanisms are functional and that financial reports are accurate. Thirdly, internal regulation mechanisms also direct that the CEO be completely independent of the treasurer. This strategy warrants checks and balances between the two senior officials and hence the witnessed accountability and success of the banking institutions.

On the other hand, external corporate governance control mechanisms affirm the indulgence of external stakeholders in monitoring the excesses of the financial institutions (Rehman & Mangla 2012). To begin with, external control mechanisms involve the actions of competitors. Competitors monitor and provide a point of comparison for companies in making decisions, for instance, decisions on prices, customers, and markets. Secondly, the demand for financial statements by the government and other regulatory authorities provides a point of the external regulation mechanism. Financial institutions will always act responsibly while knowing that an external body will audit and verify their reports. Thirdly, government regulations are another powerful form of external monitoring (Holton 2006). Through laws and parliamentary rulings, the government of the land directs and oversees the running of businesses within its jurisdiction. Finally, the media is always on the watch over the conduct of banks. Any unethical conduct or exemplary performance receives coverage either in positive or negative light. This awareness ensures accountability in the financial companies.

Conclusion

As discussed above, corporate governance may contribute to higher standards of responsibility and industry performance in the banking industry. This claim has been explored through various theories that define corporate governance guidelines and commercial laws at federal and state levels. The stakeholder and stewardship theories have been discussed in detail to support the above claim. The paper has also recommended corporate control mechanisms that boost performance in the banking sector.

References

Erturk, I, Froud, J, Johal, S & Williams, K 2004, Corporate Governance and Disappointment, Review of International Political Economy, vol. 11, no. 4, pp. 677-713.

Holton, A 2006, Investor Suffrage Movement, Financial Analysts Journal, vol. 62, no. 6, pp.1520.

Hovey, M & Naughton, T 2007, A Survey of Enterprise Reforms in China: The Way Forward, Economic Systems, vol. 31, no. 2, pp. 138156.

Jizi, M, Salama, A, Dixon, R & Stratling, R 2014, Corporate Governance and Corporate Social Responsibility Disclosure: Evidence from the US Banking Sector, Journal of Business Ethics, vol. 125, no. 4, pp. 601-615.

Khalid, M 2011, Ethical Theories of Corporate Governance, International Journal of Governance, vol. 1, no.2, pp. 484492.

Lee, J & Shailer, G 2008, The Effect of Board-Related Reforms on Investors Confidence, Australian Accounting Review, vol. 18, no. 45, pp.123-134.

Madison, W, Gregory, J, Friesen, M & Horner, E 2015, International Banking Regulators Propose Revised Corporate Governance Principles: Reinforce Board Responsibilities for Risk Oversight and Governance Culture, Journal of Taxation & Regulation of Financial Institutions, vol. 28, no. 4, pp. 51-55.

Rehman, R & Mangla, I 2012, Does Corporate Governance Influence Banking Performance?, Journal of Leadership, Accountability & Ethics, vol. 9, no. 3, pp. 86-92.

Valentin, Z & Vitaliy, Z 2006, Corporate Governance and Firms Efficiency: The Case of a Transitional Country, Ukraine, Journal of Productivity Analysis, vol. 25, no. 1, pp. 143-157.

Williamson, E 2002, The Theory of the Firm as Governance Structure: From Choice to Contract, Journal of Economic Perspectives, vol. 16, no. 3, pp. 17887.

Appendices

Australian Banking Sector Statistics

No. Of Banks (AB500)	Totals Assets (US$ billion)	Regional Bazaar Share (%)
14	2388.6	8.67

Source: Madison et al. (2015)

The Role of the Board of Directors

*Boards of Directors. Source: Madison et al. (2015)*

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