Question

Define Corporate Governance. Elaborate on the measures to prevent fraud in line with the

Sarbanes-Oxley Act.

Answer 1

Corporate governance is the collection of mechanisms, processes and relations by which corporations are controlled and operated. Corporate governance includes the processes through which corporations' objectives are set and pursued in the context of the social, regulatory and market environment. These include monitoring the actions, policies, practices, and decisions of corporations, their agents, and affected stakeholders. Corporate governance practices can be seen as attempts to align the interests of stakeholders. Interest in the corporate governance practices of modern corporations, particularly in relation to accountability, increased following the high-profile collapses of a number of large corporations in 2001–2002, many of which involved accounting fraud; and then again after the financial crisis in 2008.

The Sarbanes-Oxley Act is a federal law that enacted a comprehensive reform of business financial practices. The 2002 Sarbanes-Oxley Act aims at publicly held corporations, their internal financial controls, and their financial reporting audit procedures as performed by external auditing firms. The act was passed in response to a number of corporate accounting scandals that occurred in the 2000–2002 period. This act, put into place in response to widespread fraud at Enron and other companies, set new standards for public accounting firms, corporate management, and corporate boards of directors.

A large scandal involving the public company Enron showed the American public and its representatives in Congress that new compliance standards for public accounting and auditing were sorely needed. Enron was one of the biggest, and, it was thought, one of the most financially sound companies in the U.S.

Enron, located in Houston, Texas, was considered one of a new breed of American companies that participated in a variety of ventures related to energy. It bought and sold gas and oil futures, built oil refineries and power plants, and became one of the world's largest pulp and paper, gas, electricity, and communications companies before it filed for bankruptcy in 2001.

Several years before Enron’s bankruptcy, the government had deregulated the oil and gas industry to allow more competition, but deregulation also made it easier for companies to act fraudulently. Enron, among other companies, took advantage of this situation.

The various misdeeds and crimes that Enron's officers and employees committed were extensive and ongoing. Particularly damaging misrepresentations produced inflated earnings reports for shareholders, many of whom eventually suffered devastating losses when the company failed. Many other instances of dishonesty and fraud also occurred, including embezzlement of corporate funds by Enron executives and illegal manipulations of the energy market.

The Sarbanes-Oxley Act

To cut down on the incidence of corporate fraud, U.S. Senator Paul Sarbanes and U.S. Representative Michael Oxley drafted legislation known as the Sarbanes-Oxley Act (SOX). The intent of SOX was to protect investors by improving the accuracy and reliability of corporate disclosures in financial statements and other documents by:

• Closing loopholes in accounting practices
• Strengthening corporate governance rules
• Increasing accountability and disclosure requirements of corporations, especially corporate executives, and corporations’ public accountants and auditors
• Increasing requirements for corporate transparency in reporting to shareholders and descriptions of financial transactions
• Strengthening whistle-blower protections and compliance monitoring
• Increasing penalties for corporate and executive malfeasance
• Authorizing the creation of the Public Company Accounting Oversight Board (PCAOB) to monitor corporate behavior further, especially in the area of accounting

In response to what was widely seen as collusion between Enron and public accounting firm Arthur Andersen & Co. concerning Enron's fraudulent behavior, SOX also changed the way corporate boards deal with their financial auditors.

All companies, in accordance with SOX, must now provide a year-end report regarding the internal controls they have in place and the effectiveness of those internal controls.

Although the Sarbanes-Oxley Act of 2002 is generally credited with having reduced corporate fraud and increasing investor protections, it also has its critics. Some analysts have negative views about the degree to which Congress has weakened the act over time by withholding funding necessary to put these reforms into motion and by passing bills that effectively counter the intent of the act. Other critics have opposed the act because it increases corporate costs and reduces corporate competitiveness.