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Pre-empting the drift towards business disaster

Management needs to put greater faith in independent and frequent audits that are done in detail

Gulf News

By Tariq Chauhan, Special to Gulf News

When analysing the root cause of any corporate debacle, it is not fair to focus upon the management’s actions alone but to make a holistic review of the firm’s “governance ecology”, as no outcome can be contemplated without understanding the structural reasons for the failure.

The role of the board of directors, internal controls, statutory audits and regulatory oversights are all components of the governance ecology and their relative impacts also need to be scrutinised.

How has board functioned over the years? Were audits conducted? How did the negative results and management undoings — if any — not come under corporate governance scanners?

Any diagnosis of these outcomes often gets mired in a blame game, which unfortunately take the focus away from its containment and resolution. These forgone assumptions should be avoided as they undermine the efforts of stakeholders to contain crises and to apply the learnings from the failings.

Wisdom demands that when such events unfold, it is essential for stakeholders to have an unbiased look at the state of corporate governance regime in a company to identify how these internal controls were circumvented and the compliance framework compromised.

The board must introspect on its complacency — if not its failings — should things go wrong. Shareholders usually lay the foundation of robust business management, defining the rules of engagement for the board’s structure, mandate and functioning.

For any corporate failure, one must deep dive to see if the board adhered to the governance guidelines and exercised sufficient diligence in management representations. Especially the role of independent directors over the years, which is now magnified as this significantly strengthens governance. Their independence is imperative to the company’s overall interests.

When undertaking a diagnostic review of financial statements, understand the application of the governance policy on the treatment of doubtful/bad debts, compliance with principles of revenue recognition, and potential impairment of receivables.

Did the board just follow the formality of ticking the checklist, thereby establishing their own complicity in faulty decision making? Or did the board function in line with guidelines in all its deliberations and the decision making formalised and recorded?

An independent audit provides another corporate governance limb to safeguard companies. This process seems to have been strengthened with the enforcement of International accounting standards promoting transparency and standardised disclosures. However, a fundamental issue remains.

There is a need to move away from practice of a random sample approach and instead employ forensic tools to ensure closer scrutiny of large ticket transactions in balance-sheets. Audits need to take a saner view of how the company’s management has treated the key accounting provisions that can have material impact on financial statements. In some of the recent corporate failures, this aspect has been called into question. This can easily be avoided should the audits adopt appropriate caution. Auditors must seek satisfactory explanation to the various provisions and ensure any concerns are directly discussed with the audit committee and/or board level.

The role of internal audits is often understated although it should be the one raising the red flag at an early stage of any corporate disaster in the making. Not necessarily review them as a whistle-blower, but ensure the management follows due processes.

The internal audit must rise above controls to ensure the accounting rises above book-keeping and balancing to fundamentals of prudence.

Finally, the role of the regulator oversees the whole of the corporate governance function to be an important player in safeguarding shareholders. Regulators have the power to establish rules of engagement, monitor compliance, investigate breaches and make recommendations to penalise offenders in both a corporate and personal capacity.

Irrespective of whether it is a public or private joint stock company, this role is vital and assumes centrestage in times of any corporate turbulence and has the power to step in to protect shareholder interests. It is therefore fair to rewind to look at how regulators review the various submissions and were there were any material violations.

If so could they have stepped in to take a more engaging role to correct the course at the business?

Businesses are jostling to maintain continuity and profitability while regulators and governments are debating to improve governance. But what is fundamentally needed is to strengthen the principles of business prudence and self-accountability.

Tariq Chauhan is group CEO of the EFS Facilities Services Group.

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