Case Study Analysis: Ethical Management and Corporate Governance

The assignment content discusses the factors contributing to business failures in Australia, specifically citing three cases: OneTel, HIH Insurance, and ABC Learning. It highlights how management's wrong decisions, lack of accountability, and poor corporate governance led to these failures. The research emphasizes the importance of ethical management, improved corporate governance, and strengthened internal controls. It also notes that measures have been taken in Australia to address these issues, such as the Corporations Act 2001 and CLERP reforms. The assignment concludes that prudent corporate governance measures can help prevent business failures.

FINANCIAL ACCOUNTING

Financial accounting
Executive Summary
In wake of rising incidents involving corporate liquidation, the objective of the report is to
critically analyse the exact reasons that are contributing to this disturbing trend. One of the key
reasons often attributed to bankruptcy is the presence of huge liabilities which become so large
that the underlying asset cannot sustain the same. However, the report aims to present summary
findings on some of the recent corporate liquidation cases in Australia to explore the real causes
of liquidation. At the time of their failure, the immediate reason was quoted as the high liabilities
which far outlined the available assets but later investigative reports indicate at how lack of
sound corporate governance, unethical management, nexus with auditor coupled with fraudulent
corporate reporting were responsible for the liabilities to swell so much. Based on the
identification of exact cause, recommendations have been offered to companies to improve
auditor independence and corporate governance norms.
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Table of Contents
Introduction.................................................................................................................................................4
Analysis.......................................................................................................................................................4
Mismanagement Issues – A common observation........................................................................................7
Recommendation.........................................................................................................................................8
Conclusion...................................................................................................................................................9
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Introduction
The incidence of corporate failure is on the rise and in order to retain the confidence of the
investors it becomes imperative to analyse the underlying reasons and thereby provide
recommendations to avoid future bankruptcies. On the surface, the trigger for bankruptcy and
subsequent liquidation is essentially the outstanding liabilities whose quantum far exceeds that of
the available asset. However, the real cause in most of cases lies elsewhere which actually leads
to the problem of the liabilities increasing to such an extent. Very rarely is this a short term
phenomenon and usually the business inches towards bankruptcy in the long run. In order to
analyse the role of liabilities in corporate bankruptcy, some actual corporate bankruptcies
witnessed in Australia have been analysed so as to bring clarity on the matter besides offering
recommendations for the future.
Analysis
In order to analyse the given problem, three cases have been selected to shed light on the various
aspects that led to bankruptcy and to narrow down any common aspect which is noticeable in
each of these cases. The three companies are ABC Learning, HIH Insurance and One Tel which
essentially belonged to different sectors and have undergone bankruptcy in the first decade of the
21st century.
Case 1 - ABC Learning
The company came into existence in the late 1980’s but post listing on the ASX, it shot into
prominence owing to the ambitious plan for expanding the reach. In a short time period only, the
company was able to scale the spread of ABC centres across various geographies in a bid to
deliver superior returns to shareholders. However, the expansion strategy had one crucial flaw
which was in the form of lowering service quality as the management seemed so obsessed with
scaling the reach that quality took a back seat. As a result, the very strategy that was to deliver
superior returns for shareholders destroyed their wealth (CPA, 2012).
Case 2- HIH Insurance
The business started operations in 1968 but the growth phase of the company happened only post
1990. The company acquired a number of companies as it not only enhanced the geographical
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presence but also the insurance products on offer. The net result of this strategy was that by the
turn of the century, the company had more than 100 subsidiaries with foray in different insurance
segments coupled with geography. However, the company became bankrupt owing to the huge
insurance contracts related liabilities. But, details revealed later clearly indicate that these were
on account of imprudent risk management practices and concealing of the same through quid pro
quo relation with the external auditor. This ensured the continuance of faulty business practices
to such a period when there was no turning back (Mak, Deo & Cooper, 2005).
Case 3- One Tel
The company emerged as a prominent telecom player before filing for bankruptcy on account of
huge business losses. However, this was not sudden and could be attributed to faulty sales
penetration policy which led to huge losses which were then concealed through shoddy corporate
reporting practices. To the external users, only the rise in market share and the subscriber base
was highlighted and the losses were not reflected. As a result, the company management
continued with the aggressive expansion policy which essentially contributed to the losses which
became so large and eventually sustainable leading to company filing for bankruptcy (Monem,
2009).
Research
Causes of liquidation- ABC Learning
When the company listed, it started expanding the presence of centres and announced an
expansion plan which the management implemented with success and the stock price rose.
However, in a bid to expand, the management lost the major strength of the company which was
the quality of services. There was in increase in the complaint level which was faced due to lack
of staff and hence the reputation of the company suffered. However, the management did not
address these issues (Arens et. al., 2013). The sole concern of the management was to carry
ahead with setting up more centres without considering the falling service standards and the
overall impact on the brand. The company also acquired certain businesses so as to provide an
entry into new markets. However, this intrinsically incorrect business strategy essentially
backfired when the financial crisis began and the company had to file for bankruptcy (Kaplan,
2011). The downfall of the company could be attributed to the falling quality standards, shifting
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customer loyalty coupled with lapse in corporate governance issues and corporate reporting. An
instance of shoddy corporate governance practice relates to favour in terms of lucrative
maintenance contract and sponsorship being extended to a relative of a particular director. These
instances lead to fall in investor confidence and filing of bankruptcy (CPA, 2012).
Causes of liquidation- - HIH Insurance
The company after the humble beginning made attempts to expand the business of the company
through expansion strategy post 1990. With regards to business expansion, there is always the
increased risk which need to be taken into consideration and the management is expected to take
prudent actions to keep liabilities within control. However, the management at HIH insurance
did not manage the risks and had to pay the price for this huge expansion by declaring
bankruptcy (Mak, Deo & Cooper, 2005). The insurance business is inherently risk and the
various steps should be taken by the management taking into cognizance the associated business
risk (Gay & Simnett, 2012). However, this is found missing here as for enhancing the customer
case in a new market (USA), the premiums were kept at so low level that the underlying risk
become very high and thus, huge losses were sustained which could have been avoided through
prudent management action. Besides, the acquisition strategy of the company was also flawed as
apparent from the acquisition of FAI where due diligence was lacking and high premium was
paid which put further strain on the business (Mirshekary, Yaftian & Cross, 2005). Further,
instead of following the provisioning norms for limiting underwriting risk, the management
adopted the more risky and unsustainable reinsurance model and ventured into insurance of
planes and ships which Is considered higher risky. Also, on account of quip pro quo relation with
the external auditor, these glaring efficiencies were never brought to light and hence bankruptcy
was inevitable for the company (Mak, Deo & Cooper, 2005).
Causes of liquidation - One Tel
The key deficiency with One Tel was also a flawed management decision to expand business
which taking the bottomline into consideration and then using the shoddy reporting practices and
internal controls to hide the impact of these. As a result of the falling standards of corporate
reporting, the internal and external decision making suffered since the financial statements could
not be trusted. A contributory factor to this was that the internal controls were compromised by
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the top management and information was only selectively captured. The interest of the
management only was solely on the subscriber base increase without considering if the
shareholder wealth is being created by this practice or not. The losses arising from this strategy
were concealed so that no external user could object (Gilbert, Joseph & Terry, 2005).
In relation to financial performance reporting, the comparison drawing was virtually impossible
in an environment where the accounting policies had become so volatile. The sole concern for
the choice of the accounting policies was that a stable performance could be presented to the
shareholders which provide support to the share price. Hence, there was frequent switching of
the applicable accounting policy so as to suit the agenda of the management and they had
absolute control on the results reported as the independence of the external auditor was severely
compromised. As a result, the faulty policies continued unabated amidst falling corporate
governance norms and the only way for this to stop was the losses to become so huge that it
virtually becomes impossible to conceal leading to bankruptcy which is what essentially
transpired (Monem, 2009).
Mismanagement Issues – A common observation
A common theme which is observable in all the above bankruptcy cases is the failure on part of
the management in terms of wrong business strategy and then taking inappropriate (and at times
illegal) measures to conceal the disastrous results of the same.
Take for instance, ABC Learning where the management focus was essentially restricted only to
expansion without taking requisite measures to stop the downfall in quality. It should have been
obvious to them that such a strategy was not sustainable as essentially this would lead to erosion
of brand, reputation and profits. However, the management made no attempts to rectify the issue
at hand and instead compounded the problem by concealing the effect of such a policy. As a
result, there was systematic deterioration of the financials which the management was aware but
the failure on their part was the prime reason for the liabilities becoming so huge that liquidation
was the only choice left for the company (Bhagat & Bolton, 2008).
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For HIH Insurance, the ambitious expansion policy with minimal risk containment led to the
downfall of the company. The management desired to venture into highly risky avenues in the
insurance business and deployed aggressive premium pricing on one hand while on the other
their risk management strategy was inherently wrong and inconsistent with the industry practice
of deploying provisioning norms. Further, the decisions were taken without adequate
consultation and due diligence and the impact of the same were concealed with the help of
compromised independence of the external auditor. As a result, the business became a virtual
time bomb and eventually exploded resulting in business liquidation (Mirshekary, Yaftian &
Cross, 2005).
Further in relation to One Tel also, a similar observation can be made where an expansion of
subscriber base was implemented in manner which led to huge losses but the management made
no attempts to alter the strategy and instead tried to portray the strategy as a success. This
ensured that they continued with the policy which eventually led to mounting losses and
subsequent business failure (Brown & Caylor, 2009).
Recommendation
The research that has been conducted using the three companies clearly indicate that the business
failure is not the result of mounting liabilities but rather the wrong decisions taken by unethical
management which have continued with the faulty practices for long by compromising the
corporate reporting and corporate governance measures. Hence, the emphasis needs to be on
ethical management for which the accountability of the top executives needs to be fixed which to
an extent has been catered to by the enactment of Corporations Act 2001 which enlists the
directors’ duties and also imposes punishment for violation of these (Arens et. al., 2013). Also,
the improvement in corporate governance is essential so that the corporate disclosures and
internal control mechanism can be strengthened. Two essential parameters in this regards are
expanded role of non-executive directors and also ensuring the independence of the external
auditor (Gay & Simnett, 2012). This would go a long way in ensuring that bankruptcy is not
caused as the faulty business practices are brought to light on time. In the Australian context,
measures have been taken to ensure the above two through CLERP reforms (Clout Chappelle &
Gandhi, 2009).
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Conclusion
In accordance with the above discussion, that the actions of the management coupled with weak
corporate governance norms seem to be responsible for the bankruptcy of business. This is the
reason which effectively leads to mounting liabilities and eventually liquidation of business. The
management strategy pursued in all the discussed cases was driven by the short term purview
and did not aim at creating long term value for the shareholders. Also, the weak corporate
governance norms and internal controls allowed the management to collude with the auditor
leading to the concealment of all wrong policies till the time the losses become very huge.
Prudent corporate governance measures coupled with higher auditor independence and higher
accountability of directors would ensure that the incidence of these frauds tends to decrease and
various steps have been taken by the government and regulators in this regard.
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References
Arens, A., Best, P., Shailer, G. and Fiedler,I. (2013). Auditing, Assurance Services and Ethics in
Australia, 2nd eds., Sydney: Pearson Australia
Bhagat, S. and Bolton, B. (2008), ‘Corporate Governance and Firm Performance’, Journal of
Corporate Finance, Vol.14, No.3, pp. 257-273.
Brown, L and Caylor, M. (2009), ‘Corporate Governance and Firm Operating Performance’,
Review of Quantitative Finance and Accounting, Vol. 32, No. 2, pp. 129-144.
Clout, V, Chappelle, E and Gandhi, N (2013), ‘The impact of auditor independence regulations
on established and emerging firms’, Accounting Research Journal Vol. 26, No. 2, pp. 88-108
CPA (2012). ABC learning collapse case study., CPA Website, [online ] Available at
https://www.cpaaustralia.com.au/professional-resources/education/abc-learning-collapse-case-
study [Accessed September 14, 2017]
Gay, G. and Simnett, R. (2012), Auditing and Assurance Services in Australia, 5th eds., Sydney:
McGraw-Hill Education
Gilbert, W., Joseph J. and Terry J.E (2005), ‘The Use of Control Self-Assessment by
Independent Auditors’. The CPA Journal, Vol. 3, pp. 66-92
Kaplan, R.S. (2011). ‘Accounting scholarship that advances professional knowledge and
practice’. The Accounting Review, Vol. 86, No.2, pp. 367–383.
Mak, T., Deo, H. and Cooper, K. (2005), ‘Australia’s Major Corporate Collapse: Health
International Holdings (HIH) Insurance ‘May the Force Be with You’, Journal of American
Academy of Business, Vol. 6, No.2, pp. 104-112.
Mirshekary, S., Yaftian, A. and Cross, D. (2005), ‘Australian Corporate Collapse: The Case of
HIH Insurance’, Journal of Financial Services Marketing, Vol. 9, No.3, pp. 249-58.
Monem, R. (2009), The Life and Death of OneTel, Griffith University, [online] Available at
http://www98.griffith.edu.au/dspace/bitstream/handle/10072/42673/74746_1.pdf [Accessed
September 14, 2017]
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