Corporate Governance: Assurance Function and Financial Fraud

This report delves into the critical relationship between the assurance function and corporate governance, emphasizing their role in preventing financial fraud. It begins by establishing the importance of corporate governance in the modern business environment, highlighting the various stakeholders involved and the need for ethical practices. The Enron scandal serves as a detailed case study, illustrating the devastating consequences of corporate malfeasance and the failure of governance mechanisms. The report examines the scandal's impact, including the downfall of Arthur Andersen and the subsequent enactment of the Sarbanes-Oxley Act. It then defines the assurance function, explaining its purpose in providing stakeholders with reliable information and ensuring compliance with regulations. The report emphasizes the independence of assurance providers and their role in conducting financial audits. The report concludes by underlining the importance of corporate governance and the assurance function in protecting stakeholders from financial fraud and ensuring the integrity of financial reporting. The report highlights how these functions provide a balance between stakeholders, management, and directors, and empowers shareholders with the right to access information regarding an organization's financial conditions.

RELEVENCE OF ASSURANCE FUNCTION AND CORPORATE GOVERNANCE
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Contents
Introduction................................................................................................................................3
Body...........................................................................................................................................4
Conclusion................................................................................................................................12
Reference List..........................................................................................................................13
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Introduction
The importance of corporate governance in the modern day corporate set up is of huge
importance. Corporate governance is basically the various sets of rules that guide the
management of the corporations. Corporate governance has various components which deal
with various aspects of the management of a corporation. The principles of corporate
governance takes into consideration the interest of the various components of a corporate set
up. The various components of the modern day business are the shareholders, management,
supplier, financers, government and the immediate community of the business. Corporate
governance principles guide all these components and make sure that each of them is
satisfied. As we can see from the set up that the modern businesses are such formed that the
money of an entity is utilised by another set of people to conduct the business. Such set ups
are especially risky because in case of lack of accountability the mistake of one set of people
is capable of harming many people in terms of money. Thus the importance of clear and
ethical corporate governance rules is of high importance. Various incidences and
malfunctions prove such points more clearly. The Enron scandal has been one eye opening
experience of the level of the magnitude of mal practice and the number of people who are
impacted by that. Enron has been one of the largest financial frauds till the year 2011 in
United States of America. The amount of asset involved in this was an astonishing $ 63.4
billion. This has made the security and exchange commission to close the business of
partnering audit firm. This incidence has also triggered the formation of legislation like the
Sarbanes-Oxley Act.
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Body
The Enron Scandal
The corporate governance and its importance can be understood properly with a proper
illustration of the Enron scandal. The Enron Corporation was formed in the year 1985 when
two companies Houston natural gas and Inter North was merged. Kenneth lay was the person
responsible for this successful merger. This merger helped the company Enron to sell energy
at a good rate contributing to a higher amount of revenue for both the company. In the year
1992 Enron became the largest company in the energy sector (Harford et al. 2012). The
financial auditing of the company was done by a large accountancy firm called Arthur
Andersen. The company utilised various loopholes in the accounting system to hide money
from its debt account and was able to show that they were in a good position which has
helped the company to gain investment which it didn’t had the capacity to pay back. Not only
were they unable to pay back they also spending the money thus earned relentlessly by
providing a large fund to its executives to utilise. Thus they were able to keep employees. the
company even though they were having poor financial performance in generating profit they
were also making loss in most of the ventures they were able to attract large number of
investment just with the help of false information.( Fan et al. 2007) They used to release their
earning statement each year without their balance sheet. They were the only company who
were trading their stocks at a price which was 55 times of the amount that they were earning.
The Enron financial scandal not only destroyed the company it was also the reason for the
death of the Arthur Andersen audit firm. Arthur Andersen was one of the largest audit firms
counted among the first 5 largest audit firms in the United States. The management of the
company also convinced the financial firm to approve their faulty method of accounting.
Later cases proved that Enron management rather used force to make Arthur Andersen to
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sign the paper. The Enron used a complicated method of accounting called the mark to
market accounting this method of accounting made the entire process so complicated that it
was difficult for the investors to understand the document ( Dittmar & Mahrt-Smith 2007).
They increased asset and in no time gave recognition to earnings from those assets even
though the assets had not started to operate. The board of directors were also misled by the
management of the company. Later it was also proved that the board of director also complex
accountancy knowledge to be able to recognise the fraud. This can also be the case that the
board of director trusted the management blindly and practiced negligence in rechecking the
information that was provided by the management of the company. The company also
counted the amount of money spent on projects which got cancelled under the asset head
(Nelson et al. 2008). But the complexity of the method of accounting made it difficult to
catch them early enough.
The stock prices of Enron kept on rising from since the year 1990. The increase of stock price
from 1990 to 1998 was as high as 311 per cent. In the year 2000 the cost of each unit of stock
in the market was $ 90.75 and in the next by the month of October the share prices fell to .67
percent (Azibi et al. 2011). This is the time period that the security and exchange board
sniffed some malpractices in the accounting of the company and as a result probed an enquiry
the enquiry resulted in the exposure of the corrupt accounting practices in the corporate
business.
They didn’t only indulged in corruption but also tried to hide the corruption by destroying
evidence. The management of the corporation destroyed numerous documents to hide the
malpractices of the company (Matoussi & Jardak 2012). Their audit partner Arthur Andersen
also destroyed document evidences as well as countless emails exchanged between the
companies to hide the corruption. Eventually the security and exchange board abolished the
licence of the audit firm and the Enron was facing a 40 billion US dollar lawsuit (Ailon.
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2011). The 40 million dollar lawsuit was brought against the company by its shareholders.
The Enron Corporation faced bankruptcy after they were unable to get a merger with another
corporate. The assets of the company was used to pay back the debts of the company and also
used to pay back the investors of the company. But large numbers of the shareholders were
unable to receive back their investment.
Formation of Corporate Governance Legislation
Sarbanes Oxley act was devised as an answer to the Enron scandal. The government decided
a meeting between the senate committee responsible for this sector along with the housing
committee on financial services. The committee after taking detail information of the
methods of fraud conducted in this case devised an act which counters the kind of fraud
committed in this case. This act established an independent board called the public company
accounting oversight board (Abbott et al. 2007). The chief function of this board was to make
sure that accounting standards followed by various organisations are uniform. This act also
made sure that the auditing firms are free and independent bodies and were not in any sort of
tie up with the company that they are auditing. The SEC also formulated some rules for the
stock exchange board. Some of the points of the suggestion of this board are; each company
should have directors who operate independently of the organisation, there are criteria for
being an independent director which is a elaborate statement all the points of the criteria has
to be fulfilled by the person who shall be appointed as an independent director, each of the
committee for compensation nomination or audit shall have such directors, financial literacy
was mandatory for people who are in the audit committee and the board shall also have
sessions where there will be no interference from the management of the company (Coates,
2007).
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Assurance Function as a protection in Financial Fraud Cases
Assurance function is a portion of corporate governance. The main objective of assurance
function is to provide proper information to the stakeholders’ regarding the various policies
and operations of the company. It is also mandatory according to assurance function to
provide information to the stakeholders which are of current date. The assurance is the
function of the management of the company. The various legislations that are formulated
following the incidence are called statutory obligations such obligations have to be followed
by the management of any corporation (Zhang, 2007). Evidence regarding the proper
compliance has to be presented to the stakeholders. The reason for the formation of assurance
is to make sure that the stakeholders can take decision on the basis of clear and correct
information which will probably enhance their chances of making correct decision. The
assurance services are provided by an independent chartered accountants/certified public
accountants/chartered certified accountants. It is mandatory that the assurance service is
provided by a body which in no means in relation with the corporation that they are dealing
with. The key of the assurance services is its independence. The assurance services can also
be taken for only the purpose of reviewing a single document as well which can be classified
under a financial document like a financial transaction, loan transaction, a financial website
or any sort of contract. Financial audits are an example of assurance services (Engel, Hayes
& Wang 2007). The stakeholders have the right to demand for an assurance service from the
management of a company. The assurance functions in making sure that the companies’
financial health are good and that their accounting systems are standard.
In the Enron case the chief problem arise because of the false accounting practices of the
company. They used false accounting techniques and the investors or stakeholders were not
knowledgeable enough to catch their false claims. The audit firm that was taking care of
reviewing the genuinely of the document was also an accomplice in this case as they were
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long term associates in the business. The assurance is the perfect answer for such kind of
corrupt practice as the assurance function is done by independent bodies and thus it will be
difficult for the management of the company to purchase them illegally. The second thing is
that the bending of the method of accounting would not have been possible because the
assurance function involves making sure that the statutory obligations are being observed in
each of the document. Before the practice of the assurance function the stakeholders and
investors had no other independent body that they could ask help from in finding the fault
(Hu et al. 2010). The lack of financial knowledge of the board of directors responsible for the
internal audit was also taken by the management of the company. The assurance has also
become a tool for the board of directors that they can use to counter such practices.
Importance of Corporate governance as a protection in Financial Fraud cases
Assurance is one particular function of the corporate governance. The corporate governance
includes various functions. In generic terns it can be stated that the corporate governance
aims at creating a balance among the interest of the shareholders, management, supplier,
financer etc. In the Anglo-US model of corporate governance there are 3 components that are
the shareholders, management and directors (Kwon et al. 2012). The only method of
interaction between shareholder and the other 2 bodies are done in the annual general
meeting. The annual general meeting is the only time during which the stakeholders come to
know about the financial condition of the company in which they have invested their money.
The explanation that the management provides the board of directors is explained by the
board of directors to the stakeholders. The money of the stakeholders are thus in the hand of
the management and the stakeholders. Thus the corporate governance model gives enough
power in the hand of the shareholders. They have the right to ask for information regarding
the financial condition of the organisation. They also can ask for any kind of external auditing
in case they are not satisfied with the information provided by the management. The
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stakeholders have the right to ask for assurance services and audit their company. They can
also remove anybody they think are indulging in any sort of malpractices in the organisation.
There are various ethical and political issues that are part of the corporate governance of the
company. Factors like corporate social responsibility and situation ethics is also a huge part
of the corporate governance.
The impact of corruption has been studied in detail through various examples yet it is highly
complicated to address because of its complicated nature. It is difficult to pin point its exact
nature. It can be of various types like reducing the value of following laws, to restrict growth,
delaying possible developments etc. In the current picture of corporate governance as
mentioned before the responsibilities are well demarcated. The contribution of the
shareholders in corporate governance is to appoint members of the board of directors and
auditors, the formulation of the aims of the company and taking proper account of the
management of the company is done by the board (Simnett, Vanstraelen & Chua 2009). The
management is responsible for the fulfilment of the aims that are set by the board of director
through free and fair practices. There are 4 corporate governance principles that ought to be
present i the company so that these three pillars of the corporation can function with
smoothness. These 4 principles are transparency, accountability, fairness and responsibility. It
is responsibility of the management to clearly state the confirmation of the utilization of the
fund to the board and the board should clarify that to the stakeholders of the company this is
the function of transparency. The board of director should be held accountable for their
decisions. The principle of accountability is very important as it makes the board to take
judicious decisions. The third pillar of fairness denotes that the members of the board of
directors should give equal importance to each shareholder and not give preference to anyone
for personal biases. The management is also to be fair in executing decisions and not form
any sort of tie up with any member of board or form groups (Kolk, 2008). Responsibility is
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the fourth principle according to which the management or the board should conduct their
work with integrity. Good corporate governance in a mandatory thing especially for
companies that use external capital with complex ownership system. The chief function of
good corporate governance is to enhance the ethical practices in a corporate set up.
Corporations with standard ethical conduct are capable of making contribution on financial
benefit of the company. Various studies have been conducted in US to check whether ethical
practices have any direct contribution in the profit of the company. A study conducted by
Deutsche bank has proved the fact that there is a correlation (Crane & Matten 2016). This
study stated that companies with strong ethical practices in their corporate governance has a
chance of having more than 19 per cent advantage over the companies with less standard
ethical practices.
Ethics in corporate governance and its contribution in anti corruption
Ethics is also a strong component of corporate governance. As stated before there are various
governance rules that are being formulated for fighting corruption. But maintain ethical
standard from the top to down level contributes significantly in creating that edge which
makes a company really successful. The businesses are now mostly global in nature and as a
result it has often been observed that there is not only expectation but pressure from the
market to implement strong ethical code of conduct in the corporate governance of the
company. Each company according to their own standard or practice along with the country
of operation sets standards for developing code of ethics as a part of their corporate
governance practice (Freeman et al. 2010). There are various markets that won’t accept
business with companies that do not follow standard ethical practices.
The implementation of the ethical code of conduct in the corporation follows three steps. The
first part of it involves formation of a written code of ethics which has to be formulated in
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consultation with the stakeholder. An ethics officer has to be appointed to whom all the
reporting has to be done and all documents will be produced. The second level is to take
opinion of people who are not directly involved with the company. External stakeholders will
also be consulted as a part of the second level of implementing the ethical standards. The
third steps involve the initiation of the leaders in developing collective activity against
corrupt practices.
Stakeholder Theory and its relevance in fighting corruption
The stakeholder theory defines the stakeholders more elaborately. The stakeholder theory
recognises various stakeholders including the public as well as the competitors. Thus the
stakeholder theory adds more responsibility on the corporation by increasing the number of
stakeholder at the same time this theory makes it easier for more number of people to
question the function of the company (Laplume, Sonpar & Litz 2008). The Enron fraud case
shows the level of impact that the corruption of one company has on the stakeholders. As
discussed before various legislations have been formulated because of this case which has an
impact on the competitors of the company as well. Thus the stakeholder theory is proved by
this case. So in such scenario the competitors also develop a right to question ethical
corporate governance of a company.
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Conclusion
To sum up it can be said that the Enron scandal has been a landmark event that has made the
various corporate and legislators to consider the importance of corporate governance. The
Enron has impacted the various stakeholders to a huge extend. The business world was
shocked to know the level of incompetency that exists among the board of directors and its
immense financial impact. This case became the reason for formation of legislative acts like
the Sarbanes Oxley act. This act was a legislative action in the formation of corporate
governance principle to counter malpractices of businesses. Each of the opening that was
utilised as a means of corruption in the Enron scandal was countered through this act. The
importance of assurance functions can be understood in such cases. The assurance functions
if properly done could have been affective in saving the amount to harm that this case was
responsible for. To sum it can be said that ethical corporate governance has taken the modern
shape from experiences like Enron.
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