Ethics Leading To Financial Stress Of Companies Essay

Question:

Discuss about the Ethics Leading to Financial Stress of Companies.

Answer:

Introduction:

The selected companies went into liquidation had their corporate governance practices suffering from flaws. The lack of professional competence and the bad governance on the part of senior managers and directors in the organization is often responsible for financial distress. The buying and selling decision and the analysis of assets are entrusted to the young professionals who do not have any experience (Miglani et al. 2015). The model used by them was based on overly simplistic assumptions and they make use of sophisticated models, which was criticized by nobody. The weakness in the corporate governance can lead to the financial crisis of the corporate. Ethics and corporate governance is of critical importance to the success of the company and ignoring can prove to be detriment to the health of the company. This is what happened in the scenario presented below where the companies had misled the stakeholders by malpractising and duping them, which led to the downfall. The business model of the company was not suitable which made them to raise huge amount of debt and ultimately unable to clear it off and calls for their liquidation (Cheng and Seeger 2012).

Case of ABC learning

ABC learning was one of the world’s largest childcare providers and its spectacular fall was attributable to the ignorance of the fundamentals of sound accounting. The company was delisted from the stock exchange and the creditors decided to wound up the company in 2010. The profits reported by ABC learning had posed a question to the accounting practices it followed. The company left behind a debt of about $2 million when it collapsed and it was accused of misleading the share market regarding the revenue it booked and used cheap debt facility to make a rapid expansion in Australia, US, UK and Newzealand. The company had some quality issues in the education imparted in the centre beside the problem of acquiring the whole market. The degradation in the quality of education provided was because of the inadequate staffs. In addition, the percentage of revenue attributable to the staffs which was earned by the company was only 56.7%, quite lesser than the nonprofit organization which has 80% (Governanceforstakeholders.com 2016).

The financial statements of the company also suffered from discrepancies. The financial mismanagement is such as acquiring debt more than normal acquisition. The financial information provided by the company suffered from wide discrepancies. The company used malpractices to gain the market. The asset side of the balance sheet of the company comprised of 72% to 81% of the intangible assets, which consisted of various operating licenses, and this license had no value in trading sense of term (Sumsion 2012).

The valuation of operating licenses were used as a platform for attracting traders and investors in the market and therefore raising high value and the company made a false claim on such licenses. The ABC was following malpractices in the course of maintaining the accounts, which leads to fall in the share value. The company revaluated the assets year after year, which did not have any material impact on the company’s financial performance. The revaluation of the assets and its inflated amount duped the investors and send them wrong signal. ABC learning was not able to generate enough cash flows to pay suppliers, dividends to its shareholders, salaries and interest (Kruger 2009).

Case of HIH Insurance:

The HIH collapse was one of the biggest financial collapses in the history of corporate of Australia. The financial depressing of HIH insurance was mainly attributable to the ineffective practice of corporate governance, the risk management system that was inferior and the auditing of the company was questionable. The inferior finance resource management and the poor cash position of the company was responsible for its collapse as it was unable to clear off its debt and to pay the claims to the policy holders of the insurance. HIH had a major investment failure in UK and US.

The flawed corporate governance leading to HIH collapse:

Corporate governance is of critical importance to the company and its failure is one of the reasons leading to the corporate bankruptcy. The practice of corporate governance in the insurance industry presented some odd features such as the policies were not clearly defined and recorded, the conflict of interest could not be recognized and resolved and the system lacked independently analyzing the criticality of the management proposals. For example, the authorities of CEO in some virtually important areas were not clearly defined. The agenda of the board meetings and the evaluations of some senior executives were manipulated so that the CEO was able to control the company and the board. The company was to run in the interest of senior managers rather than at the interest of the shareholders who are the owner of the company. Therefore, it poses a big threat to the model of the corporate governance, that leads the company to go in to the corporate excess and departed the company form the interest of the shareholders. There were negligence on the part of directors to analyze the strategy concerning investment decisions and the failure of the risk management added to the reason of HIH collapse (Duarte et al. 2007).

Another element of the corporate governance system is the accounting system. The accounting system was designed and directed by the management and this leads to the inherent risk. The company had five non-executive directors that are independent directors in the Audit committee or the Board committee. Despite being majority of the independent directors comprising the board, it was not possible for these directors to examine the judgment independently.

HIH seemed to fall short of the requirements such as assurance the effectiveness and independence of the audit committee and ensuing that the independent directors are properly and directly informed about the accounting information. The company suffered from the defect in the independence of non-executive directors who were the part of the audit committee, it was obvious that the functions of the audit committee were doubtful. It was not possible for the independent directors to fulfill their responsibility with due diligence. The corporate governance practice was inadequate and suffered from flaws. The company went in to the provisional liquidity position, as it was not able to pay off its debt. It had an estimated deficiency of around $ 5.3 billion (Mak et al. 2005).

Case of One Tel Phone Company:

One Tel Telephone company was the largest telecommunication company in Australia and its collapse is classic case of strategic mistakes, failed expectations and pricing policy, which were wrong. The major fall of the company was mainly associated with the deficiencies in the practice of corporate governance. The failure of the company served an important lesson relating to the importance of the corporate governance. Poor communication of the board with the management, poor quality of audit, internal control weakness and the scrutiny of the board relating to the management were the reasons attributable to the One Tel phone collapse (Monem 2011).

The company had a strategy of low yield and high risk, which could not sustain in the market of Australia and leads to collapse. The company suffered from low quality of earnings and it was due to manipulation by the management and high proportions of accruals. The company also suffered from operating cash deficits. The financial capability along with the misguided decision of management leads to the collapse of the company. The failure of One Tel was also attributable to the corporate governance practices. The failure on the part of managers and the directors to exercise their power with due diligence, the compensation of management was also inappropriate, audit functioning lacking independence, creative accounting were some of the reasons. The managing director of the company was misleading the shareholders and the market by making a completely wrong statement about the company’s profit that the company is having huge surplus of cash available and is making substantial amount of profits and repeated assurance was given by him regarding the profitability and the cash position of the company. He presented the accounts to others the way he wanted to see. The company reported a loss of amount of $ 291 million and despite this; the directors of the company were receiving the bonus and their basic salary (Prasad 2012).

The system of collecting debt and the state of billing also accelerated the failure of the company. The financial position of the company was presented in a wrong way and the directors mislead the board on this matter. The CFO of the company was not able to spot the discrepancies in the books of accounts. The director of the company did not care about the employees of the company, its shareholders and the privilege information gained by him at the board meeting were used for trading for his own personal gains, and the board was misled regarding the actual cash flow of the company. The financial performance and the position were not properly assessed to detect the adverse material development (Murphy 2012). The system was not monitored and maintained which resulted in the inaccuracy of the financial information, which flows, from the management to the board.

The judgment of the board of director was manipulated as per the choice of the company’s executive directors. The directors made the false public statement, which does not have any factual basis. The directors did not comply with the duties of ASX and the reasons of the collapse was also due to the failure of the management in maintain the cash reserves which would ensure liquidity, failure to establish the system which would lead to the production of the reliable and accurate information, failure of employing qualified finance directors. The directors of the company have breached the corporate governance rule. It had acted in their own personal interest, and did not take any active participation in caring for the shareholders and the benefits of the company. The company collapsed because of the directors who did not employ their expertise to the company’s management. No efforts were taken by them to appraise the system of accounting, which were used to collect and control the payments (Lessambo 2014).

Major factor contributing to the liquidation:

In all the cases of the companies discussed above which collapsed and went into liquidation, they suffered from flawed practices of the corporate governance. The above three companies that is ABC learning, HIH Insurance and One Tel Phone Company was collapsed and the common factor attributable to their fall was the inadequacy of the corporate governance practice which is of utmost importance in determining the success of the company. However, the factor, which contributed to the liquidation of the company, cannot be solely regarded to the liability factor, though the companies had substantial amount of debt to be paid. This was mainly because of the flaws in the accounting system and malpractice by the management of the company, which forms an element of the corporate governance (Kang et al. 2013).

Recommendations:

The companies, suffering from the inadequate corporate governance, needs to change way of dealing with the business and should not focus on gaining the market share as they have shareholders who have invested their money. A competitive board should be created that is capable of independent judgment. The board, which is, created with the support of the independent people and this, would form a structural tool to measure the effectiveness of the Board. The appointment of the shareholders in nominating the members of the board should be enhanced, as this would take into account the structure of the ownership of the company. The policy agenda should disclose the duties and liabilities of the board members. The structure of management should be determined keeping in mind that they are responsible for performing specific tasks relevant to the management decision.

Conclusion:

From the above discussion, it is concluded that the practice corporate governance and ethics is vital to the success of the company. The downfall of the company because of its inability to clear off its debt is related to the accounting system, which is inappropriate and this forms an important element of the corporate governance. Concluding that the liabilities were a major factor responsible for the liquidation would be partially correct, as the way of measuring the liabilities depends on the corporate governance practices. Therefore, the corporate governance and ethics can be regarded as the major factor leading to financial distress of companies.

Reference:

Cheng, S.S. and Seeger, M.W., 2012. Lessons learned from organizational crisis: Business ethics and corporate communication. International Journal of Business and Management, 7(12), p.74.

Duarte, F., Gray, J. and McAllister, G., 2007. Ethics and Social Responsibility in the HIH Collapse: A Dialectical Approach. Corporate Social Responsibility: Theory and Practice with Case Studies, p.97.

Governanceforstakeholders.com. (2016). The ABC of a corporate collapse | Governance For Stakeholders. [online] Available at: [Accessed 21 Aug. 2016].

Kang, H., Leung, S., Morris, R. and Gray, S., 2013. Corporate governance and earnings management: An Australian perspective. Corporate Ownership and Control, 10(3), pp.95-113.

Kruger, C., 2009. Lessons to be learnt from ABC Learning’s collapse.Sydney Morning Herald, p.24.

Lessambo, F.I., 2014. Corporate Governance, Accounting and Auditing Scandals. In The International Corporate Governance System (pp. 244-263). Palgrave Macmillan UK.

Mak, K., Deo, H.N. and Cooper, K.A., 2005. Australia's major corporate collapse: Health International Holdings (HIH) Insurance" May the force be with you".

Miglani, S., Ahmed, K. and Henry, D., 2015. Voluntary corporate governance structure and financial distress: Evidence from Australia. Journal of Contemporary Accounting & Economics, 11(1), pp.18-30.

Millmow, A., 2004. ONE. TEL, Once Told [Review of the book Rich Kids][Book Review]. Australian Universities' Review, The, 45(2), p.41.

Monem, R., 2011. The One. Tel collapse: lessons for corporate governance.Australian Accounting Review, 21(4), pp.340-351.

Murphy, D., 2012. Corporate Governance: The Conflict Between Money and Morality. Hong Kong LJ, 32, p.233.

Prasad, V.H., 2012. Ethics and Auditing: An International Perspective.International Journal of Finance and Accounting, 1(4), pp.63-68.

Ross, P., Sy, A. and Tinker, T., 2012. ABC Learning: accounting lessons never learned?. International Journal of Critical Accounting, 4(1), pp.21-29.

Sumsion, J., 2012. ABC Learning and Australian early education and care: a retrospective ethical audit of a radical experiment. Childcare markets local and global: can they deliver an equitable service, pp.209-225.

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