Rules Based Approach to Corporate Governance

Rules Based Approach
This rules based approach instills the code into law with appropriate penalties for transgression. For instance, US corporate governance practices were enshrined into law by virtue of ( Sharbanes and Oxley ) SOX Act . It is, therefore, known as rules based approach. In 2002, following a number of corporate governance scandals such as Enron and WorldCom, tough new corporate governance regulations were introduced in the US by the SOX.

SOX is extremely detailed and carries the full force of law and it includes requirements for the Securities and Exchange Commission ( SEC) to issue certain rules on corporate governance. SOX requirements are applicable to directors of subsidiaries of US listed businesses and auditors working on US listed businesses.

Measures introduced by SOX include:

i. All companies with a listing for their shares in the US must provide a signed certificate to the SEC vouching for the accuracy of their financial statements.
ii. If a company’s financial statements are restated due to material non-compliance with accounting rules and standards, the CEO and Chief Finance Officer( CFO) must forfeit the bonuses awarded in the previous twelve (12) months.
iii. Restrictions are placed on the type of non-audit work that can be performed for a company by its firm of auditors
iv. The senior audit partner working on a client’s audit must be changed at least every five years (i.e, audit partner rotation is compulsory)
v. An independent five men board called Public Company Oversight Board (PCOB) has been established, with responsibilities for enforcing professional standards in accounting and auditing.
vi. Regulations on the disclosure of off-balance sheet transactions have been tightened up
vii. Directors are prohibited form dealing in the shares of their company at sensitive times.

Key effects of SOX are as follows.

i. Personal liability of directors for mismanagement and criminal punishment
ii. Improved communication of material issues to shareholders
iii. Improved investor and public confidence in corporate US
iv. Improved internal control and external audit of companies
v. Greater arm’s length relationships between companies and audit firms
vi. Improved governance through audit committees

Negative Reaction to SOX

i. Doubling of audit fee costs to organizations
ii. Onerous documentation and internal control costs
iii. Reduced responsibility and responsiveness of companies
iv. Reduced risk taking and competitiveness of organizations
v. Limited impact on the ability to stop corporate abuse
vi. Legislation defines a minimum legal standard and little more