ASX Corporate Governance Principles
In the recent years, there has been increased incidence of corporate failures in Australia which has left investors low in confidence. Theoretically, bankruptcy of a company tends to happen when the assets of the company are not able to discharge the outstanding liabilities and hence the liabilities have become very high. However, it is noteworthy that this typically does not happen overnight and is usually the result of certain faulty practices which have continued over a significant length of time. IN this backdrop, the objective of the given report is to critically analyse the bankruptcies of three companies i.e. ABC Learning, HIH Insurance and One Tel. Based on this, the role played by liabilities with regards to these corporate failures needs to be critically analysed. Also, the various principles of corporate governance endorsed by ASX along with ethical code for professional accountants (i.e. APES 110) has also been introduced.
The ASX Corporate Governance Council has recommended the following eight principles to improve corporate governance practices in companies (ASX, nd).
Principle 1 – Board should disclose information regards underlying responsibility of each board member along with role assumed so as to enhance accountability and transparency.
Principle 2 – There must be suitable representation of non-executive independent directors in the board and also the members of the board should possess the requisite skills and knowledge for the discharge of their duties.
Principle 3 – Any potential conflict of interest need to be disclosed so that the board members can engage in ethical and responsible decision making.
Principle 4 – It is expected that suitable measures would be undertaken to enhance the independence of the internal and external audit function.
Principle 5 – Relevant disclosures need to be made related to the material information and this should be carried out promptly without any reference to the impact on company valuation or stock price.
Principle 6 – The various mechanisms that company has to allow shareholders to participate in the functioning of the company must be respected and not breached upon.
Principle 7 – In order to identify and mitigate business risk, suitable measures need to be taken by the company preferably though the formation of an internal risks management committee.
Principle 8 – The executives of the company should be provided fair remuneration which must be decided by the remuneration committee and must have shareholder approval.
Additionally, professional accountants also need to adhere to a code of ethics as prescribed in APES 110 which advocates the following values (APESB, 2010).
Principle 1 – Disclosure of Board Roles and Responsibilities
Integrity – The professionals should not exhibit dishonesty in their profession and must conduct their activities in a honest manner.
Objectivity – The objective assessment of the situation must be upheld by the professionals and hence they should not place themselves in any situation where any conflict of interest may be inherent.
Professional competence and due care – The professionals in accounting field must build on their existing knowledge based on academic and regulatory development and must ensure that they discharge their duty to care towards the clients and users.
Confidentiality – While conducting their work, the accounting professionals are exposed to confidential information about their client which they must not share with anyone and keep the same as secret.
Professional Behaviour – The accounting professionals while conducting business with clients and users must conduct themselves professionally.
A brief description of the scenario which led to the bankruptcy of following companies is carried out below.
ABC Learning
The company started in 1988 with the first day care centre and by 2001 it had a modest growth whereby it has reached 43 centres across Australia. However, post this period, the company focused aggressively on expansion fuelled by US based acquisitions in 2005 and 2006. This is the time when the company went public with a valuation of $ 2.5 billion from an earlier valuation of $ 25 million. In order to fund this explosive growth, the company had taken significant amount of loans. Also, the quality of the company services were adversely impacted as owing to cost cutting, the number of staff was less (CPA, 2012).
Further, during the expansion phase, the company used creative accounting especially with regards to valuation of assets on historical basis rather than their book value. As a result, the impairment of goodwill on the assets did not reflect on the financial statements and ensured that they looked healthy. Eventually, by 2007 the company had reached 2238 centres and the losses were mounting as the quality of the company had deteriorated and the management could not control this expanded set of centres. As, the profitability of the company dipped, the company dipped, the company could not afford to honour its outstanding debt obligations taken for expansion and hence in 2007 went into liquidation (Kaplan, 2011).
HIH Insurance
The company was a prominent insurance company (2nd largest in Australia) at the time of bankruptcy. It had grown in size by adopting an inorganic expansion based model in the 1990’s when it made a significant number of acquisitions. As a result of these acquisitions, the company was able to enter into new markets and could offer a wide range of insurance products. However, the key issue in pursuing this strategy was that the risk management practices at the company were inappropriate owing to complex reinsurance model arrangements (Mirshekary, Yaftian & Cross, 2005).
Principle 2 – Suitable Representation of Non-Executive Directors
Further, through the acquisitions the risk further increased. One reason was that that these acquisitions were done by the company without any long term strategy and thereby a premium price was paid without conducting relevant due diligence of the target. This is especially prominent in case of FAI Insurance. Also, the acquisitions of the company were not limited to Australia or New Zealand but extended to USA and Argentina. Further, in some of the markets such as US, the company offering insurance products at very low premiums thereby under –pricing. As a result, the company was incurring losses due to this expansion and the mismanagement of the same. The directors had a quid pro quo relation with the external auditor thereby ensuring that the financial statements were misrepresented and the auditor never indicated the faulty risk management practices (Mak, Deo & Cooper, 2005).
This resulted in decreasing asset base of the company and at the time of bankruptcy the company while the report assets were $ 8 billion, in reality it was only $ 137 million. Such was the magnitude of financial fraud in the company and hence the bankruptcy was inevitable for the company (Gay and Simnett, 2012).
One Tel
The company was started in 1994 and before filing for IPO in 1997, the company witnessed significant growth which was linked to the contract with Optus whereby One Tel would receive $ 120 per mobile SIM of Optus that the company would sell. However, the company indulged in malpractices where it started paying every customer $ 10 to buy the mobile SIM. As a result most of these were not used and the business model of the company seemed akin to pump and dump operation. Optus terminated the contract with One Tel in 1996 (Monem, 2009).
Right from going public in 1997, the company started focusing on independent operations and increasing raising financing through debt and equity to invest in excess of $ 1 billion in acquisition of spectrum. However, the customers that company made were on account of infeasible plans owing to which the company was not able to recoup the huge investments it had made in spectrum and eventually in 2001, the company was faced severe liquidity issues. The company was not able to receive incremental finances for the business and thereby liquidation resulted (Gilbert, Joseph & Terry, 2005).
The corporate failure discussed above even though belonged to different sectors had similarities which explain their failure which was potentially inevitable considering the internal governance (Caanz, 2016). A common aspect of the three companies is an aggressive expansion strategy eventually culminating into failure. Consider for instance, ABC Learning entered receivership in 2007 while the highest centre count was achieved by the company in 2006. In case of One Tel also, it filed for bankruptcy in 2002 when in 2000, it made investment upward of $ 500 million in buying spectrum. In case of HIH Insurance also a similar observation can be made since it went into liquidation at the time when it was the second largest insurance company in Australia (Arens et. al., 2013).
Principle 3 – Disclosure of Potential Conflicts of Interest
It is thereby apparent that during the expansion phase the management lost control and in a bid to ensure that the valuation of the company and their compensation was maximised, they continued with the expansion strategy without consolidating any meaningful gains. The focus was on ensuring that positive sentiments were attached so that the share price could be supported. Meanwhile, the real costs of this aggressive expansion were undisclosed due to use of creative accounting technique, destruction of internal controls and collusion with the external auditors (Bhagat, and Bolton, 2008). The net result was that the performance and valuation of the company plummeted more swiftly than it reached the top. Clearly, liabilities are not the major culprit for these corporate failures as it was the erosion of assets from the balance sheet that led to liabilities appearing huge in comparison of the assets present on the books of the company (Gay and Simnett, 2012).
The analysis conducted above is indicative of improvement in corporate governance framework to be adopted in companies especially those which are listed owing to the high stakes of the public stakeholders. To an extent, this gap has been plugged with the introduction of corporate governance principles by ASX which form an intrinsic component of the listing agreement between the company and the exchange (ASX). This places a mandatory obligation on the company to adhere with the eight principles in both letter and spirit. Besides, in accordance with CLERP 9 economic reforms, focus has been put on taking measures to safeguard external auditor independence through rotation and other mechanisms. Besides, considering the role of directors in various corporate failures, statuto9ry duties of directors have been implemented and accountability is placed on directors (Arens et. al., 2013).
Even though a slew of measures have been taken to strengthen the corporate governance practices, there is still more to be done. The role played by non-executive independent directors does not match their envisioned role in various corporate governance principles and concrete measures in this regards are imperative. Also, the liability imposed on directors and auditors need to be increased considered their involvement in most of the corporate failures. An additional aspect is that there must be more emphasis on ethics training at managerial positions. Also, these should be introduced in various educational institutions offering management and accounting related courses. This is imperative as in order to avoid corporate failure, reliance on only the negative law based mechanisms would not prove sufficient and effective. Hence, it requires additional support in the form of improved ethical standards of accounting professionals and executives so that such incidents do not reoccur (Clout Chappelle & Gandhi, 2009).
References
APESB (2010) APES 110 Code of Ethics for Professional Accountants, [online] Available at https://www.apesb.org.au/uploads/standards/apesb_standards/standard1.pdf [Accessed September 11, 2018]
Arens, A., Best, P., Shailer, G. and Fiedler,I. (2013). Auditing, Assurance Services and Ethics in Australia, 2nd eds., Sydney: Pearson Australia
ASX (n.d.) Corporate Governance Principles and Recommendations, [online] Available at https://www.asx.com.au/documents/asx-compliance/final-revised-principles-complete.pdf [Accessed September 12, 2018]
Bhagat, S. and Bolton, B. (2008), ‘Corporate Governance and Firm Performance’, Journal of Corporate Finance, Vol.14, No.3, pp. 257-273.
Caanz, S. (2016), Auditing and Assurance Handbook 2016 Australia, 3rd ed., Sydney: John Wiley & Sons
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 13, 2018]
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 https://www98.griffith.edu.au/dspace/bitstream/handle/10072/42673/74746_1.pdf [Accessed September 14, 2018]
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