Arewa, Olufunmilayo B.

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Case Western Reserve University School of Law

Case Western Reserve Law ReviewVolume 55 | Issue 32005Comment: Corporate Governance Events: LegalRules, Business Environment and CorporateCultureOlufunmilayo B. ArewaFollow this and additional works at: https://scholarlycommons.law.case.edu/caselrevPart of the Law CommonsThis Symposium is brought to you for free and open access by the Student Journals at Case Western Reserve University School of Law ScholarlyCommons. It has been accepted for inclusion in Case Western Reserve Law Review by an authorized administrator of Case Western Reserve UniversitySchool of Law Scholarly Commons.Recommended CitationOlufunmilayo B. Arewa, Comment: Corporate Governance Events: Legal Rules, Business Environment and Corporate Culture, 55 Case W.Res. L. Rev. 545 (2005)Available at: https://scholarlycommons.law.case.edu/caselrev/vol55/iss3/6COMMENT: CORPORATEGOVERNANCE EVENTS: LEGALRULES, BUSINESS ENVIRONMENTAND CORPORATE CULTUREOlufunmilayo B. ArewatCommissioner Campos has focused our attention on what might betermed corporate governance events. Such events may be seen asepisodes involving the failure of a company's corporate governanceprocess to address behaviors that may involve undesirable, unethicalor even fraudulent actions or activities. Understanding corporategovernance events requires attention to the actual behaviors underly-ing such events both in terms of affirmative acts as well as acts ofomission, which in turn highlights the importance of education as onetool to avert such events. Corporate governance events also entailrecognition of two distinguishable features of the settings in whichthey take place. The first is broader and relates to the general busi-ness environment in which such events occur. The second is moreparticular and concerns the specific corporate cultural context wheresuch events unfold.The episodes, often grouped within the rubric of corporate govern-ance events, are by no means identical. A Google search for corpo-rate governance events reveals a familiar list of names: Enron, World-Coin, Conseco, Global Crossing and Tyco, and more recently FannieMae, Freddie Mac, Computer Associates and Disney. Such episodesare also not limited to the United States, and a number of companiesbased in Europe could be added to the above list, including ABB,Vivendi, Parmalat and Shell. Although not identical, one commonal-ity in a large majority of these cases relates to questionable, and int Assistant Professor, Case Western Reserve University School of Law. I would like tothank George Dent for inviting me to participate in the George A. Leet Business Law Sympo-sium.CASE WESTERN RESERVE LAW REVIEWsome cases even fraudulent, accounting practices. The fact that ac-counting practices tie many of these episodes together is in large parta result of the business environment of the late 1990s in which theseand other companies operated.Corporate governance events from the late 1990s onwards havetaken place in the context of a changing business environment inwhich intangibles such as information technology were increasinglyimportant forces. In fact, during the latter half of the twentieth cen-tury a transition has been apparent to what might be characterized asan intangibles paradigm in which intangibles have been more andmore pervasive in business worldview and practice.1 This increase inintangibles has been attributed to a number of factors, including in-creased global competition and deregulation in the latter half of thetwentieth century, particularly in the 1980s and 1990s.2 These fac-tors, combined with an upsurge in information and communicationtechnologies (ICTs), have contributed to the rise of intangibles.3 Therising prevalence of intangibles has in many respects presented chal-lenges to existing accounting and legal disclosure standards.The corporate behaviors manifested in corporate governanceevents must be evaluated within the context of this changing businessenvironment. This business environment is important because it re-flects to some extent changing rules of the game that were an impor-tant background element to corporate governance events. As Com-missioner Campos has noted, new rules of the game often also presentnew opportunities for fraud. This new paradigm has put pressure onexisting standards and rules, as is evident in accounting, for example.As a result, the intangibles paradigm also can make transparencymore difficult to achieve; it can make measurement and verificationof accounting numbers more difficult, and it can challenge the abilityof companies to make adequate and accurate disclosures.4The most obvious response to such corporate episodes would be tochange the rules that may have either failed to prevent or facilitatedtheir occurrence. This is an approach that is currently being applied.As a result, one important consequence of the post-Enron regulatoryera has been changes in governance rules. For example, the Sar-banes-Oxley Act of 20025 and other rules with respect to accountingI Olufunmilayo B. Arewa, Breaking Through the Intangibles Haze: Measuring and(Mis)Representing Economic Reality under the Intangibles Paradigm, 45-56 (January 25, 2005)(unpublished manuscript on file with author).2 BARUCH LEV, INTANGIBLES, MANAGEMENT, MEASUREMENT, AND REPORTING 9(Brookings Institution Press 2001).3 Id.4 Arewa, supra note 1, at 56-65.5 Sarbanes-Oxley Act of 2002, 15 U.S.C. §§ 7201-7266 (West Supp. 2002) [hereinafter,[Vol. 55:3CORPORATE GOVERNANCE EVENTStreatment of special purpose entities (SPEs),6 which increased theminimum third-party interest from 3 percent to 10 percent to avoidconsolidation of the SPE, are two specific rule changes that cameabout subsequent to and no doubt at least partly as a result of the cor-porate governance events that occurred in and after the late 1990s.Although it may be early to determine the effectiveness of these rulechanges, as Commissioner Campos has observed, rules really caninfluence behavior. As a result, changes in rules that might lead togreater board independence, separation of the CEO from the chair-man, which is still under discussion in the U.S. and which remainsmore typical in Britain than the U.S., and changes in the compositionof audit committees can make a difference in behavior. Further, suchrule changes may have an influence on outcomes with respect to po-tential corporate governance events.Although rule changes have the potential to influence behavior,two points should be noted about the rule changes adopted in thepost-Enron context. In the first place, these rules do not and likelycannot by their nature directly address many of the issues that arisefrom the business context of the intangibles paradigm within whichthese corporate events occurred. In addition, such rules do not neces-sarily touch upon issues of internal corporate cultural context. Corpo-rations often have discernible cultural styles and practices that form afoundation that may encourage or discount particular types of behav-iors. One example of corporate culture influencing behavior is Enron,where what might be described as an aggressive, assertive and largelyunreflective corporate culture contributed to and facilitated fraud.7Sarbanes-Oxley].6 See FINANCIAL ACCOUNTING STANDARDS, Emerging Issues Task Force Issue 90-15,Impact of Nonsubstantive Lessors, Residual Value Guarantees, and Other Provisions in LeasingTransactions (Financial Accounting Research System CD-Rom, current through 1984) (setting3 percent as the minimum third-party interest in an SPE to avoid consolidation of the SPE); seealso Bala G. Dharan, Financial Engineering with Special Purpose Entities, in ENRON ANDBEYOND: TECHNICAL ANALYSIS OF THE ACCOUNTING, CORPORATE GOVERNANCE, ANDSECURITIES ISSUES 103, 114-116 (Julia K. Brazelton & Janice L. Ammons eds., CCH Incorpo-rated 2002) (discussing changing consolidation rules for SPEs and noting that the 3 percent rulewas an ad-hoc solution intended as a short term band-aid that subsequently became standardpractice); Jalal Soroosh & Jack T. Ciesielski, Accounting for Special Purpose Entities Revised:FASB Interpretation 46(R), THE CPA J., July 2004 at 30-37, available athttp://www.nysscpa.org/cpajoumal/2004/l04/essentials/p30.htm (examining the response of theFinancial Accounting Standards Board to the development of sophisticated SPE transactions);FINANCIAL ACCOUNTING STANDARDS BOARD, Interpretation No. 46(R) (Dec. 2003).7 BETHANY MCLEAN & PETER ELKIND, THE SMARTEST GUYS IN THE ROOM: THEAMAZING RISE AND SCANDALOUS FALL OF ENRON (Portfolio 2003). See also Ronald R.Simms, & Johannes Brinkmann, Enron Ethics (Or: Culture Matters More Than Codes), 45 J.BUS. ETHICS 243 (2003) (discussing role of Enron corporate culture on the ethics of its employ-ees).20051CASE WESTERN RESERVE LAW REVIEWSuch cultural factors play a role in the behaviors manifested in corpo-rate governance events. Moreover, differences in cultural contexthighlight the fact that similar rules may apply differently in variedbusiness environments and in the context of different internal proc-esses and relationships that are in part a product of corporate culture.Assessing corporate governance events reveals that behaviors of-ten matter and that particular corporate responses to the changinggeneral business environment may depend on multiple interrelatedfactors, many relating to what might be identified as features of cor-porate culture, including the relationships and actions of the board ofdirectors within and with respect to the broader corporate culture.The unhealthy distance mentioned by Commissioner Campos is rele-vant here. This gap is characterized by an unhealthy distance be-tween members of the board of directors and business decisions of thepublic companies on whose boards they serve.This unhealthy distance is partly a result of corporate cultural con-text, but it is also a function of education, which is a related aspect ofthis context. Good corporate governance is at least partially a learnedbehavior. As a result, good corporate governance and best practicesmay need to be relearned and revisited in different business environ-ments and corporate cultural contexts.The development of best practices can be considered in the contextof the intangibles paradigm. Under the intangibles paradigm, compa-nies may relate to and use accounting in a different way. The wide-spread and pervasive nature of intangibles and ICTs in the intangiblesparadigm business practice has clearly posed challenges for both ac-counting rules and legal disclosure requirements. 8 As a result, in thecase of software companies, recognition of revenue may pose newchallenges to existing regulatory frameworks. These challenges maybe a reflection of both business environment and aspects of corporateculture.Business environment may influence accounting decisions by vir-tue of the fact that existing rules may need to be adapted to the par-ticular business environments such as those associated with the intan-gibles paradigm. At the same time, corporate culture may also berelevant in shaping how particular companies confront the challengesthat a particular business environment may pose. As a result, differ-ent companies may respond quite differently to such challenges. Inthe case of accounting revenues of a software company, the extent towhich a particular corporate culture fosters flexibility in confrontingquestions that result from changes in the general business environ-8 Arewa, supra note 1, at 56-65.[Vol. 55:3CORPORATE GOVERNANCE EVENTSment can be important. Furthermore, this highlights the need to in-corporate ongoing learning and reeducation in the face of new busi-ness environments and challenges as a desirable core feature of cor-porate culture.The challenges that new business environments pose for legal andaccounting rules are thus partly an issue of education and ensuring thebroadest possible range of education as to the types of fraud and thetypes of misrepresentations that might occur in this new environmentas well as taking practical steps to prevent activities and practices thatmight lead to corporate governance events. Such education shouldextend to actors within corporations as well as their gatekeepers andregulators. Such education must also be informed by the realities ofthe corporate cultures within which corporate governance events takeplace and should also seek to influence behavioral outcomes.In many respects, Enron has been a watershed from the perspectiveof both legal and accounting issues. Prior to Enron, the consequencesof corporate governance failure did not represent a clear and presentdanger to many actors in corporate contexts. For many, business fail-ure was a much closer and pertinent concept, and intuitive under-standing of the concept of business failure thus came rather easily tomost actors within corporate contexts. In contrast, the concept of abusiness falling or ceasing to exist on account of corporate govern-ance problems or failure was a much more distant reality. As Com-missioner Campos has mentioned, however, executives being led offin handcuffs contributed enormously to the ability of many to under-stand the potential consequences of corporate governance failure andlikely has had a significant deterrence effect.The post-Enron era represents an important opportunity for educa-tion and relearning in the context of changing business environmentsand varied corporate milieus. Understanding corporate governanceevents thus can be transformed into a question of how to encourageprivate enforcement of best practices by educating diverse groups andconstituencies within corporate contexts as to what constitutes bestpractices within changing business environments as well as within thecontext of different corporate cultures.99 See Denton Collins, Austin L. Reitenga & Juan Manuel Sanchez-Cuevas, ManagerialConsequences of Earnings Restatements (October 2004), available athttp://business.utsa.edu/departments/ acc/arc/papers/CR.Draft.pdf (looking at penalties givento managers connected to earnings restatements); Hemang Desai, Chris E. Hogan & Michael S.Wilkins, The Reputational Penalty for Aggressive Accounting: Earnings Restatements andManagement Turnover (August 2004), available athttp://papers.ssm.com/sol3/papers.cfm?abstract id-471842 (noting the importance of privatepenalties and enforcement of GAAP rules).20051CASE WESTERN RESERVE LAW REVIEWSuch education requires a continuing effort that reflects Commis-sioner Campos's discussion of ethical education within corporatecontexts. Such education should focus on integrity and honesty andthe importance of good business practices in general as well as spe-cific issues that might arise from consideration of the relevant busi-ness environment and applicable cultural context. As part of thiseducation process, the distinction between structures and rules such asSarbanes-Oxley, which are often very important, and actual behavior,must be noted. Any education effort must focus on helping actorswithin corporate contexts understand that behavior as might be re-flected in both questions asked and those not asked. Such questionsshould be seen as important ways to assess and evaluate the impactand application of pertinent rules. Furthermore, how individuals whomight be members of management or the board of directors actuallyoperate within the broader corporate culture is also very important.Consequently, whether a company is run by an imperial CEO, howthe board relates to this CEO, whether the board questions a CEO, aswell as a myriad of other factors, are all issues of corporate culturalcontext and behavior that have an impact and that must be consideredwithin the context of how to best effectuate a system of rules givenexisting corporate culture and the general business environment. Forthat reason, in addition to considering relevant rules and focusing onactual behaviors, continuing education about corporate practicesshould reflect an understanding of the significance of broader envi-ronmental and contextual factors.[Vol. 55:3

Comment: Corporate Governance Events: Legal Rules, Business Environment and Corporate Culture

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Comment: Corporate Governance Events: Legal Rules, Business Environment and Corporate Culture

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