Corporate governance is a set of instructions and best practices that enable a company to achieve its goals and communicate its success to the respective stakeholders. However, there are certain drawbacks of corporate governance that may enable the company officials to use this to their own advantage. A few key drawbacks are mentioned below.
Many managers strive to achieve goals that are not aligned with the organizational goals. This causes ‘agency problem’ and can harm the company in the long run. Even investors and other stakeholders having an interest in the company will face the negative impact of the agency problem. This is largely witnessed in organizations that publicly trade in stocks. The board of directors and officers responsible for the corporation’s assets face a conflict of interest when they try to gain personal benefits from the company’s success rather than working towards maximizing shareholder wealth.
‘Corporate insiders’ are company officials who have access to highly confidential and non-public company information. Some confidential information may have an impact on the value of the firm’s shares in the market. If company officials, abreast with such information, use it for their own benefit and sell their shares to a person unaware of that information, this is called insider trading.
Shareholders, who are not directly related to the company such as a government regulator, an external auditor or a relative of a corporate official, can also commit the illegal act of insider trading.
There are many ways in which corporate officials can misrepresent financial information to avoid paying heavy taxes or to affect the value of company shares on the market. They can do this by forming a complicated network of cross-shareholdings and subsidiaries or by trading properties between the parent company and its subsidiaries to increase or decrease the amount of revenues or assets. This is also a drawback of corporate governance as misleading information can let companies get away with their corrupt acts.
Due to extensive abuse of the power delegated to company officials under corporate governance, laws have been formulated to prevent such misuse and abuse of power. However, complying with these laws can be costly and stressful for many companies.
For instance, the 1933 Securities and Exchange Act requires corporations to get listed on a stock exchange and then make detailed disclosures to interested investors. Complying with this rule can cost a company hundreds or even thousands of dollars.
Moreover, the recent 2002 Sarbanes-Oxley Act requires companies to setup appropriate internal control systems to ensure that their financial statements are not misleading and are factually correct.