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Corporate Governance and Financial Reporting: Importance, Regulations and Compliance

06 May
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More than two decades after its disastrous fall from grace, Enron remains the epitome of bad corporate governance. As part of the fallout from the debacle, new regulations were passed to increase oversight and prevent corporate fraud.1 While there have been several examples of blatant corporate mismanagement since then, corporate governance policies are designed to balance the interests of a company’s many stakeholders, such as shareholders, management, customers, suppliers, financiers, the government and the community.2

Corporate governance in finance is the framework of the rules and procedures that specify how everyone involved in an organization is expected to behave. These policies promote transparency, fairness and accountability in a company’s relationship with all of its stakeholders. Effective governance frameworks promote ethical behavior and integrity and reduce the potential risk of fraud. They help companies build a positive reputation and create sustainable growth.3

This post will explore several of the essential components of corporate governance and financial reporting.

Principles of Corporate Finance Governance

The principles of corporate governance, including in regard to finance, build trust and integrity in the relationship between a corporation and its stakeholders. Requirements of transparency and disclosure call on companies to share—openly and accurately—all relevant financial and operational information. This guarantees that stakeholders, including investors, employees and the public, have access to the data they need to make informed decisions.4

In a culture of accountability and responsibility, people in governance and leadership roles are answerable for their actions. Directors and managers are responsible for their decisions and the performance of the company. They’re required to make sure the company follows legal and ethical standards.5 Accountability mechanisms include regular audits, reporting and a clear division of roles and responsibilities so that decisions are made in the best interest of all stakeholders.6

The principles of fairness and equity maintain that all stakeholders should be treated equitably and justly. The rights of shareholders, employees and other parties should be protected, and their interests considered, regardless of their number, influence or relationship with the company. This promotes a culture of respect and ethical treatment. Taken together, these principles support sustainable business practices and long-term success.7

Regulatory Frameworks and Standards

Businesses must follow several major finance regulations and compliance standards as part of their corporate governance practices. After the Enron fiasco and several other corporate scandals, the United States Congress passed the Sarbanes-Oxley Act (SOX), which was designed to protect investors by improving the accuracy and reliability of corporate disclosures. SOX mandates strict rules for financial disclosures to prevent accounting fraud. It also holds top management and auditors accountable for compliance.8

The International Financial Reporting Standards (IFRS) are global accounting standards that apply to companies in more than 140 jurisdictions. The IFRS provide a common language so a company’s finances are understandable and comparable across international boundaries. This standardization helps investors and other stakeholders make informed economic decisions, promoting transparency and efficiency in the global markets.9

The Securities and Exchange Commission (SEC) enforces federal securities laws in the United States. It oversees securities exchanges, securities brokers and dealers, investment advisors and mutual funds, and it makes sure that they adhere to the law and provide investors with accurate and timely information. Together, SOX, the IFRS and the SEC create an intricate network of regulations and standards with which publicly traded companies must comply.10

Board of Directors and Governance Structure

A corporation’s board of directors governs by setting the company’s vision, mission and strategic direction. It oversees management’s performance and manages the company’s risks. It’s also responsible for safeguarding stakeholders’ interests, making decisions on major company issues and setting policies on dividends, corporate governance and executive compensation.11

The board must consist of a mix of executive and independent directors. The majority of the directors must be independent and provide unbiased oversight and objective judgment. This is especially important when dealing with potential conflicts of interest and ensuring that decisions are made in the best interests of the corporation and its stakeholders.11

  • In publicly listed companies in the United States, shareholders elect members of the board of directors at the annual meeting; candidates can be nominated by the board's nomination committee or by investors interested in changing a board's membership and policies
  • In private companies, members of the board can be chosen in accordance with the company's bylaws or articles of incorporation; they may also be chosen by simple agreement among the shareholders

Committees improve the board’s efficiency by focusing on specific tasks within particular areas of corporate operation:

  • An audit committee oversees financial reporting, internal controls and compliance with legal and regulatory requirements
  • A compensation committee sets executive pay and assesses performance-related pay
  • A nomination committee handles the selection and evaluation of board members

These committees are typically staffed by independent directors and provide specialized oversight and governance.12

Financial Reporting and Disclosures

Investors and other stakeholders can’t make informed decisions regarding investments, loans, and other business relations without accurate financial reports. Financial reporting and disclosure statements provide essential information about a company’s financial health and operational results. The guidelines for financial reporting and disclosures give all market participants equal access to material information to maintain market integrity and investor trust.13

The primary components of financial statements are three documents: the balance sheet, the income statement and the cash flow statement:13

  • The balance sheet includes the company’s assets, liabilities and shareholders’ equity at a specific point in time, giving a snapshot of the company’s financial position
  • The income statement, or profit-and-loss statement, shows the company’s revenues, expenses and profits over a period, highlighting its operational efficiency
  • The cash flow statement details the inflows and outflows of cash and provides an overview of the company’s liquidity and financial health

Independent auditors attest to the credibility of financial reports. They review the financial statements to check that they’re prepared according to the relevant accounting standards and are free from fraud or errors. This independent assurance adds a layer of trust, affirming that the financial reports accurately reflect the company’s financial status, thus supporting stakeholders in each decision-making process.14

Develop Your Leadership Skill in Corporate Finance Governance

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Led by world-class experts, our comprehensive curriculum covers essential topics such as principles of finance, advanced corporate finance, investments and financial statement analysis and modeling. The flexible online experience helps you expand your professional network as you enhance your essential business acumen.

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