The stock market has gained extraordinary significance over recent years. Large proportions of society invest in equity markets in order to save for their retirement. Various bodies exist to fight abuses by executives of publicly owned companies. Parliament has created the New Zealand Securities Commission (SEC), an independent Crown entity in terms of the Crown Entities Act 2004, to fight ‘white collar fraud’ and the abuse of business ethics and the law. Numerous scandals worldwide but especially the Enron case in the United States of America (USA) at the beginning of this decade shocked investors and led to a decrease in shareholder confidence. Investors lost their trust in corporate governance techniques and the credibility of managements.
In the 1930s, in the aftermath of the 1929 stock exchange crash in the USA, Berle and Means ascertained the underlying problem of corporate governance as the separation of ownership and power. In accordance with Adam Smith, they explained that, as a basic human trait, executives never apply the same diligence when running a company as the owner of the same company might apply. This fundamental understanding is the reason for the necessity of corporate governance rules. As a pro-tection of shareholder interests, the interests of the owners of the company, the regulator tries to set standards which create investor confidence and security.
By now the large majority of nations have implemented some form of corporate gov-ernance regime. The US government has tried to counter fraud and investor scepticism by adopting a statutory corporate governance code called the Sarbanes-Oxley Act 2002 (SOX). New Zealand, on the other hand, opted for a more voluntary ap-proach to governance regulation based on principles rather than legal norms, which impose no legal obligation on affected parties. Farrar disapproves of his approach and calls New Zealand’s principles “bland provisions”. He fears a decrease of investments in the New Zealand market if it does not follow the US lead quickly.
This paper tries to evaluate Farrar’s proposal of imitating the US example. Section II portrays corporate governance regulations currently in place in New Zealand. It focuses predominantly on listed public companies and shows shortfalls in this area. Section III illuminates SOX and its provisions. The paper provides explanations ma-jor fraud scandals in the USA and discusses in the light of these findings the effectuality of SOX. It concludes that the US legislation has numerous pitfalls and fails to achieve necessary fraud prevention. Based on this understanding, Section IV discusses the advantages and disadvantages of a principle-based approach to corporate governance regulation. It is shown how selfregulation paired with a strong legal framework provides sufficient protection for investors and how such an approach values the theory of free markets. This author believes strongly in the efficiency of free, unregulated markets and eventually concludes with a few humble suggestions on how New Zealand might change their corporate governance regime.
Table of Contents
I. INTRODUCTION
II. NEW ZEALAND’S APPROACH TO THE CODIFICATION OF CORPORATE GOVERNANCE
A. The New Zealand Corporate Market
B. Corporate Governance in New Zealand: Principles and Guidelines
C. NZX Corporate Governance Best Practice Code
D. Attracting International Investments
III. THE SARBANES-OXLEY ACT 2002 – PRIME EXAMPLE OF THE STRCT RULE-BASED APPROACH
A. Introduction
B. Historical Context
C. Causes of the Market Failure
1. Introduction
2. Agency Costs
3. Bubble Atmosphere
4. Gatekeeper Failure
D. Brief Account of Regulations
1. Introduction
2. Scope of Application
3. Regulations
a. Internal Monitoring
b. Gatekeeper Regulation
c. Regulation of Insider Misconduct
4. Increase in Financial Disclosure
5. Fraud Liability
E. Evaluation of SOX
1. Introduction
2. Effectiveness of Regulations
a. Independent Directors
b. Whistleblowers
c. Gatekeeper Regulations
d. Increased Disclosure
e. Increased Liability
3. Higher Costs
a. Agency Costs
b. The Effect of Stricter Liability
c. Information Costs
4. Conclusion
IV. WHY COMPLY-OR-EXPLAIN – REASONS BEHIND THE SPATE OF INCORPORATIONS
A. Introduction
B. Reasons for Substantive Regulation
C. Advantages of Self-Regulation
1. The Theory of Free Markets
2. Free Markets in the Common Law World
3. Evaluation of the Principle-Based Approach in the light of the Free-Market Theory
a. Flexibility
b. Investor Education
c. Considering New Zealand Circumstances
d. Comply-or-Explain in New Zealand
V. SUMMARY AND CONCLUDING REMARKS
Research Objective and Core Themes
This work evaluates whether New Zealand should adopt a rigid, rule-based corporate governance regime similar to the U.S. Sarbanes-Oxley Act (SOX), or if it should maintain its current voluntary, principle-based approach to foster long-term market health and investor confidence.
- Comparison of rule-based (SOX) versus principle-based ("comply-or-explain") governance models.
- Analysis of the historical causes of market failures (Enron, WorldCom) and the subsequent regulatory responses.
- Evaluation of the effectiveness and inherent costs of mandatory versus flexible disclosure regulations.
- Examination of New Zealand’s economic landscape and its dependency on small to medium-sized enterprises.
- The role of self-regulation and free-market theory in creating sustainable investor confidence and market growth.
Excerpt from the Book
C. Causes of the Market Failure
According to Ribstein there are three reasons for the 2001/02 market failures. He describes them as agency costs, a “bubble atmosphere”, and a gatekeeper failure. This subsection explains these terms and their severe effect on the US securities market which made Enron and WorldCom inevitable.
The separation of ownership and control leads to so-called “agency costs”. Corporate managers function as agents of the shareholders who own the company. The main benefit of having non-owner managers is that passive owners are able to invest in diversified portfolios, leaving the risk of failure to the specific agent. These agents have, as Ribstein observes, “incentives to use their control [over the company] to benefit themselves rather than the owners”. Costs arising from supervising management and protecting owners as well as residual losses caused thereby are called “agency costs”. Since ownership is highly dispersed in most securities markets, the monitoring process is particularly impractical in listed public companies raising agency costs substantially. These costs are exacerbated by the “free-rider” mentality of minor shareholders who are either unwilling or unable to invest money and time in monitoring management. The Enron as well as the WorldCom case show indubitably the dilemma that may arise when owners put too much trust in their agents and lose their natural scepticism.
Summary of Chapters
I. INTRODUCTION: This chapter highlights the significance of the stock market and the necessity of corporate governance rules to protect shareholder interests in the wake of major scandals like Enron.
II. NEW ZEALAND’S APPROACH TO THE CODIFICATION OF CORPORATE GOVERNANCE: This section portrays the current voluntary, principle-based corporate governance regime in New Zealand and emphasizes the need for regulations that match its specific, small-scale economic environment.
III. THE SARBANES-OXLEY ACT 2002 – PRIME EXAMPLE OF THE STRCT RULE-BASED APPROACH: This part provides a deep critique of the U.S. Sarbanes-Oxley Act, examining its historical context, regulatory provisions, and its failure to prevent accounting scandals due to its rigid nature.
IV. WHY COMPLY-OR-EXPLAIN – REASONS BEHIND THE SPATE OF INCORPORATIONS: This chapter argues for the advantages of a principle-based "comply-or-explain" approach, highlighting the inherent flexibility and market-responsiveness of such a system compared to statutory rules.
V. SUMMARY AND CONCLUDING REMARKS: The final chapter summarizes the findings, arguing that New Zealand should refrain from adopting US-style mandatory rules and instead strengthen its principle-based framework with a mandatory enforcement tool.
Keywords
Corporate Governance, Sarbanes-Oxley Act, SOX, New Zealand, Comply-or-Explain, Principle-based, Market Failure, Agency Costs, Gatekeeper Failure, Investor Confidence, Self-regulation, Securities Market, Financial Disclosure, Auditing, Free Market Theory
Frequently Asked Questions
What is the core focus of this research paper?
The paper examines whether New Zealand should implement a mandatory, rule-based corporate governance regime (modeled after the U.S. Sarbanes-Oxley Act) or continue with its voluntary, principle-based system.
What are the primary themes discussed in the study?
The key themes include the comparison of regulatory philosophies, the impact of market failures like Enron on global policy, the economic burden of compliance on small companies, and the role of market self-correction.
What is the primary research goal?
The objective is to determine if adopting SOX-like regulations would actually enhance market integrity in New Zealand or if it would be counter-productive, given the unique structure of the New Zealand economy.
Which scientific methodology does the author utilize?
The author performs a comparative legal and economic analysis, reviewing existing academic literature, corporate governance codes, and historical case studies of financial market failures.
What topics are covered in the main body of the work?
The main body covers the theoretical frameworks of corporate governance, an evaluation of the Sarbanes-Oxley Act's effectiveness in the U.S., and the practical arguments for or against "comply-or-explain" enforcement mechanisms.
What keywords characterize the research?
The core keywords include Corporate Governance, Sarbanes-Oxley Act, Comply-or-Explain, Agency Costs, Gatekeeper Failure, and New Zealand Market.
How does the author evaluate the "gatekeeper failure" during the Enron scandal?
The author argues that gatekeepers (like auditors and lawyers) failed due to conflicting loyalties and a lack of independence in a highly competitive market, compounded by a "bubble atmosphere" of unrealistic optimism.
Why does the author advocate against the full adoption of the Sarbanes-Oxley Act in New Zealand?
The author concludes that SOX imposes excessive costs on smaller companies, promotes conservative/risk-averse behavior that stifles innovation, and fails to be truly preventive, making it an unsuitable solution for New Zealand's unique market conditions.
- Quote paper
- Lars Haverkamp (Author), 2006, Corporate Governance: Codification or Self-Regulation? , Munich, GRIN Verlag, https://www.grin.com/document/82884
