Re-Evaluation of Corporate Governance & Sustainability Including Covid 19 Insights

                               

Sudden impact made by Covid 19 on the social and economic environment globally, is massive. Today , decision making in the business has become a very complex task than the traditional approach of having regular board meetings. During the decision-making process boards should consider multiple factors including health and safety of employees, government regulations related to controlling the pandemic, availability of uninterrupted supply chain, availability employees  etc. Business decision makers should also consider the interest of all stakeholders including shareholders , senior management, employees, customers  while keeping corporate governance standards.   This has been a very challenging task for business leaders.  It is very important to have good corporate governance throughout the decision-making process and that have a direct influence on the sustainability of the business.  

Corporate governance is said to be a framework of rules and practices by which a board of directors ensures accountability, fairness, and transparency in a company's relationship with all its all stakeholders. (Chen, 2020) The concept of sustainability is composed of three pillars: economic, environmental, and social—also known informally as profits, planet, and people. (Hansmann, Mieg and Frischknecht, 2012) This article will discuss how corporate governance and sustainability are closely interrelated using current day examples.

Health and safety of people including management , employees , customers, and community became more critical factor during the pandemic situation. In mid-2020 ,more than 1,000 of the factory’s 1,400 workers got tested positive for COVID-19 in Brandix Apparel Limited one of Sri Lanka’s largest apparel companies. (Aneez, 2020) Brandix is supplying garments for world famous brands including Victoria’s Secret ,Gap etc. After this incident Sri Lankan government ordered to  shut down the factory immediately and started investigating the incident to see if the factory management could have prevented the virus spread. Due to the situation company was not able to fulfill the orders on time and they incurred additional expenses to direct customer orders to different factories and to provide quarantine facilities to many employees.  This incident was a negative impact on company’s reputation. There can be times for a business which health and safety of people is the most important factor. This is where boards  should be vigilant when making decisions and ensure the impartiality for all stakeholders and these decisions have a direct impact of the sustainability of the company. Employee health and safety must be a factor to consider when accepting customer orders.

                Covid 19 pandemic had a huge impact on some industries like tourism, hospitality , airlines etc. Some business sectors had to stop their businesses suddenly. Some companies could not pay salaries of their employees only few weeks after the pandemic. This was not a good indication from the sustainability perspective. Companies should be able to look after their employees at least for few months when there is  a crisis situation. If that cannot be done boards should re-evaluate how sustainable is their remuneration system. Also, management should analyze if they have hired excess people, or they are overpaid. Covid 19 crisis brought up the fact that boards should look from different perspectives when they are setting performance-based incentives. Specially for sales professionals who work in distribution industry could not reach their targets due to travel restrictions imposed by government. Most of the companies consider the incentive as a part of the salary. Irrespective of the unforeseen crisis , employees will still have to provide for their families and pay their bills. It will be impossible if 40% of monthly income of an employee is target based incentive. Covid 19 has questioned the rightness and ethical ground of target-based incentive system. Some companies might have to relook at their remuneration system and think about more sustainable system which will balance interests of all stakeholders including shareholders, management, and employees.

                Rapid innovations were done by many companies to sustain during the pandemic. Some of these innovations changed the entire business model. Some of the manufacturing companies started to make completely different products. P & G renowned consumer goods manufacturer in US enhanced production of hand sanitizers in early 2020. Foxcon moved into making ventilators to support the fight against pandemic.  (Wu, 2020) Some of the apparel companies rapidly moved into manufacturing face masks. These decisions were very important at a time whole world is fighting against the pandemic. They considered the stake of the society which is fighting against the pandemic as their top priority. Eventually it helped the business to sustain, and it was good for other internal and external stakeholders including shareholders, employees etc. Milton Friedman stated that, ‘The social responsibility of business is to increase its profits’. (Friedman, 1970) Pandemic situation revealed that stakeholder priority can be dependent on various parameters during different social and economic situations.

Financial reporting constitutes an important element of the corporate governance system. In fact, some failures of corporate governance may be reduced by an adequate financial reporting system. (Melis, 2003) Ethical behavior of the business is an important part of the corporate governance.  Misreporting financial records to manipulate the financial position of a company is a key governance problem. Enron , American energy company bankrupted in 2001 due to misreporting of financial record by its management. Company was writing unrealized future gains from some trading contracts into current income statement. This gives a wrong picture that company has a higher profit.  (Bondarenko, 2018)

Accurate reporting of financial records has become even more important during the pandemic situation. Some industries got drastically impacted due to Covid 19 such as tourism, construction, manufacturing etc. Relevant financial bodies of countries have issued new guidelines to prepare financial statements specially during the pandemic. Institute of Chartered Accountants in Sri Lanka has issued guidelines to provide financial statements in the areas including financial instruments, Impairment of Assets , Measurement of deferred tax etc.(www.casrilanka.com, n.d.) Accurate reporting of financial records will allow the board to take the right decision specially during the pandemic which factor of uncertainty has become high during this period. Finance managers should accurately identify payables and receivables to the period to get the right view of the working capital. Finance firms such as KPMG has published Covid 19 financial Reporting Implications to advise on financial reporting specially during the Covid 19 period. For example, interruptions in construction and development projects due to the COVID-19 outbreak could lead to a suspension in the capitalization of borrowing costs.  (www.kpmg.com) Therefore, it is advised to capitalize the borrowing cost only if project suspension is temporary. Boards should monitor the steps taken by government and check if there is any tax relief or any other relief  provided by government to continue the business operation. These changes of the business could have a positive impact on the working capital management of the company which will ensure they have sufficient cashflow meeting their operating expenses and short-term debt. Working capital management is an important aspect of corporate governance and it has direct affiliation with sustainability of the company.

Environment Pillar, Social Pillar and Economic pillar are three pillars of sustainability. (Hansmann, Mieg and Frischknecht, 2012) Social and economic perspective of corporate governance is discussed above. Most of the companies are concerned about environment aspects such as carbon footprint, wastage, recycling , using renewable energy etc. This has a long term and short-term financial benefit in return. Stakeholders mainly including environmentalists, media , community, and investors are interested in ecofriendly companies.

                In 2013 there was an incident happened between villagers and the management of the company named Dipped products PLC in an area called Rathupaswala in Sri Lanka. This rubber glove factory ran their operation for several years and they have given many job opportunities to villagers. Later, villagers started to claim the ground water is contaminated in the area and people are getting health issues because of this contaminated water. Finally, villagers did a massive rally against the factory management, and it was attacked by police and 3 innocent people were killed and several others got injured. (Human Rights Watch, 2013) This was unfortunate incident in Sri Lankan history. After the legal proceedings court ordered the company to relocate the factory within an industrial zone. This situation could have been handled better if the board and senior management of the company gave more attention on  the allegation came from the community at the beginning. Interest of every stakeholder matters for the sustainability of the entity.

The closure of the factory unfortunately led to severe losses across the value chain, from rubber farmers to company’s global customers, apart from the loss of foreign exchange to the country.  As per 2013 /2014 annual report Profit before tax decreased from Rs. 2,154 million to Rs. 1,519 million (10) As per 2015/2016 annual report  profit before tax has decreased to 648 million.  (Annual Report of Dipped products PLC) Main reason for this was customers of Dipped Products Plc moved to competitor suppliers in the region due the delays happen because of this incident. Share price of the company went down drastically. It took years for the company to recover this situation.  This incident set an example to the business world to show the importance of corporate governance practices and its impact on the sustainability.

Conclusively, today’s businesses can be changed dramatically in volatile, uncertain, complex, and ambiguous  world. Board should be ready to do business with any unexpected situation. However, success or the failure of the business will directly depend on corporate governance practices, and it has been proven the business world in the past.

Jeewana Premarathne , MBA Undergraduate, University of Bedfordshire (UK)

Reference list

Aneez, S. (2020). Garment workers on front line of Sri Lanka coronavirus outbreak. Reuters. [online] 4 Nov. Available at: https://www.reuters.com/article/us-health-coronavirus-sri-lanka-workers-idUSKBN27K08Z.

Bondarenko, P. (2018). Enron Scandal. In: Encyclopædia Britannica. [online] Available at: https://www.britannica.com/event/Enron-scandal.

Chen, J. (2020). Corporate Governance. [online] Investopedia. Available at: https://www.investopedia.com/terms/c/corporategovernance.asp.

Friedman, M. (1970). A Friedman Doctrine - The Social Responsibility of Business Is to Increase Its Profits. The New York Times. [online] 13 Sep. Available at: https://www.nytimes.com/1970/09/13/archives/a-friedman-doctrine-the-social-responsibility-of-business-is-to.html.

Hansmann, R., Mieg, H.A. and Frischknecht, P. (2012). Principal sustainability components: empirical analysis of synergies between the three pillars of sustainability. International Journal of Sustainable Development & World Ecology, 19(5), pp.451–459.

Human Rights Watch. (2013). Sri Lanka: Investigate “Clean Water” Protest Deaths. [online] Available at: https://www.hrw.org/news/2013/08/09/sri-lanka-investigate-clean-water-protest-deaths.

Melis, A. (2003). FINANCIAL REPORTING, CORPORATE COMMUNICATION AND GOVERNANCE. Corporate Ownership and Control, 1(2).

Wu, D. (2020). Bloomberg - Are you a robot? [online] www.bloomberg.com. Available at: https://www.bloomberg.com/news/articles/2020-04-08/apple-partner-foxconn-to-start-making-ventilators-in-u-s.

www.casrilanka.com. (n.d.). Application Guidance for COVID-19 Pandemic: The Implications on Financial Reporting. [online] Available at: https://www.casrilanka.com/casl/index.php?option=com_content&view=article&id=3150%3Aapplication-guidance-for-covid-19-pandemic-the-implications-on-financial-reporting&catid=1%3Ageneral-latest&lang=en [Accessed 24 Jun. 2021].