HIH COLLAPSE....................................?

HIH INSURANCE IS LACKING OF GOOD CORPRATE GOVERNANCE PRINCIPLE?

Corporate governance is the systematic framework of various rules, relationships and the process by which authority is exercised and controlled within the corporation  (ASXCGC, 2014).It focuses on directing and controlling of the management activities (Rankin, Stanton, McGowan, Ferlauto, & Tilling, 2012, pp. 188-189). There are different frameworks of corporate governance in the world, such as the Anglo-American, German and Japanese models. The Australian corporate governance system is a hybrid model of the Anglo-American, German, and Japanese models which will supply the mix the anglo board structure with the internal relationship of corporate governance mechanism seen in Germany and Japan (Buchanan, Arnold, & Nail, 2003, p. 4).Corporate failure is the inability of a corporation to generate income or revenue from its operations (Miglani, Ahmed, & Henry, 2015, p. 19). Both systematic and unsystematic risk is associated with corporate collapse. A good corporate governance system can eliminate systematic risk and decrease the impact of unsystematic risk (Zou, Adams, & Buckle, 2003, p. 16). HIH Insurance suffered the biggest financial collapse to date in Australian history.

The main aim of this research is to evaluate the corporate failure issues of HIH Insurance, applying the relevant accounting theories in the light of three main principles of good corporate governance that could have contributed to preventing the failure. HIH Insurance suffered the biggest corporate collapse in Australian history, with a debt of 5.2 billion AUD, and was the subject of a Royal Commission Investigation (Mak, Deo,  & Cooper, 2005).

Ray Williams (chairman) Rodney Adler, (non-executive director), and Fodder (chief financial officer), of HIH Insurance, did not delegate their authority and responsibility with the required degree of care and diligence and collectively break “officer’s duties” of 197 provisions (Sarre, 2005, p. 2).Mr Williams, was taking an extraordinary salary (one million AUD in 1992 and five million AUD in 2000 ) and  involved in stock market speculation (buying one million AUD shares by himself)  that is not in the best interests of the company (Buchanan et al., 2003, pp. 7-18). In 1995, as part of his expansion plan, Mr William had applied the wrong business judgment rule by continuing the business in the US and UK and buying FAI Insurance (which was not audited for a six-month period and entailed a large loss) despite losses (DeMott, 2006, p. 4).Mr Williams had also breached his fiduciary duties by negotiating with a Swiss insurance company to sell his shares at a higher price (Mellahi, 2005, p. 267).

Mr Williams was reckless as he bought FAI Insurance (not audited of $50–$60 million AUD for six months and suffered a loss of an investment of $22 million AUD in the first quarter) at a premium of 43%, which was not in good faith and the best interests of the corporation (Buchanan et al., 2003, p. 9). The members and directors of HIH Insurance were involved in breaching section 558G (1) and (2) of corporation act 2001 with the announcement of a dividend payout ratio of 70% to 80%, which required a $80 million AUD profit even though there was a huge loss after the acquisition of FAI (Haines, 2007, p. 524). HIH had increased its goodwill by $143 million AUD, did not keep periodontal margins of 10%–25% in their reserve balance and keep  higher discount rate of 6.4% and lower the inflation rate 3.8% in the year of 2000 (Buchanan et al., 2003, p. 7). These earning management practices of HIH had wiped out $360 million AUD from shareholder’s wealth (Callaghan, Wood, & Svensson, 2006, p. 6).

According to the Australian Stock Exchange (ASX)’s Corporate Governance Principles and recommendations, a listed entity should actively promote ethical and responsible decision making. The company should establish the code of conduct to maintain the integrity and investigation of unethical practices in the organization to full fill the reasonable expectation of their stakeholders (ASXCGC, 2014, pp. 21-22)

The directors, managements and the executives of HIH did not act ethically and responsibly. Mr William had involved in unethical contracts with the Swiss insurance company of profit sharing of ten percent for his own benefits. He had also involved in the market speculation (in order to support the stock downfall), inflating intangible assets, rent extraction and transferring money, activities of unethical and irresponsible behaviour (Haines, 2007, p. 525).The management must have reported all the misconduct and unethical behaviour to take timely a course of actions.

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Agency Theory is applied in this case, because the management of the company are agents of the shareholders (owners).As the agent of the shareholders, the directors and the executive of HIH must have worked ethically and responsibly in the best interest of their shareholders (Hill & Jones, 1992, p. 133).Unfortunately, management of HIH didn’t act ethically and responsibly to develop legitimacy and transparency into their performances .

 Strength: Acting ethically will establish the highest ethical standard for the performance with true and fair view of accounting.

 Weakness: In the absence proper systematic framework of the ethical code of conduct, Acting ethically and responsibly might create a lot of confusion in operating activities.

 According to ASX principle 4, companies should have a proper validated structure to independently verify and safeguard the integrity of financial reporting. The board should establish the audit committee to oversee the preparation of the financial statements which represent the true and fair view. The responsibility of the audit committee is to confirm that the accounting method which is applied by management are consistent and comply with applicable accounting standard and accounting concept (ASXCGC, 2014, pp. 21-23).

In the given case of HIH, there were not any safeguard to monitor integrity of the financial statements, neither it present true and fair view nor comprehensive and comply with accounting rules and standards. Even though, the management of HIH was involved in fraudulent accounting practices (inflating the goodwill of $143 million, didn’t keep the prudential margin of 15% to 25% in their reserve) and insolvent trading (Buchanan et al., 2003, p. 23), there were not any safeguard for stopping them.

Stakeholders theory and agency theory can be applied to this principle, According to the stakeholder theory, normative branch, the company should treat fairly to perform their duties towards their shareholders, Investors, lenders and the public by providing a true and fair view in the financial statements (Donaldson & Preston, 1995, p. 4). Unfortunately, the financial statement of HIH did not create a trustworthy environment towards its stakeholders because of lacking integrity with absence of legitimacy. AS  the agents of the shareholders, The directors of the company must act in the best interest of the shareholders by providing a true and fair view on financial statements (Hill & Jones, 1992, p. 133).

 Strength: If there were the integrity in the financial statements of HIH, The shareholders wealth of $320 million would have been protected.

 Weakness: It is a very careful and systematic involvement into periodic review.

As per ASX Principle 7, companies should establish the proper framework for the risk oversight and internal control system. It should also establish special policies for reviewing the potential business risk. Furthermore, companies can establish the risk management committee for reviewing and approving the risk management strategy and policy (ASXCGC, 2014, pp. 28-30). In the case of HIH, we can see that the above principles of risk management were completely ignored. Mr. Williams, Mr. Adler and other employee were engaged in aggressive expansion  policies with high risk and high yield strategies without evaluating the potential risk (Haines, 2007, pp. 525-526).If there were Enterprises Risk Management (ERM) practices in HIH to monitor the risk profile of FAI and capital level before acquisition, It might be prevented from potential collapse (Tripp et al., 2008, p. 435)

Institutional theory and agency theory can be applied in above principle. Institutional theory advocates that the of rules, norms, routines and establish guideline are critically analysed in a rational decision making process (Scott, 1987, p. 495). Agency theory states that th

e management of the company must act as the best interest of the shareholders (owners). In the given case, HIH management did not establish the systematic framework of the risk management committee to protect the shareholder wealth by analyzing systematic and unsystematic risk associated with FAI insurance before the acquisition.

 Strength: If the company would follow ASX principle 7, it would have provided proper risk management framework which may prevent HIH in wrong acquisition with FAI insurance.

Weakness: Risk management committee and framework process is comparative costs more.

After analyzing all the recommended principles for HIH, I would go for principle seven which have highest advantages and weakest disadvantages among three. There is no doubt that the principle three and principle four also provide the positive effect into performance of the organization; however ,the application of the risk management framework into the corporation will help to provide a rational decision making process (Freeman & Evan, 1991, p. 354).Rational decision making process eventually reduce the cost, develop ethical behavior and integrity into the financial reporting (Deng, 2015, p. 9).This recommended policy will also go parallel with the stakeholder theory  because, The Integrity into the financial reporting will also fulfill the stakeholder’s expectations (Constantinescu & Kaptein, 2015, p. 249).

The recommendation above is conducted solely based on secondary data by referring to various online journals, newspaper articles, books and previous researches.Therefore, it is not possible to conduct depth analysis of the already published data so the recommendation will not apply in all the cases. The demand of opting primary data with depth personal interviews with the person associated with HIH scandal may alter decision options.

References

ASXCGC. (2014). CGC-principles-and-recommendations-3rd-edn.pdf.  Third. Retrieved 14 Apri 2015, from http://www.asx.com.au/documents/asx-compliance/cgc-principles-and-recommendations-3rd-edn.pdf

Buchanan, B., Arnold, T., & Nail, L. (2003). Beware of the ides of March: The demise of HIH Insurance.

Callaghan, M., Wood, G., & Svensson, G. (2006). A longitudinal study of the commitment to business ethics of corporate Australia: 1995-2005. Paper presented at the ANZAM 2006: Management: pragmatism, philosophy, priorities.

Constantinescu, M., & Kaptein, M. (2015). CSR Standards and Corporate Ethical Virtues: A Normative Inquiry into the Way Corporations Integrate Stakeholder Expectations Corporate Social Responsibility and Governance (pp. 159-180): Springer.

DeMott, D. (2006). Inside the Corporate Veil: The Character and Consequences of Executives' Duties. Australian Journal of Corporate Law, 19.

Deng, X. (2015). Understanding Chinese consumers’ ethical purchasing decision-making process: A combination of qualitative and quantitative study. Geoforum.

Donaldson, T., & Preston, L. E. (1995). The stakeholder theory of the corporation: Concepts, evidence, and implications. Academy of management Review, 20(1), 65-91.

Freeman, R. E., & Evan, W. M. (1991). Corporate governance: A stakeholder interpretation. Journal of Behavioral Economics, 19(4), 337-359.

Haines, F. (2007). Crime? What Crime? Tales of the Collapse of HIH International Handbook of White-Collar and Corporate Crime (pp. 523-539): Springer.

Hill, C. W., & Jones, T. M. (1992). Stakeholder-agency theory. Journal of management studies, 29(2), 131-154.

Mak, K., Deo, H. N., & Cooper, K. A. (2005). Australia's major corporate collapse: Health International Holdings (HIH) Insurance" May the force be with you".

Mellahi, K. (2005). The dynamics of boards of directors in failing organizations. Long range planning, 38(3), 261-279.

Miglani, S., Ahmed, K., & Henry, D. (2015). Voluntary corporate governance structure and financial distress: evidence from Australia. Journal of Contemporary Accounting & Economics, 11(1), 18-30.

Rankin, M., Stanton, P. A., McGowan, S. C., Ferlauto, K., & Tilling, M. (2012). Contemporary issues in accounting: Wiley.

Sarre, R. (2005). ALTA Law Research Series. 1-4.

Scott, W. R. (1987). The adolescence of institutional theory. Administrative science quarterly, 493-511.

Tricker, R. I. (2015). Corporate governance: Principles, policies, and practices: Oxford University Press, USA.

Tripp, M., Chan, C., Haria, S., Hilary, N., Morgan, K., Orros, G., . . . Tahir-Thomson, K. (2008). Enterprise Risk Management from the General Insurance Actuarial Perspective. British Actuarial Journal, 14(03), 433-525.

Zou, H., Adams, M. B., & Buckle, M. J. (2003). Corporate risks and property insurance: Evidence from the People's Republic of China. Journal of Risk and Insurance, 70(2), 289-314.

RESEARCH GENRE ON CORPORATE SOCIAL RESPONSIBILITY

CORPORATE SOCIAL RESPONSIBILITY: A NEW BUSINESS TREND AS AN INSURANCE (?)

Corporate social responsibility (CSR) exemplifies a growing tactical concern for organizations around the world. Many organizations are adopting CSR as a core management or board-level function. In general, CSR is only about the corporate functions toward the community, society and the environment.

Nowadays, the insurance perspective of CSR is the emerging concept in the field of management, There are the enormous questions about CSR in the field of corporate governance; Whether CSR could be taken as insurance or not? Whether CSR activities could increase the financial performance of the organisation or not? Within the periphery of CSR with insurance perspective, the research paper by Peloza, John (2006) in the  topic of “Using corporate social responsibility as an insurance for financial Performance” provides in depth knowledge about CSR, Insurance and financial performance.

There are tremendous advantages of incorporating CSR into the organisation. The corporate strategy for social investment helps management to build the social image, good reputation, increase sales and obtain customer goodwill. In the process of strengthening the goodwill by social involvements, the insurance prospective of CSR will be developed and protect organisations from future social uncertainty and improve the financial performance. However, this is the topic of social involvement which required to consider the social, legal and ethical framework of the society. Therefore, the micro level study is required for rationality and proper application of insurance prospective of CSR.

The CSR as an insurance is important for two reasons. Firstly, even though there is not a visible return which is associated with the CSR cost, many organizations are using CSR like as insurance that protect against a possible eventuality. Secondly, there is the positive financial impact of the CSR act as an insurance of the society by reducing negative publicity.                           

Negative publicity can lead to disastrous consequences for an organisation. The reputation of the organisation is badly tarnished. It is like the tiny spark that results in a disastrous fire. Negative publicity can quickly destroy a business. Positive CSR can safeguard the organisational reputation and social image of the organisation from negative publicity. It also helps to increase revenue by developing customer loyalty and fulfilling stakeholder expectations. CSR, with strategic social investment, is a tool that can enhance organisational reputation and reduce financial impact as a consequence of negative publicity.

The finding of this research paper indicate that, in the absence of negative publicity, the value of a socially responsible organisation can be increased through this insurance. Even when the relationship between CSR and financial performance is neutral, CSR investment can still be justified by its insurance value. A corporation having strong CSR is affected half in the stock decline as much as a corporation with weak CSR after the riots in 1999, surrounding the meeting of WTO in Seattle, This results reflects that positive CSR acts as insurance to protect the corporation from the social consequences .On the other hand, the consumer purchase intentions in the strong CSR companies  appears double than the weak CSR reputation following a product recall.

Insurance is a tool to protect the organisation from some possible eventuality. There are three factors which is identified by this research paper that allow CSR to be leveraged for insurance:

1. Strong effort and commitment: an organisation should develop its long-term relationship with social causes in order to build its reputation. Positive relations with society can be developed by, for instance, employee volunteer programs, product donations, advocacy support and legal support programs. A positive and highly committed relationship with a social cause and social involvement activities will boost the organisation’s social image, and can be leveraged for insurance.

2. Modesty in promoting CSR: this is the second factor for organisations to gain customer goodwill and third party promotion. Leading corporate brands, such as Citibank, 3M and GE value, are all promoting activities in support of various social causes.

3. Supporting social causes as a core business strategy: social responsibility has developed in importance, and organisations are supporting social causes as a core business strategy. Programs that are appropriate, relevant and reasonable not only develop good reputation and goodwill but also boost the insurance benefits to the organisation

Finally, CSR as insurance can be a tool for enhancing a company’s reputation in society. It should project a holistic image of the company and generate goodwill. At the same time, the social initiatives selected for CSR should fit with the business strategy and contribute to expertise, rather than simply donating to generic causes. However, some critics maintain that CSR is not suitable for all organisations because the nature of their business is incongruent with CSR activities. Furthermore, the critics are fascinating that CSR is only the way of green-washing the corporation’s image.

                                                                                   THANK YOU

Citation:

Peloza ,John (2006) :Using corporate social responsibility as a insurance for financial Performance .