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
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