THE HISTORY OF CORPORATE GOVERNANCE (STUDY OBJECTIVE 4)

Corporate governance has changed over the years as the focus of the business world has changed. In addition, since compliance is such an important function within the corporate governance process, changes in legislation have had a big impact on corporate governance. The pace of change has been fast in recent years, especially since the turn of the century. This section presents a chronology of significant developments that have influenced corporate governance.

The origin of the corporate governance concept in the United States coincides with the establishment of the SEC and enactment of the securities laws, in response to pressure from investors following the stock market crash of 1929 and the Great Depression of the 1930s. Investors wanted greater protection against misleading accounting and reporting practices. The Securities Act of 1933 requires full disclosure of financial information through the filing of registration statements before securities can be sold in the financial markets. The Securities Exchange Act of 1934 requires ongoing disclosures for registered companies, as well as regulation of stock exchanges, brokers, and dealers.

In the subsequent decades, as companies were rebuilding and recovering from the Great Depression, more emphasis was placed on the accounting function. Until the 1970s, sharp focus was on materiality, as companies and their auditors concentrated on the transactions and accounts that were most significant to the overall business. The Foreign Corrupt Practices Act of 1977 prohibited bribery payments associated with business transactions, and addressed the necessity for internal controls over financial reporting to promote transparency. By the 1980s, however, it became clear that market pressures were a bigger influence on accountants and corporate leaders. There was intense pressure for companies to meet or beat their earnings targets. As a result, earnings management and other creative accounting practices became more common. Even after the release of COSO's internal control framework in 1992, the number of accounting irregularities was still on the rise. In fact, the irregularities became so severe that in the early 2000s, a series of high-profile corporate scandals erupted, including the most noteworthy cases, those at Enron and WorldCom. These scandals robbed thousands of people of their jobs and retirement savings and caused major corporations to file bankruptcy. In response, many investors demanded that new legislation be introduced to avoid repeat instances of these types of accounting-based scandals.

The Sarbanes–Oxley Act of 2002 is the legislation enacted to combat deceptive accounting practices. This Act is so extensive that its details and impacts are presented in the next two sections of this chapter.

In addition to the Sarbanes–Oxley Act, many other new guidelines were implemented in the early 2000s. For instance, the U.S. Patriot Act (2001), the Basel II (2004) and Basel III (2010) regulations, and the Dodd-Frank Wall Street Reform and Consumer Protection Act (2010) were put into practice to provide for improved financial systems for the financial services industry. Other industries have followed suit, with the goal of improving corporate governance in their companies.