The Disadvantages of Corporate Governance

By David Carnes

Corporate governance is one of the law's most intensely regulated fields. This is because corporations are privately owned but are treated as independent legal entities, rendering their assets vulnerable to a variety of potential abuses. Corporate governance is generally governed by state law, although the federal government has also enacted legislation to curb abuses.

Ownership-Management Separation

The officers and directors who run the day-to-day affairs of a corporation and make most of its policy decisions are not necessarily shareholders. This can become a problem in large, publicly traded corporations. If no shareholder holds a controlling interest in the corporation, and most shareholders vote by proxy, the corporation's assets are controlled by the board of directors and the officers. The separation of ownership and management can lead to a conflict of interest between management's duty to maximize shareholder value and its interest in maximizing its own income. A CEO, for example, might be paid a large bonus even as the corporation approaches bankruptcy.

Illegal Insider Trading

The term "corporate insiders" refers to corporate officers, directors and employees because they may have access to confidential, non-public information about the corporation that might affect the value of its shares. Corporate insiders are not strictly prohibited from trading corporate shares but must report these trades to the Securities and Exchange Commission. Illegal insider trading occurs when a shareholder, while in possession of confidential information relevant to the future value of his shares, sells shares to a buyer without access to this information. Illegal insider trading can also be committed by a shareholder not directly affiliated with the corporation, such as an outside auditor, a government regulator or a relative of a corporate insider. Because access to confidential corporate information can be widely dispersed, laws against insider trading can be difficult to enforce.

Ready to incorporate your business? Get Started Now

Misleading Financial Statements

There are many ways to present factually accurate information on a financial statement in a manner that is misleading to investors -- by, for example, selling property from a parent company to a subsidiary to maximize parent company revenues. It is also possible to present factually incorrect information that is difficult to detect by establishing complex networks of subsidiaries and cross-shareholdings.

Costs of Regulation

The abuse of corporate governance has triggered the enactment of a large body of state and federal laws designed to prevent such abuses from recurring. Compliance with these laws can be burdensome and expensive for corporations. For example, the Securities and Exchange Act of 1933 requires companies seeking to list on a stock exchange to make such extensive disclosures to potential investors that compliance can cost hundreds of thousands of dollars. More recently, the Sarbanes-Oxley Act of 2002 requires corporations to establish extensive systems of internal controls to ensure that their financial statements are both factually accurate and non-misleading.

Ready to incorporate your business? Get Started Now
How Can a Person That Owns a Corporation Get Sued for Fraud?

References

Related articles

What Liability Does a Corporation Have for Its Officers?

Employees of a corporation, which includes its officers, generally aren’t personally liable when engaging in business transactions or otherwise acting as a representative of the business. Instead, the corporation is solely liable for the acts of its officers. However, exceptions do exist when a corporation’s officers act outside the scope of their duties.

Is a Corporation the Same as an LLC?

At one time, there were only three options for company organizers choosing a form of business organization: the sole proprietorship, the partnership and the corporation. Then in the 1970s, the limited liability company (LLC) was introduced in some states. As of 2010, LLCs are authorized by all 50 states and the District of Columbia. It is similar to the corporation in some ways and different in others.

Why Do Companies Incorporate in Delaware?

You may incorporate in any state, regardless of where your company does business or where its principal business office is located. Many companies choose to incorporate in Delaware because the state offers certain advantages to its corporations. In fact, the Delaware Division of Corporations states that more than half of the nation's Fortune 500 corporations are incorporated in Delaware.

LLCs, Corporations, Patents, Attorney Help

Related articles

Corporation Law Notes

A corporation is a legal entity that gradually developed into its modern form over hundreds of years. It is designed to ...

Steps to Sell an S-Corp

An S corporation is simply a corporation that is taxed under Subchapter S of the Internal Revenue Code. The S ...

What Is the Difference in the Board of Directors and the Stockholders of a Corporation?

A corporation with many owners functions similarly to the American government in that it would be almost impossible for ...

Corporation vs. Officer vs. Owner

A business that operates as a corporation generally drafts bylaws – a document that governs all aspects of the company. ...

Browse by category
Ready to Begin? GET STARTED