From: Steffan Rambaran, Business Consultant
To: Board of Directors (Costco)
Sent: February 16, 2024, 10:00 am (CT Time)
Subject: Understanding the Corporate Governance Issues (Auditing Frauds, poor internal control, and Lack of effective decision making) and Need for Sustainable Leadership Practices at Costco
Dear Board of Directors,
One major retailer of big-box warehouse club membership-only domains is Costco. The firm is ranked the 3rd largest retailer worldwide. Company revenues were $242.3 billion in 2023 (Business Insider, 2023). The company employs 316,000 employees. The firm, however, has stumbled due to several corporate governance issues that have created a negative impact on performance. It hinders financial success because it puts an extra financial burden on the organization. Also, it is hard to allocate funds for sustainable projects. Fraud in auditing, poor internal controls, and lack of effective decision-making have been some daunting corporate governance issues. Restoring the firm’s performance is imperative to improving corporate governance to set the foundation for sustained success. The most important thing is to enhance the corporate image, win investor’s trust, and bring transparency to the internal business climate. Concerns regarding the declining performance in the competitive retail industry are in the limelight. Understanding the need for good corporate governance is paramount to maintaining ethical behavior, stakeholder confidence, compliance, and long-term sustainability. It is also essential to adopt sustainable leadership, as it can also be a solution to evade these challenges. Sustainable leadership can become a vital driver of improving the image and maintaining transparency. The combination of responsibility and ethics must be preserved. Indeed, there needs to be more accountability and short-term focus. This limited accountability and short-term focus has led to a chain of unsustainable practices. For instance, Costco’s auditors have been accused of felony theft and forgery, as they have manipulated the audit reports for personal benefit (Allison, 2009). Internal control still needs to be stronger as far as financial reporting is concerned (Norman Marks, 2018). Poor decision-making, especially in the context of product development, marketing, and promotion, is also in the spotlight, contributing to declined performance (Burrows, 2024). Corporate governance, sustainability, and ethics are interrelated with each other, as these aspects collectively design the trajectory of the firm. Costco can maintain CG to establish an ethical decision-making framework and transparency. Leadership can play a vital role in driving the combination of sustainable practices and standards.
Corporate Governance
Corporate Governance at Costco
Corporate Governance Challenges and Issues
Frauds in Auditing: Auditing fraud at Costco has been typical, becoming one of the daunting corporate governance challenges for the organization. For instance, the former Costco auditor has been accused of forged statements and records regarding travel expenses (Allison, 2009). Excessive false expenses put an extra burden on the organization’s finances. The issue has been optimized, but the auditing needs to be more transparent due to many loopholes in claims. It shows the weaknesses in transparency and accountability measures that have restrained the firm from each of its expected earnings. Section 404 of the Sarbanes-Oxley Act unveils that management is always responsible for maintaining a sound internal control structure and the whole reporting process, including auditing. In the case of Costco, instead of just delegating the process to external audits, the management needs to assess the effectiveness of the structure and control (Wagner and Dittmar, 2006). The compliance needs to be included in Costco. Failing to maintain transparency and accountability practices has led to the loss of stakeholder trust. Fraud is eroding the trust of customers, investors, and even employees. Costco faces some financial consequences. as far as the mismanagement of funds is concerned. The negative impact on the bottom line of the company is evident. Regulatory actions, impaired reputation, loss of business opportunities, and decline in market value are adverse outcomes for Costco. The agency theory has been breached. Agency theory stresses the connection between agents (management) and principals (owners/executives). In Costco’s case, the interests of the agency (agents) contradicted the interests of principals (executives). Indeed, it has been a misalignment of interest at Costco. Conducting a wide-ranging investigation, improving internal controls, and implementing whistleblowing protocols are some excellent recommendations to get things on track (Bonazzi and Islam, 2007).
Poor Internal Control: There have been some things that could be improved in financial controls. Several investors have accused the organization of permitting unauthorized people to change financial information to have favorable decisions from investors (Norman Marks, 2018). The firm has responded to the issues, but it has yet to realize the negative impact of outdated information technology on the financial unit. Manipulation of financial information is one of the critical accusations, and the firm often stumbles due to it. The company has a code for its financial officers, which interrelates with Section 406 of the Sarbanes-Oxley Act. This section compels the organization to disclose the statements. Internal control can be improved by making executives clarify financial statements, maintain internal controls, evade criminal penalties, and support whistleblowing (Findlaw.com, 2016). For example, a violation of the Sarbanes-Oxley Act occurred when Costco filed a 10-Q for the end of the quarter in 2018. The firm claimed that the financial reporting process was adequate, with no material weaknesses. However, plaintiffs accused the organization of having multiple material flaws in its reporting (Bennett, 2019). Costco has stumbled due to this issue, as financial misinterpretation is apparent. It leads to a misrepresentation of Costco’s financial health. Investors usually depend on the accuracy and authenticity of the information, and this misinterpretation has led to a false impression. The firm lost its trust and credibility and declined investors’ trust, which is evident.
Lack of Effective Decision-Making: Expanding the product portfolio illegally and unethically has been a wrong decision. The firm stumbled when it was accused of selling mislabeled Tiffany Jewelry (Burrows, 2024). Using the brand’s name to enhance sales is unethical. Also, supply chain (sourcing) decisions are under scrutiny. For instance, the firm has sourced eggs from farmers who packed their chickens in battery cages. Also, the firm’s Black Lives Matter campaign doesn’t resemble the internal policies and actions as far as discrimination is concerned. Thus, product portfolio, sourcing, and marketing decisions have not been strategic, leading to legal, financial, and reputational consequences.
Implications and Impact on Financial Performance
Concerning the auditing fraud, the firm has faced financial implications. False expenses put an extra burden on financial health along with a negative impact on the bottom line. It is a corporate governance breach, as the firm has failed to maintain accountability and transparency principles. Clearly, there has been a misalignment between management and owners/executives, indicating a violation of the agency theory. False claims by auditors have put extra pressure on economic strength, contributing to declining earnings. These fraudulent activities (false claims) accused the organization of violating the “Civil Monetary Penalties Law.” For example, managers submitted wrong drug prescription claims. The firm paid almost $340,000 to authorities, which put a dent in its financial performance and profitability (Office of Inspector General, 2016). Poor internal controls led to impaired investors’ trust and regulatory consequences. Costco violated the Sarbanes Oxley Act due to internal material weaknesses. The authenticity and accuracy of information have been compromised. Unethical decisions also led to legal and reputational consequences and it also led to decreased customer trust. Wrong or ineffective decision-making has also created a negative impact on economic performance, especially on sales. For instance, comparable sales have declined. The firm’s sales just increased 0.4% to $22.86 billion in June (2023). The growth rate has decreased, especially since significant improvements last year. The earnings also remained low due to a lack of spending on non-essential items. It indicates the poor decisions made in product development and marketing.
Costco Falling Short of Earnings
(Hyerczyk, 2023)
Four Fundamental Pillars of Corporate Governance
Critically, four pillars of CG have yet to be implemented by the organization, leading to declining performance in multiple ways.
Accountability: Auditors and financial managers need to disclose results transparently. It was violated because Costco failed to ensure accuracy in financial reporting and permitted wrong expenses. This mismatch of interest showed a need for more accountability.
Transparency: Auditors and managers need to become transparent. Excessive transparency measures must be embedded as far as decision-making, financial reporting, auditing claims, and operational performance are concerned. Forged statements indicated the need for more transparency in the firm’s financial reporting. There needed to be more clarity in the financial domain. Weak internal controls also indicated the need for more transparency in reporting.
Responsibility: Costco has not been responsible regarding its decisions, and the battery cage controversy and its impact on consumer health are the best examples. Liability for maintaining accurate internal control was compromised, indicating the lack of liability towards stakeholders (investors). Similarly, poor product and marketing decisions indicated a need for more responsibility regarding society and the environment (Platt, 2022).
Fairness: Training people equally, especially in the internal business climate, is imperative. Ineffective decisions breached this principle, as these practices became unfair to customers as far as their trust in the products was concerned. If the firm wants to champion equality, it must become fair in the internal business climate.
What Good Corporate Governance Involves
Regarding auditing fraud and poor transparency, the firm needs to implement robust internal controls to validate good corporate governance. Consistent reviews and updates can make the organization resilient and adaptive. Independent evaluations and audits are also reasonable solutions, as these can be excellent drivers of accuracy and transparency. Regarding poor internal controls, the firm needs to come up with a thorough compliance program (Suroso, 2022). This program will help the organization align with the regulations, especially the Sarbanes-Oxley Act. Apart from that, there can be whistleblowing functions, as employees will be open to sharing or reporting unethical activities. It is the best time for the organization to establish a wide-ranging ethical decision-making framework. The most important thing is to align these ethical decisions with corporate values, especially when it comes to product, sourcing, and marketing decisions (Aras and Ingley, 2016).
Benefits to Organization
Internal control implementation and independent audits can provide benefits to the company in the form of augmented financial accuracy. Of course, the company can restore the investor’s trust and improve its credibility. Also, stakeholders’ confidence can be enhanced. A compliance program is also beneficial for the organization, as the firm will be capable of adhering to the regulatory requirements. Evading the probability of legal consequences is essential. Whistleblowing can be beneficial because the firm can detect these issues early and evade excessive adverse outcomes. An ethical decision-making framework is valuable to improving reputation and enhancing stakeholder engagement. This intervention can open ways for responsible and sustainable practices.
Sustainability
Sustainability Issues/Challenges
Food Waste and Packaging: The firm sells products at low prices. It is always valuable for customers, but it also leads to massive packaging and food waste. Perishable products are bought by customers, leading to waste and spoilage. Single-use packaging is also an interrelated issue, as it includes single packets, clamshells, and plastic wraps. Pollution and landfills have adverse outcomes. The firm also contains limited recycling options, making the responsible disposal of material less probable (Riemenschneider, 2021).
Sourcing: The firm aims to sell a diverse range of products with a competitive pricing approach. It requires global sourcing, and air and sea routes are used. It leads to excessive carbon omissions and unfavorable climate impact (Klein, 2022).
Implications of Sustainability Issues
Regarding packaging and food waste, Costco is becoming responsible for greenhouse gas emissions and climate change. Customers are becoming environmentally conscious, and Costco has impaired its reputation. Excessive packaging and waste can also increase the cost of compliance (Reuter, 2023). Customers are expecting sustainable activities from the company, and the probability of an impaired brand image is high. This issue led to a violation of intergenerational equity as far as resources for future generations are concerned. FoodFood waste also violates the closed-loop system, as the intention should be to maximize resource utilization with minimum waste. Investing in recycling and reusable material in packaging is the fundamental solution. Multi-use packaging is also a good option when it comes to individual or small customers. A new food waste reduction program must be introduced, and it may include collaboration with food banks and awareness campaigns. Unethical sourcing is also leading to the violation of climate responsibility principles, as decreasing carbon emissions is essential. Costco can stumble due to possible boycotts and impaired reputation. Local sourcing should be prioritized with the new transparency measures, and it is one of the best solutions to move forward (Sustainable Supply Chains: A Research-Based Textbook on Operations and Strategy, 2016).
Triple Bottom-Line
Planet: Costco violated these aspects because it kept selling bulk and large packages, indicating excessive waste and pollution (Reuter, 2023). Investments in renewable energy, landfill management, and sustainable products are indicating progress.
People: Unethical labor practices in Costco’s supply chain justified the violation of this aspect (McKevitt, 2017). Ethical labor practice is the primary concern as far as discrimination issues or challenges in the internal climate are concerned. Diversity and inclusion are good facets to justify social responsibility.
Profit: Costco violated this facet because environmentally conscious customers are being converted. Costco needs to maintain the perfect balance between profitability and sustainability to satisfy the shareholders. The most important thing is to streamline profitability through sustainability.
Importance/Benefits of Sustainability
Costco can get several benefits from sustainability. The firm can reduce waste and become conservative in resource utilization. The best thing that the firm can do is improve the working conditions. Fair labor practices and inclusion initiatives can set the ground for better working conditions. Product safety and community engagement are also probable outcomes (benefits) of sustainability. The organization can become more innovative through sustainability as it can introduce new methods, processes, and measures to become socially and environmentally responsible.
Linking Sustainability to Corporate Governance
Ethical practices at Costco can become the foundation for incredible corporate governance. For instance, in good governance, the firm will be transparent and accountable regarding the strategic decisions, which are further interrelated with social and environmental responsibility. Ethical practices in the internal setting can evade the risks related to compliance. Even the board of directors can set the moral direction. Sustainability should be embedded in strategic choices and decision-making, and it can be the true essence (Aras and Ingley, 2016).
Business Ethics
Ethical Issues/Challenges
There has been a wage gap at Costco when it comes to hourly and salaried workers (Taylor, 2021). It is an unethical practice as far as the need for equality is concerned. The firm has also been criticized due to excessive resistance to unions (Kline, 2023). Gender and racial discrimination have been a significant concern, making the organization unethical. The campaign “Black Lives Matter” has not been justified due to discrimination cases in Costco’s workplace. Several lawsuits related to discrimination are examples of it (Zippia, Inc, 2023). Product recalls and poor safety have become concerns. Despite efforts, product safety is still a significant challenge (CBS News, 2015).
Implications of Ethical Issues
Excessive wage gaps are leading to employee demotivation and less productivity (Omoigui, 2022). Employees always strive for better working conditions, and the probability of high turnover is apparent. The organization has become more vulnerable due to possible lawsuits related to discrimination and unfair work practices. For example, Wal-Mart faced a lot of backlashes due to discrimination issues. There has been unequal pay based on gender discrimination, and the company has faced several lawsuits (Sainato, 2019). Employees, as stakeholders, can stumble due to the negative impact on their well-being (Belton, 2013). Community members showed less trust in the organization due to a lack of representation. Consumers are also concerned about product safety and unethical sourcing. Investors can be reluctant due to the legal paradoxes, impaired image, and decreased employees. The impact on organizational performance has been negative, as the firm is no longer an ideal place to work for employees. Less motivation and more employee turnover have become concerns. Of course, there is also reputational damage to the company in the industry where ethical practices are evolving (Akdeniz, 2019).
Carroll’s CSR Pyramid
Economic Responsibility: Costco violated this responsibility due to the wage gap, as it offers high amounts to top leadership and offers low wages to bottom-line employees. Employees usually fail to meet their economic labilities.
Legal Responsibility: Discrimination-related lawsuits violated legal liability. The firm needs an effective compliance strategy when operating in both home and other countries.
Ethical Responsibility: Ethical responsibility is breached by Costco because the wage gap remained, leading to demotivation and turnover. Equality has not been embedded in culture due to multiple discrimination cases and lawsuits. Of course, social responsibility still needs to be met by the company.
Philanthropic Responsibility: Costco has streamlined charities and donations, especially in disaster relief programs. However, it is still a challenge to balance the core liabilities and philanthropic domains (Kusyk, 2021).
Benefits of Business Ethics
Practical business ethics drives benefits for Costco. It can enhance its brand image due to excessive loyalty and trust at the stakeholder level. Attracting investors and new talent becomes a new possibility. Improved customer perception is also a critical benefit that can enhance sales and revenues. Ethical practice or consideration can improve employee motivation and minimize misconduct.
linking Business Ethics to Corporate Governance
Good CG can drive business ethics. For instance, Costco’s accountability and transparency measures can improve ethical decision-making. Complying with regulations can evade risks and build trust. CG drives risk identification and elimination, and it is effective when it comes to ethical risks and decision-making. Effective corporate governance is good for streamlining some practical solutions. For instance, the governance system must strive for a wage gap reduction, and it is possible by maintaining a transparent wage structure. Consent salary audits are relevant to having a proper check and balance. Legal compliance can make the firm evaluate employment practices. Indeed, effective compliance with the employee law is imperative. (Grøgaard, Ryg and Benito, 2019).
Leadership
Leadership Style at Costco
Authentic leadership would have contributed to the issues mentioned above in many ways. For instance, authentic leadership can be the best driver for this company to maintain open communication and transparency. Authentic leadership can acknowledge the probability of wage gaps and related equity issues. Thus, consistent communication channels could have helped streamline and address these issues. Authentic leadership can be the best driver of ethical role modeling (Liu et al., 2018). Leaders at the top levels must streamline fairness, and rectification of the wage gap is one possibility. Leadership fosters robust relationships and empathy, which depicts respect and comprehension. Despite these specific values, there has been a transformational leadership at Costco. It is a primary style, as the firm concentrates on long-term vision, employee motivation, and change. The firm’s leadership identifies the need for change and enhances employee motivation to make the change a reality (Morgan, 2020).
Leadership Issues/Challenges
Costco has faced several leadership issues or challenges. For instance, it is hard for the leadership to preserve the right balance between growth and challenge. Growth requires personalization, and aligning new employees with new perspectives is a big challenge. The leadership needs help to evade ethical concerns. There have been wage gaps, a lack of unionization, and discrimination. Leadership needs to be more capable of avoiding these issues or challenges to restore its reputation. Ineffective decision-making has been a significant challenge. As discussed, some of the decisions went wrong, which also impaired the earnings or financial performance. Rational decision-making is still a challenge, and it must be improved to move forward in the dynamic retail industry (Cikaliuk et al., 2022).
Regenerative or Sustainable Leadership Style
Regenerative or sustainable leadership style can be the best driver for evading these challenges. Through sustainable leadership, the organization can have and sustain a long-term vision that can foster employee well-being and empowerment. Of course, this leadership intervention can make the workplace more inclusive and adaptive. Sustainable leadership will strive for social, economic, and environmental solutions. Costco needs to improve these three areas, as new sustainability values, such as equality, inclusion, fairness, community engagement, and environment consciousness, can be well embedded. Sustainable leadership is the best consideration for the organization to become adaptive and resilient, and it is the best way to eliminate issues or challenges (Ducheyne, 2017). In the retail industry, trends are changing with time, and integrating with the new trends can help to make the organization relevant. For instance, a cross-boundary leadership network and a sustainability mindset can set the foundation for innovative solutions. It is an excellent benefit for the organization because it can further set the ground for differentiation and competitive advantage. Critically, Costco can strive for this leadership transition. However, it needs to become adaptive. For example, sustainable or regenerative leadership always requires commitments at all levels of the company. Thus, informing obligations and expectations at all levels of the organization is imperative to get results. Apart from that, specific objectives, transparent communication, and consistent engagement are better for the excellent execution of sustainable leadership and benefits. Eventually, the critical assumption is that Costco needs to shape some effective measures to evaluate the progress of sustainable leadership (Avery and Bergsteiner, 2011).
Integrating Sustainable Leadership with Corporate Governance and Leadership
Integrating sustainable leadership with corporate governance is essential. It is possible through proactive engagement and education. First, the board of directors must be diverse with a sustainability mindset and expertise. It is all about incorporating the diverse viewpoints at the top level. Stakeholder engagement at the external level is also essential. Integrating with NGOs, industry experts, and communities can help to understand the sustainability challenges and new strategic options (Eweje and Bathurst, 2017). For better strategic decision-making, executive teams must foster consistent training regarding sustainability, regulations, and new trends. Processes in the internal business climate must be embedded with sustainability. For instance, corporate culture must portray sustainability values. All strategic decisions in the internal business climate must be assessed with the eye of sustainability, as far as the social, economic, and environmental liabilities are concerned. The combination of governance and incentive is also in the limelight. Costco can shape the dedicated committee that should work on sustainability efforts and measures. Executives will be getting compensation based on sustainability performance and targets. Leaders’ recruitment should also be embedded with a sustainability mindset and measures (Brabandt, 2019).
Eventually, the organization can become transparent in reporting. Costco needs to be progressive in publishing the sustainability report. Again, collaboration with industrial experts to augment sustainability efforts is the right approach.
Conclusion
Effective corporate governance has become a vital source to set the foundation for efficiency and transparency. The most important thing is to enhance the investors’ trust and confidence, which can further lead to excessive sales, revenues, and profitability. The government governance section has streamlined several issues, such as fraud in auditing, weak internal control, and poor decision-making. The brief explanation of these issues has streamlined the possible breaches of laws, theories, and implications. Each section also presented some solutions along with some benefits to the organization. Corporate governance is also interrelated with sustainability issues and business ethics. There is a strong link between CG, business ethics, and business ethics. This retail giant must strive for good CG, which must adhere to new sustainability and ethical measures. Several models and theories, such as the four aspects of CG and the CSR pyramid, have supported the research and arguments. Sustainable leadership is also integral for the organization. Costco has an authentic and transformational leadership style, which provides certain benefits. However, there is a need to adopt a sustainable leadership style to improve corporate governance. The research has justified the benefits for the organization due to this leadership intervention.
Recommendations
The research and analysis have helped to derive valuable insights and implications. These implications have set the ground for some good recommendations. The illustration of these recommendations is as follows.
- The firm needs to cultivate an independent audit committee in the internal business climate to evade fraudulent activities. The most important thing is to escape the probability of manipulation, false reporting, or claims through direct reporting. This independent audit committee will adhere to transparency and accountability, as these are critical facets of corporate governance (Spira, 2007).
- It is the best time to incorporate CG principles, such as responsibility, accountability, fairness, and transparency, in the internal setting. It is the best recommendation, especially in the context of strategic decision-making (Suroso, 2022). These principles will facilitate the making of strategic decisions, especially in terms of product portfolio, sourcing, and safety relevance.
- Incorporating the CSR pyramid is also a good recommendation (Kusyk, 2021). However, in the domain of economic responsibility, the organization must incorporate the utilitarian principle of ethics. The most important thing is to maximize the benefits with less harm as far as the impact on society and the environment is concerned.
These recommendations should be vague, as Costco needs to be resilient and flexible to keep moving in the dynamic and competitive retail industry.
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