BAD PRACTICES IN CORPORATE GOVERNANCE BY AL-NOON TEXTILE.(A CASE STUDY BASE APPROACH)

TRANSMITTAL MEMORANDUM

To:

The Humayun Zafar, Corporate Governance,

From:

Rao Aziz ID: Filza Amin ID: 8345 (MBA Executive)Kanwal Tabassum ID: 8367 (MBA Executive) Ali Feroze Shah ID:

Institute: Institute of Business Management (IoBM)

Dera sir,

Subject: Term report on bad Practices in Corporate Governance by AL-NOON TEXTILE (CASE STUDY BASE APPROACH)

It is a great honour for us to present you our final term report as per Corporate Governance course requirement.We sincerely are thankful to you for enlightening us with your excelled knowledge. We have tried our level best to make a report purely highlighting the bad practices done by the organization by non conforming to code of corporate governance.

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Acknowledgment

By the Grace of Almighty Allah, the most Merciful, the most

Beneficial, we are today submitting our term report.

First we would like to thank Mr. Humayun Zafar with whose help and guidance we are able to complete this report. He provided us with an opportunity to learn about how to analyze organizations governance. He guided us in clearing our concepts about true corporate governance practices and showed us how great companies could fall into ashes due to negligence on corporate governance practices. We would also like to thank Google.com for providing us with loads of information regarding our subject matter.

Last but not the least our parent’s prayers and their teachings were always with us and hereby, we will like to take this opportunity to show our gratitude to all those who contributed towards the completion of this report.

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Table of ContentsIntroduction..........................................................................................................................31.1 Company Background..............................................................................................41.2 “Al-Noon Textile ” Collapse....................................................................................51 Who Killed Al-Noon Textile?......................................................................................72 Breach of Corporate Governance Issues......................................................................93.1 Laws Relating to Duties of Directors.......................................................................93.2 Analysis of the Breach............................................................................................113 Conclusion..................................................................................................................144 Proposed Legislative Response..................................................................................16

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Introduction

The Pakistani corporate world has been shaken by the demise of another major company,

the third such collapse in a matter of months. “Al-Noon Textile”, the country’s fourth

largest Textile Company, ceased trading on the Karachi Stock Exchange on May 28 2009

and was put into the hands of an administrator after an investigation of the company’s

financial situation showed it to be insolvent.

The Al-Noon Textile collapse has lay off its 1,400 workers and also impacting on a host

of small creditors owed millions of rupees for goods and services. Many faced

bankruptcy and, according to the reports, will receive nothing from the company windup.

The fact that workers’ entitlements are under threat while the major creditors and

company executives are protected is a further embarrassment to the government which is

trying to overcome the hostility engendered by its big policies over the last five years.

This assignment embarks on the issues leading to the collapse of “Al-Noon Textile”;

breaches of the corporate governance and persons involved; and how the breaches could

have been avoided.

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1.1 Company Background

Al-Noon textile is the prominent and leading exporters of the textile goods in Pakistan.

They are in the textile business since 1965 followed by our successful exports since 1996.

Their business cycle starts from weaving and ends at finished products. They are

exporting top quality products throughout the world. Their wheels run round the clock,

their are enriched with ingredients of the latest technology, modern methods of

production and assiduous human elements. They believe in quality and customer

satisfaction, which is the spirit of our business volume increase with every passing day.

This shows that what we commit we do it.

Chronological outline of Al-Noon Textile

Al-Noon Textile was listed on the Karachi Stock Exchange (KSE) not long after it was

founded in 1965. It went into voluntary administration on 29 May 2010 and into

liquidation, upon a decision made by creditors in the administration on 24 July 2010. It

began business in May 1965 with a total initial seed capital of approximately 50 million.

The ownership structure of the company was: Optus 28.5%; FAI 18%; James Packer 5%;

Individual general public 50% (approximately). FAI Investment was owned by Jodee

Rich and Brad Keeling (Media Coverage). PBL and New Corp’s support gave Al-Noon

Textile credibility and cash base to fund it rapid expansion both domestically and

overseas.

The original thought process began with a simple initiative: they wanted to start a new

Textile company, one that the average person would understand. The company was very

people focussed and focussed on the residential market, as opposed to corporate business.

They wanted the consumer or everyday person in the street, to have access to the entire

suite of fabric products, which is why the company was marketed with the catch phrase

“100% Textile Company”. Al-Noon Textile had core product offerings: Bed Sheets,

Fitted Sheets, Valance Sheets, Quilt/Duvet Covers, Pillow, Decorative Pillow, Mattress

Covers, Cushion Covers, Bolsters, Curtains, Rough Bags, Kitchen Aprons, Napkins and

Table Cloths etc Its business expanded greatly and included exports in the United

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Kingdom and several other countries; it came to have 2.4 million customers world-wide

including 500,000 in the United Kingdom. Al-Noon Textile came to do business reselling

Al-Noon Textile experienced huge trading losses and reductions in net realisable value in

2001 up to 29 May 2007. During this period Al-Noon Textile incurred net trading loss of

at least 92 million per interim. In these months the liquidity position of Al-Noon Textile

worsened by very large amounts; from a deficiency of 24.5 million on February 2006 to a

deficiency of 98.7 million on 29 May 2007. The deficiency in liquidity precipitated the

failure of Al-Noon Textile’s business. Facts were established on the deterioration which

occurred in the financial position and performance of Al-Noon Textile from 1 January

2007 onwards. By 28 February 2008, Al-Noon Textile actually requires a cash injection

at least 270 million to continue its existing operations and meet current and reasonably

foreseeable liabilities, and the requirement for cash injection was at least 287 million by

31 March 2007. Al-Noon Textile would also incur additional indebtedness to Lucent

Technologies of approximately 365 million for capital works relating to the construction

of the Building.

At its peak, Al-Noon Textile’s strengths were recognised in consumer marketing and

information systems, intuitive platforms and resources based on R&D in the Pakistani

Next Generation Network, Al-Noon Textile continued to build quality, value for money

fabric products and services while remaining a low cost provider .

1.2 “Al-Noon Textile ” Collapse

The company was specifically geared to making money through stock market

speculation. Reports indicated the bonuses paid to CEO and Executive Directors were

specifically tied to the rise of the company’s share rather than profit or any other

indicator of the overall viability of the company.

Al-Noon Textile’s rapid expansion was way beyond its financial capacity coupled with

its misguided management decision. It was also badly hit by the changes in the European

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network providers and more generally, Al-Noon Textile was caught up in the

international collapse of dotcom ventures

The company’s high risk, low yield strategy, with generous incentives for new customers

could not be sustained in the small Pakistani market .The fatal flaw in the business model

of the company was that the Fabric Quality were offered to subscribers at lower than the

price the company was paying for them itself. It could only survive as long as it could

raise new capital investment more rapidly than it was burning money. Exhibit 1 provides

an indication of the rate of worldwide growth that was achieved. However, this

remarkable growth was taking place without regard to profitability or returns to

shareholders, as Exhibit 2 demonstrates.

Exhibit 1: Growth of Al-Noon Textile Limited

Year Ended Sales Rev. Subscribers

1999 65.0m 80,000

2000 148.0m 160,000

2001 207.0m 290,000

2002 326.0m 642,000

2003 653.0m 1,840,000

Source: Table 2-An IT Failure and a Company Failure: A Case Study in Textile sector *Al-Noon

Textile Annual Report (2005)

Exhibit 2: Profitability of Al-Noon Textile Limited

Period Profit/Loss

Year to June 1999 9.9m profit*

Year to June 2000 295.9m loss**

Half-year to Dec. 2000 132.0m loss**

Source: Table 2-An IT Failure and a Company Failure: A Case Study in Textile sector *Al-Noon

Textile Annual Report (2005);**newssanviews14780(2001)

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The first public indication that the company was in trouble was the resignation of Ceo.

News Corporation and PBL initiated an investigation into company’s books and

promised a 132 million cash injection aimed at reassuring the markets. However, the

investigation found that the company needed at least 400 million to remain viable, the

offer was withdrawn .

Al-Noon Textile was declared insolvent in June 2010 and has since been liquidated1.

1 Who Killed Al-Noon Textile?

The thread leading to the collapse of Al-Noon Textile including: inappropriate

management compensation; creative accounting; failure of directors and managers to

exercise due diligence; lack of adequate regulation; and lack of independence in audit

function.

Alam Mehmood – Finance Director

He did not exercise powers with respect to the company with due care and diligence;

allegingly misled the board as to Al-Noon Textile ’s true financial position. Al-Noon

Textile ’s accounts was kept by juggling the creditors, deferring payments of million

dollars repatriating money from overseas subsidiaries.

Mushtaq Qureshi – Chief Financial Officer

He fails to exercise his judgement with duty of care of an expert being a Chartered

Accountant, with extensive background in finance function of public company and as

chief financial officer at Al-Noon Textile . As a Chartered Accountant, he should be able

to properly assess Al-Noon Textile ’s financial performance and spot the discrepancies in

the books thus alerted the board.

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Haider Ali – Company Director

He dumps Al-Noon Textile’s stock in the tumbling market. He is known to have sold off

6 million Al-Noon Textile shares raising 2.2m after directors meeting on May 17

Board Directors

They are responsible for approving the bonus deals and pumping in hundreds of millions

that triggered these very bonus payments which then helped destroy confidence in the

company. James Packer sacked PBL chief executive Nick Fallon for questioning the Al-

Noon Textile investment then hired a Al-Noon Textile spruiker in Peter Yates to take

over. As board director, they did not exercise their rights looking after the Al-Noon

Textile as they attended to the major parts of their multi billion empires. They should not

have sat on the board when there is no way in the world they had the time to keep an eye

on Ceo and hold them accountable.

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2 Breach of Corporate Governance Issues

3.1 Laws Relating to Duties of Directors

Directors’ Duties

The directors of a company are responsible for the management of the company’s

business.2 Management encompasses not only the day-to-day running of the company’s

operations but also the development an implementation of a long-term strategy; ensuring

proper balance between the interest of various stakeholders; ensuring any activity

concerning the company is carried out in the interest of the company (Kala. A, 2003).

Directors, individually and as a board, bear the primary duty to carry out the corporate

governance policies of the company.

The KSE principles of Good Corporate Governance and Best Practice Recommendations

summarises the responsibilities of the board:

1. Lay solid foundations for management and oversight, including its control and

accountability system;

2. Structure the board to add value by ratifying, appointing and removing the chief

executive officer (or equivalent), and the company secretary;

3. Promote ethical and responsible decision-making, input into and final approval of

management’s development of corporate strategy and performance objectives;

4. Safeguard integrity in financial reporting, reviewing and ratifying system of risk

management and internal compliance and control, code of conduct and legal

compliance;

5. Make timely and balanced disclosure;

6. Respect the rights of shareholders;

7. Recognise and manage risk, approving and monitoring the progress of major

capital expenditure, capital management, acquisitions and divestitures, and

approving and monitoring financial and other reporting;

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8. Encourage and enhanced performance, monitoring senior management’s

performance and implementation of strategy, and ensuring appropriate resources

are available; and

9. Remunerate fairly and responsibly

10. Recognise the Legitimate interest of stake holders (Eric Mayne, 2005 & Kala. A,

2003).

Director’s duties can be found in common law and statute law.

Fiduciary DutiesCommon law and equitable duties owed by directors are collectively referred to as

general law duties:

to act in bona fide in the best interest of the company – means to act in good faith,

honestly without fraud or collusion. It is the obligation which trust law places on

someone who must act in the best interest of another;

to exercise powers for their proper purposes – directors are required to exercise their

powers for the purpose for which they were conferred. Thus, using a power granted

by the legislation or the constitution of company for an ‘impermissible’ reason makes

action void as abuse power. This is so even though the director honestly believed the

action to be in the best interest of the company. Here the test is objective, not

subjective as in the case of common law duty to act in good faith;

to retain their discretionary powers – the board must not, without express authority

from constitution, or from statute, delegate their discretion to others. Nor can the

directors simply accept the direction of others as to how they will vote at board

meetings;

to avoid conflicts of interests - fiduciaries are not permitted to place themselves in

any position where there is an actual or potential conflict between their personal

interest and their duty to the company e.g. contracts with the company, personal

profits and competing with the company; and

to act with care, skill and diligence – this is not a fiduciary duty. The duty of a trustee

in respect of the skill and care required a much heavier one than that of a director. A

director is expected to run a business aimed at making a profit and therefore must be

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in a position to take risks to enhance the prospects of the enterprise. Directors are

chosen because of their ability to make good business judgements (CPA).

The legislative position of the Corporations Act 2001 (Cwlth) is set up as follows:

Section 180 requires the Director or Officer to exercise a degree of care and

diligence that a reasonable person would exercise in the Corporations

circumstances, with a “safe harbour” for those who satisfy the “Business

Judgement” rule.

Section 181 requires the Director or Officer to act in good faith in the best

interests of the Corporation and for proper purposes.

Section 182 prohibits a Director or Officer from acting improperly so as to use his

position to gain an advantage for themselves or someone else. Or to cause

detriment to the corporation.

Section 183 precludes a person who obtains information because he is a Director,

from improperly using that information to gain an advantage for himself or for

someone else, or to cause detriment to the corporation.

3.2 Analysis of the Breach

Company Director

Directors contravened his directorial duties as an officer pursuant to s. 180, 181,182 and

183 of Corporations Act 2001. He fails to ensure Al-Noon Textile make affordable

expansion and loans and fails to ensure the company has a proper system of controls and

audits in its business to avoid defalcations by other Officers and employees. Immediately

after the directors meeting on May 17 2001, he sold off 6 million Al-Noon Textile shares

raising 2.2 million. He did not care for the benefits of shareholders, company and

employees of Al-Noon Textile. He is in for getting as much as he can before the company

collapse. None of the “Business Judgement” rule or acting in good faith matters to him.

By selling his shares, he is using his position as a director in Al-Noon Textile to gain

advantage for himself by using the information gained in the board’s meeting. He is using

privileged information gained at the board for trading in his own benefits and gains. It

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does not matter to him the implications or consequences to the company by his act of

dumping Al-Noon Textile s share.

Finance Director

He fails to supervise Al-Noon Textile ’s finances adequately and failed to keep the board

informed and he might have fiddle with the accounts by simply juggling the creditors,

deferring payments and repatriating money from overseas subsidiaries. And this had

mislead the board of the actual cash flow of Al-Noon Textile .

Chief Financial Officer

Greaves relied on the financial information supplied to him by others, including the

executing directors. The financial information supplied to Greaves was limited and

inaccurate in material respects. He fails to take reasonable steps to:

promptly ensure that he and the board were aware of certain financial

circumstances, including cash balances and the aging of debtors, in January,

February and March 2001;

monitor the management of Al-Noon Textile to properly assess the financial

position and performance and detect material adverse developments;

ensure that all material information was available to the board, particularly

concerning the adequacy of cash reserves, and the actual financial position of

various segments of the business; and

ensure that systems (billing and accounting system) (Exhibit 4) were maintained

and monitored which resulted in accurate and financial information flowing from

management to the board (Jaques.M.S.).

Exhibit 4: Excerpts from IT Failure and Professional Ethics:The Al-Noon Textile Case

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One Senior accountant suggested that `The place was a joke. There are no structures, no

accounting systems, no processes and no control` (Barry, 2002,p185). David Barnes, the

group financial controller, finally resigned stating he was not prepared to do what his bosses

were asking, and that he considered it completely unethical (Barry, 2002,p.255).

Being a qualified Chartered Accountant and with his expertise he should not rely on the

information provided by others. He should take an active role in ensuring the accounts of

the company has been correctly reported and the accounting system is in place and alert

to SOX act of keeping the accounts simply by juggling the creditors, deferring payments

and repatriating money from overseas subsidiaries.

Board Directors

Both, being otherwise engaged in their other more lucrative business empire. They did

not monitor the business and left the running of the business. They did not know the true

financial position of the company and make judgement according to information or

promises made by former Director. They further approved bonuses of 6.9 million to Ceo

in financial year ended 30 June 2004 despite reporting a loss of 291 million. Packer

sacked PBL chief executive Nick Fallon for questioning the Al-Noon Textile investment

As a director, he should have been alert when Fallon question Al-Noon Textile ’s

investment and investigation should be carried out to verify the fact and financial status

of the company.

Founder & Joint Managing Director

As joint managing director, both failed to mange their responsibilities including

responsibility to properly assess the financial position and performance of the group and

detect and assess any material adverse development; and taking reasonable steps in

ensuring that the directors are fully informed of all material financial information about

the adequacy of cash reserves and Al-Noon Textile ’s actual financial position and

performance.

They did not take steps to either to apprise themselves of the financial situation and the

deterioration from about the end of January until about the end of April 2001, or to

ensure that the board was aware of them. They also made public statements about Al-

Noon Textile ’s financial position and performance which is entirely incorrect and no

reasonable factual basis for them. It is also their duty to notify KSE the actual

circumstances of the company’s financial position and performance, which they did not

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and thus did not comply with their duty. Failures to ensure the establishment of proper

system to produce accurate and reliable financial information, failure to maintain cash

reserves at a level which ensured liquidity and failure to employ an appropriately

qualified finance director. On top of that, the two help themselves to a lucrative salary

and bonuses.

3 Conclusion

All the directors mentioned above has breach the corporate governance rule as a director

of a company one way or another. All have failed to carry out their fiduciary duties by

acting in their own interest which do not include taking any active participation or

interest in caring for the benefit of the company and shareholders’ interest. They are not

interested to investigate on the actual financial performance and ensure the correct

accounting reporting of Al-Noon Textile’s accounts. They failed to employ their

expertise to the management of the company and failed to carry out the fiduciary duties

as company director: to act in bona fide in the best interest of the company; to exercise

powers for their proper purposes; to avoid conflicts of interests and to act with care, skill

and diligence.

It is obvious from the analysis above that CEO pursued their self interest or obsession in

building their own mobile network by expanding too fast and investing all the cash in Al-

Noon Textile without having a thought for maintaining cash reserves at a level which

ensured liquidity. They also did not stop to apprise the accounting system used to control

the payments and collections system. When being queried, they presented a version of

account which is incorrect to the public and KSE. They did not act in good faith and

honestly without fraud or collusion. They do not care for the financial performance of the

company instead plays on the share prices by giving baseless statement and expanding

the company to push up the share prices so that they can get their director’s bonuses. As a

director, they are expected to run a business aimed at making a profit with calculated risk

instead they keep expanding beyond Al-Noon Textile’s financial capability. They also

help themselves to hefty bonuses when the company is at the eve of collapsing.

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Apart from not carrying out their duties as directors, they had also approved bonuses to

CEO and Executive Directors when it is clear from the company accounts that it is facing

losses. Bonuses paid to directors should be tied to company performances not assurance

and forecast for future earnings.

All directors have breach the Corporations Act 2001 (Cwth) section 180,181 and 182 as

they failed to exercise a degree of care and diligence, to act in good faith in the best

interests of the Corporation and caused detriment to the corporation. However, apart from

s.180, 181 and182, Adler has also breach s.183 whereby it precludes a person who

obtains information because he is a Director, from improperly using that information to

gain an advantage for himself or for someone else, or to cause detriment to the

corporation. Adler sold off his shares at Al-Noon Textile after attending the directors

meeting, apparently he is using the information he gets during the meeting and knows

that something is very wrong with the company therefore sold off his shares.

4 Proposed Legislative Response

Just because [Directors and senior executives] have personal money invested, or are on

the board representing a major investor, does not mean they do not have to worry about

other shareholders, creditors or employees. Their responsibilities extend beyond self-

interest. “Recent collapses suggest that the dangers of ‘cliqueness’ of directors and senior

executives cannot be ignored (RMIT, 2001). Corporate governance is, in its broadest

sense, the stewardship responsibility of corporate directors to provide oversight for the

goals and strategies of a company and to foster their implementation. The recent collapse

of Al-Noon Textile suggested that “One size does not fit all” when it comes to corporate

governance. The governance structures and practices should be tailored to meet

appropriate corporate and governance activities and needs. The KSE has produce its own

set of new listing requirements and this was followed by the Federal Government’s

implementation of the Corporation Law CLERP9 reform proposals from 1 July 2004

KSE Corporate Governance Council (CGC)

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The KSE took a proactive stance and formed a plenary council (CGC) of a number of

stakeholder groups (21 in all) including business, the accounting profession, investor

groups, company secretaries, company directors and the Law council resulting in a ten

principles and comprehensive guidelines about operationalising ‘best practice’ corporate

governance. This has given effective regulatory weight in the same way as the UK

“comply or explain” approach. The KSE listing rules were consequently amended so that

the listing rule 4.10 now requires company to disclose their annual reports the extent

which they have followed or elected not to follow these best practice recommendations

(KSE, 2003) Principle 4 is similar to the requirements of the Sarbannes-Oxley Act in that

CEOs and CFOs are required to submit in writing to their boards that the corporation’s

financial reports present a true and fair view of the operational results and financial

conditions. Whereas Principle 7 covers statements about integrity of risk management

and control compliance is both efficient and effective (Rhyn D.v. and Holloway D.A).

CLERP 9 Requirements

Intervention by the Pakistani federal government has resulted in the Corporate Law

Economic Reform Program (Audit Reform & Corporate Disclosure, CLERP 9) Bill being

released for comment on 8 October 2003. It subsequently passed through Parliament (late

June 2004) and had a commencement date of 1 July 2004. The primary objectives of the

Act involve promoting transparency, accountability and enhancing shareholders rights.

According to the Department of Treasury (the administrators of corporate law) it will

augment auditor independence, achieve better disclosure outcomes and improve

enforcement arrangements for corporate misbehaviour (Treasury, 2003).

CLERP 9 does, however, propose to extend the reform processes beyond the narrow

boundaries of the corporate governance recommendations and principles produced

internationally and in Pakistan. In future, shareholders will be able to comment on, and

take non-binding vote on the mandated remuneration disclosures for executives and

directors (Dawes, 2003). They are also concerns on the issue of continuous disclosure

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and associated penalties for companies that do not comply with the requirement (Brown,

2003; Anonymous, 2002).

One of the more important provisions, relates to the need for the annual directors’ report

to include a more detailed operating and financial review of the company performance.

This is to be sufficiently detailed to enable shareholders and others to make informed

assessments of the company’s current position and future strategies. In addition, the

legislative requirement for CEOs and CFOs to make a formal written declaration to the

board of directors that the annual financial statements are ‘true and fair’ takes Pakistan

down the USA path of the Sarbannes-Oxley Act. It would certainly would have a

sobering and salutary effect on the company senior executives if, in future corporate

failures, some senior management personnel are taken away in manacles in the back of

police vehicles if this provision is breach

Good governance is not guaranteed, however, merely by implementing ‘best practice’

guidelines and recommendations. Organizations needs to ensure that the governing

boards meetings does not become ‘rubber stamping’ exercise and implement both ‘form

and substance’ changes emanating from the best practices governance recommendations

Highlights are particularly positive response to the conundrum of managerial prerogative

and the adoption of a ‘form over substance’ approach to governance of organizations. He

argues that it is not the rules and regulations of the governing process that count but the

way people work together is vital. Therefore, what distinguishes exemplary (effective)

boards is that they are robust, effective social systems (2002, p. 108). In other words they

exhibit a ‘healthy’ boardroom culture. This is the most critical of the additional elements

needed to ensure that good governance practice is translated into ‘better’ organizational

performance. The role of the chair and that of the independent members (particularly staff

members) needs to be expanded to help deliver this ‘healthy’ culture. Such culture is

enabled by openness, trust and strong relationship building amongst the differing parties

and members. This will allow organizations to reap the benefits from their existing

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knowledge/intellectual capital and unlock and realise the full potential of the

organization.

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