Corporate Governance(Aafreen 62)

8/7/2019 Corporate Governance(Aafreen 62)

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CORPORATE GOVERNANCE Aafreen Babar (62)

H OW TO P R OM OTE G OOD C OR P OR A TEG OV E R N A N C E

The proper governance of companies will become as crucial to the world economy as the propergoverning of countries. strong corporate governance produces good social progress. The two go

together.

James Wolfensohn, 1999

WHAT IS CORPORATE GOVERNANCE?

Corporate Governance hit the news in 2001 and 2002 with the collapse of global corporationssuch as Enron, WorldCom, Global Crossing and the intern ational accountants, Andersen. Thesewere blamed on a lack of business ethics, shady accountancy practices and weak regulators.They were a wake-up call for developed countries on corporate governance. Prior to this,commentators had focused on failings in developing countries - blaming the 1997-98 East Asiancrisis on poor corporate governance, crony capitalism, poor management practice and lack ofdisclosure and transparency.

Corporate governance has come to encapsulate the blend of law, regulation and private-sectorpractice that enables companies to attract financial and human capital, to perform efficiently,and generate long-term economic value for their shareholders, whilst respecting the interests ofstakeholders and society as a whole. Corporate governance needs to be addressed at mainlythese two integral levels:

The country level. Various regulatory and enforcement mechanisms are important, such as theneed for bankruptcy laws, property rights and an effective judiciary. A corporation cannotoperate effectively if it is unable to rely on legislation and its enforcement. Good corporategovernance therefore requires good political governance, and vice versa.

The corporation. Corporate governance at the company level refers to the rules andregulations that shape its effective operation, as this is what eventually translates into thecompanys culture and defines the actions of all the stakeholders involved.

Complementary interaction between these two levels is vital to ensure the effective operation ofthe private sector, in a manner that is both accountable and transparent.


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In 1999, the OECD issued five Principles of Corporate Governance (see Table below). Theseprinciples, which are non-binding, have been widely accepted as providing the broadframework for countries to use. It is expected that countries should then adopt their owncountry-owned corporate governance frameworks taking account of their unique culture and

regulatory and legislative systems. The World Bank argues that these frameworks should bebased on four pillars - of responsibility, accountability, fairness and transparency (RAFT). Inconjunction with the OECD Principles, these four pillars are key to ensuring equitable growthand a flourishing private sector.

OECD PRINCIPLES OF CORPORATEGOVERNANCE

EXPLANATION

(1) The rights of the shareholder A corporate governance framework should

protect shareholders rights.(2) The equitable treatment of shareholders All shareholders should be treated equally,

including minority and foreign shareholders.(3) The role of the stakeholders in corporate

governanceGood corporate governance recognises that it is in

the long-term interest of the corporation to

respect the rights and interests of thestakeholders.

(4) Disclosure and transparency There is a need to ensure timely and accuratedisclosure of all material matters regarding the

corporation including financial aspects,performance, ownership and governance.

(5) The responsibilities of the board The board is key to the strategic guidance of thecompany and the effective monitoring of themanagement. It should be fully able to undertake

its tasks and responsibilities and be fullyaccountable to shareholders.

WHY CORPORATE GOVERNANCE MATTERS: TOWARDS THE

MILLENNIUM DEVELOPMENT GOALS

DFID (Dept. for Intl Development) has been working for some time to ensure that the publicsector in developing countries is more accountable. However, the private sector is the maindriver of a countrys economic growth and it too needs to be accountable. Good corporategovernance increases the integrity and effectiveness of the private sector and helps markets tooperate more effectively. This matters for many reasons, including:

y Avoidance ofbusiness scandals, which damage trust in business.


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y Value placed on good corporate governance by institutional investors.y Growing involvement of the private sector in service delivery.y Need for systems to prevent and deter corruption in developing countries.y The deregulation and integration of capital markets.y Recognition of the importance of harnessing domestic savings for economic growth.y The risk offinancial crisis and contagion.

McKinsey 2002 Survey

The McKinsey Survey, commissioned by the Global Corporate Governance Forum in 2002,surveyed institutional investors managing $2 trillion of capital. An overwhelming majoritystressed the importance of good corporate governance in their investing decisions.

y The survey suggested that institutional investors would be willing to pay more for shares incompanies that exhibited high governance standards. Suggested premiums for companiesaveraged 12-14% in North America and Western Europe; 20-25% in Asia and Latin America;and over 30% in Eastern Europe and Africa.

y A third of investors stated they would avoid countries with poor corporate governance.

In sum, good systems of corporate governance are required by developing countries in order tobolster overall trust in the private sector and to make the most efficient use of available capital.

An example of a breakthrough: Novo Mercado, Brazil

In reaction to concerns about corruption and poor corporate governance, which were curtailingthe Brazilian markets ability to attract capital, the Brazilian stock exchange, Bovespa, took theunparalleled step of setting up an alternative market in April 2001. The new market, the NovoMercado, require companies that list on it to comply with minimum corporate governancepractice. Through its minimal corporate governance criteria on voting rights, improveddisclosure requirements and the requirement to comply with international accountingstandards, it aims to ensure that management is more accountable to shareholders. Whilst it isstill early days, this innovative move of the public and private sector, with support from theinternational community, demonstrates that corporate governance is recognised by investors.


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ISSUES TO BE AWARE OF WHEN SUPPORTING CORPORATE

GOVERNANCE REFORM

Identify a National Champion. To achieve reform it is often necessary to find a national

champion to drive it forward, which may be from the private or public sector. Possiblecandidates include the Ministry of Finance, the relevant regulatory bodies, the stock exchange,and the central bank or private sector leaders. A useful starting point may be to propose thewriting of a code of corporate governance.

Consensus building.There may be a need to build greater understanding of the implications ofcorporate governance for developing countries. This can be done through linking withinternational bodies involved in corporate governance, such as the Global CorporateGovernance Forum (GCGF) (see below) or the Commonwealth Association of CorporateGovernance (CACG) or regional bodies such as the Pan African Consultative Forum on Corporate

Governance.

Mobilising the private sector.The private sector is integral to corporate governance reform.DFID needs to work in partnership with the private sector in order to facilitate betterunderstanding of corporate governance and to harness its enthusiasm for reform. Potentialplatforms for engaging the private sector in the debate are local commercial or professionalmembership organisations, which have often led the development of codes of corporategovernance. See also the NEPAD Business Group below.

One sized

oes not fit all. Corporate governance structures should be adapted to the uniquecharacteristics of a country. The OECD principles are voluntary, but can be used to inform acountrys own code. For example, the OECD Principles were used as a starting point in writingthe King Code II of South Africa and the Kenyan Corporate Governance Code, which are codesowned by the private sectors of the countries concerned.

Statutory vs voluntary: the role of regulation in corporate governance. Although the OECDprinciples are voluntary, there is a debate on whether country codes should be voluntary orstatutory. The UKs Combined Code on corporate governance provides for voluntarycompliance but statutory disclosure for departure from the provisions of the code (comply ordisclose). Other countries have taken different views, such as India (where the code is

mandatory).

Institutional capacity constraints: one rule for all? Corporate governance cannot be appliedbroad brush to all companies. Imagine forcing a company of 10 employees to have 2 non-executive directors on the board! Corporate governance must therefore have a tiered naturedepending on the size and value of the company in order to balance burden against benefit.


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Corporate Social Responsibility (CSR).CSR is an important complement to corporategovernance. CSR looks at the way companies can add social, environmental and economic valueto the society in which they operate through their core activities. In other words, CSR isconcerned with responsibility to the company's wider stakeholders. (See How To Note onApproaching Corporate Social Responsibility).

Corruption interface.Corporate governance provides the basis to protect shareholders, to treatstakeholders fairly, and ensure transparency and accountability of managers. Corporategovernance therefore works to underpin government regulations, by focusing on the privatesectors desire to operate efficiently, and to provide a framework in which bribery is made moredifficult.

Accounting andAuditing. In the post-Enron / Worldcom world, there are calls to reform theaccounting and auditing professions, and for greater recognition of international accounting andauditing standards. There are also calls for greater regulation of the professions. Whilst thesedebates are ongoing, the FIRST Initiative can provide technical assistance in the upgrading offinancial sector architecture (see box below).

The FIRST Initiative

The FIRST Initiative is a US$51 million multi-donor project, supported by DFID, which providestechnical assistance grants to recipients in developing and transition countries for capacitybuilding and policy development in financial sector regulation, supervision and development.FIRST is aimed at supporting the 12 Key Standards for Sound Financial Systems recognised bythe Financial Stability Forum, which include corporate governance, accounting and auditing.

Corporate Governance(Aafreen 62)

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