GovernanceFinal

11
[NINE PILLARS OF GOOD CORPORATE GOVERNANCE] In this paper we detailed out and critically analyzed the 9 pillars of Dubai SME Corporate Governance and went on to explore the question of how important are those principles for a SME. 2015 Corporate Governance Report Sayanta Tripathy

Transcript of GovernanceFinal

Page 1: GovernanceFinal

[]

In this paper we detailed out and critically analyzed the 9 pillars of Dubai SME Corporate Governance and went on to explore the question of how important are those principles for a SME.

2015

Corporate Governance Report

Sayanta Tripathy

Page 2: GovernanceFinal

ContentsINTRODUCTION...........................................................................................................................................3

Critical Analysis of the Pillar.....................................................................................................................4

Conclusion...................................................................................................................................................8

Reference....................................................................................................................................................8

2

Page 3: GovernanceFinal

INTRODUCTION

Dubai‘s Small and Medium Enterprise widely known as Dubai SME was created in the year of 2002 as an integral part of Department of Economic Development. The overall objective of creating the same was to provide ample amount of support, information and outreach for the growing SME Sector. The major goal of the same was to support the entrepreneurs in their phase of development which would further strengthen the economy of the country. Dubai SME helps to convert the ideas and creativity of an individual into a growing and successful business.

Dubai SME not only looks into converting minds into Business in legal way but also takes care of all the ethical perspective. To do so they have established a strong corporate governance pillars. Their partnership with International Finance Organization (IFC) stands as a supportive statement towards their approach. This strategic partnership aims towards identifying the gaps in the business and address them with Corporate Governance Solution.

Dubai SME which account towards 95% of the enterprise population and 42% of total workforce needs to constantly adjust towards the new business technology/environment, restructure the organization to be more corporate, and display transparency in financial management. To meet these ethical and legal needs THE CORPORATE GOVERNANCE CODE was encoded by Hawkmah Institute of Corporate Governance in 2011. The code sets the framework of 9 key pillars of Corporate Governance. The 9 pillars are:-

1) Adopt a formal corporate governance framework outlining the roles of the key bodies such as

partners, shareholders, board of directors and management.

2) Conduct a succession planning process.

3) Establish a timely, open and transparent flow of information with shareholders.

4) Endeavour to set a formal board of directors to accompany the growth of the company.

5) Develop a clear mandate for the board of directors to oversee the operational performance of

the business, as well as evaluating and improving business strategies.

6) Maintain a credible book of accounts, which are annually audited by an external auditor.

7) Set up an internal control framework and conduct a regular review of risk.

8) Recognize the needs of stakeholders.

9) Formulate a framework, setting out the family’s relationship with the business.

3

Page 4: GovernanceFinal

Critical Analysis of the Pillar

The 9 pillars of Corporate Governance are in complete line with the OECD Principle of Corporate Governance which states:-

“Corporate governance involves a set of relationships between a company’s management, its board, its shareholders and other stakeholders. Corporate governance also provides the structure through which the objectives of the company are set, and the means of attaining those objectives and monitoring performance are determined.”

Dubai SME organization along with Hawkmah Institute have interestingly slated the 9 Pillars of governance and making sure it addressed the following sections:-

A. Corporate Governance Policies and Procedures

B. Transparency and Shareholder Relations

C. Board of Directors

D. Control Environment (internal controls, audit and risk management)

E. Stakeholder Relations

F. Family Governance

Looking into the first pillar which states about outlining roles of the key participant solves the major issue of Agency Cost within an organization. Originating in 1980s, Agency theory is often defined in terms of Contract. As Jensen and Meckling (1976) states agency theory is directed more towards ubiquitous relationship between the owners (Principle) who delegates the work to another part (Agent). To avoid any Agency Cost, the shareholders should be made aware of their right and also the share structure. One should be disclosing the voting rights and other rights associated with each class of share. While an SME majorly starts with an idea from an individual and slowly grows into a small and then medium level enterprise, there is no clear boundary between shareholders, directors and the manager. Also many a times, the company reaches a stage when the owner who is the manager can no longer continue the fulfill the roles of Shareholder/Director/Manager as the enterprise is a medium level enterprise and needs a much more detailed framework to be regulated. At this point a well established framework needs to be in place with clear distinction been made in between the roles. The key decision of running the company not only now in the hands of one person but should require approval of shareholder, directors and management and to avoid any agency problem, this needs to be formalized in writing. However the buck does not just stop here. It would be highly beneficial if the roles defined are as well disclosed along with the performance evaluation of the board. This would just take a step further towards transparency.

While companies may only think of the legal framework or policy formulation into their governance policy, Dubai SME has taken a step forward to also make sure that a successful

4

Page 5: GovernanceFinal

planning process is also an integral part of the 9 pillars. While many might think, this has nothing to do with governance, but Dubai SME thinks that planning should be done in much non-disruptive manner and should also make sure the shareholders, employees, stakeholders are aware of the longetivity of the company. Involvement of this policy is an essential matter as it helps to address managerial and ownership success. This also should address the exit strategy of the owner on whether to pass on the business to the owner’s family or business partner. This rule sets a key step towards appointment of board of director and management position that in lines with the company’s success story.

Transparency towards Shareholder is key to any company’s success. Any differences found by the shareholders might lead into illegal framework of the company which would thereby affect its brand, reputation. In order to address this issue, Dubai SME sets a key pillar in its governance policy where it asks all the SME to establish a timely, open and transparent flow of information to its shareholders. Also as stated by Paul G Mahoney (1995), mandatory disclosure is used as a means to remedy the agency problem between management and shareholders .To follow the same, the company should be holding Annual General Meeting (AGM) where it meets its shareholder discussing the progress report of the company and thereby allowing the investors to participate in the key governance decision.

For any organization to run smoothly, the board of director plays a key role with its strategic plan and is also a corner stone of good corporate governance. Most of the Dubai SMEs do have their board of directors; however setting them in a right way is an integral part. Dubai SME governance policy gives the freedom to one to set their board of director as it does not mention the key components in the same. It does not mention the number of Dependent/Independent Directors required or so. However it is recommended that an organization which is at its initial stage and might be uncomfortable in setting up any power to any board members should start with forming an advisory board with no decision powers. However Dubai SME does recommend entrepreneurs who are looking towards a brighter future should look forward towards appointment of Independent Non Executive Directors. While every SME has the complete freedom to choose its Board of Director, it is highly recommended that one should choose more of Independent Nonexecutive Directors as their incentives are not compromised by their dependence on CEO or other board members or the organization. It is seen many of the Dubai SME steps back from the recommendation and go ahead to stay with Executive Directors. This might not help much as it would have been by bringing the Non Executive Director ; as they not only bring fresh views and ideas and advices along with their experience and expertise, they also bring assurance to the investors that their interest are being taken care of and not compromised with the other groups. Dubai SME Code of framework recommends induction program whereby the Non Executive Directors meet the major shareholders, and managers. This step proves to be quite beneficial as one comes to know the participants in the organization, the structure, the framework of an organization and thereby take steps accordingly keeping the interest of all the participants to its best.

However with thorough research and studies being conducted, there is no solid evidence that suggest that independent directors in the Board improve the corporate performance. To amaze us Bhagat and Black have rather found in their studies that insiders in the board do add value.

5

Page 6: GovernanceFinal

Also Evan and Evans for their part found that presence of independent directors have no effect on the CEO play levels. This being just the other side of the coin, many theories and recent studies favor the involvement of Independent Directors into the organization as their compensation is not dependendant on the CEO roles. This just being better and safer than other side of the coin is on the verge of being acceptable on a broader sense.

A critical pillar in the governance structure formed by Dubai’s SME is developing a clear mandate for Board of Director. This point is very crucial and should be focused more by the owner while creating its board of director as to what expect from them and how it can add value. It makes the owner responsible to prepare the Board Mandate and define the goals of every participant that Board Members should be taking. This helps to avoid Agency Problem although conflict of interest can arise at later stage. Agency Theorist define the major function of the Board of Director is to monitor the action of manager on behalf of shareholder [Eisenhardt 1989; Jensen 1976]. The SME corporate Governance as well recommends the involvement of Independent Non Executive Government as they being independent would foster for long term success, evaluating and approving sound business strategies. A highly effective measure of corporate governance that has been specified by Hawkmah while formulating the framework is the self performance evaluation of the board of director or by third party. This helps to maintain an effective board keeping the right people in at right time’ an essential step towards not only avoiding conflict of interest or agency problem but as well avoiding Managerial Hegemony where the board might overlook performance and look for the associates that matches their thinking levels. An essential step towards a healthy performance is separation of Chairman and CEO unlike in US companies. This separation would be beneficial to the shareholders and the company in long term as there would always be check on the performance of both the members rather than a single entity taking control of the complete organization and running for his/her benefit. Dubai SME’s corporate governance does make sure of raising awareness among the company to set an appropriate board of director, but this can be strengthen more if formation of Nomination Committee is also clearly mentioned or mandated. Setting up of Nomination Committee with all Independent Directors and chaired by the Independent director helps in efficient, fair selection of Board of Director thereby avoiding the famous Class Hegemony.

For a company to have a successful performance matrix, it is quite essential to have effective corporate governance. However this still remains a debatable statement. To have effective corporate governance, a key element is auditing of the accounting framework of a company. Dubai SME corporate governance does not fail to miss the same. A complete accurate picture of company’s operation helps to create a financial stable company. This is a critical step defining the independence of an external financial auditor and compliance towards international accounting framework. Failure of the same can lead to the most famous scandal: - ENRON SCANDAL. Previous studies by KLIEN (2002) uses the proportion of outside director to measure the quality of audit committee and its effectiveness towards the governance policy. The studies suggest a positive proportion towards the same. A highly recommended and also being followed by Dubai SME is a step towards independent financial auditor and not someone auditing its own company. Company’s policy should be formulated and not be applicable to the external auditors which may end up in compromising their independence.

6

Page 7: GovernanceFinal

Being a fertile field, corporate governance has many debatable statements. One of them being should the Board work for the welfare of Shareholders or Stakeholders? While some say in for and some against, I would believe a small portion of dedication towards stakeholders does help the business to run effectively as keeping them happy keeps the business in for a long term which would turn beneficial for the shareholders as well. To support the same, Tirole [2001] also proposed the definition of corporate governance as “Institution that induces or forces management to internalize the welfare of stakeholders.” Also as the Stake Holder Theory suggest that the company should design their corporate strategies considering the interest of Stakeholder, [Freeman, 1984]. Understanding the importance of the Stakeholders, Dubai SME’s key governance policy includes a provision towards recognizing the needs of their as well. It is important for a company to view itself as an integral part of the community and commit itself to a sound relationship with its surrounding which is built on trust, honesty and fairness. Dubai SME rightly focuses on the same thereby advising the companies to formulate policy that works best in the interest of customers, employees, satisfaction, environment and the community in which the company operates.

With stakeholder’s interest being as much important as that of shareholder, one might think of an alternative of having a Stakeholder Director in its board meeting. This would add more strength to the SME’s corporate governance and would bring in more confidence within the stakeholders that their interests are not being compromised. This has also been proposed by Mitchel and Agel (1997) that inclusion of a stakeholder in the board meeting can be a formal mechanism that acknowledges the relationship of stakeholders with firm and also stakeholder director would be more knowledgeable about the interest of its group and bring a broader perspective of decision into picture [Hillman,2001].

While all these pillars that indeed lead to a stronger corporate governance and look towards ethical and legal functioning in a broader way, there might always be some gaps that the Board might try to find and escape for their benefit. This might be completely contrary to Stewardship Theory but major scandals like that of Enron, Disney or GE does make us aware of the loopholes. A key step of fair remuneration can add a key value to strengthen the SME Corporate Governance; a step quite often mentioned within the Australian Committee of Corporate Governance Structure. An establishment of fair Remuneration Committee with majority of Independent Directors and chaired by independent Chairperson can bring a company 1 step closer toward not compromising the goals of shareholders/stakeholders. This fair process helps in assisting a clear distinguish between Remuneration package of Executive and Nonexecutive Directors. As we went on analyzing the Dubai SME Corporate governance, we have repeatedly mentioned the beneficiary points of having Independent Nonexecutive Directors. There is a general consensus in corporate governance literature that independent Nonexecutive Director will be more effective in managing the organization and evaluating the management board based on the increased objectivity [Dalton, 1998].

7

Page 8: GovernanceFinal

Conclusion

In this paper we detailed out and critically analyzed the 9 pillars of Dubai SME Corporate Governance and went on to explore the question of how important are those principles for a SME. As we move step by step, we understand that each of the key pillars sets up a stepping of success for a SME towards not only as legally working entity but make it also ethically well sound. In contrast to the conventional shareholder-wealth maximizing firm, the pillar of stakeholder interest approach helps the firm to be viewed as socio-economic organization. This paper makes understands the key contribution that the Governing Principles would make towards a successful SME by challenging the conventional assumption that good corporate governance focus only on shareholder’s interest and not on stakeholder’s interest . It also challenges the notion of having Majority Executive Directors as its board members and understands the importance of the key pillar of setting up a board of director to accompany towards the growth of company.

Reference1. Australian Security Exchange, ASX Corporate Governance, 2010 Amendments2. Bhagat & Black (1999), The Uncertain relationship between Board Composition and

Performance3. Hawkmah Institue and Dubai SME Government, “The Corporate Governance Code for

Small and Medium Enterprise”4. Dalton(1998),”Meta Analytical Review of Board Composition, Leadership Structure and

Financial Performance”, Strategic Management Journal 5. Eisenhardt(1989),Control: Organization and Economic Approaches, Management

Science6. Hillman(2001),”Board Composition and Stakeholder Performance: Do Stakeholder

directors really make a difference ?”, Business and Society 7. Freeman, R E(1984),”Strategic Management: A Stakeholder Approach”, Pitman Boston8. Jensen and Heckling (1976), “Theory of Firm: Managerial Behavior, Agency Cost and

Ownership Structure”, Journal of Finance Economics9. Kathleen(1989),”Agency Theory: Assessment and Review”, The academy of

Management Review10. Mitchel and Agle(1997),”Towards a theory of Stakeholder Feature and Salience :

Definiing the pricinple of who and what really counts” Academy of Management Review11. Irish Chiu,”Reviving Shareholder Stewardship”12. Robert Evans & John Evans(2001), The influence of Nonexecutive Director Control and

Rewards on CEO Remuneration13. Tirole J(2001), “ Corporate Governance”, Econometrica

8