CORPORATE GOVERNANCE Aafreen Babar (62)

HOW TO PROMOTE GOOD CORPORATE

GOVERNANCE

“The proper governance of companies will become as crucial to the world economy as the proper
governing 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 corporations
such as Enron, WorldCom, Global Crossing and the international accountants, Andersen. These
were 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 Asian
crisis on poor corporate governance, crony capitalism, poor management practice and lack of
disclosure and transparency.

Corporate governance has come to encapsulate the blend of law, regulation and private-sector
practice 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 of
stakeholders and society as a whole. Corporate governance needs to be addressed at mainly
these two integral levels:

The country level. Various regulatory and enforcement mechanisms are important, such as the
need for bankruptcy laws, property rights and an effective judiciary. A corporation cannot
operate effectively if it is unable to rely on legislation and its enforcement. Good corporate
governance therefore requires good political governance, and vice versa.

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

Complementary interaction between these two levels is vital to ensure the effective operation of
the 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). These
principles, which are non-binding, have been widely accepted as providing the broad
framework for countries to use. It is expected that countries should then adopt their own
country-owned corporate governance frameworks taking account of their unique culture and
regulatory and legislative systems. The World Bank argues that these frameworks should be
based on four ‘pillars’ - of responsibility, accountability, fairness and transparency (RAFT). In
conjunction with the OECD Principles, these four pillars are key to ensuring equitable growth
and a flourishing private sector.

OECD PRINCIPLES OF CORPORATE EXPLANATION

GOVERNANCE
(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 Good corporate governance recognises that it is in
the long-term interest of the corporation to
governance respect the rights and interests of the
stakeholders.

(4) Disclosure and transparency There is a need to ensure timely and accurate
disclosure 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 the
company and the effective monitoring of the
management. It should be fully able to undertake
its tasks and responsibilities and be fully
accountable to shareholders.

WHY CORPORATE GOVERNANCE MATTERS: TOWARDS THE

MILLENNIUM DEVELOPMENT GOALS

DFID (Dept. for Int’l Development) has been working for some time to ensure that the public
sector in developing countries is more accountable. However, the private sector is the main
driver of a country’s economic growth and it too needs to be accountable. Good corporate
governance increases the integrity and effectiveness of the private sector and helps markets to
operate more effectively. This matters for many reasons, including:

 Avoidance of business scandals, which damage trust in business.

CORPORATE GOVERNANCE Aafreen Babar (62)

 Value placed on good corporate governance by institutional investors.

 Growing involvement of the private sector in service delivery.

 Need for systems to prevent and deter corruption in developing countries.

 The deregulation and integration of capital markets.

 Recognition of the importance of harnessing domestic savings for economic growth.

 The risk of financial 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 majority
stressed the importance of good corporate governance in their investing decisions.

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

 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 to
bolster 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 curtailing
the Brazilian market’s ability to attract capital, the Brazilian stock exchange, Bovespa, took the
unparalleled step of setting up an alternative market in April 2001. The new market, the ‘Novo
Mercado’, require companies that list on it to comply with minimum corporate governance
practice. Through its minimal corporate governance criteria on voting rights, improved
disclosure requirements and the requirement to comply with international accounting
standards, it aims to ensure that management is more accountable to shareholders. Whilst it is
still early days, this innovative move of the public and private sector, with support from the
international 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. Possible
candidates 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 the
writing of a code of corporate governance.

Consensus building. There may be a need to build greater understanding of the implications of
corporate governance for developing countries. This can be done through linking with
international bodies involved in corporate governance, such as the Global Corporate
Governance Forum (GCGF) (see below) or the Commonwealth Association of Corporate
Governance (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 better
understanding of corporate governance and to harness its enthusiasm for reform. Potential
platforms for engaging the private sector in the debate are local commercial or professional
membership organisations, which have often led the development of codes of corporate
governance. See also the NEPAD Business Group below.

One size does not fit all. Corporate governance structures should be adapted to the unique
characteristics of a country. The OECD principles are voluntary, but can be used to inform a
country’s own code. For example, the OECD Principles were used as a starting point in writing
the King Code II of South Africa and the Kenyan Corporate Governance Code, which are codes
‘owned’ by the private sectors of the countries concerned.

Statutory vs voluntary: the role of regulation in corporate governance. Although the OECD
principles are voluntary, there is a debate on whether country codes should be voluntary or
statutory. The UK’s ‘Combined Code’ on corporate governance provides for voluntary
compliance but statutory disclosure for departure from the provisions of the code (comply or
disclose). 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 applied
broad 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 nature
depending 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 corporate

governance. CSR looks at the way companies can add social, environmental and economic value
to the society in which they operate through their core activities. In other words, CSR is
concerned with responsibility to the company's wider stakeholders. (See How To Note on
Approaching Corporate Social Responsibility).

Corruption interface. Corporate governance provides the basis to protect shareholders, to

treat stakeholders fairly, and ensure transparency and accountability of managers. Corporate
governance therefore works to underpin government regulations, by focusing on the private
sector’s desire to operate efficiently, and to provide a framework in which bribery is made more
difficult.

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

The FIRST Initiative

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