The whole world is in economic and financial crisis. Struggle is going on to come out of it. Several solutions have been suggested and are being offered by scholars, economists, government functionaries and other stakeholders. This piece presents a lucid analysis on corporate governance for developing sound corporate management to add value and for enriching the results of corporate entitles for society in general and shareholders in particular to be the beneficiaries.
This paper has been divided into the following parts:
-- Central concerns of corporate governance
-- Experiential learning: global experiences
-- World Bank indices
-- Five-point strategy as way forward
Each of the above is now explained below: Central concerns of corporate governance: Based on the past experience, failure stories and experiential learning in the area of corporate governance, following central concerns are identified and shown in Box No 1.
===============================================================
Box No: 1
===============================================================
1) Role of board of directors.
2) Basic structure of board of directors and its composition.
3) Remuneration pattern.
4) Ownership of directors.
5) Availability of freedom to an enterprise - BoD role.
6) Role of services of institutional directors.
7) Accountability of members of BoD.
8) Financial reporting.
9) Institutionalisation of audit functions.
10) Linkage with stakeholders.
===============================================================
Each of the above point is now briefly reviewed as under: Role of Board of Directors: For managing the affairs of a corporate entity basically three functions are followed namely, Strategic Planning, Tactical Controls and Actual Operations. These three roles are reflected in the following figure:
Legend: Strategic planning, tactical controls, actual operations.
BoD must understand that their basic role is at Serial No 1. Therefore, for delivery system it needs to be well-equipped. It should be professionally well qualified to deliver the goods. It must identify any weaknesses or gaps in its role and remove the deficiencies through continuous training and management development so that it can perform its duties in a befitting manner. Its leadership can open a golden chapter in the history of success of corporate enterprises, failing which the fate of the corporate enterprise, will be heading towards disaster and bankruptcies. Searching question to be asked by each one of them is: Are they well equipped and bejewelled to perform their role?
Basic structure of board of directors and its composition: The composition of the board of directors should be well balanced. For successfully operating, the affairs of the corporate entities diversified expertise should be possessed by them in the following areas namely, Personnel Management: (HRM/HRD), Production Operations Management (POM), Supply Chain Management (SCM), Finance, Marketing and Innovation backed up by out of the box thinking. Accordingly, any director who either does not have a grip on account of foregoing six aspects or at least one out of six, failing which he / she will be a liability rather than a tangible asset for the organisation.
Remuneration Pattern: The remuneration of BoD members will have several patterns. Ordinarily each BoD member is paid an honorarium for attending the meeting. Fair amount may be determined in this respect. Some of the directors need to deliver services on full time basis including the managing director/CEO. Their remuneration may be fixed by the board of directors and approved in the annual general meeting as part of transparency. There is a common practice in Pakistan to determine the remuneration package of the managing director/CEO by the BoD as a part of open door policy. This is communicated to all shareholders for information so that they stand fully communicated about the remuneration aspects.
Ownership of directors: Ordinarily, the minimum qualification shares to be possessed by a director to hold his office as director is prescribed in the articles of association of a company. Over and above, the minimum qualification shares, a ceiling may also be laid down so that the spirit of broad basing the ownership continues to be practically implemented. In some countries, eg Hong Kong, there is a rider clause of restricting the total number of shares to 50% relating to a director and his family members. Corporate ownership ought to be broad-based so that there is a wider application of participation in the corporate entity and consequently stakeholders across the board are beneficiaries.
Availability of freedom of an enterprise - governing BoD role: Members of BoD should enjoy full degree of freedom and must exercise their initiative in terms of new harbinger and explore new frontiers of expanding horizons of the business. They must provide enlightened leadership and inspire the whole organisation to swing into active work to earn high profits achieve, greater productivity identify, new vistas of leadership, ensure growth and tap markets through various approaches including market penetration. A success in this dimension can take a corporate entity to greater heights.
Role of services of institutionalised directors: Directors of BoD have to be natural persons. However, if an institution is holding financial stake in a corporate entity it needs to be represented on the BoD through a nomination known as institutionalised director. One should be well-equipped and well-experienced person so that one can make an enriched contribution on the BoD to ensure its success. If the one is lacking any knowledge and expertise, he/she will be a liability to be carried as a baggage on the BoD rather than perform their role as a productive and efficient member of the BoD team.
Accountability of members of BoD: It is very interesting that the rise of joint stock companies in the world presents a big problem namely, owners are many in number, but their governance is with very small in number constituting BoD. The hope is that BoD will follow the objectives of serving the interest of the corporate entity rather than their own personal interest. In this respect, the role of their accountability becomes very meaningful. In the Western model, the accountability is enforced through legislation and through the circulation of financial statements in the annual general meeting. This traditional approach unfortunately has not succeeded as clever management through BoD continued to show losses through manipulation rather than perform their duties in the very basic interest of the corporate entity. Several examples in the world can be cited including downfall of Enron in USA and Satyam Computer Services Limited, India to name a few. In this respect, Islamic model needs to be comprehended for moral reformation and its true implementation. The following two verses from the Holy Quran are quoted below:
-- "So whoever does an atom's* weight of good will see it,
-- And whoever does an atom's* weight of evil will see it".
-- [* "The weight of a small ant"]
-- (Al-Quran, 99: 7 & 8)
Divine message contained in Al-Quran is stressing an obvious. It lays sound foundation for strengthening moral frontiers of self-accountability and therefore suggests a firm grip against manipulations in financial and non-financial matters which ought to be uprooted, failing which adverse impact will continue to be reflected in the financial statements through malpractices of all types.
The message of feed forward emanates from the following divine message contained in the Al-Quran to be used as feed back to be provided on the Day of Judgement. This message from Al-Quran is quoted below: "That Day, We will seal over their mouths, and their hands will speak to Us, and their feet will testify about what they used to earn". (Al-Quran, 36: 65) The above message should provide a feed forward to every member of BOD to be self-accountable as God will provide feed back on the Day of Judgement.
Financial reporting: Legislative aspects make it mandatory for a corporate entity to give adequate disclosure through the following reporting systems:
a) Quarterly reports including quarterly highlights of all operational results and financial position of a company. This is mandatory for listed companies in some countries, including Pakistan for circulation to shareholders.
b) Half-yearly financial reports: Through various legislative aspects it is mandatory in many countries including Pakistan, to release half-yearly financial reports to shareholder for listed companies.
c) Annual financial report: Several practices exist in the world including prescribing the formats of annual financial reports. However, the current trend is to prescribe minimum disclosure requirements in respect of the following:
i) Balance sheet
ii) Income statement
iii) Funds flow statement
In Pakistan, we follow sunshine legislation of prescribing disclosures of information governing the above financial reports through Fourth Schedule of the Companies Ordinance, 1984 for listed companies and through Fifth Schedule governing non-listed companies. Continuous efforts are going on, with leadership provided by International Federation of Accountants, New York, and International Accounting Standards Board, London for adequate disclosure of information for the benefit of the stakeholders in general and shareholders in particular.
Enlightened management led by good role of BoD continue to publish several other types of information voluntarily through pictorial displays, statistical charts, figures, ratios and computer graphics. The rise of IT has been of great interest and instrumental in display and dissemination of voluntary and non-mandatory disclosure of information for the benefit of users.
In this respect the role of government, regulatory bodies, stock exchanges, world of academics, financial analysts, financial institutions etc is laudable. This ought to continue for strengthening the logistics to sound corporate management practices as foundation for accountability and high performance.
Institutionalization of audit functions: External audit is governed by legislation in several countries. It is mandatory to be conducted by professionally qualified persons, generally by chartered accountants and in the case of private companies falling below a specified paid up capital of share capital by non-qualified accountants also. Efforts are in the offing to strengthen this role for sound legislation and through productive role of other stakeholders namely, Professional Institutes of Accountants, stock exchanges, securities and exchange commissions and other regulatory bodies etc.
Internal audit needs to be organised on sound footing. Internal auditors will, in future serve as the 5th pillar of the state for sound corporate management. Every country must address to enact the statutory support in terms of institutionalisation and make sure that on the pattern of the US and UK institute of internal auditors get mandatory support and internal auditors are afforded an opportunity to play their productive role. Management audit is yet another area which needs to be properly addressed for laying sound foundation for excellent corporate management. Several models exist in this respect and there is a need for each corporate entity to voluntarily respond to these challenges with a sense of urgency. In this respect, while several models exist in the world, the one followed by General Electric Corporation (GEC) needs to be given proper attention by Corporate Management. For ready reference this is reproduced below:
a) Profitability, market position, productivity, product leadership, personnel development, employees' attitude, public responsibility, balance between short and long-term goals.
-- GEC has highlighted the above eight areas for evaluation as part of overall performance appraisal.
-- To achieve productive results due to foregoing efforts, system of sound internal controls needs to be developed and operationalized.
Linkages with stakeholders: The corporate management ought to realise that they are not only accountable to shareholders, but also to various other stakeholders eg government for fiscal aspects, lending institutions for debt servicing, social awareness for Corporate Social Responsibility (CSR), regulatory bodies for compliance for its prescribed regulations etc. Therefore, the expectations of internal and external stakeholders need to be properly visualised and addressed.
-- Experiential learning-global experiences
-- Selected countries experiences are summed up below:
United States of America: Sound corporate governance models were developed in the US. However, unfortunately in some corporate entities these were not properly implemented. Consequently, the financial collapse of some giant corporations were seen in the world. Enron is one of the examples. Yet another example from the US is World Com. Consequently, the legislators in the US take a lesson and legislated - Sarbanes Oxlay Act, 2002. The world is struggling to focus on implementation aspects where good models exist. However, the crying need is to implement the spirit of sound Corporate Governance.
United Kingdom: Cadbury Committee in the early part of 1990's was set up and addressed four issues on the frontier of corporate governance namely, board of directors, non-executive directors, executive directors and reporting and controls. Dominating emphasis was given on holding regular BoD meetings, effective and full control of the company by BoD, monitoring of executives development and maintaining a balance between authority and power.
The guidance provided was that the directors must keep the control formally in their hands. An independent professional advice is to be obtained from non-executive directors, who should have the calibre for inclusion in BoD. The secretary of the board should stay independent and his removal should be by the board as whole. The non-executive directors should focus their contribution on strategy, performance, key appointments and developing standards of conduct. The Executive Directors should have contract of three years with formal approval from BoD and their emoluments should be transparently disclosed and Audit Committee should be set up with clear terms of reference in black and white and deal with the matters with clarity, authority and clear-cut duties. Effective internal controls should be in operation to ensure business as a going concern. Later in 1995, Hempel Committee was set in UK. This committee was given two years to complete their assignment with six aspects as their scope of work namely, principles of corporate governance, application of the principles, the future directors, remuneration and shareholders and annual general meeting. They gave recommendations in January 1998 to lay sound basis for Corporate Governance.
Hong Kong: Accounting profession in Hong Kong has great impact from UK. Some Working Groups were set up. The report of the first working group on corporate governance was released in 1995 and the report of the second working group was released in January 1998. The following 10-point code was issued for compliance:
==================================================================
Box No 2
==================================================================
1. Compliance Matters to be identified.
2. Board Same family members not to
have more than 50%.
3. CFO Mandatory for appointment.
4. AGM Attendance record was made mandatory.
5. Board Meeting Frequency of four Compulsory every
year. Six preferred.
6. Auditors Other Fees Separate disclosure.
7. Annual Report Separate Disclosure on:
Corporate Governance.
8. Audit Committee Be established with Defined Functions.
9. Interim Report Be released. Scope: Balance Sheet,
Income statement and Cash Flow statement.
10. Auditors To review No 9 above.
==================================================================
Malaysia: Two separate Codes of ethics for directors and company secretaries were issued. The five-point code of ethics for board of directors emphasised on introductory aspects, principles, objectives, definition, code of conduct for corporate governance. Four parts constituted code of ethics for company secretaries namely, introductory aspects, principles, objectives and five point code of conduct.
Pakistan: The first code of corporate governance was released by Securities and Exchange Commission of Pakistan with the assistance from the Institute of Chartered Accountants of Pakistan and other stakeholders with the mission that sound corporate practices will be developed and implemented. Currently it is applicable to listed companies, banking companies, DFIs, NBFIs, insurance companies, mutual funds, unit trust, and company corporations held or controlled by the government constituents of the code of corporate governance include director, CFO and secretary, corporate and financial reporting framework and audit Committee. The crying need is to legislate through amendments to be incorporated in the Companies Ordinance, 1984 so that its application can be made across the board in a full-fledged manner for the benefit of stakeholders.
South Africa: The King's Report on Corporate Governance was published by the Institute of Directors in South Africa on November 19, 1994 and detailed recommendations were released for implementation. This produced productive results.
World Bank indices While globally efforts have been on to prescribe procedures governing sound _corporate management practices, The World Bank has been developing certain indices. Two successful efforts were made by them in respect of developing CGI (Corporate Governance Index) and WGI (World Governance Index).
The focus of this article is on Corporate Governance. However, it may be of interest to the readers to see the productive work undertaken by the World Bank for developing World Governance Index. In this respect, the World Bank used three elements to evaluate for developing the above index namely, Regulations, Corruption and Rule of Law. Based on our research on the regulatory front, the best-rated country was Hong Kong (99%) and the worst was Myanmar (1.5%). On the corruption front the best-rated country with least corruption was Singapore (96.1%) and the worst was again Myanmar (1.4%). In respect of rule of law, the best-rated country was Singapore (95.2%) and the worst was again Myanmar (5.2%).
Regarding overall Corporate Governance Index, the best performer was Germany (90.8%) and the lowest performer at the bottom was Bangladesh (24.3%). In this respect, Box No 3 shows the ranking of fourteen (14) countries.
==================================
BOX NO. 3
==================================
OVERALL CORPORATE GOVERNANCE INDEX
==================================
Country CGI
(out of 100)
==================================
Germany 90.8
United States 89.8
Singapore 80.9
Hong Kong 69.2
Malaysia 66.7
India 55.4
South Korea 55.4
Thailand 49.7
Philippines 48.9
Indonesia 44.7
Vietnam 38.1
China 35.3
Pakistan 31.3
Bangladesh 24.3
==================================
Source: Extracted from Dawn, Lahore, January 10, 2009.
Five-point strategy as way forward There is an outcry for developing and later enforcing sound Code of Corporate Governance. In this respect, the following suggestions are offered for implementation:
Public life focus: There is a need to first reform individuals or participants in the process of corporate governance. In this respect, guidance can be sought from Box No 4 containing seven principles of public life as suggested in the first report of committee of standards in public life, published in UK in May 1995:
===============================================================================
Box No 4.
===============================================================================
The Seven Principles of Public Life
===============================================================================
Selflessness: Holders of public office should take decisions
solely in terms of the public interest.
They should not do so in order to gain financial
or other material benefits for themselves,
their family, or their friends.
Integrity: In carrying out public business, including making public
appointments, awarding contracts, or recommending
individuals for rewards and benefits, holders of public
office should make choices on merit.
Objectivity: Holders of public office should not place themselves under
any financial or other obligation to outside individuals
or organisations that might influence them in the
performance of their official duties.
Accountability: Holders of public office are accountable for their decisions
and actions to the public and must submit themselves to
whatever scrutiny is appropriate to their office.
Openness: Holders of public office should be as open as possible about
all the decisions and actions that they take.
They should give reasons for their decisions and restrict
information only when the wider public interest clearly
demands.
Honesty: Holders of public office have a duty to declare any private
interests relating to their public duties and to take steps
to resolve any conflicts arising in a way that protects the
public interest.
Leadership: Holders of public office should promote and support these
principles by leadership and example.
===============================================================================
Role of governance: In several countries, various models exist relating to corporate governance. In some countries, corporate sector entities are voluntarily following code of corporate governance. In other countries, these have been developed by professional accounting institutes and supported by regulatory framework, generally through securities and exchange commissions, central banks, stock markets etc. These have been developed and released for implementation. There is crying need for incorporating all the codes of corporate governance in the laws governing corporate sector so that these constitute a mandatory requirements for compliance.
Implementation: To reap real benefits emanating from the implementation of codes of corporate governance, implementation aspects should be strengthened through institutional approach which must also include monitoring and total compliance. In this respect, in some countries external auditors are playing a useful role and a separate report on compliance of corporate governance code is issued by them for release to the shareholders. These aspects need to be fully supported and strengthened.
Feedback: Feedback technique of management should be used on continuous basis so that basic Code of Corporate Governance together with its compliance is properly addressed. It is interesting to know that Satyam Computer Services Limited, Hyderabad Deccan, India which claimed to have implemented Corporate Governance in good spirit earned Golden Pea-Cock Award for Corporate Governance in 2006 from the World Council of Corporate Governance. However, on January 7, 2009, its Chairman himself, in his letter addressed to the board of directors, admitted various frauds and manipulations aggregating to over one billion dollars. His confession came for inflating the past several years with fictitious assets and non-existing cash. Therefore, the message is to constantly review the criteria of the procedure adopted for checking the compliance and revisit periodically with some reconnaissance over the affairs of the Company.
Curriculum review: The business schools and professional institutes of accountants throughout the world must include some courses on corporate governance so that a new breed is developed to pave the way for implementation of sound code of corporate governance and its total compliance. A bold beginning should be made in this respect to ensure that logistics are available for delivery system to achieve the foregoing objectives.
(The paper has been presented by the writer in the second Balkans and Middle East countries conference on Auditing and Accounting History held in Istanbul, Turkey, in September 2010) ([email protected])
Comments
Comments are closed.