Lord Emerick Edward Dalberg Acton perhaps made the founding statement on corporate governance when he wrote his Essays on Liberty:
"Liberty is not a means to a higher political end; it is the highest political end. Liberty is the only object which benefits all alike and provides no sincere opposition. The damage is not that a potential class is unfit to govern. Every class is unfit to govern. Power tends to corrupt and absolute power corrupts absolutely"
Most of us are aware of the last sentence of the above quotation. Democracy through the doctrine of separation of powers divides power and control between the judiciary, the executive and the legislature and each must have a separate and distinct autonomy. In a similar vein the government places an expectation upon business houses that divisions should be created and the requisite autonomy maintained within its own business organisations.
The reason to draw this comparison is important. Governments view multinational enterprises as having the economic power of any government. In each case the government and the private sector have a separation between the principal and agent.
In the case of the government the principal being society and in the case of the company the principal being the shareholders. The agent would be the public servant for the government whereas for the company would be the management. Indeed, the division between the public sector and the private sector has been increasing particularly with privatisation and corporatisation.
We have seen the privatisation of the banking system in Pakistan and other previously public services. Indeed, if all the large banks in Pakistan came together they could yield serious economic power and seek any change that they desire from the government, including perhaps of the government itself.
With all of the above, we have seen the need to bring about corporate governance or a similar division of power and control in board rooms.
When the Code of Corporate Governance was introduced in March 2002, consensus emerged that it would be unhelpful to put the Code into the Companies Ordinance, 1984. The reason probably was that while we have seen outrageous behaviour, including attempts to circumvent the legal and regulatory framework, the natural consequence is to tighten the same to contain the distortion.
If the tightening is carried too far, there is a danger that the system as a whole could become overconstrained by such efforts to protect it from a relatively few bad apples. The consequence of bad behaviour cannot be dealt with penalties alone.
It is not possible to address loss of confidence and discipline with penalties. Hence the Code was introduced keeping in mind the need for flexibility. Indeed this was the correct decision at the time as the Code derives its strength not from the fear of penalties but from the widespread support and heightened level of expectation it has now introduced.
What is the purpose of the Code of Corporate Governance? Where public investment is sought the obligation of the State is to protect investors against malpractices. In the case of banking and finance, the twin peaks are confidence and integrity. One compliments the other and each is co-dependent on the other. The slightest doubt about the integrity of a financial system can erode the confidence that supports it.
We may not have seen corporate scandals such an Enron, Worldcall but at home we have seen financial institutions collapsing. Larger financial institutions could have also collapsed had it not been for timely privatisation by the government of the large State-owned banks which brought back and resurged the confidence of having a safe and well managed bank.
Prior to privatisation, the government as a first step changed the senior management of the three large banks in Pakistan in 1997, thereby avoiding scandals of lack of corporate governance in these institutions. The private sector celebrity bankers brought confidence and integrity which are also the pillars of Corporate Governance.
Even without the formal Code of Corporate Governance (which was introduced in 1992), these banks were turned around through major restructuring particularly in relation to ensuring good governance. This further fortified the view that discipline and integrity cannot be ensured only with regulation.
All banks are used to Capital Adequacy Ratios; SLR requirements; per party limits; limits on equity investment etc which are all requirements to protect the bank deposits and investments which are placed in its trust.
This fiduciary responsibility is the pillar of Corporate Governance, which rests solely with none other than the senior management of the Bank and its Board of Directors.
The most frequently asked question is who do the management and the Board owe this fiduciary responsibility to. Almost 80% of bank assets are financed by the depositor's funds and in some cases less then 5% by equity, making banking business a highly leveraged business in an economy. In these circumstances, the position is clear; the primary responsibility of the management of the bank is to their depositors and not to their shareholders.
This is followed by the question as to what are those responsibilities. In legal terms the director's responsibilities are embodied in the Articles of Association and the complex and at times in-accessible case law. As a result directors were never clear about their general duties and to whom they owed the same. The Code of Corporate Governance is certainly a step in the right direction of achieving clarity in this regard.
We see Corporate Governance being introduced in various forms in the case of banks. These are (i) the fit and proper test for directors and senior management, (ii) directors remuneration, (iii) the number of meetings that directors have to attend, (iv) limitation on number of the directorships each director can hold, (v) rotation of auditors, (vi) restriction on directors investing in shares and (vii) governance of Employees Share Owning Plans (ESOP).
While the Code of Corporate Governance requires substantial disclosure, the most listed companies, including banks do not have sufficiently broad-based shareholding to ensure shareholder independent are strong enough to demand such disclosures.
In a typical general meeting in Pakistan, it is usually the case of one representative of the majority shareholder holding proxy for 51% to 75% shareholding and casting the vote on behalf of one or more of the major shareholders. As a result, Corporate Governance can only be implemented in the true sense, if the shareholding structure becomes broad-based.
To conclude the onus of good governance rests with the directors and no amount of regulation or codes or standards can replace the integrity, honesty and responsible conduct of a director in a board room.
(The writer is Barrister at Law, is the President of SAARCLAW and a senior partner of Mandviwalla and Zafar.)
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