The President of the World Bank, Wolfensohn J, stated in an article published in the Times of June 21, 1999 "Corporate Governance is about promoting corporate fairness, transparency and accountability."
Deaken and Hughes regarded corporate governance as a system by which companies are directed and controlled. It is concerned with the ways of bringing the interests of investors and managers in line ensuring that the firms are run for the benefit of investors.
It regulates the relationship between the internal governance mechanisms of corporations and society's conception of the scope of corporate accountability.
The OECD in its "corporate Governance Rules" described Corporate governance as a "set of relationships between company's management, its boards, its shareholders and other stakeholders that provides a structure through which the objectives of the company are set and the means of attaining those objectives and monitoring their performance are determined."
This definition meets today's business requirements that take care of interconnection between the various stakeholders involved in corporate governance.
Until recently it was very difficult to quantify or evaluate the quality of corporate governance and to establish its real worth for an investor.
Standard and Poor's, Moody's and other rating organisations have started comparing American companies on the basis of improvement in corporate governance.
There are several issues that are taken into account to determine if the company is showing good governance and one of the issues that are taken into consideration is the separation of role of Chief Executive Officer and Chairman.
ADVANTAGES OF IMPROVING CORPORATE GOVERNANCE:
According to Mckinsey and Company, investors have indicated that they would pay more for a share of a well governed company and it has been estimated that the premium could go up to 14 percent of the price.
This means that generally the share price of such a company may either be stable or higher than the market performance.
Two-thirds of the companies appointed new non-executive directors in advance of their initial public offering and 81 per cent acknowledged that their appointment of non-executive directors made an important contribution in that floatation.
As such firms having strong shareholders rights had higher firm value, higher profits, higher sales growth, lower capital expenditures and fewer corporate acquisitions.
Corporate governance could become a benchmark for attracting talented employees and may attract good candidates for the position of non-executive directorships due to lesser risks attached to these positions in well-governed companies.
It should place internal checks and controls required to ensure transparency and accountability that is a major objective of shareholders.
The code should streamline the relationship between management's, directors, shareholders and auditors with a view to manage the company with an independent mind and should be willing and able to challenge, question and speak up in the best interest of stakeholders.
How best the independence of mind and judgement is obtained remains to be discussed and adopted from company to company.
It is not an easy task to introduce certain discipline without the force of legislation or regulations.
This is implemented through the listing rules that are voluntary. However, these are not the final set of rules and may require changes as the business requirement changes.
There should be a process of reviewing these rules periodically to ensure if the code fulfils the requirements of local corporate needs as well as this document is comparable with the other set of codes already exists in other parts of the world if we wish to maintain competitiveness in inviting direct foreign investment.
There is a need to critically evaluate the Code of Corporate Governance recommended by the Securities and Exchange Commission of Pakistan (SECP).
The official code of corporate governance, prepared by SECP for implementation has been issued on march 28, 2002 directing all stock exchanges to insert the code in their respective listing regulations to see if it reflects the essential ingredients of corporate governance or it desires some modifications to suit our requirements and to establish that it is comparable with codes adopted by other developing economies.
This was possibly done on the British pattern where the Cadbury recommendations of corporate governance and the recommendations by the Higgs Review were implemented through the listing rules of London Stock Exchanges on the principle of "comply or explain" basis.
This method of implementation offers flexibility and intelligent discretion and allows for valid exception to the sound rule.
Derek Higgs stated, "The rigidity of legislation couldn't dictate the behaviour, or foster the trust that is fundamental to the effective unitary board and to superior corporate performance".
However, EU Commission's view was different. After analysing and reviewing forty different code of corporate governance of member States, it concluded that a self-regulatory approach based on non-binding recommendations was not sufficient on its own to guarantee sound corporate governance. This is contrary to the suggestion that Higgs suggested in his Review.
The same view was taken by the OECD recommendations. In these circumstances, it is arguable if the same way of implementation may bring in any positive results desired from this implementation and SECP must give a serious thought to this side of the argument.
If the suggested code recommended by SECP is examined, it is evident that it lacks some of the important elements that were part of code of corporate governance suggested by the Cadbury Committee, the Higgs Review and the OECD proposals.
The Cadbury code mainly focused on accounting and auditing issues and the proper structure of the board of directors and their conduct.
The recommendations contained in the Higgs review were based upon the effectiveness of Independent non-executive directors through proper appointments, their defined role and responsibilities as a group.
This effectiveness has to be achieved through a proper procedure of directors' appointments, their role in the board, their remuneration linked with the performance and their relationship with the other stakeholders.
More emphasis was placed on the concept of Independence of directors, splitting the roles of CEO and Chairman and shareholder's activism.
The OECD recommendations mainly focused on independence of non-executive directors and the mode of implementation stressing that it should be enforced through regulatory and legislative means.
It is evident from the above recommendations that the code of corporate governance is mainly directed towards the independence of non-executive directors and more emphasis has been placed that they should play an effective role in balancing the acts of management's and other stakeholders.
In Britain, when companies were contacted, most of the companies were unaware that their directors did not comply with the code.
Less than 40% of remuneration and audit committees were fully independent and only 34% of companies stated that they were fully compliant with the combined code on corporate governance. There is still a need to do lot of work on these issues to make the companies fully compliant. This is contrary to what is happening in Pakistan.
The important remuneration and audit committees are mostly chaired and composed of non-executive directors who happen to be related to chief executive or are employees of the companies. Under these conditions, what useful purpose these committees could serve.
Therefore, it is essential that rules should be amended to make it compulsory that independent non-executive directors chair these committees and the definition of independence must be fully understood and fulfilled while appointing these individuals.
However, no reliable data exists in Pakistan, which should confirm that the corporate culture in Pakistan is in compliance of code of corporate governance suggested by SECP in true sense except that a statement from directors appears in the annual report informing the shareholders regarding the management's views relating to various issues of corporate governance.
The views expressed in the statement of compliance with the Code of Corporate Governance are not exhaustive and do not explain the reason of non-compliance of any of the provisions of code.
Explaining the non-compliance is in itself a process of corporate governance that should be strictly followed in the process of "comply or explain" principle.
It is important to see that almost 90 per cent of the companies state that the companies encourage representation of independent non-executive directors on its board but does not disclose why the board does not contain Independent directors.
Most of the companies state that the board contains non-executive directors but non-executive directors does not make the board members Independent or effective. Non-executive directors have always been there in the boards that were either family members or friends and they took minimum part in the affairs of the company effectively, resulting in poor performance at the expense of ordinary shareholders.
The real focus should have been on appointment of non-executive directors who are in real terms independent and the term independent has been properly defined in the Higgs Review as follows:
" A non-executive director is considered independent when the board determines that the director is independent in character and judgement and there are no relationships or circumstances which could affect, or appear to affect, the director's judgement.
a) Is a former employee of the company or group until five years after employment.
b) Has, or has had within the last three years, a material business relationship with the company either directly or indirectly, or as a partner, shareholder, director or senior employee of a body that has such a relationship with the company;
c) Has received or receives any additional remuneration from the company apart from a directors fees
d) Has close family ties with any of the company's advisors, directors or senior employees;
e) Holds cross-directorships or has significant links with other directors
f) Represent a significant shareholder; or
g) Has served on the board for more than ten years.
The board should identify in its annual report the non-executive directors it determines to be independent.
The above term defining independence of a director is very exhaustive. Unless this independence is enforced and a specified number of directors are independent non-executive directors, there seems to be no effective change in code of corporate governance.
The code in its present form only suggests at least one Independent non-executive director representing institutional investor.
As per the definition contained in the Higgs Review, any director representing an institutional investor or any group is not considered as an independent non-executive director as he is supposed to be protecting the interest of a group of investor and would not be able to act independently to protect the interest of shareholders and the company on a long-term basis.
Therefore, it is logical to argue that the Code of Corporate Governance in its present form does not make any obligation on listed companies to appoint any Independent non-executive director.
This is contrary to good principles of corporate governance and this anomaly should be removed as soon as possible.
If we examine the structure of majority of company's board of directors, it becomes evident that non-executive directors are not independent in most of the cases and they represent family members, friends, ex-employees or major shareholders.
This area requires more attention of SECP so that the discipline could be brought into the structure of the boards to make the directors more independent. It is being widely accepted that at least fifty percent of the directors should be Independent non-executive and this is what SECP should be aiming at gradually.
The companies must disclose in their annual report why they have not appointed the requisite number of independent non-executive directors in their boards.
This limitation is too generous and confusing. It is not possible for any one individual to effectively attend and participate in the affairs of a company for at least 80-100 board meetings per annum averaging 1.75 meetings per week assuming that an individual is holding directorship with the maximum of ten companies that is allowed in the code of corporate governance.
An effective contribution towards these meetings requires sufficient time for preparation and study. It is arguable if an independent non-executive director could spare this amount of time when no payment is made for his services except for meeting fees. It may be argued that the person so performs is technically and professionally incompetent.
In this situation, how can we expect an effective contribution from this group of people who are non-executive? SECP should give a serious thought to reduce the number of directorship from 10 to 5 directorships and to increase the amount of "meeting fees" to compensate them for preparing themselves for effective contributions in board meetings.
The companies should reimburse them for secretarial costs for the preparation, research and planning to prepare them for the board meetings.
This is in line with other developed economies where it has been felt that effectiveness would not be achieved if the independent non-executive directors are not properly reimbursed for the time they spend on companies affairs.
In Britain, a non-executive independent director is paid on an average at least 15000-30000 pounds per annum to meet his expenses on this account and still it is thought that good candidates are not available to serve on board as the remuneration and liabilities for these positions do not justify the acceptance of these positions.
In practice, loans are granted to companies and not to individual directors so it is legally arguable if the directors are defaulters as individual or is it a company that is defaulting its liability on the basis of it being a separate legal entity.
Even if it is argued that the directors are themselves defaulters, these are the issues that should be resolved by SECP at the time of approving the nominations of directors.
Annual reporting of these matters has no validity and should be excluded from the annual compliance statement, as this does not have material impact on corporate governance.
There should have been a general policy drafted by SECP or by Stock Exchanges as part of their listing rules that should cover elements like equal opportunities for employment, payment of government dues on timely basis, fair working conditions for employees and a declaration not to violate any governmental and environmental laws.
It should have been incorporated that there would be a proper liaison between the company and its shareholders on the pattern of the Higgs Review where a lead director has been assigned this role to hold a continuous dialogue with shareholders to remove their doubts and answer their questions.
It should be director's personal responsibility to identify violations of Ethics policy that are in the knowledge of any director. It should be made compulsory to sign the policy by each director at the time of his appointment.
These are purely internal matters of companies that express aspirations and wishes and in certain cases these may have no bearing on reality.
These are considered as moral building measures for the stakeholders and it has been mostly misleading statements for outsiders.
Visions and mission statements do not establish any targets and therefore there are no means to compare the performance against the set targets.
So visions and mission statements should not form part of code of corporate governance.
Therefore, it is evident from the study of various code of corporate governance in different parts of the world that it has not been part of any code of corporate governance.
Director's precise duties are a complex issue that has been debated over the last several years throughout the world. It is advisable that a standard statement of director's statutory duties and duties under other local laws and regulations should be drawn up by SECP and directors are required to sign this statement before they accept directorship of a company.
The company should declare that the directors have been provided a statement of duties relating to their legal responsibilities and they understand these responsibilities.
The non-executive directors should be aware that there is no difference in their legal responsibilities and liabilities if compared with the executive directors.
This issue has been extensively debated in Britain and the Law Commission appointed by the British government supported this view that a statement of duties should be prepared and signed but the government opposed this idea and left it to the courts to enforce compliance of statutory and common law duties of directors.
There are general concerns that full disclosures are still not being made, which are easily understood by the shareholders. It is difficult to identify the total amounts being spent on directors and it is being proposed that companies should disclose total executive remuneration to shareholders that should include their long-term benefits and how much it is costing to the companies.
This will ensure that the remuneration package is reasonable, justified and based on performance-oriented results. (See Financial Times editorial page 16, May 25th 2004, "Information that shareholders need").
This topic has become an important issue for the shareholders activism to keep a check and balance upon the executive management's compensation package to ensure that these are in line with the company's performance and no wasteful expenditure is incurred on these individuals at the expense of shareholders if the management's performance is below expectation and that the company's income does not justify this amount of expenditure.
There seems to be complete agreement that directors remuneration's and compensation packages is an important area where shareholders should be involved.
Therefore, most of the western economies have enacted laws to give powers to shareholders to approve their remuneration.
In Britain, Directors remuneration has been made an issue that needs shareholders approval by virtue of Directors Remuneration Report Regulations 2002 (S1 2002/1986).
Recently a former chairman of the New York Stock Exchange was sued on the basis that the board was misled about the aspect of his compensation contract and the formula used to set his pay was flawed.
It involved a payment of $187.5 million that was not reasonable according to state law and that being in a dual role of a regulator and an employee there was a conflict of interest in this arrangement.
The board was also misled about bonus awards totalling more than $18 million. This demonstrates the problems and the mistrust shareholders may have upon the board that needs an independent review.
In another case Sir Peter Davis had to step down in the wake of a shareholders revolt over his bonus that was awarded to him worth 2.4 million pounds for the year 2003 in which Sainsbury experienced falling sales and profits.
In Pakistan, this area has been somewhat neglected due to various reasons. If we look at the audited accounts and annual reports of the listed companies, the disclosure relating to director's total compensation is not adequate.
For example no details or explanation is provided for the amounts spent on fixtures and furnishing of director's residences and the maintenance amount spent on these premises separately.
No details are provided for the cost of free company cars provided to these executives and no details are disclosed for the contracts signed with these executives for loss of office and payments made to them at the time of golden hand shake or share option schemes.
Likewise it is customary not to disclose payments made to directors on account of children's education, travel and medical expense reimbursement and the cost of employees placed at the disposal of the directors who are placed on company payroll. This is causing a two-fold damage.
Non-disclosure of these benefits misrepresent total amounts being spent on directors and at the same time, these are regarded as tax free benefits and no taxes are paid on these unofficial facilities.
It is not possible to calculate the total amount of compensation package for an individual director and, therefore, shareholders are unable to question this aspect of corporate governance.
There is no way that shareholders are in a position to determine if the compensation package is performance related or not.
Therefore, a change is desired in the code of corporate governance that should make compulsory disclosure of all the payments and these should be presented to the shareholders for approval.
This should provide an understanding to the shareholders of the kind of payments being made to directors. This process of check and balance should result in improved corporate governance.
In Britain, institutional shareholders accounted for 52.7 percent of UK ordinary share as at December 1997 with a combined value of 669 billion British Pounds.
Likewise, Pakistanis institutions have also become active in the development of stock markets and there is strong evidence that their role will keep on increasing in the coming years.
Institutional investors in Pakistan have not shown any activism towards improving corporate governance.
This lack of activism is seen all over the world and efforts are being made consistently to make these institutions aware of their responsibilities towards improving corporate governance through dialogue and regular and periodic meetings with company's management's.
The code of corporate governance does not incorporate any obligations on the institutional shareholders to play an effective role in the process of conducting dialogue with the management to improve corporate governance.
The code should incorporate specific reporting by the executive management to disclose how the institutional shareholders have effectively conducted their policies by influencing the management's to improve corporate governance.
It is also not disclosed how they vote on important and vital issues facing the companies in the annual meetings on major issues affecting shareholders interests.
If the institutional investors are forced for this disclosure then it is widely believed that the company's management could be influenced to improve its corporate governance image.
The major investment institutions should co-ordinate their activities to monitor the progress of the companies to ensure that corporate governance is being improved continuously otherwise these institutions should seek a continuous dialogue to force the management to implement and show improvement.
They should intervene when necessary and in case of investment managers, report back to the clients on whose behalf they invest.
In Britain, a similar Institutional Shareholders Committee has been formed to unveil new statement of principles on shareholders activism to influence the management's to improve their corporate governance image through consistent dialogue with management's.
These principles are well defined and are meant to apply a uniform policy towards all listed companies that may face questions from the institutional investors in case the corporate governance lack in certain areas.
If we examine the annual reports of the listed companies, it is evident that even institutions like National Investment Trust, State Life Insurance of Pakistan, Pakistan Insurance Corporation and other banking institutions that holds substantial holdings in listed companies do not represent their institutions in the board or at annual general meetings on regular and effective basis.
This behaviour reflects lack of interest in company's affairs. Their participation and voting pattern mostly goes with the management and no support is provided to minorities in their efforts to demand additional voluntary disclosures that may be necessary for improving corporate governance.
This situation desires a change and institutional investors should make every effort to mobilise minority shareholders also in improving corporate governance.
There is a need that shareholders interests are protected by forming shareholders associations to act as a bridge between the company's management's and shareholders to minimise grievances.
SECP must not neglect this area while updating its code of corporate governance.
This lack of activism is witnessed all over the world and in Britain, it is being widely thought that some legislative measures should be introduced to force the institutional investors to play their role of ownership if the government efforts are not fruitful to bring a voluntary change.
The chairman has to be an independent person whose main task is to act as a bridge between the shareholders, non-executive directors and executive management.
This role cannot be fulfilled if it remains in one position. In case it remains in one person, then there should be a senior independent director that should chair the board meetings.
The Higgs Combined Code suggests that the Chief Executive should not chair the same company.
This issue has been very controversial when introduced in Britain.
FTSE 100 chairmen expressed concern that the proposed appointment of senior independent director is likely to split the board and undermine their role.
Their argument was that having a non-executive director's representative would make the chairman a quasi-executive and may create an alternate power base in the boardroom.
This issue has been given so much importance that even in United States, EU Commission and OECD countries have supported this idea recently.
In Pakistani code of corporate governance, this important issue has been completely ignored and the concept of splitting these two important positions or the appointment of a senior independent director has not been made part of the Code to improve impartiality and transparency.
Looking at various annual reports of the listing companies, the boards meetings were mostly held with the Chairman present but in case he is not present, CEO acts as a Chairman that is against the very essence of code of corporate governance as these two positions should not be held in one person for the sake of transparency and effectiveness.
This may act as whistleblower for shareholders to be aware regarding the events taking place within the company.
These are published daily in national newspapers for the information of public. This declaration creates awareness among the public regarding the reasons of abnormal buying and selling in these shares and is an important part of transparent system SECP is trying to establish in the Stock Exchanges of Pakistan to curb and discourage insiders trading.
Currently this disclosure is made to SECP within 60 days of the transaction-taking place, which is not disclosed to the public.
We are unable to understand the reason why this vital information that may have a crucial impact on investor's decisions are held by SECP and not disclosed to investors on timely manner.
Now this information is disclosed as part of Code of Corporate Governance in the annual report of the company. Does it have any value to the investors or shareholders? Is it not stale information that can never be used by the shareholders or potential investors?
Daily disclosure should be the responsibility of directors as well as the brokerage houses.
The code of corporate governance must be amended to include this change otherwise this information is of no use to any outsider.
Non-executive members are normally from the same family and friends controlling the management of the company. It is arguable how effective this audit committee may carry out its duties.
While examining one of the annual reports, in one of the listed companies the chairman of the Audit Committee is the younger brother of the Chairman of the company who has controlling shares.
In this situation how an audit committee could perform the role that was visualised with this arrangement.
This report is a standard report and treated as a waiver of auditor's responsibility by outsiders. The usual wording that normally appears in these reports demonstrates that it is neither a confirmation nor a denial of the existence of code of corporate governance and in fact amounts to a waiver of responsibility by the auditors.
The author has not seen any report that highlights even a smallest deviation from the code of corporate governance for the information of shareholders. Under these circumstances, even if this report does not become part of annual report, it does not matter at all.
The purpose of this report should have been to highlight and explain departure from code of corporate governance and not to protect them against any negligence that may be detected in future.
While addressing the Best Corporate Awards-2003 ceremony organised jointly by the Institute of Chartered Accountants of Pakistan (ICAP) and Institute of Cost and Management Accountants of Pakistan (ICMAP), he said that the need for developing a sound corporate reporting was reflected in the corporate governance code issued by the Securities and Exchange Commission of Pakistan (SECP).
It is essential to mention here that SECP has not been able to provide a sound and effective infrastructure for listed companies to implement the code of corporate governance.
If the implementation of code of corporate governance is analysed impartially, it seems quite clear that the code is not only defective in several areas but also outdated and has no utility to the stakeholders.
There is an urgent need to upgrade this code and make it more effective in line with the rest of the world. Before the private sector is asked to adopt code of corporate governance, it should be realised that the compliance cost is high and we should not discourage formation of private companies just because we want these companies to adopt code of corporate governance.
The code should strictly be applicable to those listed companies where outside funding is involved in the shape of listed capital.
The other important factor is that the application of code of corporate governance should be strictly enforced on all those institutions that are controlled and managed by governmental appointments.
That should serve as an example of seriousness that the code is not only meant for window dressing but is a tool to bring in good corporate governance.
(The writer is working on a project of corporate governance at Law School, University of Northumbria at Newcastle-upon-Tyne.)