Corporate Governance

Presentation by Susan MutangaduraIAC Conference 2011

7-9 September Troutbeck Nyanga

©Susan Mutangadura

A case for Corporate Governance• “If a country does not have a reputation for strong

corporate governance practices, capital will flow elsewhere. If investors are not confident with the level of disclosure, capital will flow elsewhere. If a country opts for lax accounting and reporting standards, capital will flow elsewhere. All enterprises in that country – … suffer the consequences. … Markets exist by the grace of investors. And it is today’s more empowered investors that will determine which companies and which markets will stand the test of time and endure the weight of greater competition. It serves us well to remember that no market has a divine right to investors’ capital”. (Arthur Levitt, the former Chairperson of the US Securities and Exchange Commission)

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Conclusion

Topics

Some case studies

Corporate Governance in Africa

The evolvement of Corporate Governance

Why Corporate Governance is so important

Defining Corporate Governance

Defining Corporate Governance

“Corporate governance is a complex multi faceted subject matter involving not only legislation and regulation but also what is usually known as best practice, which is very much a matter of corporate culture, mind-set and education”

(Phillip Baldwin CEO Hong Kong Inst of Chartered Secretaries.)

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Defining Corporate Governance

The institutional investor and activist, Hermes, observes:“Traditionally…, the concept refers to corporate decision

making and control, particularly the structure of the board and its working procedures. However, the term corporate governance is sometimes used very widely embracing a company’s relations with a wide range of stakeholders or very narrowly referring to a company’s compliance with the provisions of best practice codes.”

(Corporate Governance and Performance, 2005)

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Defining Corporate Governance

Corporate governance is the system by which companies are directed and controlled. Boards of directors are responsible for the governance of their companies. The shareholders’ role in governance is to appoint the directors and the auditors and to satisfy themselves that an appropriate governance structure is in place. The responsibilities of the board include setting the company’s strategic aims, providing the leadership to put them into effect, supervising the management of the business and reporting to shareholders on their stewardship. The board’s actions are subject to laws, regulations and the shareholders in general meeting. (UK Code on CG 1992.)

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OECD Definition

• “The procedures and processes according to which an organisation is directed and controlled. The corporate governance structure specifies the distribution of rights and responsibilities among the different participants in the organisation, such as board, managers, shareholders and other stakeholders – and lays down the rules and procedures for decision making.”

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Subjects of analysis and variables relating to corporate governance (Turnbull 1997)

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Essentially …..

• Corporate governance involves a set of relationships between a company’s management, its board, its shareholders and its stakeholders.

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Corporate Governance is a dimension of a much larger picture of the ways in which a company engages in social responsibility to

its stakeholders and to society at large. CG is part of a larger picture of a company’s CSR

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Company

LabourRights

HumanRights

Environmental Concern

Philanthrophy

Corporate Governance

EthicalBusinessPractices

Why Corporate Governance?

“At the end of the day, good governance is more about people than it is about procedures. So professional bodies need to ensure that there are enough people with the professional knowledge and skills to ensure that commonsense governance, and not governance by mass regulation, prevails.”

Phillip Baldwin CEO Hong Kong Inst of Chartered Secretaries.

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Why Corporate Governance?

The International Finance Corporation (IFC), a lending arm of the World Bank Group, is the largest source of financing for private sector projects in Emerging Markets.

IFC argues:Good corporate governance won’t just keep your

companies out of trouble. Well-governed companies often draw huge investment premiums, get access to cheaper debt, and outperform their peers.

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Why CG Matters

• The purpose of corporate governance is to facilitate effective, entrepreneurial and prudent management that can deliver the long-term success of the company. (The UK Corporate Governance Code 2010)

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Why CG Matters

There is increasing recognition that business is no longer just about financial performance. Good corporate governance has become one of the cornerstones of business excellence and underpins market confidence, integrity and efficiency, and hence promotes economic growth and financial stability (Khoza and Adam 2005).

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Why CG matters

• Good corporate governance principles focus on establishing mechanisms of ensuring that corporations are managed effectively and that those in positions of control and influence are held accountable for the assets of the firm.

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Corporate governance and investor interest

• McKinsey’s Global Investor Opinion Survey (2002) is the most widely quoted research on the link between good corporate governance and investor interest. McKinsey found that 80% of institutional investors would pay a premium for a well governed company.

• (The premium varied from approx 40% for companies in countries where corporate governance standards were dubious eg Egypt & Russia, to approx 12% for companies in countries where corporate governance standards were regarded as high eg Canada, the UK, South Africa?)

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The evolvement of Corporate Governance

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The Development of Corporate Governance Consciousness

Three developments occurred in corporate governance thinking in the 1970s:

#1: In the US, the importance of independent external directors was recognised

#2: In Europe, the European Commission promoted the establishment of two-tier boards

#3: A debate began about the duties of companies towards stakeholders and not simply shareholders.

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Developments in the 1980s and 1990s

Research which probed the concept of corporate governance was published during the 1980s, and the phrase ‘corporate governance’ emerged as the concept began to be developed.

The American Law Institute published a report in 1984, Principles of Corporate Governance.

Robert Tricker, sometimes called the father of corporate governance thinking in Britain, published a book, also in 1984, Corporate Governance: Practices, Procedures and Powers in British Companies and their Boards of Directors

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The evolvement of Corporate Governance

Developments in CG thinking and practice have been responses to company collapses, corporate corruption or the domination of companies by an individual.

UK Cadbury report followed unacceptable excesses in the Guinness and Maxwell Companies

US Sarbanes-Oxley Act was in response to the collapses of Enron & WorldCom

The failure of the Carrian Group led to the first CG code Hong Kong.

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Institutional investors began to become active

Important institutional investors, e.g. pension funds began to become very active in corporate governance issues from the early 1990s onwards.

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It really began with Cadbury

Cadbury (1992)

The Cadbury Committee was established by the London Stock Exchange, the Financial Reporting Council and the accountancy profession as a result of a number of financial scandals and the consequence lack of confidence in financial reporting in the UK.

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The Cadbury Report

The Cadbury Report has almost certainly been the most influential report on corporate governance ever written. Its most essential recommendations were probably these:

the wider use of independent non-executive directors

the introduction of an audit committee to be composed of only non-executive directors, with a majority of them independent.

the separation of the roles of CEO and chairman of the board

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Comply or Explain

It is no exaggeration to say that the British approach to corporate governance – anchored the ‘comply or explain’ principle – has had exceptional influence worldwide, especially with regard to countries in the British Commonwealth. Virtually all of the 54 countries, with a combined population of 2 billion, that have a code have adopted the British approach.

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The OECD Principles

During the 1990s, the Organisation of Economic Cooperation and Development (OCED) worked on a set of principles of corporate governance that would help Governments in their efforts to improve their corporate governance regimes.

The first set of principles were published in 1999.

The current set of principles were published in 2004.

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Corporate Governance in Africa

• Coinciding with the dawning of a new democracy and the readmission of South Africa into the world economy in 1994, The King Committee on Corporate Governance, headed by former Supreme Court judge, Mervyn King S.C., published The King Report on Corporate Governance (the “King Report 1994”).

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The King Code 1994

Apart from the financial and regulatory aspects of corporate governance the report advocated for an integrated approach to good governance in the interests of a wide range of stakeholders having regard to the fundamental principles of good financial, social, ethical and environmental practice.

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King II 2002

Backed by the IOD and the JSE, a revised corporate governance code was issued in 2002. The report promotes an ‘inclusive’ approach to corporate governance, taking into account Africa’s preference for the community over individualism and consensus over competition.

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King II 2002

• The Report 2002 identifies the seven primary characteristics of good governance as discipline, transparency, independence, accountability, responsibility, fairness and social responsibility

• King 2002 introduced into mainstream corporate governance the concept of the triple bottom line, which embraces the economic, environmental and social aspects of a company’s activities.

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King III 2010

• The King III Report is based on an “apply or explain” basis.

• This enables companies to operate for the purposes for which they were intended, without being bound to follow standards which are, by nature, inflexible.

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KEY PRINCIPLES OF THE KING III REPORT

The Report places great emphasis on:• Leadership;• Sustainability; and• Corporate Citizenship.The importance of the concepts of integrated

sustainability and social transformation is highlighted. This leads to a lasting concentration on the effects of business on society and the environment.

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EMERGING GOVERNANCE TRENDS INCORPORATED IN THE KING III REPORT

Emphasis is placed on the following:• Alternative dispute resolutionIt is suggested that alternative dispute resolution will enable business to preserve

business relationships, by speedily solving problems.• Risk based internal auditThis will enable companies to place more reliance upon internal controls, which

internal audit will verify/assure.• IT GovernanceIT governance is important as it is a major operational risk.• Shareholders and RemunerationThere is a need for the policy of the remuneration of non-executive directors of the

Board, to be authorised by shareholders, before implementation.• EvaluationThe Board of directors, the Board Committees and individual directors should be

evaluated, annually.©Susan Mutangadura

Corporate Governance in SA – The test

Perhaps the most significant debate on governance in SA in recent times has been influenced by the events leading to the removal from office of the then Deputy President of South Africa Jacob Zuma, by President Thabo Mbeki. Delivering judgment in the trial of prominent SA businessman Shaik, the judge found the deputy president to have conducted himself improperly in the corrupt events that led to a fifteen-year jail term for the accused. The onus fell squarely on President Thabo Mbeki to demonstrate whether his country’s repeated commitments to good governance were sincere or mere rhetoric.

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Codes vs Legislation?

Havard research (2009) found strong consensus among directors that:

the key to improving boards’ performance was not government action, but action by each board.

boards & companies differ. each board needs to develop structures, processes, &

practices that fit the company & its business needs. no one size fits all.

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Some case studies

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#1 Enron

• American energy company• Named by Fortune Magazine “America’s most

Innovative Company” 6 years in a row• In its review of CG in 2000, Chief Executive

Magazine named Enron one of the 5 best boards in the US

• Enron collapsed in 2001 due to lack of CG controls!

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Consequences of Enron’s collapse

Loss of jobs (20000)Loss of pensions ($2+ billion)Loss of retirement plans ($1.2billion)Arthur Anderson, Enrons accountants went

out of business with a loss of 85000 jobsLoss of investment

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The Consequences

• Jeff Skilling, Enron’s COO & later CEO was sentenced to 25years for securities fraud.

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#2 WorldCom

Before its collapse in 2002, in the largest bankruptcy in U.S. history at that time, WorldCom was:

the 2nd largest long-distance telecommunications provider in the United States.

the largest carrier of international traffic in the United States

the largest carrier of Internet traffic in the world

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What went wrong? In their treatment of the WorldCom collapse, Hamilton &

Micklethwait argue that the problem were these:‘poor strategic decisions’‘an all-consuming drive for growth’‘an incompetent and dominant CEO’‘a supine board which rubber-stamped Ebbers’ decisions’‘a complete lack of other normal checks and balances’

Mr. Sullivan had directed his subordinates to inflate revenues and hide expenses at WorldCom, once the USA’s second-largest phone carrier.

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The consequences In March 2005, Bernard J. Ebbers, WorldCom's founder

and chief executive, was found guilty of securities fraud, conspiracy and seven counts of filing false reports with regulators. In July 2005, he received a prison sentence of 25 years.

Mr. Sullivan, the former chief financial officer who acknowledged his leading role in WorldCom’s $11 billion accounting fraud was sentenced to five years in prison after the court took cognizance of his co-operation with the investigation.

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#3 Lehman Brothers

Lehman Brothers was a leading U.S. financial services firm which before its bankruptcy employed 26,000 people in 20 different countries.

When it filed for bankruptcy in September 2008, its filing represented the largest bankruptcy in American history. The bank reported debts of $768 billion but assets of only $639 billion.

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What had happened?

• Lehman Brothers encountered very substantial losses due to the subprime mortgage crisis and also due to its real estate investments.

• In the first half of 2008 alone, Lehman’s stock lost 73% of its value.

• Lehman tried to find a buyer for the bank, negotiating especially with the Korean Development Bank. When news that those talks had fallen through became public, Lehman’s stock fell 45% in a single day, on 9 September.

• More losses followed. Lehman filed for bankruptcy on 15 September 2008.

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What were the corporate governance issues?

Where was the board of directors leading up to the financial crisis?

Many analysts since Lehman’s collapse have argued that Lehman’s board of directors were unfit to serve on the board and could not really understand the contemporary financial world.

• 9 members of the 10-member board were retired

• 4 members were over 75 years of age (2 members were in their 80s)

• only 2 members of the board had direct experience of the financial services industry – and in both cases their experience was more than a quarter of a century (before the age of securitisation, credit default swaps, derivatives trading, and so on)

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The Board

Is it fair to say that these people should not have been board members of a sophisticated financial services company??

• A 2006 member of the board, just retired, was an 83 year-old actress.

• Another member of the board was a 75 year-old theatre producer.

• The risk committee, headed by an 80 year-old board member (with experience of banking some quarter of a century before) met only 2 times in 2006 and 2007 as Lehman’s risks were building up.

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Impact of the Global Financial Crisis?

• Organisation for Economic Co-operation & Development (OECD) : the real need is to improve the practice of existing principles

• Areas needing attention: Board practices Risk management Top level remuneration Shareholder rights

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Impact of the Global Financial Crisis

A Harvard paper identified 6 areas for improvement: Clarifying the boards role Acquiring better information & a deeper understanding of

the company Mantaining a sound relationship with management Providing oversight of compant strategy Assuring Management development & succession Improving risk management(Perspectives from the Boardroom 2009 – Prof J Lorsch & colleagues)

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Impact of the Global Financial Crisis

UK CG Code proposed changes:To enhance accountability to shareholdersEnsure boards are well balanced & challenging Improve a board’s performance & deepen awareness

of its strengths & weaknessesStrengthen risk managementLink performance related pay to the company’s long

term interests and risk policy

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Conclusion

Abraham Lincoln:“You can fool all of the people some of the time,

and some of the people all the time, but you cant fool all the people all the time.”

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THANK YOU…

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PRESENTATION……..

©Susan Mutangadura