Over the past few decades many developing countries have faced financial crises due to the lack of accountability of major corporate groups. Adopting corporate governance rules and principles proved to be a highly effective way of overcoming these crises.
In their assistance to developing countries, international financial institutions such as the World Bank, the International Monetary Fund and the Asian Development Bank insisted that corporate governance standards should be given high priority in any reform strategy. As a result, principles of corporate governance were adopted and global legitimacy was given to a set of corporate governance standards that would nonetheless vary from one country to another.
Good corporate governance rules are basically a set of principles that should enhance the long-term value of equity investment by providing a mechanism to protect the interests of the shareholders and to limit the likelihood of mismanagement. It leads to the most efficient allocation of capital by individual investors and eventually most effectively drives a nation's economy. Good corporate governance principles are intended to protect the interests of shareholders from potentially self-serving actions of management and encourage investors to invest in these countries rather than investing elsewhere. In the absence of good corporate governance investors cannot be assured that their interests are faithfully represented by an independent board of directors, and, therefore, would seek investment opportunities elsewhere.
More recently, the transformation of a business entity from sole proprietorship or simple partnership (based on pooled capital and resources of a limited number of individuals) to a public joint stock corporation (where the investment capital of many people is pooled and there is a separation of ownership from control) highlights the need for effective corporate governance. The recent scandals involving auditors, regulators and shareholders have further emphasised the important role that corporate governance plays in mitigating the risks caused by the different interests of shareholders and managers. The collapse of Enron and WorldCom, the closure of leading accounting firm Arthur Anderson and examples of accounting fraud and criminal conduct among leading corporate executives revealed fundamental defects in the functioning of corporate governance.
Consequently, the pace of corporate governance reform has quickened and initiatives for reform have touched almost every country in which shares are publicly traded.
For example, some leading companies in Japan have adopted a corporate governance scheme relying heavily on independent directors and a proactive board, in a significant departure from the prevailing pattern of management dominated governance.
On the other hand, from a financial perspective, good corporate governance is a way of structuring business. It is a way of reporting on business and generating clear financial statements, which allow an assessment of the firm's financial performance. This mechanism also lowers the costs associated with investors due diligence. In addition, independent oversight of corporate financial matters assists underwriters in an IPO or the buyer in an M&A transaction to be more comfortable with a company's financial status.
Adopting a good code of ethics or conduct is also one of the fundamental elements of good governance. The benefits of having a code in place prior to preparation for an IPO are significant as it indicates a strong ethical culture.
Independent Directors:
Good corporate governance cannot be achieved without independent directors who have no direct relationship with the corporation, its shareholders or officers, as there are concerns that institutional shareholders will be able to exercise inappropriate power over smaller stakeholders by promoting their own directors.
According to the New York Stock Exchange "independent director" means the person who has no material relationship with the listed company, either directly or as a partner, shareholder or officer of an organisation that has a relationship with the company, including such company's parent or subsidiary. The board of directors must examine a director's independence, and accordingly disclose the identity of independent directors and the basis of their decision as to whether such a director is truly independent or not. The board may adopt certain standards for assessing the director's independence and should disclose these standards. A director cannot be deemed to be independent if he/she is an employee of the listed company or if he/she has an immediate family member who is an executive officer of the listed company. The term "immediate family member" includes a person's spouse, parent, children, siblings, parent-in-law, sons and daughters-in-law or siblings-in law or anyone else who might be considered as immediate family.
Moreover, any director who receives, or whose immediate family member receives, more than U.S. $100,000 in any 12 month period in direct compensation from the listed company cannot be deemed to be independent until 3 years after his receipt of such an amount.
Therefore, good corporate governance shall require clear oversight of key areas - such as conflicts of interest, management succession, risk management, internal controls, financial reporting and strategic planning. In addition to that, there has to be pre-defined roles and responsibilities for each category.
Standard principles of good corporate governance
Although the standards and measures of a good corporate governance differ around the world, it is yet understood that the most effective features of good governance include the following:
- A strong board of non-executive directors, which outline the overall objectives of the corporation and the strategies, required for achieving such objectives, the "Planning Body".
- An independent board of management, which translates the vision of the Planning Body into facts and figures, the "Executive Directors".
- External or internal expertise to oversee corporate management on behalf of the shareholders, the "Supervisory Board".
- Good corporate laws and regulations under which the rights of the shareholders are well protected.
- Independent audit body and transparent procedures.
- Transparent public reporting including both financial and non-financial reporting so as to furnish the shareholders with a true and accurate picture of the corporation's performance at any time.
Hanan Al Qennah
© Al Tamimi & Company 2005
