Corporate governance and its importance

What is corporate governance?

According to the World Bank Corporate governance is “the system by which companies are directed and controlled”. It involves the balance of powers among three key corporate constituencies: the board of directors,

which is charged with monitoring, overseeing, and guiding the company; the shareholders, who invest their funds in the company’s shares and, therefore, have the right to elect and possibly dismiss directors; and, the company’s management, whom the board hires to run the company on a day-to-day basis.

“Corporate governance is therefore about what the board of a company does and how it sets the values of the company, and is to be distinguished from the day to day operational management of the company by full-time executives,” says Financial Reporting Council of the UK.

The Organization for Economic Co-operation and Development (OECD) which has over thirty developed countries as members has also addressed the issue of Corporate Governance. OECD has official relations with other international organisations and bodies, such as the International Labour Organization (ILO), Food and Agriculture Organization (FAO), International Monetary Fund (IMF), World Bank, International Atomic Energy Agency (IAEA,) and many other United Nations bodies. OECD also co-ordinates with the International Transport Forum, an independent body linked to OECD that deals with issues of improvement of all forms of transport.

The OECD Principles of Good Governance are given below:

1. Ensuring the basis for an effective corporate governance framework: The corporate governance framework should promote transparent and efficient markets, be consistent with the rule of law and clearly articulate the division of responsibilities among different supervisory, regulatory and enforcement authorities.

2. The rights of shareholders and key ownership functions: The corporate governance framework should protect and facilitate the exercise of shareholders’ rights.

3. The equitable treatment of shareholders: The corporate governance framework should ensure the equitable treatment of all shareholders, including minority and foreign shareholders. All shareholders should have the opportunity to obtain effective redress for violation of their rights.

4. The role of stakeholders in corporate governance: The corporate governance framework should ensure the equitable treatment of all shareholders, including minority and foreign shareholders. All shareholders should have the opportunity to obtain effective redress for violation of their rights.

5. Disclosure and transparency: The corporate governance framework should ensure that timely and accurate disclosure is made on all material matters regarding the corporation, including the financial situation, performance, ownership, and governance of the company.

6. The responsibilities of the board: The corporate governance framework should ensure the strategic guidance of the company, the effective monitoring of management by the board, and the board’s accountability to the company and the shareholders.

Corporate governance in Sri Lanka

In Sri Lanka too, a code has been developed by the Institute of Chartered Accountants of Sri Lanka with the Securities Exchange Commission in 1997 and updated in 2003.

The key aspects of the Sri Lankan Code include:

na single board is collectively responsible for the success of the company

nchecks and balances:

    na separate chief executive and chairman

    na balance of executive and independent non-executive directors

    nstrong, independent audit and remuneration committees

    nannual evaluation by the board of its performance

nemphasis of objectivity of directors in the interest of the company

ntransparency on appointment and remuneration

neffective rights of shareholders

Clarifying these areas there is emphasis on the separation of role of governance from the role of management where governance should not interfere with the management but provide only direction, policy, guidance, and values. It is the job of the Executive Director to perform the management function of the organisation. In companies where the Governance and management has merged their duties at least to a certain extent the governance has been found fault with taking decisions individually and forcing them on the management; e.g. Golden Key, and the Ceylinco Group.

In some situations the shareholders are ignored and the organisation is run by a small number of directors or one person; e.g. a chairman of a company was not allowed to step into his own company by one powerful director.

To minimise conflict of interest having an independent audit committee and an independent remuneration committees are promoted by the code. Transparency, recruitment etc. are also handled independently by committees. These are some salient features of the Sri Lankan code of Corporate Governance.

Even with all these issues arising, I know of a certain NGO and a certain professional association which were transparent enough to allow a third party to regularly monitor the financial activities of their organisations. Thus the board received a set of accounts from the finance division as well as a financial/audit report from the independent financial organisation. This minimised the risk of an internal fraud for which the directors are accountable for in the eyes of the law.

By law, boards have the ultimate responsibility for the company’s affairs (see companies act of 1997) hiring and giving direction to management and representing shareholders’/members’ interests. Thus, the board sits at the centre of the company’s governance structure.

In certain NGOs and associations such as professional institutes, the executive committee or a national council which takes policy decisions replace the board of directors and the secretary general or the executive director replace the managing director or the CEO of a company.

It is unfortunate that most Sri Lankan professional organisations do not practice good governance. These can be categorised in to several groups:

1.They have a code but do not practice it on members nor on the organisation

2.A code is available and enforced only on members and not on the association

3.A code is available but is not practiced

4.They do not use any code of governance at all.

Unfortunately this happens when the president or the chairman is weak and cannot delegate authority. These organisations have slow growth as the span of management of each president will depend on his or her capability.

When a person with little experience in people management becomes a president or a chair, he/she will appoint his/her friends or relatives to senior positions, who will not challenge the chair and will overrule the decisions of the CEO. Thus they break another rule of good governance of getting involved with the management of the company.

A well known case in Sri Lanka is where a CEO of a professional association had to communicate with the parent organisation which funded the association. Keeping good governance as a foundation the president was removed from the position, and the CEO was in charge of managing the association during its most difficult period without a president.

According to my knowledge except for this organisation no other professional body, association, nor institute practices good governance in Sri Lanka. These institutes are either used to glorify the president or the chairman, who will also take their friends on joyrides abroad and use the association as a job bank for their friends, and also take decisions which they cannot take in their respective companies and have a gala time at the cost of the association or the institute.

Being with Sri Lanka Institute of Marketing some time ago I know that they had a code for members which was initiated by my Past President Taslim Rahaman nearly 20 years ago and corporate governance was a main area covered in this futuristic document. They are also a signatory to ‘Global Compact,’ a UN-based organisation which promotes good corporate governance.

In the corporate world, except for several multinational organisations based in Sri Lanka I have not come across any other corporate entity which promotes good corporate governance within their organisation.

 What are corporate governance disputes?

Corporate governance disputes involve corporate authority and its exercise. Such disputes frequently involve the corporation’s shareholders, board directors, and senior executives. These disputes constitute a category of their own, one that differs from labour, commercial, consumer, or other disputes involving the corporation.

Although they are less common for well-governed companies, most companies will experience a corporate governance dispute.

Companies, their boards, investors, and other key stakeholders need to care about corporate governance disputes because once they arise, they can harm the company. Left unchecked, corporate governance disputes can have a highly negative impact on the company’s reputation, operations, and performance and thereby lead to a loss in shareholder value and market standing.

Although the court is the traditional way of resolving disputes in many jurisdictions, the impact of litigation for corporate governance disputes can be highly counter-productive. The proceedings can inflame the dispute, increase its cost, damage the company’s reputation, and delay the resolution of strategic issues. Moreover, corporate governance disputes often lack the legal basis to be tried in court, or are premised more on personal issues and/or business judgment than on legal principles.

A family dispute in corporate governance

Dhirubhai Hirachand Ambani founded Reliance Industries and the business expanded into petrochemicals, textiles, crude oil and gas production, and polyester and polymer products. Reliance Industries became one of India’s most powerful non-state holding companies.

When Dhirubhai died in July 2002, the Ambani family was in control of 46.76 per cent of the company. Dhirubhai’s two sons — Mukesh Ambani, who earned an M.B.A. from Stanford University, and Anil Ambani, a graduate of the Wharton School — formally took the group’s reins after their father’s death.

Rivalry for control between the two quickly emerged, resulting in an intense family feud and the feud was brought to a head when Reliance’s directors approved a proposal to give Mukesh Ambani power to overrule Anil Ambani’s decisions. Mukesh Ambani is said to be unhappy over Anil’s recent plunge into politics and his nomination as a Member of Parliament.

On 25 November, six of 14 Directors of Reliance Energy quit without giving a reason. Reliance Energy’s shares fell six per cent, their biggest drop in six months.

In June 2005, the Ambani brothers agreed to split the $ 20-billion business and, thereby, end their ownership feud. Mukesh retained control of refining, oil, gas exploration, and chemicals, while Anil took cell phones, power, and financial services. The news caused shares in Reliance to hit record levels.

The calm was broken in February 2006, when Anil disputed the terms of a gas supply agreement with Mukesh, accusing Mukesh and his group of acting in an “arbitrary, non-transparent and unfair manner”. The dispute headed to the courts in India.

In January 2009, the Bombay High Court temporarily lifted a ban on the sale of natural gas, allowing Mukesh to tap the gas reserves.

Types of disputes affecting corporate governance

nDisagreements between the company’s shareholders and the company or its board.

nDisputes between the board and the CEO and/or senior management.

nDisputes among board directors.

nDisputes between the board and employees’ representatives

nDisputes between the board and communities and/or social activists.

Other corporate disputes

nCommercial disputes

nFinancial disputes

nSecurities disputes

nLabor disputes

nRegulatory disputes

These disputes can lead to long term shareholder value or the value addition an association can provide its members and also the funds an NGO can attract in the future. Therefore, organisations that minimise governance disputes through good corporate governance practices will stand a better chance in a highly competitive environment which has all the signs of becoming even more competitive in the future.

Other corporate disputes are not fundamental to the long term or even medium and sometimes short term success of the organisation. A board can even change the chairman or the president of an association or even go to extreme case of shareholders changing the whole board which has been happening in various professional associations.

Way forward

Using the principles which are established for local organisations which are also in line with the Companies Act No. 07 of 2007 is the way forward. Unfortunately there are only a limited number of people who are conversant with corporate governance in Sri Lanka. If the Government can subsidise this cost by having a pool of corporate specialists paid for by the Government and these specialists will be required to help organisations at a reduced and affordable cost.

Usually the better equipped corporate governance organisations have a wealth of through well accepted lawyers, accountants, marketers, and HR professional. This goes well beyond the traditional audit firms and will be an investment well worth.

Bibliography

nGlobal Governance Corporate Forum – International Finance Corporation of World Bank Group

nCompanies Act, No. 07 of 2007

nCode of Good Practices in Governance in Corporate Governance published jointly by The Securities and Exchange Commission of Sri Lanka and The Institute of Chartered Accountants of Sri Lanka – July 2008

nThe UK Corporate Governance Code published by Financial Reporting Council June 2010

nCompanies Act No. 07 of 2007 – Parliament of the Democratic Socialist Republic of Sri Lanka

nThe OECD Principles of Corporate Governance August 2004

(The writer, Chartered Marketer, MCIM, MSLIM, HMIMM (SA), FASMI (Aus), is a Marketing and Corporate Consultant. He is President Elect of the Rotary Club of Colombo Millennium City, Board Member – International Chamber of Commerce Sri Lanka Chapter, a former Executive Director of the Sri Lanka Institute of Marketing, Centre Member – Organization of Professional Associations and the first representative of the Effie Awards in Sri Lanka.)