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Good Corporate Governance

  1. GATT: The new system of valuation
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Prof. Dr. Khawaja Amjad Saeed, FCA, FCMA*
Sep 06, 1999

The decade of 1990s has been on interesting one. Several management thoughts were the major contributions. From an emphasis on Strategic Planning to Strategic Management and finally to Strategic Intent, all these aspects received great attention. Corporate Sector kept debating operational aspects of the above aspects and many operationalized these in reality to their great advantage. Innovation and creativity were in full swing and healthy Corporate Sector practices were witnessed.

However, the World Bank provided a dynamic leadership in asking recipient of financial assistance to ensure Good Governance. Economist, London, in June 1999, published an interesting feature in this respect. Led by these motivations, the concept of Good Corporate Governance has been gaining popularity. Accordingly lot of home work was undertaken in UK, France, Japan, Hong Kong, South Africa, USA, Malaysia and Australia. Now every country is struggling to evolve an excellent Good Corporate Governance model to ensure discipline in Corporate Sector.

Corporate sector

Corporate Sector, in South Asia, is fairly large. Its size in all SAARC Countries, is a big one. However, generally speaking, the following symptoms are conspicuous by their presence:

1) Sick Units continue to dominate the corporate sector. Listed Companies are also included in this sector.

2) Large number of companies continue to show losses. Their contribution to Government exchequer in Income Tax is neglible. Shareholders yearn to receive dividend but it represents no better than their dream. Based on the Report of the State Bank of Pakistan, Central Bank of the Country, for 1997-98, only 145 Companies paid dividend out of 770 listed companies on the Karachi Stock Exchange.

3) The statutory audit by an external auditor needs to be restructured to identify tricks applied by clever management to show losses.

4) The quality of members of the Board of Directors needs to be upgraded for dynamic and effective management.

5) Productivity consciousness, avoidance of wastage with focus on three Ms namely Men, Material and Machine are the subjects to be carefully addressed by management.

6) The practice of Non-Executive Directors to be associated by legally constituted Board of Directors needs to be operationalized in our region.

7) Management Audits need to be institutionalized and logistically well cushioned for producing productive results.

Concept of corporate governance

Several definitions exist in the World for Corporate Governance. However, OECD has defined the concept of Corporate Governance as under:

"Corporate Governance comprehends that structure of relationship and corresponding responsibilities among a core group consisting of:

 

(Shareholders

(Board members, and

(Corporate Managers

designed to best foster the competitive performance required to achieve the corporation's primary objective."

Global practices

Lot of space and research is needed to comprehensively explain global practices in the area of Good Corporate Governance. This piece explains excellent Corporate Governance practices of some selected countries.

Asia

We have selected two countries from Asia to share good corporate governance systems. These include Hong Kong and Malaysia.

Hong kong

Hong Kong remained under administrative control of UK for a long time. Consequently, the events in UK have been having healthy impact on Hong Kong. Lead in Good Corporate Governance was provided by the Hong Kong Society of Accountants. Two Working Groups Reports are available. Their major initiatives to operationalize good corporate governance are contained in these reports. The two reports of the two Working Groups are named as under:

1) Report of the Working Group on Corporate Governance: Published in December 1995 and reprinted in February, 1996.

2) Second Report of the Working Group on the Corporate Governance: Published in January, 1997.

Salient features of the Code for effective Corporate Governance are summarized below:

1) Compliance matters should be identified.

2) Same family must not have more than 50% members of Board of Directors.

3) There should be a Chief Financial Officer through a mandatory provision.

4) Attendance record of Board at Annual General Meeting should be maintained.

5) Four board meetings must be held every year. However, six meetings are preferred.

6) Other fees paid to auditors should be separately disclosed.

7) There should be separate disclosure regarding Corporate Governance in the annual report of the company.

8) An Audit Committee, with defined functions, should be established.

9) Interim reports containing balance sheet, income statement and cash flow should be released.

10) The above interim reports should be reviewed by auditors.

Malaysia

Magnificent work was undertaken to develop Code of Ethics for Directors and Secretary of the Company. These codes have been published by Registry of Companies, Malaysia.

It is high time that the South Asian Countries should benefit from the experiences of the above two countries.

Europe

One country has been selected from Europe namely, United Kingdom. The framework developed need to be carefully studied and intelligently adapted to suit to the needs of South Asian Countries. Some of the useful and highly instructive thoughts are shared here.

Two Committees were set up in U.K. The first one was titled Cadbury Committee in 1991. The second one was set up in 1995 and was known as Hampel Committee. This Committee submitted its report in January, 1998.

Cadbury committee report

The above report focussed on four major areas namely, Board of Directors, Non-Executive Directors, Executive Directors and Reporting and Controls. Salient features of recommendations included the following:

I. Board of Directors

(1) Meeting of Board of Directors should be regularly held.

(2) It must retain full and effective control over the company.

(3) It must monitor the executive development.

(4) No one individual be given unfettered power. A balance be maintained between power and authority.

(5) Non-executive direction having sufficient caliber and number be included in the board of directors.

(6) Direction and control of the company should be firmly in their hand.

(7) Independent professional advice at company's expense be obtained for furtherance of their duties.

(8) For getting benefits from the Secretary of the Board and enabling him to stay independent, the following guidelines be followed:

(a) Access to advice and services.

(b) Procedures are followed and rules and regulations are complied with.

(c) Board as a whole should examine the question of removal of the secretary.

 

II. Non-Executive Directors:

(1) The role of non-executives directors may extend to the following:

(a) Contribute towards independent judgment.

(b) Areas of contributions may include:

i) Strategy performance

ii) Key appointments

iii) Standards of conduct

(2) For ensuring fairness and independence, the following guidelines be followed:

(a) Be independent of management

(b) Fees should reflect the time which they commit to the company.

(c) They should be appointed for specified terms and re-appointment should not be automatic.

(d) They should be selected through a formal process.

Board as a whole should make this decision.

III. Executive Directors

(1) The contract of service should not exceed three years without the shareholders approval.

(2) There should be transparent disclosure of directors and chairman's total emolument, separately together with the highest paid UK directors. Pension contributions and stock operations be separately highlighted.

Salary and performance related elements be separately stated including the basis on which performance is measured.

(3) A remuneration committee should be set up to recommend the pay of executive director. This committee should be made up wholly or mainly of non-executive directors.

IV. Reporting and controls

(1) Board must accept it a duty to present a balanced and understandable assessment of the company's position.

(2) An objective and professional should be maintained between Board and the internal and external auditors.

(3) The Board should set up an audit committee of at least three non-executive directors. Terms of reference must be in writing and should clearly deal with its authority and duties.

(4) The directors should report on the effectiveness of the company's system of internal control. They should also report that the business is a going concern. Supporting assumptions or necessary qualifications should also be included.

The Corporate Governance issue is now under review in UK. Sir Ronald Hampel, ICI Chairman, has been appointed to submit a report by the end of 1997.

 

Hampel committee report on corporate governance

This report was released in January, 1998. The work was undertaken by this Committee during two years (1995-97). Summary of conclusions and recommendations cover the following aspects:

1) Principles of Corporate Governance

2) Application of the Principles

3) The Future

4) Directors

5) Directors' Remuneration

6) Shareholders and the AGM

 

Their recommendations are given on Annex "A".

 

AFRICA

South Africa has provided an excellent leadership in good corporate governance. A magnificent treatise in the shape of King's Report is available for study, comprehension and implementation. A chart tabulating the salient features of King's Report is given as Annex "B".

Conclusion

Today is an appropriate time for all of us in South Asian Countries to carefully examine the glorious work already undertaken in the world and learn from the innovative literature already produced. In particular, the study of the literature cited in selected Bibliography is highly recommended.

We, in South Asia, should set up a task force of most Eminent Scholars to evolve a framework for Good Corporate Governance and help the Corporate Sector, shareholders, auditors, regulatory bodies, Government, managements and all those whose stakes are pegged to achieving great heights of good corporate governance. Let us commit ourselves with dedication and zeal and achieve our goals. Indeed South Asia is poised for a forward thrust in the 21st Century. Let Good Corporate Governance be the first step.

 

SELECTED BIBLIOGRAPHY

A: ARTICLES

1) Proceedings, Silver Jubilee National Convention and Third International Conference of Company Secretaries - Corporate Governance: Global Perspectives

INDIA: Hyderabad, The Institute of Company Secretaries of India, August, 1997, pp 226.

2) The Pakistan Accountant containing Proceedings of the 5th Pakistan Chartered Accountants Conference with the theme of Corporate Governance - Myths and Realities

PAKISTAN: Institute of Chartered Accountants of Pakistan, Karachi Special Issue, November/December, 1998, pp 228.

3) Saeed, Khawaja Amjad, Corporate Governance : An Essential Element

PAKISTAN: "The News International" (of Lahore), May 05, 1997.

4) Saeed, Khawaja Amjad, Towards Corporate Governance in Pakistan

PAKISTAN: The Institute of Cost and Management Accountants of Pakistan Official Journal "Management Accountant" May - June, 1997, P 1-2.

B: Books

1) Dadiseth, K.B., Corporate Governance

INDIA: Mumbai, Forum of Free Enterprise, November, 1997, pp16.

2) Ghosh, Dr. T. P., Corporate Governance and Management Audit

INDIA: Calcutta, The Institute of Cost and Works Accountants of India, July 1998, pp159.

3) Monks, Robert A.G., Minow, Nell, Corporate Governance

CAMBRIDGE (MASSACHUSETTS - USA), Blackwell Publisher, 1995, pp 550.

C: Code of Ethics

1) The Company Directors Code of Ethics

MALAYSIA: Pejabat Pendaftar Syarikat (Registry of Companies), n. d. (Procured on visit to Kuala Lumpur in October, 1996)

2) Company Secretary's Code of Ethics

MALAYSIA: Pejabat Pendaftar Syarikat (Registry of Companies), n. d. (Procured on visit to Kuala Lumpur in October, 1996)

D: Reports of Accredited Committees

1) Corporate Governance: A Review of Disclosure Practices in Canada

TORONTO (ONTARIO - CANADA): The Canadian Institute of Chartered Accountants 1996 Annual Reports Award, pp 59.

2) The 21st Century Annual Report, Corporate Governance

LONDON: The Institute of Chartered Accountants in England & Wales, n.d. pp 32.

3) Report of the Working Group on Corporate Governance

HONG KONG: Hong Kong Society of Accountants, December, 1995 (Reprinted February 1996), pp 36.

4) Second Report of the Corporate Governance Working Group

HONG KONG: Hong Kong Society of Accountants, January, 1997, pp 1-20

5) The King's Report on Corporate Governance

JOHANNESBURG: The Institute of Directors in Southern Africa, November 29, 1994, pp 70.

6) Report of the Committee to make Recommendations on matters relating to Financial Aspects of Corporate Governance

COLOMBO: The Institute of Chartered Accountants of Sri Lanka, pp 43.

7) Cadbury Report on The Financial Aspects of Corporate Governance

LONDON: Gee Publishing Ltd., December 01, 1992, pp 91.

8) Hampel Final Report: Committee on Corporate Governance

LONDON: Gee Publishing Ltd., January, 1998, pp 66.

Annex "A"

SUMMARY OF CONCLUSIONS AND RECOMMENDATIONS

Principles of Corporate Governance

1. We recommend that companies should include in their annual reports a narrative account of how they apply the broad principles set out in Chapter 2 (2.1).

Application of the Principles

 

2. Companies should be ready to explain their governance policies, including any circumstances justifying departure from best practice; and those concerned with the evaluation of governance should apply the principles in Chapter 2 flexibly, with common sense, and with due regard to companies' individual circumstances (1.11). 'Box ticking' is neither fair to companies nor likely to be efficient in preventing abuse (1.12-1.14).

The Future

 

3. We intend to produce a set of principles and code of good corporate governance practice, which will embrace Cadbury and Greenbury and our own work. We shall pass this to the London Stock Exchange. We suggest that the London Stock Exchange should consult on this document, together with any proposed changes in the Listing Rules (1.23).

 

4. We envisage that the London Stock Exchange will in future make minor changes to the principles and code; and we suggest that the Financial Reporting Council should keep under review the possible need for further studies of corporate governance. But we see no need for a permanent Committee on Corporate Governance (1.25-1.26).

Directors

 

5. Executive and non-executive directors should continue to have the same duties under the law (3.3).

6. Management has an obligation to provide the board with appropriate and timely information and the chairman has a particular responsibility to ensure that all directors are properly briefed. This is essential if the board is to be effective (3.4).

7. An individual should receive appropriate training on the first occasion that he or she is appointed to the board of a listed company, and subsequently as necessary (3.5).

8. Boards should appoint as executive directors only those executives whom they judge able to take a broad view of the company's overall interests (3.6).

9. The majority of non-executive directors should be independent, and boards should disclose in the annual report which of the non-executive directors are considered to be independent (3.9). This applies for companies of all sizes (3.10).

10. There is overwhelming support in the UK for the unitary board, and virtually none for the two tier board (3.12).

11. We suggest that boards should consider introducing procedures for assessing their own collective performance and that of individual directors(3.13).

12. We consider that, to be effective, non-executive directors need to make up at least one third of the membership of the board (3.14).

13. We believe that people from a wide range of backgrounds are able to make a real contribution as non-executive directors (3.15).

14. Separation of the roles of chairman and chief executive officer is to be referred, other things being equal, and companies should justify a decision to combine the roles (3.17).

15. Whether or not the roles of chairman and chief executive officer are combined, a senior non-executive director should be identified in the annual report, to whom concerns can be conveyed (3.18).

16. Companies should set up a nomination committee to make recommendations to the board on all new board appointments (3.19).

17. All directors should submit themselves for re-election at least every three years, and companies should make any necessary changes in their Articles of Association as soon as possible (3.21).

18. Names of directors submitted for re-election should be accompanied by biographical details (3.21).

19. There should be no fixed rules for the length of service or age of non-executive directors: but there is a risk of their becoming less efficient and objective with length of service and advancing age, and boards should be vigilant against this (3.22).

20. It may be appropriate and helpful for a director who resigns before the expiry of his term to give an explanation (3.23).

Director's Remuneration

21. We urge caution in the use of inter-company comparisons and remuneration surveys in setting levels of directors' remuneration (4.4).

22. We do not recommend further refinement in the Greenbury code provisions relating to performance related pay. Instead we urge remuneration committees to use their judgement in devising schemes appropriate for the specific circumstances of the company. Total rewards from such schemes should not be excessive (4.7).

23. We see no objection to paying a non-executive director's remuneration in the company's shares, but do not recommend this as universal practice (4.8).

24. We consider that boards should set as their objective the reduction of directors' contract periods to one year or less, but recognize that this cannot be achieved immediately (4.9).

25. We see some advantage in dealing with a director's early departure by agreeing in advance on the payments to which he or she would be entitled in such circumstances (4.10).

26. Boards should establish a remuneration committee, made up of independent non-executive directors, to develop policy on remuneration and devise remuneration packages for individual executive directors (4.11).

27. Decisions on the remuneration packages of executive directors should be delegated to the remuneration committee; the broad framework and cost of executive remuneration should be a matter for the board on the advice of the remuneration committee (4.12). The board should itself devise remuneration packages for non-executive directors (3.14).

28. The requirement on directors to include in the annual report a general statement on remuneration policy should be retained. We hope that these statements will be made more informative (4.15).

29. Disclosure of individual remuneration packages should be retained; but we consider that this has become too complicated. We welcome recent simplification of the Companies Act rules; and we hope that the authorities concerned will explore the scope for further simplification (4.16).

30. We consider that the requirement to disclose details of individual remuneration should continue to apply to overseas based directors of UK companies (4.17).

31. We support the requirement to disclose the pension implications of pay increases which has been included in the Stock Exchange Listing Rules. We suggest that companies should make clear that transfer values cannot meaningfully be aggregated with annual remuneration (4.19).

32. We agree that shareholder approval should be sought for new long-term incentive plans (4.20); but we do not favour obliging companies to seek shareholder approval for the remuneration report (4.21).

Shareholders and the AGM

33. We recommend pension fund trustees to encourage fund managers to take a long view in managing their investments (5.6).

34. We believe that institutional investors have a responsibility to their clients to make considered use of their votes; and we strongly recommend institutional investors of all kinds, wherever practicable, to vote the shares under their control. But we do not recommend that voting should be compulsory (5.7).

35. We suggest that the ABI and the NAPF should examine the problem caused by the existence of different and incompatible shareholder voting guidelines (5.8).

36. We recommend that institutions should make available to clients, on request, information on the proportion of resolutions on which votes were cast and non-discretionary proxies lodged (5.9).

37. We encourage companies and institutional shareholders to adopt as widely as possible the recommendations in the report Developing a Winning Partnership (5.11).

38. Companies whose AGMs are well attended should consider providing a business presentation at the AGM, with a question and answer session (5.14(a)).

39. We recommend that companies should count all proxy votes and announce the proxy count on each resolution after it has been dealt with on a show of hands (5.14(b)).

40. We hope that the DTI will soon be able to implement their proposals on the law relating to shareholder resolutions, proxies and corporate representatives (5.16).

41. We consider that shareholders should be able to vote separately on each substantially separate issue; and that the practice of 'bundling' unrelated proposals in a single resolution should cease (5.17).

42. The chairman should, if appropriate, provide the questioner with a written answer to a significant question which cannot be answered on the spot (5.18).

43. The decision on who should answer questions at the AGM is one for the chairman; but we consider it good practice for the chairmen of the audit, remuneration and nomination committees to be available (5.19).

44. Companies should propose a resolution at the AGM relating to the report and accounts (5.20).

45. Notice of the AGM and related papers should be sent to shareholders at least 20 working days before the meeting (5.21).

46. Companies may wish to prepare a resume of discussion at the AGM and make this available to shareholders on request (5.22).

47. We commend the practice of some companies in establishing in-house nominees, in order to restore rights to private investors who use nominees; and we note that the DTI and the Treasury are considering changes in the law for the same purpose (5.25).

48. Each company should establish an audit committee of at least three non-executive directors, at least two of them independent (6.3). We do not favour a general relaxation for smaller companies, but recommend shareholders to show flexibility in considering cases of difficulty on their merits (6.4).

49. We do not recommend any additional requirements on auditors to report on governance issues, nor the removal of any existing prescribed requirements (6.7).

50. We suggest that the bodies concerned should consider reduction from 10% the limit on the proportion of total income which an audit firm may earn from one audit client (6.8).

51. We suggest that the audit committee should keep under review the overall financial relationship between the company and its auditors, to ensure a balance between the maintenance of objectivity and value for money (6.9).

52. We recommend that the word "effectiveness" should be dropped from point 4.5 in the Cadbury code, which would then read 'The directors should report on the company's system of internal control'. We also recommend that the auditors should report on internal control privately to the directors, which allows for an effective dialogue to take place and for best practice to evolve (6.12).

53. Directors should maintain and review controls relating to all relevant control objectives, and not merely financial controls (6.13).

54. Companies which do not already have a separate internal audit function should from time to time review the need for one (6.14).

55. The requirement on directors to include a 'going concern' statement in the annual report should be retained (6.18).

56. Auditors are inhibited from going beyond their present functions by concerns about the law on liability. Accounts should be taken of these concerns by those responsible for professional standards and in taking decisions on changes in the law (6.19).

Source: Extracted from: Agenda for Change by Syed Masoud Ali Naqvi, "The Pakistan Accountant", November 1998, Appendix, pp 105-108

Annex "B"

SUMMARY OF COMMON RECOMMENDATIONS OF KING COMMITTEE

1. The code shall apply to all the affected corporations.

2. The recommendations should become a listing requirement for companies on the main board of the Johannesburg Stock Exchange.

The affected corporations should include in their annual reports a statement by the directors or officers as the case may be, that the company or entity supports and has applied the principles of "The Code of Corporate Practices and Conduct". Any departures from the Code should be disclosed and the reasons therefor stated.

3. A non-executive director should be independent in the sense that they are independent of management and do not have any benefits from the company other than their fee. This is not intended to exclude persons being appointed as non-executive directors who have a contractual nexus with the company for reward or to prevent as non-executive directors from acquiring shares in the company by means independent from the company.

A non-executive director who is independent in the above sense, would comprise:

( A director or manager of the company's holding company, or major investor, who has no executive responsibilities in the company,

( A former executive director who is no longer employed on a full time basis but nevertheless is capable of giving valuable input to the board arising from his past experience.

( A senior executive director of major listed subsidiaries and associates of the holding company, who has no executive responsibility in the holding company.

4. The term served by a non-executive director should be determined by the board and it should be the duty of the chair to ensure that any non-executive director who in not contributing to the decisions of the board, should not be re-elected and if necessary, should be requested to resign and if he refuses, to remove him from the board.

5. To carry out its functions the board must meet regularly. How regularly or at what intervals must be determined by each board, having regard to its company's own special circumstances. A board should however, meet at least once a quarter.

6. Each appointment on board, should be a matter for the board as a whole and as such nomination committees are not recommended.

7. Whilst recognizing the shortage of trained and experienced people to be appointed directors in South Africa and even if the chair is an independent non-executive director, no board should have less than two non-executive directors of sufficient calibre that their views should carry significant weight in board decisions.

8. The board must retain full and effective control over the company.

The board should have a definition of materiality on matters.

A technical or executive sub-committee of the board may have to be appointed to investigate the matters of technical nature.

9. The affected corporations should employ a competent and qualified company secretary or contract with a professional organization to render company secretarial services. The board should be entitled at the affected corporation's expense to seek independent professional advice about the affairs of such corporation.

10. An executive director's service contract should not exceed five years in duration and if a longer period is required it should be subject to the approval of the shareholders.

11. There should be a separate full and clear disclosure of the total of executive directors and non-executive directors earnings broken down into headings such as, fees, salary, share options, benefits, bonuses, etc. Director's remuneration, including that of the non-executive directors, should be the subject of recommendations to the board by a Remuneration Committee with the majority of its members (including the chair) being non-executive directors.

The affected corporation should have remuneration committees.

12. The directors should make a statement that the financial statements are their responsibility; and the auditor is responsible for reporting on the financial statements.

13. The directors should make a statement that the financial statements fairly present the state of affairs of the company.

14. The directors should make a statement that an effective system of internal control is being maintained.

15. The directors should state that there is no reason to believe that the business will not be a going concern in the year ahead and if there is reason so to believe, it must be disclosed and explained.

16. The board should establish an Audit Committee with the majority of its members (including the chair) being non-executive directors with written terms of reference confirmed by the board. The head of internal audit, the external auditors or audit partner and the financial director should be invited to attend audit committee meetings.

17. The Companies Act should be amended to require that interim reports should be subject to audit review.

Source: Summary of Conclusions and Recommendations, The Hampel Committee Report on Corporate Governance, London: Gee and Co. January 1998.

* Former President, AMDISA.

Former Pro Vice-Chancellor and Founder Director, Institute of Business Administration, University of the Punjab, Lahore. Pakistan.

President, Institute of Cost and Management Accountants of Pakistan (Member - AMDISA).