Sep 1 - 7, 2008

Karachi Stock Exchange (KSE) outperformed all exchanges in developing countries over the past five years yet the total number of companies listed at KSE has actually gone down from 701 at end 2002 to 654 at end 2007. This simply means more companies are getting themselves unlisted (or being removed from the list by appropriate authorities) than new companies joining the list. While the KSE index has grown from 2,701 at end 2002 to 14,075 at end 2007, indicating a remarkable annual growth rate of 31.62%, the total paid up share capital of these companies has grown only negligibly if we do not count the bonus issue shares. At the end of 2004, total market capitalization was Rs 1,723 billion and at end 2007 it stood at Rs 4,330 billion; yet the total funds raised through rights or new issues during this period were only Rs 79 billion (inclusive of share premiums). What is this a sign of? Would it be a lack of investors' confidence in companies? Why is there such a lack of public confidence in companies listed at the best performing exchange in the developing world? In one phrase: perception of poor corporate governance at these companies.

Do not be misled by the notion that corporate governance being a nascent area, general public in Pakistan would not be making any investment decisions on the basis of companies' performance in this area. Without being formally aware of the term corporate governance, whatever an investor expects from the company which he is investing his money in relates to the manner in which the corporate body governs itself. Just as a villager needs to regularly inhale oxygen without being aware of its scientific name, investors act on their perception of each company's corporate governance profile when they make their investment decisions.

Corporate Governance is attracting a lot of attention in the developed world. While there have not been any scandals of Enron or WorldCom proportions in Pakistan yet, it is not to say that companies in this country are not exposed to the ills of poor corporate governance policies. The regulators in Pakistan have already brought out a voluntary Code of Corporate Governance while an Institute of Corporate Governance has also been set up through assistance from IFC. All this will certainly lead to improving the situation in the long run, but considerably more needs to be done now.

There are three distinct objectives of writing this article.

The first is to attempt to define corporate governance. The second is to highlight what I consider to be the main cause of the rather poor state of corporate governance among Pakistani listed companies. I wish to clarify that I do not intend to cover all the problems relating to corporate governance in Pakistan that would require a much longer discourse. My focus is just on one area which I consider to be the prime cause. My third objective is to present a proposal that would help improve the situation, if not substantially solve the problem in so far as it relates to my focus area.

Having sat on the boards of four listed companies for over a decade and later having observed the performance of stock exchanges in the country as an academician for another decade, I have come to believe that the best way to define corporate governance, both as a field of study and a management phenomenon, is to take the stakeholders' perspective route. For this purpose, the first step is to classify stakeholders.

We can classify stakeholders in a listed company in two different ways.

The first is on the basis of their respective roles in the company. On this basis we can say the stakeholders are owners, lenders, employees, business associates and society at large. Owners include all sorts of shareholders like those who do or do not control the company, individuals as well as institutional investors, long term holders as well short term players, those with voting rights and those without them, etc. For the purpose of this classification, I use the term Lenders to include only those who extend financial advances to the company, rather than credit for services rendered or trade goods supplied. These may be formal financial institutions or individuals (those who buy bonds, or grant loans through asset management firms). Employees of course include executive directors, senior managers and all others who are on the pay roll of the company. Business Associates are company's suppliers and clients while the Society includes public at large as well as the government. All these stakeholders (owners, lenders, employees, business associates and society) stand to benefit or lose from a company's performance and state of affairs.

Another potent way of classifying stakeholders is on the basis of how much opportunity they have to protect their respective interests. On this basis, stakeholders either have full opportunity, a limited opportunity or relatively no opportunity to protect their interests. Now if we try to list the stakeholders, using both of the above bases of classification in one table, it would appear as follows:


Classified on basis of Role in the Company

Classified on basis of opportunity to protect individual interests

Those with Full 45 Opportunity

Those with a Partial Opportunity

Those with Virtually No opportunity


Controlling Shareholders

Institutional Investors with Board representation

Minority and individual shareholders with no board representation


Financial institutions with elaborate lending contracts

Buyers of listed bonds with trustee arrangements

Other lenders


Executive Directors

Senior Managers

Other employees on regular or contract terms

Business Associates

Suppliers who sell only on cash terms

Major Suppliers and clients with contracts

Smaller suppliers and smaller clients




Public at large

Every class of stakeholders has its own particular interests. The interest of the owners lies in sustainable growth in the net worth of the company, lenders require security of their investment and assurance of timely interest payments, employees want continued employment at attractive terms, business associates seek opportunities to further their own profits while the society looks up to the company to be a good citizen. Quite understandably, the interests of these stakeholders often clash with each other. For example, the interest of owners is often best served by depriving the other stakeholders of their rightful dues. Inadequate salaries to employees, lower prices to suppliers, higher charges to clients, tax avoidance, disregard of social obligations, all contribute to higher profits for the company. And then, there is the overall interest of the company, which I refer to as the collective interest of all the stakeholders, namely the continued profitable existence of the company.

Decisions made by a company affect all the stakeholders; yet only a few of them have influence on the company's decision-making process. Now those stakeholders (like controlling shareholders, larger institutional lenders, executive directors, etc.) who have greater influence on the company's decisions, can ensure the protection of their interests without having sufficient regard for the interests of all the other stakeholders, or of the collective interest of the company. The decision-makers in developing countries like Pakistan are not always likely to stop at mere protection of their narrow interests. They often cross the line and try to enrich themselves by actually depriving other stakeholders of their rightful dues.

There is therefore a need for a mechanism that will ensure that:

a. the individual interest of each stakeholder is served and protected,

b. the collective interest of all the stakeholders is served and protected,

c. no stakeholder is allowed to expropriate the interest of other stakeholders, and

d. no single stakeholder enjoys a monopoly over the decision making process of a company.

So, is Corporate Governance a simple extension of Agency Theory?

Not really. Agency theory covers only the agent-principal relationship. If we were to say that corporate governance is only about protection of individual interests of each stakeholder, we would be confining the discussion to the application of agency theory. But a very important aspect of corporate governance is the protection of the collective interest of all stakeholders. This takes corporate governance well beyond the simple application of agency theory.

Protection of collective interests of all stakeholders brings the focus on the company - something that is simply ignored by the agency theory as propounded by psychologists and management scientists alike. To protect and serve the collective interest of all stakeholders, decision makers of a company must extend their vision well beyond operational management of its affairs. They should venture into the very important realms of strategy development and risk management.

When I talk of the mechanism used to conduct the affairs of a corporate body, I include all laws, professional codes, industrial practices and management techniques. When I state the first objective of using these tools as protecting and serving the individual interests of each stakeholder, I refer to the appropriate application of the various agency theories that abound. And when I say that the second, equally important, objective is to protect and serve the collective interest of all stakeholders I extend the list of basic tools (laws, professional codes, industrial practices and management techniques) to include strategy development, image building and risk management.





Individual Interests


Sustainable growth in net worth

General Management
Legal frame work
Professional Codes
Industrial practices


Security / timely interest payments


Continued employment at good terms

Business Associates

Continued business at good terms


Good citizenship by the company

Collective Interest of all stakeholders

Continued profitable existence

Strategic Management Risk

Maintenance of reputation



The prime source of poor corporate governance in Pakistan , or any where else, is the board room where all strategic decisions are taken. Almost the entire thrust of codes or legislation on corporate governance is on board room practices. It is believed, and not unduly so, that good corporate governance can only emerge from responsible board rooms. Now, what happens in the board room naturally depends on the people who are there in the board room. This brings us to the board structure and composition. If a board is not balanced in terms of representation, talents, power and attitudes, its performance will not measure up to the standards of good corporate governance, i.e. it will fail to protect and serve the individual interest of each stakeholder and the collective interest of all stakeholders. The prime cause of poor state of corporate governance in Pakistan and most developing economies is the absence of balanced boards. The sad aspect of this state of affairs is that this absence of balance in board structures is more often by design than unavoidable circumstances.

Balance of representation means all the stakeholders should have adequate representation on the board. With only shareholders allowed to vote in directors, and controlling shareholders stage-managing AGMs in an orchestrated manner, most companies in Pakistan lack a balance of representation. A small percentage of listed companies may have long term creditors represented on the board, but the other stakeholders like employees (other than executive directors), business associates and public at large are seldom represented on the board. Neither the Companies Ordinance, nor the Articles of Association of most companies provide for any mechanism that would ensure representation of all stakeholders at a board. Sadly, the Code of Corporate Governance issued by Securities & Exchange Commission of Pakistan (SECP) also fails to address this serious lapse. For as long as we leave the election of directors in the hands of only one class of stakeholders, a balance of representation on the board will remain a dream - and the boards will continue to perform contrary to the spirit of good corporate governance.

Balance of talents means having a blend of all the necessary talents and technical expertise needed to lead the company. This requires the presence of managerial, legal, financial, operational, social, marketing and industry-specific technical experts on the board. The argument that companies have managers who carry these skills does not hold well. If the board does not have the talent to understand and scrutinize the proposals made by the managers, it will simply not be able to perform its basic function of control. While it is understandable (if not pardonable) that shareholders in Pakistan refuse to allow a balance of representation on the board, the alarming absence of balance of talents in most boards is truly surprising. This can only be attributed to the desire of controlling shareholders to have no opposition at the board.

Balance of power means having an adequate number of truly independent non-executive directors on a board who enjoy sufficient power to overturn the proposals put forward by executive or representative non-executive directors. Perhaps this requires a bit of explanation. An executive director is part of company's management, while a non-executive director (NED) sits only on the board and takes no part in company's day to day operations. Now an NED may be a representative non-executive director (RNED) or independent non-executive director (INED). A representative NED represents a particular stakeholder and acts only for the protection and furtherance of interests of that stakeholder, e.g. a director nominated by a lending institution on a debtor company's board. Similarly, non-executive directors nominated by majority shareholders often - and in case of Pakistan always - act only to serve the interest of that group of shareholders. An independent NED does not represent any particular stakeholder and is expected to act for the collective interest of all stakeholders. Very sadly, INEDs are totally missing from the boards of most listed companies in Pakistan . This means these boards do not have a balance of power. With each director representing only a particular interest, and virtually no one looking after the collective interest of all stakeholders, the quality of corporate governance is bound to suffer.

The balance of attitudes means having diversity at the board that ensures presence of a wide range of social, moral and managerial attitudes of directors. If all, or majority of, the directors are timid, complying sort of individuals with no courage to stand up to the chairman, the board will inevitably become a rubber stamp board. Similarly, if the majority of directors are radicals with no one to mitigate the impact of their adventurous spirit, the company can land into more trouble than it can handle. A good board requires a balanced combination of people who are motivated differently: some by profit, some by caution, some by social justice, some by excellence, some by growth, some by experimentation, etc. Another aspect of attitudes is the style of handling matters: some are bold persons who insist on being fully convinced before they vote on a proposal, some believe in just going along with the majority, some only aim to protect their jobs, some simply do not care. In an ideal attitude-balanced board, all of the directors will be bold and righteous and yet excellent team players. We must accept the fact that boards of Pakistani listed companies are far from that ideal situation. To repeat an earlier observation, for as long as we leave the election of directors in the hands of only one class of stakeholders, a balance of attitudes on the board will remain a dream - and the boards will continue to perform contrary to the spirit of good corporate governance.