Sep 8 - 14, 2008

The prime cause of poor governance in Pakistani listed companies is unbalanced boards. And the prime cause of lack of balance in Pakistani boards is absence of sufficient number of INEDs, who have:

a. the knowledge and talents to participate meaningfully in board proceedings,

b. an understanding of the individual interests of all stakeholders and are willing to work for their protection,

c. he independence and courage to differ with the management where it is necessary, and

d. the power to over-rule the representative directors where the collective interest of all stakeholders so demands.

Since companies are not keen to discuss their boards with academicians, my efforts to talk to directors of listed companies have not been successful. The only source left is to go through the published annual reports. As behooves companies with minimum regard for corporate governance, only a tiny percentage of annual reports give any information in excess of statutory minimum. A not-so-cursory look at the published list of directors of most listed companies in Pakistan reveals that the following trends are prevalent:

a. Majority of the directors are family members or close associates of controlling shareholders.

b. Directors who are technically designated as independent non-executive directors are seldom independent. In almost all cases they are representative directors, protecting the interest of a particular stakeholder. Usually only two classes of stakeholders are represented on the board: the controlling shareholders and major lenders.

c. No attention is paid to having a pool of talents at the board. The general preference is to have well paid managers (who are subservient to the controlling stakeholder) over having competent and qualified INEDs.

d. No attempt is made to ensure that the board comes in touch with other stakeholders and learn about their preferences and interests.


One very apparent reason for absence of INEDs on Pakistani boards is of course the attitude of the controlling stakeholders. However, this is not the only reason. There is a genuine dearth of well qualified and competent persons who are willing to act as INEDs. The reasons are:

a. Non-executive directors are paid only meeting fees. Generally no salaries or perks are paid to company directors in Pakistan . Directors' fees typically range between Rs 500 to Rs 5,000 ($7 to $70) per meeting and most companies have no more than the prescribed minimum number of meetings per annum, i.e. four. This is hardly an incentive for any professional to join a board, or to pay any real attention to what transpires at board meetings.

b. The law does not protect INEDs. The Companies Act treats all directors equally responsible, regardless of their role. If the executive directors choose to bring only selected information before the board on the basis of which a decision is made, all directors are held liable for its consequences. There have been a significant number of cases where SECP has ruthlessly handled INEDs in the name of bringing discipline to board proceedings. Given the paltry meeting fees and heavy potential for penalties, professionals are understandably reluctant to join company boards.

c. Professional people do not like being ineffective, or not listened to. If there is only one INED (the minimum number recommended by the Code of Corporate Governance issued by SECP) on a board, he often finds himself ignored at board meetings. His comments and views are frequently omitted from board meeting minutes because "the company does not want to give an impression to the world that its board is divided".

d. One of the reasons INEDs are effective in the West is the backing they receive from institutional investors who have a significant holding in the company. Quite often, institutional investors are instrumental in getting truly independent non-executive directors appointed. They then support them, listen to them and supply them with whatever information (or influence) they require to do their jobs well. In Pakistan , institutional investors rarely make long term investment in listed companies. Even NIT (the government sponsored mutual fund) has no formal long term strategy in this regard. This means NEDs are nominated on the board of a company only by a financial institution that has loaned heavy amounts to the company. This immediately takes away the "independence element" from the appointment, as such directors inevitably assume the posture of representative directors. Due to the special nature of NIT, it does nominate directors on the boards of quite a few companies. But these directors are often full time employees of NIT whose primary responsibility is not being a director. They are engaged in some law or finance related duties in NIT and are assigned the additional responsibility of being a director on some companies. These nominees rarely measure up to the standards required of independent directors.


There is an immediate need to promote, strengthen and support the INEDs. And by INEDs, I mean Independent NEDs not just NEDs. There are two aspects of this issue: the first is to ensure that controlling shareholders are somehow persuaded to elect sufficient number of truly INEDs on their boards - and the second is to ensure that there are sufficient incentives for suitably qualified and competent persons in the country to come forward and be assigned the onerous responsibility of being INEDs.

In developing countries, it is often believed that the only way to get good behavior from citizens, corporate or individual, is to pass a law. Unfortunate and sad as it may sound, the history bears out this observation. No amount of preaching from SECP or professional bodies like ICAP gets any response from companies yet a mere possibility of a fine does wonders. Only the force of law made companies take steps to improve the contents of their annual reports. Only after the issuance of Code of Corporate Governance (CCG), did companies start having audit committees - although they are still far from granting true independence to these committees. So I believe that the best way to prompt controlling shareholders to behave more responsibly is to legislate. The first step would be to revise the present Code of Corporate Governance along the following lines:

a. Adherence to the Code of Corporate Governance should be mandatory, not voluntary.

b. CCG should have specific guidelines on the constitution of boards. It is proposed that:

* The number of executive directors should not be more than one third of total number of board members. This means at least two-thirds of the board directors should be non-executive directors (NEDs). And no less than half of the NEDs should be independent non-executive directors INEDs).

* This means on average, no more than one-third of the directors would be EDs, no more than one-third would be RNEDs and no less than one-third would be INEDs. This should bring some balance of representation and power on the board.

* Specific criteria (qualification, experience, background, etc.) should be laid down for all directors, but in particular for INEDs. Similarly, roles of each class of directors (EDs, RNEDs and INEDs) should be defined more elaborately.

c. Specific recommendations should be made for remunerating INEDs suitably, for example:

* Average remuneration for INEDs should be around 33% of the average remuneration of executive directors.

* If INEDs perform any additional task like chairman/membership of special committees (e.g. audit committee, remuneration committee, nomination committee, CG Compliance committee, etc.) they should be suitably compensated.

* In addition, INEDs should be accorded some protection by the law. The current practice of treating all directors alike is unfair and devoid of natural justice.

d. The possibility of allowing companies to have two-tier boards should be seriously explored. The first tier, to be called Management Board, may comprise entirely of executive directors plus one or two representative directors from the controlling shareholder while the second tier to be called say Supervisory Board should have only NEDs, perhaps with the exception of CEO. Rules may be framed allowing:

* the shareholders to vote in the entire Management Board, and

* all the stakeholders (including shareholders, lenders, employees and civil society) to vote for election of directors on the Supervisory Board. Defining the electoral college for civil society may be difficult, but I am sure a solution can be found if there is sufficient will.

* the Chairman who must be non-executive and elected by shareholders, to be common on both the boards.


While the Institute of Corporate Governance, established through assistance from IFC, is yet to produce any tangible results, I wish to make another proposal that could speed up the pace of improvement in the state of corporate governance in Pakistan.

This proposal is based on the observation that only the presence of truly independent non-executive directors supported by long term investing companies can bring about a meaningful difference to the present sorry state of corporate governance in Pakistani companies. This proposal has two distinct steps.


The government should make it mandatory for all financial institutions and mutual funds having investment funds in excess of say Rs. one billion to invest no less than 20% of their total available funds on a long term basis. The test should be that at any time, at least 20% of their portfolio should represent holding in companies for an average of not less than 3 years. An incentive can also be offered to mutual funds and investment companies for holding shares for a period over three years, e.g. any dividends received from shares held by a mutual fund or investment company for over three years may be exempted from corporation tax. This will promote institutional investors' interest in listed companies. Gradually, they will start playing the role which their counterparts in the West are playing so well. With presence of knowledgeable representatives from institutional investors, the company boards will start behaving more responsibly.


NIT could play a far more active role in improving the corporate governance state of listed companies than it is currently doing. But perhaps, this is outside its present scope of responsibilities. It is proposed that the government should float a new investment company (or a mutual fund). Its equity can come from companies like NBP, NIC and State Life that are sitting on mountains of investable funds. The new investment company (IC) should have the following explicit mandate:

* It should invest primarily in listed companies on long term basis. It must hold shares in companies for considerable duration, long enough to exert a meaningful influence on the boards of such companies.

* It should hold sufficient number of shares in companies to earn a right to get at least two directors elected on the boards of such companies. Like the NIT, the new IC could be granted a right to purchase 10 to 15% of all new issues of shares.

* It should employ a team of well qualified, competent, experienced and honest professionals who would draw a decent salary from the IC but have no responsibility except to act as INEDs at the boards of companies in which the IC has a holding. In order to ensure proper performance from these INEDs, none of them may be made a director of more than six companies.

* The directors placed by the IC should be categorically informed that they are expected to act as independent, non-executive directors (INEDs) looking after the interests of all stakeholders, rather than representative directors protecting the interest of the IC alone. They should attend every meeting of their respective boards, take an active part in its deliberations, scrutinize every proposal put forward by the executive directors, take external professional help where needed, and to generally ensure that the controlling shareholder does not get away with any improper act. In addition, they may act as members (or chairmen) of the various committees constituted by their respective boards. They should write periodic reports on the performance of their "ward companies" which the IC may share with the company where necessary.

* The IC can join hands with rating companies and start a system of formal rating of "boards of directors" of its investee companies. This could be confidential but its mere presence will infuse considerable responsibility into boards.

* It is hoped that presence of these INEDs on the boards of various companies will bring about a balance of representation and power on those boards. The IC could do even more. While nominating these directors on the board of various companies, the IC should also pay attention to getting a balance of attitudes and talents on those boards. This means the IC must carefully study how the board of each of its investee companies is constituted, so that it may nominate that particular talent or attitude that is missing from a particular board.

What is really important for the country is not how much money in poured into the secondary markets (trading of already issued shares at KSE) - but how much money companies are able to get from general public for their new projects. The above proposals will go a long way in restoring the confidence of investing public in listed companies so that the bulk of public money will go to the companies - not speculators at stock exchanges.