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Articles/Papers Corporate Citizenship: The Issues by Dr. PK Rao New Frontiers for Corporate Governance in 2004 and Beyond by Michael Gillibrand

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New Frontiers for Corporate Governance in 2004 and Beyond

by
Michael Gillibrand
Independent Director in the UK and Ireland
Fmr. Acting Director/Special Advisor, Commonwealth Secretariat

Potential changes in 2004

2004 will be a significant year in the field of corporate governance, as it will be marked by the publication of the revised version of the OECD Principles for Corporate Governance, first issued in 1999. These OECD Principles are highly relevant not only to financial specialists and investors in stock markets in the industrial countries and emerging markets, but also to all policy makers, corporate executives, and public sector administrators in all countries. The reasons are both because corporate governance has been identified as one of the pillars of the international financial architecture, and because it has emerged as a powerful policy instrument with a wide range of applications for economic development strategy and for public service reform. Hence the whole subject of corporate governance, and the possible changes to the OECD principles, merit attention from political, official, corporate and non-governmental leaders throughout the world.

There are numerous national and international corporate governance principles and codes, starting with the Cadbury Report in Britain 1992, extending to the various guidelines of the International Corporate Governance Network (representing over $10 trillion of corporate investment funds), to the Bank of International Settlements (BIS) guidelines for banks, and to the Commonwealth Principles (first produced in 1998 and the final version published in 1999). Today many countries have their own national codes in one form or another or recognise a neighbouring country’s code as their own guide to practice (in particular Southern African countries use the King Report as their standard). In addition a number of international investment funds (such as Calpers and Hermes) have their own codes which they expect to be followed by companies in which they invest.

But among all these various guidelines the OECD Principles have become the de facto international standard for corporate governance, having been endorsed both by the OECD ministers and the Global Corporate Governance Forum (GCGF), representing the OECD and the World Bank Group. This does not necessarily mean that the OECD Principles are ‘the best’ or are entirely sufficient – in fact a number of international groups have already recommended changes – but it does mean that they represent an official international consensus among OECD members, which was itself a significant achievement in the circumstances prevailing back in 1999. Hence the OECD Principles and any changes to them have far reaching implications, as countries and companies will need to adapt and conform to them, whether the changes are marginal or major. It is reasonable to expect that pressures will increase rather than decrease on both countries and companies to implement corporate governance standards which are equivalent to the OECD Principles, to the extent that they could be applied more widely as conditions for international loans to governments for financial sector and other structural adjustment reforms, and certainly for equity investment in and bank loans to larger companies. Currently the pressure is on listed companies to ‘comply or explain’ to corporate governance principles, and this requirement is likely to be extended to not only all listed companies but other privately owned companies and organisations which want to use ‘Other People’s Money’ as equity, loans or bonds.

Recognising the significance of their principles, the OECD has initiated a programme of consultation on the revisions with non-member countries, with a major conference at their Paris headquarters in November 2003. This conference in fact builds on prior debates in all regions of the world through the OECD’s programme of regional round tables on corporate governance in East and Central Asia, East Europe and South America, of conferences in the Middle East organised by the GCGF, and of regional forums in Africa and the Caribbean jointly organised with the Commonwealth. The process of reviewing the principles will continue during 2004, hence there will be a continuing need for interested governments and countries to monitor the progress and potential impacts.

The Problem of Poor Corporate Governance

But why is there all this attention on corporate governance? Is there a real problem? Corporate governance was an obscure subject of interest almost exclusively to specialists in the financial markets for many years. It first came to some prominence with the Cadbury Report in Britain in 1992, which arose after some prominent companies collapsed suddenly and spectacularly (notably Poly Peck and the group of companies dominated by Robert Maxwell). Cadbury was rapidly followed by similar reports in Australia (the Bosch report), Canada (the Dey report), South Africa (King committee), India (Bajaj committee). Previously there had been numerous corporate governance scandals in America during the 1980’s, with investors complaining about executives abusing company assets to their personal advantage and to the detriment on shareholder value. But the basic issues of corporate governance derive from the fundamental principal-agent relationship of the joint stock company, and corporate scandals have a history as old as the joint stock company itself, with memorable examples such as Lonrho in the early 1970’s, the East India Company in the eighteenth and the nineteenth centuries, and the South Seas Company in the early eighteenth century.

But, despite the long historical roots, the problem of poor corporate governance was clearly revealed by the extent of the damage at the time of the 1997/98 East Asian and Russian financial crises, when the links between systemic corporate governance failures and the financial crises became widely known. In response, the OECD members and emerging market countries focused on corporate governance as a policy priority. This period of high profile was followed by something of a lull, with mounting evidence that corporate executives, and also some investment managers, had reached a degree of ‘governance fatigue’, especially in the mature markets. Indeed, as far back as 1998, after the Hampel committee report in Britain, the British corporate leadership asked that ‘a line be drawn under corporate governance’. The British government responded by ‘rubbing out the line’ and moving further ahead with the Myners and Higgs committees. These proved prescient, as in 2002 and 2003 the procession of hurricane-force scandals of Enron, WorldCom, Tyco, Arthur Anderson, Ahold, Vivendi, SK Corporation, Elf-Aquitaine, General Electric, and many others, reminded the world that corporate governance was not going to fade away as a passing fad but is here to stay and to expand. Indeed, at the close of 2003, there are new scandals apparently emerging in Parmalat, Italy’s eighth largest industrial corporation, and in Londis, a large British retailing cooperative.

In addition to these scandals, there was mounting evidence of deeper underlying needs for improved corporate governance, such that the scandals were not just a few exceptional ‘bad apples’ but symptoms of a wider malaise. Obviously it is essential to maintain a balanced perspective and pause to reflect that the majority of companies are sound and their directors perfectly good at their job (there would be many more collapses if they were not), so the problem is certainly not that all, or even a majority, of directors are incompetent. Rather, the problems are that there is a significant minority who are less than satisfactory, and that the scandals show that there has been a worrying number of boards and senior executives who have been seriously deficient. There are indications that too many directors are just not properly competent, have been appointed on the traditional grounds of being a ‘member of the great and the good’, and regard a directorship as an ascribed honorary status rather than as an achieved professional role. For example, a survey of directors in 2001 by the Institute of Directors in Britain found that 80% of the sample survey did not know about nor understood their duties as a director under the law, and the cost to the British economy of poor directors had been estimated at many billions of pounds sterling (the collapse of the share price of Marconi alone lost over £ 20 billion of shareholders’ funds). A survey of directors of state enterprises in one state in India found similar deficiencies, especially in financial management. Few other countries have yet produced similarly candid studies, but there is sufficient anecdotal evidence that the professional standards of board directors are not as high as they should be – and in a competitive global market there is no quarter for second rate companies.

There is a standard joke in corporate governance circles that there are only three jobs for which no educational, technical or professional qualifications are required, nor open competition, nor any training provided : board directors, cabinet ministers, and parents. There is also the Parkinson-type law that “the principles, skills and knowledge required for getting to the top are in equal but inverse proportions to the knowledge and skills required for being at the top” – the guiding principle of ‘what’s in it for me’ rather than ‘ what is in the best interests of the organisation’, the skills of destroying rivals for first place rather than building teams, the knowledge of the internal micro-politics of the organisation rather than of the global business environment. But joking apart, it is a serious issue that the commercial competitiveness of companies operating in the global market, the protection of ‘other people’s money’ in banks and investments, and thus the economic future of countries, are in the hands of many leaders who do not know their legal duties, are untested in the essential knowledge required to lead their organisations, untrained in the skills needed for their positions, and often appointed through cronyism rather than personal merit. Nobody would accept medical care from untrained doctors (pace traditional healers), or fly in an airliner with an untrained pilot, or trust the defence of their country to an army where the officers are promoted on their personal and family connections instead of their military prowess.

Indeed, the military in most Commonwealth countries include intensive training as an integral part of every officer’s whole career path, which outshines anything provided by most business companies : all officers pass through a cadet training college, their promotion to the middle rank of major depends on further training and an examination, promotion to senior rank as colonels require passing through staff college, with promotion to top rank as generals means attendance at war college before they take over senior command posts. So corporate governance advocates ask why is it widespread and acceptable practice that the leaders of the national economy should have no formal training for their vital role, but are assumed to gain the necessary knowledge and skills only through on-the-job experience? Is the national economy any less important than war ? The conventional wisdom is that nowadays many managers gain MBAs, and that the quality of directors is determined by market disciplines which force the take-over or closure of inefficient companies led by incompetent directors, and thereby function as an incentive to directors to improve themselves. But the corporate scandals are a vivid demonstration that the knowledge learned as an MBA student thirty years earlier tends to be forgotten, that many years of sitting on boards does not necessarily bring valuable experience and knowledge, especially to prevent things going wrong, and that closure is a high cost solution to poor direction which should be avoided rather than trusted as an incentive. It makes little sense to rely on defeat as an incentive for army officers to improve themselves when soldiers are decimated, civilians massacred and the country laid waste, and similarly a more constructive approach is needed than relying on market forces to kill inefficient companies and destroy national industrial capacity. The Commonwealth corporate governance programme has emphasised that the cost of company closure is very high in economic and social terms, and that it is better to stimulate efficiency so as to prevent closures except in the worst cases.

On top of the evidence of insufficient competence among corporate leaders, there are indications of decreasing public confidence in the probity of company directors. In the last quarter of 2003, there have been some high-profile trials of company directors in America, Korea, and Russia, and of politicians and executives in France. At the same time, various annual opinion research surveys received considerable publicity when they highlighted a further decrease in public trust in big business in the US, UK, France and Germany. The surveys had shown that trust in big corporations (as opposed to entrepreneurs) had always been low, but dipped even lower in the wake of the corporate scandals. In UK there was a wave of protests from investors and the public about ‘fat cat directors’, and this sobriquet has now become an international catchphrase. Surveys such as those of MORI in UK in 2003 showed that only 25% of the sample survey felt they could trust and admire the business leaders of large corporation, while surveys in Germany gave the levels of public trust in business leaders falling to 18% of the sample, in America as low as 5-10% (with the lowest figures among members of the public who were active investors), while levels of trust in chief executives in France range from 5% to 30%. Even allowing for the well-known complications with opinion surveys, it is evident that there is a serious problem of trust in big business in the OECD countries. Again there are very few indicators from developing countries, but anecdotal evidence suggests that public trust in big business is equally low.

The Importance of Good Corporate Governance

The big question is : does corporate governance matter to the average citizen - and therefore to politicians who are concerned about the votes of average citizens? Are corporate governance, and trust in business leadership, problems which are exclusively for rich investors and ‘big shots’ who run large business companies? Or are these matters which the average citizen, the politician and the civil servant should worry about?

The answers are that these issues of corporate governance should concern everybody. For a start, the biggest investors in stock markets are not rich individuals but the financial institutions – the pension and insurance funds in which very many average citizens have a direct interest through their own pensions and insurance. Some of the strongest advocates of good corporate governance are organisations like Calpers (representing the California public sector pensioners), TIAA-CRFF (American school teachers’ pensions), and Hermes (British telecommunications and postal workers pensions). Pension funds from developing countries have shares in the large multinational companies listed on the stock markets of New York, London and Singapore (for example Shell has investors from over 100 countries), in addition to the companies listed on their own stock exchanges. So if the investments fail due to poor corporate governance, the pensions of average citizens are at risk, and insurance premiums rise as part of their household bills.

As well as their direct interests in investment for pensions, very many average citizens in most countries are also direct employees of the large listed, privately-owned, or state-owned national or multi-national companies, or of medium and smaller companies in the large companies’ supply and distribution chain. In addition, all citizens, including those in developing countries, have a concern for the operations of the big and medium sized companies because, even if they are not necessarily the largest employers, they are the drivers of the modern economy, while the multinationals are the leading investors who generate employment and transfer technology. Furthermore, in very many poor agricultural countries, innumerable small farmers are members of co-operatives, or sell cash crops through state agricultural boards, and are therefore directly effected by the quality and probity of the directors and top managers of these organisations. The bottom line is clear : the cost of corporate and cooperative collapse is more than a loss to investors - citizens lose their livelihoods and the country loses part of its economic capacity, so corporate governance matters to everyone.

In addition to the importance of savings and employment, the behaviour of companies can directly or indirectly effect all citizens, whether or not they are employees or pensioners. Corporate corruption insidiously corrodes the economy as well as the system of governance; corporate pollution damages the environment without regard to national borders and impacts citizens who may otherwise have no participation in the modern economy. Hence all citizens need to take an interest in corporate governance for better corporate conduct.

Then there is the matter of the long term strength of the whole economic system which depends on re-investment, which again depends on good corporate governance to a great extent. If the directors of companies are not safeguarding all the investments from pension funds and private citizens with the proper diligence due to OPM (“Other People’s Money”), the investors will first divert their funds to other companies and other countries, then seek to change the directors of companies where they have long term interests, and ultimately just stay away and put their money into bank deposits, treasury bills or property, and send as much as they can out of the country, which will starve the national economy of essential investment capital for growth. This is bad for any individual economy, and, in the cases of the larger economies which are growth engines for whole regions or the whole world, damaging for the global economy. For example, Japan led the growth for East Asia and the world for decades after 1960, and many countries in the region built their own prosperity in large part as part of the supply chain to Japan. Now Japanese growth has stalled for a variety of reasons, one of them being that “Mrs. Suzuki”, the quintessential Japanese individual investor, is very cautious about investing family savings in companies with poor corporate governance (Japan has a high proportion of individual investors, their total value being similar to the separate values of institutional, bank and company investment funds). Other potential regional growth engines, such as Nigeria and South Africa for the African continent, can similarly benefit from improved corporate governance to boost confidence for investment and growth.

The links between corporate governance and the whole economic system extends beyond investment. The evidence of low levels of public trust in business is not just a matter of the reputation of a few companies and the lack of respect to a few directors, but also involves the credibility of the whole free market system. If some of the essential pillars of the modern market system such as the accounting profession and audit systems are frequently demonstrated to be flawed (from Poly Peck, to Enron to Parmalat), and the leaders of the private sector are widely perceived to be self-serving ‘fat cats’, then citizens will seek out alternative economic systems. The problem is that the world has searched for alternatives to the market economy and found that they are invariably worse, so the challenge is to make the market system not only more efficient but also humane and responsible through better governance.

For all these reasons, corporate governance is a critical issue which merits attention from citizens as well as private, public and civil society leaders – it is a system of control over leaders in the national and international economic chain, and if the leaders are a weak link the whole chain will soon break.

Expanding applications of Corporate Governance beyond the stock markets.

The primary focus of attention of most corporate governance advocates, in particular the OECD, the World Bank, IMF and IFC, has been on capital markets, in particular on protecting the interests of shareholders. The underlying theory has been that higher standards of transparency, accountability and probity will reinforce market disciplines to increase shareholder value, stimulate liquidity and improve the allocative efficiency of the capital markets. In addition, there has indeed been regard for stakeholder interests, but the dominating areas of concern have been on shareholder value in the developed and emerging stock markets.

It should be stated at the outset that this attention to the capital markets is certainly essential, for all the reasons outlined above. Hence one of the expanding needs is for more and better corporate governance for all companies listed on all stock markets throughout the world. The American stock exchanges have been very active in this respect, especially through the Sarbanes-Oxley Act, while the European Community formed a special committee under Professor Winter to both harmonise the more than forty national and sectoral codes across Europe, and to deepen the application of corporate governance. The main issues preoccupying the Winter Committee have been the role of non-executive directors and supervisory boards, director remuneration, financial reporting, auditing practices and systems (in the wake of Enron), the position of stakeholders and shareholder activism. These issues are typical for most of the OECD countries. Accordingly, it is anticipated that the priorities for the revision of the OECD principles will include further protection of shareholder interests, especially minority shareholders; matters of detail which significantly effect shareholder interests, such as related party transactions; and the promotion of active shareholder roles and responsibilities, especially institutional shareholders.

But while these are undoubtedly important matters for mature and emerging capital markets, are they enough to achieve the full potential of corporate governance, especially in developing countries ? The summary of experience in the Commonwealth countries is that, while these are priorities in emerging markets, in the developing countries there is much more that can be gained and needs to be done by corporate governance. The focus of the OECD Principles on stock markets illuminates one important part of the spectrum of corporate governance, but other parts are still in darkness. Accordingly, the Commonwealth Secretariat convened an expert group, with representatives from all regions, to examine the scope for corporate governance for development, and the areas where the OECD principles might be revised to better accommodate the concerns of developing countries as well as (not instead of) the emerging and mature markets. The highlights of the findings of the expert group, and of the continuing work of the Commonwealth, are summarised in the following section.

The Commonwealth experience is especially valuable as the commonalities of company law, accounting, business institutions, public administration and language of the Commonwealth, facilitate the comparison and exchange of information among the global cross section of mature, emerging and developing economies of the member countries, to generate useful lessons for the rest of the world. Additionally, there is a wide cross section of experience as the Commonwealth Secretariat has been active in promoting corporate governance since 1995, before the subject became well known and formed part of the international policy agenda. Commonwealth developing countries became interested in corporate governance when it became clear that the privatisation of state-owned companies, whether through flotation on the stock markets or trade sale, needed to be accompanied by improved standards of corporate probity, accountability, transparency and social responsibility, especially among companies delivering essential public goods and services to voters who demanded better quality and value for the prices they paid. In parallel, many governments recognised the need for more efficient boards of directors of those companies which were retained under state ownership either permanently (as public service providers) or pending privatisation. Accordingly, the Secretariat developed a comprehensive corporate governance technical assistance programme which included advocacy, policy formulation, professional institution-building and director training.

Expanding applications of Corporate Governance – indications from the Commonwealth

With eight years of accumulated experience of a global scale corporate governance programme, the Commonwealth has highlighted a range of needs and issues where the expanded application of corporate governance can have a real benefit. Each of these requires a book on its own to cover all the substance, and in particular the practical measures for dealing with the needs and issues, so only the briefest highlights can be covered in this short article. Nevertheless, this summary can still serve to identify the areas which merit further consideration during 2004 when the world gives some more attention to corporate governance during the review of the OECD principles.

Geographical expansion to developing countries. One of the first needs is the extension of the application of corporate governance to developing countries. As noted above, the focus of attention has been on the emerging and mature markets, while the attention of the Commonwealth programme has been additionally on developing countries, where it has been found that corporate governance can have a significant contribution to national development (as outlined below). This geographical expansion has been largely achieved in the Commonwealth, with the programme reaching out to 45 countries, with support from the GCGF and the OECD to the pan-Africa and pan-Caribbean forums. But it does not appear to have been quite so extensive in breadth or depth in other developing countries, though the process is accelerating.

Linkage of corporate governance to priority national development needs. The extension to developing countries in turn requires that corporate governance should demonstrate that it can make a significant contribution to national development, especially to overcoming poverty. The perception of corporate governance as being something for the fine-tuning of stock markets implies that it is not of the highest priority in developing countries. However, there are strong arguments to show that corporate governance makes not only an indirect but also a direct contribution to a number of key development challenges :

These linkages are not often articulated in the conventional corporate governance promotional programmes, nor does corporate governance often feature as a development policy instrument, but the Commonwealth experience is that the connections can and should be made.

Sectoral as well as geographical expansion of corporate governance. Even three years ago, the conventional approach to corporate governance regarded it as irrelevant for state-owned enterprises, for family owned corporations, public service boards, cooperatives, small and medium enterprises – and even as unimportant in the banking sector. One of the main reasons was theoretical : the concepts of corporate governance were based on the principal-agent relationship, which was considered to apply only to joint stock companies. This restricted approach seems anachronistic today, when an authority of the status of Sir Adrian Cadbury has published a book on corporate governance for family-owned companies, but it was a powerful constraint to the wider application of corporate governance in the 1990’s. Today there are also well established codes for state enterprises, for universities, for health and education boards, not only in countries like India which retain a large public sector, but also in countries like Australia which have completed extensive public sector reform and privatisation programmes, while New Zealand has applied the systems of corporate governance even to government ministries. The Commonwealth has prepared guidelines for cooperatives, small and medium enterprises, and work is in progress for NGOs, recognising that in many countries NGOs have a vital role in public affairs, while in some countries they are also significant economic actors. In October 2003, the UK Audit Commission produced a landmark report on corporate governance in three core areas of the public sector : local government, health, and the police and probation service – all a long way from the stock exchange.

Thus the sectoral extension of corporate governance beyond companies listed on the stock exchange is underway, but so far only in a few areas and countries, so there is enormous scope for the application of corporate governance throughout the public service delivery agencies, and throughout the millions of medium and small enterprises and cooperatives, not only in developing countries but also mature and emerging market countries.

Expansion in and through the banking sector. Corporate governance has been progressively expanding in the banking sector, and appears to be gaining momentum. The Bank of International Settlements (BIS) had produced guidelines on corporate governance for banks in 1999, and a special feature of the Commonwealth Programme has been a focus on the banking sector, working through the Central Banks. This initiative was supported at a special meeting of a number of Commonwealth Central Bank Governors in May 2000, as a result of which a Commonwealth working group was established, a comprehensive check list and guidelines for the financial sector published, and a number of country action plans prepared. The Commonwealth programme was endorsed by the Commonwealth Central Bank Governors’ and the Finance Ministers’ meetings 2001, then in 2003 the GCGF issued a handbook for bank directors. The reasons for this special focus on the banking sector are threefold:

Convergence and segmentation of different aspects of corporate governance. Linked to the sectoral extension of corporate governance is the convergence of different core aspects of governance which have been running in parallel for the past decade, but now seem to be flowing together into a comprehensive approach to corporate governance. In the past there was a tendency towards segregation between corporate governance, corporate social responsibility, corporate environmental responsibility, corporate citizenship, and director professionalism, although the Commonwealth has always espoused the broader ‘inclusive’ approach to corporate governance. Corporate governance was traditionally perceived as based strictly on the principal-agent relationship, as covering procedural and organisation aspects, as concerned with somewhat bureaucratic structures, systems, audits, codes and ‘ticking boxes’, and as applied especially to companies listed on the stock market. Corporate citizenship, at the other end of the spectrum, was concerned with the political economy of companies, especially the relationship between multinational corporations and their host government and societies. The proponents of corporate social and environmental responsibility consistently talk in terms of stakeholders, while some of the stricter exponents of corporate governance denied that there was any validity whatsoever in the concept of ‘stakeholder’, and argued that it served to weaken the essential principle of corporate accountability to shareholders.

Today, there appear to be more trends of convergence, so the formerly somewhat heated arguments between the shareholder and the stakeholder approaches again seem anachronistic, and while there is still useful debate, it generates more light than heat and seeks to find ways to agree rather than disagree. For example, fewer people seem have to have difficulties in accepting the dual principle of accountability to shareholders, and responsibility to stakeholders. A significant indicator of the shift in approach came in 2002 when the Association of British Insurers, who collectively account for over 50% of the value of the London Stock Exchange, called for the companies they invest in to draw up charters of social responsibility – a move which they acknowledged would have been unthinkable just two years earlier. In late 2003, GES Investment Services, a Swedish corporate social responsibility group advising institutional investors with over $ 70 billion in assets, recommended the exclusion of Nomura Securities from investment on grounds of allegations of sex discrimination in employment, and of BASF due to a finding of the US Environmental Protection Agency of sales of illegal pesticides Those who previously rejected the concept of stakeholder now talk of the need for “the enlightened shareholder” to recognise the diverse social and environmental responsibilities of the company and long term wealth creation as well as short term share value. This is not simply a case of people becoming broader-minded, but of absorbing the lessons of experience. It is now recognised that reputational risk is a critical factor effecting the public acceptance of a company, demand for its products and the value of its shares, so a company with a poor social or environmental risk soon becomes a credit risk. As risk management is at the heart of corporate governance, it forms a functional linkage between corporate governance and corporate responsibility.

Similarly training for director professionalism traditionally concentrated on the technical knowledge and skills for directors as an extension of management skills and was not always explicitly connected to corporate governance, often being handled by Institutes of Directors, while corporate governance was largely the domain of stock exchanges. Today, there are close linkages between director training and corporate governance policies, for example the Kuala Lumpur stock exchange now insists that the directors of listed companies attend accredited training courses every year, and the British Institute of Directors’ Chartered Director accreditation has been recognised as a way to improve the credit status of companies whose boards are all or mostly chartered directors.

In turn, there are indications of fundamental re-thinking of some of the basic concepts of corporate governance, which underlie these different aspects. For example, the U.K. Audit Commission’s definition of corporate governance for the public sector merits attention : “Corporate Governance means the framework of accountability to users, stakeholders and the wider community, within which organisations take decisions, and lead and control their functions, to achieve their objectives . . . good corporate governance combines the ‘hard ’ factors – robust systems and processes – with the ‘softer ’ characteristics of effective leadership and high standards of behaviour . . .. it incorporates both strong internal characteristics and the ability to scan and work effectively in the external environment”. This definition resonates the Commonwealth emphasis on leadership in the Principles published in 1999. But the Audit Commission also makes an important theoretical leap by setting the framework of accountability for public services to ‘users, stakeholders and the wider community’, and evidently extending the concept of ‘principal’ in the principal-agent relationship beyond the owner to the customers, other stakeholders and the community. This breaks through the conceptual boundary which conventionally allocated accountability only to owners (on the basis that wider accountability leads to dilution) and responsibility to the stakeholders.

But at the same time as there are trends of conceptual convergence, there are also indications, not so much of divergence, but of ‘market segmentation’. Due to the sectoral extension of corporate governance noted above, there have been some suggestions to distinguish ‘corporate governance’ (related to joint stock companies listed on stock exchanges) from ‘organisational governance’ (related to all types of corporate entities, whether companies, public service agencies, or NGO’s). In terms of the essential structure, systems and functions of governance there seems little purpose to be served by this distinction, but in practical operational terms of promoting corporate governance there may be some advantages in some form of sectoral segmentation within the whole broad field of corporate governance.

Corporate Governance as a policy instrument for development. A special feature of the Commonwealth programme is the application of corporate governance as a lever for change in the chain of development. It should be emphasised that corporate governance is not a panacea for development, but it can make a powerful contribution to increasing efficiency, as a complement (certainly not as a substitute) to macro-economic policies. Indeed, corporate governance cannot succeed without parallel macro-economic and public governance reforms to provide the enabling policy environment for micro-economic reforms. Just as the macro-economic reforms are designed to set off a chain reaction by liberalising market forces to increase competition and thereby efficiency, so corporate governance aims for a sequence of operational and institutional objectives which accumulate to form a micro-economic chain of development to complement the macro-economic forces. This chain may be summarised as:

1) A comprehensive national corporate governance programme, covering policies, codes, professional institutions and training for wide scale improvement in the quality and efficiency of boards of both state and private sector companies and public service agencies, leading on to

2) the improved performance of state enterprises, to stop their fiscal haemorrhage through subsidies, and gain their real contribution rather than cost to national GDP;

3) the improved performance of public service agencies, to improve their value for money, operational efficiency and quality of public infrastructure and essential services;

4) and to increased performance, profitability and value added of private companies;

5) all of which in turn leads to increased commercial and industrial growth and exports;

6) and to increased share prices of listed companies, stock market capitalisation and listings,

7) all of which in turn contributes to higher rates of GDP growth.

8) At the same time, improved understanding and standards of corporate environmental and social responsibility promote greater trust between the corporate sector, the government and the general public

9) while the large scale training for directors, and the national corporate governance action programme, should send a strong signal to the markets to encourage domestic and international investor confidence,

10) all of which should lead to increased inflow of national and international investment funds,

11) which in turn will lead to increased growth, employment and alleviation of poverty.

This use of corporate governance as a policy instrument applies just as much to mature economies, in particular to strengthen the ‘mittelstand’ - the whole economic sector of medium-sized companies which provide the largest numbers of employment and are often more important to the national economy as industrial clusters than are the large listed companies. Thus any instruments which help to lever up the competitiveness of this sector can be a powerful force for national policy. While often operationally and technologically efficient, medium-sized companies in mature economies often suffer from a lack of senior management depth (with restricted private or family ownership), from a concentration on short term business tactics rather than medium and long term strategy, from risk-averse management, and from limited equity finance for investment. Many of these weaknesses can be overcome by the application of good corporate governance practices, and also serve to prepare the companies for flotation on the stock market to raise funds for capital investment for growth, when investors will require compliance with the high standards prevailing among the blue-chip companies. Similarly, high technology start-up companies which survive to the stage of stock market flotation on the NASDAQ, AIM, OFEX or an equivalent specialist exchange, need to develop mature systems of corporate governance to take over from the initial dynamic but high-risk entrepreneurship and from the mentoring and direction provided by their venture capital backers.

New concepts and directions in corporate organisation. As a lateral extension of the conceptual convergence, there are indications that the new approaches to corporate governance represent a ‘seismic’ shift in the way companies are organised. For many years now, the focus has been on the management of the structures and operations of business companies, as an inheritance from Alfred Sloan, the grandfather of business management structures for the business corporation. Perhaps one of the main difficulties with the past debates on corporate governance is that the whole subject has often been portrayed as something like an accounting standard which has to be complied with – certainly important, but essentially a mechanical system, a procedure, a bureaucratic process of ‘ticking boxes’, most of which the chairman and chief executive can delegate to the company secretary to manage. But corporate governance is far more than a matter of compliance - it deals with the relationships between a company’s principals (the shareholders), their agents (the management) and the stakeholders, and thus goes right to the heart of the joint stock company, which is one of the basic building blocks of the modern market economy. It also allocates final responsibility for strategy, investment and risk management to the board, not just to the executive managers, while re-emphasising the role of the board in appointing and monitoring the senior executives. The Marconi case was perhaps a landmark in this process, when the near collapse of the company was explicitly blamed not only on the new top executive team but also on the board as a whole.

Thus the corporate governance involves business fundamentals, not procedural adjustments. It is worth recalling that when Professor Robert Tricker originally coined the term ‘corporate governance’ back in 1984, he made the critical distinction between management and direction, stating “if management is about running business, governance is about seeing that it is run properly”. This is the old difference between doing things right, and doing the right thing, and it marks an important frontier between operational management and strategic direction. The boundary lines along this frontier shift and are sometimes blurred, but the differences are nevertheless real, although they take time to work out. For example, thirty years ago there was little distinction between marketing and sales, but today the differences are well recognised such that marketing has emerged as a science in its own right, with corporate organisational structures built around the marketing function rather than the traditional production base. The distinctions between management and direction are as significant as those between marketing and sales, or, for example, between the more recent differentiation between Information Technology and Knowledge Management. For these reasons corporate governance is here to stay as a fundamental shift in business and economic thinking, not just a procedural standard.

Increasing evidence that corporate governance is delivering results. It has to be said that jury is still out on this matter because some ongoing research has not been finalised, and it is still early to measure the extent to which good corporate governance has led not only to increased corporate performance, but also to really stimulate the whole chain of development from increased investment, in turn leading to growth and employment generation. It should be noted that the juries are still out or reconsidering earlier verdicts on other fundamental development policies, for example there are still many questions about the efficacy of the conventional structural adjustment macro-economic reforms. But there is growing statistical and circumstantial evidence from various parts of the world that good corporate governance leads to improved performance:

Additional priorities and issues for the future

Thus corporate governance is expanding both in terms of its practical application and of its own conceptual framework, and continues to be a dynamic area which merits priority attention from politicians and officials as well as business executives (who cannot avoid corporate governance whether they like it or not). But in addition to the areas outlined above, the expansion of corporate governance has highlighted a number of other areas and issues where additional attention may be needed.

Need for a dual focus on corporate governance for capital markets and for development. As mentioned (often!) above, the conventional focus of corporate governance has been on stock markets and shareholder interests, with an underlying logic that improvements in corporate governance would lead to improvements in the capital markets and ultimately trickle down to improve national development. However, as emphasised above, corporate governance has a much wider frame of application and enormous scope as a policy instrument for economic development and for improvement of the public services. It is considered essential that the debate on the revision of the OECD principles should encompass the wider application of corporate governance to development, covering unlisted medium enterprises, state enterprises, the banking sector, public services agencies and NGOs, as well as stock markets.

Director professionalisation and training. As outlined above, there is still a worrying number of directors who do not know their duties, are untested in the essential knowledge required to lead their enterprises, and untrained in the skills needed for their positions. These deficiencies can be overcome by a large scale training programme designed to upgrade the quality of the boards of directors throughout the country. Hence in some countries the central banks are now insisting that the directors of commercial banks be not only ‘fit and proper’ but also ‘qualified’ persons to be bank directors; the Kuala Lumpur Stock Exchange is insisting that all directors of listed companies undergo a certain amount of re-training each year; and the governments of several countries are insisting that all the directors of state enterprises undergo corporate governance training. However, there is still a serious dearth of corporate governance training programmes in developing countries. While a few bilateral development agencies have funded some director training, the Commonwealth Secretariat is the only international agency which has a widespread corporate governance technical assistance programme concentrating on developing professional institutions and training, which builds capacity at the country level. The GCGF is now advancing rapidly in this area, after designing two special toolkits, one to help establish institutes of directors or of corporate governance, the other to help draft national codes.

One special feature of the Commonwealth programme to improve the quality and efficiency of boards is the purpose to change board behaviour, as well as to ensure the standard structures and systems of good corporate governance such as separation of the offices of chairman and C.E.O. and formation of board committees. This can be done by establishing standards and benchmarks of corporate governance and board performance, whole-board and individual director performance appraisals, and a recommendation that boards should spend at least 50% of board time allocated to proactive strategy and risk management, and less time on retrospective review of accounts and past performance. Other Commonwealth recommendations are that all companies should have their own company codes, covering codes of conduct for directors. The Commonwealth Association for Corporate Governance has a draft code of conduct and is preparing a generic company code.

Need for parallel reforms in public governance and economic governance. The evidence from many countries is that some of the greatest constraints to good corporate governance are external to the corporate sector, and emanate from deficiencies in the government, in company and contract law, in the business professions (especially auditing and financial advisers) and in the policy environment. This means that the debate on corporate governance will need to involve government policy makers, Parliamentary select committees and civil service structures. This opens up a large area for discussion and still wider subject for solution, but it would be unrealistic to believe that the necessary changes can be made by the corporate sector alone. There is a movement towards a whole new ‘governance’ agenda, covering the integration of the full spectrum of state governance, economic governance, corporate governance and civil society governance.

Roles and responsibilities of investors and stakeholders. Corporate governance has been promoted most actively by investors, especially the large institutional investors for circumstances where they find themselves in a minority position (usually the institutional investors are collectively the largest group of shareholders). Accordingly, the investors have been quick to point to errors of the executive management and of the board of directors as failures of corporate governance. However, there have been many occasions when the investors have not been activist enough, and have not intervened when they should have. There have also been accusations by executive teams that the investors have followed a ‘short-termist’ approach, taken profits and sold shares when the going was good, then bailed out and made things worse when times are hard even though the medium and long term prospects are good. The Myners Report in the UK has established the international standard on the roles and responsibilities of investors, and shown that good corporate governance depends not only on the executive team and the board of directors but also on the conduct of the investors. It can be said the Myners opened the door to an area which needs serious attention, and is likely to gain much more.

However, while there is increasing recognition of the role of investors, there is less of the role of stakeholders – and also much more dissension, especially in terms of the actions and responsibilities of pressure groups and of trade unions. In Germany and Holland, trades unions have long been represented on the supervisory board of companies, while this has never been accepted in other countries which have unitary boards. The South African King Reports (first published in 1994, the second updated version in 2003) deal with the respective roles and responsibilities of the company and its stakeholders, covering the rights, duties, responsibilities of the company shareholders, directors, managers, employees, customers, suppliers and the general public, and remain the only significant reference point for all these issues severally and jointly.

The prevention of corruption and abuse of office – “gouvernance oblige”. Anti-corruption has always been an important part of corporate governance, quite explicitly in terms of dealing with the probity and transparency of the directors and executives of the company in relation to shareholders, and often implicitly in terms of relationships with government departments, customers and suppliers. There appear to be several reasons for a subtle and implicit rather than a forceful and explicit approach to corruption: one is that it is only relatively recently that it was possible to express the ‘C-word’ out loud in national and international meetings, so that anti-corruption measures were introduced under the terminology of ‘transparency’ and ‘probity’; another reason was that corruption was being tackled as a separate policy agenda, for example the OECD has been working diligently on gaining international consensus for conventions against foreign corrupt practices in parallel to its corporate governance programme.

But corporate governance has a vital function in cutting off the supply side of public corruption, while public sector reforms attack the demand side, with the internal auditing and financial management operations of corporate governance dealing with private sector fraud. Corruption is usually associated with the public sector, but the use of bribery to secure contracts or favours by private companies from other private companies is also practised, and defrauds the shareholders as much as public sector corruption defrauds the citizens. The South Africa King report again is the world leader in explicitly demonstrating the functions of corporate governance in dealing with public corruption and fraud, and merits replication in other parts of the world. Other countries and companies are advocating a zero tolerance policy and initiating special methods to deal with corruption, for example, even before Sarbanes-Oxley, a government ministry in one Commonwealth country requires the chief executive and senior management team of state enterprises to declare in the monthly and annual Financial and Operating Statement to the board of directors that no staff have been engaged in improper activities with the knowledge, tacit acceptance, or ‘blind eye’ of the company. This statement helps to formally link the board of directors and operations, and helps to overcome the excuse which is often used by top executives and directors to delegate their accountability on the grounds that they cannot know the details of what line managers are doing in all departments and local offices of a large company.

Corporate governance also tackles abuse of office, which may not be corruption in the legal sense but still outrages shareholders and the general public. One of the driving forces for the corporate governance movement was the disgust at executive excess in large corporations, when ‘other people’s money’, and the efforts of the company staff, appeared to be used to fund a luxurious lifestyle for top management, in many cases when the companies they led were doing badly. The stories of executive excess are legion, ranging from instances when a company jet was sent to collect a pet dog left behind at a weekend resort owned by the company and used by top executives, to $4,000 wastepaper baskets purchased by company funds for the CEO’s apartment which had been bought for him by the company. Few shareholders or staff begrudge handsome rewards for key executives whose intelligence, initiative and hard work deliver excellent results, but there are genuine concerns when the total remuneration rises to extraordinary levels. As it is, the remuneration of top executives is frequently at a level of 100 times higher than the average wage of the company staff, and differentials have been known to have risen to levels of 400 times higher. Twenty to thirty years ago the differentials were of the order of a factor of 20. It should be recognised that these remuneration levels have been paralleled more recently by a much shorter life-span for chief executives : the average duration of office has been reduced to four to five years as the pressure to deliver ever-increasing results has taken its toll, so chief executives have demanded compensation in terms of high salaries and privileges. The problems have come when appropriate rewards have been abused, so in the future it may be expected that corporate governance will need to strengthen self-regulation and echo some of the values of ‘noblesse oblige’ of other privileged groups, to recognise that privileges and rewards are compensations for the burdens of responsibility and duty which come with high rank, not entitlements of unearned status. If too many directors continue to abuse their reward systems they cannot be surprised if there are public reactions not only against ‘fat cats’ but also against the whole free market system which can give the appearance of facilitating such abuse.

The Thin End of the Wedge for the Public Sector ?

One of the most outstanding features of corporate governance has been its exceptional progress. There have been few, if any, other concepts and practices which have changed so rapidly from obscurity to global prominence and actually achieved some significant improvements, even though there has been a long underlying history. In 1990 the term ‘corporate governance’ was effectively unknown, never seen in the popular or even the business media, and only very occasionally in academic business management journals. By 1998 corporate governance became known on a global scale after the East Asian financial crisis, and after the Enron affair in 2002 it is impossible to avoid corporate governance. This can only be very healthy and eminently desirable, and has certainly improved standards throughout the corporate world, though the continuing emergence of scandals shows that there is still plenty of room for improvement.

The residual question from the progress of corporate governance is whether it will be emulated by equivalent improvements in the public sector? The corporate sector has come under massive criticism from within (the shareholders) and without (the stakeholders and lobby groups) to clean up its act, and has responded, to the extent of toppling some very powerful organisations and individuals. Can it be said that the public sector, both the politicians and the civil servants, have been as responsive as the corporate sector? Is there a similar real problem of doubts about the competence and probity of the public sector as there is about the private sector? If the corporate governance movement has shown that pressure can encourage the private sector to improve so fast, will there be equivalent expectations for the public sector? Will corporate governance be the thin end of the wedge to push through greater accountability, transparency, probity, efficiency and responsibility throughout the public sector?

While it would be difficult, and not especially useful, to try to compare the extent and level of the problems in the public and corporate sectors respectively, there is little doubt that the continuing deficiencies in public sector governance are certainly of a degree which require urgent remedial and preventive action, just as they have in the corporate sector. Although the public sector reform programmes have already made significant improvements, these have mostly been concentrated on cost-cutting and efficiency. The Transparency International annual surveys of countries throughout the world demonstrate the extent and the level of corruption in government. The MORI survey of public trust in UK, noted in the early part of this article, established that only 25% of the sample felt they could trust and admire the business leaders of large corporations, but also found that politicians and journalists were considered even worse - only 19% of the sample trusted politicians and 13% trusted journalists. In contrast 91% of the respondents trust doctors, 85% trust teachers, 80% the clergy, and 59% the police.

But it is still early to assess whether the progress in corporate governance will accelerate parallel improvements in public governance. One of the key determinants will be the factors which drive this process of reform. In corporate governance the driving forces have been a combination of shareholder activists, regulators of financial markets, central bankers and governments concerned about financial stability, while NGOs and lobby groups have had an influence on corporate social and environmental responsibility affecting reputational risk. The underlying concerns have been, on the part of the shareholders, their perception that majority shareholders and executives have been taking an unfair proportion of the wealth created by their companies, and on the part of the regulators, their perception that the whole economic system was in danger of being undermined. Perhaps surprisingly, there have been few cases when trades unions have led the demands for better corporate governance.

In public governance there have been different drivers of reform in different countries : in some, the most powerful influence has been the voters who have tired of governmental incompetence, waste and sleaze and have responded to political leaders who appear able to provide an alternative; in other countries the pressure has come from donors; in many countries, both developing and industrial, the trigger has been a national financial crisis which has made reform unavoidable and overthrown the leaders of the past. Future drivers of reform may include a second bite from voters gaining some inspiration and hope from the improvements in corporate governance and demanding equally large changes in the public sector. It is also possible that the public sector staff themselves may become the ‘insider drivers’ for improvements in governance of the public services, just as institutional shareholders were the main drivers for improved corporate governance. The reasons for the potential influence of ‘insider drivers’ lie in the structures and systems of corporate governance, which build up an internal dynamic for greater accountability and transparency of the organisational leaders and thereby make it more obvious where lie the boundaries between the policy decisions of the elected politicians and the operational decisions of the appointed officials and executives, and the also the distinctions between the interests of the persons and of the organisation. These clearer lines of responsibilities are usually advantageous to the operational officials and executives, hence might possibly evolve as a driver for further change. For years it has been assumed that the civil servants constitute the problem rather than the solution, as they are seen as simply seeking to perpetuate their own positions and power, hence politicians can often achieve popularity by attacking bureaucracy. But civil servants in turn often perceive the politicians as the source of problems, by acting according to political and personal self-interest rather than national interest. Furthermore, middle ranking public servants sometimes feel that senior officials also constitute a ‘governance problem’, either by compromising their professional position to party political interests as opposed to valid policy directives in order to gain personal advancement, or by just manipulating the systems for their personal benefit rather than public organisational advantage – just as middle managers often feel that board directors are pursuing their own rather than the company’s interests. There are indications that civil servants, state enterprise and public service executives, including civil service unions, are tiring of political interference and personal advancement constraining the integrity of their operational work, and therefore may welcome more and better corporate governance. All this however, remains to be seen in the future chapters of corporate governance.

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