CORPORATE GOVERNANCE CHALLENGES FOR DEVELOPING COUNTRIES

by
Mr. Michael Gillibrand
(Director, Management Training Services Division of the Commonwealth
Secretariat and Special Advisor, Commercialisation and Privatisation).

The theme of the presentation today is “corporate governance challenges for developing countries”. The title itself contains an explicit question on what are the main corporate governance challenges for developing countries ? and the supplementary question how are we to tackle these challenges ?

The title also contains another implicit question : whether the corporate governance challenges for developing countries are different from those facing the industrial countries. My answers to this latter question is Yes and No – not out of a sense of mischief to deliberately pose conundrums and indulge in sophistry, but out of a sense of the complexities of corporate governance and of national development issues.

To the question : are the corporate governance challenges for developing countries different from those facing industrial countries ? – I would answer Yes : the challenges of development are different and therefore the challenges of corporate governance to tackle development are different. But I would also have to answer No : the challenges of corporate governance per se are not really different, and the fundamentals of corporate governance are the same (the principles of probity, accountability, transparency and responsibility). But even though these corporate governance challenges are not substantively different, there are different perspectives on these challenges. Indeed, many of the challenges of corporate governance are clearer and better understood in developing countries than in industrial countries, especially those relating to public policy issues, such as those of corporate social and environmental responsibility. I have found that there is a sharper perception and a better grasp of the fundamentals of corporate governance in developing countries than in industrial countries, and that the industrial countries can learn much from the experience of developing countries, because of the starkness of the development challenges, and because the contributions which corporate governance can make to economic and social development are more evident – a matter to which I shall revert later. In many industrial countries corporate governance has evolved to be perceived more like a technical accounting standard than as a pillar of national governance, which I believe to be a misperception, while in developing countries there seems to be a clearer recognition of the importance of corporate governance as part of the fabric of national governance.

Thus, although it may be inaccurate to affirm that the corporate governance challenges in developing countries are fundamentally different from those in the industrial countries, I am struck by the contrasts, hence I have no hesitation in dealing with the challenges of corporate governance in developing countries. The real question may not be whether corporate governance challenges in developing countries are different from those in industrial countries, but the supplementary question : whether the different corporate governance challenges reflect different issues of corporate governance in developing and industrial countries, or reflect different national challenges which have to be solved by corporate governance.

Certainly, I find that the agenda for corporate governance debates and programmes in Europe to be less than essential for the developing countries of the Commonwealth where I spend my time. This is not to say that the European and American corporate governance policy agendas have no relevance for developing countries – far from it, the issues are important, and integral for good corporate governance everywhere. But I find that there is much which is missing from the European and American debates, which concentrate on matters of form and procedure rather than squarely on the policy questions of how corporate governance can deal with national issues.

Perhaps at this point it would be useful to pause and outline my personal approach, which could explain my perspective. Most of the specialists in corporate governance approach the subject from a particular vantage point and usually with a particular specialist concern. I have not had the opportunity to carry out some form of statistical survey of corporate governance specialists, nor have I yet seen any such analysis (if anyone knows of such a study I would be grateful for a reference), but the majority of corporate governance specialists appear to be drawn from the professions (accountants, or corporate lawyers, or company secretaries) or from institutional investors, or from academics who research in these areas of accountancy, law and finance, or from a few individuals who have attained eminence and considerable experience as company directors. Increasingly there are specialists attached to regulatory agencies, whether stock exchange commissions, financial services agencies or central banks. I say ‘increasingly’ deliberately, because one of the single most striking features of the corporate governance scene has been the incredible increase in interest in the subject and in the number of people getting involved – it surely must be one of the highest growth sectors in the past decade, which is by no means a bad thing, but it does seem at times that corporate governance is becoming a business in its own right rather than a business and governance function and subject area.

My own perspective is somewhat different from many others in the corporate governance, in that my own work has been largely as a public policy analyst, and as an economic and social policy adviser. Certainly I have also been a company director (of US, British and Middle Eastern companies) and also what is apparently sometimes known as an “executive shareholder”, but my foremost interest in corporate governance is from the perspective of public policy. Certainly I am not an academic, and so I often plead guilty to the charge of a loose interpretation of terminology – not, I hope, due to lack of rigorous thinking but often due to the lack of the available conceptualisation of the issues which arise in the breadth of the debates on corporate governance.

This means that my own focus is on how corporate governance can function to strengthen public policy – how it can support national competitiveness policy, how it can encourage national and international investment, how it can support economic growth, generate employment, and help to overcome poverty and social exclusion. I hasten to add that I am quite realistic and fully recognise that corporate governance is no panacea which can solve the problems of development at a stroke – but I also affirm that it has a critical developmental function in helping to tackle these problems, and that these developmental functions of corporate governance need to be recognised and harnessed.

I also see corporate governance not only as a matter for the corporate sector, but as part of the Whole of Governance – linked to public governance, to economic governance, to the governance of civil society. While recognising the need for considerably more thinking on the whole subject of governance (the need for what Compte called ‘ a dose of conceptual hygiene’), and recognising the danger of governance becoming an over-used term, I suggest that the linkages and the interface between corporate governance, public governance and economic governance are becoming increasingly important. It is now more widely recognised that we cannot achieve good corporate governance if public governance is deficient – if the political leadership and political institutions are distrusted by the electorate, if the law is outdated, and legal administration takes years or even decades to deliver justice. May I suggest that this could be a valuable area for investigation by the Academy of Corporate Governance, and that many policy advisers would look forward to your ideas and guidance.

In colloquial terms, my perspective is of corporate governance as a means to a developmental end, not just as an end in itself. Nor do I see corporate governance as an ‘economic assumption’ – that if you have good corporate governance in place many other benefits will sequentially and consequentially follow. Corporate Governance is a means which can and should be used as a development policy instrument.

Mr. Chairman, I believe that these different perspectives are important for the debate on corporate governance, and it is important that the differences (or the contrasts !) be recognised. The perspectives of the various types of specialists can lead to a concentration on single aspects of corporate governance to the neglect of others. As a policy analyst I am obviously an enthusiast for corporate governance and want more of it. As an investor I am a supporter, especially for minority shareholders, and want more of it – especially after the recent scandals have cast doubt on published accounts. But as a company director, especially as a company director of a privately held or family company, I may be much less enthusiastic. The preoccupations of a company director are to survive in a viciously competitive global market, to maximise profits, and (usually) to be a decent corporate citizen by obeying the law and observing the prevailing standards of corporate conduct to staff, suppliers and customers – no more, no less, and certainly not to bother with contributions to public policy. I recall the authors of the Hempel Committee on Corporate Governance in Britain (who represented the views of eminent company directors), concluding with a palpable note of weariness, that the British corporate sector was suffering from ‘corporate governance fatigue’, from the investigations and the box-ticking, and that they “wanted a line drawn under corporate governance”. The government responded by calling for a new consolidated code of corporate governance and rubbing out the line by threatening to legislate unless the corporate sector came up with their own convincing code. In retrospect the government was certainly right.

But the different perspectives cut across representative groups to professional interests, where one can see a significant and global scale shift of opinion over the past few years. I clearly recall the great debate in the late 1990’s whether corporate governance is applicable to state enterprises and family-owned companies. There were strong opinions, voiced in particular by public policy economists, lawyers, and institutional investors, that corporate governance is relevant only for publicly listed companies where there is a principal-agent relationship between shareholder and management. There was also the great debate on shareholders and stakeholders, with powerful voices arguing that the very concept of ‘stakeholder’ is void, and that the suggestion of corporate governance in terms of accountability to stakeholders would dilute the principle of accountability and render its practice impossible as there are too many stakeholders with too many interests. There was what I would call an attitude of dismissiveness towards corporate social responsibility and corporate citizenship, which were treated more as charity work by ‘do-gooders’ rather than issues for serious board directors. There was also a strong argument from financial economists that the primary development function of corporate governance is purely to improve the transparency and efficiency of national and international capital markets, and that an efficient and liquid capital market would rapidly lead to investment and consequential economic growth.

Today, very few people appear to deny that corporate governance for state enterprises and for family companies is not just desirable but essential. Indeed, corporate governance structures and practices are being extended to government departments and executive agencies as well as enterprises. There are still debates about the rights of stakeholders, but there has been a significant shift to the concept of the ‘enlightened shareholder’ who recognises the interests (if not the rights) of stakeholders and takes these into account together with the short interests of the shareholder when making decisions for the long term benefit of the company as a whole. Corporate social responsibility and corporate citizenship are now part of the standard lexicon of board directors – many of the largest companies in the world follow Triple Bottom Line accounting and reporting, while the Association of British Insurers, representing most of the largest institutional investors in Britain, produced guidelines on social responsibility in 2001, which they themselves said would have been unthinkable two years previously. While no-one denies the importance of corporate governance in promoting transparent, efficient and thus more liquid capital markets, and thereby greater investment and growth, the Monterey Development Summit earlier this year recognised the broader and vital role which corporate governance can play in national development.

Mr. Chairman, the most striking feature of this shift in opinion is that, according to my perception as quite an active participant in the global debate, it was heavily influenced by developing countries. The perceptions of the challenges of corporate governance in developing countries was certainly different in developing countries than in the industrial countries. For example, I do not recall any developing countries even considering that corporate governance is not applicable to state enterprises. Indeed, when I personally became first involved in corporate governance as a policy analyst it was to deal with problems in the state enterprises here in the sub-continent in the mid-1980’s. All the issues which seemed such a radical challenge to conventional wisdom in the industrial countries three years ago were part and parcel of the prevailing ideas of corporate governance in the developing countries. I recall when Mervyn King of South Africa attended the first Global Corporate Governance Forum at the World Bank Meeting in Washington in 1998, and affirmed that responsibility to stakeholders is perfectly compatible with accountability to shareholders, and later that appropriate corporate social responsibility is an essential part of a company’s ‘license to operate’ from the host society. In India, I have seen that social responsibility has long been a fundamental part of corporate governance, and included in the model company reports recommended by the CII. I find that the cutting edge of thinking on corporate governance comes from the King 1 and King II reports from South Africa, and from the numerous reports in India – from the Company Law Reform, from SEBI, from CII, and from the professional institutes.

So in this context of contrasting and changing perceptions, what are the main corporate governance challenges for developing countries ? And are they likely to be the same as those in the industrial countries ? As a starting point, let us see the key issues which have been identified in the industrial countries. In the United States, the tone is set by the fall-out from Enron – tighter regulation of the accounting profession, segregation between the research and investment advisory arms and the trading arms respectively in investment banks and stockbrokers, greater investigative and punitive powers for the regulators. In Japan – I have to be frank and say that Japan looks to me like an empty space in corporate governance terms. There is clearly a need and there seems to be some activity in the banking sector, but unless I have missed some real breakthrough during my recent rather hectic travel schedule I do not see new directions in Japan. In Europe the tone is set by the ‘Winter Group’ – the reports on corporate governance being prepared by the team led by Professor Winter for submission to the European Union. The key issues which have been identified by the Winter Group are :

To this list I would add a focus on corporate governance for the institutional investment funds themselves. For a decade now much of the pressure for good corporate governance has come from the international investment funds – CalPERS, TIAA, Hermes, and the others – who have rightly insisted on high standards of transparency, accountability and probity from the companies and countries where they invest their collective trillions of dollars. But there has always been the question of who guards the guards themselves – who governs the governors? What are the standards of accountability, responsibility and transparency to be expected from a major investment fund which has the power to destroy a company and even a whole country by suddenly withdrawing all investments, causing share prices to tumble and a crisis of confidence ? The Myners Committee in UK was the first comprehensive approach to setting corporate governance for the investment community, and I would expect the ideas and practices of Myners to be extended to other countries.

Are these the main corporate governance challenges for the developing countries ? Certainly all these issues are to be included, and none can be neglected. All are standard fare for corporate governance, and improvements in all of these should lead to the gains in investment and employment to be derived from efficient capital markets, and to increased trust in companies and their directors.

But are these the only challenges ? I do not think so. I perceive that developing countries will have additional corporate governance and public governance challenges which will make their task even harder. Despite the enormous progress which has been made over the past five years (and let us never forget how short is the history of corporate governance in development) there is still a long road ahead.

It is necessary to start with the basics. As I have argued earlier, corporate governance can be seen as a means to the end of accelerated and improved national economic and social development, and if corporate governance cannot be seen to make a significant and direct contribution to the process of development it cannot be seen to be a priority in developing countries – it will be a useful adjunct of development, but more of a luxury than a necessity. Hence corporate governance must be able to and be seen to contribute to the challenges of development – not all of them, but a significant number. It must be harnessed as a policy instrument which will promote investment, growth and diversification, and thereby create employment which will help to overcome poverty. I suggest that this will require more than the conventional approach that improved corporate governance will lead to more efficient capital markets. I suggest that corporate governance can be linked to a number of development objectives and assigned development targets as a policy instrument.

More specifically, Corporate Governance can be a policy instrument contributing to :

The goal of corporate governance as a policy instrument is to stimulate a developmental “Chain Reaction” in the economy, setting off a sequence of actions which can have the cumulative impact of directly contributing to growth :

How is this ideal world to be achieved ? First of all through a national strategy which seeks to identify and prepare all the key elements for a comprehensive corporate governance programme. The Commonwealth Secretariat has prepared such national strategies which are being implemented in various stages in a number of countries. This national strategy must be formulated by the government and the corporate sector in partnership.

The second method is through the strengthening of corporate governance professional institutions, which need to generate both the ideas and the thinking to guide the strategy, and to provide the institutional base for training, professional development and the monitoring of professional standards.

Third, through the training of a critical mass of directors, in sufficient numbers to make a difference to the performance of the economy – and the numbers will obviously vary between huge countries like India which need tens of thousands of directors to small island economies which will need just a few hundred. The training will need to be sufficient to be credible to investors, staff and the public. It is a matter of real concern that in almost all countries in the world it is possible to become a director of a company, and thereby be part of a cadre of people who influence the economic destiny of their nation, without any preparation or training for the job. This cannot be right.

Fourth, through the application of a number of ‘micro-instruments’ which can still have a powerful effect on the whole company, and cumulatively on the whole economy. For example, it has long been recognised that too many boards spend too much time analysing past performance and neglecting future activities. Indeed, I am constantly horrified at the numbers of companies which do not have a strategic plan, or have a minimal plan based on a simple SWOTS analysis. There is already evidence from a few countries that the encouragement of boards to spend at least 50% of their time on strategy and risk management can do wonders for the company performance. Similarly, far too few companies evaluate the performance of their directors and of the board as a whole. The introduction of a range of these ‘micro-governance’ instruments can have a powerful effect on the efficiency and performance of the boards, and thereby on the companies, in the same way that benchmarking, TQM and ISO can help transform the management of companies.

One particular micro-management technique is worth special mention, and that is the requirement for the management to report any case of corruption, such as the demand for a bribe, and the evidence of malpractice, in the monthly management and financial report. Only a few companies do this – but if it became widespread practice in the corporate sector it could lead to a transformation of business practices, because it would make the board, not just the line managers, knowledgeable and accountable for corruption. I am not holding my breath waiting for this practice to be widespread, but it is one which could make a powerful difference to the credit rating of a company and a whole country.

The combination of all these measures should send a strong signal to the markets to encourage domestic and international investor confidence – and this reflects what may be the major challenge for developing countries, namely to boost investor confidence, both domestic and international. Investor confidence has taken a beating everywhere in the wake of the collapse of Enron and Arthur Anderson, and in the future we may actually have to be grateful to both these companies for giving us a savage but salutary reminder of the damage which is done when we stray from the proper standards of corporate governance. But investor confidence will not be satisfied by improvements in corporate governance alone. Good corporate governance cannot survive in a country which has poor public governance, and so an inescapable challenge for developing countries will be to forge the links between good corporate and good public governance. The linkage has already been made explicit in NEPAD, the New Partnership for African Development, set between African governments, multilateral agencies and the G7 countries, and this has set a precedent which will apply elsewhere. We have received the message from the institutional investors some years ago – no corporate governance, no investment. We are now hearing the message – no public governance, no investment.

As a final note I cannot avoid mentioning the challenge of HIV-AIDS. In terms of effecting a large percentage of the population, this is not a problem in India. But in many developing countries it is – the worst effected countries have over 40% of their population infected, and what has been a medical problem of the worst sort is now rapidly becoming a human resource problem as companies and countries face critical skills shortages. This is also a corporate governance problem – and has been fully recognised as such by South African companies, and many companies in other parts of Africa, the Caribbean, South East Asia and the Pacific, which have reached pandemic levels of infection.

Mr. Chairman, ladies and gentlemen, I hope that I have managed to stimulate your thoughts and encouraged some debate by highlighting some of the critical corporate governance challenges for developing countries, and I look forward to discussion on the subjects I have raised – and on some which I have not had time to raise. Thank you very much for your attention.

Corporate Governance-Academy of Corporate Governance
Address by Dr E A S Sarma
Trustee, Academy of Corporate Governance (ACG), Hyderabad
on the occasion of the
First Foundation Day of the ACG