HOW TO PROMOTE GOOD CORPORATE
GOVERNANCE
“The proper governance of companies will become as crucial to the world
economy as the proper governing of countries…. strong corporate
governance produces good social progress. The two go together.”
James Wolfensohn, 1999
What is Corporate Governance?
Corporate Governance hit the news in 2001 and 2002 with the collapse of
global corporations such as Enron, WorldCom, Global Crossing and the
international accountants, Andersen. These were blamed on a lack of
business ethics, shady accountancy practices and weak regulators. They
were a wake-up call for developed countries on corporate governance. Prior
to this, commentators had focused on failings in developing countries blaming the 1997-98 East Asian crisis on poor corporate governance, crony
capitalism, poor management practice and lack of disclosure and
transparency.
Corporate governance has come to encapsulate the blend of law, regulation
and private-sector practice that enables companies to attract financial and
human capital, to perform efficiently, and generate long-term economic value
for their shareholders, whilst respecting the interests of stakeholders and
society as a whole. Corporate governance needs to be addressed at two
levels:
The country level. Various regulatory and enforcement mechanisms are
important, such as the need for bankruptcy laws, property rights and an
effective judiciary. A corporation cannot operate effectively if it is unable to
rely on legislation and its enforcement. Good corporate governance therefore
requires good political governance, and vice versa.
The corporation. Corporate governance at the company level refers to the
rules and regulations that shape its effective operation.
Complementary interaction between these two levels is vital to ensure the
effective operation of the private sector, in a manner that is both accountable
and transparent.
In 1999, the OECD issued five Principles of Corporate Governance (see
Table below). These principles, which are non-binding, have been widely
accepted as providing the broad framework for countries to use. It is
expected that countries should then adopt their own country-owned corporate
governance frameworks taking account of their unique culture and regulatory
and legislative systems. The World Bank argues that these frameworks
should be based on four ‘pillars’ - of responsibility, accountability, fairness and
transparency (RAFT). In conjunction with the OECD Principles, these four
pillars are key to ensuring equitable growth and a flourishing private sector.
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OECD Principles of Corporate Explanation
Governance
(1) The rights of the shareholder
A corporate governance framework should
protect shareholders’ rights.
(2) The equitable treatment of shareholders All shareholders should be treated equally,
including minority and foreign shareholders.
(3) The role of the stakeholders in corporate Good corporate governance recognises that it is
governance
in the long-term interest of the corporation to
respect the rights and interests of the
stakeholders.
(4) Disclosure and transparency
There is a need to ensure timely and accurate
disclosure of all material matters regarding the
corporation
including
financial
aspects,
performance, ownership and governance.
(5) The responsibilities of the board
The board is key to the strategic guidance of the
company and the effective monitoring of the
management.
It should be fully able to
undertake its tasks and responsibilities and be
fully accountable to shareholders.
NB. The OECD Principles of Corporate Governance (1999) are currently being reviewed in
order to take into greater consideration the view of non-OECD members. The review will
include a wide consultation process and be finalised by 2004.
Why Corporate Governance
Development Goals
matters:
Towards
the
Millennium
DFID has been working for some time to ensure that the public sector in
developing countries is more accountable. However, the private sector is the
main driver of a country’s economic growth and it too needs to be
accountable. Good corporate governance increases the integrity and
effectiveness of the private sector and helps markets to operate more
effectively. This matters for many reasons, including:
•
•
•
•
•
•
Avoidance of business scandals, which damage trust in business.
Value placed on good corporate governance by institutional investors.
Growing involvement of the private sector in service delivery.
Need for systems to prevent and deter corruption in developing countries.
The deregulation and integration of capital markets.
Recognition of the importance of harnessing domestic savings for
economic growth.
• The risk of financial crisis and contagion.
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McKinsey 2002 Survey (available at www.gcgf.org)
The McKinsey Survey, commissioned by the Global Corporate Governance
Forum in 2002, surveyed institutional investors managing $2 trillion of capital.
An overwhelming majority stressed the importance of good corporate
governance in their investing decisions.
• The survey suggested that institutional investors would be willing to pay
more for shares in companies that exhibited high governance standards.
Suggested premiums for companies averaged 12-14% in North America
and Western Europe; 20-25% in Asia and Latin America; and over 30% in
Eastern Europe and Africa.
• A third of investors stated they would avoid countries with poor corporate
governance.
In sum, good systems of corporate governance are required by developing
countries in order to bolster overall trust in the private sector and to make the
most efficient use of available capital.
Novo Mercado, Brazil
In reaction to concerns about corruption and poor corporate governance,
which were curtailing the Brazilian market’s ability to attract capital, the
Brazilian stock exchange, Bovespa, took the unparalleled step of setting up
an alternative market in April 2001. The new market, the ‘Novo Mercado’,
require companies that list on it to comply with minimum corporate
governance practice. Through its minimal corporate governance criteria on
voting rights, improved disclosure requirements and the requirement to
comply with international accounting standards, it aims to ensure that
management is more accountable to shareholders. Whilst it is still early days,
this innovative move of the public and private sector, with support from the
international community, demonstrates that corporate governance is
recognised by investors.
Issues to be aware of when supporting Corporate Governance reform
Identify a National Champion. To achieve reform it is often necessary to
find a national champion to drive it forward, which may be from the private or
public sector. Possible candidates include the Ministry of Finance, the
relevant regulatory bodies, the stock exchange, and the central bank or
private sector leaders. A useful starting point may be to propose the writing of
a code of corporate governance.
Consensus building. There may be a need to build greater understanding of
the implications of corporate governance for developing countries. This can
be done through linking with international bodies involved in corporate
governance, such as the Global Corporate Governance Forum (GCGF) (see
below) or the Commonwealth Association of Corporate Governance (CACG)
or regional bodies such as the Pan African Consultative Forum on Corporate
Governance.
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Global Corporate Governance Forum (GCGF) (www.gcgf.org)
The OECD, the World Bank, and the Governments of the United Kingdom
(represented by DFID), Luxembourg, the Netherlands, Norway, Sweden,
Switzerland and the United States, established the GCGF in 1999. DFID
chaired the steering committee for the first two years of operation (2001-2002)
and actively encouraged the participation of developing countries. Partly as a
result of our efforts, India joined in early 2003. The GCGF aims to build the
understanding of corporate governance in developing countries through
conferences and round tables, supporting a research agenda through its
establishment of a global Research Network, and provision of capacity
building and technical assistance. The GCGF has set up a Private Sector
Advisory Group (PSAG) made up of key international representatives of the
private sector in order to bring the private sector and policy makers together
to agree what needs to be done to facilitate greater investment. The GCGF
Secretariat,
in
Washington
DC,
can
be
contacted
at:
[email protected].
Mobilising the private sector. The private sector is integral to corporate
governance reform. DFID needs to work in partnership with the private sector
in order to facilitate better understanding of corporate governance and to
harness its enthusiasm for reform. Potential platforms for engaging the private
sector in the debate are local commercial or professional membership
organisations, which have often led the development of codes of corporate
governance. See also the NEPAD Business Group below.
One size does not fit all. Corporate governance structures should be
adapted to the unique characteristics of a country. The OECD principles are
voluntary, but can be used to inform a country’s own code. For example, the
OECD Principles were used as a starting point in writing the King Code II of
South Africa and the Kenyan Corporate Governance Code, which are codes
‘owned’ by the private sectors of the countries concerned.
Statutory vs voluntary: the role of regulation in corporate governance.
Although the OECD principles are voluntary, there is a debate on whether
country codes should be voluntary or statutory. The UK’s ‘Combined Code’
on corporate governance provides for voluntary compliance but statutory
disclosure for departure from the provisions of the code (comply or disclose).
Other countries have taken different views, such as India (where the code is
mandatory).
Institutional capacity constraints: one rule for all? Corporate governance
cannot be applied broad brush to all companies. Imagine forcing a company
of 10 employees to have 2 non-executive directors on the board! Corporate
governance must therefore have a tiered nature depending on the size and
value of the company in order to balance burden against benefit.
Corporate Social Responsibility (CSR). CSR is an important complement
to corporate governance. CSR looks at the way companies can add social,
environmental and economic value to the society in which they operate
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through their core activities. In other words, CSR is concerned with
responsibility to the company's wider stakeholders. (See How To Note on
Approaching Corporate Social Responsibility).
Corruption interface. Corporate governance provides the basis to protect
shareholders, to treat stakeholders fairly, and ensure transparency and
accountability of managers. Corporate governance therefore works to
underpin government regulations, by focusing on the private sector’s desire to
operate efficiently, and to provide a framework in which bribery is made more
difficult.
Accounting and Auditing. In the post-Enron / Worldcom world, there are
calls to reform the accounting and auditing professions, and for greater
recognition of international accounting and auditing standards. There are also
calls for greater regulation of the professions. Whilst these debates are
ongoing, the FIRST Initiative can provide technical assistance in the
upgrading of financial sector architecture (see box below).
The FIRST Initiative (www.firstinitiative.org)
The FIRST Initiative is a US$51 million multi-donor project, supported by
DFID, which provides technical assistance grants to recipients in developing
and transition countries for capacity building and policy development in
financial sector regulation, supervision and development. FIRST is aimed at
supporting the 12 Key Standards for Sound Financial Systems recognised by
the Financial Stability Forum, which include corporate governance, accounting
and auditing.
How is DFID helping Developing Countries to improve their Corporate
Governance?
DFID recognises that corporate governance is a key element in the
investment climate of developing countries and aims to support the
improvement of corporate governance in those countries. In addressing this
agenda, DFID is supporting the following initiatives:
•
At the International level, DFID is a donor and member of the steering
committee of the Global Corporate Governance Forum (GCGF).
Developing country governments and institutions interested in improving
their corporate governance regimes may be directed to the GCGF
Secretariat. (See box above)
• DFID supports the FIRST Initiative, which provides Technical Assistance
to the financial sector. It is currently being proposed that FIRST also
provide TA on corporate governance in the wider economy.
• At the regional level, DFID is supporting the 2nd Pan African Consultative
Forum on Corporate Governance, which is a good example of an
initiative aimed at agreeing a best practice framework and building country
capacity to implement good corporate governance in African countries.
• DFID is fully supportive of NEPAD’s goal of improving corporate
governance in member states as a key element of economic development
and eliminating poverty in Africa. Following the G8 Summit in Kananaskis,
the G8 Africa Action Plan was released which supports NEPAD’s aim to
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improve corporate governance in Africa. DFID is providing financial
support for the new NEPAD Business Group which is a private sector
body set up to complement the NEPAD initiative and is well placed to
further the understanding of corporate governance in Africa.
• Policy Division, with DFID Bangladesh, is supporting a comparative
analysis of corporate governance practice in South Asia (to include
Bangladesh, Pakistan, India and Sri Lanka) with the primary intention of
supporting Bangladesh’s reform movement. A secondary outcome was the
establishment of the South Asia Corporate Governance Network, which is
aimed at mobilising the region’s corporate governance agenda.
• Policy Division has completed a project that examined the role and
significance of corporate governance for banking operations. The report
is available on request.
For further information contact:
Investment, Competition and Business Development Services Team
Policy Division, DFID, London.
This Team belongs to the Pro-Poor Growth Cluster in Policy Division and has
drafted this Note, which forms part of a series of short “How To Notes”
intended to be of practical value to all those working on Private Sector
Development agendas in DFID Country Offices and Regional Policy
Departments. The series is being co-ordinated by PD’s Investment,
Competition and Business Development Services Team, to whom comments
on this Note and recommendations for further Notes should be addressed:
[email protected]
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