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.

HTN7: Promoting Good Corporate Governance10 December 2003

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 countrys 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.

HTN7: Promoting Good Corporate Governance10 December 2003

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 markets 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.

HTN7: Promoting Good Corporate Governance10 December 2003

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 (20012002) 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: cgsecretariat@worldbank.org. 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 countrys 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 UKs 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

HTN7: Promoting Good Corporate Governance10 December 2003

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 sectors 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 NEPADs 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 NEPADs aim to
HTN7: Promoting Good Corporate Governance10 December 2003

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 Bangladeshs reform movement. A secondary outcome was the establishment of the South Asia Corporate Governance Network, which is aimed at mobilising the regions 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 PDs Investment, Competition and Business Development Services Team, to whom comments on this Note and recommendations for further Notes should be addressed: PDInvestmentTeam@dfid.gov.uk

HTN7: Promoting Good Corporate Governance10 December 2003