Good corporate governance – It is not systems but people

The final module of the popular series of seminars conducted by the Sri Lanka Institute of Directors (SLID) under ‘Contemporary Views on Corporate Stewardship and Boardroom Governance’ took place amidst a significant gathering at the Cinnamon Grand, Colombo.

The module, aptly titled ‘Governance Issues of Specific Organisations,’ took a shift away from the previous five modules with an attempt at focusing on the key institutes of banks, SMEs and other financial institutions and their affiliation with corporate governance.

As pointed out by Nithya Partners Precedent Partner Arittha Wikramanayake, who played the role of Challenger/Leader of the evening, this was a “fitting end to a series of programmes that focused on the aspect of corporate governance as a general, all consuming principle”.

Instead he opted to swing away from the standard view of promoting governance to a study on its impact on the common citizen and its pros and cons with regard to certain institutions.

Assisting Wikramanayake in this venture were Institute of Certified Management Accountants of Sri Lanka (CMA) founder and President Prof. Lakshman Watawala, CCC Solutions CEO/Managing Director Prema Cooray, John Keells Holdings President and Group Executive Committee Member Krishan Balendra and Ceylon Cold Stores PLC Director Prasanna Jayawardena.

Concept of corporate governance

Wikramanayake playing the devil’s advocate questioned the audience as to whether we really needed this so-called governance. The concept of corporate governance itself made its entry in the ’90s as an important set of guidelines that needed to be followed in business transactions.

Prior to that period the business community in Sri Lanka consisted of a handful of the elite, which made communication easier and swifter. But with the flood of more and more investors due to the Government’s decision to broad-base the capital market, the need for governance itself took on a life of its own, with the corresponding duty being placed on the Government to protect such people.

The various crises around the world also prompted the need to bring in more rules on corporate governance, as in the case of the Standard Code of the Colombo Stock Exchange (CSE), which is required to be followed by public listed companies and the codes laid down by the Central Bank, which are to be followed by banks and financial institutions.

Standards of corporate governance

“The question is, do we need the same standards of corporate governance for the SMEs and private companies? Corporate governance is not a religion. In my opinion every institution must attempt to do some soul searching and decide what is best for them so that they are able to discharge their obligations for running a company efficiently towards their stakeholders,” stated Wikramanayake.

“Not every institution is the same. Obviously you can’t have six different rules, but you must create a standard code of conduct as what has been done in the case of public listed companies, but as far as a small and medium enterprise or a private company is concerned, I don’t think that they can pick up the code of corporate governance that has been formulated by the Securities and Exchange Commission (SEC) or any other regulatory body and expect to follow it. In such a situation, what would take place is merely playing lip service to the rule,” he continued.

Especially with regard to banks, the need for a custom made code of principles is important because of the large gamut of stakeholders involved in them; ranging from the shareholders to the employees, the community and the depositors, etc. These institutes also have a responsibility towards the regulator and the community as a whole, because of the huge ripple effect it may cause in the event of a crash.

Need for a specialised code

Joining in the discussion, Prema Cooray drew from his own experience with SMEs and saw the need for such a specialised code. Having dealt extensively with such enterprises in his tenure at the Ceylon Chamber of Commerce, he went on to refer to a theory of corporate governance being relevant to SMEs and public companies in equal force.

“In sense all companies, be it public, private or SMEs, all want to do well. They have directors and other personnel who run this in order to make it work within a certain structure. It makes sense to follow good practices, but the method in which it needs to be done will probably differ from a listed company to a SME, because of the very nature of the structure,” he stated. In other words, you need to follow good practices to be recognised as a good company by your stakeholders.

On being questioned on the above, Cooray upheld that “in terms of sustaining the business, it matters. If you advice a SME that it is good to have directors overlooking advisory bodies and have checks and balances to maintain good records and make good decisions, they might ask you if it makes good business sense to them. My experience has been that you may ask them to do this, or be this in five years’ time, but they will not buy it, but would rather look at how they can survive and go along with the present, rather than the future. If you want to incorporate good practices in them it has to make business sense to them.”

Due to their limitations in resources and access to finance, it becomes important to show them that in their operations, whatever initiative brought in, will in turn bring in some efficiency, which follows some benefits to the company.

Since even the smallest of initiatives to be implemented needs a certain amount of money, it becomes important to show them that the end result will be an increase in their revenue. Cooray continued that he was currently involved in two programmes with SMEs to provide advice, consultancy, walk in through audits, energy audits, etc.

Importance of a specialised code

Krishan Balendra referred to his own experience at John Keells Holdings PLC and its number of independent directors to impress upon the importance of such a specialised code.

Referring to the Cadbury Report that dates back to the early 1990s, on which most modern corporate governance rules are based, he pointed out that the report itself didn’t form regulations of governance, but instead introduced a set of checks and balances that could be implemented in companies.

Although at its inception John Keells had a majority of executive directors that number became lesser and lesser over the years until today the majority of its directors are independent directors as opposed to executive directors. However, he stated that this was not a process that took place overnight.

“Lots of thought and debate went into this prior to the shift to having independent directors. Certainly one recommendation would be to have outside parties on the board, to have an audit committee with an outside party heading it, even committees like the nomination committee and the remuneration committee to have outside parties heading it. In choosing these outside parties it is important to choose people from varied backgrounds.”

Balendra recommended that separate codes of guidelines be applicable to the said institutions and the appointment of independent directors. When choosing these parties with varied backgrounds it was important that they appreciated the subtlety between getting involved in operations and getting involved in governance and strategy. However, such an exercise was easier said than done as it entailed a huge cost in compliance as well as time.

Cost of compliance

Prof. Lakshman Watawala chose to have a different viewpoint on the matter. On one hand along with the benefits of compliance there was also the cost of such compliance. Taking the example of some companies in the United States of America, they still crashed despite the existence of these various committees in force. It could be argued that the above would not have occurred if the proper compliance and controls were in place.

“The cost of not complying can result in more cost than the cost of compliance.” The difference however exists between the controls on paper and practice. “Satyam won an award for corporate governance in India, but yet they fell into trouble with fraud committed by their own proprietor and others,” he added.

He further went on to comment on the International Financial Reporting Standards (IFRS) existing in the USA and the new accounting standards due to be introduced in Sri Lanka in the near future.

The Sri Lanka Financial Reporting Standards is due to be enforced in 2012 and the installation will cost a substantial amount of money. For SMEs however there is a separate standard with regard to financial reporting as well as accounting, which would entail being looked after better and having less reporting.

Independence of independent directors

Answering a question on the probability of independent directors being completely independent, Prasanna Jayawardene was of the view that the remuneration that such a director gets can be substantial and therefore to some extent qualify or dilute such a director’s independence.

The matter was also raised as to whether an independent director is actually in a position to make proper informed decisions due to the fact that a board meets only once or twice a month, limiting the chances of an independent director being kept informed of the changes that take place in the company.

Jayawardene responded: “I don’t think it’s the role of an independent director to get involved in the day-to-day proceedings of a company. He is there primarily to oversee the general direction in which the company is going and to make sure that he represents an independent view.

“A company should not pay an independent director excessively and also it must be ensured that the independent director so appointed is not in any way dependent on the remuneration. Further, an independent director must know what the law and its requirements are. The law indeed places a higher responsibility on such directors, particularly in the event of a company that has very powerful shareholders. The various codes of governance might give the impression to the investor that they are protected by the regulator. Could this result in being counterproductive?”

Cooray quipped, “If a situation arises where a director cannot voice his opinion, then it is the time for such a person to quit.”

“However on the other hand it could also be pointed out that if a director representing a minority view decided to step down because of the above, that may be the situation in which such director should ideally hang in there and represent that minority view,” added Balendra.

However, such instances may hardly take place due to the fact that independent directors are ultimately appointed by the majority shareholder, thus in a way limiting the whole prospect of governance being exercised in such a company. As stated by Cooray, “Corporate governance after all is a set of rules, crystallising certain principles of common sense and principles of good practice.”

The question was raised as to whether good governance prevailed due to the existence of strict regulations and codes and also whether they were sufficient in providing an unswerving obligation on the respective parties to be bound.

Referring to the various provisions found in these codes, Balendra opined that regulations are and can be prevalent extensively, but are “going through the motions rather than being effective”. Taking the provision on ownership rights in banks, and its limitation of 15% as well as existence of effective independent directors, given the structure, who is really responsible for the failure in such a company’s practice of governance?

Dog-eat-dog culture

“Corporate governance is not something that will come from within in this country. We don’t have a culture of self regulation in this country unlike other countries. And it’s a dog-eat-dog culture, to be frank.” stressed Wikramanayake.

The lack of a perfect regulatory system, the existence of an unlevelled playing field between the listed and private companies and the lack of a proper regulatory body in respect of private companies were some of the reasons pointed out by Wikramanayake for the above.

“Most companies are regulated by the Central Bank, which cannot do its own examination. It delegates that function to approved auditors. In this instance the regulator becomes a stakeholder. There is a duty to give proper accounts so that it can be monitored properly. Not only the regulators but we as stakeholders, shareholders, and customers have also to play a part in this, for example authorised financial companies accepting deposits.”

Referring specifically to banks and financial institutions, Watawala impressed upon the need for specific controls on governance matters with regard to the above. “You have the shareholders and they are accepting deposits from the public. As such the public has to have the confidence in them. The Central Bank in addition to the rules and regulations imposed by the SEC needs to have more guidelines, such as all banks and financial institutions being listed. All shareholders must be educated and guided in the right direction.”

The carrot and stick approach

The panel also referred to the various approaches used in HR practices, such as the carrot and stick approach in which the former refers to the incentives or a promise of incentives to employees, at successive intervals to ‘get the job done’.

The stick approach incidentally was an approach which used force and aggression in fulfilling the above. It was felt that the stick approach was more suitable in the business market although a doubt remained as to its success due to the fact that it was ultimately exercised by the regulator and the shareholder.

“In some of the bigger markets it is a statistically proven fact that the companies that are perceived to practice better governance trade shares at a premium to those that are perceived to not have good governance. But in this market most companies are controlled, free floats are small, market is not efficient and the people running the company are not incentivised to keep the share trading at a premium,” stated Balendra.

He went on to point out that in other markets where the senior management has e-stocks and there is an incentive to have the share trading at a premium, they tend to have a projected image of good governance.

On being questioned on the application of the stick approach and as to whether the stick has to come through law or the education of stakeholders and shareholders of their rights, Jayawardena preferred the former.

“Educating your stakeholders and shareholders is not the stick approach but the carrot approach where the shareholder has a certain expectation from you. The only way in which you can implement the stick approach is through legal sanctions in the event of failure to perform.” He further pointed out several provisions found in the Companies Act of 2007 which exemplified the above:

• As a director if you see a serious loss of capital there are some legal requirements expected of you which if you don’t take you can be held personally liable for such loss.
• If you found that at anytime the company is unable to settle its debts then at a board meeting you must raise the question as to whether the company must be put up for liquidation. If not you may be held personally liable in the event the company is placed in liquidation.
• If you are part of the company when a major transaction takes place without going through the correct channel then again you can be held personally liable.

“The problem today is that many of the directors don’t realise how big a stick it is and how close to the head it hangs,” he declared.

A question was raised by a participant on the availability of a systemised approach to safeguard that a best practice was actually being followed. For example if the chairman is independent, then the corporate governance becomes better vs. otherwise.

“I don’t think systems make good governance, people do. Very ‘clear’ people who are proud of what they do and are equipped with the right tools can ensure that there is good governance. Directors must know the Articles of the company and the provisions of the Companies Act,” concluded Wikramanayake.

This was indeed a very interactive session meticulously handled by Wikramanayake and brought to a close the final of the six modular series of ‘Contemporary Views on Boardroom Stewardship and Corporate Governance’ conducted by SLID.

The institute has plans to continue its drive to educate the directors of the Sri Lankan boardroom and to be the medium of knowledge through which they could be transformed in to dynamic stalwarts of business leadership.