OF late, the issue of governance has been in the limelight. I have just returned from the Asian Shadow Financial Regulation Committee (ASFRC) meeting, held in conjunction with the Asian Financial Management Conference in Singapore.
Corporate governance (CG) was the sole preoccupation of the 10 ASFRC members present. To better cope with the unique characteristics of corporate Asia, its communiqué emphasised that real improvements in governance have become ever more urgent and critical.
Furthermore, new recognition that financial institutions should “assist in protecting taxpayers... creates new challenges” for their boards of directors. This realisation can result in a “potential dilemma” which requires a new mindset to resolve.
The big picture The recent financial crisis, triggered by the bankruptcy of Lehman Brothers, raised serious issues on governance of SIFIs (systemically important financial institutions) and how they are regulated and supervised.
The massive injection of public monies in the United States and Europe – estimated at up to 25% of gross domestic product – raised a huge outcry among taxpayers about the moral hazard and the diminished responsibility of private stakeholders.
The European Commission’s Larosière report highlighted three crucial gaps: Boards of directors (BoDs) and supervisory and regulatory authorities (SRAs) failed to understand the nature and scale of risks taken, shareholders failed to effectively perform their role; and lack of effective control mechanisms led to excessive risk-taking.
What’s most worrying is that CG determines and regulates business life, which raises the question: Is existing CG deficient or at best, badly implemented?
Traditionally, CG is relied upon to chart the relationship among senior management, BoDs, shareholders and other stakeholders (e.g. employees, society at large, creditors), and to determine the organisation and means used to meet goals and monitor their implementation.
But interdependence and connectivity among fast growing SIFIs can lead to systemic risks. In the recent crises, this led governments to shore-up bad large banks with public funds. Consequently, taxpayers have since become reluctant stakeholders – adding a new dimension of CG.
At the heart of it all, as I see it, is greed, mostly at the expense of the innocent, perpetuated within organisations supposedly well-run by professionals with business acumen.
In reality, key management were lying, living-it-up and cheating, or just being downright suckered by liars and cheats around them. Those charged to notice didn’t do so, or failed to raise their hands.
To reform, an effective CG system (based on smart control mechanisms with checks and balances) must make the main stakeholders (BoDs, owners, senior management) assume greater responsibility with transparency.
Bear in mind rule-based supervision focused on internal control, risk management, audit and compliance structures could not prevent excessive risk taking by SIFIs. To restore confidence, a number of critical issues have to be addressed.
Conflict of interestThe model of shareholder-owner who looks to long-term business viability has since been severely shaken. The emergence of new shareholders with little long-term interest have amplified risk-taking for short-term gains (and contributed to excessive remuneration).
This is reminiscent of the old Jack Welch adage that a firm’s sole aim is to maximise shareholders’ return, which dominated US business for the past 25 years.
With the crisis, even “Neutron Jack” had since retracted: “(Maximising) shareholders value is the dumbest idea...” he said last year. Traditionalists in the US and UK showed disdain for “stakeholder capitalism” practised in Europe where interests of employees, creditors and society at large are taken seriously.
Such conflict came to the fore in the recent BP US oil spill – many BP shareholders were eyeing hefty dividends and didn’t pay enough attention to environmental risks.
Given systemic risk and the high volume, diversity and complexities of SIFIs’ business, conflicts of interest can arise in a variety of situations, ranging from exercising incompatible roles and activities to clash on performance measurement between management and shareholders/investors.
The current travails of Goldman Sachs epitomises the conflict. When it went public in 1999, Goldman embraced the axiom of maximisation of shareholders’ value.
As wooing sustainable customers became increasingly important, concentration on maximisation over the short-term put at risk building stable relationships that rely on long-term success.
Or, when US Senators questioned Goldman on their fiduciary duty to clients when selling them sophisticated products, it admitted caveat emptor is the only rule.
To improve CG, perhaps long-term shareholders (LTShs) should be given more clout. In the US, shares traded on the New York Stock Exchange changed hands every three years on the average in the 1980s. Today, the average tenure is less than a year (10 months).
Last year, a taskforce comprising seasoned investors (Warren Buffett, Peter Peterson, Felix Rohatyn, et.al) advocated in a report “Overcoming Short-Termism” measures to encourage LTShs, including withholding voting rights for new shareholders for a year.
Netherlands is considering loyalty bonuses for LTShs. Roger Carr (Cadbury’s ex-chairman) suggested that investors who bought shares in a takeover bid should not be allowed to vote on the offer.
Would these work? As I see it, the real issue is not the length of time investors hold on to shares, but how to encourage them to take their duties as owners more seriously.
One hat is enoughThe US is unusual in lavishing power on chief executive officers (CEOs) who also act as chairman of BoDs (chairman).
Splitting the job is commonplace in the UK, Canada, Australia, and much of Europe and Asia. In the UK, 95% of FTSE companies have an outside chairman.
In contrast, 53% of Standard & Poor’s (S&P) top companies combine the two jobs. Activists in the US have since been up in arms against these “imperial bosses.”
In April 2009, they forced Ken Lewis to surrender his second hat (chairman) at Bank of America. The case for “two” lies in the basic principle of separation of powers.
How to monitor the boss when he sits at the head of the table? It conjures images of CEOs writing their own performance reviews and determining their own salaries.
One of the notable steps taken by troubled US banks (Citigroup, Washington Mutual, Wells Fargo) when the crises hit was to separate the two jobs. No doubt, the arguments are compelling.
Empirical evidence is not conclusive. Enron and World Com both split the jobs as did Royal Bank of Scotland and Northern Rock.
Separation has its problems – it’s harder for CEOs to make quick decisions, ego-driven CEOs and chairmen do squabble over who’s in charge, and shortage of talent makes separation sub-optimal.
Be that as it may, BoDs have since become more independent; 90% of the US S&P companies now have a “lead” or “presiding” director to act as counterweight.
Indeed, recent changes make the old-style strongman an anachronism. However, I see no one-size-fits-all solution. Best way has to be evolutionary: split or explain-why-not (comply, or explain).
Independent directorsIndependent non-executive directors (or indies) are at the apex of CG. Widely criticised during the crisis, indies failed to foresee troubles ahead or push management to find solutions.
They are usually well connected and often sit on several boards as companies seek their experience and connections. SRAs now want them to be more diverse.
Traditionally, when appointing new indies, existing BoDs are inclined to look in the mirror – appoint in their image rather than look through the window and recognise diversity.
This “old school tie” approach is too cosy. Also, BoDs need to be more transparent in recruitment. In the UK, the Financial Reporting Council code now requires firms to explain if indies are not put up for re-election.
More controversial is the annual election of chairman and other board members in an attempt to promote the best long-term performance in an intensively competitive environment.
However, says its critics, this promotes a focus on short-term results, makes boards less stable, and discourage robust challenges in boardrooms.
Good CG relies on indies to set smart checks and balances, and fix the boundaries of organisational behaviour. They hold the key to maintain confidence in the company’s integrity.
To do their job well, indies need to be independent from management, business relationships and substantial shareholders.
In practice, they ensure that internal and external rules of conduct are applied, risks taken are commercially sound and consistent with the board’s risk appetite, and future success of the business is reasonably assured.
This is an onerous task. To succeed, its best practices code needs to operate under well-defined core values which the board and management are committed.
A true indie knows how much work he can take on and still be effective. He needs no code on age, maximum appointments or terms served or time spent to bind him.
Integrity demands he will not accept a role he can’t fulfil, unlike many who comply on paper. Companies and stakeholders cannot be readily protected from the vagaries of human frailty.
Like it or not, their behaviour reflects the ethics and mores of society. What is really needed is to rediscover moral values. SRAs just can’t regulate for ethics and common sense.
Asia on the goAsian economies encounter two rather unique limitations in CG. First, cultural differences and being more “tradition-bound” place less emphasis on formal contacts but face greater subservience to authority and age.
Second, Asia has a limited pool of qualified and experienced indies since CG is a relatively new phenomenon.
While it is desirable for Asia to recognise and learn from new codes of conduct being proposed in the US and Europe, these need to be adapted and modified to fit local culture and experiences.
In Asia, while CG sets the tone, it is imperative that indies take individual responsibility not only to do the right thing by the firm they serve, but also as individuals when it comes to ethical behaviour. After all, Asia has 5,000 years of history, diversity, culture and tradition.
An evolutionary approach towards excellence in CG is what’s really needed. Best practices work best in an ecosystem of “comply or explain.”
Augmented critically by purposeful continuing education to develop and improve skills and expertise. Building, in the process, a culture of strict compliance, rigorous risk assessment and common-sense ethical behaviour. To succeed, CG and ethics must go hand-in-hand.
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Former banker Dr Lin is a Harvard-educated economist and a British Chartered Scientist who now spends time writing, teaching and promoting the public interest. Feedback is most welcome at
starbiz@thestar.com.my.
