Governance
of Corporations in a Disparate World
by
Dr Madhav Mehra
President
World Council for Corporate Governance
1. Corporate governance today in a competitive
necessity for driving business. Corporate Governance movement
began almost 20 years ago and achieved a great momentum following
Sir Adrian's report about 10 years ago. In the last few years
a series of corporate governance codes have been written in
various countries. In the last few years a series of corporate
governance codes have been written in various countries. The
question that we must ask ourselves today is where has it
led us? The corporate frauds that we are witnessing today
are far greater in frequency, intensity & magnitude. It
is naive to believe that Enron, Marconi and Vivendi are simply
isolated cases where corporations have cheated the innocent
public. Lynn Turner, Chief Accountant of the SEC from 1998-2001
who was earlier a partner of Cooper & Lybrand admitted
in a TV interview "All the Big Five accounting firms
helped Wall Street investment banking firms to engineer hypothetical
transactions to make companies look better than they actually
were". In fact, instead of bashing Enron, we should be
grateful to it for throwing open the murky world of corporates
and providing us an opportunity of getting real with the huge
problem of cleansing it. Arthur Levitt, the former chairman
of Securities and Exchange Commission tried for 4 years to
curtail the power of Accounting profession. He could not even
get the Big Five to meet in his office. Finally, he had to
hold it in the office of one of them.
2. We are also grateful to the technology
bubble without which all the frauds may never seen the light
of the day. Enron has debunked the myth of so called role
models. Enron itself was declared the "most innovative
company" by Fortune for five successive years. McKinsey,
the super consulting firm, was consultant to Enron and collected
fees of $10 million a year. A McKinsey director attended board
meetings and the CEO himself was a former McKinsey partner.
GE under super star CEO Jack Welsh is suspected of not generating
but managing earnings of General Electric. Corporate preacher
George Soros himself has been fined for insider trading. Corporate
hero Messier of Vivendi has the police raiding his premises.
Jean Claude Trichet who is to head the European Central Bank
has been put on trial for massaging Credit Lyonnaise accounts.
3. There is no shortage of egregious conduct
in the bizarre world of corporate finance. It is a tribute
to the American system that such conduct has at least been
apprehended and penalised. But this has not been due to legislation.
The manner in which Eliot Spitzer, the New York Attorney General
and William Donaldson, the Chairman of SEC has made the ten
big banks including Citibank, CSFB and Merryll Lynch shell
out 1.4 billion in fines, restitution and independent research
shows that one does not always need legislation to take action.
The fact is we are already overlegislated. Far more effective
is the determined execution.
4. The question that should come to one's
mind why all these cases are happening in America? Is America
the only country with greedy executives? A recent survey conducted
in the UK revealed that 64% of the companies dodged the spirit
of the combined code. According to Simon Low, partner at Grant
Thornton said: "Our research indicates that embedding
corporate governance best practice into the culture of an
organisation is still a long way off. Instead of wholly embracing
the changes, companies are merely ticking boxes to ensure
that they comply with the bare minimum."
5. 44% of the people surveyed in a recent
interview claim that stock markets are a sure way to ruin.
There has been a continuous weaning away of the small investor
in the market. Individual share ownership in the UK has fallen
from over 50% of the market in the 1960s to less than 20%
today. Good corporate governance should aim to bring back
that investor. Sustainable growth impossible to be achieved
until the little guy has come back to the market place.
6. "The storm that has been raised even
by a mild report on corporate governance reform by Derek Higgs
is indicative of how the system defends itself against any
change. Think what would have happened in the UK if Higgs
would have come out with something like Sarbanes Oxley Act."
He added that unbridled greed poses the biggest threat to
capitalisation. Despite the government's strong stand to get
the report implemented, it now transpires that the government
has buckled to the criticism of Higgs review by the FTSE 100
chiefs. Ms Hewitt has recently admitted that the report was
being consulted on. Consultation with industry has been going
on for the past 12 weeks and Sir Bryan Nicholson who chairs
the Financial Reporting Council stated "We are looking
at what are best left as `comply or explain' provisions and
what is better as guidance. It is not a dilution of the Higgs
report but a proper response to the process of consultation
in which good points were made."
7. The debate on non-executive directors is
missing one vital element, i.e. representation of employees
on the board. Employees have a much greater stake in the long
term future of the company than the shareholders who are interested
only in the shorter movement of the share prices. Ultimately,
the board of a multinational company must have representation
from each constituency i.e. shareholders, investors, employees
and experts.
8. Pay for leading executives had continued
to escalate last year despite falling share prices, depressed
corporates profits and increasing shareholder angst according
to a new research. Income Data Services say that total earnings,
including benefits, bonuses, payments on long-terms incentive
plans and notional gains on options exercised during the year
was up 23% in the UK. The continued lack lustre performance
of the companies and relentless demands of pay increases by
executives have put shareholders up in arms against their
directors. The problem was emphasised by Bill McDonough President
of New York Fed on the first celebration of the terrorist
attack on Twin Towers of 11 September in 2002. He pointed
out that the differential between the CEO and workers pay
which 42:1 has risen to 400:1 during the last 2 decades. Yet,
UK companies took no notice. Patricia Hewitt, the Secretary
of State for Department of Trade and Industry has expressed
her concern for payments to those who were sacked for poor
performance. She has exhorted the investors to use the change
in the law and vote on the remuneration policies and make
it difficult for the directors to reap rewards for failures.
The issues of executive remunerations, however, too complex
to be addressed effectively without a proper performance appraisal
system. Directors need to get involved on a long term basis
in reviewing the performance of executives.
9. Studies in US & UK both countries show
no link between the remuneration of chief executives and corporate
performance primarily. Over 60% of the mergers and acquisitions
destroy shareholder value which increasing CEO remuneration.
Most value-destroying companies are serial acquirers. Our
challenge therefore is how to develop proper criteria to measure
CEO success.
10. There is also a controversy raging on
the manner of rewarding the CEOs and expensing stock options.
A very valuable suggestion has been made by Sir Nigel Rudd,
the chairman of the CBI's new taskforce on boardroom pay,
that directors could receive far more of their payment in
shares, which they would be prevented from selling until they
leave their posts. The move would be a de facto punishment
for executives who drive businesses into the ground because
they would be left with a load of shares on their hands whose
value has been greatly reduced.
11. In a recent article Prof Jensen, with
Joseph Fuller of the Monitor Group, argued: "As the historic
bankruptcy case of Enron suggests, when companies encourage
excessive expectations or scramble too hard to meet unrealistic
forecasts by analysts, they often take risky value-destroying
bets. In addition, smoothing financial results to satisfy
analysts' demands for quarter-to-quarter predictability frequently
requires sacrificing the long-term future of the company.
Quarterly reports therefore are the biggest ....... of the
corporations. It is the fear of the quarterly results that
drives CEOs to .......................... objectives and inflate
earnings.
12. The glorification of greed continues with
the rape of corporations for the personal enrichment of the
senior executives and the creation of ventures whose business
plan do not extend beyond the initial public offering. Greed
is the biggest blame of the market economy and may well become
the death knell of the capitalism. So, the biggest challenge
before us is how to handle this greed. How can human behaviour
be rewarded other than through the money. One, therefore,
has to look for fundamental purpose of the corporation. It
is relevant to draw attention to Enron again in this context.
In their book on Enron's demise What Went Wrong At Enron Peter
Fusaro and Ross Miller record that when at Harward Business
School Mr Skilling was asked what he would do if his company
was producing that might cause harm - or even death - to people
who used it, he is said to have replied: "I'd keep making
and selling the product. My job is a businessman is to be
a profit centre and to maximise return to the shareholders.
It's the government's job to step in if a product is dangerous".
The traditional belief that the corporations are to maximise
shareholder value cannot hold ground in the interdependent
world of today. The value of the corporations is created by
cooperation of various stakeholders viz employees, customers,
suppliers and public policy and community at large. Such cooperation
cannot sustain unless each of the stakeholders can answer
the question: "what's in it for me?" Corporations
role, therefore, has to change to maximize the value for all
stakeholders.
13. The problems in corporate governance are
the problems of execution. There is too much rhetoric. The
real question is how do we handle greed before it destroys
capitalism. For this we need to change our model and move
it away from a box ticking approach. There is still an argument
as to whether more money is destroyed by frauds or strategy.
There are many among business still not convinced about the
moral angle of business. Corporate governance is not just
a legal formality. It is an instrument of business and social
transformation. Our biggest challenge lies in replacing greed
for running the corporation to a zest for making a difference
to the community. Corporate governance, therefore, is an issue
of the heart and not simply statutory compliance. To have
the institution managed in the interest of real owners has
been a challenge at all times. The question will we be able
to meet is effectively even in the 21 st Century?
14. The simplistic view that prevailed in
1990s that business leaders need to focus exclusively on shareholder
value as determined by the share price and that financial
analysts are the best judge of business strategy simply cannot
hold ground today. The ultimate purpose of the corporations
has to be to make a difference to the community. Companies
have to find innovative ways to contribute to broader needs
of society and at the same time improve the revenue and cut
operating costs. The corporations need to find new models
of constructive engagement involving all stakeholders to bring
about change in the society. The business must look for innovative
formats that stimulate systemic thinking and dialogue rather
than posturing. The question is no longer whether the business
has a role in social change but how it should play this role
and corporate governance has to be a catalytic for that change.
Corporate governance has to be based on equity and fairness.
Company's goal should not be the prosperity of a few but many.
Inequality can be the greatest threat for the security of
corporation. People can live in poverty but not injustice.
Indeed, social good has become the greatest competitive differentiator.
These are some of the thoughts that we need to develop in
corporate governance in the conference to formulate a framework
of governance that will help emerging economies achieve both
economic and social transformation.
15. The good news is that the role of business
today is far more encompassing than ever before. Its constituency
is global. So, its mindset is not stuck into parochial grooves
as in the case with national governments. It must recognise
that its success will come from involving everyone and that
it is only the clash of ideas that will sparkle innovations
that will sustain the corporations in the future. For this
the corporations must recognise the impotence of diversity
and dissent. The value today is created not by conformity
but diversity deference but difference.
16. Today it is the economy that drives politics.
It is the business that drives governments. In fact, the political
system has failed to address the human problems of inequity,
poverty and terror. Business run on true principles of transparency,
equity, accountability, integrity and responsibility can make
a difference that could give pride to execution and the true
incentive for driving the corporations. For corporate governance
to succeed we have to go through profound metamorphosis from
inside out. We have to change our ............. of success
of "winner takes all" and "success at all costs"
and develop an inner value systems that prides on ethics,
innovation, equity, legitimacy, transparency, ...................
17. The fines and restitution amount of $1.4
billion imposed on the big US banks were expected to end the
multimillion dollar pay packets some analysts enjoyed in the
bill market, which were justified by the amount of investment
banking business they brought in. But such is the bizarre
world of corporate finance that soon after CSFB had offered
an equity analyst at JP Morgan Chase a package that could
earn him up to $4 million in the first year. Where will this
money come from if not the unholy alliance between the analysts
and underwriters.
18. A revealing statistic was presented to
Congress during the hearings leading up to the Sarbanes-Oxley
Act: the ratio of buy to sell recommendation by securities
analysts employed by brokerage firms rose from 6 to 1 in 1991
to a high of 100 to 1 in 2000. During the 1990s, analysts
appear to have moved from being neutral umpires to becoming
cheerleaders for their firms' underwriting clients.
19. Inequality can be the greatest threat
to corporations. In today's connected world people can live
in poverty but not injustice. Equality and fairness have to
be the cornerstone of corporations. Company's goal should
not be the prosperity of few but many. Indeed social good
has become a corporations differentiator and helps market
capitalisation. There are some of the thoughts that need to
be developed to provide a framework of governance that will
help emerging economies achieve both economic and social transformation.
20. Adam Smith also wrote "The Theory
of Moral Sentiments". While emphasising the importance
of self interest he expected it to be enlightened and moral.
Corporate Governance is to highlight the reputational risk
posed to companies and shareholders by public disclosure of
frauds. Their concern about good behaviour is not because
it is right but because its absence affect the value of their
stock.
21. For making corporate governance work we
have to go through a profound metamorphosis from inside out.
We have to change our metaphors of success from "winner
takes all" and "success at all costs" and develop
an inner value system which prides on ethics, morality, equity,
legitimacy, transparency, diversity and most of all courage
to own genuine failures.
