Wednesday, June 22, 2011

Reflections on Corporate Governance

By Olu Akanmu

Usually, discussions on corporate governance can become too abstract and technical beyond the reach of the ordinary investor and the larger society. It is critical that the language of corporate governance be understood by the ordinary investor who may not necessarily have a finance degree. In this essay, we identify eleven simple issues that determine the quality of corporate governance of a company. We define corporate governance as activities and organization processes that ensure that the organization is governed, directed and managed in the larger interest of shareholders as owners of the company, who have delegated the governance of their investments, in trust to corporation managers and board directors as their agents. Below, in our view are the eleven issues that determine to what extent an organization is governed well.

1. A functioning board that represents or reflects the interests of shareholders in truth and in spirit. A board may exist. It does not however mean that it functions. Functioning of a board goes beyond its periodical sittings. A functioning board will be such that sets policies and defines the larger purpose of the business, approves strategic directions and hold executives accountable for performance. Board members must not own their seats to the benevolence of the executives they are meant to govern, if they would exercise objective judgments in the discharge of their fiduciary duties.

2. The Board must represent real shareholders. Subject to independent directors who will bring other kind of values to the board, the board should consist of individuals who have something fundamental to lose if the company does not do well. In fact, board members should have a bigger stake in the success of the firm than an ordinary investor because of the quantum of their personal investments or that of the institution that they represent.

3. There should be on the board independent directors who have no filial, business or other types of relationships with executives of the firm, that could compromise their judgment or the objective discharge of their fiduciary responsibility. Independent directors must be truly independent. They must not have any pecuniary interest directly or indirectly in their relation to the corporation beyond their sitting allowances, which must be reasonable so as not to compromise the objective discharge of their duties.

4. The degree of transparency in the organization, in its day to day governance, its systems and decision making processes. A culture of organization transparency is critical to sound ethical practice and corporate governance. Low level of organization transparency is usually the umbrella that hides abuse of power and unethical managerial behavior.

5. The degree of candour between the executives of a firm and its staff is usually a good signal of quality of corporate governance. Where staff as internal stakeholders cannot express themselves with candour, it might signal excessive power concentration at the top of the organization which can be potentially abused by leaders of the organization. It leads to the next point. Candour between staff and executives of firms is also a critical ingredient that builds an internal culture of organization transparency. Because, people can ask and feel free to ask, nothing un-towards can be hidden in the organization, ensuring a high degree of corporate governance.

6. Power Concentration and Imperialness. Absolute power corrupts absolutely. It is not for nothing that great democracies have a system of checks and balances. The organization should have a system of check and balances that ensures that power is not concentrated in few people. While a firm should not be run like a democracy, it should also not be run like an imperial kingdom. Imperialness of power leads to abuse of power. So many good men with good intentions have found themselves corrupted by power and end up abusing their office because the organization is not run by a system of checks and balances against excessive power concentration.

7. Is there an open and well implemented conflict of interest policy that ensures that interests of managers, executives and directors are disclosed where they enter into relationships with the company? This will be to ascertain that such business is fair to the firm, the larger shareholders and that such business interests are not in conflict with the fiduciary responsibilities of directors and in the case of mangers, that such interest are not in conflict with their duty as agents of shareholders.

8. Open disclosure of compensation policies and practices. Is the compensation of managers and executives of the firm in tandem with the short and long term value they have created for the company? An important development today is the need to ensure that a significant portion of executive compensation is deferred relative to maturity of their risk decisions especially in financial services. The quality of a loan decision cannot be ascertained fully in its early years. Managers should not be fully paid bonuses on profitability on loans created in early years because the quality of their risk decisions on such business assets may not be fully known until later years.

9. Does the organization have a whistle-blowing policy that encourages the confidential reporting of unethical practice or misconduct among employees, suppliers and customers in their business dealings with the company? Are there clear hierarchies of whistle blowing up to the board level, usually an independent board ethics or audit committee to report such malpractices or misconduct? Are there sufficient safeguard to protect whistleblowers from victimization? The perceived integrity, objectivity ad independence of the reporting hierarchy for whistle-blowing up to the board level is critical for whistle-blowing to work.

10. Activist external regulation and monitoring. It is true that businesses should not be over-regulated. It is also true, especially given recent experiences that without an activist regulator that monitors compliance of business to specified rules of engagement by society, business may not always behave responsibly. While the organization deploys its governance process as described above, an activist regulatory environment can further compel companies to stick to high levels of corporate governance. An activist regulatory environment may also be important where extant laws are lagging behind ethical or governance challenges of corporations, or the institutions to enforce such extant laws are weak leading to potential impunity behavior by companies.

11. Strong market institutions that protect shareholder democracy and reward good corporate governance. It is critical that we build strong market institutions that will reward companies that are governed well through a lower investment risk rating, lower cost of capital and higher valuation. The trend is already emerging on the Nigeria stock exchange. For this trend to become consolidated, we must ensure that we reduce information asymmetries in financial markets, get information that is true and factual to flow more freely among companies, shareholders and potential investors. Improvement in standards of financial reporting through the adoption of the IFRS system will go a long way in correcting information asymmetries in our financial markets.

Olu Akanmu is an executive in the financial service industry and an active public speaker. He has a unique diversity of experience at senior levels in the consumer goods, manufacturing, health-care, social development, telecommunications and financial service industries. He publishes a blog on Strategy and Public Policy on . He can be reached on